a. Fair Value of Financial Assets and Liabilities Recorded at the Carrying Amount.

At September 30, 2011 and December 31, 2010, the carrying amount of cash, cash equivalents, and outstanding commercial paper approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE Energy's and MGE long-term debt is based on quoted market prices for similar financial instruments at September 30, 2011 and December 31, 2010. The estimated fair market value of MGE Energy's and MGE's financial instruments are as follows:

		September 30, 2011				December 31, 2010
		Carrying		Fair		Carrying		Fair
(In thousands)		Amount		Value		Amount		Value
MGE Energy
Assets:
Cash and cash equivalents	$	44,893	$	44,893	$	7,110	$	7,110
Liabilities:
Short-term debt - bank loans		0		0		19,000		19,000
Short-term debt - commercial paper		0		0		3,500		3,500
Long-term debt*		365,139		412,108		336,973		356,395

MGE
Assets:
Cash and cash equivalents		26,497		26,497		4,494		4,494
Liabilities:
Short-term debt - commercial paper		0		0		3,500		3,500
Long-term debt*		365,139		412,108		336,973		356,395

*Includes long-term debt due within one year.

Fair value is defined as the price that would be received to sell an asset or would be paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The standard clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability including assumptions about risk. The standard also establishes a three level fair value hierarchy based upon the observability of the assumptions used and requires the use of observable market data when available. The levels are:

Level 1 - Pricing inputs are quoted prices within active markets for identical assets or liabilities.

Level 2 - Pricing inputs are quoted prices within active markets for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations that are correlated with or otherwise verifiable by observable market data.

Level 3 - Pricing inputs are unobservable and reflect management's best estimate of what market participants would use in pricing the asset or liability.

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for MGE Energy and MGE.

	Fair Value as of September 30, 2011
(In thousands)		Total		Level 1		Level 2		Level 3
MGE Energy
Assets:
Exchange-traded investments	$	386	$	386	$	0	$	0
Total Assets	$	386	$	386	$	0	$	0
Liabilities:
Derivatives, net^(a)	$	26,583	$	673	$	0	$	25,910
Deferred compensation		1,660		1,660		0		0
Total Liabilities	$	28,243	$	2,333	$	0	$	25,910

MGE
Assets:
Exchange-traded investments	$	170	$	170	$	0	$	0
Total Assets	$	170	$	170	$	0	$	0
Liabilities:
Derivatives, net^(a)	$	26,583	$	673	$	0	$	25,910
Deferred compensation		1,660		1,660		0		0
Total Liabilities	$	28,243	$	2,333	$	0	$	25,910

(a) These amounts are shown gross and exclude $0.4 million of collateral that was posted
against derivative positions with counterparties.

	Fair Value as of December 31, 2010
(In thousands)		Total		Level 1		Level 2		Level 3
MGE Energy
Assets:
Exchange-traded investments	$	430	$	430	$	0	$	0
Total Assets	$	430	$	430	$	0	$	0
Liabilities:
Derivatives, net^(b)	$	19,230	$	14	$	0	$	19,216
Deferred compensation		1,525		1,525		0		0
Total Liabilities	$	20,755	$	1,539	$	0	$	19,216

MGE
Assets:
Exchange-traded investments	$	260	$	260	$	0	$	0
Total Assets	$	260	$	260	$	0	$	0
Liabilities:
Derivatives, net^(b)	$	19,230	$	14	$	0	$	19,216
Deferred compensation		1,525		1,525		0		0
Total Liabilities	$	20,755	$	1,539	$	0	$	19,216

(b) These amounts are shown gross and exclude $0.5 million of collateral that was posted
against derivative positions with counterparties.

No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2011.

Investments include exchange-traded investment securities valued using quoted prices on active exchanges and are therefore classified as Level 1.

Derivatives include exchange-traded derivative contracts, over-the-counter party transactions, a ten-year purchased power agreement, and FTRs. Most exchange-traded derivative contracts are valued based on unadjusted quoted prices in active markets and are therefore classified as Level 1. A small number of exchange-traded derivative contracts are valued using quoted market pricing in markets with insufficient volumes and are therefore classified as Level 3. Transactions done with an over-the-counter party are on inactive markets and are therefore classified as Level 3. These transactions are valued based on quoted prices with markets with similar exchange traded transactions. The ten-year purchased power agreement (see Footnote 11) was valued using an internally-developed pricing model and therefore classified as Level 3. The model includes both observable and unobservable inputs. Inputs to the model require significant management judgment and estimation. The model uses a forward power pricing curve based on exchange-traded contracts in the electric futures market. As described above, the market prices from this source have insufficient volumes and are classified as Level 3 in the fair value hierarchy. To project future prices beyond the period in which these quoted market prices are available, MGE calculates the price based on forward gas prices and an implied heat rate. MGE considers the assumptions that market participants would use in valuing the asset or liability. This consideration includes assumptions about market risk such as liquidity, volatility and contract duration. The fair value model incorporates discounting, credit, and model risks. FTRs are priced based upon monthly auction results for identical or similar instruments in a closed market with limited data available and are therefore classified as Level 3.

The deferred compensation plan allows participants to defer certain cash compensation into a notional investment account. These amounts are included within other deferred liabilities in the balance sheets of MGE Energy and MGE. The notional investments earn interest based upon the semiannual rate of U.S. Treasury Bills having a 26 week maturity increased by 1% compounded monthly, with a minimum annual rate of 7%, compounded monthly, and are therefore based upon observable market data and classified as Level 1.

The following table summarizes the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE.

		Three Months Ended				Nine Months Ended
(In thousands)		September 30,				September 30,
		2011		2010		2011		2010
Beginning balance,	$	(22,983)	$	(17,604)	$	(19,216)	$	(13,047)
Realized and unrealized gains (losses):
Included in regulatory liabilities (assets)		(2,927)		(1,594)		(6,694)		(6,151)
Included in other comprehensive income		0		0		0		0
Included in earnings		182		(306)		815		(1,409)
Included in current assets		(7)		0		(66)		0
Purchases		178		0		342		0
Sales		0		122		0		223
Issuances		0		0		0		0
Settlements		(353)		184		(1,091)		1,186
Transfers in and/or out of Level 3		0		0		0		0
Balance as of September 30,	$	(25,910)	$	(19,198)	$	(25,910)	$	(19,198)
Total gains (losses) included in earnings attributed to
the change in unrealized gains (losses) related to
assets and liabilities held at September 30,^(c)	$	0	$	0	$	0	$	0

The following table presents total realized and unrealized gains (losses) included in income for Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE (c).

(c) MGE's exchange-traded derivative contracts, over-the-counter party transactions, ten-year purchased power agreement, and FTRs are subject to regulatory deferral. These derivatives are therefore marked to fair value and are offset with a corresponding regulatory asset or liability.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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