10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 0-296

El Paso Electric Company

(Exact name of registrant as specified in its charter)

Texas	74-0607870
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
Stanton Tower, 100 North Stanton, El Paso, Texas	79901
(Address of principal executive offices)	(Zip Code)

(915) 543-5711

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     YES x    NO ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    YES x    NO ¨

As of November 1, 2004, there were 62,768,180 shares of the Company’s no par value common stock outstanding.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

INDEX TO FORM 10-Q

		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets – September 30, 2004 and December 31, 2003 (restated)	1
	Consolidated Statements of Operations – Three Months, Nine Months and Twelve Months Ended September 30, 2004 and 2003 (restated)	3
	Consolidated Statements of Comprehensive Operations – Three Months, Nine Months and Twelve Months Ended September 30, 2004 and 2003 (restated)	5
	Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2004 and 2003 (restated)	6
	Notes to Consolidated Financial Statements	7
	Report of Independent Registered Public Accounting Firm	28
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	41
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 6.	Exhibits	42

i

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

ASSETS (In thousands)	September 30, 2004 (Unaudited)		December 31, 2003 (Restated)
Utility plant:
Electric plant in service	$	1,815,142	$	1,788,652
Less accumulated depreciation and amortization		655,262		595,371
Net plant in service		1,159,880		1,193,281
Construction work in progress		83,539		69,175
Nuclear fuel; includes fuel in process of $879 and $6,878, respectively		71,384		70,198
Less accumulated amortization		38,667		33,888
Net nuclear fuel		32,717		36,310
Net utility plant		1,276,136		1,298,766
Current assets:
Cash and temporary investments		34,578		34,426
Accounts receivable, principally trade, net of allowance for doubtful accounts of $3,585 and $3,470, respectively		76,349		66,589
Accumulated deferred income taxes		3,683		36,248
Inventories, at cost		26,089		25,321
Undercollection of fuel revenues		15,175		12,399
Prepayments and other		24,462		27,190
Total current assets		180,336		202,173
Deferred charges and other assets:
Decommissioning trust funds		84,266		80,475
Regulatory assets		17,155		—
Other		12,513		15,200
Total deferred charges and other assets		113,934		95,675
Total assets	$	1,570,406	$	1,596,614

See accompanying notes to consolidated financial statements.

1

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (Continued)

CAPITALIZATION AND LIABILITIES (In thousands except for share data)	September 30, 2004 (Unaudited)			December 31, 2003 (Restated)
Capitalization:
Common stock, stated value $1 per share, 100,000,000 shares authorized, 62,662,642 and 62,487,263 shares issued, and 104,231 and 146,489 restricted shares, respectively	$	62,767		$	62,633
Capital in excess of stated value		271,551			264,235
Unearned compensation – restricted stock awards		(836	)		(878	)
Retained earnings		387,292			350,939
Accumulated other comprehensive loss, net of tax		(11,461	)		(9,613	)
		709,313			667,316
Treasury stock, 15,365,108 and 15,070,266 shares respectively; at cost		(176,076	)		(171,548	)
Common stock equity		533,237			495,768
Long-term debt, net of current portion		557,201			588,536
Financing obligations, net of current portion		—			20,186
Total capitalization		1,090,438			1,104,490
Current liabilities:
Current portion of long-term debt and financing obligations		39,986			22,106
Accounts payable, principally trade		25,002			19,197
Taxes accrued other than federal income taxes		18,427			15,167
Interest accrued		13,699			14,706
Overcollection of fuel revenues		548			10,070
Other		25,749			20,781
Total current liabilities		123,411			102,027
Deferred credits and other liabilities:
Accumulated deferred income taxes		96,925			144,419
Accrued postretirement benefit liability		99,747			94,510
Asset retirement obligation		59,078			55,149
Accrued pension liability		47,221			53,000
Regulatory liabilities		16,007			—
Other		37,579			43,019
Total deferred credits and other liabilities		356,557			390,097
Commitments and contingencies
Total capitalization and liabilities	$	1,570,406		$	1,596,614

See accompanying notes to consolidated financial statements.

2

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands except for share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003 (Restated)			2004			2003 (Restated)
Operating revenues	$	204,941		$	197,425		$	542,999		$	507,409
Energy expenses:
Fuel		59,014			53,608			145,867			123,860
Purchased and interchanged power		17,534			13,274			52,128			39,905
		76,548			66,882			197,995			163,765
Operating revenues net of energy expenses		128,393			130,543			345,004			343,644
Other operating expenses:
Other operations		43,295			41,976			125,876			124,281
Impairment loss on CIS Project		—			17,576			—			17,576
Maintenance		9,162			8,715			29,116			39,485
Depreciation and amortization		23,396			22,070			69,822			65,407
Taxes other than income taxes		11,928			11,726			34,421			33,826
		87,781			102,063			259,235			280,575
Operating income		40,612			28,480			85,769			63,069
Other income (deductions):
Investment and interest income, net		906			691			1,618			1,218
Loss on extinguishments of debt		(854	)		—			(4,692	)		(1	)
Miscellaneous other income		57			161			355			372
Miscellaneous income deductions		(771	)		(243	)		(2,755	)		(1,387	)
		(662	)		609			(5,474	)		202
Interest charges (credits):
Interest on long-term debt and financing obligations		12,179			12,768			37,158			38,659
Other interest		132			96			419			285
Capitalized interest and allowance for borrowed funds used during construction		(757	)		(1,421	)		(2,348	)		(4,086	)
		11,554			11,443			35,229			34,858
Income before income taxes, extraordinary item and cumulative effect of accounting change		28,396			17,646			45,066			28,413
Income tax expense		4,458			6,474			10,515			10,277
Income before extraordinary item and cumulative effect of accounting change		23,938			11,172			34,551			18,136
Extraordinary gain on re-application of SFAS No. 71, net of tax		1,802			—			1,802			—
Cumulative effect of accounting change, net of tax		—			—			—			39,635
Net income	$	25,740		$	11,172		$	36,353		$	57,771
Basic earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	0.50		$	0.23		$	0.73		$	0.38
Extraordinary gain on re-application of SFAS No. 71, net of tax		0.04			—			0.04			—
Cumulative effect of accounting change, net of tax		—			—			—			0.81
Net income	$	0.54		$	0.23		$	0.77		$	1.19
Diluted earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	0.50		$	0.23		$	0.72		$	0.37
Extraordinary gain on re-application of SFAS No. 71, net of tax		0.04			—			0.04			—
Cumulative effect of accounting change, net of tax		—			—			—			0.81
Net income	$	0.54		$	0.23		$	0.76		$	1.18
Weighted average number of shares outstanding		47,456,759			48,034,945			47,469,393			48,662,323
Weighted average number of shares and dilutive potential shares outstanding		48,092,572			48,441,240			47,991,751			49,028,404

See accompanying notes to consolidated financial statements.

3

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands except for share data)

	Twelve Months Ended September 30,
	2004			2003 (Restated)
Operating revenues	$	699,952		$	661,207
Energy expenses:
Fuel		187,374			156,332
Purchased and interchanged power		67,815			58,823
		255,189			215,155
Operating revenues net of energy expenses		444,763			446,052
Other operating expenses:
Other operations		169,092			164,775
Impairment loss on CIS project		—			17,576
FERC settlements		—			15,500
Maintenance		37,877			54,656
Depreciation and amortization		92,036			87,385
Taxes other than income taxes		43,323			43,306
		342,328			383,198
Operating income		102,435			62,854
Other income (deductions):
Investment and interest income, net		2,240			1,183
Loss on extinguishments of debt		(4,692	)		(1	)
Miscellaneous other income		372			709
Miscellaneous income deductions		(3,253	)		(2,234	)
		(5,333	)		(343	)
Interest charges (credits):
Interest on long-term debt and financing obligations		49,899			52,354
Other interest		829			2,644
Capitalized interest and allowance for borrowed funds used during construction		(3,834	)		(5,395	)
		46,894			49,603
Income before income taxes, extraordinary item and cumulative effect of accounting change		50,208			12,908
Income tax expense		13,471			3,550
Income before extraordinary item and cumulative effect of accounting change		36,737			9,358
Extraordinary gain on re-application of SFAS No. 71, net of tax		1,802			—
Cumulative effect of accounting change, net of tax		—			39,635
Net income	$	38,539		$	48,993
Basic earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	0.77		$	0.19
Extraordinary gain on re-application of SFAS No. 71, net of tax		0.04			—
Cumulative effect of accounting change, net of tax		—			0.81
Net income	$	0.81		$	1.00
Diluted earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	0.76		$	0.19
Extraordinary gain on re-application of SFAS No. 71, net of tax		0.04			—
Cumulative effect of accounting change, net of tax		—			0.80
Net income	$	0.80		$	0.99
Weighted average number of shares outstanding		47,531,797			48,900,634
Weighted average number of shares and dilutive potential shares outstanding		48,039,553			49,279,690

See accompanying notes to consolidated financial statements.

4

EL PASO ELE CTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS

(Unaudited)

(In thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,						Twelve Months Ended September 30,
	2004			2003 (Restated)			2004			2003 (Restated)			2004			2003 (Restated)
Net income	$	25,740		$	11,172		$	36,353		$	57,771		$	38,539		$	48,993
Other comprehensive income (loss):
Minimum pension liability adjustment		—			—			—			—			(4,234	)		(21,148	)
Net unrealized gains (losses) on marketable securities:
Net holding gains (losses) arising during period		(1,251	)		274			(2,030	)		4,411			2,323			6,521
Reclassification adjustments for net (gains) losses included in net income		68			(8	)		(280	)		788			(346	)		1,654
Total other comprehensive income (loss) before income taxes		(1,183	)		266			(2,310	)		5,199			(2,257	)		(12,973	)
Income tax benefit (expense) related to items of other comprehensive income (loss):
Minimum pension liability adjustment		—			—			—			—			1,673			8,193
Net unrealized gains or losses on marketable securities		237			(93	)		462			(1,820	)		165			(2,837	)
Total income tax benefit (expense)		237			(93	)		462			(1,820	)		1,838			5,356
Other comprehensive income (loss), net of tax		(946	)		173			(1,848	)		3,379			(419	)		(7,617	)
Comprehensive income	$	24,794		$	11,345		$	34,505		$	61,150		$	38,120		$	41,376

See accompanying notes to consolidated financial statements.

5

EL PASO ELECTRIC CO MPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

	Nine Months Ended September 30,
	2004			2003 (Restated)
Cash flows from operating activities:
Net income	$	36,353		$	57,771
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of electric plant in service		69,822			65,407
Impairment loss on CIS project		—			17,576
Amortization of nuclear fuel		13,235			12,984
Cumulative effect of accounting change, net of tax		—			(39,635	)
Extraordinary gain on the re-application of SFAS No. 71, net of tax		(1,802	)		—
Deferred income taxes, net		(7,892	)		6,417
Loss on extinguishments of debt		4,692			1
Other amortization and accretion		6,701			5,812
Other operating activities		619			1,427
Change in:
Accounts receivable		(9,839	)		(10,998	)
Inventories		(56	)		242
Net (under)/overcollection of fuel revenues		(12,298	)		9,645
Prepayments and other		718			(21,937	)
Accounts payable		5,805			284
FERC settlements payable		—			(15,500	)
Taxes accrued other than federal income taxes		3,260			1,526
Interest accrued		(1,007	)		(1,354	)
Other current liabilities		4,968			(1,376	)
Deferred charges and credits		(5,018	)		485
Net cash provided by operating activities		108,261			88,777
Cash flows from investing activities:
Cash additions to utility property, plant and equipment		(46,535	)		(49,545	)
Cash additions to nuclear fuel		(9,499	)		(8,820	)
Capitalized interest and allowance for borrowed funds used during construction:
Utility property, plant and equipment		(2,169	)		(3,887	)
Nuclear fuel		(179	)		(199	)
Decommissioning trust funds:
Purchases, includes funding of $4.5 million and $9.0 million, respectively		(14,112	)		(17,670	)
Sales and maturities		8,061			7,754
Other investing activities		(1,754	)		1,539
Net cash used for investing activities		(66,187	)		(70,828	)
Cash flows from financing activities:
Proceeds from exercise of stock options		877			—
Repurchases of common stock		(4,528	)		(16,728	)
Repurchases of and payments on first mortgage bonds		(35,729	)		(39,360	)
Nuclear fuel financing obligations:
Proceeds		10,429			9,847
Payments		(12,683	)		(15,246	)
Other financing activities		(288	)		(336	)
Net cash used for financing activities		(41,922	)		(61,823	)
Net increase (decrease) in cash and temporary investments		152			(43,874	)
Cash and temporary investments at beginning of period		34,426			75,142
Cash and temporary investments at end of period	$	34,578		$	31,268

See accompanying notes to consolidated financial statements.

6

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A. Principles of Preparation

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Annual Report of El Paso Electric Company on Form 10-K/A for the year ended December 31, 2003 (the “2003 Form 10-K/A”). Capitalized terms used in this report and not defined herein have the meaning ascribed for such terms in the 2003 Form 10-K/A. In the opinion of management of the Company, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company at September 30, 2004 and December 31, 2003 (restated); the results of its operations and comprehensive operations for the three, nine and twelve months ended September 30, 2004 and 2003 (restated); and its cash flows for the nine months ended September 30, 2004 and 2003 (restated). The results of operations and comprehensive operations for the three and nine months ended September 30, 2004 and the cash flows for the nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full calendar year.

Pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), certain financial information has been condensed and certain footnote disclosures have been omitted. Such information and disclosures are normally included in annual financial statements prepared in accordance with generally accepted accounting principles. Certain prior period amounts, primarily related to the presentation of energy service operation revenues and expenses, have been reclassified to conform with the current period presentation.

Restatement of Previously Issued Financial Statements. During the quarter ended September 30, 2004, the Company determined that Alternative Minimum Tax (“AMT”) credit carryforward assets pertaining to the pre-reorganization time period were overstated by $4.5 million and reorganization-related transmission and distribution assets were understated by $4.5 million. To correct this error, the Company will amend and reissue the 2003 Form 10-K and the March and June 2004 Form 10-Qs. In this report, the Company has restated its consolidated balance sheet as of December 31, 2003; the consolidated statements of operations for the three, nine and twelve months ended September 30, 2003; the consolidated statements of comprehensive operations for the three, nine and twelve months ended September 30, 2003; and the consolidated statement of cash flows for the nine months ended September 30, 2003. The Company has also restated the notes to consolidated financial statements as necessary to reflect the adjustments. The adjustments to the consolidated balance sheet as of December 31, 2003 include the elimination of $4.5 million of AMT credit carryforward assets, the related increase of $4.5 million in reorganization-related transmission and distribution assets, an increase of $3.8 million in accumulated depreciation, an increase of $0.3 million in deferred tax liabilities and a decrease of $4.1 million in retained earnings. The consolidated statements of operations and comprehensive operations were adjusted by a quarterly increase of $0.1 million and an annual increase of $0.5 million in depreciation and amortization expense. Net income and comprehensive income were reduced by $0.1 million, $0.2 million and $0.3 million for the three, nine and twelve months ended September 30, 2003, respectively, as a result of the aforementioned adjustments. Please read Note H for a discussion of the adjustments.

7

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

At January 1, 2004, the Company adopted FASB Interpretation No. 46 (“FIN 46R”), “Consolidation of Variable Interest Entities,” which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. As of September 30, 2004, the Company has had no transactions that have established a variable interest entity and the implementation of this standard did not have an impact on the Company’s financial position or results of operations.

Re-application of SFAS No. 71 to New Mexico Jurisdiction. Regulated electric utilities typically prepare their financial statements in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 71, “Accounting for the Effects of Certain Types of Regulation.” Under this accounting standard, certain recoverable costs are shown as either assets or liabilities on a utility’s balance sheet if the regulator provides assurance that these costs will be charged to and collected from its customers (or has already permitted such cost recovery). The resulting regulatory assets or liabilities are amortized in subsequent periods based upon their respective amortization periods in a utility’s cost of service.

Beginning in 1991, the Company discontinued the application of SFAS No. 71 to its financial statements. This decision was based on the Company’s determination that its rates were no longer designed to recover its costs of providing service to customers. Upon emerging from bankruptcy in 1996, the Company again concluded that it did not meet the criteria for applying SFAS No. 71 because of the 10-year rate freeze in Texas and its ongoing intention not to seek changes in its New Mexico rates, which had been established in 1990.

During the quarter ended September 30, 2004, the Company determined that it met the criteria necessary to re-apply SFAS No. 71 to its New Mexico jurisdictional operations. For the New Mexico jurisdiction, two key events transpired that, when considered together, resulted in the Company’s decision to re-apply SFAS No. 71. In late April of 2004, the Company received a final order approving a unanimous stipulation which established new base and fuel rates for its New Mexico customers which were implemented June 1, 2004. The Company’s approved rates were based upon its cost of providing service in New Mexico. That event, coupled with the repeal of New Mexico’s electric utility industry restructuring law which occurred in April of 2003, resulted in the Company meeting the criteria for the re-application of SFAS No. 71 to New Mexico, and as such, resulted in its re-application beginning July 1, 2004. The third quarter 2004 re-application of SFAS No. 71 to the Company’s New Mexico jurisdiction resulted in the recording of $18.5 million of regulatory assets, $5.0 million in related accumulated deferred income tax assets, $16.2 million of regulatory liabilities, $5.5 million in related accumulated deferred tax liabilities and the recording of a $1.8 million extraordinary gain, net of tax, or $0.04 basic and diluted earnings per share.

The Company’s Texas jurisdiction has been operating under a rate freeze since August 2, 1995. The rate freeze is for a ten-year period which expires on July 31, 2005. Although the Company believes the rates established in 1995 were based upon its costs of service, the unusual length of the rate freeze period created substantial uncertainty as to the ultimate recovery of its costs over the entire

8

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

freeze period. Consequently, the Company determined that it would not re-apply SFAS No. 71 to its Texas jurisdiction at the time it emerged from bankruptcy in February 1996. As the freeze period draws to a close, the Company will continue to evaluate whether it meets the criteria for the re-application of SFAS No. 71 to its Texas jurisdiction.

Stock Options. The Company has two stock-based long-term incentive plans and accounts for them under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Stock options have typically been granted with an exercise price equal to fair market value on the date of grant and, accordingly, no compensation expense is recorded by the Company. If compensation expense for the option portion of the plans had been determined based on the fair value of the option at the grant date and amortized on a straight-line basis over the vesting period, consistent with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net earnings and earnings per share would have been reduced to the pro forma amounts presented below:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003 (Restated)		2004		2003 (Restated)
Net income, as reported	$	25,740	$	11,172	$	36,353	$	57,771
Deduct: Compensation expense, net of tax		223		228		682		687
Pro forma net income	$	25,517	$	10,944	$	35,671	$	57,084
Basic earnings per share:
As reported	$	0.54	$	0.23	$	0.77	$	1.19
Pro forma		0.54		0.23		0.75		1.17
Diluted earnings per share:
As reported	$	0.54	$	0.23	$	0.76	$	1.18
Pro forma		0.53		0.23		0.75		1.17

9

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	Twelve Months Ended September 30,
	2004		2003 (Restated)
Net income, as reported	$	38,539	$	48,993
Deduct: Compensation expense, net of tax		911		1,050
Pro forma net income	$	37,628	$	47,943
Basic earnings per share:
As reported	$	0.81	$	1.00
Pro forma		0.79		0.98
Diluted earnings per share:
As reported	$	0.80	$	0.99
Pro forma		0.79		0.98

Restricted Stock. Restricted stock has been granted at fair market value. Compensation expense for the restricted stock awards is recognized on a fair value basis and is measured by referencing the quoted market price of the shares at the grant date, amortized ratably over the restriction period. Unearned compensation related to restricted stock awards is shown as a reduction of common stock equity and is the remaining unamortized portion of the restricted stock awards.

Performance Shares. Subject to meeting certain performance criteria, performance shares will be granted to certain officers under the Company’s existing long-term incentive plan on January 1, 2006 and 2007. The Company currently recognizes the related compensation expense by ratably amortizing the current fair market value of awards that would be granted based on the current performance of the Company over the performance cycles. Consistent with the provisions of APB Opinion No. 25, compensation expense for performance shares will be adjusted for subsequent changes (such as the number of shares to be granted, if any, and the fair market value of the Company’s stock) in expected outcome of the performance-related conditions until the end of the performance cycle. Any such adjustments are accounted for as a change in estimate, and the cumulative effect of the change on current and prior periods is recognized in the period of the change.

Unbilled Revenues. Accounts receivable include accrued unbilled revenues of $17.0 million and $16.5 million at September 30, 2004 and December 31, 2003, respectively.

10

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Supplemental Cash Flow Disclosures (in thousands)

	Nine Months Ended September 30,
	2004			2003
Cash paid for:
Interest on long-term debt and financing obligations	$	37,310		$	39,263
Income taxes		7,300			17,660
Non-cash financing activities:
Grants of restricted shares of common stock		792			690
Changes in federal deferred tax valuation allowance debited (credited) to capital in excess of stated value (1)		(5,642	)		490

⁽¹⁾ See Note H of Notes to Consolidated Financial Statements in the 2003 Form 10-K/A.

B. Regulation

For a full discussion of the Company’s regulatory matters, see Note B of Notes to Consolidated Financial Statements in the 2003 Form 10-K/A.

General

In 1999, both the Texas and New Mexico legislatures enacted electric utility industry restructuring laws requiring competition in certain functions of the industry and ultimately in the Company’s service area. In Texas, the Company is exempt from the requirements of the Texas Restructuring Law, including utility restructuring and retail competition, at least until the expiration of the Freeze Period in August 2005. The Texas Commission, however, recently adopted a rule that would delay competition in the Company’s Texas service territory until at least the establishment and independent operation of a regional transmission organization (“RTO”) is achieved. In April 2003, the New Mexico Restructuring Act was repealed and as a result, the Company’s operations in New Mexico will continue to be fully regulated. The Company cannot predict at this time the full effects the repeal of the New Mexico Restructuring Act will have on the Company as it prepares for retail competition in Texas.

Federal Regulatory Matters

Federal Energy Regulatory Commission. The FERC has been conducting an investigation into potential manipulation of electricity prices in the western United States during 2000 and 2001. On August 13, 2002, the FERC initiated a Federal Power Act (“FPA”) investigation into the Company’s wholesale power trading in the western United States during 2000 and 2001 to determine whether the

11

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(Unaudited)

Company and Enron engaged in misconduct and, if so, to determine potential remedies. The Company reached settlements with the FERC and other parties in 2002 and 2003. Under the terms of the settlements, the Company agreed to refund a total of $15.5 million of revenues it earned on wholesale power transactions. In July 2003, the FERC approved the settlements and on August 5, 2003, the Company deposited the $15.5 million into an interest bearing escrow account to consummate the settlements. The Company believes the FERC’s order resolved all issues between the FERC and the other parties to this investigation. Under the settlements, the Company has agreed to make wholesale sales pursuant to its cost of service rate authority rather than its market-based rate authority for the period December 1, 2002 through December 31, 2004. This agreement allows the Company to sell power into wholesale markets at its incremental cost plus $21.11 per MWh. To the extent that wholesale market prices exceed these agreed upon amounts, the Company will forego the opportunity to realize these additional revenues. Although this provision has not had a significant impact on the Company’s revenues through September 30, 2004, the Company is unable to predict the effect, if any, this will have on the Company’s revenues for the remainder of 2004.

Texas Regulatory Matters

The rates and services of the Company are regulated in Texas by municipalities and by the Texas Commission. The largest municipality in the Company’s service area is the City of El Paso. The Texas Commission has exclusive appellate jurisdiction to review municipal orders and ordinances regarding rates and services within municipalities in Texas and original jurisdiction over certain other activities of the Company. The decisions of the Texas Commission are subject to judicial review.

Deregulation. The Texas Restructuring Law required certain investor-owned electric utilities to separate power generation activities from transmission and distribution activities by January 1, 2002, and on that date, retail competition was instituted in some parts of Texas. The Texas Restructuring Law, however, specifically recognized and preserved the Company’s Texas Rate Stipulation and Texas Settlement Agreement by, among other things, exempting the Company’s Texas service area from retail competition until the end of the Freeze Period. On October 13, 2004, the Texas Commission approved a rule delaying retail competition in the Company’s Texas service territory. The rule approved by the Texas Commission changed the beginning of retail competition from the end of the Freeze Period, and instead sets a schedule which identifies various milestones for the Company to reach before competition can begin. The first milestone calls for the development, approval by the FERC, and commencement of independent operation of a RTO, including the development of retail market protocols to facilitate retail competition. The complete transition to retail competition would occur upon the completion of the last milestone which would be the Texas Commission’s final evaluation of the Company’s readiness to offer fair competition and reliable service to all retail customers. The Company believes that adoption of such a rule will likely delay retail competition in El Paso for at least several years. There is substantial uncertainty about both the regulatory framework and market conditions that will exist if and when retail competition is implemented in the Company’s service territory, and the Company may incur substantial preparatory, restructuring and other costs that may not ultimately be recoverable. There can be no assurance that

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

deregulation will not adversely affect the future operations, cash flows and financial condition of the Company.

Renewables and Energy Efficiency Programs. On January 1, 2006, the Company will be subject to the renewable energy and energy efficiency requirements under Texas Restructuring Law. Under the renewable energy requirements, the Company will have to obtain and retire for 2006, and each compliance period thereafter, its pro rata share of renewable energy credits as determined by the Texas Commission, based on total retail sales in Texas that are subject to renewable energy credit allocation. The Company’s ultimate obligation to obtain renewable energy credits will not be known until January 31 of the year following the compliance year, and it will have until March 31 to obtain, if necessary, and submit to the Texas Commission, sufficient credits. In addition, the Company will be required to fund incentives for energy efficiency programs that, beginning on January 1, 2006, will achieve the goal of meeting, at a minimum, 5% of its growth in demand through energy efficiency savings resulting from these programs by January 1, 2007, and 10% of its growth in demand by January 1, 2008, and each year thereafter. Costs incurred by the Company to meet these requirements will not be recoverable in the Company’s Texas service territory prior to the expiration of the Freeze Period.

Fuel. Although the Company’s base rates are frozen in Texas pursuant to Texas Commission rules and the Texas Rate Stipulation, the Company can request adjustments to its fuel factor to more accurately reflect projected energy costs associated with providing electricity and seek recovery of past undercollections of fuel revenues, subject to periodic final review by the Texas Commission in fuel reconciliation proceedings.

The Company reconciled its Texas jurisdictional fuel costs for the period January 1, 1999 through December 31, 2001 in PUC Docket No. 26194, and on May 5, 2004, the Texas Commission issued its final order. At issue was the Company’s request to recover an additional $15.8 million, before interest, from its Texas customers as a surcharge because of fuel undercollections from January 1999 through December 2001. The Texas Commission disallowed approximately $4.5 million of Texas jurisdictional expenses, before interest, consisting primarily of (i) approximately $4.2 million of purchased power expenses which the Texas Commission characterized as “imputed capacity charges,” and (ii) approximately $0.3 million in fees which were deemed to be administrative costs, not recoverable as fuel. In Texas, capacity charges are not eligible for recovery as fuel expenses but are to be recovered through the Company’s base rates. As the Company’s base rates were frozen during the period in which the imputed capacity charges were deemed to have been incurred, the $4.2 million of imputed capacity charges were therefore permanently disallowed, and not recoverable from its Texas customers. The Texas Commission’s decision has been appealed by two parties and the Company, and the Company is unable to predict the ultimate outcome of the appeals.

The Company has incurred similar purchased power costs for the fuel reconciliation period beginning January 1, 2002. The Company believes that it has accounted for its purchased power costs during the reconciliation period beginning January 2002 in a manner consistent with the Texas

13

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(Unaudited)

Commission’s decision in PUC Docket No. 26194. However, the Texas Commission has indicated its desire to conduct a generic rule making proceeding to determine a statewide policy for the appropriate pricing of capacity in purchased power contracts. On August 31, 2004, the Company filed an application to reconcile Texas jurisdictional fuel costs for the period January 1, 2002 to February 29, 2004 in PUC Docket No. 30143. There can be no assurance as to the outcome of such rulemaking and its potential impact on the Company with respect to fuel recovery in future reconciliation periods, including those in PUC Docket No. 30143.

New Mexico Regulatory Matters

The New Mexico Commission has jurisdiction over the Company’s rates and services in New Mexico and over certain other activities of the Company, including prior approval of the issuance, assumption or guarantee of securities. The New Mexico Commission’s decisions are subject to judicial review. The largest city in the Company’s New Mexico service territory is Las Cruces.

Deregulation. In April 2003, the New Mexico Restructuring Act was repealed, and as a result, the Company’s operations in New Mexico will continue to be fully regulated. The Company cannot predict at this time the full effects the repeal of the New Mexico Restructuring Act will have on the Company if it ultimately transitions to retail competition in Texas.

New Mexico Rate Stipulation. On June 1, 2004, the Company implemented new rates according to the New Mexico Stipulation whereby, among other things, the Company agreed for a period of three years beginning June 1, 2004 to (i) freeze base rates after an initial non-fuel base rate reduction of 1%; (ii) fix fuel and purchased power cost associated with 10% of the Company’s jurisdictional retail sales in New Mexico at $0.021 per kWh; (iii) leave subject to reconciliation the remaining 90% of the Company’s New Mexico jurisdictional fuel and purchased power costs not collected in base rates; (iv) continue the collection of a portion of fuel and purchased power costs in base rates as presently collected in the amount of $0.01949 per kWh; (v) price power provided from Palo Verde Unit 3 to the extent of its availability at an 80% nuclear, 20% gas fuel mix; and (vi) deem reconciled, for the period June 15, 2001 through May 31, 2004, the Company’s fuel and purchased power costs for the New Mexico jurisdiction.

Fuel. In April 2004, the New Mexico Commission, as part of the New Mexico Stipulation, approved a fuel and purchased power cost adjustment clause. The Company will continue to recover fuel and purchased power costs in base rates in the amount of $0.01949 per kWh and continue the fuel and purchased power cost adjustment to recover 90% of the remaining fuel and purchased power costs. Fuel and purchased power costs associated with the remaining 10% of the Company’s jurisdictional retail sales in New Mexico are fixed at $0.021 per kWh. The Company and all intervenors entered into the New Mexico Stipulation on the Company’s compliance filing.

Renewables. The New Mexico Renewable Energy Act of 2004 requires that, by January 1, 2006, renewable energy comprise no less than 5% of the Company’s total retail sales to New Mexico customers. The requirement increases by 1% annually until January 1, 2011, when the renewable portfolio standard shall reach a level of 10% of the Company’s total retail sales to New Mexico

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

customers and will remain fixed at such level thereafter. On September 1, 2004, the Company filed its Transitional Procurement Plan detailing its proposed actions to comply with the Renewable Energy Act.

C. Common Stock

Common Stock Repurchase Program

In February 2004, the Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of its outstanding common stock. During the third quarter of 2004, the Company repurchased 200,000 shares of common stock. Since the inception of the stock repurchase programs in 1999, the Company has repurchased a total of 15,250,000 shares of common stock at an aggregate cost of $174.9 million, including commissions. The Company may continue making purchases of its stock at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

Reconciliation of Basic and Diluted Earnings Per Share

The reconciliation of basic and diluted earnings per share before extraordinary item and cumulative effect of accounting change is presented below:

	Three Months Ended September 30,
	2004					2003
	Income		Shares	Per Share		Income (Restated)		Shares	Per Share (Restated)
	(In thousands)					(In thousands)
Basic earnings per share:
Income before extraordinary item	$	23,938	47,456,759	$	0.50	$	11,172	48,034,945	$	0.23
Effect of dilutive securities:
Unvested restricted stock		—	122,546				—	67,327
Stock options		—	513,267				—	338,968
Diluted earnings per share:
Income before extraordinary item	$	23,938	48,092,572	$	0.50	$	11,172	48,441,240	$	0.23
	Nine Months Ended September 30,
	2004					2003
	Income		Shares	Per Share		Income (Restated)		Shares	Per Share (Restated)
	(In thousands)					(In thousands)
Basic earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	34,551	47,469,393	$	0.73	$	18,136	48,662,323	$	0.38
Effect of dilutive securities:
Unvested restricted stock		—	59,820				—	38,326
Stock options		—	462,538				—	327,755
Diluted earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	34,551	47,991,751	$	0.72	$	18,136	49,028,404	$	0.37

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

	Twelve Months Ended September 30,
	2004					2003
	Income		Shares	Per Share		Income (Restated)		Shares	Per Share (Restated)
	(In thousands)					(In thousands)
Basic earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	36,737	47,531,797	$	0.77	$	9,358	48,900,634	$	0.19
Effect of dilutive securities:
Unvested restricted stock		—	67,929				—	56,368
Stock options		—	439,827				—	322,688
Diluted earnings per share:
Income before extraordinary item and cumulative effect of accounting change	$	36,737	48,039,553	$	0.76	$	9,358	49,279,690	$	0.19

Options excluded from the computation of diluted earnings per share because the exercise price was greater than the average market price for the periods presented are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,				Twelve Months Ended September 30,
	2004		2003		2004		2003		2004		2003
Options excluded		2,184		967,820		238,459		1,018,147		444,645		1,043,153
Exercise price range	$	15.65 - $15.99	$	11.88 - $15.99	$	13.77 - $15.99	$	11.00 - $15.99	$	12.78 - $15.99	$	11.00 - $15.99

D. Commitments, Contingencies and Uncertainties

For a full discussion of commitments and contingencies, see Note I of Notes to Consolidated Financial Statements in the 2003 Form 10-K/A. In addition, see Note B above and Notes B and C of Notes to Consolidated Financial Statements in the 2003 Form 10-K/A regarding matters related to regulation and Palo Verde, including decommissioning, spent fuel storage, disposal of low-level radioactive waste, steam generators and liability and insurance matters.

Power Contracts

In addition to the contracts disclosed in the Company’s 2003 Form 10-K/A, the Company has entered into a 20-year contract for the purchase of up to 133 MW of capacity and associated energy from Southwestern Public Service Company beginning in 2006. This contract includes a demand charge, energy charge and a transmission charge.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

Environmental Matters

The Company is subject to regulation with respect to air, soil and water quality, solid waste disposal and other environmental matters by federal, state, tribal and local authorities. Those authorities govern current facility operations and have continuing jurisdiction over facility modifications. Failure to comply with these environmental regulatory requirements can result in actions by regulatory agencies or other authorities that might seek to impose on the Company administrative, civil, and/or criminal penalties. In addition, unauthorized releases of pollutants or contaminants into the environment can result in costly cleanup obligations that are subject to enforcement by the regulatory agencies. Environmental regulations can change rapidly and are often difficult to predict. While the Company strives to prepare for and implement changes necessary to comply with changing environmental regulations, substantial expenditures may be required for the Company to comply with such regulations in the future.

The Company analyzes the costs of its obligations arising from environmental matters on an ongoing basis and believes it has made adequate provision in its financial statements to meet such obligations. As a result of this analysis, the Company has a provision for environmental remediation obligations of approximately $0.8 million as of September 30, 2004, which is related to compliance with federal and state environmental standards. However, unforeseen expenses associated with compliance could have a material adverse effect on the future operations and financial condition of the Company.

The Company incurred the following expenditures (the majority of which are non-remediation) during the three, nine and twelve months ended September 30, 2004 and 2003 to comply with federal environmental statutes (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,				Twelve Months Ended September 30,
	2004		2003		2004		2003		2004		2003
Clean Air Act	$	59	$	171	$	693	$	729	$	1,024	$	963
Clean Water Act		104		317		460		699		410		2,352

The Company is not aware of any active investigation of its compliance with environmental requirements by the Environmental Protection Agency, the Texas Commission on Environmental Quality or the New Mexico Environment Department. Furthermore, the Company is not aware of any unresolved, potentially material liability it would face pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, also known as the Superfund law.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

Tax Matters

The Company received final approval from the IRS during the quarter ended September 30, 2004 to settle all issues relative to its 1996 through 1998 federal income tax returns. As part of the settlement, the Company was required to capitalize approximately twenty percent of the previously claimed lease rejection damage deductions. In addition, the IRS conceded the litigation settlement issue related to a terminated merger agreement. As a result of the IRS settlement, the Company reduced its estimated contingent tax liability by $3.5 million related to the resolution of certain tax contingency items and adjusted its state deferred tax liabilities by $2.7 million. The IRS settlement reduced income tax expense by approximately $6.2 million during the quarter ended September 30, 2004 which increased net income for such period by the same amount. The IRS is currently performing an examination of the 1999 through 2002 income tax returns. The Company has established, and periodically reviews and re-evaluates, an estimated contingent tax liability on its consolidated balance sheet to provide for the possibility of adverse outcomes in tax proceedings. Although the ultimate outcome of the ongoing examination cannot be predicted with certainty, and while the contingent tax liability may not in fact be sufficient, the Company believes that the amount of contingent tax liability recorded as of September 30, 2004 is a reasonable estimate of any additional tax that may be due.

Also during the quarter, the Company determined that AMT credit carryforward assets pertaining to the pre-reorganization time period were overstated. The correction of this overstatement has been accomplished by making several adjustments to previously issued financial statements. See Note H.

Union Matters

On October 2 and 3, 2003, a majority of employees in the Company’s meter reading and collections areas, comprised of 68 employees, voted in favor of representation by the International Brotherhood of Electrical Workers, Local 960 (“Local 960”). This vote was certified by the National Labor Relations Board (“NLRB”) on October 14, 2003. In addition, a majority of employees in the Company’s facilities services area, comprised of seven employees, voted in favor of representation by Local 960 on October 16, 2003. This vote was certified by the NLRB on October 24, 2003. The Company has begun negotiations with Local 960 on behalf of these employees.

On August 20, 2004, a majority of employees in the customer service area, comprised of 63 employees, voted in favor of representation by Local 960. This vote was certified by the NLRB on August 30, 2004.

E. Litigation

The Company is a party to various legal actions. In many of these matters, the Company has excess casualty liability insurance that covers the various claims, actions and complaints. Based upon a review of these claims and applicable insurance coverage, the Company believes that, except as

19

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

described below, none of these claims will have a material adverse effect on the financial position, results of operations or cash flows of the Company.

On January 16, 2003, the Company was served with a complaint on behalf of a purported class of shareholders alleging violations of the federal securities laws (Roth v. El Paso Electric Company, et al., No. EP-03-CA-0004). The complaint was filed in the El Paso Division of the United States District Court for the Western District of Texas. The suit seeks undisclosed compensatory damages for the class as well as costs and attorneys’ fees. The lead plaintiff, Carpenters Pension Fund of Illinois, filed a consolidated amended complaint on July 2, 2003, alleging, among other things, that the Company and certain of its current and former directors and officers violated securities laws by failing to disclose that some of the Company’s revenues and income were derived from an allegedly unlawful relationship with Enron. The allegations arise out of the FERC investigation of the power markets in the western United States during 2000 and 2001, which the Company previously settled with the FERC Trial Staff and certain intervening parties. On August 15, 2003, the Company and the individual defendants filed a motion to dismiss the complaint for failure to state a claim upon which relief can be granted. On November 26, 2003, the Court denied the motion to dismiss as to the Company and three of the individual defendants and granted the motion to dismiss as to two individual defendants. On April 13, 2004, the Court granted a motion of the Company and the remaining individual defendants requesting permission to file an interlocutory appeal to the U. S. Court of Appeals for the Fifth Circuit regarding certain legal questions relating to the Court’s denial of the motion to dismiss the complaint as to those defendants. On April 27, 2004, the Court entered an order staying the district court proceedings until the Fifth Circuit completed its review. On June 7, 2004, the U. S. Court of Appeals denied the appeal which automatically lifted the stay in the district court. This matter is presently set for trial on March 28, 2005, but such date may be extended. While the Company believes the lawsuit is without merit and intends to defend itself vigorously, the Company is unable to predict the outcome.

On May 21, 2003, the Company was served with a complaint by the Port of Seattle seeking civil damages under the Sherman Act, the Racketeer Influenced and Corrupt Organization Act, and state anti-trust laws, as well as for fraud (Port of Seattle v. Avista Corporation, et al., No. CV03-117OP). The complaint was filed in the United States District Court for the Western District of Washington. The complaint alleges that the Company, indirectly through its dealings with Enron, conspired with the other named defendants to manipulate the California energy market, which had the effect of artificially inflating the price that the Port of Seattle paid for electricity. The Company, together with several other defendants, filed a motion to dismiss. On May 12, 2004, the Court granted the Company’s motion, and the suit was dismissed. The Port of Seattle has filed an appeal of the Court’s decision with the U. S. Court of Appeals for the Ninth Circuit.

On May 5, 2004, Wah Chang, a specialty metals manufacturer which operates a plant in Oregon, filed suit against the Company and other defendants in the United States District Court for the District of Oregon. (Wah Chang v. Avista Corporation, et al., No. 04-619AS). The complaint makes substantially the same allegations as were made in Port of Seattle and seeks the same types of

20

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

damages. In addition, on June 7, 2004, the City of Tacoma filed suit against the Company and other defendants in the United States District Court for the Western District of Washington (City of Tacoma v. American Electric Power Service Corp., et al., C04-5325RBL). This complaint also makes substantially the same allegations as were made in Port of Seattle and seeks civil damages (including treble damages) from the Company and the other defendants for violations of certain antitrust provisions under the Sherman Act. Both of these matters have now been transferred to the same court that heard and dismissed the Port of Seattle lawsuit. While the Company believes that these matters are without merit and intends to defend itself vigorously, the Company is unable to predict the outcome.

On November 3, 2003, TNP filed a complaint against the Company with the FERC, asking the FERC to make a determination that TNP has certain “rollover rights” to network-type transmission service over the Company’s transmission system as a result of a power sales agreement between it and the Company which expired at the end of 2002. TNP asserted that it has such rights under the rollover provisions of FERC Order No. 888. The Company responded to TNP’s complaint by contesting TNP’s assertion of rollover rights on several grounds. Due to existing transmission constraints, a FERC ruling granting TNP’s complaint could adversely impact the Company’s ability to import lower cost power from Palo Verde and Four Corners to serve its retail customers, which could result in higher rates for the Company’s retail electric customers. A hearing on this matter before an administrative law judge (“ALJ”) was held on July 19 and 20, 2004, and, on September 20, 2004, the ALJ issued a proposed decision, dismissing TNP’s complaint and concluding that TNP has no rollover rights over the Company’s transmission system. In his decision, the ALJ also recommended that the Commission issue an order requiring the Company to show cause why it should not be subject to sanctions because of the Company’s delinquent filing of a notice relating to the termination of the TNP agreement that was required under FERC rules. The parties have submitted exceptions to the proposed order, and the ALJ’s decision is subject to review by the Commission. The Company cannot predict the outcome of this matter or the effect that an adverse ruling by the Commission might have on the Company or its retail customers.

On June 29, 2004, the Company filed suit against TNP in the Third Judicial District Court of New Mexico, claiming that TNP acted in bad faith by claiming such transmission rights and seeking to obtain use of more transmission rights than originally allocated to TNP under its original contract with the Company. The Company seeks both actual and exemplary damages from TNP as well as a declaration that TNP breached its agreements with the Company, acted in bad faith and violated New Mexico law prohibiting such actions. On November 1, 2004, the Company filed a motion for leave to amend the complaint to add PNM as a defendant in this action, alleging, among other things, that PNM tortiously interfered with the Company’s contractual relationships with TNP.

On February 9, 2004, Enron North America Corp. (“ENA”) filed suit against the Company seeking payment of approximately $5.4 million, plus interest and costs, relating to certain natural gas supply contracts (Enron North America Corp. v. El Paso Electric Co., Case No. 01-16034, United States Bankruptcy Court, Southern District of New York). Based upon the Company’s assessment of

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

the probability of an adverse outcome, the Company expensed $1.5 million, pre-tax, in 2003 for this matter. On April 19, 2004, the Bankruptcy Court approved a confidential settlement agreement and mutual release by and between ENA and the Company, resolving all issues in the suit. The Company does not expect any further charge to earnings as a result of this settlement.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

F. Employee Benefits

Retirement Plans

The net periodic benefit cost recognized for the three, nine and twelve months ended September 30, 2004 and 2003 is made up of the components listed below as determined using the projected unit credit actuarial cost method (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Components of net periodic benefit cost:
Service cost	$	1,113		$	953		$	3,339		$	2,859
Interest cost		2,522			2,403			7,566			7,209
Expected return on plan assets		(1,927	)		(1,884	)		(5,781	)		(5,652	)
Amortization of:
Unrecognized loss		843			434			2,529			1,302
Unrecognized prior service cost		5			5			15			15
Net periodic benefit cost	$	2,556		$	1,911		$	7,668		$	5,733

	Twelve Months Ended September 30,
	2004			2003
Components of net periodic benefit cost:
Service cost	$	4,292		$	3,698
Interest cost		9,967			9,490
Expected return on plan assets		(7,665	)		(7,593	)
Amortization of:
Unrecognized loss		2,963			1,302
Unrecognized prior service cost		21			21
Net periodic benefit cost	$	9,578		$	6,918

In August 2004, the Company contributed an additional $8.0 million to its retirement plans. This additional contribution increased total contributions to $13.7 million for the nine months ended September 30, 2004 and increases total projected contributions for 2004 to $15.6 million.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

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(Unaudited)

Other Postretirement Benefits

The net periodic benefit cost recognized for the three, nine and twelve months ended September 30, 2004 and 2003 is made up of the components listed below (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Components of net periodic benefit cost:
Service cost	$	1,159		$	979		$	3,477		$	2,937
Interest cost		1,756			1,617			5,268			4,851
Expected return on plan assets		(315	)		(255	)		(945	)		(765	)
Amortization of unrecognized gain		—			—			—			—
Net periodic benefit cost	$	2,600		$	2,341		$	7,800		$	7,023

	Twelve Months Ended September 30,
	2004			2003
Components of net periodic benefit cost:
Service cost	$	4,455		$	3,715
Interest cost		6,885			6,274
Expected return on plan assets		(1,200	)		(1,014	)
Amortization of unrecognized gain		—			(197	)
Net periodic benefit cost	$	10,140		$	8,778

During the nine months ended September 30, 2004, the Company contributed $2.6 million to its other postretirement benefits plan.

In December 2003, the Company elected to defer recognition of the potential effect of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “Act”) until authoritative guidance on the accounting for the federal subsidy is issued. In May 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 106-2 (“FSP 106-2”) which requires measurement of the accumulated post-retirement benefit obligation and the net periodic post-retirement benefit cost to reflect the effects of the subsidy for interim or annual periods beginning after June 15, 2004. The Company has not yet determined the effects of the Act on its results of operations, financial condition or liquidity.

G. Franchises and Significant Customers

City of El Paso Franchise

The Company’s franchise agreement with the City of El Paso, Texas (“City”) includes an option to acquire all of the non-cash assets of the Company at the end of the franchise on August 1, 2005. To

24

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

exercise the option, the City was required to deliver written notice to the Company one year prior to the expiration of the franchise term. The option expired on August 1, 2004 without being exercised by the City.

H. Restatement of Previously Issued Financial Statements

During the quarter ended September 30, 2004, the Company determined that AMT credit carryforward assets pertaining to the pre-reorganization time period were overstated by $4.5 million and reorganization-related transmission and distribution assets were understated by $4.5 million. To correct this error, the Company will amend and reissue the 2003 Form 10-K and the March and June 2004 Form 10-Qs. In this report, the Company has restated its consolidated balance sheet as of December 31, 2003, the consolidated statements of operations for the three, nine and twelve months ended September 30, 2003, the consolidated statements of comprehensive operations for the three, nine and twelve months ended September 30, 2003, and the consolidated statement of cash flows for the nine months ended September 30, 2003. The Company has also restated the notes to consolidated financial statements as necessary to reflect the adjustments.

The effects of the revisions on the consolidated balance sheet as of December 31, 2003 are summarized in the following table (in thousands):

	December 31, 2003
	Previously Reported		As Restated
Utility Plant:
Electric plant in service	$	1,784,134	$	1,788,652
Less accumulated depreciation and amortization		591,613		595,371
Net plant in service		1,192,521		1,193,281
Net utility plant		1,298,006		1,298,766
Total assets	$	1,595,854	$	1,596,614
Capitalization:
Retained earnings		354,993		350,939
Common stock equity		499,822		495,768
Total capitalization		1,108,544		1,104,490
Deferred credits and other liabilities:
Accumulated deferred income taxes		139,605		144,419
Total deferred credits and other liabilities		385,283		390,097
Total capitalization and liabilities	$	1,595,854	$	1,596,614

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The consolidated statements of operations and comprehensive operations were adjusted by a quarterly increase of $0.1 million and an annual increase of $0.5 million in depreciation and amortization expense. Net income and comprehensive income were reduced by $0.1 million, $0.2 million and $0.3 million for the three, nine and twelve months ended September 30, 2003.

The effects of the revisions on the consolidated statements of operations for the three, nine and twelve month periods ended September 30, 2003 are summarized in the following table (in thousands, except share data):

	Three Months Ended September 30, 2003				Nine Months Ended September 30, 2003				Twelve Months Ended September 30, 2003
	Previously Reported		As Restated		Previously Reported		As Restated		Previously Reported		As Restated
Other operating expense:
Depreciation and amortization	$	21,950	$	22,070	$	65,047	$	65,407	$	86,905	$	87,385
Total other operating expense (1)		101,860		102,063		279,682		280,575		380,945		383,198
Operating income		28,600		28,480		63,429		63,069		63,334		62,854
Income before income taxes and cumulative effect of accounting change		17,766		17,646		28,773		28,413		13,388		12,908
Income tax expense		6,520		6,474		10,416		10,277		3,736		3,550
Income before cumulative effect of accounting change		11,246		11,172		18,357		18,136		9,652		9,358
Net income	$	11,246	$	11,172	$	57,992	$	57,771	$	49,287	$	48,993
Basic earnings per share:
Income before cumulative effect of accounting change	$	0.23	$	0.23	$	0.38	$	0.38	$	0.20	$	0.19
Cumulative effect of accounting change, net of tax		—		—		0.81		0.81		0.81		0.81
Net income	$	0.23	$	0.23	$	1.19	$	1.19	$	1.01	$	1.00
Diluted earnings per share:
Income before cumulative effect of accounting change	$	0.23	$	0.23	$	0.37	$	0.37	$	0.20	$	0.19
Cumulative effect of accounting change, net of tax		—		—		0.81		0.81		0.80		0.80
Net income	$	0.23	$	0.23	$	1.18	$	1.18	$	1.00	$	0.99

(1) Total other operating expense (restated) includes a reclassification of operating expense related to MiraSol.

26

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The effects of the revisions on the consolidated statements of comprehensive operations for the three, nine and twelve month periods ended September 30, 2003 are summarized in the following table (in thousands):

	Three Months Ended September 30, 2003				Nine Months Ended September 30, 2003				Twelve Months Ended September 30, 2003
	Previously Reported		As Restated		Previously Reported		As Restated		Previously Reported		As Restated
Net income	$	11,246	$	11,172	$	57,992	$	57,771	$	49,287	$	48,993
Comprehensive income		11,419		11,345		61,371		61,150		41,670		41,376

The effects of the revisions on the consolidated statement of cash flows for the nine months ended September 30, 2003 are summarized in the following table (in thousands):

	Nine Months Ended September 30, 2003
	Previously Reported			As Restated
Net income	$	57,992		$	57,771
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of electric plant in service		65,047			65,407
Deferred income taxes		6,556			6,417
Other operating activities cash flow items		(40,818	)		(40,818	)
Net cash provided by operating activities	$	88,777		$	88,777

There was no net impact on net cash provided by operating activities, net cash used for investing activities, and net cash used for financing activities on the consolidated statement of cash flows for the nine months ended September 30, 2003 due to the restatement.

The following Notes to Consolidated Financial Statements have been restated to reflect the correction of the AMT credit carryforward asset overstatement and the reorganization-related transmission and distribution asset understatement: (i) the Stock Options disclosure in Note A and (ii) the Reconciliation of Basic and Diluted Earnings Per Share disclosure in Note C.

27

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

El Paso Electric Company:

We have reviewed the condensed consolidated balance sheet of El Paso Electric Company and subsidiary as of September 30, 2004, the related condensed consolidated statements of operations and comprehensive operations for the three-month, nine-month, and twelve-month periods ended September 30, 2004 and 2003, and the related condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

As discussed in Notes A and H, the Company has restated the condensed consolidated statements of operations and comprehensive operations for the three-month, nine-month, and twelve-month periods ended September 30, 2003, and the related condensed consolidated statements of cash flows for the nine-month period ended September 30, 2003.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of El Paso Electric Company and subsidiary as of December 31, 2003 (restated), and the related consolidated statements of operations (restated), comprehensive operations (restated), changes in common stock equity (restated), and cash flows (restated) for the year then ended (not presented herein); and in our report dated March 10, 2004, except as to Note P, which is as of November 8, 2004, we expressed an unqualified opinion on those consolidated financial statements. Our report referred to a change in the Company’s method of accounting for asset retirement obligations in 2003. Our report also referred to the Company’s restatement of its 2003 and 2002 financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 (restated), is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

KPMG LLP

El Paso, Texas

November 8, 2004

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information contained in this Item 2 updates, and should be read in conjunction with, the information set forth in Part II, Item 7 of the Company’s 2003 Form 10-K/A.

Statements in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, as well as other oral and written forward-looking statements made by or on behalf of the Company from time to time, including statements contained in the Company’s filings with the Securities and Exchange Commission and its reports to shareholders, involve known and unknown risks and other factors which may cause the Company’s actual results in future periods to differ materially from those expressed in any forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: (i) increased prices for fuel and purchased power and determinations by regulators that may adversely affect the Company’s ability to recover incurred fuel costs in rates; (ii) fluctuations in economy sales and margins due to uncertainty in the economy power market; (iii) unanticipated increased costs associated with scheduled and unscheduled outages; (iv) the cost of replacing steam generators for Palo Verde Units 1 and 3 and other costs at Palo Verde; (v) the costs of legal defense and possible judgments which may accrue as the result of litigation arising out of the FERC investigation or any other regulatory proceeding; (vi) deregulation of the electric utility industry; and (vii) other factors discussed below under the headings “Summary of Critical Accounting Policies and Estimates,” “Overview” and “Liquidity and Capital Resources.” The Company’s filings are available from the Securities and Exchange Commission or may be obtained through the Company’s website, www.epelectric.com. Any such forward-looking statement is qualified by reference to these risks and factors. The Company cautions that these risks and factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company except as required by law.

During the quarter ended September 30, 2004, the Company determined that AMT credit carryforward assets pertaining to the pre-reorganization time period were overstated by $4.5 million and reorganization-related transmission and distribution assets were understated by $4.5 million. To correct this error, the Company will amend and reissue the 2003 Form 10-K and the March and June 2004 Form 10-Qs. In this report, the Company has restated its consolidated balance sheet as of December 31, 2003; the consolidated statements of operations for the three, nine and twelve months ended September 30, 2003; the consolidated statements of comprehensive operations for the three, nine and twelve months ended September 30, 2003; and the consolidated statement of cash flows for the nine months ended September 30, 2003. The Company has also restated the notes to consolidated financial statements as necessary to reflect the adjustments. The adjustments to the consolidated balance sheet as of December 31, 2003 include the elimination of $4.5 million of AMT credit carryforward assets, the related increase of $4.5 million in reorganization-related transmission and distribution assets, an increase of $3.8 million in accumulated depreciation, an increase of $0.3 million in deferred tax liabilities and a decrease of $4.1 million in retained earnings. The consolidated statements of operations and comprehensive operations were adjusted by a quarterly increase of $0.1 million and an annual increase of $0.5 million in depreciation and amortization expense. Net income and comprehensive income were reduced by $0.1 million, $0.2 million and $0.3 million for the three, nine and twelve months ended September 30, 2003, respectively, as a result of the aforementioned adjustments. Please read Note H for a discussion of the adjustments.

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Summary of Critical Accounting Policies and Estimates

The preparation of the Company’s financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented and actual results could differ in future periods from those estimates. In addition to the discussion on re-application of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” presented below, critical accounting policies and estimates, which are both important to the portrayal of the Company’s financial condition and results of operations and which require complex, subjective judgments are more fully described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2003 Form 10-K/A.

SFAS No. 71

Regulated electric utilities typically prepare their financial statements in accordance with SFAS No. 71. Under this accounting standard, certain recoverable costs are shown as either assets or liabilities on a utility’s balance sheet if the regulator provides assurance that these costs will be charged to and collected from its customers (or has already permitted such cost recovery). The resulting regulatory assets or liabilities are amortized in subsequent periods based upon their respective amortization periods in a utility’s cost of service.

Beginning in 1991, the Company discontinued the application of SFAS No. 71 to its financial statements. This decision was based on the Company’s determination that its rates were no longer designed to recover its costs of providing service to customers. Upon emerging from bankruptcy in 1996, the Company again concluded that it did not meet the criteria for applying SFAS No. 71 because of the 10-year rate freeze in Texas and its ongoing intention not to seek changes in its New Mexico rates, which had been established in 1990.

During the quarter ended September 30, 2004, the Company determined that it met the criteria necessary to re-apply SFAS No. 71 to its New Mexico jurisdictional operations. For the New Mexico jurisdiction, two key events transpired that, when considered together, resulted in the Company’s decision to re-apply SFAS No. 71. In late April of 2004, the Company received a final order approving a unanimous stipulation which established new base and fuel rates for its New Mexico customers which were implemented June 1, 2004. The Company’s approved rates were based upon its cost of providing service in New Mexico. That event, coupled with the repeal of New Mexico’s electric utility industry restructuring law which occurred in April of 2003, resulted in the Company meeting the criteria for the re-application of SFAS No. 71 to New Mexico, and as such, resulted in its re-application beginning July 1, 2004. The third quarter 2004 re-application of SFAS No. 71 to the Company’s New Mexico jurisdiction resulted in the recording of $18.5 million of regulatory assets, $5.0 million in related accumulated deferred income tax assets, $16.2 million of regulatory liabilities, $5.5 million in related accumulated deferred tax liabilities and the recording of a $1.8 million extraordinary gain, net of tax, or $0.04 basic and diluted earnings per share.

The Company’s Texas jurisdiction has been operating under a rate freeze since August 2, 1995. The rate freeze is for a ten-year period which expires on July 31, 2005. Although the Company believes the rates established in 1995 were based upon its costs of service, the unusual length of the rate freeze period created substantial uncertainty as to the ultimate recovery of its costs over the entire freeze period. Consequently, the Company determined that it would not re-apply SFAS No. 71 to its Texas jurisdiction

30

at the time it emerged from bankruptcy in February 1996. As the freeze period draws to a close, the Company will continue to evaluate whether it meets the criteria for the re-application of SFAS No. 71 to its Texas jurisdiction.

Reserves for Tax Dispute

The Company received final approval from the IRS during the quarter ended September 30, 2004 to settle all issues relative to its 1996 through 1998 federal income tax returns. As part of the settlement, the Company was required to capitalize approximately twenty percent of the previously claimed lease rejection damage deductions. In addition, the IRS conceded the litigation settlement issue related to a terminated merger agreement. As a result of the IRS settlement, the Company reduced its estimated contingent tax liability by $3.5 million related to the resolution of certain tax contingency items and adjusted its state deferred tax liabilities by $2.7 million. The IRS settlement reduced income tax expense by approximately $6.2 million during the quarter ended September 30, 2004 which increased net income for such period by the same amount. The IRS is currently performing an examination of the 1999 through 2002 income tax returns. The Company has established, and periodically reviews and re-evaluates, an estimated contingent tax liability on its consolidated balance sheet to provide for the possibility of adverse outcomes in tax proceedings. Although the ultimate outcome of the ongoing examination cannot be predicted with certainty, and while the contingent tax liability may not in fact be sufficient, the Company believes that the amount of contingent tax liability recorded as of September 30, 2004 is a reasonable estimate of any additional tax that may be due.

Overview

El Paso Electric Company is an investor owned electric utility that serves retail customers in west Texas and southern New Mexico and a wholesale customer in Texas. The Company also periodically sells power to the CFE. The Company owns or has substantial ownership interests in six electrical generating facilities providing it with a total capacity of approximately 1,500 MW. The Company’s energy sources consist of nuclear fuel, natural gas, coal, wind powered resources and purchased power. The Company owns or has significant ownership interests in four major 345 kV transmission lines and three 500 kV transmission lines utilized to transfer power from Palo Verde and Four Corners, and owns the transmission and distribution network within its retail service territory. The Company is subject to regulation by the Texas and New Mexico Commissions and, with respect to wholesale power sales, transmission of electric power and the issuance of securities, by the FERC.

The Company faces a number of risks and challenges that could negatively impact its operations and financial results. The most significant of these risks and challenges are the deregulation of the electric utility industry and the possibility of increased costs especially from Palo Verde.

The electric utility industry in general and the Company in particular are facing significant challenges and increased competition as a result of changes in federal provisions relating to third-party transmission services and independent power production, as well as changes in state laws and regulatory provisions relating to wholesale and retail service. In 1999, both Texas and New Mexico passed industry deregulation legislation requiring the Company to separate its transmission and distribution functions, which would remain regulated, from its power generation and energy services businesses, which would operate in a competitive market in the future. New Mexico repealed the New Mexico Restructuring Act in April 2003, and the Company’s operations in New Mexico will remain fully

31

regulated. On October 13, 2004, the Texas Commission approved a rule delaying retail competition in the Company’s Texas service territory. The rule approved by the Texas Commission changed the beginning of retail competition from the end of the Freeze Period, and instead sets a schedule which identifies various milestones for the Company to reach before competition can begin. The first milestone calls for the development, approval by the FERC, and commencement of independent operation of a regional transmission organization (“RTO”), including the development of retail market protocols to facilitate retail competition. The complete transition to retail competition will occur upon the completion of the last milestone which will be the Texas Commission’s final evaluation of the Company’s readiness to offer fair competition and reliable service to all retail customers. The Company believes that adoption of such a rule will likely delay retail competition in El Paso for at least several years. There is substantial uncertainty about both the regulatory framework and market conditions that will exist if and when retail competition is implemented in the Company’s Texas service territory, and the Company may incur substantial preparatory, restructuring and other costs that may not ultimately be recoverable. There can be no assurance that deregulation will not adversely affect the future operations, cash flows and financial condition of the Company.

The changing regulatory environment and the potential for unregulated power production have created a substantial risk that the Company will lose important customers. The Company’s wholesale and large retail customers already have, in varying degrees, alternate sources of economical power, including co-generation of electric power. If the Company loses a significant portion of its retail customer base, the Company may not be able to replace such revenues through either the addition of new customers, an increase in rates to remaining customers, or sales in the economy market.

Another risk to the Company is potential increased costs, including the risk of additional or unanticipated costs at Palo Verde resulting from (i) increases in operation and maintenance expenses; (ii) the replacement of steam generators in Palo Verde Units 1 and 3; (iii) an extended outage of any of the Palo Verde units; (iv) increases in estimates of decommissioning costs; (v) the storage of radioactive waste, including spent nuclear fuel; (vi) insolvency of other Palo Verde Participants; and (vii) compliance with the various requirements and regulations governing commercial nuclear generating stations. At the same time, the Company’s retail base rates in Texas are effectively capped through a rate freeze ending in August 2005. As a result, the Company cannot raise its base rates in Texas in the event of increases in non-fuel costs or loss of revenue. Additionally, upon initiation of competition, there may be competitive pressure on the Company’s power generation rates which could reduce its profitability. The Company cannot assure that its revenues will be sufficient to recover any increased costs, including any increased costs in connection with Palo Verde or other operations, whether as a result of inflation, changes in tax laws or regulatory requirements, or other causes.

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Liquidity and Capital Resources

The Company’s principal liquidity requirements in the near-term are expected to consist of interest payments on the Company’s indebtedness, operating and capital expenditures related to the Company’s generating facilities and transmission and distribution systems, income and other taxes, and reorganization costs related to deregulation in Texas, if and when deregulation occurs. The Company expects that cash flows from operations will be sufficient for such purposes. As of September 30, 2004, the Company had approximately $34.6 million in cash and cash equivalents, an increase of $0.2 million from the balance of $34.4 million on December 31, 2003.

In addition to the contractual obligations disclosed in the Company’s 2003 Form 10-K/A, in July 2004 the Company entered into a 20-year power contract beginning in 2006. The contractual obligation related to this contract will be $11.3 million, $11.5 million and $11.7 million for 2006, 2007 and 2008, respectively, and $230.3 million for 2009 and later.

Pollution control bonds of $193.1 million are subject to remarketing in 2005, and first mortgage bonds of $175.8 million are scheduled to mature in 2006. The Company expects that these obligations and the $100 million revolving credit facility, which matures in January 2005 (against which approximately $39.9 million had been drawn for nuclear fuel purchases as of September 30, 2004) will be refinanced through the capital and credit markets. Additionally, the Company has $183.6 million of first mortgage bonds which become callable in 2006. The Company’s ability to access capital and credit markets may be adversely affected by uncertainties related to operating in a competitive energy market, tight credit markets and debt rating agency actions.

Long-term capital requirements of the Company will consist primarily of construction of electric utility plant and the payment of interest on and retirement and refinancing of debt. Utility construction expenditures will consist primarily of expanding and updating the transmission and distribution systems, possible addition of new generation, and the cost of capital improvements and replacements at Palo Verde and other generating facilities, including the replacement of steam generators in Palo Verde Units 1 and 3.

As a result of the IRS settlement for the 1996 to 1998 tax years, the Company has fully utilized its federal tax loss carryforward in 2004. As a result, the Company’s cash flow requirements for income taxes are expected to increase over that required in recent years.

The Company is continually evaluating its funding requirements related to its retirement plans, other postretirement benefit plans, and decommissioning trust funds. The Company made additional contributions of $8.0 million and $3.2 million in August 2004 and September 2003, respectively, to one of its retirement plans. The Company also contributed an additional $4.7 million to the decommissioning trust funds in January 2003 in order to meet its funding requirement as of December 31, 2002.

Since inception of its deleveraging program in 1996, the Company has repurchased or retired with internally generated cash $581.8 million of first mortgage bonds. First mortgage bonds totaling $31.3 million were repurchased in the nine month period ended September 30, 2004. Common stock equity as a percentage of capitalization, including current portion of long-term debt and financing obligations, was 47% as of September 30, 2004.

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Although the Company is currently slightly above industry averages, the degree to which the Company is leveraged could have important consequences for the Company’s liquidity, including (i) limiting the Company’s ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate or other purposes in the future; and (ii) placing the Company at a competitive disadvantage by limiting its financial flexibility to respond to the demands of the competitive market and making it more vulnerable to adverse economic or business changes.

Since the inception of the stock repurchase programs in 1999, the Company has repurchased approximately 15.3 million shares in total at an aggregate cost of $174.9 million, including commissions. In February 2004, the Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of the Company’s outstanding common stock. During the third quarter of 2004, the Company repurchased 200,000 shares of common stock in the open market at an aggregate cost of $3.1 million, including commissions. The Company may continue making purchases of its stock at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.

Historical Results of Operations

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003 (Restated)		2004		2003 (Restated)
Income before extraordinary item and cumulative effect of accounting change (in thousands)	$	23,938	$	11,172	$	34,551	$	18,136
Diluted earnings per share before extraordinary item and cumulative effect of accounting change		0.50		0.23		0.72		0.37

	Twelve Months Ended September 30,
	2004		2003 (Restated)
	Actual		Actual		Pro forma
Income before extraordinary item and cumulative effect of accounting change (in thousands)	$	36,737	$	9,358	$	10,514
Diluted earnings per share before extraordinary item and cumulative effect of accounting change		0.76		0.19		0.21

Income before the extraordinary item for the three months ended September 30, 2004 increased $12.8 million, or $0.27 diluted earnings per share, compared to the results for the same period a year ago (restated). This after-tax increase resulted primarily from the 2003 asset impairment loss of $10.7 million on the CIS project with no comparable loss in the current period and the recording of the benefits of the IRS settlement of $6.2 million in the quarter ended September 30, 2004 with no comparable amounts in the previous period. These increases were partially offset by the following items, which are all presented on an after-tax basis (i) decreased retail sales of $1.9 million;

34

(ii) increased pensions and benefits expense of $1.5 million; (iii) increased depreciation and amortization expense of $0.8 million; and (iv) the loss on extinguishment of debt of $0.5 million.

Income before the extraordinary item and cumulative effect of accounting change for the nine months ended September 30, 2004 increased $16.4 million, or $0.35 diluted earnings per share, compared to the results for the same period a year ago (restated). This after-tax increase resulted primarily from (i) the 2003 asset impairment loss on the CIS project of $10.7 million with no comparable loss in the current period; (ii) the recording of the benefits of the IRS settlement of $6.2 million; and (iii) decreased non-Palo Verde maintenance expense of $6.1 million. These increases were partially offset by the following items, which are all presented on an after-tax basis (i) increased loss on extinguishment of debt of $2.9 million; (ii) increased depreciation and amortization expenses of $2.7 million; and (iii) increased pension and benefits expenses of $2.7 million in the current period.

Income before the extraordinary item and cumulative effect of accounting change for the twelve months ended September 30, 2004 increased $26.2 million or $0.55 diluted earnings per share, compared to the pro forma results for the same period a year ago (restated). The pro forma net income and earnings per share amounts shown above assume SFAS No. 143 had been applied on a retroactive basis. This after-tax increase was primarily due to (i) the 2003 asset impairment loss on the CIS project of $10.7 million with no comparable loss in the current period; (ii) the 2002 accrual for the FERC settlements of $9.5 million; (iii) decreased non-Palo Verde maintenance expense of $9.5 million; and (iv) the recording of the benefits of the IRS settlement of $6.2 million with no comparable amount in the previous period. These increases were partially offset by (i) increased pension and benefits expenses of $4.4 million; (ii) an increase in the loss on extinguishment of debt of $2.9 million; and (iii) increased depreciation and amortization expense of $2.8 million.

Operating revenues net of energy expenses decreased $2.2 million for the three months ended September 30, 2004 compared to the same period last year primarily due to decreased retail sales of $3.0 million. This decrease was partially offset by an increase in wheeling revenues of $0.3 million.

Operating revenues net of energy expenses increased $1.4 million for the nine months ended September 30, 2004 compared to the same period last year primarily due to increased retail sales of $3.6 million and increased wheeling revenues of $1.2 million. This increase was partially offset by (i) decreased sales and/or margins on economy sales of $1.4 million; (ii) $1.0 million of various fuel expense items; and (iii) 2003 CFE margins of $0.5 million with no comparable activity in 2004.

Operating revenues net of energy expenses decreased $1.3 million for the twelve months ended September 30, 2004 compared to the same period last year primarily due to (i) decreased wholesale sales revenues of $5.3 million primarily related to the expiration of two long-term contracts; (ii) the Texas fuel disallowance of $4.5 million; (iii) the $1.6 million expense which related to the settlement agreement with ENA; (iv) decreased sales and/or margins on economy sales of $1.0 million; and (v) a $1.0 million decrease in revenue from the energy service operation. This decrease was partially offset by an increase in retail sales of $12.3 million.

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Comparisons of kWh sales and operating revenues are shown below (in thousands):

					Increase (Decrease)
Quarter Ended September 30:	2004		2003		Amount			Percent
kWh sales:
Retail:
Residential		586,905		605,256		(18,351	)	(3.0	)%
Commercial and industrial, small		618,039		628,261		(10,222	)	(1.6	)
Commercial and industrial, large		311,814		314,266		(2,452	)	(0.8	)
Sales to public authorities		346,887		358,152		(11,265	)	(3.1	)
Total retail sales		1,863,645		1,905,935		(42,290	)	(2.2	)
Wholesale:
Sales for resale		11,163		19,861		(8,698	)	(43.8	)(1)
Economy sales		536,151		409,136		127,015		31.0	(2)
Total wholesale sales		547,314		428,997		118,317		27.6
Total kWh sales		2,410,959		2,334,932		76,027		3.3
Operating revenues:
Base revenues:
Retail:
Residential	$	52,420	$	54,323	$	(1,903	)	(3.5	)%
Commercial and industrial, small		47,036		47,501		(465	)	(1.0	)
Commercial and industrial, large		11,237		11,215		22		0.2
Sales to public authorities		19,495		20,169		(674	)	(3.3	)
Total retail base revenues		130,188		133,208		(3,020	)	(2.3	)
Wholesale:
Sales for resale		481		926		(445	)	(48.1	)(1)
Total base revenues		130,669		134,134		(3,465	)	(2.6	)
Fuel revenues		47,499		42,844		4,655		10.9	(3)
Economy sales		23,382		17,697		5,685		32.1	(2)
Other		3,391		2,750		641		23.3	(4)(5)
Total operating revenues	$	204,941	$	197,425	$	7,516		3.8

36

Nine Months Ended September 30:	2004		2003		Increase (Decrease)
					Amount			Percent
kWh sales:
Retail:
Residential		1,523,708		1,483,707		40,001		2.7	%
Commercial and industrial, small		1,629,402		1,600,965		28,437		1.8
Commercial and industrial, large		930,649		880,791		49,858		5.7
Sales to public authorities		949,559		931,600		17,959		1.9
Total retail sales		5,033,318		4,897,063		136,255		2.8
Wholesale:
Sales for resale		33,916		59,067		(25,151	)	(42.6	)(1)
Economy sales		1,454,125		1,442,720		11,405		0.8
Total wholesale sales		1,488,041		1,501,787		(13,746	)	(0.9	)
Total kWh sales		6,521,359		6,398,850		122,509		1.9
Operating revenues:
Base revenues:
Retail:
Residential	$	134,572	$	132,142	$	2,430		1.8	%
Commercial and industrial, small		126,483		125,624		859		0.7
Commercial and industrial, large		32,540		32,125		415		1.3
Sales to public authorities		55,098		55,232		(134	)	(0.2	)
Total retail base revenues		348,693		345,123		3,570		1.0
Wholesale:
Sales for resale		1,393		2,873		(1,480	)	(51.5	)(1)
Total base revenues		350,086		347,996		2,090		0.6
Fuel revenues		123,843		94,811		29,032		30.6	(3)
Economy sales		60,873		58,367		2,506		4.3
Other		8,197		6,235		1,962		31.5	(4)(5)
Total operating revenues	$	542,999	$	507,409	$	35,590		7.0

37

Twelve Months Ended September 30:	2004		2003		Increase (Decrease)
					Amount			Percent
kWh sales:
Retail:
Residential		1,972,172		1,889,444		82,728		4.4	%
Commercial and industrial, small		2,125,297		2,059,691		65,606		3.2
Commercial and industrial, large		1,246,923		1,157,129		89,794		7.8
Sales to public authorities		1,242,308		1,196,550		45,758		3.8
Total retail sales		6,586,700		6,302,814		283,886		4.5
Wholesale:
Sales for resale		42,603		217,422		(174,819	)	(80.4	)(6)
Economy sales		1,932,287		1,787,455		144,832		8.1
Total wholesale sales		1,974,890		2,004,877		(29,987	)	(1.5	)
Total kWh sales		8,561,590		8,307,691		253,899		3.1
Operating revenues:
Base revenues:
Retail:
Residential	$	173,889	$	167,930	$	5,959		3.5	%
Commercial and industrial, small		166,293		162,745		3,548		2.2
Commercial and industrial, large		43,709		42,559		1,150		2.7
Sales to public authorities		73,003		71,407		1,596		2.2
Total retail base revenues		456,894		444,641		12,253		2.8
Wholesale:
Sales for resale		1,743		7,989		(6,246	)	(78.2	)(6)
Total base revenues		458,637		452,630		6,007		1.3
Fuel revenues		151,792		131,426		20,366		15.5	(3)
Economy sales		79,042		68,423		10,619		15.5	(7)
Other		10,481		8,728		1,753		20.1	(4)(8)
Total operating revenues	$	699,952	$	661,207	$	38,745		5.9

(1) Primarily due to a 2003 CFE wholesale power contract with no comparable contract in 2004 and decreased sales to the Rio Grande Electric Cooperative.

(2) Primarily due to an increase in the availability of power from Palo Verde and Four Corners.

(3) Primarily due to an increase in recoverable fuel expenses, as a result of an increase in the price and volume of natural gas burned and an increase in purchased power costs.

(4) Represents revenues with no related kWh sales.

(5) Primarily due to increased transmission revenues.

(6) Primarily due to the expiration of a wholesale power contract with TNP on December 31, 2002 and a 2003 CFE wholesale power contract with no comparable contract in 2004.

(7) Primarily due to higher market prices and increased sales.

(8) Primarily due to increased transmission revenues partially offset by decreased revenues from the energy service operation.

Other operations expense increased $1.3 million for the three months ended September 30, 2004 compared to the same period last year primarily due to increased pension and benefits expense of

38

$2.4 million. This increase was partially offset by (i) decreased regulatory expense of $0.6 million; and (ii) decreased Palo Verde expense of $0.5 million.

Other operations expense increased $1.6 million for the nine months ended September 30, 2004 compared to the same period last year primarily due to (i) increased pension and benefits expense of $4.4 million resulting from plan asset performance and decreasing discount rates; and (ii) increased legal and consulting fees of $0.5 million primarily related to implementing Sarbanes-Oxley Section 404. These increases were partially offset by (i) decreased regulatory expense of $1.4 million; (ii) decreased customer accounts expense of $0.8 million; and (iii) decreased Palo Verde expense of $0.8 million.

Other operations expense increased $4.3 million for the twelve months ended September 30, 2004 compared to the same period last year primarily due to (i) increased pension and benefits expense of $7.0 million resulting from plan asset performance and decreasing discount rates; (ii) increased consulting and legal fees of $1.8 million; and (iii) increased accretion expense of $1.5 million related to the implementation of SFAS No. 143. These increases were partially offset by (i) decreased regulatory expense of $2.6 million; (ii) decreased Palo Verde expense of $2.5 million; and (iii) decreased customer accounts expense of $1.1 million.

The Company abandoned a CIS project and recognized an asset impairment loss of $17.6 million in September 2003. The Company is now analyzing various options to meet its current and projected CIS needs.

The FERC settlements relate to the settlements with the FERC Trial Staff and principal California parties pursuant to which the Company agreed to refund $15.5 million of revenues it earned on wholesale power transactions in 2000 and 2001. These settlements were recorded in December 2002.

Maintenance expense increased $0.4 million for the three months ended September 30, 2004 compared to the same period last year primarily due to the timing of refueling and maintenance outages at Palo Verde of $0.5 million offset by reduced maintenance outages at non-Palo Verde generating stations of $0.3 million.

Maintenance expense decreased $10.4 million and $16.8 million, respectively, for the nine and twelve months ended September 30, 2004 compared to the same periods last year primarily due to reduced maintenance expenses at non-Palo Verde generating stations of $9.9 million and $15.3 million, respectively.

Depreciation and amortization expense increased $1.3 million, $4.4 million and $4.7 million for the three, nine and twelve months ended September 30, 2004, respectively, compared to the same periods last year (restated). The increases for the three, nine and twelve month periods were primarily due to (i) an increase in other depreciable plant balances resulting in increased depreciation of $0.3 million, $1.7 million and $1.6 million, respectively; (ii) depreciation of the new Palo Verde Unit 2 steam generators of $0.5 million, $1.6 million and $1.6 million, respectively; and (iii) the implementation of new depreciation rates based on an updated depreciation study resulting in an increase of $0.5 million, $1.1 million and $1.2 million, respectively.

Taxes other than income taxes remained relatively unchanged for the three and twelve months ended September 30, 2004 and increased by approximately $0.6 million for the nine months ended

39

September 30, 2004 compared to the same periods last year. The increase was primarily related to an increase in estimated property taxes partially offset by a change in New Mexico occupation street rental tax.

Other income (deductions) decreased $1.3 million for the three months ended September 30, 2004 compared to the same period last year primarily due to losses on extinguishments of debt of $0.9 million recorded in 2004 with no comparable amount in the prior period. Other income (deductions) decreased $5.7 million for the nine months ended September 30, 2004 compared to the same period last year primarily due to (i) losses on extinguishments of debt of $4.7 million; (ii) $1.0 million related to an adjustment of interest income associated with the resolution of the Texas fuel reconciliation in PUC Docket No. 26194; and (iii) $0.8 million related to certain tax refunds received in 2003 with no comparable amount in the current period. These decreases were partially offset by an increase of $1.4 million in investment and interest income related to the decommissioning trust fund. Other income (deductions) decreased $5.0 million for the twelve months ended September 30, 2004 compared to the same period last year primarily due to (i) losses on extinguishments of debt of $4.7 million; (ii) $1.2 million related to an adjustment of interest income associated with the resolution of the Texas fuel reconciliation in PUC Docket No. 26194; and (iii) $0.6 million related to certain tax refunds received in 2003 with no comparable amount in the prior period. These decreases were partially offset by an increase of $2.4 million in investment and interest income related to the decommissioning trust fund.

Interest charges (credits) increased $0.1 million and $0.4 million, respectively, for the three and nine months ended September 30, 2004 compared to the same period last year primarily due to reduced capitalized interest of $0.7 million and $1.7 million for the three and nine month periods, respectively, as a result of transferring Palo Verde Unit 2 steam generators to plant in service. These increases were partially offset by decreased interest expense of $0.6 million and $1.4 million for the three and nine month periods, respectively, due to a reduction of outstanding debt as a result of open market purchases of the Company’s first mortgage bonds. Interest charges (credits) decreased $2.7 million for the twelve months ended September 30, 2004 compared to the same period last year primarily due to (i) a $2.5 million decrease resulting from a reduction of outstanding debt as a result of open market purchases of the Company’s first mortgage bonds; and (ii) a $2.0 million decrease resulting from the adoption of SFAS No. 143. These decreases were partially offset by an increase of $1.6 million primarily due to reduced capitalized interest as a result of transferring Palo Verde Unit 2 steam generators to plant in service.

Income tax expense, excluding the tax effect of cumulative effect of accounting change, decreased $2.0 million for the three months ended September 30, 2004 primarily due to a $6.2 million tax benefit recorded for the IRS settlement with no comparable adjustment in the prior period (restated). This decrease was partially offset by an increase in tax expense related to changes in pretax income and certain permanent differences. Income tax expense, excluding the tax effect of cumulative effect of accounting change, remained relatively the same and increased $9.9 million for the nine and twelve months ended September 30, 2004, respectively, compared to the same periods last year (restated). The increase was primarily due to changes in pretax income and certain permanent differences and adjustments partially offset by a $6.2 million tax benefit recorded for the IRS settlement with no comparable adjustment in the prior period.

40

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risk due to changes in interest rates, equity prices and commodity prices. See the Company’s 2003 Form 10-K, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” for a complete discussion of the market risks faced by the Company and the Company’s market risk sensitive assets and liabilities. As of September 30, 2004, there have been no material changes in the market risks faced by the Company or the fair values of assets and liabilities disclosed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in the Company’s 2003 Form 10-K.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of September 30, 2004, (the “Evaluation Date”), have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures (as required by paragraph (b) of the Securities Exchange Act of 1934 Rules 13a-15 or 15d-15) were adequate and designed to ensure that material information relating to the Company and the Company’s consolidated subsidiary would be made known to them by others within those entities.

Changes in internal control over financial reporting. In the third quarter of 2004, the Company discovered an error in its consolidated balance sheets. The error, which was caused by a mathematical miscalculation in a tax return schedule that was reflected in the Company’s 1996 financial statements, resulted in a $4.5 million overstatement of AMT credit carryforward assets and a $4.5 million understatement of transmission and distribution assets. The error has remained in the financial statements until the reconciliation in connection with the recent IRS settlement. Management promptly brought these matters to the attention of its Audit Committee and independent accountants and determined that it would restate its consolidated balance sheets as of December 31, 2001, 2002 and 2003 and March 31, and June 30, 2004, and its consolidated statements of operations, consolidated statements of comprehensive operations, changes in common stock equity and cash flows for each annual, quarterly and twelve month period ending on the above dates. Management and the Company’s independent accountants have determined that the deficiency in reconciliation procedures constituted a material weakness in the Company’s internal controls over financial reporting. The Company’s management has implemented additional procedures for reconciling and analyzing AMT credit carryforward assets on a timely basis and believes that the controls now in place are adequate to assure that similar errors will not recur. Except for the changes discussed above, there were no changes in the Company’s internal control over financial reporting in connection with the evaluation required by paragraph (d) of the Securities Exchange Act of 1934 Rules 13a-15 or 15d-15, that occurred during the quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

41

PART II. OTHER INFORMATION

I tem 1. Legal Proceedings

The Company hereby incorporates by reference the information set forth in Part I of this report under Notes B and E of Notes to Consolidated Financial Statements.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Period	Total Number of Shares Purchased		Average Price Paid per Share (Including Commissions)		Total Number of Shares Purchased as Part of a Publicly Announced Program	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (a)
July 1 to July 31, 2004	0		$	—	0	1,950,000
August 1 to August 31, 2004	47,342	(b)		15.32	2,500	1,947,500
September 1 to September 30, 2004	197,500			15.48	197,500	1,750,000

^(a) In February 2004, the Company’s Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of its outstanding common stock.

^(b) In August 2004, the Company purchased 44,842 shares of stock from Wilson K. Cadman, a retired Director of the Company.

Item 6. Exhibits

See Index to Exhibits incorporated herein by reference.

42

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EL PASO ELECTRIC COMPANY
By:	/s/ TERRY BASSHAM
	Terry Bassham
	Executive Vice President,
	Chief Financial and
	Administrative Officer
	(Duly Authorized Officer and
	Principal Financial Officer)

Dated: November 9, 2004

43

EL PASO ELECTRIC COMPANY

INDEX TO EXHIBITS

Exhibit Number	Exhibit
†10.01	Form of Directors’ Restricted Stock Award Agreement between the Company and certain directors of the Company. (Identical in all material respects to Exhibit 10.07 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1999)
10.02	Master Power Purchase and Sale Agreement and Transaction Agreement, dated as of July 7, 2004, between the Company and Southwestern Public Service Company.
15	Letter re Unaudited Interim Financial Information
31.01	Rule 13a-14(a)/15d-14(a) Certifications
32.01	Section 1350 Certifications

† In lieu of non-employee director cash compensation, two agreements, dated as of July 1, 2004, substantially identical in all material respects to this Exhibit, have been entered into with Kenneth R. Heitz and Patricia Z. Holland-Branch; directors of the Company.

44

EX-10.02

Confidential treatment has been requested for portions of this exhibit. The copy filed herewith omits the information subject to the confidentiality request. Omissions are designated as *****. A complete version of this exhibit has been filed separately with the Securities and Exchange Commission.

Exhibit 10.02

MASTER POWER PURCHASE AND SALE AGREEMENT

This Master Power Purchase and Sale Agreement (this “Master Agreement” and together with all Transaction Agreements, collectively, the “Agreement”) is entered into effective as of this 7th day of July, 2004 (the “Effective Date”) by and between Southwestern Public Service Company (“Company”), and El Paso Electric Company (“Counterparty”). Each of the Company and Counterparty may also be referred to individually as a “Party” or collectively as the “Parties.” Unless otherwise defined in this Master Agreement, capitalized terms shall have the meanings set forth in Appendix “1” attached to this Master Agreement.

SECTION 1.

SCOPE OF AGREEMENT

1.1. Scope of Agreement. (a) This Master Agreement is entered into in accordance with the Company’s Rate Schedule for Market-Based Power Sales (“Rate Schedule”), and the terms of that Rate Schedule, and the service agreement between the Parties entered thereunder (“Service Agreement”), apply to this Master Agreement and any Transaction Agreements as though set forth herein and therein. From time to time, the Parties may, but shall not be obligated to, enter into Transactions for the sale and purchase of Power hereunder. Certain terms of specific Transactions will be set forth in appropriate Transaction Agreements entered into in accordance with this Master Agreement. However, the Parties are relying upon the fact that all Transaction Agreements, together with this Master Agreement, shall constitute a single integrated agreement, and that the Parties would not otherwise enter into any agreement to undertake a specific Transaction. In the event of any conflict between or among the documents comprising this Agreement, the following order of precedence shall apply: (i) written Transaction Agreement (including Confirmations), (ii) Master Agreement, and (iii) oral Transaction Agreement. All purchases and sales between the Parties from and after the Effective Date shall be deemed to be under the Rate Schedule, the Service Agreement, and this Master Agreement unless expressly agreed to otherwise. The Parties acknowledge that this Master Agreement and any Transaction Agreement governed by it shall be subject to the filing, disclosure, or notification requirements, if any, of the FERC.

(b) Each Party conducts its operations in a manner intended to comply with FERC Order No. 2004, Standards of Conduct for Transmission Providers, requiring the separation of its transmission and merchant functions. Moreover, each Party’s transmission function offers transmission service on its system in a manner intended to comply with FERC policies and requirements relating to the provision of open-access transmission service. Accordingly, each Party acknowledges that the other Party’s responsibilities and obligations under the Master Agreement and any Transaction are those of that Party’s merchant function, not of its transmission function, and that neither this Master Agreement nor any Transaction Agreement imposes any responsibilities or obligations on that Party’s transmission function. To the extent either Party obligates itself to arrange transmission on its system in connection with a Transaction, it is understood that such Party will do so in a manner consistent with the open-access

1

transmission tariff that is applicable to its system, and it will only communicate with its transmission function in a manner consistent with FERC Order No. 2004 (as it may be modified or superseded by subsequent FERC orders).

1.2. Transaction Procedures. During the term of this Agreement, the Parties may notify each other that Power is sought or available for purchase or sale. Each Transaction shall be effectuated and evidenced by the Authorized Representatives of the Parties at the time the Transaction is agreed to and shall be set forth as follows: (i) by a written Transaction Agreement executed by the Parties or (ii) in a telephone conversation between the Parties whereby an offer and acceptance shall constitute an oral Transaction Agreement of the Parties (which agreement may be subsequently set out in a Confirmation, as described below) provided each Party may stipulate by prior notice to the other Party that all Transactions or particular types of Transactions (e.g., having a certain duration or above a certain price) shall be effectuated and formed only by means of procedure (i) above. Long-term Transactions (i.e., having a duration of greater that a year) must be evidenced by a written Transaction Agreement. The specific terms to be established by the Parties for each Transaction in a Transaction Agreement shall include the Buyer and Seller, the nature of the Power to be provided (i.e., capacity, energy, or both), the Period of Delivery, the Contract Price, the Delivery Point, the Contract Quantity, whether the Transaction is Firm or Non-Firm, Scheduling, and such other terms as the Parties shall agree upon. The Seller may confirm a telephonic Transaction by forwarding to the Buyer a Confirmation, which shall be executed by the Buyer (with any objections noted thereon) and returned to the Seller within two (2) Business Days of Buyer’s receipt of it or else be deemed correct as sent, absent manifest error. Failure by the Seller to send a Confirmation shall not invalidate any Transaction agreed to by the Parties. The Parties agree not to contest or assert any defense to the validity or enforceability of telephonic Transactions entered into in accordance with this Master Agreement under Laws relating to whether certain agreements are to be in writing or signed by the Party to be bound, or the authority of any employee of the Party to enter into a Transaction. Each Party consents to the recording of its representatives’ telephone conversations without any further notice. All recordings may be introduced into evidence and used to prove oral agreements between the Parties permitted by this Section 1.2.

1.3. Term of Agreement. The Parties intend that the term of this Master Agreement shall commence on the Effective Date and continue until terminated by either Party upon thirty (30) days prior written notice; provided, however, that this Master Agreement shall remain in effect with respect to any Transaction(s) entered into prior to the effective date of the termination until both Parties have fulfilled all their obligations with respect to such Transaction(s).

1.4. Regulatory Approval. The Parties acknowledge that under current FERC policy, neither Company nor Counterparty are required to file this Master Agreement with the FERC for its approval. In the event that FERC changes its policy, either Party may file this Master Agreement with the FERC, and the other Party shall not oppose such filing.

2

SECTION 2.

REPRESENTATIONS AND WARRANTIES

On the Effective Date and the date of entering into each Transaction, each Party represents and warrants to the other Party that: (i) it is duly organized, validly existing and in good standing under the Laws of the jurisdiction of its formation and is qualified to conduct its business in each jurisdiction in which a Transaction will be performed by it, (ii) it has all regulatory authorizations necessary for it to legally perform its obligations under this Master Agreement and each Transaction, (iii) the execution, delivery and performance of this Master Agreement and each Transaction are within its powers, have been duly authorized by all necessary action and do not violate any of the terms and conditions in its governing documents, any contracts to which it is a party, or any Law applicable to it, (iv) this Master Agreement and each Transaction when entered into in accordance with this Master Agreement constitutes its legally valid and binding obligation enforceable against it in accordance with its terms, subject to any Equitable Defenses, (v) there are no Bankruptcy Proceedings pending or being contemplated by it or, to its knowledge, threatened against it (vi) there are no Legal Proceedings that materially adversely affect its ability to perform its obligations under this Master Agreement and each Transaction, and (vii) it has knowledge and experience in financial matters and the electric industry that enable it to evaluate the merits and risks of entering into this Master Agreement and each Transaction.

SECTION 3.

OBLIGATIONS AND DELIVERIES

3.1. Seller’s and Buyer’s Obligations. Subject to the terms of this Master Agreement and any applicable Transaction Agreement, Seller, with respect to each Transaction, shall sell and deliver, or cause to be delivered, and Buyer shall purchase and receive, or cause to be received, at the Delivery Point the Contract Quantity, and Buyer shall pay Seller the Contract Price. Seller shall be responsible for any costs or charges imposed on or associated with the delivery of the Contract Quantity up to the Delivery Point. Buyer shall be responsible for any costs or charges Imposed on or associated with the Contract Quantity at and from the Delivery Point.

3.2. Transmission and Scheduling. Seller shall arrange and be responsible for any necessary transmission service to the Delivery Point and shall Schedule or arrange for Scheduling services with its Transmission Providers to deliver the Power to the Delivery Point. Buyer shall arrange and be responsible for transmission service at and from the Delivery Point and shall Schedule or arrange for Scheduling services with its Transmission Providers to receive the Power at the Delivery Point. Each Party shall designate Authorized Representatives to effect the Scheduling of the Contract Quantity of Power.

3.3. Title, Risk of Loss and Indemnity. Seller warrants that it will deliver to Buyer the Contract Quantity free and clear of all liens, claims, and encumbrances arising prior to the Delivery Point. Title to and risk of loss related to the Contract Quantity shall transfer from Seller to Buyer at the Delivery Point.

3

Notwithstanding any limitation or exclusion prescribed by Section 5.1 or any other provision of this Agreement, each Party shall indemnify and hold harmless the other Party, its directors, officers, employees, agents, and contractors for, against, and from any and all Claims for personal injury (including mental anguish), death, or damage to the property of any third party(s) arising from or out of any event circumstance, act, or incident first occurring or existing during the period when title to the Power is vested in the indemnitor; provided, however, the obligations prescribed by this sentence shall not apply to the extent such Claims are determined to be attributable to the negligence, gross negligence, willful misconduct, or strict liability in tort of the indemnitee, its directors, officers, employees, agents and/or contractors, if any (it being the intent of the Parties that the indemnitee shall be entitled to comparative indemnification for such Claims).

3.4. Force Majeure. If either Party is rendered unable by Force Majeure to carry out in whole or part, its obligations with respect to a Transaction and such Party gives notice and full details of the event to the other Party as soon as practicable after the occurrence of the event, then the obligations of the Party affected by the event (other than the obligation to make payments then due or becoming due with respect to performance prior to the event) shall be suspended for such period as is necessary for the Party claiming Force Majeure, using all reasonable dispatch, to remedy either the event of Force Majeure or the effects thereof so as to be able to resume performance; provided, however, that this provision shall not require Seller to deliver, or Buyer to receive, Power at points other than the Delivery Point.

3.5. Failure to Deliver/Receive in Firm Transactions. (a) Unless excused by Force Majeure in accordance with Section 3.4 or Buyer’s failure to perform any material obligation under this Agreement, if Seller fails to deliver all or part of the Contract Quantity pursuant to a Firm Transaction that Buyer has Scheduled, Seller shall pay Buyer, on the date payment would otherwise be due to Seller, an amount for each MWh of such deficiency equal to the positive difference, if any, obtained by subtracting the Contract Price from the Replacement Price. “Replacement Price” means the price at which Buyer, acting in a commercially reasonable manner, purchases substitute Power not delivered by Seller (plus any (i) Costs (as the term “Cost” is defined in Section 4.2) reasonably incurred by Buyer in purchasing the substitute Power, and (ii) additional transmission charges incurred by Buyer to the Delivery Point) or, absent a purchase, the market price for such quantity at such Delivery Point as determined by Buyer in a commercially reasonable manner. For purposes of determining Buyer’s Replacement Price and its duty to mitigate damages under Section 5.2, Buyer shall not be required to use or change its use of its owned or controlled assets or market positions to minimize Seller’s liability.

(b) Unless excused by Force Majeure in accordance with Section 3.4 or Seller’s failure to perform any material obligation under this Agreement, if Buyer fails to receive (i) the minimum requirement of the Contract Quantity, if any, as required to be received pursuant to a Firm Transaction or (ii) amounts of Power that the Parties agreed to Schedule pursuant to a Firm Transaction, Buyer shall pay Seller, on the date payment would otherwise be due, an amount for each MWh of such deficiency equal to the positive difference, if any, obtained by subtracting the Sales Price from the Contract

4

Price. “Sales Price” means the price at which Seller, acting in a commercially reasonable manner, resells the Power not received by Buyer (plus any (i) Costs reasonably incurred by Seller in selling such minimum requirement, and (ii) additional transmission charges incurred by Seller) or, absent a resale, the market price for such quantity at the Delivery Point as determined by Seller in a commercially reasonable manner. For purposes of determining Seller’s Sales Price and its duty to mitigate damages under Section 5.2, Seller shall not be required to use or change its use of its owned or controlled assets or market positions to minimize Buyer’s liability.

(c) Notwithstanding the requirements and obligations specified in this Section 3.5, the Parties in a written Transaction Agreement may agree to alternative arrangements that would apply in the event of a Seller’s failure to deliver or a Buyer’s failure to accept the Contract Quantity or any portion thereof.

3.6. Failure to Deliver/Receive Non-Firm Transactions. A Party may be excused from delivering or receiving the Contract Quantity, in whole or in part, in a Non-Firm Transaction for any reason without liability.

3.7 Exclusive Remedy. Except as may be provided in a Transaction Agreement, the applicable remedy prescribed by Section 3.5 shall be the sole and exclusive remedy for a Party’s failure to deliver or receive the Contract Quantity referenced therein.

SECTION 4.

DEFAULTS AND REMEDIES

4.1. Events of Default. An “Event of Default” shall mean with respect to a Party (“Defaulting Party”): (i) the failure to make, when due, any payment required pursuant to this Agreement if such failure is not remedied within five (5) Business Days after written notice of such failure is received by the Defaulting Party from the other Party (“Non-Defaulting Party”) and provided the payment is not the subject of a good faith dispute as described in Section 6, (ii) any representation or warranty made by the Defaulting Party pursuant to Section 2 shall prove to be false or misleading in any material respect when made, (iii) the failure to perform any material covenant set forth in this Agreement (other than the events that are otherwise specifically covered in this Section 4.1 as a separate Event of Default or its obligations to deliver or receive Power the exclusive remedy for which is provided in Section 3) or any Transaction Agreement, and such failure is not excused by Force Majeure in accordance with Section 3.4 or cured within five (5) Business Days after written notice thereof is received by the Defaulting Party, (iv) the Defaulting Party shall be subject to a Bankruptcy Proceeding, or (v) Adequate Assurance of Performance is not provided in accordance with Section 4.4.

4.2. Remedies upon an Event of Default. (a) If an Event of Default occurs at any time during the term of this Agreement, the Non-Defaulting Party may, for so long as the Event of Default is continuing, (i) establish a date (which date shall be between 2 and 20 Business Days after the Non-Defaulting Party delivers notice) (“Early

5

Termination Date”) on which (x) if the Event of Default arises under clauses (i) or (iii) of Section 4.1, the Transaction(s) underlying or giving rise to such Event of Default shall terminate (each a “Terminated Transaction”) or (y) if the Event of Default arises under clauses (ii) (unless relating to the failure to obtain regulatory approval for any Transactions (Section 2(ii)), in which case only those specific Transactions may be terminated), (iv), or (v) of Section 4.1, all Transactions shall terminate, and (ii) withhold any payments due in respect of the Terminated Transaction(s). If an Early Termination Date has been designated, the Non-Defaulting Party shall in good faith calculate its Gains, Losses, and Costs resulting from the termination of the Terminated Transaction(s). The Gains and Losses shall be determined by comparing the value of the remaining term, Contract Quantities and Contract Prices under each Terminated Transaction had it not been terminated to the equivalent quantities and relevant market prices for the remaining term either quoted by a bona fide third-party offer or which are reasonably expected to be available in the market under a replacement contract for each Terminated Transaction. To ascertain the market prices of a replacement contract, the Non-Defaulting Party may consider, among other valuations, any or all of the settlement prices of NYMEX Power futures contracts, quotations from leading dealers in energy swap contracts, and other bona fide third-party offers, all adjusted for the length of the remaining term and differences in transmission. It is expressly agreed that a Non-Defaulting Party shall not be required to enter into replacement transactions in order to determine the amount due under Section 4.2. The Non-Defaulting Party shall aggregate such Gains and Losses, and all associated Costs with respect to all Terminated Transaction(s) into a single net amount and if the Non-Defaulting Party’s (i) aggregate Losses and Costs exceed (ii) its aggregate Gains, the Defaulting Party shall, within five (5) Business Days of receipt of written demand, pay the difference between the aggregate sums referenced in clauses (i) and (ii) of this sentence (the “Termination Payment”) to the Non-Defaulting Party, which Termination Payment shall bear interest at the Interest Rate from the Early Termination Date until paid. If the Non-Defaulting Party’s (i) aggregate Gains equal or exceed (ii) the sum of its aggregate Losses and Costs, the Termination Payment shall be zero, and the Defaulting Party shall have no interest in or right or entitlement to, and shall not claim that it should be owed, the difference, if any, between the aggregate sums referenced in clauses (i) and (ii) of this sentence.

(b) As used in this Agreement with respect to each Party: (i) ”Costs” shall mean, with respect to a Party, brokerage fees, commissions, and other similar transaction costs and expenses reasonably incurred by such Party either in terminating any arrangement pursuant to which it has hedged its obligations or entering into new arrangements which replace a Terminated Transaction, and attorneys’ fees, if any, incurred in connection with enforcing its rights under this Agreement; (ii) “Gains” shall mean, with respect to a Party, an amount equal to the present value of the economic benefit (exclusive of Costs), if any, to it resulting from the termination of its obligations with respect to a Terminated Transaction, determined in a commercially reasonable manner; and (iii) “Losses” shall mean, with respect to a Party, an amount equal to the present value of the economic loss (exclusive of Costs), if any, to it resulting from the termination of its obligations with respect to a Terminated Transaction, determined in a commercially reasonable manner. At the time for payment of any amount due under this Section 4.2, each Party shall pay to the other Party all additional amounts payable

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by it pursuant to this Agreement (e.g., amounts owed for services provided prior to termination), but all such amounts shall be netted and aggregated with any Termination Payment payable hereunder.

(c) Notwithstanding any other provision of this Agreement if Buyer or Seller fails to pay to the other Party any amounts when due and such failure is not cured within five (5) Business Days following the delinquent Party’s receipt of written notice describing such nonpayment in reasonable detail, the Non-Defaulting Party may, regardless of whether it elects to exercise its remedies under Section 4.2(a), (i) suspend performance of any or all of its obligations related to any Transactions until such amounts plus interest at the Interest Rate have been paid and/or (ii) exercise any remedy available at Law to enforce payment of such amount plus interest at the Interest Rate; provided, however; If the non-paying Party, in good faith, shall dispute the amount of any such billing or part thereof and shall pay such amounts as it concedes to be correct, no suspension shall be permitted.

4.3. Other Events. Unless the Parties agree otherwise in a Transaction Agreement, in the event Buyer or Seller is regulated by a federal, state, or local regulatory body, and such body shall either (i) disallow all or any portion of any costs incurred or yet to be incurred by Buyer through a purchase, or (ii) through its setting of rates attribute costs to a sale made by Seller under any provision of this Agreement, such action shall not operate to excuse Buyer or Seller from performance of any obligation nor shall such action give rise to any right of Buyer or Seller to any refund or retroactive adjustment of the Contract Price provided in any Transaction. Notwithstanding the foregoing, if a Party’s activities hereunder become subject to regulation of any kind whatsoever under any Law to a greater or different extent than that existing on the Effective Date and such regulation renders this Agreement illegal or unenforceable in its entirety, the Parties shall, through their duly authorized representatives, convene to discuss and assess in good faith appropriate modifications to or restructuring of this Agreement so that it is no longer rendered illegal or unenforceable; provided, however, if despite such good faith efforts the Agreement cannot be so modified or restructured, either Party shall have the right to declare an Early Termination Date effective as of the date this Agreement becomes illegal or unenforceable and no Termination Payment shall be owing to either Party.

4.4. Credit Assurances. (a) If either party (“X”) has reasonable grounds for insecurity regarding the performance of any obligation under this Contract (whether or not then due) by the other party (“Y”) (including, without limitation, the occurrence of a material change in the creditworthiness of Y), X may demand Adequate Assurance of Performance in an amount determined by X in a commercially reasonable manner. In the event that Y fails to provide Adequate Assurance of Performance reasonably acceptable to X within three (3) Business Days following Y’s receipt of such demand, an Event of Default under Section 4.1 will be deemed to have occurred and X will be entitled to the remedies set forth in Section 4.2 of this Master Agreement.

(b) Absent a change in a Party’s (Y’s) financial circumstances that would justify a request by the other Party (X) for Adequate Assurance of Performance in accordance with Section 4.4, X may only request Adequate Assurance of

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****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

Performance to the extent that Y’s obligations under this Agreement (after netting of all obligations pursuant to Section 6.2) exceed the applicable credit limit. The credit limit for each Party, which is based upon each Parties’ creditworthiness as of the Effective Date, is as follows: (i) for Counterparty, and (ii) for Company. Either Party may request Adequate Assurance of Performance to secure payment projected to be owed in excess of the applicable credit limit amount irrespective of whether a change in financial circumstances has occurred.

(c) Upon the occurrence of a material change in the creditworthiness of a Party (“X”), the Parties shall convene within a reasonable time (but in no event more than fifteen (15) days following a Party’s receipt of written request) to establish a revised credit limit for X based upon Y’s standard criteria for creditworthiness which, in turn, shall be based upon commercially reasonable criteria; provided, however, that in the event that the Parties are unable to agree to a revised credit line, each Party reserves its respective rights (i.e., (i) Y to either retain or modify X’s credit limits based on its standard criteria, and (ii) X to dispute the credit limit that Y retains or establishes).

SECTION 5.

LIMITATIONS; DUTY TO MITIGATE

5.1. Limitation of Remedies, Liability and Damages. THE PARTIES CONFIRM THAT THE EXPRESS REMEDIES AND MEASURES OF DAMAGES PROVIDED IN THIS AGREEMENT SATISFY THE ESSENTIAL PURPOSES HEREOF. FOR BREACH OF ANY PROVISION FOR WHICH AN EXPRESS REMEDY OR MEASURE OF DAMAGES IS PROVIDED, SUCH EXPRESS REMEDY OR MEASURE OF DAMAGES SHALL BE THE SOLE AND EXCLUSIVE REMEDY, THE OBLIGOR’S LIABILITY SHALL BE LIMITED AS SET FORTH IN SUCH PROVISION AND ALL OTHER REMEDIES OR DAMAGES AT LAW OR IN EQUITY ARE WAIVED. IF NO REMEDY OR MEASURE OF DAMAGES IS EXPRESSLY HEREIN PROVIDED, THE OBLIGOR’S LIABILITY SHALL BE LIMITED TO DIRECT ACTUAL DAMAGES ONLY, SUCH DIRECT ACTUAL DAMAGES SHALL BE THE SOLE AND EXCLUSIVE REMEDY, AND ALL OTHER REMEDIES OR DAMAGES AT LAW OR IN EQUITY ARE WAIVED. EXCEPT FOR CLAIMS FOR INDEMNIFICATION UNDER SECTION 3.3, EACH TO WHICH THE PROVISIONS OF THIS SECTION 5.1 SHALL NOT APPLY, NEITHER PARTY SHALL BE LIABLE FOR CONSEQUENTIAL, INCIDENTAL, PUNITIVE, EXEMPLARY OR INDIRECT DAMAGES, LOST PROFITS OR OTHER BUSINESS INTERRUPTION DAMAGES, BY STATUTE, IN TORT OR CONTRACT, OR OTHERWISE. IT IS THE INTENT OF THE PARTIES THAT THE LIMITATIONS HEREIN IMPOSED ON REMEDIES AND THE MEASURE OF DAMAGES BE WITHOUT REGARD TO THE CAUSE OR CAUSES RELATED THERETO, INCLUDING THE NEGLIGENCE OF ANY PARTY, WHETHER SUCH NEGLIGENCE BE SOLE, JOINT OR CONCURRENT, OR ACTIVE OR PASSIVE. TO THE EXTENT ANY DAMAGES REQUIRED TO BE PAID HEREUNDER ARE LIQUIDATED, THE PARTIES ACKNOWLEDGE THAT THE DAMAGES ARE DIFFICULT OR IMPOSSIBLE TO DETERMINE, OTHERWISE OBTAINING AN ADEQUATE REMEDY IS INCONVENIENT, AND THE LIQUIDATED DAMAGES CONSTITUTE A REASONABLE APPROXIMATION OF THE HARM OR LOSS.

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5.2. Duty to Mitigate. Each Party agrees that it has a duty to mitigate damages and covenants that it will use commercially reasonable efforts to minimize any damages it may incur as a result of the other Party’s performance or non-performance of this Agreement.

5.3. Disclaimer of Warranties. EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, SELLER EXPRESSLY NEGATES ANY OTHER REPRESENTATION OR WARRANTY, WRITTEN OR ORAL, EXPRESS OR IMPLIED, INCLUDING, WITHOUT LIMITATION, ANY REPRESENTATION OR WARRANTY WITH RESPECT TO CONFORMITY TO MODELS OR SAMPLES, MERCHANTABILITY, OR FITNESS FOR ANY PARTICULAR PURPOSE.

SECTION 6.

BILLING; PAYMENT

6.1. Billing and Payment. Seller shall render to Buyer (by regular mail, facsimile or other acceptable means pursuant to Section 8.3) for each calendar month during which purchases/sales are made, a statement setting forth the total quantity of Power that was Scheduled or that Buyer was obligated to purchase and any other charges due Seller, including Demand Charges or payments or credits between the Parties pursuant to Section 3.5, under this Agreement during the preceding month and the total net amounts due to Seller from Buyer therefor. Billing and payment will be based on Scheduled hourly quantities (with such amount adjusted as appropriate for curtailments that are allowable under a Transaction Agreement). On or before ten (10) days after receipt of Seller’s statement or if such day is not a Business Day, the immediately following Business Day, Buyer shall render, by wire transfer or as otherwise agreed between the Parties, the amount set forth on such statement to the payment address provided in Exhibit “A” appended to this Master Agreement. Overdue payments shall accrue interest from, and including, such tenth (10^th) day (or following Business Day, as applicable) to, but excluding, the date of payment at the Interest Rate. If Buyer, in good faith, disputes a statement, Buyer shall provide a written explanation of the basis for the dispute and pay the portion of such statement conceded to be correct no later than such tenth (10^th) day (or following Business Day, as applicable). If any amount disputed by Buyer is determined to be due to Seller, it shall be paid within ten (10) days of such determination, along with interest accrued at the Interest Rate from the date such payment was originally due to the date paid.

6.2. Mandatory Netting/Setoff. On or before the tenth (10^th) calendar day of each month the Parties shall communicate by telephone to determine whether the netting and setoff provisions of this Section 6.2 are applicable to the payments to be made with respect to such month. Any amounts (other than amounts disputed in good faith) owed by the Parties under this Agreement shall be aggregated and the Parties shall discharge their obligations to pay through netting, in which case the Party, if any, owing the greater aggregate amount shall pay to the other Party the difference between the amounts owed. Each Party reserves to itself all rights, setoffs, counterclaims, and other remedies and defenses consistent with Section 4 (to the extent not expressly

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herein waived or denied) which such Party has or may be entitled to arising from or out of this Agreement. All outstanding Transactions and the obligations to make payment in connection therewith or under this Agreement (including any damages that may be determined and owed in accordance with Section 3.5 and any Termination Payment determined and owed in accordance with Section 4.2) may be offset against each other, set off, or recouped therefrom. A Party’s failure to net, offset, setoff, or recoup such obligations shall not alter, waive, or otherwise affect such Party’s right to payment under this Agreement.

6.3. Audit. Each Party (and its representative (s)) has the right, at its sole expense and during normal working hours, to examine the records of the other Party to the extent reasonably necessary to verify the accuracy of any statement, charge, or computation made pursuant to this Agreement. If requested, a Party shall provide to the other Party statements evidencing the quantities of Power delivered at the Delivery Point. If any such examination reveals any inaccuracy in any statement, the necessary adjustments with such statement and the payments thereof will be promptly made and shall bear interest calculated at the Interest Rate from the date the overpayment or underpayment was made until paid; provided, however, that no adjustment for any statement or payment will be made unless objection to the accuracy thereof was made prior to the lapse of four (4) years from the rendition thereof.

SECTION 7.

TAXES

7.1. Taxes. Seller shall pay or cause to be paid all taxes imposed by any governmental authority (“Taxes”) on or with respect to a Transaction arising prior to the Delivery Point, Buyer shall pay or cause to be paid all Taxes on or with respect to a Transaction at and from the Delivery Point (other than ad valorem, franchise, or income Taxes that are related to the sale of Power and are, therefore, the responsibility of the Seller). In the event Seller is required by Law to remit or pay Taxes that are Buyer’s responsibility hereunder, Buyer shall promptly reimburse Seller for such Taxes. If Buyer is required by Law to remit or pay Taxes that are Seller’s responsibility hereunder, Buyer may deduct the amount of any such Taxes from the sums due to Seller under Section 6 of this Agreement. Nothing shall obligate or cause a Party to pay or be liable to pay any Taxes for which it is exempt under Law.

7.2. Cooperation. Each Party shall use reasonable efforts to implement the provisions of and to administer this Master Agreement in accordance with the intent of the parties to minimize all Taxes, so long as neither Party is adversely affected by such efforts.

SECTION 8.

MISCELLANEOUS

8.1. Assignment. Neither Party shall assign this Agreement or its rights hereunder without the prior written consent of the other Party; provided, however, either Party may, without the consent of the other Party (and without relieving itself from

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liability hereunder), (i) transfer, sell, pledge, encumber or assign its rights under this Agreement or the accounts; revenues or proceeds hereof in connection with any financing or other financial arrangements, (ii) transfer or assign this Agreement to an Affiliate of such Party provided that the creditworthiness of such Affiliate is equal to or greater than that of the transferring entity, or (iii) transfer or assign this Agreement to any person or entity succeeding to all or substantially all of the assets of such Party; provided, however, that in each such case, any such assignee shall agree to in writing be bound by the terms and conditions hereof. Additionally, in the event a Party undertakes a reorganization to comply with any Law (including, without limitation, Section 39.051 of the Texas Utility Code), the Parties agree that such Party may transfer or assign this Agreement (including any Transaction Agreements entered into pursuant to this Master Agreement) to an Affiliate, and be released of its obligations thereunder, provided that the Affiliate’s ultimate parent company provides a guarantee of the Affiliate’s payment obligations at terms and conditions that are reasonably acceptable to the receiving Party.

8.2. Financial Information. If requested by Counterparty, the Company shall deliver within 120 days following the end of each fiscal year, a copy of its audited consolidated financial statements for such fiscal year certified by independent certified public accountants. If requested by the Company, Counterparty shall deliver within 120 days following the end of each fiscal year, a copy of its audited consolidated financial statements for such fiscal year certified by independent certified public accountants. In all cases the statements shall be for the most recent accounting period and prepared in accordance with GAAP or such other principles then in effect; provided, should any such statements not be available within such 120 day period due to a delay in preparation or certification, such delay shall not be considered a default so long as such Party diligently pursues the preparation, certification and delivery of the statements.

8.3. Notices. All notices, demands, requests, statements, Confirmations, payments, or other communications between the Parties shall be made as specified in Exhibit “A”. Notices and other communications required to be in writing shall be delivered by letter, facsimile, or other documentary form. All notices and other written communications shall be effective upon receipt if sent by facsimile, the next Business Day if sent by overnight courier, or three days later if mailed, provided, however, that receipt after 5:00 p.m. local time of the recipient shall be effective the following Business Day. A Party may change its addresses by providing notice of same in accordance herewith.

8.4. Governing Law. THIS AGREEMENT AND THE RIGHTS AND DUTIES OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY AND CONSTRUED, ENFORCED AND PERFORMED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS, WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAW OR CHOICE OF LAWS.

8.5. Survival. The following provisions shall survive the expiration or termination of this Master Agreement: Sections 1.3, 3.3, 3.5, 4.2, 5.1, 5.2, 6.2, 6.3, 8.3, 8.4, 8.5, 8.6, 8.7, and 8.8. The provisions of any Transaction Agreement shall survive

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the expiration or termination of such Transaction Agreement to the extent necessary to give such provisions their intended meaning and effect.

8.6. General. This Master Agreement, the Exhibits and Appendices hereto, if any, and each Transaction Agreement constitute the entire agreement between the Parties relating to the subject matter contemplated by this Agreement. No amendment or modification to this Master Agreement shall be enforceable unless reduced to writing and executed by both Parties. This Master Agreement shall not impart any rights enforceable by any third-party other than a permitted successor or assignee bound to this Agreement. No waiver by a Party of any default by the other Party shall be construed as a waiver of any other default. Nothing in this Master Agreement shall be construed to create a partnership or joint venture between the Parties. Any provision declared or rendered unlawful by any applicable court of law or regulatory agency or deemed unlawful because of a statutory change will not otherwise affect the remaining lawful obligations that arise under this Agreement, and the Parties shall use their best efforts to reform this Agreement in order to give effect to the original intent of the Parties. The term “including” when used in this Agreement shall be by way of example only and shall not be considered in any way to be in limitation. The headings used herein are for convenience and reference purposes only.

8.7 Rate Changes, Mobile-Sierra. The terms and conditions and the rates-for service specified in this Agreement shall remain in effect for the term of each Transaction hereunder. Absent the Parties’ agreement in a written Transaction Agreement, this Master Agreement and any Transaction Agreement entered into pursuant to this Master Agreement shall not be subject to change by application of either Party pursuant to the provisions of Section 205 or 206 of the Federal Power Act.

Absent the agreement of all Parties to the proposed change, or a process by which or circumstances under which a Party may seek a change in rates, the standard of review for changes to this Master Agreement or any Transaction Agreement entered pursuant to this Master Agreement whether proposed by a Party, a non-party or FERC acting sua sponte shall be the “public interest” standard of review set forth in United Gas Pipe Line Co. v. Mobile Gas Service Corp., 350 U.S. 332 (1956), and Federal Power Commission v. Sierra Pacific Power Co., 350 U.S. 348 (1956) (the “Mobile-Sierra” doctrine).

8.8 Terminations.

The Parties acknowledge that under FERC regulations (specifically 18 C.F.R. §35.15(b)(2)), neither Party is required to provide FERC with a notice of termination before it may terminate any Transaction entered into under this Master Agreement, in accordance with the terms of the Master Agreement and the corresponding Transaction Agreement Neither Party will contend before any forum that such a notice of termination is required.

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8.9 Bankruptcy.

Each Party further agrees that, for purposes of this Agreement, the other Party is not a “utility” as such term is used in 11 U.S.C. Section 366, and each Party waives and agrees not to assert the applicability of the provisions of 11 U.S.C. Section 366 (as may be amended from time to time) in any bankruptcy proceeding wherein such Party is a debtor. In any such proceeding, each Party further waives the right to assert that the other Party is a “provider of last resort.”

The Parties have executed this Master Agreement in multiple counterparts to be construed as one effective as of the Effective Date.

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SOUTHWESTERN PUBLIC SERVICE COMPANY
By:	/s/ Paul J. Bonavia
Name:	Paul J. Bonavia
Title:	Vice President

By:	/s/ Gary L. Gibson
Name:	Gary L. Gibson
Title:	President and CEO

EL PASO ELECTRIC COMPANY
By:	/s/ Gary R. Hedrick
Name:	Gary R. Hedrick
Title:	President and CEO

By:	/s/ J. Frank Bates
Name:	J. Frank Bates
Title:	Vice President and COO

APPROVED AS TO FORM
OFFICE OF THE GENERAL COUNSEL	/s/ Illegible

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APPENDIX “1” – DEFINITIONS

MASTER ENERGY PURCHASE AND SALE AGREEMENT

All references to Articles and Sections are to those set forth in this Agreement. Reference to any document means such document as amended from time to time and reference to any Party includes any permitted successor or assignee thereof. The following definitions and any terms defined internally in this Agreement shall apply to this Agreement and all notices and communications made pursuant to this Agreement.

“Adequate Assurance of Performance” shall mean sufficient security in the form, amount and for the term reasonably acceptable to the Party requesting such assurance, including, but not limited to, a standby irrevocable letter of credit, a prepayment, a security interest in an asset, guaranty from a creditworthy entity, or such other means as the Parties may mutually agree.

“Affiliate” means, with respect to any person, any other person (other than an individual) that, directly or indirectly, through one or more intermediaries, controls, or is controlled by, or is under common control with, such person. For this purpose, “control” means the direct or indirect ownership of fifty percent (50%) or more of the outstanding capital stock or other equity interests having ordinary voting power.

“Authorized Representatives” means those individuals, designated by a Party who has the authority to negotiate and enter into a Transaction on behalf of such Party. Each Party’s Authorized Representatives may be changed by written notice provided in accordance with Section 8.3.

“Bankruptcy Proceeding” means with respect to a Party or entity, such Party or entity (i) makes an assignment or any general arrangement for the benefit of creditors, (ii) files a petition or otherwise commences, authorizes, or acquiesces in the commencement of a proceeding or cause of action under any bankruptcy or similar law for the protection of creditors, or becomes a debtor pursuant to an order for relief entered under 11 U.S.C. §303(h) (as may be amended from time to time), (iii) otherwise becomes bankrupt or insolvent (however evidenced), or (iv) is unable to pay its debts as they fall due.

“Business Day” means a day on which banks in New York City are open for business; and a Business Day shall open at 8:00 a.m. and close at 5:00 p.m. local time for each Party’s principal place of business.

“Buyer” means the Party to a Transaction who is obligated to purchase and receive, or cause to be received, Power during a Period of Delivery.

“Claims” means all claims, demands, or actions, threatened or filed and whether groundless, false or fraudulent, that directly or indirectly relate to the subject matter of an indemnity, and the resulting losses, damages, expenses, attorneys’ fees

i

and court costs, whether incurred by settlement or otherwise, and whether such claims, demands, or actions are threatened or filed prior to or after the termination of this Agreement.

“Confirmation” means a written notice confirming the specific terms of an oral Transaction Agreement which may be in any form adequate at law; an example of a Confirmation which may be utilized hereunder is shown in “Exhibit B-1”.

“Contract Price” means the price in $U.S. per MWh (unless otherwise provided for) to be paid by Buyer to Seller for the purchase of Power, including the Power Price, Demand Charges, Transmission Charges, and any other charges, if any, pursuant to a Transaction.

“Contract Quantity” means that quantity of Power that Seller agrees to sell and deliver, or cause to be delivered, to Buyer, and that Buyer agrees to purchase and receive, or cause to be received, from Seller, pursuant to the terms of a Transaction.

“Costs” shall have the meaning defined in Section 4.2(b)(i).

“Delivery Point” means the agreed point of delivery and receipt of Power pursuant to a Transaction.

“Demand Charges” means the amount, if any, to be paid by Buyer to Seller for capacity as agreed to by the Parties in a Transaction.

“Equitable Defenses” means any bankruptcy, insolvency, reorganization and other laws affecting creditor’s rights generally, and with regard to equitable remedies, the discretion of the court before which proceedings to obtain same may be pending.

“Event of Default” shall have the meaning defined in Section 4.1.

“FERC” means the Federal Energy Regulatory Commission or any successor agency.

“Firm” means, with respect to a Transaction unless otherwise specified in a written Transaction Agreement, that the only excuse for the failure to deliver Power by Seller or the failure to receive Power by the Buyer pursuant to a Transaction is Force Majeure or the other Party’s non-performance of a material duty or obligation under this Master Agreement or any Transaction Agreement.

“Force Majeure” means (with respect to Firm Transactions) an event not anticipated as of the Effective Date, which is not within the reasonable control of the Party (or in the case of third party obligations or facilities, the third party) claiming suspension (the “Claiming Party”), which is not the result of negligence of the Claiming Party, and which by the exercise of due diligence the Claiming Party, or third party, is unable to prevent, overcome or obtain or cause to be obtained a commercially reasonable substitute therefor. Force Majeure may include, but is not restricted to: acts

ii

of God; fire; civil disturbance; labor dispute; labor or material shortage (unless caused by the Claiming Party’s failure to exercise reasonable diligence to secure such materials); sabotage; action or restraint by court order or public of governmental authority (so long as the Claiming Party has not applied for or assisted in the application for, and has opposed where and to the extent reasonable, such government action); provided, that none of (i) the loss of Buyer’s markets nor Buyer’s inability economically to use or resell Power purchased hereunder or (ii) Seller’s ability to sell Power to a market at a more advantageous price shall constitute an event of Force Majeure. Notwithstanding anything herein to the contrary, nothing in this Master Agreement shall obligate either Party to settle any strike or other labor dispute.

“GAAP” means generally accepted accounting principles, consistently applied.

“Gains” shall have the meaning defined in Section 4.2(b)(ii).

“Interest Rate” means, for any date, two percent over the per annum rate of interest equal to the prime lending rate as may from time to time be published in the Wall Street Journal under “Money Rates”; provided, the Interest Rate shall never exceed the maximum lawful rate permitted by applicable law.

“Law” means any law, rule, regulation, order, writ, judgment, decree or other legal or regulatory determination by a court, regulatory agency, regional transmission organization or governmental authority of competent jurisdiction.

“Legal Proceedings” means any suits, proceedings, judgments, rulings or orders by or before any court or any governmental authority.

“Losses” shall have the meaning defined in Section 4.2(b)(iii).

“Non-Firm” means with respect to a Transaction, unless otherwise set forth in a Transaction Agreement signed by both Parties, that delivery or receipt of Power may be interrupted for any reason, without liability by either Party, including, without limitation, price fluctuations.

“OATT” means Transmission Provider’s open-access transmission tariff satisfying the requirements of the FERC under Order No. 888 and subsequent orders.

“Period of Delivery” means the period of time from the date physical delivery of the Power is to commence to the date physical delivery is to terminate under a Transaction.

“Power” means energy expressed in megawatt hours (MWh) or capacity expressed in megawatts (MW) to the extent designated in a Transaction Agreement, or both. Unless expressly agreed to in a Transaction Agreement, energy supplied shall be of the character commonly known as three-phase, sixty-hertz electric energy that is delivered at the nominal voltage of the Delivery Point.

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****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

“Power Price” means the price in $U.S. (unless otherwise provided for) per MWh to be paid by Buyer to Seller for Power in a Transaction.

“Replacement Price” shall have the meaning defined in Section 3.5(a).

“Sales Price” shall have the meaning defined in Section 3.5(b).

“Scheduling” or “Schedule” means the acts of Seller, Buyer and/or their designated representatives, including each Party's Transmission Providers, if applicable, of notifying, requesting, and confirming to each other the quantity and type of Power to be delivered hourly on any given day or days during the Period of Delivery at a specified Delivery Point.

“Seller” means the Party to a Transaction who is obligated to sell and deliver or cause to be delivered Power during a Period of Delivery.

“Transaction” means a particular transaction agreed to by the Parties relating to the purchase and sale of Power pursuant to this Master Agreement.

“Transaction Agreement” means a written or oral agreement executed or reached by the Parties to form and effectuate a Transaction. Written Transaction Agreements shall be substantially in the form of Exhibit “B-2”; oral Transaction Agreements will include similar information.

“Transmission Charges” means the amount, if any, to be paid by Buyer to Seller for transmission services as agreed to by the Parties in a Transaction.

“Transmission Provider” means the entity or entities transmitting Power on behalf of Seller or Buyer (which may include Buyer’s or Seller’s transmission function) to or from the Delivery Point in a particular Transaction.

EXHIBIT “A”

MASTER ENERGY PURCHASE AND SALE AGREEMENT

NOTICES AND PAYMENT

COMPANY:
NOTICES & CORRESPONDENCE: SOUTHWESTERN PUBLIC SERVICE COMPANY 1099 18TH STREET, SUITE 3000 DENVER, CO 80202 ATTN: DIRECTOR, CONTRACT ADMINISTRATION FAX NO: (303) 308-7639 PHONE NO: (303) 308-2710	PAYMENTS: Southwestern Public Service Company Wire Transfer: BNK: ABA: ACCT Name: ACCT: Phone No.: Fax No.:

iv

****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

INVOICES: TAMMY GORDON, ACCOUNTING MANAGER FAX NO: (303)308-7657 PHONE NO: (303)308-7739
COUNTERPARTY:
NOTICES & CORRESPONDENCE: MR. STEVEN BURACZYK SUPERVISOR, RESOURCE MANAGEMENT EL PASO ELECTRIC COMPANY P.O. BOX 982 EL PASO, TEXAS 79960 PHONE NO. (915) 543-4368 FAX NO. (915) 521-4751	PAYMENTS: WIRE TRANSFER: COMPANY NAME: TAXPAYER ID NUMBER: COMPANY ADDRESS: CONTACTS: BANK: LOCATION: ABA(ROUTING TRANSIT NO.): CREDIT: ACCT: TYPE OF ACCOUNT:
INVOICES: MS. KATHY PETERSON PHONE NO. (915) 543-2039 FAX NO. (915) 521-4751

OR TO SUCH OTHER ADDRESS AS COUNTERPARTY OR                      SHALL FROM TIME TO TIME DESIGNATE BY LETTER PROPERLY ADDRESSED.

A-5

EXHIBIT “B-1”

MASTER ENERGY PURCHASE AND SALE AGREEMENT

FORM OF CONFIRMATION FOR

TRANSACTIONS FORMED UNDER SECTION 1.2(ii)

[DATE]

[ADDRESS]

Attn.:                                     

CONFIRMATION LETTER

This letter shall confirm the agreement reached on                                     , 200     between                                                   (“Counterparty”) and Southwestern Public Service Company (the “Company”) regarding the sale/purchase of Power under the terms and conditions as follows:

SELLER:

BUYER:

PRODUCT:

CAPACITY:

ENERGY:

DELIVERY PERIOD:

DELIVERY HOURS:

DELIVERY POINT:

CONTRACT QUANTITY:

CONTRACT PRICE:

DEMAND CHARGES:

ENERGY PRICE:

TRANSMISSION CHARGES:

ANCILLARY SERVICES

OTHER (INCLUDING SPECIAL

PENALTIES)

B-1-1

FIRMNESS/CURTAILMENT:

FIRM/NONFIRM

SPECIAL CURTAILMENT PROVISIONS

SCHEDULING:

OTHER:

This Confirmation Letter is being provided pursuant to and in accordance with the Master Power Purchase and Sale Agreement dated                     , 200     (the “Master Agreement”) between Counterparty and the Company, and constitutes part of and is subject to all of the terms and provisions of such Master Agreement. Terms used but not defined herein shall have the meanings ascribed to them in this Master Agreement.

Please confirm that the terms stated herein accurately reflect the agreement between you and the Company by returning an executed copy of this letter by facsimile to the Company. If you do not return this Confirmation Letter or object to this Confirmation Letter within two Business Days of your receipt of it, you will have accepted and agreed to all of the terms included herein, including the terms and provisions of the Agreement.

“COUNTERPARTY”

By:

Title:

Date:

“COMPANY”

By:

Title:

Date:

B-1-2

EXHIBIT “B-2”

MASTER ENERGY PURCHASE AND SALE AGREEMENT

FORM OF TRANSACTION AGREEMENT FOR

TRANSACTIONS FORMED UNDER SECTION 1.2(i)

[DATE]

[ADDRESS]

Attn.:                     

TRANSACTION LETTER

This Transaction Agreement shall form and effectuate the current proposal between                                  (“Counterparty”) and Southwestern Public Service Company (the “Company”) regarding the purchase and sale of Power under the following terms and conditions:

SELLER:

BUYER:

PRODUCT:

CAPACITY:

ENERGY:

DELIVERY PERIOD:

DELIVERY HOURS:

DELIVERY POINT:

CONTRACT QUANTITY:

CONTRACT PRICE:

DEMAND CHARGES:

ENERGY PRICE:

TRANSMISSION CHARGES:

ANCILLARY SERVICES

OTHER (INCLUDING SPECIAL

PENALTIES)

B-2-1

FIRMNESS/CURTAILMENT:

FIRM/NONFIRM

SPECIAL CURTAILMENT PROVISIONS

SCHEDULING:

OTHER:

This Transaction Agreement is being provided pursuant to and in accordance with the Master Power Purchase and Sale Agreement dated                     , 200     (the “Master Agreement”) between Counterparty and the Company, and constitutes part of and is subject to all of the terms and provisions of such Master Agreement. Terms used but not defined herein shall have the meanings ascribed to them in this Master Agreement.

Please execute this Transaction Agreement and return an executed copy to the Company no later than              a.m. on                     , 200     (“Notification Time”). Your execution should reflect the appropriate party in your organization who has the authority to cause Counterparty to enter into this Transaction. In the event Counterparty fails to execute and deliver this Transaction Agreement by the Notification Time or alters the terms of this Transaction Agreement in any manner, there will be no Transaction pursuant to this Transaction Agreement.

“COUNTERPARTY”

By

Title:

Date:

“COMPANY”

By

Title:

Date:

B-2-2

TRANSACTION AGREEMENT

between

El Paso Electric Company

and

Southwestern Public Service Company

This Transaction Agreement is entered into and is effective as of this 7th day of July, 2004, by and between El Paso Electric Company (“Buyer”) and Southwestern Public Service Company (“Seller”). This Transaction Agreement is entered into pursuant to and in accordance with the Master Power Purchase and Sale Agreement dated July 7, 2004 (“Master Agreement”) between the Buyer and the Seller. The terms of the Master Agreement shall apply to this Transaction Agreement as though set forth herein, provided that any conflict between the terms of the Master Agreement and this Transaction Agreement shall be resolved in favor of this Transaction Agreement. Unless defined herein, capitalized terms used herein shall have the meanings set forth in the Master Agreement.

Section 1 - Transaction

1.1 During the term of, and subject to the terms and conditions of, this Transaction Agreement, Seller agrees to sell and deliver and Buyer agrees to purchase and receive Firm Power service at the Delivery Point (as defined in Section 6 below). Subject to Seller’s curtailment rights under Section 2 below, such Firm Power service shall consist of (i) capacity at the Contract Quantity level specified in Section 4.2 below, and (ii) associated energy up to such Contract Quantity as may be Scheduled by Buyer pursuant to Section 5 below (“Scheduled Energy”).

Section 2 - Continuity of Service

2.1 The Power to be provided by Seller under this Agreement is Firm, subject to the curtailment rights specified in Section 2.2 below. The Seller will make Firm Power (both capacity and energy) up to the Contract Quantity continuously available to the Buyer from the Seller’s generation resources, which include not only existing resources, but future capacity purchases or additions made to meet planning reserves. Seller shall maintain generation resources, including capacity purchases and additions, adequate to meet its planning and operating reserves inclusive of the Contract Quantity as a Firm obligation.

2.2 Scheduled Energy cannot be curtailed except for the following reasons:

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(i) In accordance with Section 3.4 of the Master Agreement (Force Majeure);

(ii) Due to the installation, maintenance, repair, testing, inspection, or replacement of the Eddy County HVDC tie or transmission facilities related to the Eddy County HVDC tie on Seller’s side of the Delivery Point;

(iii) Due to the functioning of under-frequency relays, other automatic load shedding equipment, or manual curtailment, but in each instance only to the extent necessary to preserve the integrity of, or to limit any instability on, Seller’s system; or

(iv) Due to the interruption or curtailment of firm transmission service that prevents the delivery or receipt of Scheduled Energy at the Delivery Point, implemented by any Transmission Provider (including any Affiliate Transmission Provider of Seller).

If the delivery of Scheduled Energy to Buyer under this Transaction is curtailed because of any of the above circumstances and in conformance with the provisions of Section 2.3 below, Seller shall have no liability to Buyer (other than as provided in Sections 4.6 and 6.5 below), and the damages specified in Section 3.5 of the Master Agreement shall not apply.

2.3 In the event of an occurrence specified in Section 2.2 entitling Seller to curtail the delivery of Scheduled Energy, Seller may curtail the delivery of Scheduled Energy to Buyer prior to curtailing energy deliveries to its firm, native load customers (SPS’s retail customers and wholesale customers located within the boundaries of the SPS control area existing as of the effective date of this Transaction Agreement), but only if Seller has first curtailed energy deliveries to its interruptible retail and wholesale customers to the extent allowed by contract. To the extent practicable, Seller shall only curtail Scheduled Energy deliveries under this Transaction Agreement on a pro rata basis with its other sales of equal firmness.

2.4 In no circumstances shall Seller curtail deliveries of Scheduled Energy with the intention of enabling itself to make other sales of capacity or energy of greater value.

2.5 In the event that Buyer curtails deliveries of Scheduled Energy, it shall not be subject to the damages specified in Section 3.5 of the Master Agreement. Buyer shall, however, be obligated to pay Seller the Demand Charge and charges specified in Section 4.5 below in such instances.

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2.6 Except as provided in this Section 2.6, Seller may not sell energy associated with the Contract Quantity to any third party. To the extent that Buyer does not Schedule energy up to the full level of the Contract Quantity for any delivery period, Seller may sell such unscheduled energy on an intraday basis subject to Buyer’s recall of such energy upon not less than ninety (90) minutes notice to Seller. Moreover, in the event Buyer cannot, in whole or in part, receive or accept deliveries of energy provided for under this Transaction Agreement at the Delivery Point (or mutually agreeable alternative delivery point) due to a planned outage of the Eddy County HVDC tie or transmission facilities related to the Eddy County HVDC tie on either side of the Delivery Point, Seller shall have the right to sell such energy that would have otherwise been supplied to Buyer to third-parties for the expected period of the planned outage, subject to Buyer’s recall of the energy upon a Day Ahead Schedule basis in the event the Eddy County HVDC tie and related transmission facilities are restored to service sooner than expected. For unplanned outages that prevent the delivery of energy, in whole or in part, to Buyer or the receipt of energy by Buyer, Seller may sell energy on an intraday basis subject to Buyer’s recall of such energy upon not less than ninety (90) minutes notice in the event the Eddy County HVDC tie and related transmission facilities are restored to service, unless the Parties agree to a different time period.

Section 3 - Term of the Transaction Agreement

The term of this Transaction Agreement shall commence with the hour ending (“HE”) 0100 Mountain Standard Time (“MST”), January 1, 2006, and continue through HE 2400 MST, December 31, 2025.

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****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

Section 5 - Scheduling

5.1. The Parties agree to comply with the scheduling policies or requirements of the North American Electric Reliability Council (“NERC”) and any applicable OATT. Tagging shall be performed according to Western Electric Coordinating Council guidelines and practices, as such may be in effect from time-to-time, or the guidelines and practices of any successor entity or other entity having responsibility for setting such guidelines or standards.

5.2 The Buyer shall provide a preliminary, non-binding schedule two (2) days prior to the delivery date. The Buyer will then Schedule energy in whole MW up to the Contract Quantity by notifying the Seller by 8:30 a.m. prevailing Mountain Time in El Paso, Texas for all energy to be delivered for the following prescheduled day(s) (“Day Ahead Schedule”).

5.3 Subject to transmission availability, the Buyer may change its Scheduled Energy for the Day Ahead Schedule as long as the Buyer provides the Seller no less than ninety (90) minutes notice prior to the top of the delivery hour in which such change is to be effective (each a “Schedule Change”). Seller will attempt to accommodate changes with less than ninety (90) minutes notice provided it does not unreasonably interfere with other commercial opportunities. All changes to the Day Ahead Schedule initiated by the Buyer will be assessed a Schedule Change Charge of multiplied by (i) the number of MWh of any such Schedule Change, whether an increase or a decrease, and by (ii) the number of hours for which such change is effective (a “Schedule Change Charge”). The Schedule Change Charge shall apply only to Schedule Changes initiated by the Buyer and shall not apply to changes necessitated by Force Majeure, transmission or converter constraints, or any interruption, curtailment or failure to deliver or receive Scheduled Energy referenced in Section 2

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above. During times of system emergencies on the Buyer’s system, Seller will work in good faith to accommodate shorter noticed Schedule Changes within the constraints of transmission scheduling and tagging requirements.

5.4. The Parties recognize that although the Scheduling practices prescribed by Section 5 of this Transaction Agreement reflect existing commercial customs and standards, such customs and standards could change during the twenty (20) year term of the Transaction. If a Party believes that Scheduling customs and standards have changed, the matter will be referred to the Operating Committee for resolution, it being the intention of the Parties to reform the Scheduling provisions of this Transaction Agreement to conform to then prevailing customs and standards and Good Utility Practice (as defined in Section 11.3 of this Transaction Agreement).

Section 6 – Delivery Point and Transmission Arrangements

6.1 The Seller shall deliver Scheduled Energy utilizing a firm transmission path, to the east side of the interconnection of the Seller and Buyer systems located near the Eddy County HVDC tie (“Delivery Point”), unless another non-firm delivery point is mutually agreed to by the Parties.

6.2 Each Party shall have the responsibility for arranging firm transmission services (including associated ancillary services) under the applicable OATT (or other permissible arrangements) for the delivery (in the case of the Seller) or receipt (in the case of the Buyer) of energy up to the Contract Quantity at the Delivery Point. Both Parties commit to make request of their applicable Transmission Providers expeditiously so as to obtain the necessary transmission services.

6.3 Each Party recognizes that there may be limitations on the ability to obtain firm transmission service (inclusive of service over and through the Eddy County HVDC tie) up to the full level of the Contract Quantity. In the event that a Party is informed that transmission service up to the full level of the Contract Quantity is unavailable, such Party may convene the Operating Committee to discuss and assess appropriate modifications to this Transaction Agreement (including termination). If the Parties are unable to reach a mutually satisfactory resolution within six (6) months following the referral to the Operating Committee and more than twenty-five percent (25%) of the Contract Quantity cannot be delivered or received due to the unavailability of firm transmission service, either Party shall have a ninety (90) day period in which it may terminate this Transaction Agreement by providing not less than two (2) years prior written notice to the other Party. In the event that a Party terminates the Transaction Agreement in

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accordance with this Section 6.3, neither Party shall be obligated to pay the Termination Payment provided for in Section 4.2 of the Master Agreement.

6.4 In the event that the unavailability of transmission referenced in Section 6.3 above prevents Seller from delivering or Buyer from receiving the full level of Contract Quantity, the Contract Quantity (and the corresponding monthly Demand Charge billings) shall be reduced to the level of Contract Capacity for which firm transmission service is available until such time as the Parties reach a mutually satisfactory resolution or this Transaction Agreement is terminated, all as prescribed by Section 6.3 above.

6.5 Seller shall cause, if possible, Buyer to be named as a third-party beneficiary in any agreement for firm transmission service entered into to perform its obligations under this Transaction Agreement. In the event that firm transmission service arranged by Seller is interrupted or curtailed by any Transmission Provider, Buyer’s damages shall be limited to such damages that Seller is able to recover from the applicable Transmission Provider. In the event Seller, exercising reasonable legal and commercial discretion, shall elect not to make a claim against the applicable Transmission Provider, Seller shall, at Buyer’s request, if possible, assign to Buyer its rights and remedies to enforce and collect damages under the affected transmission agreements. Each party to this Transaction Agreement shall retain whatever rollover rights it may have on transmission service it acquired in connection with the Transaction Agreement.

Section 7 – Rate Change

It is the intent of the Parties that the charges listed in Sections 4.2 and 4.3(a) are fixed charges that are applicable for the entire term of this Transaction Agreement and are not subject to change except as provided in this Section 7. However, given the length of the term, the Parties have agreed that if Seller experiences a change in its cost structure resulting in costs that cannot be recovered pursuant to the FCA, whether due to new investment, inflation, changes in Law (including, without limitation, changes in environmental Law), additional Taxes, fees, or charges imposed as the result of any changes in Laws after January 1, 2004, or any other causes, such that the charges set forth in Section 4.2 or 4.3(a) above, or both, result in under-recovery by Seller when compared to amounts that Seller would receive under a rate based on average system cost of service, Seller may file under Section 205 of the Federal Power Act (as may be amended or recodified from time to time) to change the Demand Charge or Energy Charge component of the Power Price, or both, solely for the purpose of increasing such charges up to the average system cost of service. Notwithstanding Section 8.7 of the Master Agreement, the “just and reasonable” standard shall apply to the review of such a rate filing. Once Seller has filed to change the Demand Charge or Energy Charge component of the Power Price through a Section 205 filing, Buyer shall subsequently have the right under Section

9

206 of the Federal Power Act (as may be amended or recodified from time to time) to file a complaint seeking a change in the Demand Charge or Energy Charge component or both if Buyer believes Seller is recovering through such charges more than it would receive under a rate based on an average system cost of service. The “just and reasonable” standard shall likewise apply to the review of such complaint. Either Party may contest and challenge at FERC (or other appropriate forum with jurisdiction, if any) the rate change request of the other Party. In the event that either (i) the rate increase(s) requested by Seller result in an aggregate increase of five percent (5%) or more in the total non-fuel cost of Power (as specified in Section 4.2 and 4.3(a) of this Transaction Agreement) to the Buyer over the term of this Transaction Agreement, or (ii) an aggregate decrease of five percent (5%) or more in the total non-fuel cost of Power (as specified in Section 4.2 and 4.3(a) of this Transaction Agreement) to Buyer over the term of this Transaction Agreement is granted by FERC pursuant to a Section 206 proceeding(s) filed by Buyer, the Party adversely affected by such ruling may, for a period of ninety (90) days following the issuance of an order granting such increase or decrease, terminate this Transaction Agreement by providing not less than two (2) years prior written notice to the other Party. In such event, neither Party shall be obligated to pay the other Party the Termination Payment provided for in Section 4.2 of the Master Agreement.

Section 8 – Adequate Assurance of Performance

If a Party has reasonable grounds for seeking Adequate Assurance of Performance pursuant to Section 4.4 of the Master Agreement, a Party may only request, and the other Party shall only be required to provide, Adequate Assurance of Performance with respect to this Transaction for the following amounts (but only to the extent that their sum is in excess of a Party’s applicable credit limit (as determined pursuant to Section 4.4 of the Master Agreement): (i) amounts due and owing (including any amounts in dispute for which payment may have been withheld in accordance with Section 6.1(b)) and (ii) amounts reasonably projected to become due and owing (assuming no default of the Master Agreement or this Transaction Agreement) for services to be provided pursuant to this Transaction Agreement during the sixty (60) day period following such request.

Section 9 – Taxes

Invoices hereunder will be increased by an amount equal to the sum of the Taxes applicable to the purchase and sale of Power pursuant to this Transaction and payable under federal, state, and local sales Tax acts, including federal, state and local sales Taxes imposed as the result of any change in Law after January 1, 2004.

Section 10 – Operating Committee

10.1 The Parties will establish an Operating Committee to address issues that arise regarding the terms and conditions of this Transaction Agreement. Each Party shall designate by written notice to the other Party the representative who will be authorized to act in its behalf on the Operating Committee. A Party may change its representative on

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the Operating Committee upon written notice to the other Party. The principal duties of the Operating Committee shall be as follows:

(i) To establish operating (normal and emergency), scheduling, tagging, and control procedures;

(ii) To attempt to develop coordinated approaches in recommending maintenance schedules involving the Eddy County HVDC tie or transmission facilities related to such tie;

(iii) To address and attempt to develop resolutions to those matters that are to be referred to the Operating Committee under this Transaction Agreement, it being understood, however, that the Operating Committee shall have no authority to modify any provisions of this Transaction Agreement and that any recommendations that it makes to modify this Transaction Agreement must be approved by each Party;

(iv) To resolve disputes about such other matters as either Party may raise under this Transaction Agreement; and

(v) To perform any other duties necessary for the proper functioning of this Transaction Agreement.

10.2 If the Operating Committee is unable to agree on any matter over which it has authority under this Transaction Agreement, it may, within fifteen (15) days after determining that it cannot reach agreement, refer the matter in writing to the chief executive officers of the Parties. If the chief executive officers are unable to agree on the matter within forty-five (45) days after the referral, then either Party may initiate legal or other proceedings in connection with such dispute; provided, however, the foregoing conditions precedent to initiation of such proceedings shall not apply to any action, claim, or other matter that, by reason of compliance with such conditions, would otherwise be barred by any statutory limitations.

10.3 Notwithstanding the provisions of Section 4.1 of the Master Agreement, a Party shall, as a condition precedent to the termination of this Transaction Agreement (other than a termination under Section 4.1 (i) and (iv) of the Master Agreement), (i) refer such matter to the Operating Committee for attempted resolution, and (ii) if the Operating Committee is unable to resolve such mater within thirty (30) days (or such longer time as the Parties may agree in writing) following referral, refer such matter to the chief executive officers of each Party for attempted resolution for a period of fifteen (15) days (or such longer time as the Parties may agree in writing) following such referral.

Section 11 – Other

11.1 Notwithstanding Section 4.3 of the Master Agreement, the Parties acknowledge that this Transaction Agreement may need to be terminated or amended in the event that it is subject to adverse regulatory action. In the case of Seller, adverse regulatory action would occur if FERC or any state commission having jurisdiction over

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** = Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

Seller in a ratemaking case assigns or attributes costs to this Transaction Agreement in such a manner that this Transaction Agreement will result in an under-recovery of what Seller would receive under a rate based on average system cost of service, or if FERC requires a modification of rates on the basis of a conclusion that Seller should not be able to make the sale provided for herein at market-based rates. In the case of Buyer, adverse regulatory action would occur if FERC or any state commission having jurisdiction over Buyer disallows the recovery of costs incurred under this Transaction Agreement. In the event either Party is subject to such an adverse regulatory action, it may convene the Operating Committee to discuss and assess what modifications to this Transaction Agreement (including termination), may be appropriate. If the Parties are unable to reach a mutually satisfactory resolution within six (6) months following the referral to the Operating Committee, either Party shall have a ninety (90) day period in which it may terminate this Transaction Agreement by providing not less than two (2) years prior written notice to the other Party. In the event that a Party terminates the Transaction Agreement in accordance with this Section 11.1, neither Party shall be obligated to pay the Termination Payment provided for in Section 4.2 of the Master Agreement.

11.2 Where a Party may terminate this Transaction Agreement without being subject to the obligation to pay the Termination Payment provided for in Section 4.2 of the Master Agreement, such termination shall relieve neither Party from the obligation to pay amounts due and owing to the other Party under this Transaction Agreement that accrued prior to the effective date of such a termination.

11.3 Each Party shall undertake its obligations under this Transaction Agreement in accordance with Good Utility Practice, namely any of the practices, methods, and acts engaged in or approved by a significant portion of the electric utility industry (subject to regional variation), during the relevant time period, or any of the practices, methods, and acts which in the exercise of reasonable judgment in light of the facts known at the time the decision was made, could have been expected to accomplish the desired result at a reasonable cost consistent with good business practices, reliability, safety, and expedition.

Section 12 – Economy Energy

Throughout the term of this Transaction Agreement, Seller shall have the right to provide Buyer with economy energy from time to time in an amount and at a time subject to the mutual agreement of the Parties. Economy energy is non-firm energy that can be curtailed by Seller or by Buyer for any reason. The Power Price of the economy energy shall be no greater than EPE’s actual avoided cost minus/MWh.

Section 13 – Signatories

The signatories hereto represent that they have been appropriately authorized to enter this Transaction Agreement on behalf of the Party for whom they sign. This Transaction Agreement is executed as of the date first above written.

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EL PASO ELECTRIC COMPANY
By:	/s/ Gary R. Hedrick
Printed Name:	Gary R. Hedrick
Title:	President and Chief Executive Officer

By:	/s/ J. Frank Bates
Printed Name:	J. Frank Bates
Title:	Executive Vice President & COO

APPROVED AS TO FORM
OFFICE OF THE GENERAL COUNSEL	/s/ Illegible

SOUTHWESTERN PUBLIC SERVICE COMPANY
By:	/s/ Paul J. Bonavia
Printed Name:	Paul J. Bonavia
Title:	Vice President

By:	/s/ Gary L. Gibson
Printed Name:	Gary L. Gibson
Title:	President and CEO

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****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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****** Certain information on this page has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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EX-15

Exhibit 15

November 8, 2004

El Paso Electric Company

El Paso, Texas

Re: Registration Statement Nos. 333-17971 and 333-82129

With respect to the subject registration statements, we acknowledge our awareness of the use therein of our report dated November 8, 2004 related to our review of interim financial information.

Pursuant to Rule 436 under the Securities Act of 1933 (the “Act”), such report is not considered part of a registration statement prepared or certified by an accountant, or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of the Act.

KPMG LLP

El Paso, Texas

EX-31.01

Exhibit 31.01

CERTIFICATIONS

I, Gary R. Hedrick certify that:

1. I have reviewed this quarterly report on Form 10-Q of El Paso Electric Company;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely

affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: November 9, 2004

EL PASO ELECTRIC COMPANY
By:	/s/ GARY R. HEDRICK
	Gary R. Hedrick
	President and Chief Executive Officer
	(Principal Executive Officer)

I, Terry Bassham certify that:

1. I have reviewed this quarterly report on Form 10-Q of El Paso Electric Company;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: November 9, 2004

EL PASO ELECTRIC COMPANY
By:	/s/ TERRY BASSHAM
	Terry Bassham
	Executive Vice President, Chief Financial and Administrative Officer
	(Duly Authorized Officer and Principal Financial Officer)

EX-32.01

Exhibit 32.01

November 9, 2004

The certification set forth below is being submitted in connection with the Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2004 (the “Report”) of El Paso Electric Company (the “Company”) for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code.

Gary R. Hedrick and Terry Bassham, each certifies that, to the best of his knowledge:

1. such Report fully complies with the requirements of Section 13(a) of the Exchange Act; and

2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ GARY R. HEDRICK

Gary R. Hedrick

President and Chief Executive Officer

/s/ TERRY BASSHAM

Terry Bassham

Executive Vice President, Chief

Financial and Administrative Officer