The Company manages its interest rate risk primarily through the issuance of fixed-rate debt of various maturities. The Company utilizes internal cash from operations, commercial paper and credit facilities to meet short-term funding needs. Short-term obligations are commonly refinanced with fixed-rate bonds or notes when needed and when interest rates are considered favorable. The Company may also enter into swap instruments or other financial hedge instruments to manage interest rate risk associated with its debt. At the date of the merger in 2009, Puget Energy entered into interest rate swap transactions to hedge the risk associated with its one-month London Interbank Offered Rate (LIBOR) floating rate debt. As of June 30, 2011, Puget Energy had four remaining interest rate swap contracts outstanding and PSE did not have any outstanding interest rate swap instruments.

Effective December 6, 2010, Puget Energy de-designated its interest rate derivatives previously recorded as cash flow hedges, as it intends to refinance the underlying debt over the next few years. A portion of the outstanding interest rate swap derivative loss on December 6, 2010 remained in OCI and is being amortized as the future interest payments on the debt occur. The portion of the outstanding interest rate swap derivative loss associated with interest payments on the debt where future occurrence became remote was reclassified from OCI into earnings. After December 6, 2010, all gains or losses associated with the interest rate swaps are marked-to-market and recorded in Puget Energy's earnings.

On June 3, 2011, Puget Energy issued $500.0 million of senior secured notes, with a maturity of September 1, 2021, to repay a portion of Puget Energy's five-year term-loan. Puget Energy paid down $484.0 million of the term-loan and, due to existing debt covenants with its banks, concurrently net settled three interest rate swaps with a total notional amount of $205.6 million for a $9.9 million loss. Since the future debt payments related to the $484.0 million repayment were determined to be remote of occurring, Puget Energy reclassified $18.4 million loss from accumulated OCI into earnings. At June 30, 2011, the fair value of the interest rate swap contracts outstanding in accumulated OCI was a $53.8 million pre-tax loss.

In July 2009, the Company discontinued cash flow hedge accounting for all energy related derivatives. As a result, the natural gas and electric derivative portfolios are marked-to-market and changes in value are recorded in earnings. However, amounts previously recorded in accumulated OCI continue to be deferred until the forecasted transaction occurs or management determines that the forecasted transaction is remote. Amounts deferred are reclassified into earnings in the period in which the forecasted transaction settles or is deemed probable of not occurring.

PSE employs various portfolio optimization strategies, but is not in the business of assuming risk for the purpose of realizing speculative trading revenue. The nature of serving regulated electric customers with its portfolio of owned and contracted electric generation resources exposes PSE and its customers to volumetric and commodity price risks within the sharing mechanism of the Power Cost Adjustment (PCA). Therefore, wholesale market transactions are focused on balancing PSE's energy portfolio, reducing costs and risks where feasible and reducing volatility in costs and margins in the portfolio. PSE's energy risk portfolio management function monitors and manages these risks using analytical models and tools. In order to manage risks effectively, PSE enters into physical and financial transactions which are appropriate for the service territory of PSE and are relevant to its regulated electric and natural gas portfolios.

Derivatives Not Designated as Hedging Instruments
Puget Energy	June 30, 2011				December 31, 2010
(Dollars in Thousands)	Assets 1		Liabilities 2		Assets 1		Liabilities 2
Interest rate swaps:
Current	$	--	$	26,795	$	--	$	30,047
Long-term		--		27,021		--		27,956
Electric portfolio:
Current		5,145		130,701		4,716		142,780
Long-term		4,300		71,660		5,046		99,801
Gas portfolio: 3
Current		4,674		74,126		2,784		100,273
Long-term		3,763		32,812		3,187		55,378
Total derivatives	$	17,882	$	363,115	$	15,733	$	456,235

Derivatives Not Designated as Hedging Instruments
Puget Sound Energy	June 30, 2011				December 31, 2010
(Dollars in Thousands)	Assets 1		Liabilities 2		Assets 1		Liabilities 2
Electric portfolio:
Current	$	5,145	$	130,701	$	4,716	$	142,780
Long-term		4,300		71,660		5,046		99,801
Gas portfolio: 3
Current		4,674		74,126		2,784		100,273
Long-term		3,763		32,812		3,187		55,378
Total derivatives	$	17,882	$	309,299	$	15,733	$	398,232

1	Balance sheet location: Unrealized gain on derivative instruments.
2	Balance sheet location: Unrealized loss on derivative instruments.
3	The Company had a derivative liability and an offsetting regulatory asset of $98.5 million and $149.7 million at June 30, 2011 and December 31, 2010, respectively, related to financial contracts used to economically hedge the cost of physical gas purchased to serve natural gas customers. All fair value adjustments on derivatives relating to the natural gas business have been reclassified to a deferred account in accordance with ASC 980, "Regulated Operations" (ASC 980), due to the Purchased Gas Adjustment (PGA) mechanism. All increases and decreases in the cost of natural gas supply are passed on to customers with the PGA mechanism and the gains and losses on the hedges in future periods will be recorded as gas costs.

Puget Energy	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in Thousands)	2011			2010			2011			2010
Gas / Power NPNS 1	$	(2,720	)	$	(7,985	)	$	(10,769	)	$	(33,584	)
Gas for power generation		1,261			(71	)		(40,262	)		48,919
Power exchange		--			(530	)		--			(1,457	)
Power		(15,536	)		(6,154	)		918			32,030
Total net unrealized (gain) loss on derivative instruments	$	(16,995	)	$	(14,740	)	$	(50,113	)	$	45,908
Interest expense - interest rate swaps	$	14,171		$	--		$	12,245		$	--
Other deductions - interest rate swaps	$	16,126		$	--		$	14,326		$	--

___________

Puget Sound Energy	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in Thousands)	2011			2010			2011			2010
Gas for power generation	$	1,476		$	5,516		$	(23,201	)	$	77,721
Power exchange		--			(530	)		--			(1,457	)
Power		(11,124	)		4,140			7,569			45,879
Total net unrealized (gain) loss on derivative instruments	$	(9,648	)	$	9,126		$	(15,632	)	$	122,143

The following tables present the effect of hedging instruments on the Puget Energy's OCI and statements of income, which are based on derivatives that were in a previous cash flow hedging relationship, for the three and six months ended June 30, 2011 and 2010:

Puget Energy (Dollars in Thousands)	Three Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion 1)					Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion 2)
	2011		2010			Location	2011			2010
Interest rate contracts:	$	--	$	(26,131	)	Interest expense	$	(24,246	)	$	(8,349	)
Commodity contracts: Electric derivatives		--		--		Electric generation fuel		(20	)		--
						Purchased electricity		(252	)		(412	)
Total	$	--	$	(26,131	)		$	(24,518	)	$	(8,761	)

Puget Energy (Dollars in Thousands)	Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion 1)					Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion 2)
	2011		2010			Location	2011			2010
Interest rate contracts:	$	--	$	(43,577	)	Interest expense	$	(30,758	)	$	(16,883	)
Commodity contracts: Electric derivatives		--		--		Electric generation fuel		(50	)		(122	)
						Purchased electricity		(510	)		(1,809	)
Total	$	--	$	(43,577	)		$	(31,318	)	$	(18,814	)

___________

The following tables present the effect of hedging instruments on PSE's OCI and statements of income, which are based on derivatives that were in a previous cash flow hedging relationship, for the three and six months ended June 30, 2011 and 2010:

Puget Sound Energy (Dollars in Thousands)	Three Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion 1)				Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion 2)
	2011		2010		Location	2011			2010
Interest rate contracts:	$	--	$	--	Interest expense	$	(123	)	$	(122	)
Commodity contracts: Electric derivatives		--		--	Electric generation fuel		(237	)		(5,587	)
					Purchased electricity		(4,663	)		(5,259	)
Total	$	--	$	--		$	(5,023	)	$	(10,968	)

Puget Sound Energy (Dollars in Thousands)	Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion 1)				Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion 2)
	2011		2010		Location	2011			2010
Interest rate contracts:	$	--	$	--	Interest expense	$	(246	)	$	(245	)
Commodity contracts: Electric derivatives		--		--	Electric generation fuel		(17,109	)		(28,923	)
					Purchased electricity		(7,159	)		(11,248	)
Total	$	--	$	--		$	(24,514	)	$	(40,416	)

___________

For derivative instruments that met cash flow hedge criteria, the effective portion of the gain or loss on the derivative was reported as a component of accumulated OCI during the hedging period and will be reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivatives representing hedge ineffectiveness are recognized in current earnings. Puget Energy expects that $17.6 million of losses in accumulated OCI will be reclassified into earnings within the next twelve months. PSE expects that $16.5 million of losses in accumulated OCI will be reclassified into earnings within the next twelve months. The maximum length of time over which the Company is economically hedging its exposure to the variability of future cash flows extends to February 2015 for purchased electricity contracts, October 2015 for gas for power generation contracts and February 2014 for interest rate swaps. Additionally, the maximum length of contract transactions deferred in accumulated OCI extends to February 2015 for purchased electricity contracts, January 2012 for gas for power generation contracts and February 2014 for interest rate swaps.

Puget Energy		Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in Thousands)	Location	2011			2010			2011			2010
Interest rate contracts:	Other deductions	$	(25,412	)	$	--		$	(25,460	)	$	--
	Interest expense		(22,699	)		--			(27,276	)		--
Commodity contracts:
Electric derivatives	Unrealized gain (loss) on derivative instruments, net 1		14,275			6,754			39,344			(79,493	)
	Electric generation fuel		(8,808	)		(8,343	)		(49,622	)		(33,000	)
	Purchased electricity		(19,158	)		(11,476	)		(33,830	)		(18,200	)
Total gain (loss) recognized in income on derivatives		$	(61,802	)	$	(13,065	)	$	(96,844	)	$	(130,693	)

Differs from the amounts stated in the statements of income as it does not include amortization expense related to contracts that were recorded at fair value at the time of the February 2009 merger and subsequently designated as NPNS of $2.7 million and $10.8 million for the three and six months ended June 30, 2011 and $8.0 million and $33.6 million for the three and six months ended June 30, 2010, respectively.

Puget Sound Energy		Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in Thousands)	Location	2011			2010			2011			2010
Commodity contracts:
Electric derivatives	Unrealized gain (loss) on derivative instruments, net	$	9,648		$	(9,126	)	$	15,632		$	(122,143	)
	Electric generation fuel		(8,808	)		(8,343	)		(49,622	)		(33,000	)
	Purchased electricity		(19,158	)		(11,476	)		(33,830	)		(18,200	)
Total gain (loss) recognized in income on derivatives		$	(18,318	)	$	(28,945	)	$	(67,820	)	$	(173,343	)

Derivatives not designated as hedging instruments:	Number of Units
Puget Energy:
Interest rate swaps	$1.277 billion
Puget Energy and Puget Sound Energy:
Gas derivatives 1	374,812,103 MMBtus
Electric generation fuel	92,925,279 MMBtus
Purchased electricity	10,351,400 MWhs

The Company is exposed to credit risk primarily through buying and selling electricity and natural gas to serve its customers and through interest rate swaps. Credit risk is the potential loss resulting from a counterparty's non-performance under an agreement. The Company manages credit risk with policies and procedures for, among other things, counterparty credit analysis, exposure measurement, exposure monitoring and exposure mitigation.

The Company monitors counterparties with significant swings in credit default swap rates, credit rating changes by external rating agencies, changes in ownership or that are experiencing financial problems. Where deemed appropriate, the Company may request collateral or other security from its counterparties to mitigate potential credit default losses. Criteria employed in this decision include, among other things, the perceived creditworthiness of the counterparty and the expected credit exposure.

It is possible that volatility of energy commodity prices could cause the Company to have material credit risk exposure with one or more counterparties. If such counterparties fail to perform their obligations under one or more agreements, the Company could suffer a material financial loss. As of June 30, 2011, approximately 99.9% of the Company's energy portfolio exposure, excluding NPNS transactions, is with counterparties that are rated at least investment grade by the major rating agencies while 0.1% are either rated below investment grade or are not rated by rating agencies. The Company assesses credit risk internally for counterparties that are not rated.

The Company generally enters into the following master agreements: (1) WSPP, Inc. (WSPP) agreements - standardized power sales contracts in the electric industry; (2) International Swaps and Derivatives Association (ISDA) agreements - standardized financial gas and electric contracts; and (3) North American Energy Standards Board (NAESB) agreements - standardized physical gas contracts. The Company believes that such agreements reduce credit risk exposure because the agreements provide for the netting and offsetting of monthly payments and, in the event of counterparty default, termination payments.

The Company computes credit reserves at a master agreement level by counterparty (i.e., WSPP, ISDA, or NAESB). The Company considers external credit ratings and market factors, such as credit default swaps and bond spreads, in determination of reserves. The Company recognizes that external ratings may not always reflect how a market participant perceives a counterparty's risk of default. The Company uses both default factors published by Standard & Poor's and factors derived through analysis of market risk, which reflect the application of an industry standard recovery rate. The Company selects a default factor by counterparty at an aggregate master agreement level based on a weighted-average default tenor for that counterparty's deals. The default tenor is used by weighting the fair value and contract tenors for all deals for each counterparty and arriving at an average value. The default factor used is dependent upon whether the counterparty is in a net asset or a net liability position after applying the master agreement levels.

The Company applies the counterparty's default factor to compute credit reserves for counterparties that are in a net asset position. The Company applies its own default factor to compute credit reserves for counterparties that are in a net liability position. Credit reserves are booked as contra accounts to unrealized gain (loss) positions. As of June 30, 2011, the Company was in a net liability position with the majority of counterparties, so the default factors of counterparties did not have a significant impact on reserves for the quarter. The majority of the Company's derivative contracts are with financial institutions and other utilities operating within the Western Electricity Coordinating Council. Despite its net liability position, PSE was not required to post additional collateral with any of its counterparties. Additionally, PSE did not trigger collateral requirements with any of its counterparties nor were any of PSE's counterparties required to post additional collateral resulting from credit rating downgrades.

As of June 30, 2011, the Company did not have any outstanding energy supply contracts with counterparties that contained credit risk-related contingent features, which could result in a counterparty requesting immediate payment or demanding immediate and ongoing full overnight collateralization on derivative instruments in a net liability position.

Puget Energy and Puget Sound Energy Contingent Feature (Dollars in Thousands)	Fair Value 1 Liability			Posted Collateral		Contingent Collateral
Credit rating 2	$	(39,652	)	$	--	$	39,652
Requested credit for adequate assurance		(102,051	)		--		--
Forward value of contract 3		(11,485	)		--		--
Total	$	(153,188	)	$	--	$	39,652

__________

1	Represents the fair value of derivative contracts with contingent features for counterparties in net derivative liability positions at June 30, 2011. Excludes NPNS, accounts payable and accounts receivable.
2	Failure by PSE to maintain an investment grade credit rating from each of the major credit rating's agencies provides counterparties a contractual right to demand collateral.
3	Collateral requirements may vary, based on changes in the forward value of underlying transactions relative to contractually defined collateral thresholds.