Integrys Energy Group

Financial Analyst Meeting - October 11, 2004

Nonregulated Strategies and Synergies - Opportunities and Challenges
by Mark A. Radtke President, WPS Energy Services, Inc. and WPS Power Development, Inc.

{Slide 1} Good afternoon. It is my pleasure to be able to again get together with you to offer insight and discuss with you our competitive nonregulated energy companies WPS Energy Services and WPS Power Development.

{Slide 2} The calendar makes this a particularly special event, as today we gather on the eve of the 10-year anniversary of the formation of WPS Energy Services.

When I look at the current slate of players in this competitive energy space, it strikes me that there are relatively few companies that have developed the experience and demonstrated record of sustained value creation for customers and shareholders alike.

Over the past decade, we have participated in this industry's evolutionary and revolutionary change. We have learned a great deal—some through careful planning and execution, and admittedly, we have earned an advanced degree from the school of hard knocks. The tuition at that school is steep, and we appreciate our shareholders' willingness to support our attendance. Be assured, we have studied hard and learned much.

Today, as I reflect on a decade of service to our customers, I will discuss some of what we have learned and describe how we are putting that education to work. I will review how our business segments, which we call income streams, are using that acquired knowledge to position our company for continued growth. I will also discuss the synergies we expect to capture as we proceed with the recently announced restructuring of WPS Energy Services and WPS Power Development and update you on the pending sale of the Sunbury Power Plant.

{Slide 3} Back in the 90s, we learned that, at least for our company, the business of taking on commodity price risk with the expectation of profiting from rising or falling prices does not provide a sustainable business platform, and it is inconsistent with our shareholder's expectations. The market has shown us that it is a force to be respected. We demonstrate our reverence for the market through our comprehensive risk policy and our ample resourcing of our risk administration group's infrastructure and the active oversight of our Board-approved risk policies.

The lessons of our past are serving us well. Today we excel in the creation of products that bring value to customers under various market conditions. We supply what we commit to sell, and we only sell products that we can profitably source at current market levels. Our hedging and risk management processes are sound. We know that the only thing worse than unmanaged market risk is unknown market risk. We place extraordinary emphasis on maintaining accurate and timely risk books.

Right behind market risk comes credit risk. While our experience with credit related loss has been very good, we recognize the significant potential risk, and place considerable emphasis on having and following sound credit policies and processes.

As with any retail and wholesale concern, this is a thin margin business. We have learned this must translate into an uncompromising focus on operational excellence. Our investment in energy delivery management systems and our emphasis on comprehensive processes minimize the operational losses that can occur in the daily delivery of physical energy products. This operational excellence is a key to realizing the full value of transactions we have entered into to meet our customer's needs.

This business is also very information intense. We know through first-hand experience the value of investing in the computational infrastructure necessary to manage our energy supply and customer deliveries. Our technical platform is built around systems where we control the source code, allowing us to take advantage of commercially available products, while having the ability to modify the systems to meet our changing business needs. Our technical infrastructure also allows customers to have access to their facility specific information via our web site to better manage their energy needs. With all that said, none of this works without a skilled and dedicated workforce. There is truly energy in everything our people do. The average age of members of the WPS Energy leadership team is just under 41 years. This is a group that is in their prime, averaging nearly 18 years of energy industry experience. Supporting the constancy of our organization, over two-thirds of those years have been dedicated to the service of the customers and shareholders of WPS Resources.

{Slide 4} We have used that learning to build a solid foundation for our organization. It is a foundation that is performing well today and poised to capture the opportunities of tomorrow. Customers have enjoyed the benefits of natural gas competition for nearly 20 years. According to a 2003 American Gas Association study, competitive suppliers like WPS Energy Services deliver 90 percent of the natural gas consumed by industrial consumers. Electric competition has not been with us for as long as natural gas—we have been supplying retail electric customers for about five years now. Certainly, the rate of transition from regulated to competitive electric markets has slowed from the early days, and that is a good thing. The current pace is allowing workable market models to develop, enabling efficient retail and wholesale market structures. Even in less developed markets, like Michigan, we have saved customers nearly 90 million dollars since the inception of competition in 2000. And as just one of more than 25 competitive suppliers in Michigan, I think that contribution of economic value speaks well for the efficiency that competition drives into a market. Too much value is being created to put the genie back in the bottle, and it is important to get the marketplace right. We welcome and participate in those efforts.

While our products and services—natural gas and electricity—are well established and absolutely essential to our customers, we have spent this last decade building a new type of organization—one that is demonstrating its ability to dynamically and competitively serve customers' needs, creating value through effective risk management of competitive market forces, without the need for regulatory oversight.

{Slide 5} That is where we have been—the source of our education. Now let me show you how we are putting that schooling to work. Let's take a closer look at the segments we use to manage at WPS Energy Services—we call them Income Streams—and dig a little deeper into the drivers behind them. Our rationale for our Income Stream approach is that is the way we go to market—the way our customers see us. While the underlying natural gas and electric commodity may be the same, the value proposition and service approach of our various income streams can be very different. Each of these segments is important, and we need the organizational focus and leadership to make these business lines the leaders they must be.

When you think about WPS Energy Services, you probably think in terms of our large commercial and industrial customers. That is what I frequently refer to as our core retail energy customer base, and I'll start by looking at our retail electric business targeting the commercial and industrial customer segment. We call it, creatively, our C&I electric income stream.

{Slide 6} The products we offer here are somewhat dependent on the market structure in a given state, but we normally compete against a very well defined rate available to customers in the form of a standard offer or default rate. This rate is generally either fixed for a defined period (as is the case in Maine and Michigan) or it follows a transparent market index as it does in New York and Ontario. When we price a product for offering to a customer, we use their historical usage information and forward contract parameters as principle inputs to our comprehensive pricing models. Our costs are based on market prices for energy and ancillary services currently available in the wholesale market. Fixed price default rates can present a challenge when market prices rise. The "headroom" we have as a retailer, or the difference between the market value of supply and a compelling sales offer to a retail customer, is compressed as market prices rise. As headroom shrinks, the forward contracting activity in our fixed price business declines. As electric market prices decline, headroom expands, and contracting activity really heats up. One way we deal with this irregularity is by contracting with customers for periods of one to three years and not waiting until contract expiration is imminent if market-derived headroom allows for an attractive contract extension opportunity for customers.

For markets like New York where the customer's default option from the utility is spot market prices, the price component of our value proposition includes savings versus historical and projected spot prices, the ability to capture attractive forward prices, and a reduction of the volatility of the dollars customers spend on energy. While not as dramatic as a fixed price default rate, spot markets rates tend to make it less attractive for customers to commit to a fixed price when forward prices are at levels higher than recent history. In that case, we offer customers competitive daily priced electricity and wait out the market to offer higher value products.

Our electric business generates about half of our total gross margin, and our C&I retail electric business accounts for about 60 percent of our electric sales volume, we are really just getting started in terms of market participation. State and federal agencies regularly report statistics on Electric Choice Programs. From those statistics, we know that Michigan is clearly our largest market where we have 31 percent of the Electric Choice market behind Consumers' and Detroit Edison's utility territories. New York is a new retail market for us with the acquisition of Advantage Energy effective July 1 of this year. Advantage holds nearly 11 percent of the market that participates in Electric Choice behind Niagara Mohawk and New York State Electric and Gas. Our southern Maine business serves over 13 percent of the electric choice market. Another way of looking at share is as a percent of the total market. We currently serve less than 5 percent of the total market in any State that we provide service, which we view as a clear opportunity for continued growth.

Overall, we characterize our C&I electric business as contributing about one third of WPS Energy Services' results. While there is more regulatory derived uncertainty in this business line, the opportunity in states open to competition in our targeted region of the northeast quadrant of the United States and adjacent Canadian markets is tremendous. We are confident that the same stakeholders, namely large C&I customers and suppliers, that forged a viable, stable and competitive retail gas market, will have continued success in accomplishing the same for retail electricity. We expect to continue our entry into new markets either through acquisition or internally generated expansion.

{Slide 7} Sticking with our primary customer group, the large commercial and industrial segment, we have our retail natural gas business serving C&I customers.

Within this income stream, we offer products with a range of delivery reliability from interruptible supply, typically for industrial customers who have alternate fuel supply or the ability to curtail consumption, up to firm "utility like" supply that is as reliable as the physical pipe to the facility can provide—often attractive to schools and hospitals. We have pricing options that range from monthly spot market prices or more intermediate managed products that take advantage of forward market instruments to dampen volatility and capture value the market periodically offers, up to the absolute certainty of a fixed price for a fixed volume of delivered supply product. These products do not contain undefined or unhedgable optionality as they did in our early years. Unlike C&I electric, customers in this income stream typically do not view the utility supply as the competitive alternative to beat. They are well informed of the market and the value our various product structures bring to their specific energy needs. As I noted earlier, competitive energy suppliers serve 90 percent of industrial gas volumes in the United States. The C&I gas segment is a great example of how the market has evolved to understand that, while the underlying product is still an energy commodity previously sold by their utility, the pricing and reliability structure of the product is most efficiently provided by suppliers who can respond to individual customer needs without the shackles of regulatory price controls.

Given this more pure market in natural gas compared to electricity, the contracting behavior of customers is less inhibited by artificial price signals. Consequently, we tend to see fairly consistent contracting patterns. The summer months (April through October) are most active. Relatively few customers make supplier changes during the winter period. During the more active summer contracting season, customers tend to commit to a minimum of the upcoming winter season, and more likely the upcoming 12-month period beginning with the November start of the winter season. Increasingly, customers are making longer-term commitments—three years is not uncommon—to ensure they will have access to firm pipeline capacity that is becoming increasingly scarce as demand for natural gas outgrows the pipeline infrastructure available to serve some local markets.

{Slide 8} The primary markets of this income stream include Wisconsin, Michigan, Ohio, Illinois, Ontario and Quebec. We have a lot of room to grow in Ohio and Illinois without additional infrastructure investment, and we are currently working on introducing a natural gas product to our newly acquired presence in the state of New York.

While we compete with other non-utility suppliers in this segment on the basis of product suitability, price competitiveness, and service, we have found customers to be very likely to extend their contract with WPS Energy Services. For our U.S. customers, we have served 83 percent of delivered volumes for more than 2 years and 45 percent for more than 4 years.

The commercial and industrial natural gas marketplace is very stable. The operating results of the business have been equally consistent over the past few years, although accounting requirements do create non-cash margin impacts depending on market conditions. The most significant impact is driven by the inventory accounting requirements of natural gas in storage. When we place natural gas in storage, we do it to capture a seasonal market spread and assure peak requirements deliverability during the winter season. In keeping with our risk philosophy, we secure the seasonal spread at the time we enter into the transaction by selling forward contracts that mirror the storage withdrawal schedule that justified the storage injection in the first place. There is an accounting standard applied to natural gas in storage that you must be aware of and keep in mind when looking at our natural gas business. We proceed into the winter season with more gas in storage than any other time of the year, and that storage is financially hedged. These hedges are designated as fair value hedges. Under FASB 133 fair value accounting method, the natural gas in storage must be valued at the current spot price at the end of a reporting period. This spot price is the cash price for next day deliveries, not the month we have hedged to withdraw the natural gas from storage. The fundamental problem occurs in the fact that we will have to "mark down or up" our inventory to this spot market although we will recover the entire "change" as we proceed with our planned withdrawals of natural gas in the winter. As the spot market price at the end of a reporting period converges on the future hedged delivery periods, the gap recorded to the income statement becomes less significant and will be completely eliminated when the natural gas is entirely withdrawn from storage.

Our C&I natural gas business contributes nearly 20 percent of WPS Energy Services' results. Our growth rate has been consistent, and we view there to be virtually no regulatory risk with respect to a sustained efficient natural gas marketplace. We expect to continue our entry into new states either through acquisition or internally generated expansion.

{Slide 9} Now I'd like to move away from our large commercial and industrial customers, and discuss how we approach residential and small commercial customers. We do that in two different ways. The first approach is through our aggregation income stream. Aggregation includes municipal aggregation like the construct in Ohio that enables municipal entities to act as the custodian of customers who choose not to select a competitive supplier, and standard offer service like we serve in northern Maine. In both of these cases, you have an element of individual customer account management, but the "sale" if you will, is through an entity that has the authority to act on behalf of a large group of customers in aggregate.

This business varies dramatically from market to market depending on the regulatory construct, and includes both electricity and natural gas. At the end of the day, aggregation is a great way to bring the benefits of competition to smaller customers that might otherwise be difficult for a competitive supplier to serve because of the acquisition cost of traditional marketing. Make no mistake about it though; this is very much a retail business. We work hard to provide customer care as if the customers made their own decision to receive service from WPS Energy Services. Our aggregation customers receive information on the energy products we deliver to them, and they have access to us through our 24/7 multilingual call center and interactive web site. Although we do not invoice customers directly, our customer information systems track each customer account and interface electronically with the distribution utility on usage, billing, and payment information. And, each of our aggregation markets is managed by local energy experts who are knowledgeable of the dynamics and nuances of their market.

The duration of aggregation contracts vary, depending on regulations and the objectives of program coordinators. Our Ohio municipal aggregation contracts are two to five years in length, with re-pricing provisions every two years in accordance with Ohio regulations. Those contracts are currently set to expire at the end of 2005, and the renewability is a function of the 2006 and beyond market structure that is in the process of being defined. Our initial two-year natural gas aggregation contract has been extended an additional two years, setting its expiration in June of 2006. We expect to renew the contract at that time. In Maine, our standard offer aggregation contracts extend through the end of 2006, and we expect those customer requirements to be re bid as they have been since competitive market inception in 2000. We are in our third term of serving standard offer loads in northern Maine.

In all cases, these aggregation contracts are for the full requirements needs of our customers. This requirement is a formidable risk management task and creates something of a barrier to entry as many less sophisticated shops or those accustomed to wholesale market risk management are less likely to be able to serve this segment profitably.

Aggregation contributes just under 15 percent of WPS Energy Services results. The marketplace is developing with an increasingly clear consensus that this construct is a viable means to bring the benefits of competition to small customers in the near-term, while the lengthy road to true residential competition is paved. Today, through aggregation, we serve about 150,000 customers, and we continue to work with stakeholders to mold workable models in markets where there is a genuine interest in the benefits of aggregation.

{Slide 10} A close cousin to aggregation is our direct mass markets income stream. Mass markets and aggregation leverage the same organizational capabilities in terms of efficient small customer care and full requirements supply management. However, direct mass markets persuade customers to raise their hand and make a deliberate decision to choose WPS Energy Services as their competitive energy supplier.

This persuasion is largely a function of allowing the pricing value of our products and the reputation of our service to speak for itself. Our marketing budgets are modest, as we need to be diligent to not allow our acquisition spend to exceed the projected profitability of the business.

Today, direct mass markets contributes a little more than 5 percent of WPS Energy Services results. We drive cost out and effectiveness into this income stream through both the use of web-based automated enrollments and online customer service, and through our 24/7 call center services. Credit risk from end-user non-payment is virtually eliminated through various utility receivable agreements that guaranty payment to WPS Energy Services. However, handling the questions and concerns of our 85,000+ customers efficiently is essential to maintaining our core value of service to our customers. To that end, we leverage our internally developed customer information system to effortlessly respond to customer inquiries as well as to manage automated account information exchange with local distribution utility companies.

{Slide 11} Rounding out our retail product and service offerings is our Energy Management Services income stream. Our EMS service offerings are designed to meet the needs of corporations with multiple production facilities across the U.S. and Canada. We establish retainer relationships with our EMS customers and become responsible for helping customers manage their energy procurement, expenditures, and risk. Our service offerings are available independent of WPS Energy Services as the physical energy supplier.

Customer benefits include having a single point of contact for comprehensive energy issues across all facilities, improved reporting and budgeting of their energy spend, access to our extensive energy expertise, while we act as a watchdog for their energy procurement process typically resulting in a 10 to 15 percent savings in their managed energy spend.

Today, this is basically a salary paying business not directly contributing to our bottom line. However, we continue to build this business because of the synergy benefits to our physical energy business, and we see it contributing to our results with each additional account. The relationships with EMS customers are truly at the strategic level, and we will often provide physical energy delivery through our C&I income streams to facilities within our footprint of capability.

{Slide 12} Shifting our focus on another type of customer segment within our portfolio, I would like to talk about our wholesale natural gas income stream.

Wholesale natural gas includes purchases and sales to customers that are not transacting the natural gas for their own consumption or power generators converting the gas into electricity. Customers include producers, utilities, pipeline and storage field operators, and other marketing companies. Many are well known, established participants in the market like BP, Sempra, Encana, ConocoPhillips, Cargill, and Union Gas. Our product suite starts with commodity sales and service, which is the high volume thin margin sale and servicing of transparent commodity products. I believe this is what people tend to think of when they think about the wholesale energy business. But this commodity product is the entrée into a relationship with a customer. Through the servicing of their commodity needs, we gain insight into their more complex energy related challenges. With this understanding, we can offer products that are specifically structured to achieve a delivery profile the customer desires. These structured products typically include flexibility the customer values and is willing to pay for. Our expertise in accumulating and pricing optionality, coupled with the innovation and hustle to close deals, all under an umbrella of consistent, reliable, and trusted behavior, which creates our competitive advantage in this segment.

Our strong credit rating puts us in a position of strength, enabling us to be steadfast on our counterparty credit standards. We frequently have multiple transactions in place with a given customer. The term of an individual transaction can span from just a single day to multiple years. Because contracts and credit are, for the most part, standardized in the industry and executed prior to any contemplated business, frequent transactions can be completed quickly. Like our retail business, sustainability is a function of building on our reputation for being able to quickly and reliably address a customer's energy needs.

Beyond the contribution of more than 15 percent of our results, this segment of our business has a strong history of profitability including more than 60 consecutive months of positive margin contribution, further emphasizing a solid foundation of customer relationships and an avoidance of sporadic "home runs" offsetting a lot of loss transactions. Wholesale natural gas also has a strong synergy with our retail business providing competitive market based supply, as well as fueling the natural gas requirements of our generation fleet.

{Slide 13} Wholesale Electricity has a lot of similarities to natural gas. Customers include generators, utilities, co-ops and municipalities, and other marketing companies. Our products include commodity sales and service, and structured products frequently being option based.

One of the greatest differences between our wholesale natural gas and electricity units is the greater responsibility our electric group has for managing the consolidated market risk associated with our generation and customer portfolios. Because of the consumption flexibility our customers are extended under our retail supply contracts, we need to actively manage our retail supply portfolios to maximize the economic value of the embedded options in our products. Generators are likewise significant sources of optionality or exercisers of optionality when they have an operational problem. Because customers and generators typically do not exercise that optionality in an economically optimal manner, we are able to capture significant value by dynamically hedging in response to changing portfolio behavior.

Some people might refer to this as trading around an asset, but that may be a dangerously gross characterization. Trading around an asset can be done in a manner where commodity risk exposure is actually increased. That is not what we do. We do have Value at Risk or VaR, but since the beginning of this year our VaR is about one third of what it had been under less active portfolio management. And, our VaR tends to be biased to owning options, improving our upside potential while providing protection against downside market moves.

In addition to reducing our Value at Risk and improving the earnings level and dependability of our retail electric segments, the wholesale electric income stream has contributed just under 10 percent of our results in the past 12 months, while the income stream was truly commercially active for the most recent 6 of those 12 months. Clearly, we are just getting started here, and we see originated wholesale electric business followed-up with active management of the portfolio to be a significant source of growth in the future.

{Slide 14} Turning our attention now to our generation fleet owned and operated by WPS Power Development, I would like to take you on a very quick tour of our fuel diverse generation portfolio, which totals about 900 megawatts of generation capacity.

First stop is our coal facilities, including Sunbury and Stoneman. Sunbury is the larger station at 425MW, and normally clears the PJM west energy market it is located in. We'll talk more about Sunbury in just a minute. Stoneman is a smaller station at 53 megawatts in southwest Wisconsin that serves the capacity markets more so than the energy markets, and is contracted into 2006.

{Slide 15} We have two solid fuel fluidized bed units in Niagara and Westwood. The great thing about these units is the work our engineers and operations groups have done to reduce fuel costs by blending lower grade coal, tire derived fuel and waste wood into the fuel stream. Both of these units dispatch competitively in their respective markets New York Zone A, and PJM West as base load generators.

{Slide 16} We have three natural gas generating stations. The two combined cycle units located in New York are about 100 megawatts each. These units dispatch very little given the current spark spread, but certainly perform solidly toward the peaking end of the dispatch stack. The fuel economy is reasonable, and all of these units are straightforward from an environmental perspective. Our 50-megawatt Combined Locks Energy Center is a thermally matched cogeneration facility in eastern Wisconsin, which has long-term contracts for both the steam and electricity it produces.

{Slide 17} In Maine, we have a package of generating units that collectively provide about 20 percent of the requirements for the standard offer service, which we operate in our aggregation income stream. The vast majority of the energy is produced at the 34-megawatt, hydroelectric Tinker station. This generation is a great example of the synergy available between WPS Power Development and WPS Energy Services, and we are interested in strengthening our generation position in the Maine market.

{Slide 18} As you know, we announced a year ago the sale of our Sunbury Station to Dequesne Power for approximately 120 million dollars. I won't repeat the details of our September 30, 2004 8-K filing, but suffice it to say the completion of that transaction is seriously in question. We were, and continue to be prepared to divest of this non-strategic asset, and expect it will remain in discontinued operations. We have retained financial advisors led by Lazard, to assist with the transaction process. In the mean time, we are creating plans to maintain operations without requiring new cash infusions. While a re-negotiated sale to Duquesne continues to be one of the options we consider, we are also entertaining interest from other potential buyers. Frankly, the market for coal-fired generation in PJM is better today that it was a year ago, and we are reasonably confident that we will have a definitive plan, if not a completed agreement, by the end of the year.

{Slide 19} Over the past year, we have been working to bring WPS Energy Services and WPS—Power Development closer together. This has hardwired the market valuations WPS Energy Services sees in the marketplace into asset acquisition and divestiture analysis. In addition, we have put tolling contracts in place for the uncontracted output of WPS Power Development's generation. This tolling arrangement keeps Energy Services focused on managing the market risk and capitalizing on the market value of Power Development's generation, while Power Development is squarely focused on operational excellence at the plants, and prudently driving costs out of the power generation process. While uncontracted merchant generation is a challenge in the current market, we do see value in owning or controlling contracted generation or generation that supports our marketing business. To that end, we continue to search for opportunities to adjust our generating fleet—both additions and divestitures—that deliver value in both the near term and long term.

{Slide 20} Tomorrow, we celebrate our ten-year anniversary. It could be said that accomplishing this feat in an industry that has gone through such an apocalyptic transformation is remarkable. But, our record of sustained growth and profitability is no accident.

Over the past ten years, we have assembled a talented and dedicated group of employees that understand you can't be successful here if it's just a job. We know that in this business, "good enough" simply isn't. Employees have internalized our corporate vision, mission, values, and beliefs. They have a passion for excellence. Maybe more importantly, our employees have a deep-rooted sense of integrity and ethics.

We are here, because we have developed the systems and infrastructure that automate our "best practices" and seamlessly share information with our customers. Shared access to data allows us to create a true sense of partnership with our customers.

We are here, because we have worked to develop deep and lasting relationships with customers. We work to understand their needs and continually develop products that are responsive to those needs. Perhaps that's the reason, our industrial customers again rated us among the six top North American gas marketers in Mastio & Company's annual independent "Customer Satisfaction Study."

And we're here because our shareholders have shown the patience to let us get it right. With that well-founded support, we are continuing to grow our geographical capability, improving the efficiency of our operations, and increasing our profitability.

As we graduate to our next decade of learning and achievement, we look to the future with confidence and optimism. That optimism has been forged by a track record of success and, yes, learning from failures. With our hard earned knowledge, and an optimistic heart, we are truly "People Creating a World Class Energy Company."

Now, Joe O'Leary will discuss the financial side of the picture. Joe…