Regulatory Matters

6 Months Ended

Jun. 30, 2011

NOTE 5. REGULATORY MATTERS

Electric Rates. Entities within our Regulated Operations segment file for periodic rate revisions with the MPUC, the FERC or the PSCW.

2010 Rate Case. On November 2, 2009, Minnesota Power filed an $81 million retail rate increase request to recover the costs of significant investments to ensure current and future system reliability, enhance environmental performance and bring new renewable energy to northeastern Minnesota. Interim rates were put into effect on January 1, 2010, and were originally estimated to increase revenues by $48.5 million in 2010. In April 2010, we adjusted our initial filing for events that had occurred since November 2009 - primarily increased sales to our industrial customers - resulting in a retail rate increase request of $72 million, a return on equity request of 11.25 percent and a capital structure consisting of 54.29 percent equity and 45.71 percent debt.

On November 2, 2010, Minnesota Power received a written order from the MPUC approving a retail rate increase of $53.5 million, a 10.38 percent return on common equity and a 54.29 percent equity ratio, subject to reconsideration. On May 24, 2011, the MPUC issued an order authorizing Minnesota Power to implement final rates of $53.5 million, effective June 1, 2011. The May 24, 2011 order authorized Minnesota Power to collect a $3.2 million differential between interim rates and final rates for the period from November 2, 2010, through June 1, 2011, all of which was recorded in the second quarter of 2011.

Under the terms of a stipulation and settlement agreement approved by the MPUC as part of this rate case, Minnesota Power agreed to forgo collection of $20.5 million in revenue receivable that it was entitled to under a prior rider for the Boswell Unit 3 environmental retrofit. The agreement required the Company to capitalize, as part of rate base, the $20.5 million to property, plant and equipment representing AFUDC. In conjunction with the settlement agreement, and upon receipt of the final rate order in February 2011, the Company reversed a $6.2 million deferred tax liability related to the revenue receivable Minnesota Power agreed to forgo. The $20.5 million revenue receivable was previously included in Regulatory Assets on the Company's consolidated balance sheet.

On February 22, 2011, Minnesota Power timely filed an appeal of the MPUC's interim rate decision in the Company's 2010 rate case with the Minnesota Court of Appeals. The Company is appealing the MPUC's finding of exigent circumstances in the interim rate decision with the primary arguments that the MPUC exceeded its statutory authority, made its decision without the support of a body of record evidence and that the decision violated public policy. The Company desires to resolve whether the MPUC's finding of exigent circumstances was lawful for application in future rate cases. The briefing schedule is complete and oral argument is scheduled for September 21, 2011. If the appeal is successful, the Minnesota Court of Appeals would remand the case to the MPUC for further action consistent with its decision. The Company cannot predict the outcome of the matter at this time.

FERC-Approved Wholesale Rates. Minnesota Power's non-affiliated municipal customers consist of 16 municipalities in Minnesota and 1 private utility in Wisconsin. SWL&P, a wholly-owned subsidiary of ALLETE, is also a private utility in Wisconsin and a customer of Minnesota Power. In 2008, Minnesota Power entered into formula-based rate contracts with these customers. In February 2011, Minnesota Power entered into a new formula-based contract with the City of Nashwauk, effective May 1, 2012, through April 30, 2022, and in June 2011, Minnesota Power entered into restated contracts, effective July 1, 2011, through June 30, 2019, with the remaining 15 Minnesota municipal customers. The rates included in these contracts are calculated using a cost-based formula methodology that is set each July using estimated costs and provides for a true-up calculation for actual costs. The contract terms include a termination clause requiring a three-year notice to terminate. Under the restated contracts, no termination notices may be given prior to June 30, 2016.

2010 Wisconsin Rate Increase. SWL&P's 2011 retail rates are based on a 2010 PSCW retail rate order, effective January 1, 2011, that allows for a 10.9 percent return on common equity. The new rates reflect a 2.4 percent average increase in retail utility rates for SWL&P customers (a 12.8 percent increase in water rates, a 2.5 percent increase in natural gas rates and a 0.7 percent increase in electric rates). On an annualized basis, the rate increase will generate approximately $2 million in additional revenue.

The Patient Protection and Affordable Care Act of 2010 (PPACA). In March 2010, PPACA was signed into law. One of the provisions changed the tax treatment for retiree prescription drug expenses by eliminating the tax deduction for expenses that are reimbursed under Medicare Part D, beginning January 1, 2013. Based on this provision, we are subject to additional taxes in the future and were required to reverse previously recorded tax benefits in the first quarter of 2010. Consequently, the reversal of the previously recorded tax benefit resulted in a non-recurring charge to net income of $4.0 million in the first quarter of 2010. In October 2010, we submitted a filing with the MPUC requesting deferral of the retail portion of the tax charge taken in 2010 resulting from PPACA. On May 24, 2011, the MPUC approved our request for deferral until the next rate case and as a result we recorded an income tax benefit of $2.9 million in the second quarter of 2011, and a related regulatory asset of $5.0 million. (See also Note 9. Income Tax Expense.)

Regulatory Assets and Liabilities. Our regulated utility operations are subject to the accounting guidance for Regulated Operations. We capitalize incurred costs as regulatory assets, which are probable of recovery in future utility rates. Regulatory liabilities represent amounts expected to be credited to customers in rates. No regulatory assets or liabilities are currently earning a return.

	June 30,	December 31,
Regulatory Assets and Liabilities	2011	2010
Millions
Current Regulatory Assets (a)
Deferred Fuel	$15.0	$20.6
Total Current Regulatory Assets	15.0	20.6
Non-Current Regulatory Assets
Future Benefit Obligations Under
Defined Benefit Pension and Other Postretirement Benefit Plans	249.5	257.9
Boswell Unit 3 Environmental Rider	-	20.5
Income Taxes	22.1	17.3
Asset Retirement Obligation	8.7	7.8
Medicare Part D	5.0	-
Premium on Reacquired Debt	1.7	1.8
Rate Case Expenses	1.0	1.4
Other	2.2	3.5
Total Non-Current Regulatory Assets	290.2	310.2
Total Regulatory Assets	$305.2	$330.8

Non-Current Regulatory Liabilities
Income Taxes	$22.2	$23.4
Plant Removal Obligations	16.4	16.9
Other	4.8	3.3
Total Non-Current Regulatory Liabilities	$43.4	$43.6

(a)	Current regulatory assets are included in prepayments and other on the consolidated balance sheet.