Citigroup UBS Investment Bank JPMorgan

Transcription

1 NEW ISSUE-BOOK-ENTRY ONLY Ratings: See RATINGS herein In the opinion of Preston Gates & Ellis LLP, Bond Counsel, assuming compliance with certain covenants of the District, interest on the 2006A Bonds is excludable from gross income of the owners of the 2006A Bonds for federal income tax purposes under existing law. Interest on the 2006A Bonds is not an item of tax preference for purposes of either individual or corporate alternative minimum tax. Interest on the 2006A Bonds may be indirectly subject to corporate alternative minimum tax and certain other taxes imposed on certain corporations. See TAX MATTERS The 2006A Bonds herein for a discussion of the opinion of Bond Counsel. In the opinion of Bond Counsel, assuming compliance by the District with certain covenants, interest on the 2006B Bonds is excludable from the gross income of the owners of the 2006B Bonds for federal income tax purposes under existing law except with respect to any period during which a 2006B Bond is held by a substantial user of the facilities refinanced by the 2006B Bonds or a related person to such substantial user, within the meaning of Section 147 of the Code. Interest on the 2006B Bonds is an item of tax preference for purposes of computing the federal alternative minimum tax imposed on individuals and corporations. See TAX MATTERS The 2006B Bonds herein for a discussion of the opinion of Bond Counsel. Interest on the 2006Z Bonds is included in gross income for federal income tax purposes. Certain information regarding the federal income tax treatment of the 2006Z Bonds is set forth under TAX MATTERS The 2006Z Bonds. PUBLIC UTILITY DISTRICT NO. 2 OF GRANT COUNTY, WASHINGTON Wanapum Hydroelectric Development Revenue and Refunding Bonds, 2006 $71,395,000 SERIES A (Not Subject to AMT) Bonds Dated: Date of Delivery $18,190,000 SERIES B (Subject to AMT) $96,845,000 SERIES Z (Taxable) Due: January 1, as shown on the inside cover The Bonds are issuable only as fully registered bonds without coupons and, when issued, will be registered in the name of Cede & Co., as nominee of The Depository Trust Company ( DTC ), New York, New York. DTC will act as securities depository of the Bonds. Individual purchases will be made in book entry form only, in the principal amount of $5,000 and integral multiples thereof. Purchasers will not receive certificates representing their interest in the Bonds purchased. The fiscal agency of the State of Washington in New York, New York, currently The Bank of New York, has been appointed as the Paying Agent and Registrar for the Bonds. The Bank of New York Trust Company, N.A., Seattle, Washington, has been appointed as Trustee for the Bonds. Interest on the Bonds, first payable on July 1, 2007, and thereafter semiannually thereafter on January 1 and July 1 of each year, and principal of the Bonds are payable by the Paying Agent to DTC or its nominee, which is obligated to remit such principal and interest to its broker dealer Participants, which are obligated in turn to remit such principal and interest to the Beneficial Owners of the Bonds, as described in APPENDIX F BOOK-ENTRY SYSTEM. The Bonds are subject to optional and mandatory redemption prior to maturity. See DESCRIPTION OF THE BONDS. The Bonds are being issued by the District to finance improvements to the Wanapum Development and to refund certain outstanding bonds of the Wanapum Development. See PURPOSE AND APPLICATION OF BOND PROCEEDS. The Bonds are payable from and secured by a lien and charge on the Gross Revenues of the Wanapum Development, after payment of Operating Expenses, and on certain other money, funds and accounts of the Wanapum Development. The Bonds are issued on a parity with Parity Bonds outstanding in the principal amount of $283,600,000 (of which $28,275,000 are being refunded with proceeds of the Bonds) and any Future Parity Bonds. The District has covenanted not to issue any bonds with a lien senior to the Parity Bonds. See SECURITY FOR THE PARITY BONDS. Once certain bonds are retired, the District may consolidate the Priest Rapids and Wanapum Developments. See SECURITY FOR THE PARITY BONDS Potential Consolidation of Developments. Payment of the principal of and interest on the Bonds when due will be insured by a financial guaranty insurance policy to be issued by MBIA Insurance Corporation simultaneously with the delivery of the Bonds. See BOND INSURANCE. THE BONDS ARE SPECIAL LIMITED OBLIGATIONS OF THE DISTRICT AND ARE NOT OBLIGATIONS OF THE STATE OF WASHINGTON OR ANY POLITICAL SUBDIVISION THEREOF OTHER THAN THE DISTRICT, AND NEITHER THE FULL FAITH AND CREDIT OF THE DISTRICT NOR THE TAXING POWER OF THE DISTRICT IS PLEDGED TO THE PAYMENT THEREOF. The maturity schedules for the Bonds are set forth on the inside of this cover page. This cover page is not intended to be a summary of the terms of, or security for, the Bonds. Investors are advised to read the entire Official Statement to obtain information essential to the making of an informed investment decision. The Bonds are offered when, as and if issued and received by the Underwriters, subject to the approval of legality by Preston Gates & Ellis LLP, Seattle, Washington, Bond Counsel, and certain other conditions. Certain legal matters will be passed upon for the Underwriters by their counsel, Orrick, Herrington & Sutcliffe LLP, Seattle, Washington. The Bonds are expected to be delivered on or about December 13, 2006, through the facilities of DTC in New York, New York, by Fast Automated Securities Transfer. Citigroup UBS Investment Bank JPMorgan Dated: November 30, 2006

2 MATURITY SCHEDULE, INTEREST RATES, YIELDS AND CUSIP NUMBERS Maturity (January 1) Amount Interest Rate Initial Reoffering Yield $71,395, A Bonds (Not subject to AMT) CUSIP No. Maturity (January 1) Amount Interest Rate Initial Reoffering Price or Yield 2008 $ 530, % 3.60% TQ $ 2,010, % 3.70% TW , TR ,600, TX ,700, TS ,690, TY ,735, TT ,765, TZ ,815, TU ,620, * UA ,910, TV4 $2,335, % Term Bonds due January 1, 2020 at a yield of 3.97%* CUSIP No.** UB6 $2,570, % Term Bonds due January 1, 2022 at a yield of 4.04%* CUSIP No.** UC4 $2,835, % Term Bonds due January 1, 2024 at a yield of 4.07%* CUSIP No.** UD2 $3,125, % Term Bonds due January 1, 2026 at a yield of 4.09%* CUSIP No.** UE0 $11,435, % Term Bonds due January 1, 2032 at a yield of 4.10%* CUSIP No.** UF7 $12,440, % Term Bonds due January 1, 2037 at a yield of 4.13%* CUSIP No.** UG5 $19,560, % Term Bonds due January 1, 2043 at a yield of 4.20%* CUSIP No.** UH3 CUSIP No.** Maturity (January 1) Amount Interest Rate Initial Reoffering Yield $18,190, B Bonds (Subject to AMT) CUSIP No. Maturity (January 1) Amount Interest Rate Initial Reoffering Price or Yield 2009 $ 25, % 3.83% UJ $ 1,740, % 3.92% UP ,425, UK , UQ ,500, UL , UR ,575, UM , US ,645, UN0 $1,275, % Term Bonds due January 1, 2020 at a yield of 4.17%* CUSIP No.** UT7 $1,490, % Term Bonds due January 1, 2023 at a yield of 4.23%* CUSIP No.** UU4 $1,715, % Term Bonds due January 1, 2026 at a yield of 4.28%* CUSIP No.** UV2 $3,425, % Term Bonds due January 1, 2031 at a yield of 4.55% CUSIP No.** UW0 CUSIP No.** $96,845, Z Bonds (Taxable) $13,440, % Term Bonds due January 1, 2017 at a yield of 5.15% CUSIP No.** UX8 $53,275, % Term Bonds due January 1, 2037 at a yield of 5.33% CUSIP No.** UY6 $30,130, % Term Bonds due January 1, 2043 at a yield of 5.42% CUSIP No.** UZ3 * Priced to the par call date of January 1, ** The CUSIP numbers are included for convenience of the holders and potential holders of the Bonds. No assurance can be given that the CUSIP numbers for the Bonds will remain the same after the date of issuance and delivery of the Bonds.

3 No dealer, broker, salesperson, or any other person has been authorized by the District or the Underwriters to give any information or to make any representation, other than the information and representations contained herein, in connection with the offering of the Bonds and, if given or made, such information or representations must not be relied upon as having been authorized by any of the foregoing. This Official Statement does not constitute an offer to sell or solicitation of an offer to buy any of the Bonds in any jurisdiction in which it is unlawful to make such offer, solicitation or sale. The information set forth herein has been obtained from the District and other sources that are believed to be reliable, but it is not guaranteed as to accuracy or completeness and is not to be construed as a representation by the Underwriters. The information herein is subject to change without notice, and neither the delivery of this Official Statement nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the District since the date hereof. The Underwriters have provided the following sentence for inclusion in this Official Statement. The Underwriters have reviewed the information in this Official Statement in accordance with, and as part of, their responsibilities to investors under the federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriters do not guarantee the accuracy or completeness of such information. In connection with the offering of the Bonds, the Underwriters may overallot or effect transactions which stabilize or maintain the market price of such Bonds at levels above that which might otherwise prevail in the open market. Such stabilizing, if commenced, may be discontinued at any time. The achievement of certain results or other expectations contained in forward-looking statements in this Official Statement involves known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements described to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The District does not plan to issue any updates or revisions to those forward-looking statements if or when their expectations or events, conditions or circumstances on which such statements are based occur.

4 PUBLIC UTILITY DISTRICT NO. 2 OF GRANT COUNTY 30 C Street S.W. Ephrata, Washington (509) Commissioners Randall M. Allred... President Greg P. Hansen...Vice President Thomas W. Flint...Secretary Vera B. Claussen... Assistant Secretary William E. Bjork, Jr....Commissioner Senior Management Tim Culbertson... General Manager Joseph A. Lukas...Assistant General Manager Nickolai A. Gerde... Treasurer/Controller Ray A. Foianini...Attorney Leon W. Hoepner... Hydro Director Dawn M. Woodward... Hydro Director Stephen R. Brown... Director of Natural Resources William G. Dearing... Director of Power Management Jim A. Bunch... Director of Accounting, Finance and Strategic Planning Anthony J. Webb...Director of Customer Service Lawrence L. Jones... Director of Information Technology Michael V. Woywod...Director of Human Resources and Support Services Kim K Justice... Auditor Bond Counsel Preston Gates & Ellis LLP Seattle, Washington Bond Trustee The Bank of New York Trust Company, N.A. Seattle, Washington -i-

5 INTRODUCTION... 1 PURPOSE AND APPLICATION OF BOND PROCEEDS... 2 Purpose of the Bonds... 2 Application of the Bond Proceeds... 3 SECURITY FOR THE PARITY BONDS... 3 Pledge of Revenues... 3 Obligations of the Electric System... 4 Potential Consolidation of Developments... 4 Flow of Funds... 5 Limited Obligations... 5 Rate Covenants... 6 Reserve Account... 6 Supplemental Renewal and Contingency Fund... 8 Additional Parity Bonds... 8 Derivative Products... 8 Contingent Payment Obligations... 9 No Acceleration Upon Default... 9 Investment of Funds... 9 BOND INSURANCE... 9 The MBIA Insurance Corporation Insurance Policy... 9 MBIA Insurance Corporation Regulation Financial Strength Ratings of MBIA MBIA Financial Information Incorporation of Certain Documents by Reference DESCRIPTION OF THE BONDS General Terms Termination of Book-Entry Transfer System Transfer and Exchange Optional Redemption Mandatory Redemption Partial Redemption Notice of Redemption Open Market Purchases THE DISTRICT General The Priest Rapids Development Management and Administration District Employees and Retirement Plans and Other Post-Employment Benefits Insurance Strategic Planning Investments Hazardous Waste Issues Security Efforts at the District THE WANAPUM DEVELOPMENT Description Wanapum Development Output and Power Sales Contracts Coordination Agreements Transmission of Power from Wanapum Development TABLE OF CONTENTS Page Page Rehabilitation Program Estimated Capital and Financing Requirements Operating Results License Status Regulatory Proceedings Affecting the Developments Debt Service Requirements for Wanapum Development THE ELECTRIC SYSTEM...41 Retail Energy Sales and Customers Power Supply Management and Power Marketing Electric Rates The Electric System s Power Supply Telecommunications Borrowings of the District Electric System Operating Results Management s Discussion of Results Operating Results Capital Requirements ECONOMIC AND DEMOGRAPHIC INFORMATION...58 LITIGATION...61 INITIATIVE AND REFERENDUM...62 Current State Initative LIMITATIONS ON REMEDIES...62 TAX MATTERS...62 The 2006A Bonds The 2006B Bonds The 2006Z Bonds Pending Audit CERTAIN LEGAL MATTERS...67 UNDERWRITING...67 CONTINUING DISCLOSURE...67 Prior Compliance with Continuing Disclosure Undertakings RATINGS...70 INDEPENDENT ACCOUNTANTS...70 MISCELLANEOUS...70 APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE POWER CONTRACTS APPENDIX C AUDITED FINANCIAL STATEMENTS OF THE WANAPUM DEVELOPMENT AND ELECTRIC SYSTEM AS OF DECEMBER 31, 2005 AND 2004 APPENDIX D DESCRIPTION OF MAJOR POWER PURCHASERS (CURRENT OBLIGATED PERSONS) APPENDIX E PROPOSED FORM OF OPINION OF BOND COUNSEL APPENDIX F BOOK-ENTRY SYSTEM APPENDIX G SPECIMEN FORM OF BOND INSURANCE POLICY -ii-

6 LIST OF TABLES Table 1 WANAPUM DEVELOPMENT HISTORICAL ENERGY PRODUCTION...26 Table 2 PARTICIPATION IN THE WANAPUM DEVELOPMENT OUTPUT...27 Table 3 WANAPUM DEVELOPMENT HISTORICAL ENERGY SALES...29 Table 4 WANAPUM DEVELOPMENT FORECAST RENEWAL AND REHABILITATION PROGRAMS EXPENDITURES...32 Table 5 WANAPUM DEVELOPMENT OPERATING RESULTS...34 Table 6 WANAPUM DEVELOPMENT TOTAL DEBT SERVICE REQUIREMENTS...40 Table 7 ELECTRIC SYSTEM 2005 RETAIL CUSTOMERS, ENERGY SALES AND REVENUES...41 Table 8 ELECTRIC SYSTEM LARGEST CUSTOMERS...42 Table 9 ELECTRIC SYSTEM RETAIL CUSTOMERS, ENERGY SALES, AND REVENUES...43 Table 10 ELECTRIC SYSTEM WHOLESALE ENERGY SALES...45 Table 11 ELECTRIC SYSTEM MONTHLY ELECTRIC BILLS COMPARISON...46 Table 12 ELECTRIC SYSTEM RECENT RETAIL RATE INCREASES...47 Table 13 GRANT COUNTY PUD SUMMARY OF OUTSTANDING LONG-TERM DEBT...53 Table 14 ELECTRIC SYSTEM HISTORICAL OPERATING RESULTS...54 Table 15 ELECTRIC SYSTEM HISTORICAL ENERGY REQUIREMENTS, RESOURCES AND POWER COSTS...56 Table 16 ELECTRIC SYSTEM PROJECTED CAPITAL IMPROVEMENTS PROGRAM Table 17 GRANT COUNTY SELECTED ECONOMIC INDICATORS...59 Table 18 GRANT COUNTY MAJOR TAXPAYERS...59 Table 19 GRANT COUNTY MAJOR EMPLOYERS...60 Table 20 GRANT COUNTY RESIDENT CIVILIAN LABOR FORCE AND EMPLOYMENT...60 Table 21 MOSES LAKE MSA (GRANT COUNTY) NONAGRICULTURAL WAGE AND SALARY EMPLOYMENT...61 Page -iii-

7 PUBLIC UTILITY DISTRICT NO. 2 OF GRANT COUNTY, WASHINGTON OFFICIAL STATEMENT RELATING TO $71,395,000 WANAPUM HYDROELECTRIC DEVELOPMENT REVENUE AND REFUNDING BONDS, 2006 SERIES A (NOT SUBJECT TO AMT) $18,190,000 WANAPUM HYDROELECTRIC DEVELOPMENT REVENUE REFUNDING BONDS, 2006 SERIES B (SUBJECT TO AMT) $96,845,000 WANAPUM HYDROELECTRIC DEVELOPMENT REVENUE AND REFUNDING BONDS, 2006 SERIES Z (TAXABLE) INTRODUCTION The purpose of this Official Statement, which includes the cover page and appendices, is to set forth information concerning Public Utility District No. 2 of Grant County, Washington (the District or Grant County PUD ), the District s Wanapum Hydroelectric Development (the Wanapum Development ), certain of the purchasers of the output of the Wanapum Development other than the District (the Power Purchasers ), the District s electric transmission, distribution, telecommunications, and generating system (the Electric System ), and the District s $71,395,000 aggregate principal amount of Wanapum Hydroelectric Development Revenue and Refunding Bonds, Series 2006A (the 2006A Bonds ), $18,190,000 aggregate principal amount of Wanapum Hydroelectric Development Revenue Refunding Bonds, Series 2006B (the 2006B Bonds ), and $96,845,000 aggregate principal amount of Wanapum Hydroelectric Development Revenue and Refunding Bonds, Series 2006Z (the 2006Z Bonds, and together with the 2006A Bonds and 2006B Bonds, the Bonds ). Capitalized terms used herein and not defined have the meanings ascribed thereto in APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS. The Bonds are to be issued pursuant to Chapter 1 of the Laws of Washington, 1931, as amended and supplemented, constituting Title 54 of the Revised Code of Washington and Chs and of the Revised Code of Washington (collectively, the Enabling Act ). The Bonds are authorized by Resolution No of the District, adopted November 30, 2006 (the Bond Resolution ). The District has previously issued $28,965,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Bonds, 1996A and B (the 1996 Bonds ), $18,547,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, Series 1997A, B and E (the 1997A, B and E Bonds ), $8,690,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, Series 1997C and D (the 1997C and D Bonds and together with the 1997A, B and E Bonds, the 1997 Bonds ), $31,620,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, Series 1998A (the 1998 Bonds ), $17,837,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, Series 1999A, B and C (the 1999A, B and C Bonds ), $18,750,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, 1999 Series D (the 1999D Bonds and together with the 1999A, B and C Bonds, the 1999 Bonds ), $17,165,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, Series 2001B and C (the 2001 Bonds ), $57,280,000 principal amount of its Wanapum Hydroelectric Development Second Series Revenue Bonds, Series 2003A, B and Z (the 2003 Bonds ), and $127,780,000 principal amount of its Wanapum Hydroelectric Development Revenue and Refunding Bonds, 2005A, B and Z (the 2005 Bonds ). The 1996 Bonds, 1997 Bonds, 1998 Bonds, 1999 Bonds, 2001 Bonds, 2003 Bonds and 2005 Bonds are referred to herein as the Outstanding

8 Parity Bonds, and the Outstanding Parity Bonds, the Bonds and any other bonds hereafter issued on a parity with such bonds are collectively referred to herein as the Parity Bonds. The Outstanding Parity Bonds are currently outstanding in the aggregate principal amount of $283,600,000. The pledges and covenants and other terms and provisions of the Bond Resolution are substantially the same as those of Resolution Nos. 7017, 7080, 7079, 7254, 7268, 7487, 7604, and 7777 authorizing the issuance of the Outstanding Parity Bonds (collectively with the Bond Resolution, the Bond Resolutions ). The Parity Bonds are secured by a lien and charge on the Gross Revenues, after payment of Operating Expenses, and on certain other money, funds and accounts of the Wanapum Development. See SECURITY FOR THE PARITY BONDS. Once the 1996 Bonds, 1997 Bonds, 1998 Bonds, 1999 Bonds and bonds of the Priest Rapids Development issued prior to 2000 are no longer Outstanding, the District may combine the Wanapum Development and the Priest Rapids Development into one system for financing and accounting purposes. In such event, the Parity Bonds and bonds issued to fund the Priest Rapids Development would be paid from revenues of the combined system. See SECURITY FOR THE PARITY BONDS Potential Consolidation of Developments. Purpose of the Bonds PURPOSE AND APPLICATION OF BOND PROCEEDS The Bonds are being issued to finance improvements at the Wanapum Development, refund certain outstanding bonds of the Wanapum Development, and pay costs of issuance of the Bonds. The net proceeds of the 2006B Bonds and 2006Z Bonds will be used to finance the portion of the costs of such improvements allocable to the use of the Wanapum Development output by the investor-owned utilities and other private purchasers and to refund certain outstanding bonds of the Wanapum Development, as described below. The bonds to be refunded with the proceeds of the Bonds are identified below (the Refunded Bonds ). Refunded Bonds Series Principal Amount Interest Rates Maturities Redemption Date 1996B $ 10,885, % /1/ % 1997A 2,620, /1/ B 4,720, /1/ C 1,840, , /1/ D 3,160, , /1/ A 5,050, /1/ A portion of the net proceeds from the sale of the Bonds will be deposited in the 2006 Refunding Account (the Refunding Account ) and used to purchase Escrow Obligations (as defined below) to be held by The Bank of New York Trust Company, N.A. (the Escrow Agent ) under an escrow agreement (the Escrow Agreement ), dated the date of delivery of the Bonds, between the District and the Escrow Agent. Funds will be irrevocably deposited in the Refunding Account and will be used to purchase direct, noncallable, obligations of the United States of America (the Escrow Obligations ). The Escrow Obligations will mature at such times and pay interest in such amounts so that, with other available funds held by the Escrow Agent under the Escrow Agreement, sufficient money will be available to pay the interest on the Refunded Bonds coming due on and prior to their respective redemption dates and to redeem and retire the Refunded Bonds on the respective redemption dates set forth above. Since all payments of principal of and interest on the Refunded Bonds will thereafter be provided for from money and securities on deposit with the Escrow Agent under the Escrow Agreement, the liens, pledges and covenants of the Refunded Bonds will terminate and be discharged and released. An independent verification shall be obtained from Causey Demgen & Moore Inc. stating that the Escrow Obligations held by the Escrow Agent and the interest to be earned thereon, together with any money held by the Price -2-

9 Escrow Agent, shall be sufficient to make all such interest payments on the Refunded Bonds to pay the principal of the Refunded Bonds on the dates fixed for redemption. The verification will also confirm the correctness of the mathematical computations supporting the conclusion of Bond Counsel that the 2006A Bonds and 2006B Bonds are not arbitrage bonds as defined by Section 148 of the Internal Revenue Code of 1986, as amended. Application of the Bond Proceeds The proceeds of the Bonds and other sources are funds are estimated to be applied as follows: Sources Series 2006A Series 2006B Series 2006Z Par Amount of Bonds... $ 71,395,000 $ 18,190,000 $ 96,845,000 Net Original Issue Premium/Discount... 5,078, , Z Bond Proceeds ,541 0 Bond Fund , ,190 31,876 Total... $ 76,655,888 $ 19,702,669 $ 96,876,876 Uses Series 2006A Series 2006B Series 2006Z Deposit to the Project Account... $ 67,300,000 $ 0 $ 93,702,000 Deposit to the Refunding Account... 8,476,530 19,504,881 1,454, Z Bond Proceeds to Series 2006B Refunding Account ,541 Underwriters Discount and Costs of Issuance (1) , ,788 1,231,062 Total... $ 76,655,888 $ 19,702,669 $ 96,876,876 (1) Includes premiums for bond insurance and reserve surety policy and other costs of issuance. Pledge of Revenues SECURITY FOR THE PARITY BONDS The Parity Bonds are special limited obligations of the District payable from and secured solely by a lien and charge on (i) Gross Revenues, which include all income, revenues, receipts and profits received by the District through the ownership and operation of the Wanapum Development, together with the proceeds received by the District from the sale, lease or other disposition of any properties, rights or facilities of the Wanapum Development and certain investment income, subject only to the prior payment of Operating Expenses, and (ii) the money and assets, if any, credited to the Bond Fund, the Project Account and the Supplemental Renewal and Contingency Fund (the Supplemental R&C Fund ), and the income therefrom. The items described above are pledged as security for the payment of the principal of, premium, if any, and interest on all Parity Bonds in accordance with the provisions of the Bond Resolutions. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS for a description of the security for the Parity Bonds and Flow of Funds below for a description of the priority of payments from the Gross Revenues of the Wanapum Development. All Parity Bonds are equally and ratably payable and secured under the Bond Resolutions without priority, except as otherwise expressly provided or permitted in the Bond Resolutions and except as to municipal bond insurance which may be obtained by the District to insure the repayment of one or more series or maturities within a series. State law provides that the revenue obligations issued by a public utility district and interest thereon shall be a valid claim of the owner thereof only as against the special fund or funds provided for the payment of such obligations and the proportion or amount of the revenues pledged to such fund or funds, and that (i) such pledge of the revenues or other money or obligations shall be valid and binding from the time made, (ii) the revenues or other money or obligations so pledged and thereafter received by a public utility district shall immediately be subject to the lien of such pledge without any physical delivery or further act, and (iii) the lien of any such pledge shall be valid and binding as against any parties having claims of any kind in tort, contract or otherwise against a district irrespective -3-

10 of whether such parties have notice thereof. The Bonds are not secured by a mortgage, deed of trust, or security interest in the Wanapum Development or any of the physical plant and facilities thereof. Obligations of the Electric System The District s Electric System currently purchases 36.5% of the output of the Wanapum Development, and the remaining output is sold to nine utilities under the 1959 Power Sales Contracts, which expire on October 31, The Parity Bonds are payable indirectly from the revenues of the District s Electric System to the extent that the Electric System is required under the 1959 Power Sales Contracts to purchase 36.5% of the output of the Wanapum Development. See THE WANAPUM DEVELOPMENT Wanapum Development Output and Power Sales Contracts. So long as the 1959 Power Sales Contracts are in effect, the District has covenanted to establish, maintain and collect rates and charges for electric power and energy sold through the Electric System sufficient to pay the Electric System s obligations under the 1959 Power Sales Contracts. Once the 1959 Power Sales Contracts are no longer in effect, if any power and energy is produced or capable of being produced in any given fiscal year by the Wanapum Development, the District has covenanted (1) to pay to the Wanapum Development from the Electric System that portion of the annual costs of the Wanapum Development for such fiscal year, including without limitation for operating and maintenance expenses and debt service on the Parity Bonds, that is not otherwise paid or provided for from payments received by the Wanapum Development from the sale of power and energy and related products from the Wanapum Development to purchasers other than the District and (2) to establish, maintain and collect rates or charges for electric power and energy and related products sold through the Electric System sufficient to make any such payments to the Wanapum Development. For so long as the 1996 Bonds, 1997 Bonds and 1998 Bonds are Outstanding (which are expected to be retired by January 1, 2009), the District is obligated to pay from Electric System revenues or other legally available funds all amounts required to be paid under the Bond Resolutions, including debt service on the Parity Bonds, to the extent payment or provision for payment of such amounts is not otherwise made, and (ii) to establish, maintain and collect rates or charges for electric power and energy sold through the Electric System sufficient to pay all costs chargeable against the revenues of the Electric System and all amounts required to be paid under the Bond Resolutions to the extent payment or provision for payment of such amounts is not otherwise made. Once the 1996 Bonds, 1997 Bonds and 1998 Bonds are no longer Outstanding, the Electric System will not be obligated to pay any costs of the Wanapum Development for any fiscal year (i) if the Electric System does not receive power from the Development during such fiscal year and (ii) no power or energy is produced or capable of being produced by the Wanapum Development during such fiscal year. Payments made by the Electric System for its share of the Wanapum Development s output, currently 36.5%, and other costs of purchased power and energy from the Wanapum Development are operating expenses of the Electric System, and, therefore, are payable prior to debt service on the Electric System bonds. The obligation of the Electric System to pay for all other costs associated with the Wanapum Development are junior in rank to all other obligations of the Electric System. For a summary of outstanding debt of the District, see Table 13. The Electric System has substantially identical obligations with respect to the Priest Rapids Development and the bonds issued by the District payable from revenues of the Priest Rapids Development. Thus, any financial difficulties encountered by the Priest Rapids Development could indirectly affect the security provided by the Electric System with respect to the Parity Bonds. Potential Consolidation of Developments Once the 1996 Bonds, 1997 Bonds, 1998 Bonds and 1999 Bonds and the Priest Rapids Development bonds issued prior to 2000 are no longer Outstanding, the District may elect to combine the Wanapum Development and the Priest Rapids Development into a single system for accounting and financing purposes. The District may consider consolidating the Developments effective on or after November 1, 2009, when output of the Wanapum Development will be subject to the New Power Sales Contracts. In such event, the revenues of both Developments would be pledged and available to pay and secure debt service on the Bonds and any Future Parity Bonds, as well as bonds of the Priest Rapids Development, and the operation and maintenance expenses, capital costs and other obligations of -4-

11 both Developments would be payable from the revenues of both Developments. For a summary of currently outstanding debt of both Developments, see Table 13. Prior to consolidating the Developments, the District must obtain confirmation from each rating agency then rating the Parity Bonds that the consolidation will not adversely impact the then current rating(s) on the Parity Bonds. In addition, the District must obtain an opinion of bond counsel that the consolidation will not adversely affect the tax-exempt status of any Outstanding Parity Bonds. The District can give no assurance that such a consolidation would not have a material adverse effect on the security for the Bonds. Flow of Funds The District has covenanted that so long as any of the Parity Bonds are Outstanding and unpaid it will continue to pay into the Revenue Fund all Gross Revenues. Earnings on money in the Supplemental R&C Fund and the Bond Fund may be paid into such funds as provided by the Bond Resolutions. The Bond Resolutions create a charge and obligation against the Revenue Fund in an amount equal to the Coverage Requirement. The Coverage Requirement is defined as (a) 1.15 times the Annual Debt Service in a Fiscal Year plus (b) any amounts required to be deposited into the Reserve Account in a Fiscal Year less (c) amounts transferred to the Bond Fund from the Supplemental R&C Fund in excess of the Supplemental Fund Cap (currently $6,000,000) as of the end of the preceding Fiscal Year. So long as any Parity Bonds are Outstanding, the amounts in the Revenue Fund will be used only for the following purposes and in the following order of priority: (1) to pay or provide for Operating Expenses; (2) to make all payments required to be made into the Interest Account in the Bond Fund; (3) to make all payments required to be made into the Principal Account in the Bond Fund and to make all required payments into the Bond Retirement Account in the Bond Fund; (4) to make all payments required to be made into the Reserve Account in the Bond Fund; (5) to make all payments required to be made into the Supplemental R&C Fund (currently an amount in each month equal to.0125 of Annual Debt Service); and (6) to make all payments required to be made into any special fund or account created to pay or secure the payment of junior lien obligations of the Wanapum Development. After all of the above payments and credits have been made, amounts remaining in the Revenue Fund may be used for any other lawful purpose of the District relating to the Wanapum Development. If required by contract with the purchasers of power from the Wanapum Development, the District may rebate money in any fund except the Bond Fund to those purchasers. If the rebate is paid from the Supplemental R&C Fund, the District may again establish in the Supplemental R&C Fund an amount equal to the Supplemental Fund Cap (currently $6,000,000) from the proceeds of Parity Bonds, from Gross Revenues, or from any other sources. Any rebates may be paid to the Electric System on the same basis as to the other purchasers of power. Under the Bond Resolutions, the District is not permitted to issue additional bonds with a lien and charge upon Gross Revenues prior to the lien and charge of the Parity Bonds. Limited Obligations The Parity Bonds do not in any manner or to any extent constitute general obligations of the District or of the State of Washington, or any political subdivision of the State of Washington, or a charge upon any general fund or upon any money or other property of the District or of the State of Washington, or of any political subdivision of the State of Washington, not specifically pledged thereto by the Bond Resolutions. -5-

12 Rate Covenants The District has covenanted in the Bond Resolutions to establish, maintain and collect rates or charges in connection with the ownership and operation of the Wanapum Development that are fair and nondiscriminatory and adequate to provide Gross Revenues sufficient for the payment of the principal of and interest on all Outstanding Parity Bonds, all amounts which the District is obligated to set aside in the Bond Fund, the payment of all Operating Expenses of the Wanapum Development, and for the payment of any amounts that the District may now or hereafter become obligated to pay from Gross Revenues. The District has also covenanted to establish, maintain and collect rates or charges in connection with the ownership and operation of the Wanapum Development sufficient to provide Net Revenues in any Fiscal Year in an amount that is at least equal to (i) 1.15 times Annual Debt Service, plus (ii) any amounts required to be deposited into the Reserve Account, less (iii) amounts transferred to the Bond Fund from the Supplemental R&C Fund in excess of the Supplemental Fund Cap at the end of the preceding Fiscal Year, in addition to the amounts required to pay debt service on any junior lien obligations of the Wanapum Development. Retail electric rates and charges of the District are fixed by the Commission, free from the jurisdiction and control of the Washington Utilities and Transportation Commission and, in the opinion of the District, free from the jurisdiction and control of the Federal Energy Regulatory Commission ( FERC ). Wholesale electric rates and charges, however, are subject to certain regulations by FERC. See THE WANAPUM DEVELOPMENT Regulatory Proceedings Affecting the Developments Proceedings Related to Allocation of Output. Additionally, the Developments are owned and operated by the District under a long-term license from FERC. See THE WANAPUM DEVELOPMENT License Status. See THE ELECTRIC SYSTEM Electric Rates for a discussion of telecommunication rates. Reserve Account There is a single Reserve Account securing all Parity Bonds. The Bond Resolutions require that there be deposited into the Reserve Account in the Bond Fund for each series of Parity Bonds an amount equal to the maximum amount of interest due in any Fiscal Year on such series of Parity Bonds, calculated as of the date of issuance of such series (the Reserve Account Requirement ). Once the 1996 Bonds, 1997 Bonds, 1998 Bonds, and 1999 Bonds are no longer Outstanding, Reserve Account Requirement will mean, with respect to a series of Future Parity Bonds, an amount set forth in the resolution authorizing such bonds; provided, however, that so long as any 2001 Bonds are insured by Financial Security Assurance Inc. ( FSA ) or any 2005 Bonds are insured by Financial Guaranty Insurance Company ( Financial Guaranty ), the Reserve Account Requirement with respect to any Future Parity Bonds secured by the Reserve Account shall be an amount equal to the maximum amount of interest due in any Fiscal Year on such Future Parity Bonds. The Reserve Account Requirement may be funded either from Parity Bond proceeds or from Gross Revenues over a five-year period following the date of issuance, except that so long as the 2001 Bonds are insured by FSA or the 2005 Bonds are insured by Financial Guaranty, the Reserve Account Requirement must be fully funded on the date of issuance of any Parity Bonds. As an alternative, the District may fund all or a portion of the Reserve Account through the purchase of Qualified Insurance or a Qualified Letter of Credit. See Certain Definitions and Bond Fund in APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS relating to the satisfaction of the Reserve Account Requirement through the deposit of a letter of credit or insurance policy. To meet the Reserve Account Requirement for the Outstanding Parity Bonds, the District has reserve account surety policies in the aggregate amount of $6,082, with Ambac Assurance Corporation ( Ambac Assurance ), surety policies in the aggregate amount of $893, with FSA, a surety policy in the amount of $2,647, with MBIA Insurance Corporation ( MBIA ), and a surety policy in the amount of $6,050, with Financial Guaranty. See Reserve Account Surety Bonds below. In addition, upon delivery of the Bonds, there will be on deposit in the Reserve Account a reserve surety policy with MBIA to satisfy the Reserve Account Requirement for the Bonds. For information about MBIA, see BOND INSURANCE MBIA Insurance Corporation. The valuation of the amount on deposit in the Reserve Account is required to be made by the Trustee on each December 31, and after certain withdrawals, and may be made on each June 30. Such valuation shall be at the -6-

13 market value thereof (including accrued interest) for obligations maturing more than six months from the valuation date or at par for obligations maturing within six months of the valuation date. The District has covenanted to make up any deficiency in the Interest Account, the Principal Account, and the Bond Retirement Account from the funds available in the Reserve Account. The District has covenanted to replenish such withdrawals from money in the Revenue Fund, Supplemental R&C Fund or the Project Account created for the Parity Bonds, in not more than six equal monthly installments. Reserve Account Surety for the Bonds Application has been made to the MBIA for a commitment to a issue surety bond (the Debt Service Reserve Fund Surety Bond ) in the amount of $10,066,601. The Debt Service Reserve Fund Surety Bond will provide that upon notice from the Registrar to the Insurer to the effect that insufficient amounts are on deposit in the Bond Fund to pay the principal of (at maturity or pursuant to mandatory redemption requirements) and interest on the Bonds, the Insurer will promptly deposit with the Registrar an amount sufficient to pay the principal of and interest on the Bonds or the available amount of the Debt Service Reserve Fund Surety Bond, whichever is less. Upon the later of: (i) three days after receipt by the Insurer of a Demand for Payment in the form attached to the Debt Service Reserve Fund Surety Bond, duly executed by the Registrar or (ii) the payment date of the Bonds as specified in the Demand for Payment presented by the Registrar to the Insurer, the Insurer will make a deposit of funds in an account with U.S. Bank National Association, in New York, New York, or its successor, sufficient for the payment to the Registrar, of amounts which are then due to the Registrar (as specified in the Demand for Payment) subject to the surety bond coverage. The available amount of the Debt Service Reserve Fund Surety Bond is the initial face amount of the Debt Service Reserve Fund Surety Bond less the amount of any previous deposits by the Insurer with the Registrar which have not been reimbursed by the District. The District and the Insurer will enter into a Financial Guaranty Agreement dated December 13, 2006 (the Agreement ). Pursuant to the Agreement, the District is required to reimburse the Insurer, within one year of any deposit, the amount of such deposit made by the Insurer with the Registrar under the Debt Service Reserve Fund Surety Bond. Such reimbursement shall be made only after payment of Operating Expenses and required deposits to the Bond Fund have been made. Under the terms of the Agreement, the District is required to reimburse the Insurer, with interest, until the face amount of the Debt Service Reserve Fund Surety Bond is reinstated before any deposit is made to the Revenue Fund. No optional redemption of Bonds may be made until the Insurer s Debt Service Reserve Fund Surety Bond is reinstated. The Debt Service Reserve Fund Surety Bond will be held by the Trustee in the Bond Fund and is provided as an alternative to the District depositing funds equal to the Debt Service Requirement for outstanding Bonds. The Debt Service Reserve Fund Surety Bond will be issued in the face amount equal to the Reserve Account Requirement and the premium therefor will be fully paid by the District at the time of delivery of the Bonds. Reserve Account Sureties for Outstanding Parity Bonds The surety bonds issued by Ambac Assurance, FSA and Financial Guaranty provide that upon the later of (i) one day after the receipt by the applicable surety of a demand for payment executed by the Paying Agent certifying that provision for the payment of principal of or interest on the Parity Bonds when due has not been made or (ii) the interest payment date specified in the demand for payment submitted to the applicable surety, the applicable surety will promptly deposit funds with the Paying Agent sufficient to enable the Paying Agent to make such payments due on the Parity Bonds, but in no event exceeding the policy limit of the surety bond so drawn on. Pursuant to the terms of the surety bonds, the policy limits of each are automatically reduced to the extent of each payment made by the applicable surety under the terms of the surety bonds, and the District is required to reimburse the applicable surety for any draws under the surety bonds with interest at a market rate. Upon such reimbursement, the surety bonds are reinstated to the extent of each reimbursement up to but not exceeding the applicable policy limits. The reimbursement obligation of the District under the surety bonds is subordinate to the District s obligations with respect to the Parity Bonds. -7-

14 In the event the amount on deposit in, or credited to, the Reserve Account exceeds the amount of the surety bonds, any draw on the surety bonds shall be made only after all the funds in the Reserve Account have been expended. In the event that the amount on deposit in, or credited to, the Reserve Account, in addition to the amount available under the surety bonds, includes amounts available under a letter of credit, insurance policy, surety bond or other such funding instrument, draws on the surety bonds and additional funding instruments shall be made on a pro rata basis to fund the insufficiency. The Bond Resolutions provide that the Reserve Account shall be replenished in the following priority: principal and interest on the surety bonds and on the additional funding instrument shall be paid from first-available Gross Revenues on a pro rata basis. The surety bonds do not insure against nonpayment caused by the insolvency or negligence of the Trustee or the Paying Agent. Ambac Assurance, FSA, MBIA and Financial Guaranty are subject to the informational requirements of the Exchange Act and in accordance therewith file reports, proxy statements and other information with the SEC. Certain SEC filings of Ambac Assurance are available on the company s website, (which is not incorporated herein by this reference). Certain SEC filings of FSA are available on the company s website, (which is not incorporated herein by this reference). Certain SEC filings of MBIA are available on the company s website, (which is not incorporated herein by this reference). Certain SEC filings of Financial Guaranty are available on the company s website, (which is not incorporated herein by this reference). Such reports, proxy statements and other information may also be inspected and copied at the SEC s Public Reference Room at 100 F Street, N.E., Washington, D.C See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTION Bond Fund. Supplemental Renewal and Contingency Fund The Bond Resolutions provide that the Supplemental R&C Fund must be maintained at a balance not to exceed $6,000,000 or such greater amount as may be authorized by resolution of the Commission. Money in the Supplemental R&C Fund must be used to make up any deficiency in the Bond Fund and to the extent not required for such purpose may be applied to other specified purposes. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS Supplemental Renewal and Contingency Fund. Additional Parity Bonds Under the Bond Resolutions, the District is not permitted to issue additional bonds with a lien and charge upon Gross Revenues prior to the lien and charge of the Parity Bonds. Additional Parity Bonds may be issued for any lawful purpose relating to the Wanapum Development upon the terms and conditions stated in the Bond Resolutions. Such conditions include the delivery of an opinion of a Professional Utility Consultant to the effect that the issuance of such Parity Bonds and the expenditure of the proceeds thereof will not result in a violation of the District s rate covenants; provided, however, that such report will not be required under certain circumstances once the 1996 Bonds, 1997 Bonds, 1998 Bonds, 1999 Bonds and 2001 Bonds are no longer Outstanding. See Rate Covenants above and Additional Parity Bonds in APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS. The District may issue bonds, notes, warrants or other obligations having a lien and charge against the Gross Revenues of the Wanapum Development junior to the Parity Bonds upon the terms and conditions stated in the Bond Resolutions. Derivative Products Once the 1996 Bonds, 1997 Bonds, 1998 Bonds and 1999 Bonds are no longer Outstanding, to the extent permitted by state law, the District may enter into Derivative Products secured by a pledge and lien on Gross Revenues on a parity with the Bonds subject to the satisfaction of certain conditions precedent. A Derivative Product is a written contract between the District and a third party obligating the District to make District Payments (subject to certain conditions) on one or more scheduled and specified payment dates in exchange for a Reciprocal Payor s obligation to pay or cause to be paid Reciprocal Payments to the District on scheduled and specified payment dates. Derivative Products include agreements providing for an exchange of payments based on interest rates (known as interest rate swaps) or providing for ceilings or floors on such payments. For a definition of terms used in this paragraph and a -8-

15 summary of the conditions precedent to the District s entering into a Derivative Product, see APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS Derivative Products. Contingent Payment Obligations The District has entered into, and may in the future enter into, contracts and agreements in the course of its business that include an obligation on the part of the District to make payments or post collateral contingent upon the occurrence or nonoccurrence of certain future events, including events that are beyond the direct control of the District. These agreements may include interest rate swaps and other similar agreements, agreements with respect to the delivery of electric energy or other energy, letter of credit agreements and other financial and energy hedging transactions. Such contingent payments or posting of collateral may be conditioned upon the future credit ratings of the District and/or other parties, maintenance by the District of specified financial ratios, future changes in energy prices, and other factors. The amount of any such payments or posting of collateral can be substantial. Some such payments may be characterized as Operating Expenses, and thus may be payable from Gross Revenues prior to the payment of debt service on the Bonds. Other such payments may be payable on a parity with debt service on the Bonds, including any regularly scheduled payments with respect to Derivative Products. The District has entered into the Western Systems Power Pool Agreements that include such contingent payment obligations. The agreements include obligations on the part of the District to post collateral or a letter of credit contingent upon the occurrence or nonoccurrence of certain future events, such as future credit ratings below investment grade or defaults under power marketing contracts or indebtedness. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS Derivative Products. No Acceleration Upon Default Upon the occurrence and continuance of an Event of Default under the Bond Resolutions, payment of the principal amount of the Parity Bonds is not subject to acceleration. The District thus would be liable only for principal and interest payments as they became due, and the Trustee or the Bondowners Trustee would be required to seek a separate judgment for each payment, if any, not made. Any such action for money damages would be subject to limitations on legal claims and remedies against public bodies under Washington law. Amounts recovered would be applied to unpaid installments of interest prior to being applied to unpaid principal and premium, if any, which had become due. The District has never defaulted in the payment of principal, premium or interest on any of its bonds. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS Events Of Default, Trustee, Remedies. Investment of Funds Money in the Bond Fund and any construction funds and/or project accounts may be, and money in the Supplemental R&C Fund is required to be, invested in Permitted Investments as defined in the Bond Resolutions. Investments in the Bond Fund must mature or be retireable at the option of the owner prior to the date needed or prior to the maturity date of the final installment of principal of the Parity Bonds payable out of the Bond Fund. The MBIA Insurance Corporation Insurance Policy BOND INSURANCE The following information has been furnished by MBIA for use in this Official Statement. Reference is made to Appendix G for a specimen of MBIA's policy (the Policy ). MBIA does not accept any responsibility for the accuracy or completeness of this Official Statement or any information or disclosure contained herein, or omitted herefrom, other than with respect to the accuracy of the information regarding the Policy and MBIA set forth under the heading BOND INSURANCE. Additionally, MBIA makes no representation regarding the Bonds or the advisability of investing in the Bonds. The MBIA Policy unconditionally and irrevocably guarantees the full and complete payment required to be made by or on behalf of the District to the Paying Agent or its successor of an amount equal to (i) the principal of (either at the stated maturity or by an advancement of maturity pursuant to a mandatory sinking fund payment) and interest -9-

16 on, the Bonds as such payments shall become due but shall not be so paid (except that in the event of any acceleration of the due date of such principal by reason of mandatory or optional redemption or acceleration resulting from default or otherwise, other than any advancement of maturity pursuant to a mandatory sinking fund payment, the payments guaranteed by the MBIA Policy shall be made in such amounts and at such times as such payments of principal would have been due had there not been any such acceleration, unless MBIA elects in its sole discretion, to pay in whole or in part any principal due by reason of such acceleration); and (ii) the reimbursement of any such payment which is subsequently recovered from any Owner of the Bonds pursuant to a final judgment by a court of competent jurisdiction that such payment constitutes an avoidable preference to such Owner within the meaning of any applicable bankruptcy law (a Preference ). MBIA s Policy does not insure against loss of any prepayment premium which may at any time be payable with respect to any Bonds. MBIA's Policy does not, under any circumstance, insure against loss relating to: (i) optional or mandatory redemptions (other than mandatory sinking fund redemptions); (ii) any payments to be made on an accelerated basis; (iii) payments of the purchase price of Bonds upon tender by an owner thereof; or (iv) any Preference relating to (i) through (iii) above. MBIA's Policy also does not insure against nonpayment of principal of or interest on the Bonds resulting from the insolvency, negligence or any other act or omission of the Paying Agent or any other paying agent for the Bonds. Upon receipt of telephonic or telegraphic notice, such notice subsequently confirmed in writing by registered or certified mail, or upon receipt of written notice by registered or certified mail, by MBIA from the Paying Agent or any owner of a Bond the payment of an insured amount for which is then due, that such required payment has not been made, MBIA on the due date of such payment or within one business day after receipt of notice of such nonpayment, whichever is later, will make a deposit of funds, in an account with U.S. Bank Trust National Association, in New York, New York, or its successor, sufficient for the payment of any such insured amounts which are then due. Upon presentment and surrender of such Bonds or presentment of such other proof of ownership of the Bonds, together with any appropriate instruments of assignment to evidence the assignment of the insured amounts due on the Bonds as are paid by MBIA, and appropriate instruments to effect the appointment of MBIA as agent for such owners of the Bonds in any legal proceeding related to payment of insured amounts on the Bonds, such instruments being in a form satisfactory to U.S. Bank Trust National Association, U.S. Bank Trust National Association shall disburse to such owners or the Paying Agent payment of the insured amounts due on such Bonds, less any amount held by the Paying Agent for the payment of such insured amounts and legally available therefor. MBIA Insurance Corporation MBIA Insurance Corporation ( MBIA ) is the principal operating subsidiary of MBIA Inc., a New York Stock Exchange listed company (the Company ). The Company is not obligated to pay the debts of or claims against MBIA. MBIA is domiciled in the State of New York and licensed to do business in and subject to regulation under the laws of all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, the Virgin Islands of the United States and the Territory of Guam. MBIA, either directly or through subsidiaries, is licensed to do business in the Republic of France, the United Kingdom and the Kingdom of Spain and is subject to regulation under the laws of those jurisdictions. The principal executive offices of MBIA are located at 113 King Street, Armonk, New York and the main telephone number at that address is (914) Regulation As a financial guaranty insurance company licensed to do business in the State of New York, MBIA is subject to the New York Insurance Law which, among other things, prescribes minimum capital requirements and contingency reserves against liabilities for MBIA, limits the classes and concentrations of investments that are made by MBIA and requires the approval of policy rates and forms that are employed by MBIA. State law also regulates the amount of both the aggregate and individual risks that may be insured by MBIA, the payment of dividends by MBIA, changes in control with respect to MBIA and transactions among MBIA and its affiliates. -10-

17 The Policy is not covered by the Property/Casualty Insurance Security Fund specified in Article 76 of the New York Insurance Law. Financial Strength Ratings of MBIA Moody's Investors Service, Inc. rates the financial strength of MBIA Aaa. Standard & Poor's, a division of The McGraw-Hill Companies, Inc., rates the financial strength of MBIA AAA. Fitch Ratings rates the financial strength of MBIA AAA. Each rating of MBIA should be evaluated independently. The ratings reflect the respective rating agency's current assessment of the creditworthiness of MBIA and its ability to pay claims on its policies of insurance. Any further explanation as to the significance of the above ratings may be obtained only from the applicable rating agency. The above ratings are not recommendations to buy, sell or hold the Bonds, and such ratings may be subject to revision or withdrawal at any time by the rating agencies. Any downward revision or withdrawal of any of the above ratings may have an adverse effect on the market price of the Bonds. MBIA does not guaranty the market price of the Bonds nor does it guaranty that the ratings on the Bonds will not be revised or withdrawn. MBIA Financial Information As of December 31, 2005, MBIA had admitted assets of $11.0 billion (audited), total liabilities of $7.2 billion (audited), and total capital and surplus of $3.8 billion (audited), each as determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. As of September 30, 2006, MBIA had admitted assets of $11.5 billion (unaudited), total liabilities of $7.0 billion (unaudited), and total capital and surplus of $4.4 billion (unaudited), each as determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. For further information concerning MBIA, see the consolidated financial statements of MBIA and its subsidiaries as of December 31, 2005 and December 31, 2004 and for each of the three years in the period ended December 31, 2005, prepared in accordance with generally accepted accounting principles, included in the Annual Report on Form 10-K of the Company for the year ended December 31, 2005 and the consolidated financial statements of MBIA and its subsidiaries as of September 30, 2006 and for the nine month periods ended September 30, 2006 and September 30, 2005 included in the Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2006, which are hereby incorporated by reference into this Official Statement and shall be deemed to be a part hereof. Copies of the statutory financial statements filed by MBIA with the State of New York Insurance Department are available over the Internet at the Company s web site at (which is not incorporated herein by this reference) and at no cost, upon request to MBIA at its principal executive offices. Incorporation of Certain Documents by Reference The following documents filed by the Company with the Securities and Exchange Commission (the SEC ) are incorporated by reference into this Official Statement: (1) The Company s Annual Report on Form 10-K for the year ended December 31, 2005; and (2) The Company s Quarterly Report on Form 10-Q for the quarter ended September 30, Any documents, including any financial statements of MBIA and its subsidiaries that are included therein or attached as exhibits thereto, filed by the Company pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of the Company s most recent Quarterly Report on Form 10-Q or Annual Report on Form 10-K, and prior to the termination of the offering of the Bonds offered hereby shall be deemed to be incorporated by reference in this Official Statement and to be a part hereof from the respective dates of filing such documents. Any statement contained in a document incorporated or deemed to be incorporated by reference herein, or contained in this Official Statement, shall be deemed to be modified or superseded for purposes of this Official Statement to the -11-

18 extent that a statement contained herein or in any other subsequently filed document which also is or is deemed to be incorporated by reference herein modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Official Statement. The Company files annual, quarterly and special reports, information statements and other information with the SEC under File No Copies of the Company s SEC filings (including (1) the Company s Annual Report on Form 10-K for the year ended December 31, 2005, and (2) the Company s Quarterly Reports on Form 10-Q for the quarters ended March 31, 2006, June 30, 2006 and September 30, 2006 are available (i) over the Internet at the SEC s web site at (which is not incorporated herein by this reference); (ii) at the SEC s public reference room in Washington, D.C.; (iii) over the Internet at the Company s web site at (which is not incorporated herein by this reference); and (iv) at no cost, upon request to MBIA at its principal executive offices. General Terms DESCRIPTION OF THE BONDS The 2006A Bonds will be issued in the aggregate principal amount of $71,395,000 and will be dated the date of their delivery. The 2006A Bonds will bear interest at the rates per annum set forth on the inside cover page hereof, payable July 1, 2007, and semiannually thereafter on each January 1 and July 1, and will mature on January 1 in each year as set forth on the inside cover page hereof. The 2006A Bonds are not private activity bonds, and interest on the 2006A Bonds is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals. See TAX MATTERS The 2006A Bonds. The 2006B Bonds will be issued in the aggregate principal amount of $18,190,000 and will be dated the date of their delivery. The 2006B Bonds will bear interest at the rates per annum set forth on the inside cover page hereof, payable July 1, 2007, and semiannually thereafter on each January 1 and July 1, and will mature on January 1 in each year as set forth on the inside cover page hereof. The 2006B Bonds are private activity bonds, and interest on the 2006B Bonds is a preference item for purposes of the federal alternative minimum tax imposed on individuals and corporations. See TAX MATTERS The 2006B Bonds. The 2006Z Bonds will be issued in the aggregate principal amount of $96,845,000 and will be dated the date of their delivery. The 2006Z Bonds will bear interest at the rates per annum set forth on the inside cover page hereof, payable July 1, 2007, and semiannually thereafter on each July 1 and January 1, and will mature on January 1 in each year as set forth on the inside cover page hereof. The District has taken no action to cause interest on the 2006Z Bonds to be excluded from gross income for purposes of federal income taxation. Certain information regarding the federal income tax treatment of the 2006Z Bonds is set forth under the heading TAX MATTERS The 2006Z Bonds. The Bonds will be issuable in registered form, in the denomination of $5,000 or any integral multiple thereof. Interest is calculated based on a 360-day year consisting of 12 months of 30 days each. The Bank of New York Trust Company, N.A., Seattle, Washington, has been appointed by the District as Trustee for the Bonds. Once the 1996 Bonds, 1997 Bonds, 1998 Bonds and the 1999 Bonds are no longer outstanding and as long as an Event of Default has not occurred, the District may require the Trustee to transfer the Bond Fund to the District and discharge the Trustee, in which case (i) a Trustee is not required to hold the Bond Fund and (ii) the District is not required to appoint a trustee for the Parity Bonds as long as an Event of Default has not occurred. The fiscal agency of the State of Washington in New York, New York, currently The Bank of New York, is the initial Registrar and Paying Agent for the Bonds. The Bonds will be issued in fully registered form initially in the name of Cede & Co., as registered owner and nominee of The Depository Trust Company, New York, New York ( DTC ). DTC will act as securities depository for the Bonds. Individual purchases may be made in book-entry form only as described below. Purchasers will not receive certificates representing their interest in the Bonds purchased. So long as Cede & Co. is the registered owner of the Bonds, as nominee of DTC, references herein to the registered owners or bondowners shall mean Cede & Co. and shall not mean the Beneficial Owners of the Bonds. In this Official Statement, the term -12-

19 Beneficial Owner shall mean the person for whom a DTC participant or indirect participant acquires an interest in the Bonds. So long as Cede & Co. is the registered owner of the Bonds, principal of and interest on the Bonds are payable by wire transfer by the Registrar to DTC, which in turn is obligated to remit such principal and interest to the DTC participants for subsequent disbursements to Beneficial Owners of the Bonds. See APPENDIX F BOOK- ENTRY SYSTEM. Termination of Book-Entry Transfer System If DTC or its successor resigns as the securities depository or if the District determines that it is no longer in the best interests of owners of beneficial interests in the Bonds to continue the system of book-entry transfers through DTC or its successor, the District will deliver at no cost to the beneficial owners of the Bonds or their nominees Bonds in registered certificate form, in the denomination of $5,000 or any integral multiple thereof. Thereafter, the principal of the Bonds will be payable upon due presentment and surrender thereof at the principal office of the Paying Agent. Interest on the Bonds will be payable by check or draft mailed on the interest payment date to the persons in whose names the Bonds are registered, at the address appearing upon the Bond Register on the 15 th day of the month prior to such interest payment date or, at the request of the owner of $1,000,000 or more in aggregate principal amount of Bonds, by wire transfer. Transfer and Exchange As long as DTC (or a successor or substitute depository) is not the registered owner of the Bonds, any Bond may be transferred at the principal office for such purpose of the Registrar by surrender of such Bond for cancellation, accompanied by a written instrument of transfer, in form satisfactory to the Registrar, duly executed by the registered owner in person or by his/her duly authorized attorney, and thereupon the District will issue and the Registrar will authenticate and deliver at the principal office of the Registrar (or send by registered or first class insured mail to the owner thereof at his expense), in the name of the transferee or transferees, a new Bond or Bonds of the same interest rate, aggregate principal amount and maturity, and on which interest accrues from the last interest payment date to which interest has been paid so that there shall result no gain or loss of interest as a result of such transfer, upon payment of any applicable tax or governmental charge. Optional Redemption 2006A Bonds The 2006A Bonds are subject to redemption prior to maturity, at the option of the District, in whole or in part, on January 1, 2017, or any date thereafter, at 100% of the principal amount thereof, plus accrued interest, if any, to the date of redemption. 2006B Bonds The 2006B Bonds are subject to redemption prior to maturity, at the option of the District, in whole or in part on January 1, 2017, or any date thereafter, at 100% of the principal amount thereof, plus accrued interest, if any, to the date of redemption. 2006Z Bonds The 2006Z Bonds are subject to optional redemption, in whole or in part, at any time prior to their maturity at the option of the District, at a redemption price equal to 100% of the principal amount thereof plus the Make-Whole Premium (as defined below), if any, plus the interest accrued to the date fixed for redemption. To the extent that any 2006ZBonds maturing in 2017, 2037 and 2043 are redeemed in part at the option of the District, the principal amount redeemed shall be applied to reduce each remaining mandatory sinking fund payment and the amount of the final payment at maturity with respect thereto pro-rata, rounded to the nearest $5,000 denomination. -13-

20 Make-Whole Premium means, with respect to any 2006Z Bond to be redeemed, an amount calculated by an Independent Banking Institution equal to the positive difference, if any, between: (i) The sum of the present values, calculated as of the redemption date of: (A) Each interest payment that, but for the redemption, would have been payable on the 2006Z Bond or portion thereof being redeemed on each regularly scheduled interest payment date occurring after the redemption date through the maturity date of such 2006Z Bond (excluding any accrued interest for the period prior to the redemption date); provided, that if the redemption date is not a regularly scheduled interest payment date with respect to such 2006Z Bond, the amount of the next regularly scheduled interest payment will be reduced by the amount of interest accrued on such 2006Z Bond to the redemption date; plus (B) The principal amount that, but for such redemption, would have been payable on the maturity date of the 2006Z Bond or portion thereof being redeemed; minus (ii) The principal amount of the 2006Z Bond or portion thereof being redeemed. The present values of the interest and principal payments referred to in clause (i) above shall be determined by discounting the amount of each such interest and principal payment from the date that each such payment would have been payable but for the redemption to the redemption date on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at a discount rate equal to the Comparable Treasury Yield (as defined below), plus 15.0 basis points. Comparable Treasury Yield means the yield which represents the weekly average yield to maturity for the preceding week appearing in the most recently published statistical release designated H.15(519) Selected Interest Rates under the heading Treasury Constant Maturities, or any successor publication selected by the Independent Banking Institution that is published weekly by the Board of Governors of the Federal Reserve System and that establishes yields on actively traded U.S. Treasury securities adjusted to constant maturity, for the maturity corresponding to the remaining term to maturity of the 2006Z Bond being redeemed. The Comparable Treasury Yield shall be determined as of the third business day immediately preceding the applicable redemption date. If the H.15(519) statistical release sets forth a weekly average yield for U.S. Treasury securities that have a constant maturity that is within three months of the remaining term to maturity of the 2006Z Bond being redeemed, then the Comparable Treasury Yield shall be equal to such weekly average yield. In all other cases, the Comparable Treasury Yield shall be calculated by interpolation on a straight-line basis, between the weekly average yields on the U.S. Treasury securities that have a constant maturity (i) closest to and greater than the remaining term to maturity of the 2006Z Bond being redeemed; and (ii) closest to and less than the remaining term to maturity of the 2006Z Bond being redeemed. Any weekly average yields calculated by interpolation will be rounded to the nearest 1/100 th of 1%, with any figure of 1/200 th of 1% or above being rounded upward. If, and only if, weekly average yields for U.S. Treasury securities for the preceding week are not available in the H.15(519) statistical release or any successor publication, then the Comparable Treasury Yield shall be the rate of interest per annum equal to the semi-annual equivalent yield to maturity of the Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price (as defined below) as of the redemption date. Comparable Treasury Issue means the U.S. Treasury security selected by the Independent Banking Institution as having a maturity comparable to the remaining term to maturity of the 2006Z Bond being redeemed and that would be utilized in accordance with customary financial practice in pricing new issues of corporate debt securities of comparable maturity to the remaining term to maturity of the 2006Z Bond to be redeemed. Independent Banking Institution means an investment banking institution of national standing that is a primary U.S. government securities dealer in the City of New York (which may be one of the Underwriters) designated by the District. Comparable Treasury Price means, with respect to any redemption date for a particular 2006Z Bond, (1) the average of five Reference Treasury Dealer quotations for such redemption date, after excluding the highest and -14-

21 lowest such quotations, or (2) if the Independent Banking Institution is unable to obtain five such quotations, the average of the quotations that are obtained. Reference Treasury Dealer means a primary U.S. Government securities dealer in the United States appointed by the District and reasonably acceptable to the Independent Banking Institution (which may be one of the Underwriters). Mandatory Redemption The 2006A Bonds maturing on January 1, 2020 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2019 $ 1,140, * 1,195,000 The 2006A Bonds maturing on January 1, 2022 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2021 $ 1,255, * 1,315,000 The 2006A Bonds maturing on January 1, 2024 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2023 $ 1,385, * 1,450,000 The 2006A Bonds maturing on January 1, 2026 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2025 $ 1,525, * 1,600,

22 The 2006A Bonds maturing on January 1, 2032 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2027 $ 1,680, ,765, ,855, ,945, ,045, * 2,145,000 The 2006A Bonds maturing on January 1, 2037 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2033 $ 2,250, ,365, ,485, ,605, * 2,735,000 The 2006A Bonds maturing on January 1, 2043 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2038 $ 2,875, ,020, ,170, ,330, ,495, * 3,670,000 The 2006B Bonds maturing on January 1, 2020 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2018 $ 405, , * 445,

23 The 2006B Bonds maturing on January 1, 2023 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2021 $ 475, , * 520,000 The 2006B Bonds maturing on January 1, 2026 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2024 $ 545, , * 600,000 The 2006B Bonds maturing on January 1, 2031 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2027 $ 625, , , , * 745,000 The 2006Z Bonds maturing on January 1, 2017 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2008 $ 700, , ,260, ,325, ,395, ,465, ,540, ,510, ,590, * 1,670,000 To the extent that the 2006Z Bond maturing in 2017 is redeemed in part at the option of the District, the principal amount redeemed shall be applied to reduce each remaining mandatory sinking fund payment and the amount of the final payment at maturity with respect to the 2006Z Bond maturing in 2017 pro-rata, rounded to the nearest $5,000 denomination. -17-

24 The 2006Z Bonds maturing on January 1, 2037 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2018 $ 1,700, ,635, ,720, ,815, ,910, ,010, ,120, ,230, ,350, ,475, ,610, ,745, ,895, ,050, ,210, ,380, ,560, ,750, ,950, * 4,160,000 To the extent that the 2006Z Bond maturing in 2037 is redeemed in part at the option of the District, the principal amount redeemed shall be applied to reduce each remaining mandatory sinking fund payment and the amount of the final payment at maturity with respect to the 2006Z Bond maturing in 2037 pro-rata, rounded to the nearest $5,000 denomination. The 2006Z Bonds maturing on January 1, 2043 shall be redeemed prior to maturity at random (or paid at maturity), on January 1 in the years and amounts set forth below, by payment of the principal amount thereof, together with the interest accrued thereon to the date fixed for redemption. *Final maturity. Year Principal Amount 2038 $ 4,385, ,620, ,870, ,135, ,415, * 5,705,000 To the extent that the 2006Z Bond maturing in 2043 is redeemed in part at the option of the District, the principal amount redeemed shall be applied to reduce each remaining mandatory sinking fund payment and the amount of the final payment at maturity with respect to the 2006Z Bond maturing in 2043 pro-rata, rounded to the nearest $5,000 denomination. Partial Redemption If less than all of the Bonds of a series subject to optional redemption are called for redemption, the District will choose the maturities within the series to be redeemed. If less than the whole of a maturity is called for redemption, the Bonds or portions thereof to be redeemed will be chosen randomly by the Registrar or, if the Bonds are -18-

25 registered in the name of Cede & Co., the nominee of DTC, or its registered assign, the Bonds to be redeemed will be chosen randomly by DTC. Anything in Sections 3.3(A) and 3.5 of the Bond Resolution to the contrary notwithstanding, to the extent that any 2006Z Term Bond of a maturity is called for optional or mandatory redemption in part, the principal amount redeemed shall be allocated among the Beneficial Owners of the 2006Z Term Bond of such maturity as nearly as practicable in proportion to the principal amounts of such 2006Z Term Bond of such maturity owned by each Beneficial Owner, rounded to the nearest $5,000 denomination; provided, however, that so long as the 2006Z Bonds are held by DTC or another depository, any redemption is subject to the operational arrangements of such depository and the District cannot provide assurance to any Beneficial Owner of a 2006Z Term Bond that the operational arrangements will accommodate this redemption methodology. Notice of Redemption Notice of redemption is to be given at least 30 and not more than 60 days prior to the redemption date by first class mail to the registered owners of any Bonds to be redeemed at their last addresses appearing on the registration records of the Registrar. The District makes no assurances that DTC Participants or other nominees of the Beneficial Owners will distribute such redemption notices to the Beneficial Owners of the Bonds or that they will do so on a timely basis. Actual receipt of such notice by the registered owner of any Bond shall not be a condition precedent to the redemption of such Bond. Notice of redemption shall also be sent to the state information depository for the State of Washington (if any) and to each nationally recognized municipal securities information repository or to the Municipal Securities Rulemaking Board. If, on the redemption date, money for the redemption of Bonds or portions thereof, together with interest to the redemption date, shall be held by the Paying Agent so as to be available therefor on such date and if notice of redemption shall have been given as aforesaid, then, from and after the redemption date, interest on the Bonds or portions thereof so called for redemption shall cease to accrue and become payable. Notice of any optional redemption may be cancelled by the District at any time on or prior to seven days prior to the designated redemption date by giving written notice of such cancellation to all parties who were given notice of redemption. Open Market Purchases The District has reserved the right to purchase Bonds in the open market in an amount and at such price as the District shall determine. General THE DISTRICT The District is a Washington State municipal corporation. It was organized in 1938 pursuant to a general election in accordance with the Enabling Act and commenced operations in The District has its administrative offices in Ephrata, Washington, the county seat of Grant County, which is located in central Washington. The District s Electric System serves all of Grant County. Pursuant to Washington statutes, the District is administered by a Board of Commissioners (the Commission ) of five elected members. The legal responsibilities and powers of the District, including the establishment of rates and charges for services rendered, are exercised through the Commission. The Commission establishes policy, approves plans, budgets and expenditures and reviews the District s operations. The District has the power of eminent domain. The District s electric utility properties and operations consist of three operating systems, each of which is accounted for and financed separately. The systems are the Electric System, the Priest Rapids Development and the Wanapum Development. The present combined total nameplate generating capacity of the systems is approximately 2,041.5 megawatts ( MW ). The revenues of the Wanapum Development are not pledged to or available for the payment of the bonds of the Electric System or the Priest Rapids Development. The District has, however, reserved the right to combine the Wanapum and Priest Rapids Developments once certain Outstanding bonds of such -19-

26 Developments are no longer Outstanding. See THE ELECTRIC SYSTEM, THE WANAPUM DEVELOPMENT, and SECURITY FOR THE PARITY BONDS Potential Consolidation of Developments. Although cities in the District s service area have statutory authority to provide electric service, only the town of Coulee Dam, which is located partially in Grant County, has its own electric distribution system. The District is not aware of any other city that is considering providing electric service. The District also has statutory rights of eminent domain which, subject to certain limitations, enable the District to acquire various assets and property rights, including electric distribution facilities in Grant County of any investor-owned utility company that may seek to serve Grant County. The District s facilities in any city and its right to provide electric service in any city are subject to the reasonable police power of such city. Under Washington law, public utility districts (such as the District) are authorized to provide retail electrical service beyond their boundaries. Further, investor-owned utilities are not prohibited from providing retail electrical service beyond their current service area. The Priest Rapids Development In addition to the Wanapum Development, the District operates the Priest Rapids Development, which consists of a dam and hydroelectric generating plant having a nameplate rating of 955,600 kilowatts ( kw ) and a net peaking capacity of 932,000 kw, located on the Columbia River in Grant and Yakima Counties approximately 18 miles downstream from the Wanapum Development. The Priest Rapids Development includes associated switching and transmission facilities necessary to deliver electric output to the transmission networks of the District, the Bonneville Power Administration ( Bonneville ) and certain other power purchasers. The Priest Rapids Development has been in full commercial operation since September During the year ended December 31, 2005, the Priest Rapids Development provided 3,792,481 megawatt hours ( MWh ) of electric energy at an average cost of $8.10 per MWh. The covenants securing the outstanding parity bonds of the Priest Rapids Development are substantially similar to the covenants in the Bond Resolutions. Management and Administration The Commissioners of the District, their titles and the expiration of their respective terms of office are listed below. Name Title Expiration of Term of Office (12/31) Randall M. Allred President 2008 Greg P. Hansen Vice President 2010 Thomas W. Flint Secretary 2008 Vera B. Claussen Assistant Secretary 2006 William E. Bjork, Jr. Commissioner 2006 Randall M. Allred, President. Commissioner Allred, elected to the Commission in the fall of 2002, has been a resident of Grant County for more than 40 years and has over 30 years of experience in agribusiness. He owns and manages five related businesses in Washington and Oregon, and is a former President and current member serving more than 20 years on the Quincy Columbia Basin Irrigation District Board of Directors. Greg P. Hansen, Vice President. Commissioner Hansen joined the Commission after being elected to the Commission in the fall of He has been a Grant County resident for the past 61 years and is retired from a real estate and insurance career and grew up on a farm near Moses Lake. He received a degree in accounting and business administration from the University of Washington. Thomas W. Flint, Secretary. Commissioner Flint joined the Commission after being elected in the fall of He is a fifth generation farmer actively farming in Grant County. Commissioner Flint serves as a director on the AgFarmation Project, the Blacksands Irrigation District and the Columbia Basin Development League. Commissioner Flint has a B.A. in Industrial Technology from Central Washington University. -20-

27 Vera B. Claussen, Assistant Secretary. Commissioner Claussen has over 30 years of professional and administrative service in the public power business and is in her 24th and final year on the Commission. Commissioner Claussen is a magna cum laude graduate of Linfield College and did graduate work in public administration at the University of Washington. Prior to election to the Commission, she was in a leadership role with the Washington Public Utility Districts Association. She was named Columbia Basin Woman of Achievement in Commissioner Claussen was elected to the Commission in She has served on the full Board of Directors of Energy Northwest (formerly Washington Public Power Supply System) since 1983 and the Executive Board since Commissioner Claussen is past president and a member of the Board of Directors of the American Public Power Association where she has been a committee leader and recognized with national awards for public power leadership. William (Bill) Bjork, Jr., Commissioner. Commissioner Bjork joined the Commission after being elected in the fall of 2002 and will complete his service on December 31, He has been a resident of Grant County for nearly 60 years. Commissioner Bjork has a degree in accounting from Big Bend Community College and Eastern Washington University. Mr. Bjork retired from the District in 1993 after 22 years of service in the Accounting and Finance Department. He served as President and Treasurer on the GRANCO Federal Credit Union Board. Commissioner Bjork is presently Chief Operating Officer and President of a local towing company. The present senior management team of the District is as follows: Tim J. Culbertson, General Manager, has been employed with the District since August Prior to holding the position of General Manager, he was the Manager of Power Marketing and Operations. In this capacity, Mr. Culbertson was responsible for all power transactions for the District. He was responsible for power supply planning and any potential additional generation developments or acquisition. He was also a member of the Risk Oversight Committee at the District, which makes policy decisions on the appropriate levels of risk. He has more than 24 years of experience in operations and wholesale power transactions in the West Coast markets and control area management. From early 1996 until March 1997, Mr. Culbertson was Director of Northwest Power Marketing for Aquila Power Corporation. In this position, he was responsible for energy transactions in the Northwest that included buys and sells as well as arranging transmission for these transactions. In April 1997, Mr. Culbertson joined Idaho Power Company as Director of Energy Sales and was responsible for deal origination for both power and gas structured transactions. His responsibilities also included working with other areas of the company such as Rates and Regulatory Affairs to help position the company to compete in new markets. He left Idaho Power Company in October 1999 to join Arizona Public Service as the Manager of Northwest Energy Accounts. His primary focus was structured deals with ranged in length from one month to multiple years. He left Arizona Public Service in July 2000 to take a position at the District. Joseph A. Lukas, Assistant General Manager, has been with the District since 1998 and from 1995 to He has a Masters of Science degree from Virginia Polytechnic Institute and State University and a Bachelor of Science degree from the University of Idaho. His experience includes a wide variety of topics related to relicensing of the Priest Rapids and Wanapum Developments and development of programs and agreements related to natural resource and power management issues. Prior to joining the District, Mr. Lukas worked as a natural resource consultant with Garcia and Associates and as a fisheries biologist with Idaho Power Company. Nickolai A. Gerde, Treasurer/Controller, has been employed with the District since April His responsibilities include supervision of the Strategic Planning, Power Management, Accounting & Finance and Information Technology departments in the District. He also manages all periodic internal and external financial reporting, cash and debt management and budgeting and forecasting for the District. Mr. Gerde has over 30 years of financial management experience with public and private companies in industries including gaseous fuel systems, aerospace manufacturing, telecommunications, commercial printing, hydraulics distribution, long-term healthcare, metal extrusions and public accounting, with annual revenues ranging from $5 million to over $600 million. Prior to joining the District during 2004 and 2005, Mr. Gerde was the Vice President Finance & CFO for IMPCO Technologies, Inc., a publicly traded NASDAQ worldwide manufacturer and distributor of gaseous alternative fuel systems. During 2003 he was an IMPCO Director and Chair of the Audit Committee. Mr. Gerde is a cum laude bachelor degree graduate of the University of Washington Business School, an honors graduate of Bellevue Community College and is a licensed inactive CPA in the State of Washington. -21-

28 Ray A. Foianini, of Foianini Law Office, has been general counsel for the District since He graduated summa cum laude from the University of Wyoming in 1974, with a Bachelor of Arts in Sociology and Political Science. In 1977, he graduated from the University of Notre Dame Law School with honors. He is a member of Phi Beta Kappa and has been active in various local and state associations and service clubs. Kim K Justice was appointed Auditor in 1998 by the Board of Commissioners. Ms. Justice holds a Bachelor of Science degree in Accounting from City University of Bellevue and is a Certified Public Accountant. Prior to joining the District, she was an Assistant Audit Manager for the Washington State Auditor's office, conducting risk based legal and financial audits of government agencies, including public utility districts. Stephen R. Brown, Director of Natural Resources, joined the District in 1982 in the Hydro Engineering Department at the District s hydro projects following experience in agricultural processing and engineering consulting to small municipalities. Until June 2004 he was the Hydro Engineering Supervisor focusing on the Wanapum Turbines Upgrade Project and Fisheries projects. Mr. Brown s education in civil engineering occurred at the Utah Technical College and the University of Utah. He also is a member of the Department of Energy s Advanced Turbine Project technical board, has sat on the Board of Directors of the National Hydropower Association since 1998 and that same year was appointed to the Board of Directors of the Hydro Research Foundation and in 2003 was appointed chairman. Jim A. Bunch, Director of Accounting, Finance and Strategic Planning, joined the District in 1983 as an Energy Auditor in the Conservation Department. Since that time, Mr. Bunch has worked primarily in the Accounting and Finance areas of the District. In 1986 Mr. Bunch accepted a position in the Finance Department as a Financial Analyst. He was promoted to the role of Senior Financial Analyst in His experience consists of a wide variety of topics including network administration, program development for treasury operations, financial forecast modeling, budgeting, rate development and Cost of Service Analysis. Mr. Bunch has a Bachelor of Arts degree from Central Washington University. Prior to joining the District, Mr. Bunch was an Energy Conservation Auditor at Benton County PUD. William G. Dearing, Director of Power Management, joined the District in May 2004 after spending 27 years at Chelan County PUD. His background at Chelan County PUD includes work in control systems, power planning, and regional power issues, and serving as Power Manager and Assistant General Manager of Power Management. Mr. Dearing graduated from Washington State University with a degree in Electrical Engineering. He is a registered Professional Engineer in the State of Washington, and a Senior Member of the Institute of Electrical and Electronic Engineers. Leon W. Hoepner, Director of Hydro, began his career in electrical engineering with the U.S. Bureau of Reclamation in Nevada and South Dakota. In 1976, he worked for the Bureau at Grand Coulee and then for the Army Corps of Engineers on the Snake River. He began his career with the District in 1983, became a Hydro Engineering Supervisor in 1985, Hydro Engineering Director in 1992, and Hydro Director in Lawrence (Larry) L. Jones, Director of Information Technology, joined the District in 1990 as a Systems Analyst to work on the Customer Service Billing system. Since that time, Mr. Jones has assumed increasingly more challenging positions within the District. He has served as the Customer Accounting/Meter Reading Supervisor, Information Services Supervisor and Y2K Project Manager. In 2000, Mr. Jones was assigned the role of project lead in establishing the District s Network Operations Center. Mr. Jones was appointed as the Director of the Telecommunication Division in April 2004 and Director of Human Resources and Support Services in May He assumed his present role in February Mr. Jones attended North Idaho College in 1970 and He is a decorated Vietnam era veteran and was honorably discharged from the United States Air Force in Mr. Jones is a graduate of the Computer Processing Institute in East Hartford, Connecticut and numerous other technology related training classes. Anthony J. Webb, Director of Customer Service, has been with the District since Mr. Webb was appointed as the Director of Human Resources and Support Service in May of 2004 and was assigned to his current position in September of His current responsibilities include Customer Care Administration, Energy Services, Fiber Business, Line and Substation Construction and Maintenance, Electric Shop and Transmission and Distribution -22-

29 Engineering. Mr. Webb has a Bachelor of Arts degree from Eastern Washington University. Prior to joining the District, Mr. Webb was an Industrial Engineering Manager for Boeing. Dawn M. Woodward, Hydro Director, began her career at the District in She worked in a variety of areas of the District, became a Local Manager in 1993 and a Director in May Ms. Woodward served as the Customer Service Director for five years prior to becoming the Hydro Director in Ms. Woodward has served as a Director of the Grant County Economic Development Council, member of the Moses Lake Response Team, member of Moses Lake s Vision 2020 Committee, member and past President/past Vice President of Royal Slope Boosters Organization. She also served for two years as a member of the Board of Directors of the Columbia Basin Foundation, is a past member of the Granco Federal Credit Union Auditing Committee and is active in Royal Slope Community projects. Michael V. Woywod, Director of Human Resources and Support Services, has been employed with the District since July He has a Bachelor of Science degree, summa cum laude, from Old Dominion University, a Master of Science degree in Psychology from California State University, Los Angeles, a Master of Science degree in Education from California State University, Los Angeles and a Master of Public Education degree from the University of Southern California. His current responsibilities include overseeing Communications, Facilities, Health, Human Resources, Procurement, Safety and Transportation. Before joining the District, Mr. Woywod held various positions for the Department of Defense, National Aeronautics and Space Administration, and the U.S. Army Corps of Engineers where he managed community relations, purchasing and contracting, warehousing, transportation, safety and health, facilities, utilities and personnel. Most recently, he was the Director of Facilities and Material for the National Archives and Records Administration where he oversaw facilities, utilities, conferences, transportation, mail, warehouses and property services. He also served as the Acting Director of Security, chaired two health and safety committees, and sat on the Department of Energy interagency team. District Employees and Retirement Plans and Other Post-Employment Benefits Following are the number of District employees by function as of June 30, Function Number of Regular Employees (FTE) Part-Time and Temporary (FTE) Manager s Division Assistant General Managers Strategic Planning Power Management Communications and External Affairs Accounting and Finance Hydro Generation Natural Resources Human Resources and Support Services Customer Service Total In addition to its regular staff, the District employs a number of employees by contract for transmission and distribution line construction work, pole-testing and tree-trimming, turbine rehabilitation, and environmental and other projects. Of the regular employees, as of June 30, 2006, 348 (62.6%) are bargaining unit employees under a Collective Bargaining Agreement ( CBA ) with the International Brotherhood of Electric Workers (the IBEW ). The current IBEW three-year CBA runs through March 31, There has not been a significant labor stoppage at the District since Pensions for the District s employees are provided by the Washington State Public Employees Retirement System ( PERS ) through three different retirement plan options. PERS Plan 1 and Plan 2 are defined benefit plans. PERS Plan 3 is both a defined pension plan (employer share) and defined contribution plan (employee share). The -23-

30 employer share is the same for all three plans. The Wanapum and Priest Rapids Developments share these costs in proportion to its share of direct payroll costs. The PERS Plan 1 system is under funded. In response to the current underfunding, the Washington State legislature adopted bill RCW that, as of July 1, 2006, required a phase-in of additional contributions dedicated to decreasing the unfunded liability of PERS Plan 1. The State Actuary has announced that employer contribution rates are set to increase to 3.69% from July 1, 2006 to January 1, 2007, to 5.46% from January 1, 2007 to June 30, From July 2007 on, estimated rates show 8.27% for 2008 as the top projected employer contribution rate. The rates were estimated by the State Actuary using preliminary investment data through September 30, The District has determined that the increased contribution rates will not materially affect its financial operations. There are no unfunded liabilities on the part of the District. For additional information, see Note 8 to the Wanapum Development s Audited Financial Statements for the Years Ended December 31, 2005 and 2004, attached hereto as Appendix C. The Governmental Accounting Standards Board ( GASB ) has issued a new standard concerning Accounting and Financial Reporting by Employers for Post-Employment Benefits Other than Pensions (GASB 45). In addition to pensions, many State and local governmental employers provide other post-employment benefits ( OPEB ) as a part of total compensation to attract and retain the services of qualified employees. OPEB includes post employment health care as well as other forms of post-employment benefits when provided separately from a pension plan. The new standard provides for the measurement, recognition and display of OPEB expenses/expenditures, related liabilities (assets), note disclosures, and, if applicable, required supplementary information in the financial reports. This pronouncement is effective for the District for the fiscal year ending on December 31, The District is currently evaluating the impact of OPEBs, but does not expect it will have a significant adverse impact on the District s finances. Insurance The District carries excess liability coverage in the amount of $60 million with a deductible of $500,000. The District has established an insurance reserve fund that has a minimum balance of $1 million and a maximum of $1.5 million to fund deductibles and that currently has a balance of $1.14 million. The District also maintains property insurance coverage with an aggregate limit in the amount of $200 million. These policies, along with other property and liability insurance policies, cover various properties and risks of the District, including the Priest Rapids and Wanapum Developments and the Electric System. The District has limited terrorism coverage. Strategic Planning The District adopted a new strategic plan in January This strategic plan addresses key District issues associated with relicensing the Priest Rapids and Wanapum Developments, resource management issues, operations and maintenance, capital improvements, power supply, customer service, reliability and institutional matters such as community relationships, employee development and succession planning, legislative and external affairs, and the District s financial strategy including rate stabilization and continued assurance of meeting the District s financial obligations and goals. Investments The District invests its available funds in a manner that emphasizes preserving principal, maintaining necessary liquidity, matching investment maturities to estimated cash flow requirements, and achieving maximum yield consistent with the foregoing criteria. Eligible investments include U.S. Treasury bonds, notes, bills or other obligations of the U.S. government or agencies of the U.S. government; interest bearing demand or time deposits issued by certain banks, trust companies or savings and loan associations; fully-secured repurchase agreements; banker s acceptances having a term of 180 days or less; taxable money market portfolios restricted to obligations of one year or less, issued and guaranteed by the full faith and credit of the U.S. government; and any other investments permitted under the laws of the State of Washington. Investments generally are made so that securities can be held to maturity. The District does not derive funds for investment from reverse repurchase agreements. In addition, the District does not invest in complex and/or volatile financial products such as inverse floaters or structured notes. The Bond Resolution provides that money in the Bond Fund, Revenue Fund and project accounts be invested in Permitted Investments. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS Certain Definitions. -24-

31 For information relating to the Wanapum Development s investments, see Notes 2 and 4 to the Wanapum Development s Audited Financial Statements for the Years Ended December 31, 2005 and 2004, attached hereto as Appendix C. Hazardous Waste Issues A substantial number of federal, state, and local laws and regulations regarding waste management have been enacted. Some of these laws and regulations impose strict liability on generators, transporters, storers, and disposers of hazardous wastes. Many normal activities in connection with the generation and transmission of electricity and maintenance of associated facilities generate both non-hazardous and hazardous wastes. The District has established systems to ensure compliance and control activities that fall under the purview of these environmental laws and regulations. The District has completed a program to remove and/or control polychlorinated biphenyl ( PCB ) equipment according to the guidelines in the Environmental Protection Agency ( EPA ) regulations and to dispose of the PCBs and contaminated equipment in a timely manner at EPA approved facilities. Security Efforts at the District While the District has been involved in emergency action plans and region-wide security programs for years, the District reviewed its security procedures at all facilities following the September 11, 2001 terrorist attacks and has implemented certain measures. The District continues to work with public agencies and the Pacific Northwest Security Coordinator (an independent position that uses federal North American Electric Reliability Council guidelines) to maintain an integrated security program. No assurance can be given that the procedures put in place will be effective. Description THE WANAPUM DEVELOPMENT The Wanapum Development consists of a dam and hydroelectric generating station having a nameplate rating of 1,038,000 kw and net peaking capacity of 985,000 kw. Located on the Columbia River in Grant and Kittitas Counties about 160 air miles northeast of Portland, Oregon and 129 air miles southeast of Seattle, Washington, and 18 miles upstream of the Priest Rapids Development, the Wanapum Development includes certain switching, transmission and other facilities necessary to deliver the electric output to the transmission networks of the District, Bonneville and certain other power purchasers. The Wanapum Development has been in commercial operation since September The District believes that the expected useful life of the Wanapum Development should extend beyond the final maturity of the Parity Bonds, assuming that the District continues to perform required periodic repair, maintenance, renewal and replacement. The Wanapum Development is operated under a license from the Federal Energy Regulatory Commission ( FERC ), which expired on October 31, See License Status below for a further description of the license, certain ongoing proceedings related thereto and certain information relating to the expiration of the license in 2005 and expected long-term renewal of the license in

32 During the year ended December 31, 2005, the Wanapum Development provided 4,108,682,000 kwh of electric energy at an average cost of $8.60 per megawatt-hours ( MWh ). The generation from the Wanapum Development in 2001 was significantly lower than historical amounts because the winter of was among the driest on record in the region and was the driest on record for the Priest Rapids and Wanapum Developments. Table 1 WANAPUM DEVELOPMENT HISTORICAL ENERGY PRODUCTION Net Peaking Production (MW) Net Energy Production (000 s MWh) (1) 2,915 3,951 3,592 3,730 4,109 Annual Availability Factor (2) 93% 90% 91% 88% 94% Plant Factor (3) 42% 57% 53% 60% 59% Average Cost ($/MWh) $12.29 $10.04 $10.48 $8.10 $8.60 (1) See discussion in prior paragraph. The decrease in generation at Wanapum Development in 2003 when compared to 2002 is a direct result of lower water flows, offset partially by less spill for fish passage. (2) The ratio of the actual hours that the generating units of the Wanapum Development are available for service during the period indicated to the total hours in the period. (3) The average energy output of a generating facility to the net peaking capability of that facility. It reflects the facility s availability, the actual need for the power production by the facility and the availability of water. Plant factor is calculated by dividing gross generation by the maximum one-hour production divided by 8,760 (the hours in one year). Wanapum Development Output and Power Sales Contracts 1959 Power Sales Contracts The District has sold 63.5% of the power and energy output of the Wanapum Development to the Power Purchasers pursuant to the 1959 Power Sales Contracts. The 1959 Power Sales Contracts expire by their terms on October 31, 2009, although they may be amended or terminated prior thereto with the consent of the Power Purchasers. The District has reserved the remaining 36.5% of the output for its use. The participation of the District and other Power Purchasers in the output of the Wanapum Development, as currently provided for in the 1959 Power Sales Contracts, is shown in Table

33 Table 2 PARTICIPATION IN THE WANAPUM DEVELOPMENT OUTPUT Power Purchaser (1) Share under 1959 Power Sales Contracts Nameplate Rating (2) (MW) PacifiCorp, OR % Portland General Electric Company, OR Puget Sound Energy, Inc. WA Avista Corporation, WA Public Utility District No. 1 of Cowlitz County, WA Eugene Water & Electric Board, OR City of Forest Grove, OR City of McMinnville, OR City of Milton-Freewater, OR Subtotal Reserved by District for Electric System Total % 1, (1) State references refer to headquarters location of the Purchaser. (2) Based on installed nameplate rating of 1,038 MW. The 1959 Power Sales Contracts do not specify participation in terms of capacity. Under the 1959 Power Sales Contracts, non-defaulting Power Purchasers allocations shall be automatically increased pro rata with each other non-defaulting Power Purchaser s allocation by a cumulative maximum of 25% in the event of a default (that is, a payment default accompanied by insolvency, bankruptcy or other causes as defined in the 1959 Power Sales Contracts) by any other Power Purchaser. See APPENDIX D DESCRIPTION OF MAJOR POWER PURCHASERS (CURRENT OBLIGATED PERSONS). The centerfold map shows the District s and the Power Purchasers service areas. The 1959 Power Sales Contracts expire by their terms on October 31, Under the 1959 Power Sales Contracts, the Power Purchasers and the District s Electric System (to the extent of its 36.5% share of the Wanapum Development) are obligated to make payments equal to annual power costs, which include all operating expenses of the Wanapum Development and debt service on the Parity Bonds (including any parity Derivative Products). These payments are payable whether or not the Wanapum Development is operable or operating. See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE POWER CONTRACTS. Each Power Purchaser has the right of first refusal under the 1959 Power Sales Contracts to purchase its proportionate part of the Wanapum Development output that is in excess of the actual and prospective needs of the District at that time for service to ultimate consumers within the service area of the District, subject to the requirements of Public Law See THE WANAPUM DEVELOPMENT Regulatory Proceedings Affecting the Developments Proceedings Before FERC for a discussion of a FERC order that affects the sale of output from the Priest Rapids and Wanapum Developments after the expiration of the current FERC license. The terms of the New Power Sales Contracts (defined below) satisfy this right of first refusal and are intended to comply with the FERC order resulting from the PL-544 proceedings. The New Power Sales Contracts The District has signed new contracts with the original Power Purchasers and ten purchasers in Idaho for the purchase and sale of output from the Wanapum Development (after October 31, 2009) and output from the Priest Rapids Development (after October 31, 2005) (the New Power Sales Contracts ). The New Power Sales Contracts consist of two separate contracts with terms that will extend until the expiration of the expected new long-term license for the Priest Rapids and Wanapum Developments. Most of the contract provisions relating to the Priest Rapids Development took effect on November 1, 2005, and those relating to the Wanapum Development would take effect on November 1, The types of power sales contracts are referred to as the Product Sales Contract and -27-

34 A1.01_E SEA Purchaser Service Areas 9/19/01 dk WASHINGTON BRITISH COLUMBIA ALBERTA PURCHASER SERVICE AREAS Priest Rapids & Wanapum Developments Seattle Grant Co. PUD PacifiCorp (1) City of Tacoma, Washington (2) Eugene Water & Electric Board, Oregon Portland General Electric Company City of Forest Grove, Oregon Forest Grove McMinnville Tacoma C o l u m b Kittitas Co. PUD i a R i v e r Wanapum Development Priest Rapids Development S n a k e R i v e r Milton Freewater MONTANA Puget Sound Energy, Inc. City of McMinnville, Oregon Avista Corporation City of Milton-Freewater, Oregon Cowlitz County PUD Kittitas County PUD (2) City of Seattle, Washington (2) Major Transmission Line Routes (1) Reflects combined Pacific Power & Light Company and Utah Power & Light Company service areas effective with their January 1989 merger. (2) City of Seattle, City of Tacoma and Kittitas County PUD are Purchasers in only the Priest Rapids Development. A N Eugene OREGON IDAHO WYOMING O C E S n a k e R i v e r P A C I F I C NEVADA UTAH COLORADO CALIFORNIA ARIZONA NEW MEXICO

35 PUBLIC UTILITY DISTRICT NO. 2 OF GRANT COUNTY, WASHINGTON ELECTRIC SYSTEM RETAIL SERVICE AREA and MAJOR TRANSMISSION LINES CO LU MB IA RIV GRAND COULEE DAM ER Grand Coulee Dam SEATTLE SPOKANE Wanapum Dam GRANT COUNTY Priest Rapids Dam Columbia River PORTLAND COULEE CITY D AN AM GR E D TO LE U O C n nnectio n Interco shingto ern Wa to West COLUM BIA RI VER Wanapum Hydroelectric Development EPHRATA GRANT COUNTY QUINCY MOSES LAKE I-90 ROYAL CITY WANAPUM DAM Interconnections to Southeast Washington, Idaho MATTAWA 500 KV TRANSMISSION LINE PRIEST RAPIDS DAM 230 KV TRANSMISSION LINE Interconnections to Oregon, California Priest Rapids Hydroelectric Development

36 the Reasonable Portion Contract. The New Power Sales Contracts expire at the end of any new long-term license with a term of at least 30 years received by the District for the Developments. The 1959 Power Sales Contracts and New Power Sales Contracts are summarized in Appendix B. In accordance with the FERC order in the Public Law proceeding, following the expiration of the 1959 Power Sales Contracts, the District will dedicate 30% of the output of the Developments (the Reasonable Portion ) for sales within the region based on market principles. The remaining 70% of the output of the Developments will be used by the District s Electric System and sold to the Power Purchasers to the extent surplus to the Electric System s needs. See subsection Regulatory Proceedings Affecting the Developments. Under the Reasonable Portion Contract, the Power Purchasers will receive the net revenues from the sale of the 30% Reasonable Portion. The District will offer the Reasonable Portion output for sale based on market principles. The District will have the ability to claim the net revenues from sale of the Reasonable Portion to the extent that the District must acquire additional power to meet its firm energy load requirements. The Power Purchasers (or the District, if applicable) are responsible for paying their proportionate share of all costs of the Developments regardless of the revenues produced from the Reasonable Portion Contract. Under the Product Sales Contract, the Power Purchasers will purchase a percentage of the remaining 70% of the Priest Rapids and Wanapum Developments combined firm energy output that is surplus to the District s requirements (Surplus Product). The amount of firm energy output required by the District each year will be based on one-year projections of the District s load compared to the projected firm energy output of the Developments based on critical water planning. In addition, if displacement capacity and energy resources are available to the District, the District will offer the Power Purchasers output from the Developments that otherwise would be used by the District if displacement capacity and energy resources are not available to the District (Displacement Product). Some of the smaller Power Purchasers have signed Exchange Agreements with the District, which assign to the District all of their rights and obligations under the District s Product Sales Contract and Reasonable Portion Contract in exchange for a fixed percentage of output from the Developments for the term of the New Power Sales Contracts. The New Power Sales Contracts provide that each Power Purchaser will be obligated to make payments equal to annual power costs, which include all operating expenses and debt service on the Parity Bonds and debt service coverage (currently 15% of Annual Debt Service) for the life of the New Power Sales Contracts, multiplied by the percentage of output or revenue, as applicable, the purchaser is entitled to that year. The New Power Sales Contracts provide that the Power Purchasers shall pay their portion of the estimated costs of the Developments irrespective of the condition of the Developments and whether or not they are capable of producing power or revenues. If the Developments are not operating, estimated costs will be based on the Developments output in the last full year of operation. See SECURITY FOR THE PARITY BONDS Pledge of Revenues for a description of the Electric System covenant to take power and pay costs associated with its share of power received from the Developments. For a discussion of the FERC order with respect to the New Power Sales Contracts, see License Status below. -28-

37 Wanapum Development Output The actual amounts of energy sold to the Power Purchasers for the fiscal years 2001 through 2005 are shown in Table 3. During the years 2001 through 2005, the Wanapum Development delivered to the Power Purchasers and the District an average of 3,658,979 MWh of net energy annually. Table 3 WANAPUM DEVELOPMENT HISTORICAL ENERGY SALES (MWh) Gross Generation (1) 3,498,335 4,767,917 4,395,049 4,608,863 5,003,434 Plus Encroachment by Priest Rapids (2) 116, , , , ,736 Plus Pond Transfer (3) 39,132 81,277 45,199 34,135 28,768 Less Rock Island Encroachment (4) (560,054) (622,061) (577,579) (591,976) (598,089) Coordination Exchange (5) 2,185 (960) (1,699) 730 1,424 Net Generation 3,096,496 4,350,617 3,982,510 4,179,825 4,563,273 Less Canadian Entitlement (6) (181,450) (175,499) (237,336) (257,638) (256,331) Less Spill Past Unloaded Units (7) 0 (54,402) (1,380) (1,919) (3,529) Less Fish Spill Transfer 0 (170,168) (152,771) (190,672) (194,731) Net Energy to Purchasers 2,915,046 3,950,548 3,591,023 3,729,596 4,108,682 Maximum One-Hour Production (MW) Plant Factor (8) 42% 57% 53% 60% 59% Annual Availability Factor (9) 93% 90% 91% 88% 94% Disposition of Net Energy: Grant County PUD 1,051,286 1,458,802 1,293,965 1,347,799 1,444,517 PacifiCorp 537, , , , ,407 Portland General Electric Co. 537, , , , ,349 Puget Sound Energy, Inc. 349, , , , ,933 Avista Corporation 235, , , , ,691 Cowlitz County PUD 77, ,803 95,172 99, ,964 Eugene Water & Electric Board 66,210 89,849 81,532 84,928 94,213 Other Purchasers (10) 60,324 81,199 74,126 77,527 85,608 Total 2,915,046 3,950,548 3,591,023 3,729,596 4,108,682 (1) Excludes station service energy requirements and includes energy produced at the Wanapum Development credited to the Priest Rapids Development equivalent to one-half of the energy that would have been produced at the Project Rapids Development if no water releases to the spawning channel occurred. Variations from year to year are a result of changing fish spill requirements and Columbia River flows drought conditions combined with increased spill requirements reduced net generation from the District s hydroelectric facilities. The decrease in generation at Wanapum Development in 2003 when compared to 2002 is a direct result of lower water flows, offset partially by less spill for fish passage. (2) Energy produced at the Priest Rapids Development credited to the Wanapum Development equivalent to a portion of the energy that would have been produced at the Wanapum Development if the Priest Rapids Development's reservoir had not encroached on the Wanapum Development s tailrace. (3) Purchases of generating capability from neighboring hydroelectric projects. (4) Energy produced at the Wanapum Development credited to the Rock Island project of Chelan County PUD equivalent to a portion of the energy that would have been produced at the Rock Island project if the Wanapum Development's reservoir had not encroached on the Rock Island project s tailrace. (5) Wanapum Development energy exchanged by the District with parties to the Mid-Columbia Hourly Coordination Agreement. (6) One-half of the computed power benefits produced at the Wanapum Development as a result of upstream Canadian storage. -29-

38 (7) Spill among the Mid-Columbia Projects is reallocated based on the requests of the participants through an hourly coordination calculation. (8) The average energy output of a generating facility to the net peaking capabilities of that facility. It reflects the facility s availability, the actual need for the power production by the facility and the availability of water. Plant factor is calculated by dividing gross generation by the maximum one-hour production divided by 8,760 (the hours in one year). (9) Actual hours that the generating units of the Wanapum Development are available for service during the period indicated divided by the total hours in the period. (10) Cities of Forest Grove, McMinnville, and Milton-Freewater. Certain columns may not add due to rounding. Coordination Agreements A number of publicly and privately owned utilities in the Pacific Northwest, including the District, have joined with Bonneville, the Corps of Engineers and the United States Bureau of Reclamation in a long-term Pacific Northwest Coordination Agreement. This agreement became effective on January 4, 1965, and had an original termination date of June 30, The agreement was amended to continue until July 31, A replacement agreement began on August 1, 2003, which extends the term to In 1973, the District entered into the Mid-Columbia Hourly Coordination Agreement to provide for moment-bymoment coordination of the seven federal and nonfederal hydroelectric projects on the Mid-Columbia River, including the Wanapum and Priest Rapids Developments, with the District designated as the central control point under the contract. The agreement calls for continuously analyzing the total electric requirements of the seven plants and allocating generation to individual plants in a manner that results in less fluctuation of reservoirs at each dam, operation of the reservoirs at a higher average level and greater total power production. This efficient operating method increases the total generation from the Priest Rapids and Wanapum Developments, simplifies power dispatching communications, and alleviates potential technical control difficulties between the projects. This agreement was renewed for an additional 20 years ending June 30, Transmission of Power from Wanapum Development The Wanapum Development s 230-kV transmission lines interconnect transmission systems of the District, Bonneville and certain Power Purchasers. These transmission lines currently have sufficient capacity to integrate fully the Wanapum Development s output into the Pacific Northwest s high-voltage transmission system. A portion of the Wanapum Development s power is delivered directly to the District and certain Power Purchasers via lines owned by the respective parties, with the remainder delivered to the District and the Power Purchasers through the Bonneville transmission system. The District entered into new transmission agreements with Bonneville effective October 1, These new transmission agreements provide transmission services for the block power purchase from Bonneville, and the purchase of Bonneville power to serve the District s loads at Grand Coulee. These agreements are standard transmission agreements offered by Bonneville for similar requirements of other public and private utilities. The District worked with Bonneville on a reconfiguration of the District s internal transmission system and the associated increase in internal power flows that result from the new configuration. An agreement with Bonneville was implemented on October 1, 2003 that resulted in substantial savings in transmission costs associated with bringing generated power from the Priest Rapids and Wanapum Developments directly to the District s service area. Bonneville s transmission facilities interconnect with the British Columbia Hydro and Power Authority ( B.C. Hydro ) in the Canadian province of British Columbia and with utilities in the Pacific Southwest. Bonneville s transmission system includes approximately 360 substations, 15,000 circuit miles of high voltage transmission lines, and other related facilities. This transmission system provides about 75% of the Pacific Northwest s high-voltage bulk transmission capacity and serves as the main power grid for the Pacific Northwest. In addition to federal power, the major portion of the power produced from several nonfederal projects, including the Wanapum and Priest Rapids Developments, is transmitted over Bonneville s transmission facilities to various investor-owned and municipally-owned utilities in the Pacific Northwest. Bonneville routinely provides both long and short-term transmission access to utilities for the purpose of wheeling power within the Pacific Northwest. -30-

39 The Pacific Northwest-Pacific Southwest Intertie (the Intertie ) provides the primary bulk transmission link between the Pacific Northwest and the Pacific Southwest. Bonneville owns approximately 73% of the portions of the Intertie located north of California and Nevada. The Intertie consists of four high-voltage transmission lines and associated facilities, and has a combined capacity of about 7,900 MW. Due to operational limitations, Bonneville operates the Intertie at varying levels during the year. The actual transfer capability varies by season and by the amount of generation available on the lower Columbia River. Depending upon the season, the Intertie is rated between 5,200 MW and 6,900 MW. The National Energy Policy Act of 1992 (the Energy Policy Act ) included provisions that promoted competition in wholesale electric markets by, among other things, easing restrictions on wholesale power producers and by allowing the FERC to order transmission access for wholesale buyers and sellers of electricity over transmission systems owned by transmitting utilities. In 1996, FERC issued its Order 888, which requires jurisdictional utilities to file wholesale transmission tariffs providing pricing and terms for transmission access for wholesale purposes. FERC Order 888 also requires non-jurisdictional utilities (including municipal and consumer-owned utilities) that purchase transmission services from a jurisdictional utility to provide, in turn, non-discriminatory, open access transmission services back to the jurisdictional utility upon terms and conditions that are comparable to the transmission service that they provide to themselves. FERC Order 889 (1) imposes certain standards of conduct intended to restrict transmission-owning utilities from using those facilities to obtain an unfair competitive advantage in power sales transactions and (2) requires utilities to post information electronically regarding the availability and pricing of their transmission services. FERC is currently revisiting Order 888. In 1999, FERC issued its Order 2000, which initiated the formation of regional transmission organizations (or RTOs ) and set forth various standards for their organization and operation. In 2000 and in compliance with the requirements of Order 2000, Bonneville and nine investor-owned utilities in the Pacific Northwest proposed the organization of a regional transmission organization to be known as Grid West. This effort collapsed in 2005 with the members agreeing to discontinue the effort. A group of investor and consumer owned utilities, along with Bonneville, initiated a new effort called ColumbiaGrid in 2006 to deal with some of the more pressing planning and reliability issues in the region in a non-rto framework. Currently, this organization, of which the District is a member, has seated a three-member independent Board of Directors, and is working on agreements related to planning and reliability. The organization expects these agreements to become operable in the first quarter of FERC s revisiting Orders 888 and 2000 has allowed this non-rto solution to progress and enabled the region to tailor a solution that matches the circumstances in the Northwest. Rehabilitation Program In the early 1980s, the Wanapum Development experienced unscheduled outages of generating units due to generator winding failures. The District began a program of equipment renewal and rehabilitation to improve generating unit availability and overall plant operation. The major programs include generating unit restoration, generating unit equipment improvements, powerhouse improvements, power plant modernization, and communication/control system improvements. All ten of the Wanapum Development generators were rewound between 1983 and During the rehabilitations, problems were discovered with cracking of the turbine trunnion keyways. Initial repairs on the first eight units were not successful as the cracking has reoccurred after several years of operation, and the last two units were repaired using a different method, which was successful. Cracking of the blades themselves was discovered to be occurring over the last few years. The cracks have been found on both the pressure and suction sides of the blades and extend into the blade root area in all cases. Weld repairs to the cracks are short-lived with recracking occurring within one year. During this period, the District began working on designs for replacing the turbines at the Wanapum Development. All of the turbines are estimated to be installed in the Wanapum Development by 2012 and all of the upgrades completed by In 1994, the District joined nine other utilities and the United States Department of Energy in a joint research and development project to develop turbine designs that would improve environmental performance of hydroelectric turbines. Biological testing of a key portion of the design at Bonneville Dam on the Columbia River showed a 40% reduction in fish injury. The advanced turbine design was completed for the Wanapum turbine and the District entered into a cooperative agreement with the Department of Energy for it to fund 50% of the approximately $2,400,000 of the costs of the advanced turbine mechanical design, engineering testing and biological testing. In -31-

40 2003, the District filed an application with FERC for an amendment to install new advanced turbines at the Wanapum Development and in 2004 the District received approval from FERC for a license amendment to install, test and operate a new advanced turbine in Wanapum Unit 8. Unit 8 was placed in service with the new turbine in February Testing of turbine performance was completed with satisfactory results and FERC authorized the District to install the remaining nine new turbines. The second new turbine has been successfully installed in Wanapum Unit 4 and the unit was placed in service on September 12, To get full use of the new turbines, the District has also begun a program to restore and upgrade the generators at the Wanapum Development. The program is expected to cost $8,000,000 per generator and be completed by Main generating unit circuit breakers have been replaced, main transformers are being evaluated for rehabilitation or replacement, hydraulic governors have been refurbished, a new plant monitoring and control system has been installed, all major plant cranes have been rebuilt, and spillway gates are being rehabilitated. A fiber optic data/communications cable has been installed between the Wanapum and Priest Rapids Developments to replace the existing microwave path as the primary link. The District continues to work on rehabilitation of station service (air, water, oil and electric) systems in the plant. In addition to the rehabilitation programs described above, fish facility improvements are planned for the Wanapum Development. These improvements may include programs to install downstream fish bypass systems and to provide improvements to existing salmon hatchery facilities and upstream fish passage facilities. The downstream fish bypass systems include installation of the Future Unit Fish Bypass at the Wanapum Development, scheduled for completion in the spring of 2007 and installation/testing of a Top Spill Fish Bypass at the Priest Rapids Development in the spring of The hatchery improvements include rehabilitation of the Priest Rapids hatchery for the increased production of Fall Chinook. The fish bypass systems and the rehabilitation of the Priest Rapids hatchery are more fully described in the Final License Application filed with FERC in October The District is also working with agencies and tribes on ongoing fish-related matters that may include efforts to improve habitat in the upstream tributaries through the Mid-Columbia River system, including the Priest Rapids and Wanapum Developments. Turbine upgrades at the Priest Rapids Development are expected to begin in 2010 and be completed by Estimated Capital and Financing Requirements The District projects that the cost of the renewal and rehabilitation programs and fish, wildlife and other environmental programs undertaken at the Wanapum Development during the period 2007 through 2008 will be approximately $161 million as shown in Table 4, which will be financed by a portion of the Bonds. In the event that certain agreements are arrived at with respect to fish mitigation issues, additional facilities may be installed at the Wanapum Development that would significantly increase program expenditures. Such additional facilities would be funded with additional Parity Bonds. See Regulatory Proceedings Affecting the Developments. Table 4 WANAPUM DEVELOPMENT FORECAST RENEWAL AND REHABILITATION PROGRAMS EXPENDITURES Generator Restoration $ 11,406,616 Turbine Replacement 53,102,559 Powerhouse Improvements 35,350,519 Fish and Wildlife 34,618,476 Miscellaneous (1) 26,521,830 $ 161,000,000 (1) Includes power plant modernization, buildings and property improvements, computer hardware and software, tools, equipment, office furniture, vehicles and communication and control systems improvements. -32-

41 To the extent that repairs, replacements, renewals, additions, betterments, extensions, improvements and extraordinary maintenance to the Wanapum Development require substantial funds in excess of the amounts available from the Bond proceeds and the Supplemental R&C Fund, the District may be required to issue Parity Bonds to finance such excess. The timing and amount of such bond issues, if any, cannot be forecast at this time. Operating Results Table 5 shows actual operating results for the Wanapum Development for the fiscal years 2001 through Revenues from the Power Purchasers and the District are currently equal to the cost of power from the Wanapum Development. Such cost of power is a function of operating expenses, annual debt service and coverage requirements on the Parity Bonds and reserve requirements imposed by the Bond Resolutions and the 1959 Power Sales Contracts. The 1959 Power Sales Contracts establish the costs to be included in the cost of power from the Wanapum Development. This table differs from the financial statements in Appendix C and is designed to show compliance with the debt service coverage requirements in the Bond Resolution. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS and APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE POWER CONTRACTS. -33-

42 Table 5 WANAPUM DEVELOPMENT OPERATING RESULTS ($000) Operating Revenues Sale of Power (1) $35,835 $39,654 $37,623 $30,185 $35,301 Interest and Other Income (2) 2,289 1, ,066 Total Operating Revenues $38,124 $40,865 $38,277 $30,519 $38,367 Operating Expenses (3) Generation $10,838 $12,369 $11,078 $10,388 $11,702 Transmission Administrative and General 5,148 6,760 6,452 5,423 5,454 Taxes Total Operating Expenses $17,453 $20,958 $19,244 $17,584 $18,899 Net Revenues $20,671 $19,907 $19,033 $12,935 $19, Bonds Debt Service (4) 7,731 7,451 5, Less Transfer Requirements (5) 1,534 1,314 1,033 0 (775) Excess Available in Supplemental R&C Fund $1,712 $1,676 $1,893 $1,892 $1,934 Remaining Net Revenues Available for Debt Service on Parity Bonds $13,118 $12,818 $14,448 $14,827 $22,177 Parity Bonds Debt Service $11,407 $11,170 $12,618 $12,893 $19,260 Debt Service Coverage on Parity Bonds (6) 1.15x 1.15x 1.15x 1.15x 1.15x Net Energy Output (MWh) (7) 2,915,046 3,950,548 3,591,023 3,729,596 4,108,682 Average Cost ($/MWh) (8) $12.29 $10.04 $10.48 $8.09 $8.58 (1) Revenues from all Power Purchasers including the District (Annual Power Costs). (2) Interest on various funds of the Wanapum Development. (3) Excludes repairs, renewals, replacements, depreciation, and extraordinary maintenance costs paid from the 1963 R&C Fund and construction funds. Operating expenses vary from year to year in part as a consequence of the amount of capital program work undertaken at the Wanapum Development in each year. During periods of higher capital program work, operating expenses will be somewhat lower due to shifts of labor costs from maintenance expense activities to capitalized programs. (4) The balance due on the 1963 Senior Lien Bonds was called in its entirety in (5) Represents amounts transferred to the 1963 Reserve and Contingency Fund and the 1963 Bond Reserve Account, or to be credited to power costs. In 2005, the money was used for payment of extraordinary items out of the construction funds. (6) Annual charges for sales of power are set at levels sufficient to produce revenues providing debt service coverage of 1.15x. (7) 2001 drought conditions combined with increased spill requirements reduced net generation from the District s hydroelectric facilities. The decrease in generation at Wanapum Development in 2003 when compared to 2002 is a direct result of lower water flows, offset partially by less spill for fish. (8) Revenues from sales of power divided by net energy output. Certain columns may not add due to rounding. Monthly payment by the Power Purchasers and the District of their respective shares of Annual Power Costs is required by the 1959 Power Sales Contracts and the New Power Sales Contracts even if no power and energy are actually delivered. Annual Power Costs are estimated one year in advance and are paid in equal monthly portions of such estimate. Payments are adjusted annually to reflect actual costs. -34-

43 License Status On November 4, 1955, the Federal Power Commission (now FERC) issued a 50-year license, effective November 1, 1955, to the District authorizing the construction, operation, and maintenance of the Priest Rapids and the Wanapum Developments ( FERC Project No ). The original license for FERC Project No expired on October 31, Consistent with the requirements of federal law and regulations, the District has filed a new license application that contains a thorough review of project resource needs and impacts, as well as a proposed package of resource mitigation measures based on scientific research. FERC is presently reviewing that application. A summary of the application may be found at (which is not incorporated herein by this reference). Upon expiration of the District s license, the Federal Power Act provides that FERC has the option under current law to (i) issue a new license to the District, (ii) issue a new license to a competing applicant, or (iii) issue a nonpower license to the District or a competing applicant if FERC finds that all or part of FERC Project No should no longer be used for power purposes. The Federal Power Act requires FERC, upon the expiration of the original license, to issue annual licenses to the District under the same terms and conditions as the original license until such time as a new license is issued. FERC has issued an annual license to the District effective through October 31, 2006, or until the issuance of a new license for the Developments, whichever occurs first. Since the new license was not issued on or before November 1, 2006, the annual license automatically renewed. The Draft Final Environmental Impact Statement ( DFEIS ) was issued on February 24, 2006 responding to the submitted license application. The DFEIS revealed no major issues and generally recommended the proposals presented in the license application. On November 17, 2006, FERC issued the Final Environmental Impact Statement ( FEIS ). Other remaining items for the new license are the 401 Water Quality Certification required by the Clean Water Act (see Regulatory Proceedings Affecting the Developments Section 401 Water Quality Certification below) and the Biological Opinion for Spring Chinook and Steelhead required by the Endangered Species Act. The Biological Opinion for Spring Chinook and Steelhead related to the new license was to be issued by the National Marine Fisheries Service by July 19, 2006, but was extended to September 18, 2006 by FERC at the request of the National Marine Fisheries Service. The Biological Opinion has yet to be issued by the National Marine Fisheries Service but it is not unusual for the biological opinions to be issued late. As FERC noted in its letter approving the extension, the delay would not impact its schedule. Once these remaining items are completed, FERC will be able to issue a new license order. In March 2002, the Yakama Nation filed a complaint with the FERC claiming that the New Power Sales Contracts contained excessively low rates and otherwise unfairly induced the signatories not to join with the Yakama Nation in filing a competing license application for the Priest Rapids Project. On November 21, 2002, the FERC issued an order dismissing the Yakama Nation s complaint. The order upheld most provisions of the New Power Sales Contracts, but found that the provisions barring signatories from competing with the District for the new license for the Priest Rapids Project constituted an unreasonable restraint of trade in violation of the Federal Power Act. These provisions were removed from the New Power Sales Contracts by operation of law. The District is appealing this portion of the FERC order. The Yakama Nation has also filed an appeal of the FERC order generally seeking review of FERC s refusal (i) to award damages to the Yakama Nation and (ii) to bar the District from filing an application for a new license. The deadline for filing a competing license application has lapsed, and FERC did not receive any competing license applications. Regulatory Proceedings Affecting the Developments Proceedings Before FERC Advanced Turbine Replacement. As discussed above under Rehabilitation Program, FERC s 2004 order authorizing the installation of advanced turbines at the Wanapum dam allows staged installation of new, more efficient turbines. The District is replacing all ten of the existing Kaplan turbines at Wanapum dam with new turbines based on design research by the Department of Energy Advanced Hydroturbine Program. The existing turbines have reached the end of their useful life and need to be replaced. The new turbine has increased power output and efficiency, and includes features intended to improve the survival of fish. The order from FERC also -35-

44 incorporates conditions in the March 12, 2004 water quality certification issued by the Washington State Department of Ecology requiring, among other conditions, a study of the Total Dissolved Gas ( TDG ) production of the new turbines and mitigation for any increases associated with increased TDG production from the new turbines as compared to the existing turbines. The TDG Study conducted following the first new turbine installation concluded the new turbine did not increase TDG production and, therefore, no mitigation was required. Turbine Unit 8 and turbine Unit 4 have been successfully replaced. The advanced turbine is an important measure projected to improve conditions for fish and water quality within the Developments project area, and the District will proceed with the remaining eight units over the next several years. Wanapum Fish Passage Facility. The District is constructing and will operate a fish passage facility, consisting of a 20,000 cubic feet per second ( cfs ) ogee-crested weir constructed through the center slot of future Unit 11 at Wanapum dam. The proposed project modification is designed to improve downstream passage of migrating smolts and improve water quality by reducing the amount of spill, TDG entrainment, fish injury and erosion at the Wanapum dam. The District has received the permits and approvals from various agencies. Construction began in 2005 and is scheduled to be completed in the spring of In the absence of an acceptable bypass system, spill has been identified as the preferred alternative in obtaining nonturbine fish passage. In 2000, the District completed construction of a full set of spillway flow deflectors at Wanapum dam that reduces gas supersaturation during periods of spill. Previously, spill was reduced due to gas saturation limitations. Installation of the spill deflectors allows greater amounts of spill to occur at the Wanapum Development than was previously possible. Survival study results in 2000, 2001, and 2002 show that survival through the spillway at Wanapum dam is less effective than survival through the turbines. In 2004, spillbay 12 was modified to include a bulkhead that would pass 20 kilo cubic feet per second ( kcfs ) of water spilled from the forebay surface (as compared to default spill of 35% or 63 kcfs based on typical spring flows of 180 kcfs). Acoustic tagged salmon smolts were monitored for their behavior as they approached the 20 kcfs topspill bulkhead. The results from this acoustic tag fish study and the fish survival and injury results from the balloon tag testing at the sluice chute the same year (2004) further verified the decision to proceed with the construction of a surface spill fish bypass at the future Unit 11 location at Wanapum dam. This future unit non-turbine fish bypass would spill 20 kcfs of water, with the intention of ending MOA (defined below) spill at Wanapum. Construction of the future unit fish bypass began in February 2005 and is expected to be completed in the spring of 2007, as stated in the Biological Opinion issued to the District by NOAA Fisheries on May 3, Additionally, installation of state-of-the-art advanced turbines has begun at Wanapum dam. See Rehabilitation Program. Fish-Related Proceedings. On December 16, 2004, the FERC issued an order which amended the District s license for the Priest Rapids and Wanapum Developments to (1) authorize the District to implement the Interim Protection Plan for ESA listed salmonid and Steelhead species filed by the District in 1997, (2) require the District to comply with various conditions contained in a Biological Opinion and incidental take statement issued by NOAA Fisheries in May 2004, and (3) require the District to comply with the summer spill provisions of a Memorandum of Agreement ( MOA ) executed by the District and various resource agencies, tribes and environmental groups in The FERC order also terminated the Mid-Columbia Proceeding, which had been pending before FERC since 1978 and in which several federal and state resource agencies and several tribes had been seeking major downstream fish passage improvement measures at the two Developments. Proceedings Related to Allocation of Output. Public Law ( PL ) is federal legislation enacted in 1954 that enabled the District to construct the Priest Rapids and Wanapum Developments. PL requires the District, among other things, to offer a reasonable portion of the output of the Developments for sale in neighboring states. On February 11, 1998, in response to a complaint filed by several electric cooperatives seeking an allocation of power under a new license, FERC issued an order regarding distribution of the Priest Rapids Development power post-2005 and the Wanapum Development power post FERC ruled that the licensee can retain 70% of the Development s firm and non-firm power. The remaining 30% is designated as the reasonable portion, and, pursuant to the order, must be sold in a fair, equitable and nondiscriminatory manner, pursuant to market-based principles and procedures with a preference in the marketing of such power being given to the utilities and the Power Purchasers which had participated in the PL proceeding. The D.C. Circuit Court of Appeals affirmed FERC s rulings in all respects. No further appeals were filed and the litigation is now concluded. -36-

45 Endangered Species and Other Fish Issues Endangered or Threatened Species of Fish. In 1997 and 1999, the Upper Columbia River ( UCR ) Steelhead and Spring Chinook, respectively, were listed as endangered. In 1998, the UCR bull trout was listed as threatened. Bull trout occurrences in the Wanapum and Priest Rapids Development area are extremely small numbers frequenting the upper reaches of the Wanapum reservoir. The ESA makes it unlawful for any person subject to the jurisdiction of the United States to take any endangered species which, under the ESA, includes an intentional or negligent act that will harm or harass, or that creates the likelihood of injury to a species by significantly disrupting normal behavior patterns. Violations of the ESA can be enforced by governmental and citizen suits. There are both civil and criminal penalties. NOAA Fisheries, under certain circumstances, has the power to legalize any incidental taking of a listed species. NOAA Fisheries can only legitimize the action if it determines, after required consultation, that the action (Developments operations) is not likely to jeopardize the continued existence of any listed species or result in the destruction or adverse modification of its critical habitat. If jeopardy or adverse modification is found, NOAA Fisheries can suggest reasonable and prudent alternatives so as to avoid jeopardy. If jeopardy is not avoided through the implementation of reasonable and prudent alternatives, no incidental take statement can be issued. In such event, project operations would continue to be subject to being enjoined or altered, and the District would remain exposed to fines and penalties for ESA violations. The District has been engaged in consultation with NOAA Fisheries under Section 7 of the ESA and has obtained a Biological Opinion related to the continued operation of the Wanapum and Priest Rapids Developments. The District has filed the Biological Opinion with FERC and requested that it issue an appropriate order incorporating the conditions of the Biological Opinion into the District s Priest Rapids license. The issuance of such an order will provide the District with an incidental take statement with respect to the listed ESA species addressed in the Biological Opinion. Any takings which are in compliance with the Biological Opinion will not constitute an ESA violation. The order was issued by FERC on December 16, To the extent such mitigation measures required by the May 2004 Biological Opinion and the FERC s order of December 16, 2004 cause the unit cost of power from the Developments to increase to the point where it is not competitive, it would have a materially adverse impact on the District. The District expects the unit cost of power from the Developments, though increasing, will remain competitive throughout the foreseeable future. Mitigation Measures. In view of the listing of salmon species under the ESA, Bonneville, the United States Bureau of Reclamation, and the United States Army Corps of Engineers have undertaken and are implementing certain measures to protect salmon. Many of these measures have been mandated by NOAA Fisheries pursuant to the ESA in Biological Opinions produced under Section 7 of the ESA. These regulatory requirements are required by the ESA in order for these federal agencies to avoid actions that would jeopardize the listed species. The most recent of these was produced in December Some of these required measures affect river operations on the Snake and Columbia Rivers. Even though the Priest Rapids and Wanapum Developments are located upstream from the confluence of the Snake and Columbia Rivers, some measures, such as substantial seasonal flow augmentations, do affect that portion of the Columbia River where the Developments are located. In particular, the flow augmentations cause over-generation in the spring and early summer when there is a glut of hydroelectric generation and the value of such energy therefore is low, and a shortage of generation in the winter when the energy is needed and the price of replacement energy therefore is high. The measures also have resulted in significant increases in expenditures by Bonneville for its fish and wildlife program to assist in recovery efforts. The Biological Opinion issued by NOAA Fisheries in May 2004 for the Priest Rapids Project includes 40 actions to mitigate for Spring Chinook and Steelhead, which are currently being implemented. In 2001 several environmental groups sued NOAA Fisheries claiming the Biological Opinion issued in December 2000 was deficient. Several parties, including the Public Power Council ( PPC ) in Portland, Oregon, were allowed to intervene as parties in the suit. The District is a member of the PPC. Intervention as a party provides the opportunity to participate in a significant way if the federal judge in Portland decides to refer the case to mediation. The December 2000 Biological Opinion clearly states federal policy to postpone consideration of any dam breachings. -37-

46 In 2001, the federal district court in Oregon ruled that NOAA Fisheries listing of coastal coho stocks under the ESA was arbitrary and capricious because it failed to list the entire population of Oregon coastal coho that it had identified as the proper listing unit. The court ruled that once NOAA Fisheries had identified certain coho hatchery populations as part of the listing unit the evolutionary significant unit of coastal coho it could not as a matter of law exclude those hatchery populations from the actual listing itself under the ESA. In response to this decision, NOAA Fisheries has voluntarily elected to review its listing decisions for coastal and Columbia basin stocks in order to rectify the deficiencies identified by the court. The existing listings remain in effect pending the completion of this review, and it is an open question whether the review will affect the stocks of UCR stocks affected by the Developments since the factual circumstances governing those listings may differ from those relating to Oregon coastal coho. Vernita Bar Agreement. The District funded a series of studies regarding Columbia River Fall Chinook salmon in the 1980s that contributed to the completion of the Vernita Bar Agreement in Parties to the agreement are the District, Chelan County PUD, Douglas County PUD, Bonneville, Washington Department of Fish and Wildlife ( WDFW ), Oregon Department of Fish and Wildlife, NOAA Fisheries, and the Colville, Umatilla, and Yakama Indian Tribes. Under the agreement, daytime flows are kept low during the spawning period to prevent spawning from occurring at high elevations on Vernita Bar. These areas would later become dewatered when water levels fall, thus exposing the eggs. This flow is kept in place from the end of spawning (typically late November) until fry emergence is completed (ranging from late April to early June). The primary effect of this operation is to shift substantial amounts of peak generation into off-peak periods. Reduced capacity and on-peak generation results in additional costs to the District s Electric System for purchased power during on-peak periods. The District has developed a cost-sharing arrangement with Bonneville that reduces some of the cost of the program. Hanford Reach Fall Chinook Protection Agreement. From 1988 to the present, the Vernita Bar Agreement has provided for stable spawning flows and ensured that minimum flows would keep a very high percentage of redds covered through emergence. In 1997, additional concerns were raised about the effects of flow fluctuations on Fall Chinook fry rearing in the Hanford Reach of the Columbia River. Bonneville funded a multi-year study by the WDFW to evaluate the impacts of flow fluctuations on Fall Chinook fry. During high flows in 1997, very little fry impact was observed. During an average flow year of 1998, WDFW researchers sampled over 30,000 newly emerged fry from isolated pools along the river margin. In the fall of 1998, WDFW approached Bonneville and Grant, Chelan and Douglas County PUDs about potential operational modifications to address the issue. Starting in 1999, the mid-columbia operators provided an experimental re-shaping program to limit flow fluctuations in the Hanford Reach, which evolved from year to year. The basic approach of the program was to develop an allowable fluctuation band (in kcfs) that varies according to defined criteria. The experimental re-shaping program was concluded in 2003 with the development of an acceptable flow regime to limit flow fluctuations. In March 2004, the Hanford Reach Fall Chinook Protection Agreement was signed by Grant, Chelan, and Douglas County PUDs, Bonneville, WDFW, NOAA Fisheries, and the Colville Confederated Tribe. The agreement combines the elements of the Vernita Bar Agreement with the experimental flow re-shaping program developed from to reduce stranding and entrapment of Fall Chinook fry. The agreement involves close coordination among the District, Bonneville, Chelan and Douglas County PUDs to provide a flow regime that protects Fall Chinook from spawning through emergence and early rearing and is based on the experience learned from and is supported by an extensive body of research, modeling and evaluation. Additional signatories to the Hanford Reach Agreement are the U.S. Fish & Wildlife Service and the Yakama Nation. Section 401 Water Quality Certification. In connection with its application to FERC for a new license for the Priest Rapids and Wanapum Developments, the District applied to the Washington State Department of Ecology on September 17, 2003 for a water quality certification in accordance with Section 401 of the Clean Water Act. On August 30, 2004, at the Department of Ecology s request, the District withdrew the request for certification. The District resubmitted its request on October 8, 2004 and subsequently on October 4, 2005 and most recently on October 2, A new FERC license is contingent on obtaining either a waiver of certification or a water quality certification. The Washington Department of Ecology is planning to issue a draft Section 401 Water Quality Certification shortly and allow a 30-day public comment period. A final Section 401 Water Quality Certification will contain terms and conditions for the Clean Water Act compliance during the next license and is expected by the -38-

47 end of calendar year The certification could entail significant new conditions to the operation of or require modifications to the Developments that have been seen in other Section 401 water quality certifications issued by the Department of Ecology. Draw-Down and Dam Removal Proposals. Removal or drawdown of dams is a controversial issue that has been subject to much discussion in the Pacific Northwest and the nation. Neither are significant issues in the case of the mid-columbia River. However, the removal of several of the 11 hydroelectric projects on the Columbia River and/or permanent draw-downs could have a significant effect on any or all of the following: local and/or regional economies, power supplies, navigation, flood control, wildlife habitat and irrigation, dam owners and operators and power purchasers. The District believes that it is unlikely that any federal or state regulatory agency would order dam removal or draw-down of the Priest Rapids or Wanapum Developments in connection with any pending or future ESA listings. Removal or permanent draw-down of either Development would preclude any power generation and would have a material adverse effect on the financial condition of the District and the security for the Parity Bonds. Potential Effects on District of ESA Proceedings. The District has committed substantial resources to mitigate the impacts of the Developments on anadromous fish, including species listed as threatened or endangered. Nonetheless, it is possible under the ESA that the continued operation of the Developments, at least during certain periods each year, could be jeopardized. As a result of its ongoing negotiations with federal and state regulatory agencies (ESA Section 7 consultation process), the District expects that it will be permitted to continue to operate the Developments, subject to required protection measures. These measures are likely to include substantial spill requirements, concomitant loss of projected power generation at the Developments, and a corresponding increase in the unit cost of power. In addition, a court could issue injunctive relief against the District in an ESA enforcement action that could result in a significant or complete loss of project power generation at the Developments and a corresponding increase in the unit cost of power. To the extent the unit cost of power from the Wanapum Development increases to the point where it is not competitive with other firm power resources in the region, it would have a material adverse effect on the security for the Parity Bonds, including the Bonds. -39-

48 Debt Service Requirements for Wanapum Development The following table gives debt service requirements for the Outstanding Parity Bonds and debt service for the Bonds. Year (1) Table 6 WANAPUM DEVELOPMENT TOTAL DEBT SERVICE REQUIREMENTS Outstanding Parity Bonds (2) The Bonds Principal Interest Total Aggregate Debt Service on Parity Bonds (3) 2006 $ 15,027,183 $ 15,027, ,180,247 $ 1,230,000 $ 10,066,600 $ 11,296,600 32,476, ,179,166 1,730,000 9,529,989 11,259,989 32,439, ,658,332 4,385,000 9,449,524 13,834,524 32,492, ,653,567 4,560,000 9,228,384 13,788,384 32,441, ,638,899 4,785,000 8,998,396 13,783,396 32,422, ,634,705 5,020,000 8,757,054 13,777,054 32,411, ,644,963 5,290,000 8,494,306 13,784,306 32,429, ,652,257 3,870,000 8,249,246 12,119,246 30,771, ,655,166 4,070,000 8,062,981 12,132,981 30,788, ,647,572 4,260,000 7,857,096 12,117,096 30,764, ,656,325 3,725,000 7,641,591 11,366,591 30,022, ,835,216 3,200,000 7,449,731 10,649,731 28,484, ,834,584 3,360,000 7,284,336 10,644,336 28,478, ,835,004 3,545,000 7,110,660 10,655,660 28,490, ,820,481 3,720,000 6,927,420 10,647,420 25,467, ,836,983 3,915,000 6,735,117 10,650,117 25,487, ,612,685 4,115,000 6,532,734 10,647,734 20,260, ,616,785 4,325,000 6,319,988 10,644,988 20,261, ,617,835 4,550,000 6,096,379 10,646,379 20,264, ,611,105 4,780,000 5,861,124 10,641,124 20,252, ,616,345 5,030,000 5,618,019 10,648,019 20,264, ,612,325 5,285,000 5,362,164 10,647,164 20,259, ,613,805 5,555,000 5,093,308 10,648,308 20,262, ,612,680 5,840,000 4,810,652 10,650,652 20,263, ,600,710 5,355,000 4,513,429 9,868,429 18,469, ,602,660 5,630,000 4,235,086 9,865,086 18,467, ,599,560 5,925,000 3,942,432 9,867,432 18,466, ,600,925 6,235,000 3,634,434 9,869,434 18,470, ,983,963 6,555,000 3,310,309 9,865,309 16,849, ,985,438 6,895,000 2,969,524 9,864,524 16,849, ,982,613 7,260,000 2,611,046 9,871,046 16,853, ,640,000 2,229,629 9,869,629 9,869, ,040,000 1,828,225 9,868,225 9,868, ,465,000 1,405,771 9,870,771 9,870, ,910, ,954 9,870,954 9,870, ,375, ,711 9,867,711 9,867,711 Total (3) $ 440,660,079 $ 186,430,000 $ 209,670,345 $ 396,100,345 $ 836,760,424 (1) January 1 payments each year allocated to the prior calendar year. (2) Excludes the Refunded Bonds. (3) Columns may not add due to rounding. -40-

49 THE ELECTRIC SYSTEM The Electric System consists of substations, transmission and distribution lines, telecommunication facilities, and associated general plant, together with a 40-year contract interest in the Potholes East Canal ( P.E.C. ) Headworks Powerplant Project, a 40-year contract interest in the Quincy Chute Project, a 32 MW diesel generation facility, and the right to receive power from a wind farm. The Electric System is owned and operated by the District and serves all of Grant County. During 2005 the Electric System operated approximately 4,144 miles of lines and served approximately 41,722 retail customers. Gross operating revenues for 2005 totaled $169.6 million. As of December 31, 2005, the District s gross investment in its Electric System was $608.5 million and its net investment was $377.6 million. The District s Electric System has established as a goal the funding of (on average) no more than 50% of capital improvements from bond proceeds, excluding generation projects. Retail Energy Sales and Customers The Electric System s gross operating revenues (excluding interest income) for 2005 totaled $169.6 million. Of this total, approximately $95.1 million (56%) was derived from retail energy sales to an average of 41,722 customers. Sales to other utilities provided $67.0 million of revenues (39.5% of the total). See Power Supply Management and Power Marketing. Non-energy retail sales provided $7.5 million (4.5% of the total). Of the retail customers, 76% were residential customers, providing 29.6% of all retail energy revenues. The number of retail customers, energy sales and revenues for the year ended December 31, 2005, for each major retail customer class, are listed below. Table 7 ELECTRIC SYSTEM 2005 RETAIL CUSTOMERS, ENERGY SALES AND REVENUES Average Number of Customers Energy Sold Revenue (2) Customer Class (1) Number % GWh (3) % $000 % Residential 31, , Commercial 5, , Irrigation 4, , Industrial , , Other Total 41, , , (1) Statistics reported by class of service classification. (2) Includes municipal taxes. (3) Gigawatt hour equal to 1,000 MWh. -41-

50 The ten largest customers, based on retail revenue of the Electric System for the 12 months ended December 31, 2005, are shown in the following table. Table 8 ELECTRIC SYSTEM LARGEST CUSTOMERS (Listed alphabetically) Customer Location Product Basic American Foods, Inc. Moses Lake Dehydrated potatoes and fresh packed potatoes Chemi-Con Materials Corp. Moses Lake Process aluminum foil for capacitors Columbia Colstor, Inc. Quincy Refrigerated frozen storage and refrigeration to J.R. Simplot freeze tunnels D&L Foundry Inc. Moses Lake Manhole rings and covers and other castings Eka Chemicals, Liquid and Crystal Moses Lake Crystal sodium chlorate and liquid sodium chlorate Inflation Systems, Inc. Moses lake Automobile airbag inflation systems J.R. Simplot, ML Quincy Vegetables processor Lamb Weston, Inc. Quincy French fried potatoes Ochoa Ag Unlimited Foods, Inc. Warden Frozen potato products REC Solar Grade Silicon LLC Moses Lake Polycrystalline silicon and saline gas The Electric System s ten largest customers used 41% of total retail energy sold and provided 33% of retail revenues in The average revenue from energy sales from these customers in 2005 was 3.13 cents/kwh. The largest customer accounted for 13% of retail revenues in The District s rate structure for industrial customers is designed to include the marginal cost of additional power purchases. Generally, any loss in sales to these customers likely would be offset by a corresponding reduction in net power costs. Several large industrial and manufacturing customers are in the process of locating or enlarging operations in Grant County. REC Solar Grade Silicon LLC (see Table 8) has begun construction of a large expansion to its facilities that will nearly double its electrical load. Microsoft Corporation and Yahoo each have broken ground on large internet server farms, which will have substantial electrical loads and will utilize the District s telecommunications infrastructure. A bio-diesel facility has committed to the District by way of paying for necessary capital required for substation construction and other industrial facilities have recently expressed a strong interest in locating in the county. Grant County has been poised for growth with low-cost electricity and desirable infrastructure for many years. An increase in industrial and manufacturing loads of 25-30% will likely materialize over the next three to five years. The District feels that this growth is manageable based on the availability of resources and the structure of the New Power Sales Contracts at the Wanapum and Priest Rapids Developments. -42-

51 The following table sets forth the customers, energy sales and revenues of the Electric System as derived from the financial statements of the Electric System for the fiscal years indicated. Table 9 ELECTRIC SYSTEM RETAIL CUSTOMERS, ENERGY SALES, AND REVENUES Number of Customers (Average) (1) Residential 30,719 30,211 30,619 31,150 31,665 Commercial 5,398 5,249 5,314 5,398 5,458 Irrigation 4,429 4,297 4,342 4,352 4,391 Industrial Other (2) Total Customers 40,751 39,958 40,477 41,105 41,722 Energy Sales (MWh) (1) Residential 632, , , , ,698 Commercial 383, , , , ,899 Irrigation 437, , , , ,299 Industrial (3) 1,200, ,088 1,252,553 1,339,444 1,539,961 Other (2) 5,189 5,123 5,212 5,254 5,286 Total Energy Sales 2,660,306 2,439,741 2,791,272 2,892,344 3,125,143 System Peak (MW) Winter Summer Revenues from Energy Sales ($000) (1) Residential $ 25,454 $ 25,839 $ 26,679 $ 27,463 $ 28,154 Commercial 12,697 12,695 13,330 13,763 13,842 Irrigation 14,175 14,708 16,231 15,621 15,990 Industrial (3) 22,824 18,871 32,933 35,283 36,209 Other (2) Total Revenues (3) $ 75,987 $ 72,923 $ 90,014 $ 92,987 $ 95,066 (1) Statistics reported by class of service classification. (2) Other includes street lighting, public authorities and non-firm retail energy sales. (3) The decrease in both energy sales and revenues from energy sales in 2002 was a result of load reduction actions taken by industrial customers in response to economic conditions. The increase in energy sales in 2003 to 2005 reflects a return of industrial loads to historical levels and a general average rate increase of 4%. In addition, the increase in industrial revenues in 2003 to 2005 reflects increased loads combined with the new rate design that includes the marginal cost of additional power purchases. The Electric System has experienced a stable residential customer base over the past five years. It is estimated that over 90% of all homes in the District s service area are electrically heated. Only Moses Lake, Quincy and Warden have natural gas service available. The single most important variable in power sales to residential accounts from year to year is weather as it relates to heating and cooling requirements. The average annual residential power bill in 2005 was $890 and the average cost per kwh for residential service was 4.2 cents. The MWh usage in industrial accounts from 2001 to 2005 grew 28.25%. The significant increase in revenue from industrial use from $22.8 million in 2001 to $36.2 million in 2005, or 59%, is partially due to the industrial rate containing a direct tie to the Bonneville rate charged to the Electric System. Thus, the increase in revenue is to help -43-

52 offset the increase in cost to the Electric System of Bonneville power. Variations in energy sales from one year to the next for the most part reflect changes in weather patterns. Power Supply Management and Power Marketing The power generated at the Priest Rapids and Wanapum Developments is a low cost resource for the Electric System. However, the amount of generation that is available to deliver over any given time period is highly variable. Minimal storage is available in the Developments reservoirs and the Developments are considered a run of the river operation. The amount of energy generated at the Priest Rapids and Wanapum Developments depends on the amount of water released from upstream reservoirs. The river flows are coordinated to meet a number of constraints, including optimizing generation, providing minimum flows for fish, and meeting other operation constraints. Regional water conditions also influence the amount of flow made available for generation, varying from high water conditions to drought conditions. This variation in flow generates surplus energy in some periods and a need for the Electric System to purchase energy in other time periods. To manage Electric System resources in this variable environment, the Electric System uses the lowest water year on record as a baseline to project available power from the Priest Rapids and Wanapum Developments ( critical water planning ). Additional firm resources such as the Bonneville contract are included in this planning. Market purchases are made in periods that are forecasted to be deficit, and sales are made in time periods where critical planning would forecast a surplus. The Electric System s retail load, serving Grant County customers, is also variable. Some industrial loads served by the Electric System have an elastic demand curve for electricity. Additionally, residential, commercial and irrigation consumption are significantly affected by weather. During periods of extreme weather patterns, consumption from these customer classes will also increase or decrease in response. To manage this variable resource and system requirements, the District enters into a number of wholesale energy transactions. These include purchases and sales in the daily and pre-schedule market. The District is also routinely a party to a number of other short-term power and capacity contracts. The District s power marketing activities are confined to balancing District loads and resources with the intent of maximizing the benefit for Electric System retail customers. Power is purchased only to meet Electric System projected loads. Power surplus to the Electric System s needs is resold in a manner that seeks to provide the greatest return. Because the District plans its energy resource requirements on critical water at its various generating projects, in almost all years, the Electric System has surplus power to sell. As a result, the District has historically generated substantial revenues from energy sales to other utilities. The 2001 and 2002 sales to other utilities were unusually high ($464.0 million and $110.9 million, respectively) compared to 2003, 2004 and 2005 sales ($55.7 million, $52.1 million and $67 million, respectively). The results in 2001 and 2002 are extraordinary relative to any prior year, and reflect the dramatic and unprecedented increase in electricity prices in the power markets and the regional imbalances in the supply and demand of electric energy resulting from increased demand for power, the limited addition of new generation sources in recent years, and regional drought conditions. Just as revenues from the sales to other utilities increased during these years, purchased power costs also dramatically increased. The purchased power cost for 2001 was approximately $513.9 million (an increase of approximately $386.4 million over 2000). The purchased power cost in 2002 similarly was extraordinarily high at approximately $150.9 million. Purchased power costs and energy sales to other utilities returned to a more typical level in 2003 and continued to remain more stable through See Management s Discussion of Results for a discussion of the deferral of purchased power costs in 2001 and To mitigate risks associated with power marketing activities, the District has established risk management guidelines that have been adopted by the District s Commission. In recognition of the increasing number of power transactions, price volatility and changing power supply contracts, a Risk Oversight Committee was established in 2001 to review and update the energy risk management policies of the District and to provide greater ongoing monitoring and review of power transactions. The Risk Oversight Committee undertook a review by a utility consultant of the District s policies and controls, which was completed in the summer of Utilizing the recommendations of this report, the Risk Oversight Committee developed Energy Risk Management Policies for the District that were adopted by the District. The Energy Risk Management policies address exposure to financial risks. Key elements of the policies include: (1) Sales and purchases shall only be made to meet the District s -44-

53 prospective needs, to dispose of surplus power and to maximize use of the Priest Rapids and Wanapum Development reservoirs. No speculative sales or purchases are to be made. (2) Power transactions shall not exceed a duration of one year. (3) The District s net position in MWh s is actively monitored using a probabilistic forecast based upon a statistically produced exceedance curve for any rolling 18-month period. Position limits are set to ensure prudent action by District personnel. (4) Counterparty credit must be established and maintained to District requirements or acceptable credit enhancements must be obtained. Individual counterparty credit limits have been established and are reviewed by the Risk Oversight Committee. Individual credit exposure is monitored in relation to a percentage of total outstanding transactions. (5) Monitoring reports describing all concluded transactions and expected future transactions (priced to current market prices) as compared to the District s adopted budget for that year are reviewed by District management on a frequent basis. The District believes that, if these policies are followed, the risk of any substantial financial loss resulting from the District s power supply management activities will be limited. The District and PacifiCorp have entered into an agreement for the sale of 14 MW of firm capacity and 87,600 MWh of energy annually to PacifiCorp. This contract can be terminated upon two years written notice given by the District. The District projects that this contract will remain in place at least through The District also sells surplus firm and non-firm energy on an as available basis to various municipally-owned and investorowned utilities both within and without the Pacific Northwest. The District s low-cost power supply has made it possible for the District to sell its surplus power to utilities in the Pacific Northwest and Southwest. The table below summarizes wholesale power sales, including the portion of the District s 36.5% share of the Developments output in excess of the Electric System s needs, and the average price for the calendar years 2001 through Table 10 ELECTRIC SYSTEM WHOLESALE ENERGY SALES (1) 2001 (2) Wholesale Energy Sales ($000) $ 464,024 $ 110,932 $ 55,658 $ 52,147 $ 67,010 Total MWh Wholesales 3,257,555 2,949,245 1,575,019 1,415,993 1,432,997 Average Revenue ($/MWh) $ $ $ $ $ (1) Sales to other utilities and power marketing entities. (2) Wholesale MWhs and revenues increased substantially in Quantity increased primarily due to the District s load buydown programs for irrigation and industrial loads. Revenues increased in part due to the quantity increase and largely because prices in 2001 were significantly higher for wholesale energy than has been historically experienced. See Management s Discussion of Results. Electric Rates The District is empowered and required under the Enabling Act and by the covenants of the Bond Resolution to establish, maintain, and collect rates and charges for electric power and energy and other services adequate to provide revenues sufficient for the punctual payment of the principal of, premium, if any, and interest on all outstanding indebtedness, to pay for the proper operation and maintenance expenses of the Electric System and to make all necessary repairs, replacements and renewals thereof. Under present law, the District has the exclusive authority to set retail rates and charges for retail electric energy and services and is by law free from the rate-making jurisdiction and control of the Washington Utilities and Transportation Commission or any other state or local agency having the authority to set rates and charges for retail electric energy and services. Under the Enabling Act, the District is required to establish, maintain and collect rates or charges that are fair and nondiscriminatory and adequate to provide revenues sufficient for the payment of the principal of and the interest on revenue obligations for which the payment has not otherwise been provided and for other purposes set forth in the Enabling Act. A person or entity that has requested wholesale telecommunications services from a public utility district may petition the Washington Utilities and Transportation Commission if it believes that the District s rates, terms and -45-

54 conditions are unduly or unreasonably discriminatory or preferential. The commission may issue an order finding non-compliance. The District charges wholesale providers of telecommunications services based on a published rate schedule. Title 1 of the Public Utility Regulatory Policies Act of 1978 ( PURPA ) requires certain utilities, including the District, to consider and make determinations after public hearings regarding a set of federal standards that have three statutory purposes: end-use conservation, utility efficiency and equitable rates. The District has adopted certain standards relating to, among other things, rates, metering and advertising. The following table shows a comparison of the District s monthly electric rates for selected residential, commercial and industrial loads with the rates charged by certain major public and private Northwest utilities. The comparative monthly electric bills shown are based on specific rate schedules for each utility; the use of other schedules applicable to particular customers will yield different results. Table 11 ELECTRIC SYSTEM MONTHLY ELECTRIC BILLS COMPARISON (1) As of May 1, 2006 Residential Commercial (2) Industrial (2) (1,000 kwh) (2,000 kwh) (30 kw, 9,000 kwh) (400 kw, 150,000 kwh) Summer Season Winter Season Summer Season Winter Season Summer Season Winter Season The District: $ 47 $ 81 $ 355 $ 355 $ 3,708 $ 3,708 Washington Cities: Tacoma Power (3) ,999 6,999 City of Seattle (4) ,917 8,917 Washington State Public Utility Districts: Benton County ,555 8,620 Chelan County ,874 3,874 Clark Public Utilities (5) ,421 9,171 Douglas County ,133 3,133 Franklin County ,796 8,950 Kittitas County ,136 8,136 Mason County No ,931 9,931 Snohomish County ,318 10,611 Private Companies: Avista ,927 10,927 Pacific Power (3)(6) ,239 7,239 Portland General Electric (6) ,392 8,392 Puget Sound Energy (7) ,806 8,826 (1) Computed from the rate schedules provided by or found on the websites of the utilities listed. There are some variations in rate schedules and rate classification of the various utilities. (2) Assumes power delivered is three-phase where available. Delivery voltage varies. (3) Rates do not vary from summer to winter season. (4) Rates vary from summer to winter season for residential only. (5) Rates vary from summer to winter season for some commercial. (6) Residential bills include credits under Bonneville s Residential Exchange Program. (7) Bills include energy exchange credits. Source: The District and individual utilities. -46-

55 The District maintains rates for electric service that have been among the lowest in the nation, are based upon cost of service and have been sufficient to provide for all operating and maintenance costs and expenses, debt service, repairs, replacements and renewals and for capital additions to the Electric System. Table 12 ELECTRIC SYSTEM RECENT RETAIL RATE INCREASES Date Percentage Increase April 1, % April 1, April 1, Over the period 1999 through 2003, the District s average retail revenue requirement increased from 2.77 cents/kwh to 3.22 cents/kwh, a 3.8% compound annual increase. The increase in retail revenue requirements is primarily a product of continued growth in Grant County, which places increasing pressure on power supply costs. At the same time growth in Grant County is occurring, external environmental issues are reducing the amount of generation available from the Priest Rapids and Wanapum Developments. The District must replace lost generation with much higher cost power and also purchase growth-related power supply that costs more than the power from the Developments. Since November 1, 2005, however, the District has taken more low-cost power from the Priest Rapids Development. See THE PRIEST RAPIDS DEVELOPMENT Priest Rapids Development Output and Power Sales Contracts. The District adopted a 4% general retail rate increase which took effect April 1, 2003 to provide adequate revenues to amortize purchased power expenses deferred from 2001 and 2002 pursuant to the statement of Financial Accounting Standards No. 71 ( FAS 71 ). See Management s Discussion of Results. There are currently no plans to implement further rate increases. The Electric System s Power Supply Until November 2005, power supply for Electric System load growth that could not be met from District resources (including Bonneville and other contracts) was purchased from the market. Effective November 1, 2005, the District began using a larger share of benefits of the power and energy from the Priest Rapids Development. In addition, the current Wanapum Power Sales Contracts expire in 2009, at which time the District will begin using a larger share of the benefits of the power and energy from the Wanapum Development. The New Power Sales Contracts for the sale of Priest Rapids and Wanapum Development power provide for the District to continue to make use of its existing Bonneville contract (which expires in 2011) to meet load requirements and in return the District s Electric System provides a like amount of its share of the Priest Rapids and Wanapum Development output to the Purchasers at the Bonneville price. See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE POWER CONTRACTS. In 2006, the District expects the Electric System to obtain approximately 53% of its firm energy requirements from the District s share of the Priest Rapids and Wanapum Developments, the Quincy Chute Hydroelectric Project, P.E.C. Headworks Powerplant Project, the Nine Canyon Wind Project, the District s Diesel Plant and market purchases. The remainder of the Electric System s power supply for 2006 is expected to be obtained from Bonneville. As described above, the cost of the Bonneville power to the Electric System is offset directly by the additional wholesale power sales provided by the New Power Sales Contracts. Quincy Chute Project. Under an agreement with three irrigation districts, the District purchases the entire capability and output of and operates the Quincy Chute Project, a 9.4 MW hydroelectric generating facility operating seasonally during the irrigation season (March through October). The District financed, designed and constructed the project and is responsible for operation and maintenance during the period of the agreement, which will expire in The Quincy Chute Project began commercial operation on October 1, 1985, and its net energy generation was 31,493 MWh in

56 P.E.C. Headworks Powerplant Project. Under an agreement with three irrigation districts, the District purchased the entire capability and output of a 6.5 MW generating facility at the P.E.C. Headworks at the O Sullivan Dam, which operates during the irrigation season (March through October). The District financed, designed and constructed the project and is responsible for operation and maintenance during the period of the agreement, which will expire in The P.E.C. Headworks Project began commercial operation on September 1, 1990, and its net energy generation was 21,983 MWh in Bonneville Power Administration. Bonneville markets power from 30 federal hydroelectric projects, from several non-federally-owned hydroelectric and thermal projects in the Pacific Northwest, and from various contractual rights with peak generating capacity of approximately 20,000 MW and a firm energy capability of approximately 9,200 average MW (the Federal System ). These projects are built and operated by the United States Bureau of Reclamation and the United States Army Corps of Engineers and are located primarily in the Columbia River basin. The Federal System currently produces approximately 45% of the region s energy requirements. The Bonneville transmission system includes over 15,000 circuit miles of transmission lines, provides about 75% of the Pacific Northwest s high-voltage bulk transmission capacity and serves as the main power grid for the Pacific Northwest. Its service area covers over 300,000 square miles and has a population of about ten million. Bonneville sells electric power at cost-based wholesale rates to more than 130 utility, industrial and governmental customers in the Pacific Northwest. Legally, Bonneville is required to give preference to publicly-owned utilities and to customers in the Pacific Northwest region in sales of its wholesale power. In 1996, Bonneville administratively divided its organization into two business lines: its power business line and its transmission business line. In 2005, Bonneville initiated a plan to recombine the administrative parts of the two lines to reduce costs. Bonneville initiated and concluded a subscription process for purchase of power from the Federal System upon the expiration of its existing customer contracts on September 30, The District signed a contract with Bonneville to purchase amw of a Shaped Block Product and a Full Requirements Product for the District s Grand Coulee load. The Shaped Block portion of the District s Bonneville Subscription Contract is for monthly fixed amounts of power and expires on September 30, See SECURITY FOR THE PARITY BONDS Contingent Payments and Obligations. The District met most of its increasing load requirements until 2005, when the Priest Rapids Development s 1956 Power Sales Contracts expired, by purchasing additional amounts of firm power from other parties. Since the majority of the District s current contract with Bonneville is for fixed amounts of power through 2011, the District s ability to use Bonneville power for load growth was limited to a purchase quantity increase in 2006 of approximately 10 amw. The cost of the District s power from Bonneville currently is approximately three times the cost of the Priest Rapids and Wanapum Developments power and is expected to remain significantly more expensive than the Developments power. Based on its base case load forecast, by 2007 the District will purchase about 52% of its energy from Bonneville. The District is a statutory preference customer of Bonneville and, as such, has priority for power over Bonneville s nonpreference customers. Bonneville is required by federal law to recover all of its costs through the rates it charges its customers. Under Bonneville s adopted rate methodology and its customer contracts, Bonneville s rates are subject to revision every six months in order to enable Bonneville to recover its actual costs of service. The federal government has borrowed money on Bonneville s behalf, and Bonneville is required to make annual payments to the U.S. Treasury to repay such borrowings. In the rate cases for its current contracts, Bonneville committed to a rate design that would build and maintain financial reserves sufficient for the agency to achieve a specific probability of making its U.S. Treasury payments in full and on time. The contracts contain Cost Recovery Adjustment Clauses ( CRAC ) that permit rates to be adjusted upward if Bonneville s net reserves fall below a threshold amount, if purchased power supply costs are greater than expected, or if Bonneville is projected to miss a U.S. Treasury payment. There are three CRACs: a Load-Based ( LB ) CRAC, a Financial-Based ( FB ) CRAC and a Safety Net ( SN ) CRAC. The Cost Recovery Adjustments are not additive, but are indexed off the base rates effective October 1, To date, all three CRACs have been invoked. Rates effective October 1, 2001 reflected a 46% average rate increase from $20/MWh to $29/MWh with no shaping or ancillary services and excluding transmission. For the fifth year of the contract, beginning October 1, 2006, the increase of the base rate is approximately 25%. Bonneville has completed the process for setting wholesale power rates for the period beginning fiscal year October 1, 2006 through September 30, 2009 for its subscription contracts, including the District s, that are slightly -48-

57 lower than prior rate levels. Bonneville also has proposed to replace the current three CRACs with one CRAC and a Dividend Distribution Clause that would provide that rate levels for each of the three fiscal years would be subject to an annual adjustment on the basis of forecasted financial results for the prior fiscal year. There also is an Energy NFB Surcharge that is available to allow Bonneville to recover fish and wildlife costs. On September 21, 2006, FERC issued an order approving Bonneville s proposed wholesale power rates on an interim basis and provided for additional comments. This order cleared the way for the rates to go into effect on October 1, All of Bonneville power contracts, including the District s, expire in Bonneville, its customers and other interested parties have been discussing the terms of new contracts that become effective in New contracts are expected to be offered by Bonneville in 2007 and executed in Bonneville has indicated that it would prefer to have customers in the region assume the role of meeting their own incremental load growth and the incremental cost incurred by Bonneville to meet such increased loads, if any, should be recovered under a separate rate increment reflective of the cost of acquiring resources to serve such loads. It is expected that Bonneville will offer an array of products comparable to those currently offered and that preference customers, including the District, will continue to be able to purchase power to meet their net requirements. However, based on the increase in power received by the Electric System from the Developments as a result of the New Power Sales Contracts, the District anticipates signing a new Bonneville power contract only to serve the load in the Grand Coulee city area. Bonneville proposes to sell firm power to a preference customer in an amount not to exceed the customer s net requirements in 2010 at Tier 1 rates, which will be the lowest cost rates and designed to cover the costs of the current Federal System. Customers will be charged Tier 2 rates for firm power to serve load growth, for which rates will be set to fully recover the costs to Bonneville of acquiring new resources. Customers will also have the option of acquiring other resources to serve their load in excess of their Tier 1 amount. There are any number of factors that could impact Bonneville s cost of service and rates, including federal legislation, Bonneville s obligations regarding its outstanding federal debt, number of customers, water conditions, fish and other environmental regulations that could impact expenditures and amount of power produced at various projects, capital needs of the Federal System, and regional transmission issues. See THE WANAPUM DEVELOPMENT Transmission of Power from Wanapum Development for a discussion of the District s transmission contract with Bonneville. Canadian Treaty. The Columbia River Treaty (the Treaty ), a 60-year treaty between the United States and Canada relating to cooperative development of the water resources of the Columbia River basin, was placed in effect by an exchange of notes and ratifications on September 16, Pursuant to the Treaty, Canada has constructed three water storage facilities in Canada and is entitled, among other things, to receive one-half of the downstream power benefits defined in the Treaty. The United States and Canada have designated entities that are empowered and obligated to carry out the operating arrangements necessary to implement the Treaty. The U.S. entity is composed of the Administrator of Bonneville and the Division Engineer, North Pacific Division, United States Army Corps of Engineers; the Administrator is chairman. The Canadian entity is the British Columbia Hydro and Power Authority. Operation of the Priest Rapids and Wanapum Developments is affected by the Treaty. In general, the Treaty and its implementing agreements are implemented via the Pacific Northwest Coordination Agreement which provides a means to coordinate the operation of all major power plants and transmission systems in the Pacific Northwest for the mutual benefit of the participants and a method to obtain and distribute the increased power benefits resulting from construction of the Canadian water storage facilities. These agreements expire in The parties are still awaiting the FERC s response to an application dated October 29, 1996 for a declaratory order that the coordination agreements are not subject to the FERC s Order 888 or, in the alternative, an order granting waiver of all requirements imposed by Order 888. Conservation and Energy Reacquisition. The District is adapting its long-term customer advisory programs with a greater focus to educate its communities on the economic and societal benefits of conservation and efficiency and to empower them to make smarter, cost-effective decisions about their power consumption. The District has offered and continues to offer a variety of conservation programs in an effort to meet the needs of its residential, commercial, agricultural and industrial customers. These programs are designed primarily to provide customers -49-

58 with cost-effective assistance to reduce their energy costs and to acquire cost-effective supplemental power resources to meet the District s loads. The District has been actively involved in conservation programs since the Residential Conservation Service Program required by the National Energy Conservation Policy Act of As a result of the Pacific Northwest Electric Power Planning and Conservation Act (1980), Bonneville began implementing conservation programs for resource acquisition purposes. Utilities, including the District, carried out these programs on a local level. In 1995, Bonneville reduced conservation programs to a minimum with hopes that utilities would maintain them without its support. The District, recognizing the value of promoting cost-effective energy conservation, voluntarily continued to promote and finance programs without Bonneville s financial assistance. In February 2001, the District increased conservation activities based upon an early start option included in the Bonneville Conservation and Renewables Discount ( C&RD ) program. This five-year program provided a rate discount that enabled the District to spend less on wholesale energy purchases and use the savings to fund local conservation and renewable energy resource activities. The District chose to use the nearly $3,650,000 for conservation related activities. The current C&RD program expired on September 30, On March 14, 2006, the District continued its conservation activities and added a new program by implementing an early start option in the Bonneville Conservation Rate Credit ( CRC ) program which replaced the C&RD program on October 1, The CRC program will continue for the period of The District will receive approximately $846,600 per year from the CRC program. In addition to supporting its own and Bonneville s cost-effective programs, the District is a member of the Northwest Energy Efficiency Alliance (the Alliance ) and holds a board director seat. The Alliance is a non-profit group of the region s electric utilities, state and local governments, public/environmental interest groups and efficiency industry representatives, which was formed to improve the efficiency of electric use in the Pacific Northwest. The Alliance, through market transformation strategies, supports regional programs that make affordable, energy efficient products and services available in the marketplace. The Alliance has garnered a total of 146 amw since it began in late Conservation opportunities are being actively pursued by the District to achieve a least-cost power supply. Conservation cost-effectiveness will be measured against the avoided cost of the next new resource available to the District, as defined by the Washington Constitution and state law. The amount spent for programs each year is established through the District s annual budgeting process. Randolph Road Generating Station. The District, due to forecasts of very low water conditions and expected power shortages in the Northwest, constructed a 32 MW diesel generation facility within Grant County in the spring of This facility is comprised of 20 Caterpillar diesel generators equipped with pollution control devices to reduce nitrous oxide emission by more than 85%. Construction of the generating station was funded from Electric System bond proceeds and cash reserves. Diesel fuel for the generators, when needed, is expected to be purchased under a State of Washington umbrella diesel fuel contract arrangement. The District s Randolph Road Generation Station has been operated on a very limited basis due to the drop in electric prices and the changing load and resource balance picture in the Northwest. The District intends to maintain the site to use the generation for reserves, if needed, and in case drought conditions cause supply shortages during the upcoming winter or in future periods. Nine Canyon Wind Project, Phase I. The District entered into a power purchase agreement with Energy Northwest for the purchase of 25% of the generating capacity of Phase I of the 48.1 MW Nine Canyon Wind Project. The power purchase agreement will terminate on July 1, The Nine Canyon Wind Project is a wind energy generation project located approximately eight miles southeast of Kennewick, Washington in the Horse Heaven Hills. Average wind speeds measured on the site at a level of 50 meters measured between 14 and 16 miles per hour. This will produce an expected annual capacity factor for the wind turbines of between 25% and 35%, with an overall project average of about 30%. Phase I of the project became commercially operable in Costs of constructing the project were financed through the issuance of $70,675,000 principal amount of Wind Project Revenue Bonds by Energy Northwest, which -50-

59 mature July 1, In 2005, Energy Northwest refunded a portion of the bonds issued in Annual costs, including repayment of debt service, is paid by the purchasers. The District is obligated under the power purchase agreement to pay 25% of the annual costs of the project in return for 25% of the project s output whether or not the project is operating or capable of operating. The District could be required to pay up to an additional 25% of the District s share of Phase I in the event of a default by another purchaser or purchasers. Annual bus bar generation costs, with expected Renewable Energy Production Incentive rebate payments, were estimated at $35 per MWh with a 3% annual escalation. The actual net cost of power for the 12 months ended December 31, 2005 was $35 per MWh. Transmission costs will vary depending on the variation of the wind resource. Phase II of the Nine Canyon Wind Project went into commercial operation on December 31, 2003 with an additional 15.6 MW. While the District did not elect to participate in Phase II, it did change the costs to the District. The District is responsible for 25% of the debt service costs of Phase I and 18.88% of the annual operating costs of the combined Phase I and Phase II Nine Canyon Wind Project. In 2005, the District received approximately 33,000 MWh of wind generation output from the project. Phase III of the Nine Canyon Wind Project is expected to become commercially operable on or before March Costs of constructing Phase III of the project are expected to be financed through revenue bonds issued by Energy Northwest in late The District has elected not to participate in Phase III of the project. Energy Northwest. The District is a member of Energy Northwest and a participant in Energy Northwest s Nuclear Projects Nos. 1 and 3, which have been terminated. The District, Energy Northwest, and Bonneville have entered into separate Net Billing Agreements with respect to $3.9 billion in outstanding bonds for the Energy Northwest s Project No. 1 and 70% ownership share of Project No. 3 (collectively, the Net Billed Projects ). Under the agreements, the District is unconditionally obligated to pay Energy Northwest its pro rata share of the total costs of the projects, including debt service, whether or not construction is terminated. The District s assignment of these project costs have been assumed by Bonneville at the levels of 0.486% and 0.420% of the capability of Project No. 1 and the Energy Northwest s ownership share of Project No. 3, respectively. Under the Net Billing Agreements, Bonneville is responsible for the District s percentage share of the total annual cost of each project, including debt service on revenue bonds issued to finance the costs of construction. The District s electric revenue requirements are not directly affected by the cost of completion of the Net Billed Projects. The revenue requirements are affected only to the extent that the costs of the projects result in increases in Bonneville s wholesale power rates. Notwithstanding the assignment of the District s share of the capability of a Net Billed Project to Bonneville, the District remains unconditionally obligated to pay to Energy Northwest its share of the total annual cost of the Net Billed Project to the extent payments or credits relating to such annual cost are not received by Energy Northwest from Bonneville. Telecommunications The Zipp Network. The District began developing an internal fiber optic telecommunications system in the 1980s. That system now links the Priest Rapids and Wanapum Developments, most of its substations, all local offices and the District s headquarters building. This system created a fiber optics backbone which has significant excess capacity. The District thus began installing a fiber optic distribution system (referred to as the Zipp Network ) in its service area starting in The Zipp Network was established to provide wholesale telecommunications services to retail providers of high speed internet, wireless, security, video and telephone services to businesses and residents within Grant County. The District has strung fiber on its existing electric utility poles and has installed community hubs at various locations around the District. Commercial and residential customers are connected to the Zipp Network s fiber run by the District directly to their homes and businesses from the hubs. Zipp Network users thus receive various services at rates hundreds of times faster than those available, for example, through traditional dial-up connections (that is, at up to 1 gigabit, as compared to 56 kilobytes, per second). As of December 31, 2005, the District s Zipp Network was available to over 10,500 homes within Grant County, out of approximately 30,000. Over 4,200 users currently subscribe to services from the existing group of retail providers. The Zipp Network currently has about 18 internet service providers, eight wireless service providers, one telephone service provider, and no video service providers, all of which are smaller local or regional companies. -51-

60 The retail service providers are charged for use of the Zipp Network system pursuant to a generally applicable rate schedule approved from time to time by the Commission. These wholesale rates are generally set by the Commission to allow the retail services to be competitive from a cost standpoint with other available options. The District currently is free from any significant federal or state regulation with respect to the Zipp Network. In 2004, the District substantially reduced the rate of build-out of the Zipp Network. In March 2005, the Commission elected to cease construction of additional hubs for the Zipp Network, although the installation of connections within existing hub areas continued. District management also was directed to significantly reduce operating costs. Between fiscal years 2004 and 2005, annual operating expenses for the Zipp Network were reduced by more than $2 million. Although this stand pat directive remains in place, it is possible that the Commission may elect in the future to continue the construction of new hubs and to make additional investments in the Zipp Network. The District is actively seeking to execute long-term licenses of its unlit fibers ( dark fibers ) for users which need extremely high-volume data transfer services, such as internet server farms. The Zipp Network is operated and accounted for as part of the Electric System. Through the fiscal year ended December 31, 2005, the District had invested more than $85 million in its telecommunications system facilities and equipment, including from bond proceeds and other available funds. This amount does not include the backbone part of the system that was built to serve internal District purposes, or net operating losses incurred by the Electric System with respect to the Zipp Network since it was first established. These net operating losses (including depreciation) currently amount to approximately $6 million each year. Excluding depreciation, the annual net operating loss currently is less than $1 million. These losses are expected to continue for the foreseeable future. See APPENDIX C AUDITED FINANCIAL STATEMENTS OF THE WANAPUM DEVELOPMENT AND ELECTRIC SYSTEM AS OF DECEMBER 31, 2005 AND 2004, including in particular Note 10, for additional financial and other information regarding the District s telecommunications system. NOANet. The District, along with 11 other Washington public utility districts and Energy Northwest, is a member of Northwest Open Access Network ( NoaNet ). NoaNet, a Washington nonprofit mutual corporation, was established in 2000 to provide its members with a broadband communications backbone throughout the State of Washington using public benefit fibers leased by NoaNet from Bonneville. This was done to assist NoaNet s members in the more efficient management of loads, energy conservation measures, and the acquisition of electric energy, as well as for other purposes. The network began commercial operations in January In 2001 NoaNet issued $27 million in bonds to finance, among other things, the acquisition and construction of necessary facilities and systems. The District s Electric System has guaranteed the repayment of up to approximately $4.75 million of such bonds (which amount includes a potential 25% step-up if another member defaults) plus accrued interest. In addition, in 2003 NoaNet established a $5 million line of credit with Bank of America to fund ongoing capital expenditures. The management of NoaNet seeks to cover the cost of its operations through charges and fees imposed for the services it provides. But NoaNet has been assessing its members in order to pay debt service on its outstanding obligations, at least during the initial years of operation. -52-

61 Borrowings of the District Table 13 lists the outstanding long-term debt of each of the District s separate systems prior to the issuance of the Bonds. Table 13 GRANT COUNTY PUD SUMMARY OF OUTSTANDING LONG-TERM DEBT As of September 30, 2006 Principal Amount Total Original ($000) Total Outstanding ($000) Date of Final Original Outstanding System Series Maturity ($000) ($000) Electric System (1) 2001-H 1/1/2022 $ 217,320 $ 216,110 $ 217,320 $ 216,110 Priest Rapids Development /1/ ,527 7, /1/ ,155 8, /1/ ,315 17, /1/ ,290 30, /1/ , , , ,315 Wanapum Development /1/ ,965 11, /1/ ,514 17, /1/ ,057 27, /1/ ,400 29, /1/ ,165 14, /1/ ,280 56, /1/ , , , ,600 Total $ 797,283 $ 704,025 $ 797,283 $ 704,025 (1) On January 1, 2007, the District expects to call for redemption $57,305,000 of the Series 2001-H Bonds maturing in

62 Electric System Operating Results The following table shows the Electric System s historical operating results for fiscal years This table is designed to show compliance with the debt service coverage requirements in the Bond Resolution. As a result, it differs from the financial statements in Appendix C, because it does not follow all of the accounting principles generally accepted in the United States of America. Table 14 ELECTRIC SYSTEM HISTORICAL OPERATING RESULTS ($000) Operating Revenues Retail Energy Sales (1) $ 75,987 $ 72,923 $ 90,014 $ 92,987 $ 95,066 Miscellaneous Electrical Revenues (2) 3,229 4,860 5,637 6,052 7,566 Sales to Other Utilities (3) 464, ,932 55,658 52,147 67,010 Total Operating Revenues $ 543,240 $ 188,715 $ 151,309 $ 151,186 $ 169,642 Operating Expenses Power Supply Costs (4) $ 562,832 $ 193,873 $ 92,381 $ 75,368 $ 78,711 Power Cost Deferral (5) (48,967) (43,000) 16,203 22,283 46,000 Operation and Maintenance (6) 25,188 24,345 20,040 32,667 25,090 Taxes 6,044 5,875 6,762 7,022 7,267 Total Operating Expenses $ 545,097 $ 181,093 $ 135,386 $ 137,340 $ 157,068 Net Operating Revenues $ (1,857) $ 7,622 $ 15,923 $ 13,846 $ 12,574 Interest and Other Income $ 8,145 $ 3,631 $ 4,361 $ 752 $ 2,793 Transfer from Rate Stabilization Fund (7) 0 3, Revenues Available for Debt Service 6,288 14,253 20,284 14,598 15,367 Less Debt Service (4,666) (11,195) (11,590) (11,590) (11,589) Uncommitted Revenues $ 1,622 $ 3,058 $ 8,694 $ 3,008 $ 3,778 Beginning Working Capital $ 116,790 $ 46,092 $ 34,630 $ 26,832 $ 66,013 Bond Proceeds Construction Fund 150, Funds Available for 268,738 49,150 43,324 29,840 69,791 Construction Less Capital Construction (87,884) (41,841) (27,230) (16,462) (16,435) Change in Deferred Power Cost Asset (5) 48,967 43,000 (16,204) (22,283) (46,000) Change in Other Balance Sheet Accounts (183,729) (15,679) 26,942 74,918 87,886 Ending Working Capital $ 46,092 $ 34,630 $ 26,832 $ 66,013 $ 95,242 R&C Fund (7) $ 26,376 $ 16,915 $ 17,172 $ 17,390 $ 17,890 Debt Service Coverage (5) 1.35x 1.27x 1.75x 1.26x 1.33x Retail Energy Sales (MWh) 2,660,306 2,439,741 2,791,272 2,892,344 3,125,143 Average Retail Energy Rate Increase (8) 0% 0% 4% 0% 0% Average Retail Revenue Requirement (cents/kwh)

63 (1) See Table 9, Electric System Retail Customers, Energy Sales, and Revenues. (2) Effective January 1, 2001, the District implemented GASB 33. This statement requires the District to recognize capital contributions from external sources as revenue in the current year. The District received contributions totaling $3,783,760, $1,953,890, $1,867,900, $1,650,263 and $2,048,501 in 2005, 2004, 2003, 2002 and 2001, respectively. (3) The increases in Sales to Other Utilities reflected in 2001 and a portion of 2002 are attributable to historically high wholesale power prices combined with an increased demand for electricity due to supply shortages resulting from various factors, including the Pacific Northwest s drought conditions. (4) 2001 drought conditions combined with increased spill requirements reduced net generation from the District's hydroelectric facilities. This combined with market prices regularly exceeding $300/MWh contributed to the dramatic increase in purchased power expense. As noted in (2) above, the market prices for purchased power are showing a more typical profile. (5) Purchased power was deferred as permitted under SFAS No. 71 and this non-cash transaction is reflected in the financial statements as a reduction of purchased power expense. Amortization of the deferral, which is reflected in the financial statements as additional purchased power expense, began with $16,203,545 in 2003, $22,383,355 in 2004, and $46,000,000 in The balance has been fully amortized as of August Debt service coverage without the effect of the power cost deferral is (9.15)x, (2.57)x, 3.15x, 3.18x, and 5.30x in 2001, 2002, 2003, 2004 and 2005, respectively. (6) Excludes noncash items of depreciation and amortization. (7) Reduction in R&C Fund reflects the use of approximately $42 million in Electric System funds to defease and refund certain Electric System bonds due January 1, 2000 through January 1, In 2002, $10,000,000 from the R&C Fund was transferred to cover operating costs, of which $3,000,000 were rate stabilization funds. (8) The Commission approved a 4% rate increase effective April 1, 2003 to ensure that the deferred power costs are amortized. -55-

64 The following table shows the Electric System s historical energy requirements, resources and power costs for fiscal years Table 15 ELECTRIC SYSTEM HISTORICAL ENERGY REQUIREMENTS, RESOURCES AND POWER COSTS Annual Energy Requirements (MWh) Retail Sales (1) 2,660,306 2,439,741 2,791,272 2,892,344 3,018,611 Electrical System Usage 9,197 10,983 11,639 11,760 10,968 Sales for Resale 3,257,555 2,949,245 1,575,019 1,415,993 1,258,416 Distribution/Transmission Line Losses 169, , , , ,844 Total Energy Requirements 6,096,397 5,637,966 4,552,194 4,544,093 4,461,839 Annual Resources (MWh) Priest Rapids Development 1,135,146 1,465,798 1,330,805 1,344,560 1,345,915 Wanapum Development 1,051,286 1,458,802 1,293,965 1,347,799 1,444,517 Quincy Chute Project 28,607 26,767 32,148 32,627 31,490 PEC Headworks Project 20,511 24,279 20,341 19,123 21,983 Bonneville/CSPE 683,812 1,481,605 1,532,091 1,494,563 1,478,858 Other (2) 3,177,035 1,180, , , ,076 Total Energy Resources 6,096,397 5,637,966 4,552,194 4,544,093 4,461,839 Average Power Cost by Resources (cents/kwh) Priest Rapids Development Wanapum Development Quincy Chute Project PEC Headworks Project Bonneville/CSPE Other (2) Annual Power Cost by Resource ($000) Priest Rapids Development $ 10,424 $ 11,703 $ 11,246 $ 11,208 $ 11,393 Wanapum Development 13,080 14,474 13,732 11,017 12,885 Quincy Chute Project ,006 1, PEC Headworks Project 967 1, Bonneville/CSPE 29,671 37,906 39,968 44,406 36,642 Other (2) 452,782 74,144 32,822 24,515 57,459 Wheeling 6,029 10,625 9, ,729 Total Power Costs ($000) $ 513,865 $ 150,873 $ 108,584 $ 97,651 $ 124,711 Average Power Costs (cents/kwh) (1) Reflects total retail energy requirements. (2) 2001 drought conditions combined with increased spill requirements reduced net generation from the District s hydroelectric facilities. This combined with market prices regularly exceeding $300/MWh contributed to the dramatic increase in purchased power expense during 2001 and a portion of As of September 2002, the District commitments for purchased power made during the period of historically high wholesale power prices had all been concluded. In addition, as of November 1, 2002, the large industrial load that had shut down production has resumed operations. The District's revenue and purchased power expense have therefore subsequently returned to a more typical profile and have remained so during 2003 to In addition, $48,967,000 and $43,000,000 of purchased power was deferred, in 2001 and 2002 respectively, as permitted under SFAS No. 71. In 2003, 2004 and 2005, respectively, the District amortized $16,203,545, $22,283,355 and $46,000,000 of deferred power costs, respectively, and amortized the remaining balance by August The amortized deferral of $46,000,000 in 2005 caused the increase in the Other Average Power Cost by Resource. Management s Discussion of Results The Electric System has historically demonstrated consistently superior financial results with high debt service coverage ratios and a substantial buildup in reserves. -56-

65 In 2001 and 2002, like other utilities in the region, the District had to cope with rapidly changing and volatile conditions in the regulatory environment, the energy markets and its own power supply. As a result, the District s financial results for 2001 and 2002 were adversely affected. However, as of September 30, 2002, the District s commitments for purchased power made during this period of historically high wholesale power prices were all concluded. In response to these dramatic cost increases, the District deferred recognition of $ million of excess power costs in 2001 and $43 million in 2002, as permitted under FAS 71, in order to meet Electric System revenue bond debt service covenants, and this amount was to be amortized with available revenues over 48 months beginning January 1, The District s Commission adopted a 4% general retail rate increase that took effect April 1, 2003, which was necessary to ensure that the deferred power costs were so amortized. The District amortized $ million, $ million, and $46 million of the deferred power costs in 2003, 2004, and 2005, respectively, and has concluded amortizing the balance of the deferral as of August The Electric System s financial results for 2003 through 2005 demonstrate a return to a more typical District financial profile. Debt service coverage for 2003, 2004, and 2005, with the non-cash expense of deferred power cost amortization included, were 1.75x, 1.26x, and 1.33x, respectively. Debt service coverage for 2003, 2004, and 2005, excluding the non-cash expense of deferred power cost amortization, were 3.15x, 3.18x, and 5.3x, respectively. The Electric System had a working capital balance of $95 million and an Electric System reserve and contingency fund balance of $17.9 million as of December 31, The District has acted to reduce the potential effects in future years from conditions such as were experienced in 2001 and In 2001, the District purchased and installed its own diesel generation and purchased power from customer-owned diesel generation. The diesel project is available for use, but the District is not currently operating the diesels because current market rates have dipped below the cost of producing power from the project. These generating facilities provide valuable operational flexibility and a reserve when power supplies are low and prices are high. In addition, the energy reserves provided by the diesel generation have allowed the District to reduce future transmission costs with Bonneville. The District has other ongoing measures including: Ongoing Management of Fish-Related Programs. In an effort to manage more effectively the increasing fish-related costs on the Priest Rapids and Wanapum Developments, in February 2006, the District signed with the fishery agencies and tribes an Adaptive Management Plan, as identified in the FERC license application, for salmon relating to by-pass, habitat, hatchery and other fish issues. The plan reaffirms the District s commitment to play a key role, in a cost-effective manner, in mitigating the adverse effects on fish passing by the Priest Rapids and Wanapum Developments. See THE WANAPUM DEVELOPMENT Regulatory Proceedings Affecting the Developments. Debt Restructuring. The District continually evaluates opportunities to restructure or refinance existing debt obligations to minimize total debt service costs, and has achieved debt service savings through several refunding issues for the Developments and the Electric System. In addition, the District has moved to increase and diversify its power supply portfolio in future years in order to avoid the need to purchase potentially high-cost power from the wholesale market during low water periods (such as ). These power supply measures include: Bonneville Contract. In September 2001, the District signed a contract with Bonneville to purchase MW of Shaped Block Product and a Full Requirements Product for the District s Grand Coulee load. The District s Bonneville contract is for monthly fixed amounts of power which requires market purchases in months where load requirements do not match the flat amounts received under this contract. The projected cost of additional market resources is, on average, three times more expensive than Priest Rapids and Wanapum Developments power and during periods of high demand and low supply can be considerably more. The District s average cost of purchased power is thus raised by the Bonneville contract, but the District is protected from wholesale power purchases that may be even more expensive. However, the loss of retail loads during periods of time where wholesale prices are lower than the cost of the Bonneville power can have a negative financial impact to the District. Although the Electric System -57-

66 instituted an annual rate increase in 2003 of 4%, the average retail rate was only 3.04 cents per kwh as of the end of Greater Output from Developments. The District s contracts for output from the Priest Rapids Development expired in 2005 and for output from the Wanapum Development expires in Under the New Power Sales Contracts, the District expects to increase its share of the output from the current 36.5%. FERC has ruled that the licensee can retain as much as 70% of the Developments firm and non-firm power. See THE WANAPUM DEVELOPMENT License Status Operating Results The Electric System unaudited financial results for the eight months ended August 31, 2006 continue to reflect a return to a more typical District financial profile. As of August 31, 2006, the Electric System had a working capital balance of $155 million. In addition, the District maintains significant reserve and contingency funds. As of August 31, 2006, the Electric System reserve and contingency fund had a balance of $31.6 million, the Priest Rapids Development R&C fund had a balance of $7.8 million, and the Wanapum Development combined R&C Funds had a balance of $14.4 million. The Electric System debt service coverage for the seven months ended August 31, 2006, with the non-cash expense of deferred power cost amortization included, was 5.58x. Debt service coverage for the eight months ended August 31, 2006, excluding the non-cash expense of deferred power cost amortization, was 6.12x. Capital Requirements As part of its planning process, the District has prepared its annual estimate of the capital requirements for the Electric System. As shown in the table below, the capital requirements include provisions for major projects involving transmission and electrical distribution lines and substations as well as normal equipment purchases, system additions, customer extensions, and general plant purchases. The District expects the cost of these expenditures in 2007 and 2008 will be $103.2 million. The District currently does not anticipate additional bond financing to fund proposed capital improvements to the Electric System. The District is undertaking substantial capital improvements to serve expected load growth. See THE ELECTRIC SYSTEM Retail Energy Sales and Customers. Table 16 ELECTRIC SYSTEM PROJECTED CAPITAL IMPROVEMENTS PROGRAM Transmission $ 15,749,000 Distribution 52,070,000 General Plant 35,407,000 $103,226,000 ECONOMIC AND DEMOGRAPHIC INFORMATION Grant County (the County ) is the fourth largest county in the State by land area, encompassing a total of 2,681.1 square miles. Within Grant County are 15 incorporated cities and towns. Moses Lake is the largest city with an estimated 2006 population of 16,830 and Ephrata, the County seat, is the second largest with an estimated 2006 population of 6,950. The County s total population has grown from 68,300 in 1997 to 80,600 in 2006, an increase of 18%. Population density in Grant County in 2005 is 29.5 persons per square mile ranking it 22nd of the 39 counties in the state. The total civilian labor force in Grant County as of 2005 was 40,

67 Grant County s economy is based on diversified agriculture, food processing, manufacturing, hydroelectric generation projects and a strong service sector. The County s prominence in agriculture is due in large part to the U.S. Bureau of Reclamation s Columbia Basin Irrigation Project, which has turned raw land into high-yield farmland through irrigation. Following are economic indicators for Grant County. Population (1) Table 17 GRANT COUNTY SELECTED ECONOMIC INDICATORS Per Capita Income (2) Taxable Retail Sales ($000) (3) Building Permits ($000) (4) Personal Income ($000) (2) ,600 $ 218,629(5) $ 54,058(6) , ,602 78, ,300 $ 22, ,596 66,819 $ 1,809, ,100 21, ,458 52,264 1,717, ,400 21, ,045 49,151 1,650, ,900 20, ,134 48,521 1,599, ,698 20, ,116 42,587 1,513, ,019 19, ,193 62,564 1,434, ,600 20, ,093 69,230 1,461, ,300 19, ,805 73,470 1,379,851 (1) Source: Washington State Employment Security Department, Labor Market & Economical Analysis Branch (2) Source: Washington State Bureau of Economic Analysis; 2004 is most recent data available. (3) Source: Washington State Department of Revenue. (4) Source: Grant County Building Department. (5) Through first quarter. (6) Through August Table 18 GRANT COUNTY MAJOR TAXPAYERS (1) Taxpayer Business Valuation % of County Assessed Valuation J R Simplot Potato Products $ 50,859, % Lamb Weston Potato Products 42,713, % Chemi-Con Materials Chemical Manufacturing 40,543, % Inflation Systems Air Bag Products 28,328, % EKA Chemicals Chemicals 28,216, % Basic American Inc. Food Products 21,865, % REC Solar Grade Silicon Chemical Manufacturing 18,265, % National Frozen Foods Food Products 17,942, % Basin Frozen Foods Food Products 18,333, % Moses Lake Industries Chemical Manufacturing 17,440, % $ 284,508, % Source: Grant County Assessor for tax collection year (1) Total County assessed valuation for 2006 taxes is $4,621,309,

68 Table 19 GRANT COUNTY MAJOR EMPLOYERS Employer Product/Service Employees Moses Lake School District Education 1,000 Genie Industries, Inc. Construction & Industrial Material Lifts & Aerial Work Platforms 732 Wal-Mart General Retail & Grocery Retail 615 Grant County PUD Electric Utility 577 Grant County Government Government 565 Quincy Foods, LLC Frozen Vegetable Processing 550 Samaritan Hospital Health Care 435 ConAgra Foods, Inc. Frozen Potato Processing 400 J.R. Simplot Co. Frozen French Fries & Dehydrated Potato Products 400 Big Bend Community College Education 375 Inflation Systems, Inc. Automotive Air Bags 300 REC Solar Grade Silicon Polysilicon Producer 280 Columbia Foods, Inc. Corn & Peas Processing 250 Quincy School District Education 242 Ochoa Foods Frozen Potato Processing 200 Moses Lake Clinic Health Care 195 Moses Lake Community Health Health Care 165 Columbia Basin Hospital Health Care 160 Ephrata School District Education 144 D&L Foundry, Inc. Manhole Cover Manufacturing 130 Washington Potato Co. Dehydrated Potato Flake Processing 125 Northwest Stone & Brick, LLC Stone and Brick Processing 115 Weyerhaeuser Co. Corrugated Box Manufacturing 113 Moses Lake Industries, Inc. Corporate Headquarters & Industrial Chemical 100 Home Depot Home Building & Repair Retail 100 Source: Grant County Economic Development Council as of September Table 20 GRANT COUNTY RESIDENT CIVILIAN LABOR FORCE AND EMPLOYMENT Annual Average (1) Employment 32,230 32,990 33,540 34,640 35,650 35,480 Unemployment 3,140 3,480 3,470 3,120 2,830 2,640 Total Labor Force 35,370 36,470 37,010 37,760 38,480 38,120 Unemployment Rate 8.9% 9.5% 9.4% 8.3% 7.4% 6.9% (1) Preliminary, through September Source: Washington State Employment Security Department, Labor Market and Economic Analysis Branch. -60-

69 Table 21 MOSES LAKE MSA (GRANT COUNTY) NONAGRICULTURAL WAGE AND SALARY EMPLOYMENT Annual Average NAICS Industry Title (1) (2) Private (Goods Producing & Services Providing) 17,110 17,190 17,150 17,710 18,250 Government 7,140 7,230 7,260 7,260 7,380 Total Nonfarm 24,250 24,420 24,410 24,970 25,630 (1) The North American Industry Classification system (NAICS) replaced the Standard Industrial Classification (SIC) code system in Totals may not add due to rounding. (2) Preliminary, through September Source: Washington State Labor Market and Economic Analysis Branch. LITIGATION There is no litigation pending or threatened in any court (either state or federal) concerning the issuance or the validity of any Parity Bonds, or questioning the creation, organization, existence or title to office of the members of the Commission or officers of the District or the proceedings for the authorization, execution, sale and delivery of the Bonds, or in any manner questioning the power and authority of the District to impose, prescribe or collect rates and charges for the services of the Wanapum Development or the Electric System. The District currently is participating in various regulatory and judicial proceedings relating to alleged overcharges in wholesale power sales made in the 2000 and 2001 time period. During this period of time, the District sold approximately $18 million of surplus electricity to the California Independent System Operator Corporation ( CAISO ) for which it has not been paid. Earlier this year, the United States Ninth Circuit Court of Appeals, reversing a FERC order, found in the Bonneville decision that FERC does not have jurisdiction over the District s sales. Several parties have indicated that they will seek rehearing of that ruling or review by the U.S. Supreme Court. Suits are currently pending in federal district courts in Washington and California wherein the District is seeking payment for amounts owed to it while the CAISO and three California investor-owned utilities are seeking redetermination of the purchase prices based on FERC mitigated market clearing prices. The District also made in excess of $53 million dollars of wholesale power sales to the California Energy Resources Scheduler ( CERS ) and related entities. While the District was paid for these transactions, a claim and other actions are being taken by CERS and others to obtain a refund of all or a portion of the monies previously paid to the District. The District is vigorously defending itself in this matter. The District was also a seller and a buyer of wholesale electricity in another series of transactions which occurred in the Pacific Northwest during this same time period. The FERC ruled that it would not order refunds or price adjustments. Appeals from that FERC ruling are pending before the Ninth Circuit Court of Appeals. It is anticipated that the Bonneville decision, if upheld on appeal, will preclude the District from being required to pay refunds. Any obligations of the District in these proceedings would be obligations of the Electric System. In addition to the contract matters, fish issues and regulatory matters at the Priest Rapids and Wanapum Developments described under THE WANAPUM DEVELOPMENT Regulatory Proceedings Affecting the Developments and Wanapum Development Output and Power Sales Contracts, the District is a party to lawsuits arising out of its normal course of business, but the District does not believe any of such litigation will have a significant adverse impact upon the District s ability to pay the Bonds. -61-

70 INITIATIVE AND REFERENDUM Under the State Constitution, the voters of the State have the ability to initiate legislation and require a public vote on legislation passed by the State Legislature through the powers of initiative and referendum, respectively. Neither power in Washington may be used to amend the State Constitution. Initiatives and referenda are submitted to the voters upon certification of a petition signed by at least 8% (initiative) and 4% (referenda) of the number of voters registered and voting for the office of Governor at the preceding regular gubernatorial election. Any law approved in this manner by a majority of the voters may not be amended or repealed by the Legislature within a period of two years following enactment, except by a vote of two-thirds of all the members elected to each house of the Legislature. After two years, the law is subject to amendment or repeal by the Legislature in the same manner as other laws. Current State Initiative State Initiative 937 ( I-937 ), which was passed at the November 6, 2006 election, requires electric utilities that serve more than 25,000 customers to obtain at least (a) 3% of their electricity from renewable resources by January 1, 2012, and each year thereafter through December 31, 2015; (b) 9% of their electricity from renewable resources by January 1, 2016, and each year thereafter through December 31, 2019; and (c) 15% of their electricity from renewable resources by January 1, 2020 and each year thereafter. I-937 also requires qualifying electric utilities to undertake various cost-effective energy conservation efforts. The District expects to meet its obligations by acquiring energy through its participation in Energy Northwest s Nine Canyon Wind Project, incremental hydro improvements at the Development, various conservation efforts and potentially biomass projects and other incremental hydro projects. See THE ELECTRIC SYSTEM The Electric System s Power Supply Nine Canyon Wind Project, Phase I. LIMITATIONS ON REMEDIES Any remedies available to the owners of the Bonds upon the occurrence of an event of default under the Bond Resolution are in many respects dependent upon judicial actions which are in turn often subject to discretion and delay and could be both expensive and time-consuming to obtain. If the District fails to comply with its covenants under the Bond Resolution or to pay principal of or interest on the Bonds, there can be no assurance that available remedies will be adequate to fully protect the interests of the owners of the Bonds. In addition to the limitations on remedies contained in the Bond Resolution, the rights and obligations under the Bonds and the Bond Resolution may be limited by and are subject to bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium and other laws relating to or affecting creditors rights, to the application of equitable principles, and to the exercise of judicial discretion in appropriate cases. The opinion to be delivered by Preston Gates & Ellis LLP, as Bond Counsel, concurrently with the issuance of the Bonds, will be subject to limitations regarding bankruptcy, insolvency and other laws relating to or affecting creditors rights. The various other legal opinions to be delivered concurrently with the issuance of the Bonds will be similarly qualified. A complete copy of the proposed form of opinion of Bond Counsel is set forth in Appendix E. The 2006A Bonds TAX MATTERS In the opinion of Bond Counsel, interest on the 2006A Bonds is excludable from gross income for federal income tax purposes and is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals and corporations; however, interest on the 2006A Bonds is taken into account in determining adjusted current earnings for the purpose of computing the alternative minimum tax imposed on certain corporations. Federal income tax law contains a number of requirements that apply to the 2006A Bonds, including investment restrictions, periodic payments of arbitrage profits to the United States, requirements regarding the use of proceeds of the 2006A Bonds and the facilities financed with proceeds of the 2006A Bonds and certain other matters. The District has covenanted to comply with all applicable requirements. -62-

71 Bond Counsel s opinion is subject to the condition that the District comply with the above-referenced covenants and, in addition, will rely on representations by the District and its advisors with respect to matters solely within the knowledge of the District and its advisors, respectively, which Bond Counsel has not independently verified. If the District fails to comply with such covenants or if the foregoing representations are determined to be inaccurate or incomplete, interest on the 2006A Bonds could be included in gross income for federal income tax purposes retroactively to the date of issuance of the 2006A Bonds, regardless of the date on which the event causing taxability occurs. Except as expressly stated above, Bond Counsel expresses no opinion regarding any other federal or state income tax consequences of acquiring, carrying, owning or disposing of the 2006A Bonds. Owners of the 2006A Bonds should consult their tax advisors regarding the applicability of any collateral tax consequences of owning the 2006A Bonds, which may include original issue discount, original issue premium, purchase at a market discount or at a premium, taxation upon sale, redemption or other disposition, and various withholding requirements. Prospective purchasers of the 2006A Bonds should be aware that ownership of the 2006A Bonds may result in collateral federal income tax consequences to certain taxpayers, including, without limitation, financial institutions, property and casualty insurance companies, individual recipients of Social Security or Railroad Retirement benefits, certain S corporations with excess net passive income, foreign corporations subject to the branch profits tax, life insurance companies and taxpayers who may be deemed to have incurred or continued indebtedness to purchase or carry or have paid or incurred certain expenses allocable to the 2006A Bonds. Bond Counsel expresses no opinion regarding any collateral tax consequences. Prospective purchasers of the 2006A Bonds should consult their tax advisors regarding collateral federal income tax consequences. Payments of interest on tax-exempt obligations such as the 2006A Bonds, are in many cases required to be reported to the IRS. Additionally, backup withholding may apply to any such payments made after March 31, 2007 to any owner who is not an exempt recipient and who fails to provide certain identifying information. Individuals generally are not exempt recipients, whereas corporations and certain other entities generally are exempt recipients. Bond Counsel s opinion is not a guarantee of result and is not binding on the IRS; rather, the opinion represents Bond Counsel s legal judgment based on its review of existing law and in reliance on the representations made to Bond Counsel and the District s compliance with its covenants. The Internal Revenue Service (the IRS ) has established an ongoing program to audit tax-exempt obligations to determine whether interest on such obligations is includable in gross income for federal income tax purposes. Bond Counsel cannot predict whether the IRS will commence an audit of the 2006A Bonds. Owners of the 2006A Bonds are advised that, if the IRS does audit the 2006A Bonds, under current IRS procedures, at least during the early stages of an audit, the IRS will treat the District as the taxpayer, and the owners of the 2006A Bonds may have limited rights to participate in the audit. The commencement of an audit could adversely affect the market value and liquidity of the 2006A Bonds until the audit is concluded, regardless of the ultimate outcome. Not Qualified Tax-Exempt Obligations. The 2006A Bonds are not qualified tax-exempt obligations within the meaning of Section 265(b)(3)(B) of the Code. Premium. An amount equal to the excess of the purchase price of a 2006A Bond over its stated redemption price at maturity constitutes premium on that 2006A Bond. A purchaser of a 2006A Bond must amortize any premium over that 2006A Bond s term using constant yield principles, based on the 2006A Bond s yield to maturity. As premium is amortized, the purchaser s basis in the 2006A Bond and the amount of tax-exempt interest received will be reduced by the amount of amortizable premium properly allocable to the purchaser. This will result in an increase in the gain (or decrease in the loss) to be recognized for federal income tax purposes on sale or disposition of the 2006A Bond prior to its maturity. Even though the purchaser s basis is reduced, no federal income tax deduction is allowed. Purchasers of 2006A Bonds at a premium, whether at the time of initial issuance or subsequent thereto, should consult their tax advisors with respect to the determination and treatment of premium for federal income tax purposes and the state and local tax consequences of owning such 2006A Bonds. -63-

72 The 2006B Bonds In the opinion of Bond Counsel, interest on the 2006B Bonds is excludable from gross income for federal income tax purposes, except for interest on any 2006B Bond for any period during which such 2006B Bond is held by a substantial user of the facilities financed by the 2006B Bonds, or by a related person within the meaning of Section 147(a) of the Internal Revenue Code of 1986, as amended (the Code ); however, interest on the 2006B Bonds is an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals and corporations. Federal income tax law contains a number of requirements that apply to the 2006B Bonds, including investment restrictions, periodic payments of arbitrage profits to the United States, requirements regarding the use of proceeds of the 2006B Bonds and the facilities financed or refinanced with proceeds of the 2006B Bonds and certain other matters. The District has covenanted to comply with all applicable requirements. Bond Counsel s opinion is subject to the condition that the District comply with the above-referenced covenants and, in addition, will rely on representations by the District and its advisors with respect to matters solely within the knowledge of the District and their advisors, respectively, which Bond Counsel has not independently verified. If the District fails to comply with such covenants or if the foregoing representations are determined to be inaccurate or incomplete, interest on the 2006B Bonds could be included in gross income for federal income tax purposes retroactively to the date of issuance of the 2006B Bonds, regardless of the date on which the event causing taxability occurs. Except as expressly stated above, Bond Counsel expresses no opinion regarding any other federal or state income tax consequences of acquiring, carrying, owning or disposing of the 2006B Bonds. Owners of the 2006B Bonds should consult their tax advisors regarding the applicability of any collateral tax consequences of owning the 2006B Bonds, which may include original issue discount, original issue premium, purchase at a market discount or at a premium, taxation upon sale, redemption or other disposition, and various withholding requirements. Prospective purchasers of the 2006B Bonds should be aware that ownership of the 2006B Bonds may result in collateral federal income tax consequences to certain taxpayers, including, without limitation, financial institutions, property and casualty insurance companies, individual recipients of Social Security or Railroad Retirement benefits, certain S corporations with excess net passive income, foreign corporations subject to the branch profits tax, life insurance companies and taxpayers who may be deemed to have incurred or continued indebtedness to purchase or carry or have paid or incurred certain expenses allocable to the 2006B Bonds. Bond Counsel expresses no opinion regarding any collateral tax consequences. Prospective purchasers of the 2006B Bonds should consult their tax advisors regarding collateral federal income tax consequences. Payments of interest on tax-exempt obligations such as the 2006B Bonds, are in many cases required to be reported to the IRS. Additionally, backup withholding may apply to any such payments made after March 31, 2007 to any owner who is not an exempt recipient and who fails to provide certain identifying information. Individuals generally are not exempt recipients, whereas corporations and certain other entities generally are exempt recipients. Bond Counsel s opinion is not a guarantee of result and is not binding on the IRS; rather, the opinion represents Bond Counsel s legal judgment based on its review of existing law and in reliance on the representations made to Bond Counsel and compliance with covenants of the District. The IRS has established an ongoing program to audit tax-exempt obligations to determine whether interest on such obligations is includable in gross income for federal income tax purposes. Bond Counsel cannot predict whether the IRS will commence an audit of the 2006B Bonds. Owners of the 2006B Bonds are advised that, if the IRS does audit the 2006B Bonds, under current IRS procedures, at least during the early stages of an audit, the IRS will treat the District as the taxpayer, and the owners of the 2006B Bonds may have limited rights to participate in the audit. The commencement of an audit could adversely affect the market value and liquidity of the 2006B Bonds until the audit is concluded, regardless of the ultimate outcome. Not Qualified Tax-Exempt Obligations. The 2006B Bonds are not qualified tax-exempt obligations within the meaning of Section 265(b)(3)(B) of the Code. -64-

73 Premium. An amount equal to the excess of the purchase price of a 2006B Bond over its stated redemption price at maturity constitutes premium on that 2006B Bond. A purchaser of a 2006B Bond must amortize any premium over that 2006B Bond s term using constant yield principles, based on the 2006B Bond s yield to maturity. As premium is amortized, the purchaser s basis in the 2006B Bond and the amount of tax-exempt interest received will be reduced by the amount of amortizable premium properly allocable to the purchaser. This will result in an increase in the gain (or decrease in the loss) to be recognized for federal income tax purposes on sale or disposition of the 2006B Bond prior to its maturity. Even though the purchaser s basis is reduced, no federal income tax deduction is allowed. Purchasers of 2006B Bonds at a premium, whether at the time of initial issuance or subsequent thereto, should consult their tax advisors with respect to the determination and treatment of premium for federal income tax purposes and the state and local tax consequences of owning such 2006B Bonds. Original Issue Discount. The initial public offering price of certain 2006B Bonds (the Original Issue Discount Bonds ), is less than the stated redemption price at maturity. In such case, the difference between (i) the stated amount payable at the maturity of an Original Issue Discount Bond and (ii) the initial public offering price of that Original Issue Discount Bond constitutes original issue discount with respect to that Original Issue Discount Bond in the hands of the owner who purchased that Original Issue Discount Bond at the initial public offering price in the initial public offering of the 2006B Bonds. The initial owner is entitled to exclude from gross income (as defined in Section 61 of the Code) an amount of income with respect to an Original Issue Discount Bond equal to that portion of the amount of the original issue discount allocable to the period that such Original Issue Discount Bond continues to be owned by the initial owner. In the event of the redemption, sale or other taxable disposition of an Original Issue Discount Bond prior to its stated maturity, however, the amount realized by the initial owner in excess of the basis of the Original Issue Discount Bond in the hands of its initial owner (adjusted upward by the portion of the original issue discount allocable to the period for which such Original Issue Discount Bond was held by the initial owner) is includable in gross income. Purchasers of Original Issue Discount Bonds should consult their tax advisors regarding the determination and treatment of original issue discount for federal income tax purposes and the state and local tax consequences of owning Original Issue Discount Bonds. The 2006Z Bonds This advice was written to support the promotion or marketing of the 2006Z Bonds. This advice is not intended or written by Preston Gates & Ellis LLP to be used, and may not be used, by any person or entity for the purpose of avoiding any penalties that may be imposed on any person or entity under the U.S. Internal Revenue Code. Prospective purchasers of 2006Z Bonds should seek advice based on their particular circumstances from an independent tax advisor. The following discussion describes aspects of the principal U.S. federal tax treatment of U.S. persons that are beneficial owners ( Owners ) of 2006Z Bonds. This summary is based on the Code, published revenue rulings, administrative and judicial decisions, and existing and proposed Treasury regulations (all as of the date hereof and all of which are subject to change, possibly with retroactive effect). This summary discusses only 2006Z Bonds held as capital assets within the meaning of Section 1221 of the Code. It does not discuss all of the tax consequences that may be relevant to an Owner in light of its particular circumstances or to Owners subject to special rules, such as certain financial institutions, insurance companies, tax-exempt organizations, foreign taxpayers, taxpayers who may be subject to the alternative minimum tax or personal holding company provisions of the Code, dealers in securities or foreign currencies, Owners holding the 2006Z Bonds as part of a hedging transaction, straddle, conversion transaction, or other integrated transaction, or Owners whose functional currency (as defined in Section 985 of the Code) is not the U.S. dollar. Except as stated herein, this summary describes no federal, state or local tax consequences resulting from the ownership of, receipt of interest on, or disposition of, the 2006Z Bonds. ACCORDINGLY, OWNERS WHO ARE OR MAY BE DESCRIBED IN THIS PARAGRAPH SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO SUCH OWNERS, AS WELL AS TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL, OR FOREIGN TAXING JURISDICTION OR UNDER ANY APPLICABLE TAX TREATY. -65-

74 In General. Interest derived from a 2006Z Bond by an Owner is subject to U.S. federal income taxation. In addition, a 2006Z Bond held by an individual who, at the time of death, is a U.S. person is subject to U.S. federal estate tax. Payments of Interest. Interest, including additional amounts of cash and interest, if any, paid on the 2006Z Bonds will generally be taxable to Owners as ordinary interest income at the time it accrues or is received, in accordance with the Owner s method of accounting for U.S. federal income tax purposes. Owners that are cash-method taxpayers will be required to include interest in income upon receipt of such interest income; whereas Owners that are accrual-method taxpayers will be required to include interest as it accrues, without regard to when interest payments are actually received. Disposition or Retirement. Upon the sale, exchange or other disposition of a 2006Z Bond, or upon the retirement of a 2006Z Bond (including by redemption), an Owner will recognize capital gain or loss equal to the difference, if any, between the amount realized upon the disposition or retirement (reduced by any amounts attributable to accrued but unpaid interest, which will be taxable as such) and the Owner s adjusted tax basis in the 2006Z Bond. Any such capital gain or loss will be United States source gain or loss for foreign tax credit purposes. Under the Bond Resolution, certain of the 2006Z Bonds are subject to optional redemption. See DESCRIPTION OF THE BONDS Optional Redemption. The 2006Z Bonds are subject to defeasance at any time prior to their stated maturities. See APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS Defeasance. If the District defeases any 2006Z Bonds, such 2006Z Bonds may be deemed to be retired and reissued for federal income tax purposes as a result of the defeasance. In such event, the Owner of a 2006Z Bond would recognize a gain or loss on the 2006Z Bond at the time of defeasance. Information Reporting and Backup Withholding. Payments of interest on 2006Z Bonds held of record by U.S. persons other than corporations and other exempt Owners must be reported to the IRS. Such information will be filed each year with the IRS on Form 1099, which will reflect the name, address, and taxpayer identification number of the Owner. A copy of Form 1099 will be sent to each Owner of a 2006Z Bond for federal income tax reporting purposes. Interest paid to an Owner of a 2006Z Bond ordinarily will not be subject to withholding of federal income tax if such Owner is a U.S. person. Backup withholding of federal income tax at a rate of 28 percent may apply, however, to payments made in respect of the 2006Z Bonds, as well as payments of proceeds from the sale of 2006Z Bonds, to Owners that are not exempt recipients and that fail to provide certain identifying information. This withholding generally applies if the Owner of a 2006Z Bond (who is not an exempt recipient) (i) fails to furnish such Owner s social security number or other taxpayer identification number ( TIN ), (ii) furnishes an incorrect TIN, (iii) fails to properly report interest, dividends or other reportable payments as defined in the Code, or (iv) under certain circumstances, fails to provide a certified statement, signed under penalty of perjury, that the TIN provided is correct and that such Owner is not subject to backup withholding. Individuals generally are not exempt recipients, whereas corporations and certain other entities generally are exempt recipients. To prevent backup withholding, each Owner will be requested to complete an appropriate form. Any amounts withheld under the backup withholding rules from a payment to a person would be allowed as a refund or a credit against such person s U.S. federal income tax, provided that the required information is furnished to the IRS. Furthermore, certain penalties may be imposed by the IRS on an Owner who is required to supply information but who does not do so in the proper manner. The federal tax discussion set forth above is included for general information only and may not be applicable depending upon an Owner s particular situation. Investors should consult their own tax advisors concerning the tax implications of holding and disposing of the 2006Z Bonds under applicable state or local laws. Foreign investors should also consult their own tax advisors regarding the tax consequences unique to investors who are not U.S. persons. Pending Audit The District received an initial audit examination letter from the IRS, dated June 15, 2005, relating to its Electric System Revenue and Refunding Bonds, Series 2001-H in the original principal amount of $217,320,000 (the -66-

75 2001-H Bonds ). The IRS is seeking technical advice from the IRS Office of Chief Counsel regarding the use of the District s fiber optic network. A portion of the proceeds of the 2001-H Bonds were used to finance the fiber optic network. The District prepared a response to the draft technical advice memorandum. The District believes that it has complied with all of the requirements necessary to maintain the status of the interest on the 2001-H Bonds as exempt from federal income tax. The IRS has not asserted that interest on the 2001-H Bonds is subject to inclusion in the gross income of the owners thereof for federal income tax purposes, but no assurance can be given that the IRS will not do so or assert a claim against the District. The District intends to take all reasonable actions to preserve the tax-exempt status of the 2001-H Bonds. The District cannot estimate the amount of the payment, if any, that the IRS might demand to settle this matter, but the District believes that any possible payment would not have a material adverse effect on the District's financial condition. CERTAIN LEGAL MATTERS Upon delivery of the Bonds, Preston Gates & Ellis LLP, Seattle, Washington, Bond Counsel, will render an opinion as to the validity of the Bonds and the tax-exempt status of interest on the 2006A Bonds and 2006B Bonds in substantially the form of the opinion included in Appendix E. Certain legal matters are subject to the approval of Orrick, Herrington & Sutcliffe LLP, Seattle, Washington, Counsel to the Underwriters. UNDERWRITING The Underwriters have agreed, subject to certain conditions, to purchase the 2006A Bonds, the 2006B Bonds, and the 2006Z Bonds from the District at Underwriters discounts of $401,988.89, $95, and $546,231.34, respectively. The Underwriters obligations are subject to certain conditions precedent, and they will be obligated to purchase all 2006A Bonds, 2006B Bonds and 2006Z Bonds, if any Bonds of such series are purchased. The Bonds may be offered and sold to certain dealers at prices lower than the public offering prices, and the public offering prices may be changed, from time to time, by the Underwriters. The Underwriters may offer and sell the Bonds into unit investment trusts or money market funds, certain of which may be managed or sponsored by the Underwriters, at prices lower than the public offering prices. CONTINUING DISCLOSURE In accordance with Section (b)(5) of the Securities and Exchange Commission ( SEC ) Rule 15c2-12 under the Securities and Exchange Act of 1934, as the same may be amended from time to time (the Rule ), the District has agreed in the Bond Resolution to provide or cause to be provided (including through a transmitting service approved by the SEC) to each nationally recognized municipal securities information repository ( NRMSIR ) and to the state information depository for the State of Washington (if one is created) ( SID ), in each case as designated by the Securities and Exchange Commission (the Commission ) in accordance with the Rule, the following historical annual financial information and operating data for the prior fiscal year (commencing in 2007 for the fiscal year ended December 31, 2006): (1) The audited financial statements of the Wanapum Development, Priest Rapids Development and Electric System prepared in accordance with generally accepted accounting principles applicable to government entities, with regulations prescribed by the Washington State Auditor pursuant to RCW (or any successor statute) and substantially in accordance with the system prescribed by the FERC; provided, that if the Wanapum Development, Priest Rapids Development and/or Electric System financial statements are not yet available, the District shall provide unaudited financial statements in substantially the same format, and audited financial statements when they become available; (2) The outstanding long-term indebtedness of the Wanapum Development, the Priest Rapids Development and the Electric System (Table 13); (3) Participation in the Wanapum Development and Priest Rapids Development by customer name and percentage share of output and disposition of net energy (Tables 2 and 3); (4) Maximum one-hour production and average production costs, net generation, plant availability factor and annual availability factor for the Wanapum Development and Priest Rapids Development (Table 1); -67-

76 (5) Wanapum Development and Priest Rapids Development operating results and debt service coverage on the outstanding Wanapum Development and Priest Rapids Development bonds (Table 5); (6) Electric System retail customers, energy sales, peak loads and revenues (Table 9); (7) Electric System operating results and debt service coverage on the outstanding Electric System parity bonds (Table 14); (8) Electric System energy requirements, resources and power costs (Table 15); and (9) The aggregate amount and percentage of total energy sold and of retail revenues provided by the Electric System s ten largest customers. Items 2 through 9, inclusive, shall be required only to the extent that such information is not included in the information provided pursuant to item 1 above. Such annual information and operating data described above shall be available on or before nine months after the end of the District s fiscal year. The District s current fiscal year ends December 31. The District may adjust such fiscal year by providing written notice of the change of fiscal year to each then existing NRMSIR and the SID, if any. In lieu of providing such annual financial information and operating data, the District may cross-reference to other documents the District provides to the NRMSIRs and the SID or to the SEC and, if such document is a final official statement within the meaning of the Rule, to the Municipal Securities Rulemaking Board ( MSRB ). The District further agrees to provide or cause to be provided to each NRMSIR and to the SID, if any, information substantially in the form set forth under Available Information in Appendix D with respect to each Obligated Person ; provided, that such information is at the time on file with the SEC pursuant to the Securities Exchange Act of 1934 (the Exchange Act ). To the extent that an Obligated Person is not required to file information with the SEC pursuant to the Exchange Act, the District agrees to provide or cause to be provided to each NRMSIR and to the SID, if any, information with respect to such Obligated Person as set forth below, in each case only if and to the extent applicable to such Obligated Person: (1) Such Obligated Person s audited financial statements prepared in accordance with generally accepted accounting principles; provided, that if such Obligated Person s financial statements are not yet available, the District shall provide unaudited financial statements in substantially the same format, and audited financial statements when they become available; (2) Such Obligated Person s outstanding long-term indebtedness; (3) Such Obligated Person s retail customers, energy sales, peak loads and revenues; (4) Such Obligated Person s operating results and debt service coverage on its outstanding indebtedness; (5) Such Obligated Person s energy requirements, resources and power costs. Items 2 through 5, inclusive, shall be required only to the extent that such information is not included in the information provided pursuant to item 1 above. Obligated Person means any person who, or entity which, at the time is obligated, directly or indirectly, by contract, generally or through an enterprise, fund or account, to make payments in the current or any succeeding Fiscal Year to be applied to pay at least 10% of the aggregate amount of principal of and interest scheduled to become due in such year on the Bonds. The District agrees to provide or cause to be provided, in a timely manner, to each NRMSIR or to the MSRB and to the SID, if any, notice of its failure to provide the annual financial information described above on or prior to the date set forth above. -68-

77 The District further agrees to provide or cause to be provided, in a timely manner, to the SID, if any, and to each NRMSIR or to the MSRB notice of the occurrence of any of the following events with respect to the Bonds, as applicable, if material: Principal and interest payment delinquencies; Nonpayment related defaults; Unscheduled draws on debt service reserves reflecting financial difficulties; Substitution of credit or liquidity providers or their failure to perform; Unscheduled draws on credit enhancements reflecting financial difficulties; Adverse tax opinions or events affecting the tax-exempt status of the 2006A and 2006B Bonds; Modifications to the rights of Bondowners; Optional redemption prior to their maturity; Defeasances; Rating changes; and Release, substitution or sale of property, if any, securing repayment of the Bonds. There is no property securing repayment of the Bonds. The only debt service reserve is the Reserve Account. The District s obligations to provide annual financial information and notices of material events shall terminate upon the legal defeasance, prior redemption or payment in full of all of the Bonds. Such undertaking, or any provision thereof, shall be null and void if the District (1) obtains an opinion of nationally recognized bond counsel to the effect that those portions of the Rule which require this undertaking, or any such provision, are invalid, have been repealed retroactively or otherwise do not apply to the Bonds; and (2) notifies each then existing NRMSIR and the SID, if any, of such opinion and the cancellation of such undertaking. Notwithstanding any other provision of the Bond Resolution, the District may amend this undertaking with an approving legal opinion of bond counsel. In the event of any amendment or waiver of a provision of this undertaking, the District shall describe such amendment in the next annual report, and shall include, as applicable, a narrative explanation of the reason for the amendment or waiver and its impact on the type (or in the case of a change of accounting principles, on the presentation) of financial information or operating data being presented by the District. In addition, if the amendment relates to the accounting principles to be followed in preparing financial statements, (i) notice of such change will be given in the same manner as for a material event, and (ii) the annual report for the year in which the change is made should present a comparison (in narrative form and also, if feasible, in quantitative form) between the financial statements as prepared on the basis of the new accounting principles and those prepared on the basis of the former accounting principles. A Bondowner s or Beneficial Owner s right to enforce the provisions of the District s undertaking described in this section shall be limited to a right to obtain specific enforcement of the District s obligations, and any failure by the District to comply with the provisions of this undertaking shall not be an Event of Default with respect to the Bonds. For purposes of this section, Beneficial Owner means any person who has the power, directly or indirectly, to vote or consent with respect to, or to dispose of ownership of, any Bonds, including persons holding Bonds through nominees or depositories. -69-

78 Prior Compliance with Continuing Disclosure Undertakings The District has complied with all prior written undertakings under the Rule. RATINGS Moody s Investors Service ( Moody s ), Standard & Poor s Ratings Services, a division of the McGraw-Hill Companies, Inc. ( S&P ) and Fitch Ratings ( Fitch ) have assigned their ratings of Aaa, AAA, and AAA, respectively, to the Bonds on the understanding that a policy insuring the payment when due of principal of and interest on the Bonds will be issued by MBIA Insurance Corporation upon delivery of the Bonds. Moody s, S&P and Fitch have also assigned their underlying ratings of Aa2, AA-, and AA, respectively, to the Bonds. Such ratings reflect only the views of the respective rating agency and are not a recommendation to buy, sell or hold the Bonds. An explanation of the significance of such ratings may be obtained from the rating agencies. The District has furnished to each rating agency certain information and materials with respect to the Bonds. Generally, rating agencies base their ratings on such information and materials, and on investigations, studies and assumptions made by the rating agencies. There is no assurance that the ratings assigned to the Bonds will continue for any given period of time or that they will not be revised or withdrawn entirely by such rating agencies if, in the judgment of the rating agencies, circumstances so warrant. The District and the Underwriters undertake no responsibility either to bring to the attention of the owners of the Bonds any downward revision or withdrawal of any such rating or to oppose any such revision or withdrawal. A downward revision or withdrawal of the ratings may have an adverse effect on the market price of the Bonds. INDEPENDENT ACCOUNTANTS The financial statements of the Wanapum Development and the Electric System as of December 31, 2005 and 2004 and for each of the two years in the period ended December 31, 2005 included in Appendix C to this Official Statement have been audited by PricewaterhouseCoopers LLP, independent accountants, as stated in their report appearing therein. MISCELLANEOUS The references, excerpts and summaries contained herein of the Bond Resolutions and the Power Sales Contracts do not purport to be complete statements of the provisions of such documents and reference should be made to such documents for a full and complete statement of all matters relating to the Bonds and the rights and obligations of the owners thereof. Copies of such documents are available for inspection at the principal office of the District. The authorizations, agreements and covenants of the District are set forth in the Bond Resolutions, and neither this Official Statement nor any advertisement of the Bonds is to be construed as a contract with the owners of the Bonds. Any statements made in this Official Statement involving matters of opinion or estimates, whether or not expressly so identified, are intended merely as such and not as representations of fact. Neither this Official Statement nor any statement which may have been made orally or in writing is to be construed as a contract with the owners of any of the Bonds. The execution and delivery of this Official Statement has been duly authorized by the District. PUBLIC UTILITY DISTRICT NO. 2 OF GRANT COUNTY, WASHINGTON By /s/ Randall M. Allred President, Board of Commissioners By /s/ Tim Culbertson General Manager -70-

79 APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS The following summary is a brief outline of certain provisions of the Bond Resolution and is not to be considered a full statement thereof and is qualified by reference to the complete Bond Resolution. Capitalized words or phrases that are not defined in this summary or conventionally capitalized have the meanings given such words or phrases in the Bond Resolution. The Bond Resolution is substantially the same as the 1996, 1997, 1998, 1999, 2001, 2003 and 2005 Bond Resolutions. Certain Definitions Annual Debt Service for any Fiscal Year means the sum of the amounts required in such Fiscal Year to pay: (a) the interest due in such Fiscal Year on all Parity Bonds then outstanding, excluding interest to be paid from the proceeds of sale of Parity Bonds; (b) the principal of all outstanding Serial Bonds due in such Fiscal Year; and (c) the Sinking Fund Requirement, if any, for any Term Bonds for such Fiscal Year reduced by certain credits made for Term Bonds. Bonds means the Wanapum Hydroelectric Development Revenue and Refunding Bonds, 2006 Series A, Series B and Series Z, authorized by the Bond Resolution. Coverage Requirement means (a) 1.15 times the Annual Debt Service in a Fiscal Year plus (b) any money required by the Bond Resolutions to be deposited into the Reserve Account in the Bond Fund or paid to providers of Qualified Insurance obtained for the Reserve Account, less (c) any amounts transferred into the Bond Fund as surplus money in the Supplemental R&C Fund as of the end of the preceding Fiscal Year pursuant to the Bond Resolutions. Derivative Payment Date means any date specified in the Derivative Product on which a District Payment is due and payable under the Derivative Product. Derivative Product means a written contract or agreement between the District and a Reciprocal Payor that has (or whose obligations are unconditionally guaranteed by a party that has) as of the date of the Derivative Product at least an investment grade rating from a rating agency, which provides that the District s obligations thereunder will be conditioned on the performance by the Reciprocal Payor of its obligations under the agreement, and (a) under which the District is obligated to pay, on one or more scheduled and specified Derivative Payment Dates, the District Payments in exchange for the Reciprocal Payor s obligation to pay or to cause to be paid to the District, on scheduled and specified Derivative Payment Dates, the Reciprocal Payments; (b) for which the District s obligations to make District Payments may be secured by a pledge of and lien on the Net Revenues on an equal and ratable basis with the outstanding Bonds; (c) under which Reciprocal Payments are to be made directly into the Bond Fund; (d) for which the District Payments are either specified to be one or more fixed amounts or are determined as provided by the Derivative Product; and (e) for which the Reciprocal Payments are either specified to be one or more fixed amounts or are determined as set forth in the Derivative Product. District Payment means any regularly scheduled payment (designated as such by resolution) required to be made by or on behalf of the District under a Derivative Product and which is determined according to a formula set forth in the Derivative Product. A-1

80 Electric System means the electric utility and telecommunications properties, rights and assets, real and personal, tangible and intangible, now owned and operated by the District and used or useful in the generation, transmission, distribution and sale of electric energy, telecommunications services and the business incidental thereto, and all properties, rights and assets, real and personal, tangible and intangible, hereafter constructed or acquired by the District as additions, betterments, improvements or extensions to said electric utility and telecommunications properties, rights and assets, including, but not limited to, the contract interest of the District in the P.E.C. Headworks Powerplant Project and in the Quincy Chute Project, but shall not include the Columbia River-Priest Rapids Hydro-Electric Development or the Wanapum Development established by Resolutions No. 313 and 474, respectively, or any additions thereto (the Hydro Systems ), or any other generating, transmission and distribution facilities which heretofore have been or hereafter may be acquired or constructed by the District as a utility system that is declared by the Commission, at the time of financing thereof, to be separate from the Electric System, the revenues of which are pledged to the payment of bonds issued to purchase, construct or otherwise acquire or expand such separate utility system or are otherwise pledged to the payment of the bonds of another such separate utility system of the District. The Electric System does not include any interest of the District in the Power Sales Contracts, but does include the right of the District to receive power and energy from the Hydro Systems. Fiscal Year means the fiscal year used by the District at any time. At the time of adoption of the Bond Resolutions, the Fiscal Year is the 12-month period beginning January 1 of each year. Future Parity Bonds means any bonds of the District issued in accordance with the Bond Resolutions after the date of issuance of the Bonds and that are secured by a lien and charge as described in the Bond Resolutions equal to the lien and charge securing the payment of the principal of and interest on the Outstanding Parity Bonds and the Bonds. Government Obligations means direct obligations of, or obligations the principal of and interest on which are unconditionally guaranteed by, the United States Government and, once the 1996 Bonds, 1997 Bonds, 1998 Bonds, and 1999 Bonds are no longer Outstanding, shall mean those obligations defined in Chapter RCW, as amended. Gross Revenues means all income, revenues, receipts and profits derived by the District through the ownership and operation of the Wanapum Development, together with the proceeds received by the District directly or indirectly from the sale, lease or other disposition of any of the properties, rights or facilities of the Wanapum Development, and together with the investment income earned on money held in any fund or account of the District, including any bond redemption funds and the accounts therein, in connection with the ownership and operation of the Wanapum Development, exclusive of insurance proceeds and income derived from investments irrevocably pledged to the payment of any specific revenue bonds of the District, such as bonds heretofore or hereafter refunded, or any Parity Bonds defeased pursuant to the Bond Resolutions or other bonds defeased, or the payment of which is provided for, under any similar provision of any other bond resolutions of the District, and exclusive of investment income earned on money in any arbitrage rebate fund established for any Parity Bonds. Net Revenues means, for any period, the excess of Gross Revenues over Operating Expenses for such period, excluding from the computation of Gross Revenues any profit or loss derived from the sale or other disposition, not in the ordinary course of business, of properties, rights or facilities of the Wanapum Development, or resulting from the early extinguishment of debt Power Sales Contracts means the contracts entered into in June 1959, between the District and other electric utilities for the sale of power and energy from the Wanapum Development, as supplemented and amended by agreements dated December 19, 1977 and December 17, Bonds means the $28,965,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Bonds, 1996 Series A and Series B authorized by Resolution No Bonds means the $18,824,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, 1997 Series A and B authorized by Resolution No and the $8,690,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Bonds, 1997 Series C and D, authorized by Resolution No A-2

81 1998 Bonds means the $31,620,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, 1998 Series A authorized by Bond Resolution No Bonds means the $17,837,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, 1999 Series A, Series B and Series C authorized by Resolution No. 7254, and the 1999D Bonds. 1999D Bonds means the $18,750,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, 1999 Series D authorized by Resolution No. 7268, as amended by Resolution No Bonds means the $16,465,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Refunding Bonds, 2001 Series B authorized by Resolution No Bonds means the $57,280,000 principal amount of Wanapum Hydroelectric Development Second Series Revenue Bonds, 2003 Series A, B and Z authorized by Resolution No Bonds means the $127,780,000 principal amount of Wanapum Hydroelectric Development Revenue Bonds, 2005 Series A, B and Z authorized by Resolution No New Power Sales Contracts means the contracts entered into in December 2001, between the District and other electric utilities for the sale of power and energy from the Wanapum Development and Priest Rapids Development, as such contracts may be supplemented and amended from time to time. Operating Expenses means the District s expenses for operation and maintenance of the Wanapum Development, and ordinary repairs, renewals of and replacements to the Wanapum Development, including payments into working capital reserves in the Revenue Fund for items of Operating Expenses the payment of which is not immediately required, and shall include, without limiting the generality of the foregoing, operation and maintenance expenses; rents; administrative and general expenses; engineering expenses; legal and financial advisory expenses; required payments to pension, retirement, health and hospitalization funds; insurance premiums; and any taxes, assessments, payments in lieu of taxes or other lawful governmental charges, all to the extent properly allocable to the Wanapum Development; and the fees and expenses of the Paying Agent, Trustee and Registrar. Operating Expenses shall not include any costs or expenses for new construction, interest, amortization or any allowance for depreciation. Outstanding when used with respect to Parity Bonds means, as of any date, Parity Bonds theretofore or thereupon issued pursuant to a resolution of the Board except (i) any Parity Bonds canceled by the Registrar or paid at or prior to such date, (ii) Parity Bonds in lieu of or in substitution for which Parity Bonds have been delivered, and (iii) Parity Bonds deemed no longer outstanding under the resolution authorizing their issuance. Outstanding Parity Bonds means the Outstanding 1996 Bonds, 1997 Bonds, 1998 Bonds, 1999 Bonds, 2001 Bonds, 2003 Bonds and 2005 Bonds. Parity Bonds means the Outstanding Parity Bonds, the Bonds and all Future Parity Bonds. Paying Agent means the designated fiscal agents of the State of Washington or any bank or banks designated a Paying Agent by the District. Permitted Investments means the following to the extent the same are legal for investments of funds of the District: (a) any bonds or other obligations which as to principal and interest constitute direct obligations of, or are unconditionally guaranteed by, the United States, including obligations of any of the federal agencies set forth in clause (b) below to the extent unconditionally guaranteed by the United States; (b) obligations of the Export-Import Bank of the United States, the Government National Mortgage Association, the Federal National Mortgage Association to the extent guaranteed by the Government National Mortgage Association, the Farmers Home Administration, or any agency or instrumentality of the Federal Government which shall be established for the purposes of acquiring the obligations of any of the foregoing or otherwise providing financing therefor; (c) new housing authority bonds issued by the public agencies or municipalities and fully secured as to the payment of both principal and interest by a pledge of annual contributions under an annual contributions contract or contracts with A-3

82 the United States, or project notes issued by public agencies or municipalities and fully secured as to the payment of both principal and interest by a requisition or payment agreement with the United States; (d) direct and general obligations of any State within the territorial United States, to the payment of the principal of and interest on which the full faith and credit of such State is pledged, provided, that at the time of their purchase, such obligations are rated in one of the two highest rating categories by either Moody s Investors Service or Standard & Poor s Rating Services or their comparably recognized business successors or both Moody s Investors Service and Standard & Poor s Rating Services or their comparably recognized business successors if such obligations are rated by both; (e) certificates of deposit, whether negotiable or nonnegotiable, issued by any bank, savings and loan association or trust company provided that such certificates of deposit shall be (i) continuously and fully insured by the Federal Deposit Insurance Corporation, or (ii) issued by a recognized qualified public depositary of the State of Washington under RCW Chapter 39.58, as amended, or (iii) continuously and fully secured by such securities as are described above in clauses (a) or (b), which shall have a market value (exclusive of accrued interest) at all times at least equal to the principal amount of such certificates of deposit; (f) any repurchase agreement with any bank or trust company organized under the laws of any State of the United States or any national banking association, which is secured by such securities as described in clauses (a) or (b) above in the possession or custody of the District, its agent or Trustee and in which the District, its agent or Trustee has a first perfected security interest free and clear of all rights of third parties, which matures within 270 days and which has a market value determined monthly equal to 100% of the face amount of the repurchase agreement; (g) Refunded Municipals; and (h) any other investments or investment agreements permitted under the laws of the State of Washington, as amended from time to time. Power Sales Contracts means the 1959 Power Sales Contracts, the New Power Sales Contracts, and any other contracts entered into by the District for the sale of power and energy from the Wanapum Development, and as such contracts may be amended and supplemented from time to time. Project Account means the account of the District authorized to be created to pay costs of improvements to the Wanapum Development financed with proceeds of the Bonds. Qualified Insurance means any municipal bond insurance policy or surety bond issued by any insurance company licensed to conduct an insurance business in any state of the United States (or by a service corporation acting on behalf of one or more such insurance companies), which insurance company or companies, as of the time of issuance of such policy or surety bond, are currently rated in the highest rating category by Moody s Investors Service or Standard & Poor s or their comparably recognized business successors or both Moody s Investors Service and Standard & Poor s or their comparably recognized business successors if such institution is rated by both. Qualified Letter of Credit means any letter of credit issued by a financial institution for the account of the District on behalf of the owners of a series of the Bonds, which institution maintains an office, agency or branch in the United States and as of the time of issuance of such letter of credit, is currently rated in the highest rating category by Moody s Investors Service or Standard & Poor s or their comparably recognized business successors or both Moody s Investors Service and Standard & Poor s or their comparably recognized business successors if such institution is rated by both. Registrar means the registrar and authenticating agent appointed pursuant to the Bond Resolutions, its successor or successors and any other entity which may at any time be substituted in its place pursuant to the Bond Resolutions. Reciprocal Payment means any payment (designated as such by a resolution) to be made to, or for the benefit of, the District under a Derivative Product by the Reciprocal Payor. Reciprocal Payor means a party to a Derivative Product that is obligated to make one or more Reciprocal Payments thereunder. Reserve Account Requirement means (a) with respect to an issue of Parity Bonds the maximum amount of interest due in any Fiscal Year on such Parity Bonds, computed as of the date of issuance of such issue and (b) with respect to all Parity Bonds then outstanding, the sum of all amounts computed under (a) above. In the case of Variable Interest Rate Bonds, the interest rate thereon shall be calculated on the assumption that such Variable Interest Rate Bonds will bear interest at a rate equal to the rate most recently reported by The Bond Buyer as The Bond Buyer s A-4

83 index for long-term revenue bonds; provided that if on such date of calculation the interest rate on such Parity Bonds shall then be fixed to maturity, the interest rate used for such specified period for the purpose of the foregoing calculation shall be such actual interest rate. Once the 1996 Bonds, 1997 Bonds, 1998 Bonds, and 1999 Bonds are no longer outstanding, Reserve Account Requirement will mean, with respect to a series of Future Parity Bonds, an amount set forth in the resolution authorizing such bonds. The resolution authorizing Future Parity Bonds may establish a separate reserve account for any such Future Parity Bonds or provide that some or all of such Future Parity Bonds be secured by a common reserve account; provided, however, that so long as any 2001 Bonds are insured by a policy of bond insurance issued by Financial Security Assurance Inc. and no event of default has occurred thereunder, or so long as any 2005 Bonds are insured under a policy issued by Financial Guaranty and Financial Guaranty is not in default thereunder, the Reserve Account Requirement with respect to any Future Parity Bonds secured by the Reserve Account shall be an amount equal to the maximum amount of interest due in any Fiscal Year on such Future Parity Bonds. Serial Bonds means Parity Bonds other than Term Bonds. Sinking Fund Requirement means, for any Fiscal Year, the principal amount and premium, if any, of Term Bonds required to be purchased, redeemed or paid at maturity for such Fiscal Year as established by the resolution of the District authorizing the issuance of such Term Bonds. Supplemental R & C Fund means the Supplemental Renewal and Contingency Fund of the District created by Resolution No Term Bonds means Parity Bonds of any principal maturity that are subject to mandatory redemption or for which mandatory sinking fund payments are required. Trustee means a trustee appointed pursuant to the Bond Resolutions, including a Bondowner s Trustee. Revenue Fund The Wanapum Revenue Fund (the Revenue Fund ) was created by Resolution No The District shall pay into the Revenue Fund all Gross Revenues, exclusive of earnings on money in the Supplemental R&C Fund and the Bond Fund. The District shall pay from the Revenue Fund, after paying or making provision for the payment of Operating Expenses, the Coverage Requirement. On or prior to the 25th day of each month, the Coverage Requirement shall be disbursed as follows: (1) The payments into the Bond Fund required by the Bond Resolutions. (2) The deposits into the Reserve Account or payments to a provider of Qualified Insurance obtained to satisfy the Reserve Account Requirement required by the Bond Resolutions. (3) An amount equal to.0125 of Annual Debt Service shall be deposited into the Supplemental R&C Fund and applied to the purposes set forth in the Bond Resolutions. The amounts in the Revenue Fund shall be used only for the following purposes and in the following order of priority: (1) to pay or provide for Operating Expenses; (2) to make all payments required to be made into the Interest Account and to make any District Payments; (3) to make all payments required to be made into the Principal Account and to make all payments into the Bond Retirement Account; (4) to make all payments required to be made into the Reserve Account and to make all payments required to be made pursuant to a reimbursement agreement or agreements (or other equivalent documents) in A-5

84 connection with Qualified Insurance or a Qualified Letter of Credit obtained for the Reserve Account; provided that if there is not sufficient money to make all payments under such reimbursement agreements, the payments will be made on a pro rata basis; (5) to make all payments required to be made into the Supplemental R&C Fund; and (6) to make all payments required to be made into any special fund or account created to pay or secure the payment of junior lien obligations. After all of the above payments and credits have been made, amounts remaining in the Revenue Fund may be used for any other lawful purpose of the District relating to the Wanapum Development. Bond Fund The Wanapum Development Bond Fund (the Bond Fund ) shall be held in trust and administered by the Trustee and consists of four accounts: the Interest Account, the Principal Account, the Bond Retirement Account, and the Reserve Account. The Bond Fund shall be used to pay the principal of, premium, if any, and interest on the Parity Bonds, and for purchasing such bonds prior to maturity. District Payments shall be made from, and Reciprocal Payments shall be made into, the Interest Account. The District obligates and binds itself irrevocably to pay into the following accounts in the Bond Fund out of Gross Revenues certain fixed amounts in the following order of priority: (1) Interest Account: On or before the 25th day of each month, 1/6th of the amount, subject to adjustment for short or long interest periods, which (together with funds available in such account) shall equal the installment of interest next falling due on all Parity Bonds then Outstanding; (2) Principal Account and Bond Retirement Account: On or before the 25th day of each month (in every year preceding a year in which an installment of principal of the Parity Bonds is due) 1/12th of the amount which (together with funds available in such account) shall equal the installment of principal next falling due on all Parity Bonds then Outstanding; on or before the 25th day of each month (in every year preceding a year in which a Sinking Fund Requirement for Term Bonds is due) 1/12th of the amount, subject to adjustment for short or long Sinking Fund Requirement payment periods, which (together with funds available in such account) will equal the Sinking Fund Requirement next falling due (reduced by any credits made). The Trustee shall apply the money in the Bond Retirement Account to the redemption or purchase of Term Bonds on the next ensuing Sinking Fund Requirement due date; and (3) Reserve Account: On or before the 25th day of each of the six months next succeeding each date of valuation of the amount in the Reserve Account, 1/6th of the amount necessary to make the valuation of the amount in the Reserve Account equal to the Reserve Account Requirement, if the valuation of the amount in the Reserve Account is less than the Reserve Account Requirement. Such amounts will be withdrawn from the Revenue Fund, the Supplemental R&C Fund or the construction funds. The District may obtain Qualified Insurance or a Qualified Letter of Credit for specific amounts required to be paid out of the Reserve Account. The valuation of the amount in the Reserve Account must be made by the Trustee on each December 31 and after certain withdrawals and may be made on each June 30. If the valuation of the amount in the Reserve Account is greater than the Reserve Account Requirement, then and only then may the District withdraw at any time prior to the next date of valuation from the Reserve Account the difference between the amount of the valuation and the Reserve Account Requirement. Once the 1996 Bonds, the 1997 Bonds, the 1998 Bonds and the 1999 Bonds are no longer outstanding, monthly deposits shall not be required into the Interest, Principal and Bond Retirement Accounts. Money in the Bond Fund may, at the option of the District, be invested and reinvested as permitted by law in Permitted Investments maturing, or which are retireable, prior to the final installment of principal of the Parity Bonds. The Trustee shall make up any deficiency in the Interest Account, the Principal Account or the Bond Retirement Account from the funds available in the Reserve Account. A-6

85 The District has purchased surety bonds from Ambac Assurance Corporation, FSA, MBIA and Financial Guaranty constituting Qualified Insurance to satisfy the Reserve Account Requirement with respect to the Outstanding Parity Bonds. See SECURITY FOR THE PARITY BONDS Reserve Account. Any resolution providing for the issuance of Future Parity Bonds may provide for payments into the Bond Fund for credit to the Reserve Account from proceeds of such Future Parity Bonds or from Gross Revenues in not more than five equal annual installments, except that so long as the 2001 Bonds are insured by FSA or the 2005 Bonds are insured by Financial Guaranty, the Reserve Account Requirement must be fully funded on the date of issuance of any Parity Bonds, or may provide for the District to obtain Qualified Insurance or a Qualified Letter of Credit for specific amounts required to be paid into the Reserve Account. Pursuant to the terms of the surety bonds, the policy limits of each are automatically reduced to the extent of each payment made by the applicable surety under the terms of the surety bonds, and the District is required to reimburse the applicable surety for any draws under the surety bonds with interest at a market rate. Upon such reimbursement, the surety bonds are reinstated to the extent of each reimbursement up to but not exceeding the applicable policy limits. The reimbursement obligation of the District under the surety bonds is subordinate to the District s obligations with respect to the Parity Bonds. In the event the amount on deposit in, or credited to, the Reserve Account exceeds the amount of the surety bonds, any draw on the surety bonds shall be made only after all the funds in the Reserve Account have been expended. In the event that the amount on deposit in, or credited to, the Reserve Account, in addition to the amount available under the surety bonds, includes amounts available under a letter of credit, insurance policy, surety bond or other such funding instrument, draws on the surety bonds and additional funding instruments shall be made on a pro rata basis to fund the insufficiency. The Bond Resolutions provide that the Reserve Account shall be replenished in the following priority: principal and interest on the surety bonds and on the additional funding instrument shall be paid from first-available Gross Revenues on a pro rata basis. The surety bonds do not insure against nonpayment caused by the insolvency or negligence of the Trustee or the Paying Agent. Ambac Assurance, FSA MBIA, and Financial Guaranty are subject to the informational requirements of the Exchange Act and in accordance therewith file reports, proxy statements and other information with the Securities and Exchange Commission (the SEC ). Certain SEC filings of Ambac Assurance are available on the company s website, (which is not incorporated herein by this reference). Certain SEC filings of FSA are available on the company s website, (which is not incorporated herein by this reference). Certain SEC filings of MBIA are available on the company s website, (which is not incorporated herein by this reference). Certain SEC filings of Financial Guaranty are available on the company s website, (which is not incorporated herein by this reference). Such reports, proxy statements and other information may also be inspected and copied at the SEC s Public Reference Room at 100 F Street N.E., Washington, D.C See SECURITY FOR THE PARITY BONDS Reserve Account Reserve Account Surety Bonds. Project Account The 2006 Bond Resolution creates a Project Account. A portion of the proceeds of the Bonds will be deposited into the Project Account and applied to pay costs of improvements to the Wanapum Development and to pay costs of issuance of the Bonds. Supplemental Renewal and Contingency Fund The 1986 Bond Resolutions created the Wanapum Development Supplemental Renewal and Contingency Fund (the Supplemental R&C Fund ). The amount in such Fund must be $6,000,000 (the Supplemental Fund Cap ). The amount in such Fund shall not exceed the Supplemental Fund Cap as of the last day of any Fiscal Year. The District may increase the amount of the Supplemental Fund Cap by resolution of the Commission. Earnings on investments in the Supplemental R&C Fund shall be transferred to the Revenue Fund to the extent not required to maintain the Supplemental Fund Cap. If money in the Supplemental R&C Fund at the end of any Fiscal Year, after making transfers into the Revenue Fund as provided in the preceding sentence, exceeds the Supplemental Fund Cap, such excess shall be transferred to the Bond Fund. A-7

86 Money in the Supplemental R&C Fund must be used to make up any deficiency in the Bond Fund. To the extent not required to make up any deficiency in the Bond Fund, money in the Supplemental R&C Fund may be applied to any one or more of the following purposes: (1) to pay the cost of any project of repair, renewal, replacement, extraordinary maintenance, and safety improvement for the Wanapum Development; (2) to pay the cost of other improvements to and extensions of the Wanapum Development, including planning and design and feasibility studies for such improvements and extensions; and (3) to pay extraordinary operation costs. Additional Parity Bonds No Additional Senior Lien Bonds. The District shall not issue any additional bonds, notes, warrants or other obligations or create any additional indebtedness that will be secured by a charge and lien on the Gross Revenues and funds of the Wanapum Development to secure the payment of the Bonds ranking prior to the charge and lien thereon established by the Bond Resolutions. Additional Parity Bonds. Future Parity Bonds may be issued for any lawful purpose of the District relating to the Wanapum Development, including, but not limited to, acquiring, constructing and installing additions, betterments and improvements to and extensions of, acquiring necessary equipment for, or making necessary renewals, replacements or repairs and capital improvements to the Wanapum Development, refunding any outstanding indebtedness, and funding the Supplemental R&C Fund. The District must comply with the following conditions before issuing additional Parity Bonds: (1) At the times of the issuance of such Future Parity Bonds there is no deficiency in the Bond Fund or in any accounts therein. (2) If such additional Parity Bonds are being issued to pay costs other than refunding Parity Bonds, there shall have been delivered to the Trustee and the District a report of a Professional Utility Consultant to the effect that (a) the plan pursuant to which proceeds of such Parity Bonds are to be expended is consistent with prudent utility practice and will not materially adversely interfere with operation of the Wanapum Development, and (b) in the opinion of the Professional Utility Consultant, based upon such assumptions as he believes to be reasonable, such plan will not result in a reduction of the Net Revenues below the amounts covenanted in the rate covenant in the Bond Resolutions to be maintained; provided, however, that once the 1996 Bonds, 1997 Bonds, 1998 Bonds, 1999 Bonds and 2001 Bonds are no longer Outstanding, no such report of a Professional Utility Consultant will be required where contracts with the Electric System (which may include a resolution of the District with respect to such obligation of the Electric System) and/or other purchasers are in effect for a term at least as long as the term of the proposed Future Parity Bonds and require the Electric System and/or other purchasers to purchase 100% of the power from and to pay 100% of the costs of the Wanapum Development, including the cost of maintaining the rate coverage requirements of the Bond Resolutions. (3) The resolution authorizing the issuance of the additional Parity Bonds shall require that there shall be paid into the Reserve Account in the Bond Fund (a) from the proceeds of such Future Parity Bonds an amount such that the amount on deposit in the Reserve Account is equal to the Reserve Account Requirement, or (b) from Gross Revenues (i) in not more than five equal annual installments commencing one year from the date of issuance of such Future Parity Bonds or (ii) on the date of issuance of such Future Parity Bonds, so long as any 2001 Bonds are insured under a policy issued by FSA and such insurer is not in default thereunder, or so long as any 2005 Bonds are insured under a policy issued by Financial Guaranty and such insurer is not in default thereunder, an amount such that the amount on deposit in the Reserve Account is equal to the applicable Reserve Account Requirement, or (c) by the deposit of a Qualified Letter of Credit or Qualified Insurance the face amount of which, together with other funds on deposit in the Reserve Account, is equal to the Reserve Account Requirement. Upon the issuance of any Future Parity Bonds, the District shall recalculate the Reserve Account Requirement. If any Future Parity Bonds are issued for refunding purposes and the issuance of such refunding Parity Bonds results in a present value monetary saving to the District and such refunding Parity Bonds will not require a greater amount A-8

87 (exclusive of issuance costs, any call premiums, and except as necessary to round out maturities to the nearest $5,000) to be paid in any Fiscal Year thereafter than would have been required to be paid in the same Fiscal Year for Annual Debt Service on the bonds being refunded, then subsection 2 above need not be complied with. Junior Lien Bonds. The District may issue bonds, notes, warrants or other obligations payable from and secured by a lien and charge junior to the lien and charge of the Parity Bonds. Derivative Products Once the 1996 Bonds, 1997 Bonds, 1998 Bonds and 1999 Bonds are no longer Outstanding, to the extent permitted by state law, the District may enter into Derivative Products on a parity with the Bonds or any Parity Bonds subject to the conditions set forth in the Bond Resolution and summarized below. The following shall be conditions precedent to the use of any Derivative Product on a parity with any Bonds under the Bond Resolution: (1) General Parity Tests. The Derivative Product and the obligations to which it relates must satisfy the requirements for Future Parity Bonds described in the Bond Resolution taking into consideration District Payments and Reciprocal Payments under the Derivative Product. District Payments shall be made from the Bond Account, and Annual Debt Service shall include any regularly scheduled District Payments adjusted by any regularly scheduled Reciprocal Payments. Reciprocal Payments shall be deposited into the Bond Account. Termination payments owed pursuant to a Derivative Product shall not be on a parity with the Parity Bonds. (2) Opinion of Bond Counsel. The District shall obtain an opinion of bond counsel on the due authorization and execution of such Derivative Product, the validity and enforceability thereof and opining that the action proposed to be taken is authorized or permitted by the Bond Resolution and will not adversely affect the excludability for federal income tax purposes of the interest on any Parity Bonds then Outstanding. (3) Payments. Each Derivative Product shall set forth the manner in which the District Payments and Reciprocal Payments are to be calculated and a schedule of Derivative Payment Dates. (4) Supplemental Resolutions to Govern Derivative Products. Prior to entering into a Derivative Product, the District shall adopt a resolution, which shall: (a) Derivative Facilities; and establish general provisions for the rights of providers of Derivative Products or (b) set forth such other matters as the District deems necessary or desirable in connection with the management of Derivative Products as are not clearly inconsistent with the provisions of the Bond Resolution. Defeasance The District may set aside with a trustee or escrow agent in a special trust account irrevocably pledged to the payment of certain Bonds, cash, Government Obligations and/or Refunded Municipals, if permitted by law, sufficient, together with the earnings thereon, to provide funds to pay when due the interest on part or all of the Bonds and to redeem and retire such Bonds at or prior to maturity in accordance with their terms. Prior to any defeasance, the District must obtain a verification from an independent certified public accountant that the escrowed cash and securities are sufficient to pay the Bonds and an opinion of nationally-recognized bond counsel that such defeasance will not cause interest on any Parity Bonds then outstanding to become subject to federal income taxes. In such event no further payment need be made into the Bond Fund for the payment of the principal of and interest on the Bonds so provided for and such Bonds shall cease to be entitled to any lien, benefit or security of the Bond Resolutions except the right to receive payment from such special account, and such Bonds shall not be deemed to be outstanding for purposes of the Bond Resolutions. A-9

88 Covenants Rate Covenant General. The District shall establish, maintain and collect rates or charges in connection with the ownership and operation of the Wanapum Development that shall be fair and nondiscriminatory and adequate to provide Gross Revenues sufficient for the payment of the principal of and interest on all Outstanding Parity Bonds, all amounts which the District is obligated to set aside in the Bond Fund, the payment of all Operating Expenses of the Wanapum Development, and for the payment of any and all amounts that the District may now or hereafter become obligated to pay from said Gross Revenues. Rate Covenant Debt Service Coverage. The District shall establish, maintain and collect rates or charges in connection with the ownership and operation of the Wanapum Development sufficient to provide Net Revenues in any Fiscal Year hereafter in an amount at least equal to the Coverage Requirement, and any amounts required to pay the principal of and interest on any junior lien obligations, excluding any capitalized interest. Tax Covenant. The District has covenanted to undertake all actions required to maintain the tax-exempt status of interest on the 2006A Bonds and 2006B Bonds under Section 103 of the Code, including the payment of arbitrage rebate, if necessary, as set forth in the Tax Certificate. FERC License. The District will use its best efforts to retain the FERC license for the Wanapum Development and renew such FERC license when it expires. Enforcement of Power Sales Contracts. The District has covenanted to enforce its rights and the obligations of power purchasers under the Power Sales Contracts. Additional Covenants Obligation of the Electric System. Until the 1996 Bonds, 1997 Bonds and 1998 Bonds are no longer Outstanding, the District shall (i) pay from the revenues of the Electric System or other legally available funds all amounts required to be paid under the Bond Resolutions to the extent payment or provision for payment of such amounts is not otherwise made and (ii) establish, maintain and collect rates or charges for electric power and energy sold through the Electric System sufficient to pay all costs chargeable against the revenues of the Electric System and all amounts required to be paid under the Bond Resolutions to the extent payment or provision for payment of such amounts is not otherwise made. Except as provided in the next sentence, the obligation to pay such amounts shall rank as a lien and charge against the revenues of the Electric System junior in rank to all other obligations of the Electric System. Payments made by the Electric System for the costs of purchased power and energy shall be an operating expense of the Electric System. See SECURITY FOR THE PARITY BONDS Pledge of Revenues for a description of the Electric System s obligations once the existing power sales contracts expire. A-10

89 Maintenance of Development in Good Condition. The District will maintain, preserve and keep the Wanapum Development in good repair, working order and condition, and will make all necessary and proper repairs, renewals, replacements, extensions and betterments thereto so that at all times the business carried on in connection therewith shall be properly and advantageously conducted, and the District will operate such properties and the business in connection therewith in an efficient manner and at reasonable cost. Disposal of Properties. The District will not sell or otherwise dispose of the Wanapum Development in its entirety unless simultaneously with such sale or other disposition, provision is made for the payment into the Bond Fund sufficient to pay the principal of and interest on all Parity Bonds then outstanding and any premium upon the retirement thereof in full, nor will it sell or otherwise dispose of any part of the useful operating properties of the Wanapum Development if such sale or disposition would result in a reduction of Net Revenues below the amounts required in the Bond Resolutions. If the FERC license is awarded to another party, the District shall deposit into the Bond Fund, promptly following receipt, any compensation received from the new licensee up to the amount necessary to pay or provide for the payment of principal of and interest on the Parity Bonds then outstanding. The District may sell or otherwise dispose of any of the properties of the Wanapum Development which shall have become unserviceable, inadequate, obsolete or unfit to be used in the operation of the Wanapum Development or no longer necessary, material to or useful in such operation. Insurance. The District will keep the Wanapum Development insured, and will carry such other insurance with responsible insurers against risks, accidents or casualties, at least to the extent that insurance is usually carried by municipal corporations operating like properties; provided the District may, if deemed necessary and advisable by the Commission, institute or continue a self-insurance program with respect to such risks. In the event of any loss or damage, the District will promptly deposit the insurance proceeds into any construction funds, and use such funds to repair or replace the damaged portion of the insured property; or in the event the District should determine not to repair or reconstruct such damaged portion, the proceeds of such insurance or self-insurance funding shall be transferred to the Reserve Account to the extent necessary to make up any deficiency in the Reserve Account and the balance, if any, shall, at the option of the District, be used for repairs, renewals, replacements, or additions to or extensions of the Wanapum Development or be used in the retirement of Parity Bonds prior to maturity, either by purchase or by call for redemption. Books of Account. The District shall keep proper books of account, showing as a separate utility system the accounts of the Wanapum Development, in accordance with the rules prescribed by the Division of Municipal Corporations of the Washington State Auditor s office, or other State agency succeeding to such duties, and if no such rules are prescribed, then in substantial accordance with the uniform system of accounts prescribed by the Federal Energy Regulatory Commission or other federal agency having jurisdiction. The District shall cause its books of account to be audited annually by the State Auditor s office or other State agency authorized by law to make such audits, or if such an audit shall not be made for 12 months after the close of any Fiscal Year, by independent certified public accountants. Any owner of any Bond may obtain at the office of the District copies of the balance sheet and statement of income and retained earnings showing in reasonable detail the financial condition of the Wanapum Development as of the close of each Fiscal Year, and the income and expenses of such year, including the amounts paid into the funds created pursuant to the Bond Resolutions, and the amounts expended for maintenance, renewals, replacements, and gross capital additions to the Wanapum Development. A-11

90 Make Only Economically Sound Improvements. The District will not expend any revenues from the Wanapum Development or proceeds of Parity Bonds or other obligations for any extensions, betterments and improvements to the Wanapum Development which will not properly and advantageously contribute to the business of the Wanapum Development. Merger or Consolidation. The District shall use its best efforts to avoid dissolution, termination of its existence or consolidation with another entity, without paying or providing for the payment of all Parity Bonds then Outstanding. Rebates To Purchasers If required by contract with the purchasers of power and energy from the Wanapum Development, the District may rebate money on hand in any fund, except the Bond Fund, relating to the Wanapum Development to such purchasers. Such a rebate may be paid to the Electric System on the same basis as to the other purchasers. Events Of Default, Trustee, Remedies Events of Default. The following constitute Events of Default under the Bond Resolutions: (1) Default in the due and punctual payment of the principal of any of the Parity Bonds when the same shall become due, either at maturity or following notice of redemption; (2) Default in the due and punctual payment of interest on any Parity Bond within 5 days when the same shall become due; (3) Failure to purchase or redeem Term Bonds in an aggregate principal amount at least equal to the Sinking Fund Requirement for the applicable Fiscal Year; (4) Defaults in the performance of any other of the covenants, conditions and agreements in the Bond Resolutions and such default continues for 90 days after the District receives from the Trustee or from the owners of not less than 66% in principal amount of any series of Parity Bonds then Outstanding, a written notice demanding the cure of such default; or (5) If the District: (a) admits in writing its inability to pay its debts as they become due; (b) files a petition in bankruptcy or seeking a composition of indebtedness under any state or federal law; (c) makes an assignment for the benefit of its creditors; (d) consents to the appointment of a receiver of the whole or any substantial part of the Wanapum Development; or (e) consents to the assumption by any court of competent jurisdiction under any other law for the relief or aid of debtors of custody or control of the District or of the whole or any substantial part of the Wanapum Development. Trustee. The Bank of New York Trust Company, N.A., Seattle, Washington is appointed to act as Trustee for the owners of all Parity Bonds. The Trustee may resign, and thereby become discharged from the trusts created, by written notice to the District and mailed to each bondowner or published once in a daily journal of general circulation or a financial journal published in New York City not less than 45 days before such resignation is to take effect. Such resignation shall take effect immediately upon the appointment of a new Trustee. The Trustee may be discharged at any time by the District as long as an Event of Default has not occurred and is continuing or by the owners of a majority in principal amount of the Parity Bonds then Outstanding. Once the 1996 Bonds, 1997 Bonds, 1998 Bonds, and 1999 Bonds are no longer Outstanding and prior to an Event of Default, the District may, by written notice to the Trustee, require the Trustee to transfer the Bond Fund to the District, discharge the Trustee, and, in that case, (1) a Trustee shall not be required to hold the Bond Fund, and (2) the District shall not be required to appoint a Trustee prior to an A-12

91 Event of Default, provided that the bondowners may appoint a Bondowners Trustee upon an Event of Default, as described below. If the Trustee shall resign, be discharged, or its position becomes vacant for any other reason, the District shall appoint a new Trustee. The District shall mail notice of any such appointment to each bondowner or shall publish notice once within 20 days after such appointment. At any time within one year after such appointment, the owners of a majority in principal amount of the Parity Bonds then outstanding may appoint a successor Trustee, which shall supersede any Trustee appointed by the District. In the event that at any time the funds held by the Trustee and the Paying Agent for the Parity Bonds shall be insufficient for the payment of the principal of, premium, if any, and interest then due on the Parity Bonds, such funds (other than funds held for the payment or redemption of particular Parity Bonds which have theretofore become due at maturity or by call for redemption) and all Gross Revenues and other money received or collected for the benefit or for the account of owners of the Parity Bonds by the Trustee shall be applied as follows: First, to the payment to the persons entitled thereto of all installments of interest then due in the order of the maturity of such installments, earliest maturities first, and, if the amount available shall not be sufficient to pay in full any installment or installments of interest maturing on the same date, then to the payment thereof ratably, according to the amounts due thereon, to the persons entitled thereto, without any discrimination or preference; and Second, to the payment to the persons entitled thereto of the unpaid principal and premium, if any, of any Parity Bonds which shall have become due, whether at maturity or by call for redemption, in the order of their due dates, earliest maturities first, and, if the amount available shall not be sufficient to pay in full all the Parity Bonds due on any date, then to the payment thereof ratably, according to the amounts of principal and premium, if any, due on such date, to the persons entitled thereto, without any discrimination or preference. Remedies. If an Event of Default shall happen and not be remedied, the District, upon demand of the Trustee, shall pay over to the Trustee (i) all securities and funds then held by the District and pledged under the Bond Resolutions, and (ii) as promptly as practicable after receipt, all Gross Revenues. If an Event of Default shall happen and not be remedied, the Trustee shall be entitled to take such necessary steps and institute such proceedings at law or in equity for the collection of all sums due in connection with the Parity Bonds and to protect and enforce the rights of the owners of the Parity Bonds under the Bond Resolutions, for the specific performance of any covenant or in aid of the execution of any power granted, or for an accounting against the District as trustee of an express trust, or in the enforcement of any other legal or equitable right as the Trustee, being advised by counsel, shall deem most effectual to enforce any of the rights of the owners of the Parity Bonds. The Parity Bonds are not subject to acceleration upon default. Any proceedings instituted by the Trustee shall be brought in its name as trustee for the bondowners. The owners of the Parity Bonds, by taking and holding the same, shall be conclusively deemed irrevocably to appoint the Trustee the true and lawful trustee of such owners, with authority to institute any such proceeding; to deposit in trust any sums becoming distributable on account of the Parity Bonds; to execute any documents for the receipt of such money, and to do all acts with respect thereto that the bondowner himself might have done in person; provided, that nothing in the Bond Resolutions shall be deemed to authorize or empower the Trustee to consent to, accept or adopt, on behalf of any owner of Parity Bonds, any plan of reorganization or adjustment affecting the Parity Bonds or any right of any owner thereof, or to authorize or empower the Trustee to vote the claims of the owners under the Bond Resolutions in any receivership, insolvency, liquidation, bankruptcy, reorganization or other proceeding to which the District shall be a party; however, that any bondowner may by mutual agreement transfer title to the Parity Bonds held by him to the Trustee. The Trustee shall have full power of substitution and delegation in respect to any of the powers granted. The owners of not less than 66% (so long as any 1996 Bonds, 1997 Bonds, 1998 Bonds, 1999 Bonds or 2001 Bonds remain Outstanding, and thereafter a majority) in principal amount of the Parity Bonds at the time outstanding may direct the time, method and place of conducting any proceeding for any remedy available to the Trustee, or A-13

92 exercising any trust or power conferred upon the Trustee; provided that the Trustee shall be provided with reasonable security and indemnity and shall have the right to decline to follow any such direction only (i) if the Trustee shall be advised by counsel that the action or proceeding so directed may not lawfully be taken or (ii) if the Trustee in good faith shall determine that the action or proceeding so directed would involve the Trustee in personal liability or that the action or proceeding so directed would be unjustly prejudicial to the owners of Parity Bonds not parties to such direction. No owner of any Parity Bond shall have any right to institute any proceeding at law or in equity for the enforcement of any provision of the Bond Resolutions or the execution of any trust under the Bond Resolutions or for any remedy under the Bond Resolutions, unless (a) an Event of Default shall have happened and be continuing, (b) owners of 66% (so long as any remain Outstanding, and thereafter a majority) of the principal amount of Parity Bonds then Outstanding have given the District and the Trustee written notice of the Event of Default on account of which such proceeding is to be instituted, and have requested the Trustee to institute such proceeding and offered indemnity to it against costs, expenses and liabilities, and (c) the Trustee shall have refused or neglected to comply with such request for 60 days after such written request is received by, and said tender of indemnity shall have been made to, the Trustee. In addition to the limitations on remedies contained in the Bond Resolution, the rights and obligations under the Bonds and the Bond Resolution may be subject to bankruptcy, insolvency, reorganization, arrangement, fraudulent conveyance, moratorium and other laws relating to or affecting creditors rights, to the application of equitable principles, to the exercise of judicial discretion in appropriate cases, and to limitations on legal remedies against public utility districts in the State. The opinion to be delivered by Preston Gates & Ellis LLP, as Bond Counsel, concurrently with the issuance of the Bonds, to the effect that the Bonds constitute legal, valid and binding obligations of the District and that the Bond Resolution constitutes a valid and binding obligation of the District, will be subject to such limitations, and the various other legal opinions to be delivered concurrently with the issuance of the Bonds will be similarly qualified. In the event the District fails to comply with its covenants under the Bond Resolution or to pay principal of or interest on the Bonds, there can be no assurance that available remedies will be adequate to fully protect the interests of the Owners of the Bonds. Bondowners Trustee. Once the 1996 Bonds, 1997 Bonds, 1998 Bonds and 1999 Bonds are no longer Outstanding, if (i) an Event of Default has occurred, is continuing and has not been remedied, and (ii) no one is then serving as Trustee, the owners of 25% in principal amount of Parity Bonds then outstanding, may appoint a bondowners trustee (the Bondowners Trustee ) by an instrument or concurrent instruments in writing signed and acknowledged by such registered owners of the Parity Bonds duly authorized and delivered to such Bondowners Trustee, notification thereof being given to the District. Any Bondowners Trustee so appointed must be a bank or trust company organized under the laws of the State of New York or a national banking association. That appointment shall become effective immediately upon acceptance thereof by the Bondowners Trustee. The bank or trust company acting as Bondowners Trustee may be removed at any time, and a successor Bondowners Trustee may be appointed, by the registered owners of a majority in principal amount of Parity Bonds Outstanding. The Bondowners Trustee may require such security and indemnity as may be reasonable against the costs, expenses and liabilities that may be incurred in the performance of its duties. The Bondowners Trustee appointed in the manner provided in the Bond Resolution, and each successor thereto, will be a trustee for the owners of all Parity Bonds outstanding and is empowered to exercise all the rights and powers conferred on the Trustee and Bondowners Trustee. The Bondowners Trustee may resign upon 60 days notice and a new Bondowners Trustee appointed by the owners of at least 25% in principal amount of Parity Bonds then Outstanding; provided, however, that no such resignation or removal can be effective until the successor Bondowners Trustee has been appointed. Any money collected by the Bondowners Trustee at any time shall be applied in the following order of priority: First, to the payment of the charges, expenses, advances and compensation of the Bondowners Trustee and the charges, expenses, counsel fees, disbursements and compensation of its agents and attorneys; and A-14

93 Second, to the payment to the persons entitled thereto, first of required interest and then of unpaid principal amounts on any Parity Bonds which shall have become due (other than Parity Bonds previously called for redemption for the payment of which money is held pursuant to the provisions of the Bond Resolution), whether at maturity or by proceedings for redemption or otherwise, in the order of their due dates and, if the amount available shall not be sufficient to pay in full the principal amounts due on the same date, then to the payment thereof ratably, according to the principal amounts due thereon to the persons entitled thereto, without any discrimination or preference. Neither the registered owner nor the beneficial owner of any one or more of Parity Bonds shall have any right to institute any action, suit or proceeding at law or in equity for the enforcement of same unless: (i) an Event of Default has happened and is continuing; and (ii) a Bondowners Trustee has been appointed; and (iii) such owner previously shall have given to the Bondowners Trustee written notice of the Event of Default on account of which such suit, action or proceeding is to be instituted; and (iv) the owners of 25% in principal amount of the Parity Bonds outstanding, after the occurrence of such Event of Default, has made written request of the Bondowners Trustee and have afforded the Bondowners Trustee a reasonable opportunity to institute such suit, action or proceeding; and (v) there have been offered to the Bondowners Trustee security and indemnity satisfactory to it against the costs, expenses and liabilities to be incurred therein or thereby; and (vi) the Bondowners Trustee has refused or neglected to comply with such request within a reasonable time. No registered owner or beneficial owner of any Parity Bond shall have any right in any manner whatever by his action to affect or impair the obligation of the District to pay from the Net Revenue the principal of and interest on such Parity Bonds to the respective owners thereof when due. Amendments Without the consent of the owners of Parity Bonds, the District may adopt supplemental resolutions to add to the covenants of the District contained in, or to surrender any right reserved to or conferred upon it by, the Bond Resolutions, or to cure any ambiguity or correct any defect in the Bond Resolutions or to change or add any provision to the Bond Resolutions which will not materially adversely affect the bondowners in the opinion of nationally recognized bond counsel. Any amendments or supplements to the Bond Resolutions may be made by the District with the consent of 66% in aggregate principal amount of the Parity Bonds then outstanding; provided that without the consent of the owner of each Parity Bond that would be affected, no supplemental resolution shall (1) change the fixed maturity date for the payment of the principal of any Parity Bond or the date for the payment of interest thereon or the terms of the redemption thereof, or reduce the principal amount of any Parity Bond or the rate of interest thereon or the redemption price (or the redemption premium) payable upon the redemption or prepayment thereof; (2) reduce the aforesaid percentage of Parity Bonds the owners of which are required to consent to any supplemental resolution; (3) give to any Parity Bond any preference over any other Parity Bond; (4) create any pledge of the Gross Revenues and other money pledged superior or equal to the pledge of and lien and charge for the payment of the Parity Bonds; or (5) deprive any owner of the Bonds of the security afforded by the Bond Resolutions. After the owners of the required percentage of Parity Bonds have filed their consents to an amending or supplementing resolution, the District may thereafter adopt such amending or supplementing resolution. Notice of any such amendment or supplement must be given to each registered owner of Parity Bonds then Outstanding and to the Trustee. Any action or proceeding to set aside or invalidate any such amending or supplementing resolution or any of the proceedings for its adoption must be commenced within 60 days after the mailing of such notice. A-15

94 Rights of Insurer For all purposes of governing events of default and remedies, except the giving of notice of default to registered owners of the Outstanding Parity Bonds, the Insurer shall be deemed to be the sole holder of the bonds it has insured for so long as it has not failed to comply with its payment obligations under the policy. Any amendment or supplement to the Bond Resolution shall be subject to the prior written consent of the Insurer. If the District fails to repay any policy costs in accordance with the Reserve Surety Bond, the Insurer shall be entitled to exercise any and all remedies available at law or under the Bond Resolution other than (i) acceleration of the maturity of the bonds it has insured or (ii) remedies which would adversely affect bondholders. A-16

95 APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE POWER CONTRACTS The power sales contracts executed in 1959, and the amendments thereto executed in 1977 and 1986, are collectively referred to in this Appendix as the 1959 Power Sales Contracts. In 2001, the District executed power sales contracts (the New Power Sales Contracts ) with all of the purchasers of power under the 1959 Power Sales Contracts as well as with ten Idaho cooperatives. The New Power Sales Contracts went into effect on November 1, 2005, with respect to power from the Priest Rapids Development, and on November 1, 2009, with respect to power from the Wanapum Development. The 1959 Power Sales Contracts and the New Power Sales Contracts are sometimes referred to collectively herein as the Power Contracts. Summaries of certain provisions of the Power Contracts are set forth below. Reference is made to the complete text of the Power Contracts for all of the provisions thereof. The major provisions of each of the 1959 Power Sales Contracts and each of the New Power Sales Contracts are substantially similar except as to the percentages of Project Output to be taken by each of the Power Purchasers. See also discussion of the Power Sales Contracts under the heading THE WANAPUM DEVELOPMENT Wanapum Development Output and Power Sales Contracts Power Sales Contracts Term: The 1959 Power Sales Contracts shall continue in full force and effect until October 31, Wanapum Development Output is defined as the amount of power and energy produced by, or received for the account of, the Wanapum Development during the term of the 1959 Power Sales Contracts under the operating conditions which exist during said term, including periods when the Wanapum Development may be inoperable, after corrections for encroachment, station and Wanapum Development use, and depletions required by the Federal Power Commission License. The District reserves 36.5% of the Wanapum Development Output for the use of the Electric System. Continuity of Parties to Power Contracts: The 1959 Power Sales Contracts are binding upon and inure to the benefit of the District and the Power Purchasers and their successors and assigns. No assignment or transfer of a Power Contract relieves the parties thereto of any obligation incurred thereunder. See Table 2 for the percentages of output from the Wanapum Development to which the Power Purchasers are entitled under the 1959 Power Sales Contracts. Continuity of Payments for Projects and Payments by Power Purchasers. Monthly payments for Wanapum Development Output shall be made by the Power Purchasers during the term of the 1959 Power Sales Contracts sufficient in aggregate amount to pay all costs of the District resulting from the ownership, operation, maintenance of and renewals and replacements to the Wanapum Development, including 115% of debt service on the Parity Bonds whether or not the Wanapum Development is operable; provided, however, that the amounts required to be paid with respect to the Parity Bonds shall include only the amounts required to be paid during the term of the Power Contracts in accordance with the amortization of the Parity Bonds. The Power Purchasers agree to pay the District their respective percentage shares of all of the District s costs related to the Wanapum Development, including, but not limited to: (1) Amounts required to be set aside by the District for the payment of debt service as required by Resolution No (which bonds have been retired); (2) Amounts which may be required to pay for the prevention or correction of any unusual loss or damage and for major replacements to keep the Wanapum Development in good operating condition to the extent that such costs are not covered by insurance and by the R&C Fund; (3) An amount which when added to the annual power costs itemized in Sections (2) and (3) above will equal 15% of the annual debt service during the applicable contract year; B-1

96 (4) All costs of producing and delivering power and energy (excluding depreciation) not accounted for by the payments out of funds and reserves specified in the foregoing subsections and properly chargeable to the Wanapum Development in accordance with the Uniform System of Accounts, less any credits against such costs by reason of net revenues from other sources than the direct sale of power, and also less any credits for interest charged during construction, all as provided for in the Uniform System of Accounts; and (5) All amounts that the District shall be obligated to pay into any fund or account as provided in the Bond Resolutions or any resolution authorizing the issuance of additional Parity Bonds. Billing: On or before September 2nd, the District shall give each Power Purchaser a pro forma statement showing estimated annual power costs, the Power Purchaser s estimated cost, and monthly payments for the following contract year. A final accounting shall be rendered to the Power Purchasers by the District on or before each April 30th and any charge or credit adjustment required shall be made promptly by the District and the Power Purchasers. Except as to any portion of a monthly bill for Wanapum Development Output which is disputed in good faith by a Power Purchaser, if a bill or portion thereof remains unpaid after 30 days notice, the District may discontinue service to such purchaser until such bill is paid. No such discontinuance shall affect the Power Purchaser s liability under the Power Contract. Increase of Power Purchaser s Allocation: Each non-defaulting Power Purchaser s allocation shall be automatically increased pro rata with other Power Purchaser s allocation by a cumulative maximum of 25% in the event of a default (that is, a payment default accompanied by insolvency, bankruptcy or other causes as defined in the Power Contracts) by any other Power Purchaser. If, prior to an imminent default by a Power Purchaser, such Power Purchaser shall demonstrate to the satisfaction of the District, and the other Power Purchasers receiving in the aggregate at least two-thirds of the balance of the Wanapum Development Output, its inability to pay for its Power Purchaser s allocation and its ability to pay for a smaller Power Purchaser s allocation, then such Power Purchaser shall be allowed to take such smaller Power Purchaser s allocation and shall thereafter be liable for the same in the same manner as for its original Power Purchaser s allocation. See Obligation of the Electric System under Additional Covenants in APPENDIX A SUMMARY OF CERTAIN PROVISIONS OF THE PARITY BOND RESOLUTIONS. B-2

97 New Power Sales Contracts The New Power Sales Contracts consist of a series of agreements signed with each of the Power Purchasers. The term of the New Power Sales Contracts will match the term of any new license received by the District for the Priest Rapids and Wanapum Developments and that has a duration of 30 years or longer. The following table shows the anticipated allocation of power based on the current allocation of the Priest Rapids Development. Actual allocations will depend on contractual terms of the New Power Sales Contracts. Percentage Allocation of Amount Remaining after the District Meets its Requirements PacifiCorp, OR 26.12% Portland General Electric Company, OR Puget Sound Energy, Inc., WA City of Tacoma Light Division (Tacoma Power), WA Avista Corporation, WA Eugene Water & Electric Board, OR 3.21 City of Seattle, City Light Department, WA 2.75 Public Utility District No. 1 of Cowlitz County, WA 1.12 Snake River Cooperative, ID (1) 0.42 City of Forest Grove, OR 0.26 City of McMinnville, OR 0.26 City of Milton-Freewater, OR 0.26 Public Utility District No. 1 of Kittitas County, WA 0.21 Kootenai, ID 0.14 Northern Lights, ID 0.13 Clearwater, ID 0.08 Idaho Co. Light & Power, ID % (1) The Snake River Cooperative is composed of the following cooperatives: Fall River Rural Electric, Lost River Electric, Lower Valley Electric, Raft River Rural Electric, Salmon River Electric, and United Electric. Wanapum Development Output is defined as the amount of power and energy produced by, or received for the account of, the Wanapum Development during the term of the Power Sales Contracts under the operating conditions which exist during said term, including periods when the Wanapum Development may be inoperable, after corrections for encroachment, station and Priest Rapids Development use, and depletions required by the FERC License. Product Sales Contracts (as amended). The Product Sales Contracts address the 70% of output from the Developments that is not reserved by the FERC for sale to power customers in the region, as required by PL-544. Of that 70% of output from the Developments, each of the Power Purchasers receives, at cost, its participating share of the output (firm and non-firm) that remains after the District has satisfied its requirements. As the District s requirements increase, the amount of power available to the Power Purchasers under the Product Sale Contracts will decrease. The District will provide the Power Purchasers with an annual forecast of its requirements. If the District eventually requires 70% of the output from the Developments, the Power Purchasers will receive only power resulting from elimination of the Additional Product Sales Contracts. Reasonable Portion Contracts. The Reasonable Portion Contracts address the 30% of output from the Developments (the reasonable portion ) that is reserved by the FERC for sale to other power customers in the region, as required by PL-544. The FERC order requires that this power be sold at market prices, and the Reasonable Portion Agreements provide that such sales will be made pursuant to a marketing plan approved by the Power Purchasers. The net revenue from sales of this reasonable portion of the output from the Developments will be distributed to the Power Purchasers in proportion to their participating shares under the Product Sales Contract. Once the District B-3

98 has taken the maximum amount of power allowed under the Product Sale Contracts, it has rights to net revenues under the Reasonable Portion Contracts to provide for its firm energy requirements beyond that provided from the 70% allocation. Continuity of Payments for Projects and Payments by Power Purchasers. Monthly payments for Wanapum Development Output shall be made by the Power Purchasers (and by the District through its Electric System) during the term of the New Power Sales Contracts sufficient in aggregate amount to pay all costs of the District resulting from the ownership, operation, maintenance of and renewals and replacements to the Wanapum Development, including 115% of debt service on Parity Bonds whether or not the Wanapum Development is operable; provided, however, that the amounts required to be paid with respect to the Parity Bonds shall include only the amounts required to be paid during the term of the Power Contracts in accordance with the amortization of the Parity Bonds. The Power Purchasers agree to pay the District their respective percentage shares of all of the District s costs related to the Wanapum Development, including, but not limited to: (1) All costs of producing and delivering power and energy (excluding depreciation) that are properly chargeable to the Developments in accordance with the Uniform System of Accounts, less any credits against such costs by reason of net revenues from other sources than the direct sale of power, and also less any credits for interest charged during construction, all as provided for in the Uniform System of Accounts; (2) Amounts required to pay for the prevention or correction of any loss or damage and for major replacements to keep the Developments in good operating condition to the extent that such costs are not covered by insurance and by the R&C Fund; (3) Amounts needed to pay debt service on bonds or other obligations financing improvements to the Developments, plus an additional 15% of the amount of debt service for Parity Bonds; (4) Costs of creating and replenishing any reserve or contingency fund required to be maintained by any Bond Resolutions and working capital funds; (5) Liabilities, including settlements and judgments, resulting from ownership, operation or maintenance of the Developments and not covered by insurance; (6) Costs incurred by the District in applying for a new FERC license for the Developments (most of which costs will be amortized over a 15-year period); (7) Obligations entered into by the District in obtaining a new FERC license for the Developments, including but not limited to the cost of replacing products that may be committed in such obligations; (8) Certain costs incurred by the District to fulfill obligations, if any, to parties to the 1959 Power Sales Contracts that do not sign a New Power Sales Contract; and (9) An amount equal to 15% of debt service in that contract year or such higher amount as may be required by a Bond Resolution to satisfy the Coverage Requirement. In addition to the credits described in (1) and (2) above, Power Purchasers will receive credits for the following: efforts; (1) Revenue, if any, received from obligations entered into by the District as part of its relicensing (2) Revenue, if any, received as a result of the District s fulfilling obligation to parties to the 1959 Power Sales Contracts that do not sign a New Power Sales Contract; (3) The 15% Coverage Requirement amount, to the extent that it is not spent for capital or other costs of the Developments; and B-4

99 (4) Interest earnings on funds of the Developments that are not required to be retained by such funds pursuant to any of the Bond Resolutions. Debt. Regardless of how the District structures debt to pay costs of improvements to the Developments, the Power Purchasers will pay their share of such debt as if it were structured with level debt service amortized over a period equal to the estimated weighted average economic service life of the improvements financed or refinanced by such debt; provided that the amortization period shall not exceed 30 years. Billing. At least 30 days before each contract year beginning in 2005, the District must give each Power Purchaser a pro forma statement showing estimated annual power costs, estimated cost to the District of selling the Displacement Product, risk premium allocable to the Power Purchaser, the Power Purchaser s estimated cost, and monthly payments for the following contract year. A final accounting shall be rendered to the Power Purchasers by the District by June 1 of each year, and any charge or credit adjustment required shall be made promptly by the District and the Power Purchasers. B-5

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101 APPENDIX C AUDITED FINANCIAL STATEMENTS OF THE WANAPUM DEVELOPMENT AND ELECTRIC SYSTEM AS OF DECEMBER 31, 2005 AND 2004

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173 APPENDIX D THE INFORMATION SET FORTH BELOW RELATING TO THE MAJOR POWER PURCHASERS HAS BEEN OBTAINED FROM DOCUMENTS FILED BY SUCH POWER PURCHASERS WITH THE SECURITIES AND EXCHANGE COMMISSION (THE SEC ) PURSUANT TO THE INFORMATIONAL REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934 (THE EXCHANGE ACT ). THE DISTRICT MAKES NO REPRESENTATION AS TO, NOR HAS IT ATTEMPTED TO VERIFY, THE ACCURACY OR COMPLETENESS OF SUCH INFORMATION. DESCRIPTION OF MAJOR POWER PURCHASERS (CURRENT OBLIGATED PERSONS) PACIFICORP PacifiCorp, an Oregon corporation ( PacifiCorp or the Company ), is a regulated electricity company serving approximately 1.6 million retail customers in service territories aggregating about 136,000 square miles in portions of six western states: Utah, Oregon, Wyoming, Washington, Idaho, and California. The regulatory commissions in each state approve rates for retail electric sales within their respective states. PacifiCorp also sells electricity on the wholesale market to public and private utilities, energy marketing companies and incorporated municipalities. Wholesale activities are regulated by the Federal Energy Regulatory Commission ( FERC ). PacifiCorp owns, or has interests in, 69 thermal, hydroelectric and wind generating plants with an aggregate nameplate rating of 9,050.8 megawatts ( MW ) and plant net capability of 8,470.0 MW. The FERC and the six state regulatory commissions also have authority over the construction and operation of PacifiCorp s electric generation facilities. PacifiCorp delivers electricity through approximately 59,510 miles of distribution lines and approximately 15,580 miles of transmission lines. As of March 31, 2006, PacifiCorp had 6,750 employees. On May 23, 2005, ScottishPower and PacifiCorp Holdings, Inc. ( PHI ), PacifiCorp s direct parent, executed a Stock Purchase Agreement (the Stock Purchase Agreement ) providing for the sale of all PacifiCorp common stock to MidAmerican Energy Holdings Company ( MidAmerican ) for a value of approximately $9.4 billion, consisting of approximately $5.1 billion in cash plus approximately $4.3 billion in net debt and preferred stock, which will remain outstanding at PacifiCorp. In January through March 2006, the state commissions in all six states where PacifiCorp has retail customers approved the Company s sale to MidAmerican. On March 21, 2006, MidAmerican completed its purchase of all of the Company s outstanding common stock from PHI. The cash purchase price was $5.1 billion. PacifiCorp s common stock was directly acquired by a subsidiary of MidAmerican, PPW Holdings LLC. As a result of this transaction, MidAmerican controls the significant majority of PacifiCorp s voting securities, which include both common and preferred stock. MidAmerican is a privately-owned global energy company based in Des Moines, Iowa, and is a majority-owned subsidiary of Berkshire Hathaway Inc. The principal executive offices of PacifiCorp are located at 825 NE Multnomah Street, Portland, Oregon 97232; the telephone number is (503) ; and its website is: (which is not incorporated herein by this reference). Available Information PacifiCorp is subject to the informational requirements of the Exchange Act and in accordance therewith files reports, proxy statements and other information with the SEC. Such information may be obtained on the Internet through the SEC s EDGAR Database at (which is not incorporated herein by this reference. Copies of this material may also be obtained at prescribed rates from the Public Reference Branch of the SEC at its principal office at 100 F Street N.E., Room 1850, Washington, D.C Information on the operation of the Public Reference Room may be obtained by calling the SEC at SEC The preferred stock of PacifiCorp is listed on the American Stock Exchange. Reports, proxy statements and other information concerning PacifiCorp may be inspected and copied at the offices of this exchange at 86 Trinity Place, New York, New York. D-1

174 Incorporation of Certain Documents by Reference The following documents filed with the SEC pursuant to the Exchange Act are incorporated in this Official Statement by reference: 1. PacifiCorp s Annual Report on Form 10-K for the fiscal year ending March 31, PacifiCorp s Quarterly Reports on Form 10-Q for the quarters ending June 30, 2006 and September 30, PacifiCorp s Current Reports on Form 8-K dated January 5, 2006, January 12, 2006, February 2, 2006, February 17, 2006, February 27, 2006, March 6, 2006, March 23, 2006, May 11, 2006, June 5, 2006, August 14, 2006, August 21, 2006, August 25, 2006 and November 22, All documents filed by PacifiCorp pursuant to Section 13, 14, or 15(d) of the Exchange Act after the date of this Official Statement and prior to the termination of the offering hereunder shall be deemed to be incorporated by reference in this Official Statement and to be part hereof from the date of the filing of such reports. PacifiCorp will provide to each person to whom a copy of this Official Statement has been delivered in connection with the offer contained herein, on the request of any such person, a copy of any or all of the documents referred to above which have been or may be incorporated by reference in this Official Statement, other than exhibits to such documents. Requests for such copies should be directed to Corporate Shareholders Relations, PacifiCorp, 825 N.E. Multnomah Street, Suite 2000, Portland, Oregon The telephone number is (503) PORTLAND GENERAL ELECTRIC COMPANY Portland General Electric Company ( PGE ), incorporated in Oregon in 1930, has principal executive offices located at 121 S.W. Salmon Street, Portland, Oregon (telephone number: (503) ). PGE is an electric utility engaged in the generation, purchase, transmission, distribution, and retail sale of electricity in the State of Oregon. PGE also sells electricity and natural gas in the wholesale market to utilities and power marketers located throughout the western United States. PGE s service area is located entirely within Oregon and includes 52 incorporated cities, of which Portland and Salem are the largest, within a state-approved service area allocation of approximately 4,000 square miles. A portion of the City of Portland is serviced by another Oregon utility. PGE estimates that the population of its service area at the end of 2005 was approximately 1.5 million, constituting approximately 43% of the state s population. PGE added approximately 13,000 retail customers during 2005, and at December 31, 2005, PGE served approximately 780,000 retail customers. As of December 31, 2005, PGE had 2,620 employees. On April 3, 2006, PGE, which was a wholly-owned subsidiary of Enron Corp. ( Enron ), entered into a Separation Agreement with Enron in connection with the cancellation of all outstanding PGE common stock, $3.75 par value per share, all of which was held by Enron prior to April 3, 2006, and the issuance of 62,500,000 shares of new PGE common stock, without par value, pursuant to the Fifth Amended Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code, dated January 9, 2004 and as thereafter amended (the Plan ). As a result of the issuance of the common stock, PGE ceased to be a subsidiary of Enron. Pursuant to the Plan and in connection with the issuance of the common stock, PGE filed with the Secretary of State of the State of Oregon the Amended and Restated Article of Incorporation of the company, effective April 3, Available Information PGE is subject to the informational requirements of the Exchange Act and in accordance therewith file reports and other information with the SEC. Such information may be obtained on the Internet through the SEC s EDGAR Database at (which is not incorporated herein by this reference). Copies of this material may also be obtained at prescribed rates from the Public Reference Branch of the SEC at its principal office at 100 F Street N.E., Room 1850, Washington, D.C Information on the operation of the Public Reference Room may be obtained by calling the SEC at SEC Certain securities D-2

175 of PGE are listed on the New York Stock Exchange. Reports, proxy statements and other information concerning Puget Sound Energy can be inspected at the office of this exchange at 20 Broad Street, New York, New York. Incorporation of Certain Documents by Reference The following documents, filed with the SEC by PGE, are incorporated by reference in this Official Statement. 1. PGE s Annual Report on Form 10-K for the year ended December 31, PGE s Quarterly Reports on Form 10-Q for the quarters ending March 31, 2006, June 30, 2006 and September 30, PGE s Current Reports on Form 8-K dated January 26, 2006, February 13, 2006, February 22, 2006, March 17, 2006, March 27, 2006, April 3, 2006, April 26, 2006, May 1, 2006, May 12, 2006, May 17, 2006, May 25, 2006, July 14, 2006, August 2, 2006, September 1, 2006, October 2, 2006, October 30, 2006, November 7, 2006 and November 20, All documents filed by PGE pursuant to Section 13, 14, or 15(d) of the Exchange Act after the date of this Official Statement and prior to the termination of the offering hereunder shall be deemed to be incorporated by reference in this Official Statement and to be part hereof from the date of the filing of such reports. PGE will provide to each person to whom a copy of this Official Statement has been delivered, on the written request of any such person, a copy of any or all of the documents referred to above which have been or may be incorporated in this Official Statement by reference, other than exhibits to such documents. Requests for such copies should be directed to Treasurer, Portland General Electric Company, 121 S.W. Salmon Street, Portland, Oregon 97204, website: (which is not incorporated herein by this reference). PUGET SOUND ENERGY, INC. Puget Sound Energy, Inc. ( Puget Sound Energy ) is an investor-owned public utility incorporated in the State of Washington furnishing electric and gas services in a territory covering approximately 6,000 square miles, principally in the Puget Sound region of Washington State. As of December 31, 2005, Puget Sound Energy had approximately 1,018,100 electric customers and approximately 693,500 gas customers. For the year 2005, Puget Sound Energy added approximately 16,400 electric customers and approximately 21,000 gas customers, representing annualized growth rates of 1.6% and 3.1%, respectively. On January 1, 2001, Puget Sound Energy reorganized into a holding company structure. Puget Energy, Inc. ( Puget Energy ) is a holding company that owns Puget Sound Energy and, until May 7, 2006, InfrastruX Group, Inc. ( InfrastruX ), a Washington corporation. On May 7, 2006, Puget Energy sold InfrastruX to an affiliate of Tenaska Power Fund, L.P. After repayment of debt, adjustments for working capital, transaction costs and distributions to minority interests, Puget Energy received after-tax cash proceeds of approximately $95.9 million for its 90.9% interest in InfrastruX in the second quarter of As of February, 2006, Puget Energy and its subsidiaries had 5,300 aggregate full-time equivalent employees, which includes approximately 2,300 full-time equivalent employees of Puget Sound Energy. Puget Energy s and Puget Sound Energy s principal executive offices are located at N.E. 4 th Street, Suite 1200, Bellevue, Washington 98004, its telephone number is (425) and its website is: (which is not incorporated herein by this reference. In November 2005, Puget Energy sold 15 million shares of common stock to Lehman Brothers Inc. for $312 million before an underwriting discount. The net proceeds of approximately $309.8 million were invested in Puget Sound Energy and used to repay short-term debt incurred primarily to fund Puget Sound Energy s construction program. Puget Sound Energy is implementing a strategy to be more self-sufficient in energy generation resources and is continually exploring new electric-power resource generation and long-term purchase power agreements to meet this D-3

176 goal. The completion of the Hopkins Ridge wind project, in southeastern Washington State, in the fourth quarter of 2005 and progress on construction of the Wild Horse wind project, in central Washington State, are two steps in reaching this goal. The Hopkins Ridge wind project provides approximately 150 MW of capacity or 52 average MW. The Company expects to complete construction of the Wild Horse wind project in the fourth quarter of The Wild Horse wind project is designed to provide approximately 230 MW of capacity or 73 average MW. Together these electric generation resources will serve the needs of approximately 123,000 of Puget Sound Energy s electric customers. The Hopkins Ridge wind project and the Wild Horse wind project were included as part of Puget Sound Energy s energy resource portfolio in its long-term electric Least Cost Plan that was filed May 2, 2005 with the Washington Utilities and Transportation Commission. The plan supports a strategy of diverse resource acquisitions including resources fueled by natural gas and coal, renewable resources and shared resources. The Least Cost Plan was followed by issuing an all-source request for proposal ( RFP ) on November 1, In August 2006, Puget Sound Energy announced the selection of seven projects for further discussion and possible negotiation as a result of the 2005 RFP process. In aggregate, these outside sources, if completed, would generate approximately 1,100 MW of long-term power supply in total. Available Information Puget Sound Energy and Puget Energy are subject to the informational requirements of the Exchange Act and in accordance therewith files reports, proxy statements and other information with the SEC. Such information may be obtained on the Internet through the SEC s EDGAR Database at (which is not incorporated herein by this reference). Copies of this material may also be obtained at prescribed rates from the Public Reference Branch of the SEC at its principal office at 100 F Street N.E., Room 1850, Washington, D.C Information on the operation of the Public Reference Room may be obtained by calling the SEC at SEC The common stock of Puget Energy is listed on the New York Stock Exchange. Reports, proxy statements and other information concerning Puget Energy can be inspected at the offices of this exchange at 20 Broad Street, New York, New York. Incorporation of Certain Documents by Reference The following documents, filed with the SEC by Puget Sound Energy, are incorporated by reference in this Official Statement. 1. Puget Sound Energy s Annual Report on Form 10-K for the year ended December 31, Puget Sound Energy s Quarterly Reports on Form 10-Q for the quarters ending March 31, 2006, June 30, 2006 and September 30, Puget Sound Energy s Current Reports on Forms 8-K and 8-K/A dated February 7, 2006, February 8, 2006, February 14, 2006, February 16, 2006, March 14, 2006, May 4, 2006, June 26, 2006, June 30, 2006, August 3, 2006, September 14, 2006, November 2, 2006 and November 6, All documents filed by Puget Sound Energy pursuant to Section 13, 14, or 15(d) of the Exchange Act after the date of this Official Statement and prior to the termination of the offering hereunder shall be deemed to be incorporated by reference in this Official Statement and to be part hereof from the date of the filing of such reports. Puget Sound Energy will provide to each person to whom a copy of this Official Statement has been delivered, on the written or oral request of any such person, a copy of any or all of the documents referred to above which have been or may be incorporated in this Official Statement by reference, other than exhibits to such documents. Requests for such copies should be directed to Puget Sound Energy, Inc., Investor Services, P.O. Box 97034, PSE-08S, Bellevue, Washington D-4

177 APPENDIX E PROPOSED FORM OF OPINION OF BOND COUNSEL Public Utility District No. 2 of Grant County, Washington Citigroup Global Markets Inc. Seattle, Washington UBS Securities LLC Los Angeles, California J.P. Morgan Securities Inc. Seattle, Washington Re: Public Utility District No. 2 of Grant County, Washington Wanapum Hydroelectric Development Revenue and Refunding Bonds, 2006 Series A $71,395,000 Series B $18,190,000 Series Z (Taxable) $96,845,000 Ladies and Gentlemen: We have acted as bond counsel to Public Utility District No. 2 of Grant County, Washington (the District ), and have examined a certified transcript of the proceedings taken in the matter of the issuance by the District of its Wanapum Hydroelectric Development Revenue and Refunding Bonds, 2006 Series A, in the aggregate principal amount of $71,395,000 (the 2006A Bonds ), Series B in the aggregate principal amount of $18,190,000 (the 2006B Bonds ), and Series Z in the aggregate principal amount of $96,845,000 (the 2006Z Bonds, and, collectively, the Bonds ), all dated as of the date hereof. The Bonds are issued pursuant to Resolution No of the District s Board of Commissioners (the Bond Resolution ) to finance improvements to the Wanapum Development and to refund certain outstanding Wanapum Development revenue bonds. Capitalized terms used herein and not otherwise defined shall have the meanings given them in the Bond Resolution. The Bonds are subject to optional and mandatory redemption as provided in the Bond Resolution. As to questions of fact material to our opinion, we have relied upon representations of the District contained in the Bond Resolution and in the certified proceedings and other certifications of public officials and others furnished to us without undertaking to verify the same by independent investigation. From such examination it is our opinion, as of this date and under existing law, that: 1. The District has the right and power under Title 54 of the Revised Code of Washington (the Act ) to adopt the Bond Resolution, and the Bond Resolution has been duly and lawfully adopted by the District, is in full force and effect, is valid and binding upon the District and is enforceable in accordance with its terms. 2. The Bond Resolution creates the valid pledges under the Act which it purports to create of (i) the money and assets, if any, credited to the Revenue Fund, the Bond Fund, the Project Account and the Supplemental R&C Fund, and the income therefrom, and (ii) the Gross Revenues, subject to prior application to pay Operating Expenses (as such terms are defined in the Bond Resolution). 3. The District is duly authorized and entitled to issue the Bonds, and the Bonds have been duly and validly authorized and issued by the District in accordance with the laws of the State of Washington, including the E-1

178 Act. The Bonds constitute the valid and binding obligations of the District as provided in the Bond Resolution, are enforceable in accordance with their terms and the terms of the Bond Resolution and are entitled to the benefits of the Act and the Bond Resolution. The Bonds are special limited obligations of the District and neither the State of Washington nor any political subdivision thereof, other than the District, is obligated to pay the principal of and interest on the Bonds. The opinions contained in paragraphs 1, 2 and 3 above are qualified to the extent that the enforcement of the rights and remedies of the owners of the Bonds may be subject to judicial discretion and the valid exercise of sovereign police powers of the State of Washington and of the Constitutional powers of the United States of America, and may be limited by laws relating to bankruptcy, receivership, reorganization, moratorium or other similar laws of general application affecting the rights of creditors, or the availability of any particular remedy. 4. Interest on the 2006A Bonds is excludable from gross income for federal income tax purposes and is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals and corporations; however, interest on the 2006A Bonds is taken into account in determining adjusted current earnings for the purpose of computing the alternative minimum tax imposed on certain corporations. The opinion set forth in the preceding sentence is subject to the condition that the District comply with all requirements of the Internal Revenue Code of 1986, as amended, that must be satisfied subsequent to the issuance of the 2006A Bonds in order that the interest thereon be, and continue to be, excludable from gross income for federal income tax purposes. The District has covenanted to comply with all applicable requirements. Failure to comply with certain of such covenants may cause interest on the 2006A Bonds to be included in gross income for federal income tax purposes retroactively to the date of issuance of the 2006A Bonds. 5. Interest on the 2006B Bonds is excluded from gross income for purposes of federal income taxation pursuant to Section 103 of the Code, provided that the continuing arbitrage requirements of Section 148 of the Code are complied with and that proceeds of the 2006B Bonds are not used to acquire used property or to provide prohibited facilities. Notwithstanding the foregoing, no opinion regarding tax-exemption is expressed for any 2006B Bond with respect to any period during which such 2006B Bond is held by a substantial user of the facility financed by the 2006B Bonds or a related person to such substantial user within the meaning of Section 147 of the Code. The 2006B Bonds are private activity bonds. Interest on the 2006B Bonds is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals or corporations, but is taken into account in the computation of adjusted current earnings for purposes of the corporate alternative minimum tax under Section 55 of the Code. The opinions stated in paragraphs 4 and 5 are subject to the condition that the District comply with all requirements of the Code that must be satisfied subsequent to the issuance of the 2006A Bonds and 2006B Bonds in order that interest thereon be, or continue to be, excluded from gross income for federal income tax purposes. The District has covenanted to comply with all such requirements. Failure to comply with certain of such requirements may cause interest on the 2006A Bonds or 2006B Bonds to be included in gross income for federal income tax purposes retroactive to the date of issuance of the 2006A Bonds and 2006B Bonds. The District has taken no action to cause interest on the 2006Z Bonds to be excluded from gross income for purposes of federal income taxation. Except as expressly stated above, we express no opinion regarding any other federal or state income tax consequences of acquiring, carrying, owning or disposing of the Bonds. Owners of the Bonds should consult their tax advisors regarding the applicability of any collateral tax consequences of owning the Bonds, which may include original issue discount, original issue premium, purchase at a market discount or at a premium, taxation upon sale, redemption or other disposition, and various withholding requirements. We have not been engaged nor have we undertaken to review the accuracy, completeness or sufficiency of the official statement or other offering material related to the Bonds (except to the extent, if any, stated in the official statement). We express no opinion relating to the undertaking by the District to provide ongoing disclosure pursuant to SEC Rule 15c2-12. E-2

179 This opinion is given as of the date hereof and we assume no obligation to update, revise or supplement this opinion to reflect any facts or circumstances that may hereafter come to our attention or any changes in law that may hereafter occur. Very truly yours, PRESTON GATES & ELLIS LLP By Nancy M. Neraas E-3

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181 APPENDIX F BOOK-ENTRY SYSTEM The following information has been provided by the Depository Trust Company, New York, New York ( DTC ). The District makes no representation regarding the accuracy or completeness thereof. Beneficial Owners (as hereinafter defined) should therefore confirm the following with DTC or the Participants (as hereinafter defined). DTC will act as securities depository for the Bonds. The Bonds will be issued as fully-registered in the name of Cede & Co. (DTC s partnership nominee) or such other name as may be requested by an authorized representative of DTC. One fully-registered Bond certificate will be issued for each maturity of the Bonds in the principal amount of such maturity and will be deposited with DTC. DTC, the world s largest securities depository, is a limited-purpose trust company organized under the New York Banking Law, a banking organization within the meaning of the New York Banking Law, a member of the Federal Reserve System, a clearing corporation within the meaning of the New York Uniform Commercial Code, and a clearing agency registered pursuant to the provisions of Section 17A of the Securities Exchange Act of DTC holds and provides asset servicing for over 2.2 million issues of U.S. and non-u.s. equity issues, corporate and municipal debt issues, and money market instruments from over 100 countries that DTC s participants ( Direct Participants ) deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities through electronic computerized book-entry transfers and pledges between Direct Participants accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-u.s. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation ( DTCC ). DTCC, in turn, is owned by a number of Direct Participants of DTC and Members of the National Securities Clearing Corporation, Fixed Income Clearing Corporation and Emerging Markets Clearing Corporation, (NSCC, FICC, and EMCC, also subsidiaries of DTCC), as well as by the New York Stock Exchange, Inc., the American Stock Exchange, Inc., and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others such as both U.S. and non-u.s. securities brokers and dealers, banks, and trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly ( Indirect Participants ). DTC has Standard & Poor s highest rating: AAA. The DTC Rules applicable to its Participants are on file with the Securities and Exchange Commission. More information about DTC can be found at and Purchases of the Bonds under the DTC system, in denominations of $5,000 or any integral multiple thereof, must be made by or through Direct Participants, which will receive a credit for the Bonds on DTC s records. The ownership interest of each actual purchaser of each Bond ( Beneficial Owner ) is in turn to be recorded on the Direct and Indirect Participants records. Beneficial Owners will not receive written confirmation from DTC of their purchase. Beneficial Owners are, however, expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the Bonds are to be accomplished by entries made on the books of Direct and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in the Bonds, except in the event that use of the book entry-entry system for the Bonds is discontinued. To facilitate subsequent transfers, all Bonds deposited by Participants with DTC are registered in the name of DTC s partnership nominee, Cede & Co. or such other name as may be requested by an authorized representative of DTC. The deposit of Bonds with DTC and their registration in the name of Cede & Co. or such other DTC nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Bonds; DTC s records reflect only the identity of the Direct Participants to whose accounts such Bonds are credited, which may or may not be the Beneficial Owners. The Direct and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers. When notices are given, they shall be sent by the Registrar to DTC only. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct F-1

182 Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. Redemption notices shall be sent to DTC. If less than all of the Bonds are being redeemed, DTC s practice is to determine by lot the amount of the interest of each Direct Participant in such issue to be redeemed. Neither DTC nor Cede & Co. (nor any other DTC nominee) will consent or vote with respect to the Bonds unless authorized by a Direct Participant in accordance with DTC s Procedures. Under its usual procedures, DTC mails an Omnibus Proxy to the District as soon as possible after the record date. The Omnibus Proxy assigns Cede & Co. s consenting or voting rights to those Direct Participants to whose accounts Bonds are credited on the record date (identified in a listing attached to the Omnibus Proxy). Redemption proceeds, distributions, and dividend payments on the Bonds will be made to Cede & Co. or such other nominee as may be requested by an authorized representative of DTC. DTC s practice is to credit Direct Participants accounts upon DTC s receipt of funds and corresponding detail information from the District or the Registrar, on payable date in accordance with their respective holdings shown on DTC s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in street name, and will be the responsibility of such Participant and not of DTC, the Registrar, or the District, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of redemption proceeds, distributions, and dividend payments to Cede & Co. (or any other nominee as may be requested by an authorized representative of DTC) is the responsibility of the District or the Registrar, disbursement of such payments to Direct Participants will be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners will be the responsibility of Direct and Indirect Participants. DTC may discontinue providing its services as securities depository with respect to the Bonds at any time by giving reasonable notice to the District and the Registrar. Under such circumstances, in the event that a successor securities depository is not obtained, Bond certificates are required to be printed and delivered. The District may decide to discontinue use of the system of the book-entry transfers through DTC (or a successor securities depository). In that event, Bond certificates will be printed and delivered to DTC. With respect to Bonds registered on the Bond Register in the name of Cede & Co., as nominee of DTC, the District and the Registrar shall have no responsibility or obligation to any Participant or to any person on behalf of whom a Participant holds an interest in the Bonds with respect to (i) the accuracy of the records of DTC, Cede & Co. or any Participant with respect to any ownership interest in the Bonds; (ii) the delivery to any Participant or any other person, other than a bondowner as shown on the Bond Register, of any notice with respect to the Bonds, including any notice of redemption; (iii) the payment to any Participant or any other person, other than a bondowner as shown on the Bond Register, of any amount with respect to principal of, premium, if any, or interest on the Bonds; (iv) the selection by DTC or any Participant of any person to receive payment in the event of a partial redemption of the Bonds; (v) any consent given action taken by DTC as registered owner; or (vi) any other matter. The District and the Registrar may treat and consider Cede & Co., in whose name each Bond is registered on the Bond Register, as the holder and absolute owner of such Bond for the purpose of payment of principal and interest with respect to such Bond, for the purpose of giving notices of redemption and other matters with respect to such Bond, for the purpose of registering transfers with respect to such Bond, and for all other purposes whatsoever. For the purposes of this Official Statement, the term Beneficial Owner shall include the person for whom the Participant acquires an interest in the Bonds. F-2

183 APPENDIX G SPECIMEN FORM OF BOND INSURANCE POLICY

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185 G-1