Filing Format

This combined Form 10-K is being filed separately by MGE Energy, Inc. (MGE Energy) and Madison Gas and Electric Company (MGE). MGE is a wholly owned subsidiary of MGE Energy and represents a majority of its assets, liabilities, revenues, expenses, and operations. Thus, all information contained in this report relates to, and is filed by, MGE Energy. Information that is specifically identified in this report as relating solely to MGE Energy, such as its financial statements and information relating to its nonregulated business, does not relate to, and is not filed by, MGE. MGE makes no representation as to that information.

Forward-Looking Statements

This report, and other documents filed by MGE Energy and MGE with the Securities and Exchange Commission (SEC) from time to time, contain forward-looking statements that reflect management's current assumptions and estimates regarding future performance and economic conditions—especially as they relate to future load growth, revenues, expenses, capital expenditures, financial resources, regulatory matters, and the scope and expense associated with future environmental regulation. These forward-looking statements are made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Both MGE Energy and MGE caution investors that these forward-looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those projected, expressed, or implied. The factors that could cause actual results to differ materially from the forward-looking statements made by a registrant a) include those factors discussed in Item 1A. Risk Factors, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8. Financial Statements and Supplementary Data, and b) other factors discussed in filings made by that registrant with the SEC.

Readers are cautioned not to place undue reliance on these forward-looking statements, which apply only as of the date of this report. MGE Energy and MGE undertake no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this report.

Where to Find More Information

The public may read and copy any reports or other information that MGE Energy and MGE file with the SEC at the SEC's public reference room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These documents are also available to the public from commercial document retrieval services and the webWeb site maintained by the SEC athttp://www.sec.gov.

Our Internet site addresses arehttp://www.mgeenergy.com andhttp://www.mge.com. On our sites, we have made available, free of charge, our most recent annual report on Form 10-K and proxy statement. We also provide, free of charge, our other filings with the SEC as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information contained on MGE Energy's and MGE's webWeb sites shall not be deemed incorporated into, or to be a part of, this report.

Definitions, Abbreviations, and Acronyms Used in the Text and Notes of this Report

Abbreviations, acronyms, and definitions used in the text and notes of this report are defined below.

PART I.

Item 1. Business.

MGE Energy operates in the following business segments:

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Electric utility operations—operations – generating, purchasing, and distributing electricity through MGE.

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Gas utility operations—operations – purchasing and distributing natural gas through MGE.

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Nonregulated energy operations—operations – constructing, owning, and leasing new electric generating capacity that will assist MGE through MGE Energy's wholly owned subsidiaries MGE Power, MGE Power Elm Road and MGE Power West Campus.

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Transmission Investments—Investments – investing in companies engaged in the business of providing electric transmission services, such as ATC. In the fourth quarter of 2005, the investment in ATC was transferred from MGE to MGE Transco.

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All Other—Other – investing in companies and property which relate to the regulated operations, financing the regulated operations, or providing construction services to the other subsidiaries through its wholly owned subsidiaries MGE Construct, MAGAEL and CWDC, and Corporate functions.

MGE's utility operations represent a majority of the assets, liabilities, revenues, expenses, and operations of MGE Energy. MGE Energy's nonregulated energy operations currently include aan undivided interest in the assets of the West Campus Cogeneration Facility. MGE Power West Campus owns 55% of the facility, which represents its interest in the electric generating assets, and the UW owns 45% of the facility, which represents their interest in the steam and chilled water assets. The UW's share of the plant and portion of the earnings from the WCCF are not reflected in the consolidated financial statements of MGE and MGE Energy. Nonregulated energy operations also include an undivided 8.33% ownership interest in each of two 615 MW generating units being constructed in Oak Creek, Wisconsin.

As a public utility, MGE is subject to regulation by the PSCW and the FERC. The PSCW has authority to regulate most aspects of MGE's business including rates, accounts, issuance of securities, and plant and transmission line siting. The PSCW also has authority over certain aspects of MGE Energy as a holding company of a public utility. FERC has jurisdiction, under the Federal Power Act, over certain accounting practices and certain other aspects of MGE's business.

MGE Energy's subsidiaries are also subject to regulation under local, state, and federal laws regarding air and water quality and solid waste disposal. See "Environmental" below.

MGE Energy was organized as a Wisconsin corporation in 2001. MGE was organized as a Wisconsin corporation in 1896. Their principal offices are located at 133 South Blair Street, Madison, Wisconsin 53703.53703, and their telephone number is (608) 252-7000.

Electric Utility Operations

MGE generates and distributes electricity in a service area covering a 315316 square-mile area of Dane County, Wisconsin. ItsThe service area includes the city of Madison, Wisconsin.

At December 31, 2007,2008, MGE supplied electric service to nearly 136,000approximately 137,000 customers, with approximately 89% located in the cities of Fitchburg, Madison, Middleton, and Monona and 11% in adjacent areas. Of the total number of customers, approximately 87%86% were residential and 13%14% were commercial or industrial. Electric revenues for 2008, 2007, 2006, and 20052006 were comprised of the following:

*See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Results of Operations, Electric Utility Operations, Electric sales and revenues, Other revenues section for additional information.

Electric operations accounted for approximately 62.8%58.8%, 63.3%62.8%, and 60.8%63.3% of MGE's total 2008, 2007, 2006, and 20052006 regulated revenues, respectively.

See Item 2,2. Properties, for a description of MGE's electric utility plant.

MGE has chosen to join the MRO as its regional reliability council.is registered with two Regional Entities (RE), The Midwest Reliability Organization (MRO) and Reliability First Corporation (RFC). The essential purposes of the MRORE are: (1) the development and implementation of regional and NERC reliability standards, and (2) determining compliance with those standards, including enforcement mechanisms. The MRO also provides other services consistent with its reliability charter.

Transmission

Reliability 2000 legislation enacted in Wisconsin mandated, among other things, the creation of a statewide transmission company to own the investor-owned utilities' transmission assets. Pursuant to these provisions, effective January 1, 2001, MGE transferred all of its electric utility transmission assets to ATC in exchange for an ownership interest in ATC. At December 31, 2007,2008, MGE Transco held a 3.6% ownership interest in ATC as a result of the aforementioned assets transferred and subsequent additional capital contributions made.

ATC is owned by the utilities that contributed facilities or capital in accordance with Wisconsin law. ATC's purpose is to provide reliable, economic transmission service to all customers in a fair and equitable manner. ATC plans, constructs, operates, maintains, and expands transmission facilities that it owns to provide adequate and reliable transmission of power. ATC is regulated by FERC for all rate terms and conditions of service and is a transmission-owning member of the Midwest ISO. MGE is however a non-transmission owning member of the Midwest ISO.MISO.

Regional Transmission Organizations

MGE is a nontransmission owning member of the MISO. On February 1, 2002, MGE started taking network transmission service from the Midwest ISO. Midwest ISOMISO. MISO is a nonprofit RTO approved by FERC. The Midwest ISOMISO is responsible for monitoring the electric transmission system that delivers power from generating plants to wholesale power transmitters. ItsMISO's role is to ensure equal access to the transmission system and to maintain or improve electric system reliability in the Midwest.

As a FERC approved RTO, Midwest ISOMISO is required to provide a real-time market-based mechanism for congestion management. On April 1, 2005, Midwest ISOMISO implemented its bid-based energy market. At that time, MGE began offering substantially all of its generation on the Midwest ISOMISO market and purchasing much of its load requirement from the Midwest ISOMISO market in accordance with the Midwest ISOMISO Tariff. In January 2009, MISO implemented and MGE began participating in the ancillary services market (ASM). The ASM is an extension of the existing energy market in which MISO assumes the responsibility of maintaining sufficient generation reserves. Previously, MGE was responsible for providing its own reserves, however in the ASM, MISO will provide the reserves for MGE's load, and MGE may offer to sell reserves from its generating units. In addition to this market change, MISO took on various Balance Authority functions.

Additionally, on May 1, 2004, MGE became a member of PJM. PJM is also an RTO. PJM is a neutral and independent party that coordinates and directs the operation of the region's transmission grid, administers a competitive wholesale electricity market, and plans regional transmission expansion improvements to maintain grid reliability and relieve congestion. MGE has two purchase power agreements, for a total of 65 MW, that are impacted by this market.

Fuel supply and generation

MGE satisfies its customers' electric demand with internal generation and purchased power and internal generation.power. During the years ended December 31, 2008, 2007, 2006, and 2005,2006, MGE's electric energy delivery requirements were satisfied by the following sources:

Sources used depend on market prices, generating unit availability, weather, and customer demand.

Coal

MGE and two other utilities jointly own Columbia, a coal-fired generating facility, which accounts for 29% (225 MW) of MGE's net generating capability.summer rated capacity. Power from this facility is shared in proportion to each owner's ownership interest. MGE has a 22% ownership interest in Columbia. The other owners are Alliant,WPL (a subsidiary of Alliant), which operates Columbia, and WPSC. The Columbia units burn low-sulfur coal obtained (pursuant to long-term contracts) from the Powder River Basin coal fields located in Wyoming and Montana.

MGE's share of the coal inventory supply for the units increaseddecreased from 31 days on December 31, 2006, toapproximately 33 days on December 31, 2007.2007, to approximately 13 days on December 31, 2008, primarily due to rail transportation issues caused by weather conditions. The co-owners' current goal is to maintain approximately a 35 day inventory.inventory and the inventory is expected to return to that level over the next several months, primarily as a result of increases in the coal inventory during scheduled annual maintenance outages.

MGE also owns the Blount Generating Facility located in Madison, Wisconsin, which is fueled by coal, gas, and other alternative renewable sources. On January 19, 2006, MGE announced a plan, subject to certain conditions, that includes discontinuing coal use at the end of 2011 at Blount. The plant will continue to run on natural gas but will be reduced from its current approximate 190 MW capacity to 100 MW when coal burning is discontinued.

Natural gas and oil

MGE owns gas fired combustion turbines. These turbines are primarily located in Madison and Marinette, Wisconsin and have a total of 174 MW of generatingnet summer rated capacity.

See discussion above for discussion of theregarding gas-fired generation at Blount Generating Facility and see below discussion under Nonregulated Operations for MGE's interest in a natural gas-fired cogeneration facility on the UW campus.

Renewable generation sources

On September 29, 2006, MGE formalized plans to acquire 29.7owns 30 MW or 18 turbines in a wind-powered electric generating facility to be constructed in Worth County, Iowa. This project is expected to be completedThe turbines were placed into service in the first quarter ofFebruary 2008. At December 31, 2007, MGE had incurred $55.9 million (excluding AFUDC) of costs on the project, which is reflected in the Construction Work in Progress balance on MGE and MGE Energy's consolidated balance sheets. Additionally, MGE had recorded a total of $2.4 million in AFUDC-debt and equity which is also reflected in Construction Work in Progress at December 31, 2007. MGE will beginbegan recovering the cost of this project in rates in 2008.

Purchased power

As mentioned under the discussion on "Regional Transmission Organizations" above, at the time Midwest ISOMISO implemented its bid-based energy market, MGE began offering substantially all of its generation on the Midwest ISOMISO market and purchasing much of its load requirement from the Midwest ISOMISO market in accordance with the Midwest ISOMISO Tariff. Accordingly, the Midwest ISOMISO market is the source of the vast majority of MGE's purchased power needs.

MGE also has purchase power contracts with two companies located in the PJM market. These agreements provide a means forallow MGE to participaterequest certain transmission rights in the PJM market via the receipt of FTRs.market. Under these agreements MGE has the contractual right to 65 MW of power.

On October 8, 2008, MGE entered into a ten-year purchase power agreement to help meet future electric supply requirements. Under this agreement, MGE has agreed to purchase 50 MW of wind power from Osceola Windpower II, LLC which is located in Iowa. This facility became operational in October 2008. MGE does not have any capacity payment commitments under this agreement. However, MGE is obligated to purchase its ratable share of the energy produced by the project.

On September 21, 2007, MGE entered into a ten-year purchase power agreement which provides MGE with firm capacity, energy, and a pro-rata share of the counterparty's rights to renewable attributes beginning on June 1, 2012, and ending on May 31, 2022 (the "base term"). This agreement obligates MGE to purchase a minimum of 50 MW of capacity each year and a fixed amount of energy. Pursuant to the terms of this agreement, MGE has the option to extend the ten year term and/or purchase additional energy and capacity during the base term. MGE has not exercised either of these options at this time.

On April 23, 2007, MGE entered into a 20-year purchase power agreement for wind generation. Under this agreement, MGE has agreed to purchase 30 MW of wind power from the Top of Iowa II project which is being constructedlocated in Iowa. This facility became operational in January 2008. MGE does not have any capacity payment commitments under this agreement. However, MGE is obligated to purchase its ratable share of the energy produced by the project.

On February 21, 2007, MGE and Invenergy signed an amendment to an existing purchase power agreement. Under this amended agreement, MGE has agreed to purchase for a 20-year term approximately 15 MW of wind power at a facility to be constructedlocated near Brownsville, Wisconsin. Construction of thisThis facility began in June 2007 and the facility is expected to bebecame operational in earlyMarch 2008. MGE does not have any capacity payment commitments under this agreement. However, MGE is obligated to purchase its ratable share of the energy produced by the unit.

Gas Utility Operations

MGE transports and distributes natural gas in a service area covering 1,6251,631 square miles in seven south-central Wisconsin counties. ItsThe service area includes the city of Madison, Wisconsin.

On December 31, 2007,2008, MGE supplied natural gas service to nearly 140,000approximately 141,000 customers in the cities of Elroy, Fitchburg, Lodi, Madison, Middleton, Monona, Prairie du Chien, Verona, and Viroqua; 24 villages; and all or parts of 45 townships. Of the total number of customers, approximately 89% were residential and 11% were commercial or industrial. Gas revenues for 2008, 2007, 2006, and 20052006 were comprised of the following:

Gas operations accounted for approximately 37.2%41.2%, 36.7%37.2%, and 39.2%36.7% of MGE's total 2008, 2007, 2006, and 20052006 regulated revenues, respectively.

MGE can curtail gas deliveries to its interruptible customers. Approximately 7%12% of retail gas deliveries in 20072008 and 8% of gas sold7% in 20062007 were to interruptible customers.

Gas supply

MGE has physical interconnections with ANR and NNG. MGE's primary service territory, which includes Madison and the surrounding area, receives deliveries at one NNG and four ANR gate stations. MGE also receives deliveries at NNG gate stations located in Elroy, Prairie du Chien, Viroqua, and Crawford County. Interconnections with two major pipelines provide competition in interstate pipeline service and a more reliable and economical gas supply mix, which includes gas from Canada and from the mid-continent and Gulf/offshore regions in the United States.

During the winter months, when customer demand is high, MGE is primarily concerned with meeting its obligation to firm customers. MGE meets customer demand by using firm supplies under contracts finalized before the heating season, supplies in storage (injected during the summer), and other firm supplies purchased during the winter period.

By contract, a total of 5,430,9645,414,600 Dth can be injected into ANR's storage fields in Michigan from April 1 through October 31. These gas supplies are then available for withdrawal during the subsequent heating season, November 1 through March 31. Using storage allows MGE to buy gas supplies during the summer season, when prices are normally lower, and withdraw these supplies during the winter season, when prices are typically higher. Storage also gives MGE more flexibility in meeting daily load fluctuations.

MGE's contracts for firm transportation service include winter maximum daily quantities of:

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161,150 Dth (including 96,078 Dth of storage withdrawals) on ANR.

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59,608 Dth on NNG.

Nonregulated Energy Operations

MGE Energy, through its subsidiaries, seeks to develop generation sources that will assist MGE in meeting the electricity needs of its customers. Decisions on the type of energy source and its size, timing, ownership, and financing depend upon a number of factors including the growth of customer demand in MGE's service area and surrounding areas, the effectiveness of customer demand management efforts, the costs and availability of alternative power sources, mandates regarding renewable energy resources, the availability of transmission capacity, issues associated with siting power generation sources, available financing and ownership structures, regulatory treatment and recovery, construction lead times and risks, and other factors. The decisions tend to involve long-time horizons due to the lead time involved in siting and constructing new generation sources and the associated transmission infrastructure.

WCCF

MGE Power West Campus and the UW jointly own undivided interests in a natural gas-fired cogeneration facility on the UW campus. The facility has the capacity to produce 20,000 tons of chilled water, 500,000 pounds per hour of steam, and approximately 150 MW of electricity. The UW owns 45% of the facility, which represents its interest in the chilled-water and steam assets. These assets are used to meet the UW's growing need for air-conditioning and steam-heat capacity. MGE Power West Campus owns 55% of the facility, which represents its interest in the electric generating assets. These assets are used to provide electricity to MGE's customers. The UW's share of the plant and portion of the earnings from the WCCF are not reflected in the consolidated financial statements of MGE or MGE Energy. MGE Power West Campus' share of the cost of this project is reflected in Property, Plant,property, plant, and Equipmentequipment on MGEMGE's and MGE Energy's consolidated balance sheetssheets.

MGE leases the electric generating assets owned by MGE Power West Campus and is responsible for operating the entire facility. On April 26, 2005, the facility lease between MGE and MGE Power West Campus commenced. The financial terms of the facility lease include a capital structure of 53% equity and 47% long-term debt, return on equity of 12.1%, and a lease term of 30 years. At the end of the lease term in 2035, MGE may, at its option, renew the facility lease for an additional term, purchase the generating facility at fair market value or allow the lease contract to end. Under the Joint Ownership Agreement for WCCF, the State has an option to acquire at the higher of book or market cost, a 45 MW interest in WCCF or enter into a purchase power agreement for 45 MWsMW of capacity.

Elm Road

On November 4, 2005, MGE Power Elm Road closed on the exercise of an option to acquireowns an undivided 8.33% ownership interest in each of two 615 MW advanced technology, coal-fired generating units being constructed by We EnergiesWisconsin Energy Corporation in Oak Creek, Wisconsin. MGE Power Elm Road's estimated share of capital costs for its 8.33% ownership interest in both units is approximately $171$172 million (excluding capitalized interest), which it intends to finance primarily through funds received from MGE Energy. MGE Energy expects that these funds will be raised through the sale of common stock (via the Stock Plan), short-term debt, and operating cash flows. At December 31, 2007,2008, MGE Power Elm Road had incurred $103.7$146.0 million (excluding capitalized interest) of costs on the project, whichproject.

In December 2008, we received notice from Elm Road Services, LLC (ERS) that it had received a letter from Bechtel Power Corporation (Bechtel) containing Bechtel's formal claim for schedule and cost relief on the construction of the Elm Road units. Bechtel has asserted two claims for cost and schedule relief in its letter to ERS. Although ERS is reflected in the Construction Work In Progress balanceprocess of analyzing the claims and its responses to them, it has stated its belief that both claims are without merit. It has also stated its view that the only circumstances and events for which the Elm Road units owners currently retain price adjustment risk under the contract are force majeure, wage escalation in excess of 4% annually as measured by published wage bulletins, delays caused by ERS, changes in scope or performance requested by ERS, and unforeseen sub-surface ground conditions. ERS has invoked the dispute resolution process provided for in the contract in order to address the claims made by Bechtel under the contract. That process involves an informal resolution process, followed by mediation and then binding arbitration. ERS is currently in the mediation phase with respect to determining the rights of the parties under the contract and the disposition of Bechtel's claims. ERS has expressed its inability to predict the length or ultimate outcome of the claims. As a result, we are unable to predict the results of these claims or their effect on MGEthe costs recoverable under the existing facility leases, in the event that the outcome of the claims should cause total construction costs of the Elm Road units to exceed the amounts authorized in the PSCW order. Bechtel continues to target an in-service date for Elm Road unit 1 three months beyond the guaranteed contract date of September 29, 2009, and MGE Energy's consolidated balance sheets.an in-service date for Elm Road unit 2 one month earlier than the guaranteed contract date of September 29, 2010.

However, Bechtel does request schedule relief that would result in six months of relief from liquidated damages beyond the guaranteed contract date for unit 1 and three months of relief from liquidated damages beyond the guaranteed contract date for unit 2. See Footnote 21 for additional information.

On the date of acquisition, MGE Energy and its subsidiaries entered into various agreements regarding the Elm Road generating units, including a facility lease agreement. This facility lease agreement is between MGE Power Elm Road (a nonregulated subsidiary of MGE Energy) and MGE. The financial terms of the facility lease include a capital structure of 55% equity and 45% long-term debt, and return on equity of 12.7%, a lease term of 30 years, and a 5% rent reduction in the first five years.

On November 1, 2005, MGE received approval from the PSCW to defer payments made to MGE Power Elm Road for carrying costs during construction of the facility, management fees, and community impact mitigation costs. MGE began collecting the carrying costs in rates in 2006. MGE estimates total carrying costs to be approximately $53.6$61.3 million. Of these costs, $21.1$22.4 million is estimated to relate to the capitalized interest and the debt portion of the facility. These costs will be recognized over the period in which the facility will be depreciated. The remaining $32.5$38.9 million is estimated to represent the equity portion and is being recognized over the period recovered in rates.

Environmental

MGE is subject to local, state, and federal regulations concerning air quality, water quality, and solid waste disposal. The EPA administers certain federal statutes relating to such matters. The DNRWDNR administers certain state statutes as to such matters and has primary jurisdiction over standards relating to air and water quality and solid and hazardous waste. Those regulations affect the manner in which MGE conducts its operations, the costs of those operations, as well as some capital and operating expenditures. It can also affect the siting, timing, and cost of new projects or other significant actions affecting the environment. MGE is not able to predict the direction of future regulations or if compliance with any such regulations will involve additional expenditures for pollution control equipment, plant modifications, or curtailment of operations. Such actions could reduce capacity or efficiency at existing plants or delay the construction and operation of future generating facilities.

Based upon current available information, compliance with various environmental requirements and initiatives is expected to result in significant additional operating and capital expenditures at Columbia and may affect those expenditures at other MGE generating facilities. MGE's share of the Columbia capital expenditures currently estimated by the plant operator is between $130 million and $170 million, and on-going operating expenditures are also expected to increase. The Columbia owners are continuing to explore various alternatives to comply with these standards, which may affect the timing and amount of the actual capital expenditures that are incurred.

MGE expects that the Columbia compliance costs will be fully recoverable through rates. The PSCW is permitting MGE to defer pre-certification and pre-construction costs related to compliance with CAIR and CAMR regulations at Columbia. Additionally, MGE is entitled to 100% AFUDC on the related pre-construction costs.

Air quality

Air quality regulations promulgated by the EPA and DNRWDNR in accordance with the Federal Clean Air Act and the Clean Air Act Amendments of 1990 impose restrictions on emission of particulates, sulfur dioxide (SO₂) nitrogen oxides (NO_x) and other pollutants and require permits for operation of emission sources. These permits have been obtained by MGE and must be renewed periodically. Various initiatives, including the Clean Air Interstate Rule (CAIR), Clean Air Mercury Rule (CAMR), maximum achievable control technology (MACT) standards, new source performance standards (NSPS) and the Clean Air Visibility Rule (also known as the Regional Haze Regulations,Rule), as well as existing and proposed state mercury emissions limits, maywhich are expected to result in additional operating and capital expenditure costs.

CAIR

The CAIR requires NO_x and SO₂ emission reductions in two phases and includes a regional cap-and-trade system. The first phase begins in 2009 for NO_xand 2010 for SO₂, and contemplates reductions of 55% and 40%, respectively, increasing in the second phase by 2015 to 65% and 70%, respectively; in each case over 2003 levels. MGE owns several generation units currently subject to CAIR: Blount Generating Station, Columbia, M34 (West Marinette)Marinette Combustion Turbine) and Fitchburg Substation.Combustion Turbines. In future generation years, Elm Road will be, and WCCF may be, affected by the CAIR. MGE anticipates that it may need to purchase NO_x and SO₂ allowances and /or install equipment at Columbia to meet CAIR allocations for its generation fleet. The exact cost of the allowances and/or equipment installation is not known at this time.

The long-term design and implementation of the CAIR, however, is uncertain at this time. On December 23, 2008, the D.C. Circuit Court remanded the CAIR to the EPA. This is a change from its previous ruling on July 11, 2008 to vacate and remand the rule. The court's remand to the EPA did not include a deadline, but did indicate that the EPA must modify CAIR consistent with the court's July 2008 opinion. The CAIR remains in effect until it is modified by the EPA. Based on this remand it is likely that the current cap-and-trade system will be modified.

CAMR/Wisconsin State Mercury Rule

The CAMR seeksis designed to reduce mercury emissions from coal-fired power plants through a system of monitoring and several compliance options, including equipment installations and allowance trading options through a cap-and-trade system which areoriginally scheduled to commence in 2009; although there2009. The ultimate fate of the CAMR is some uncertainty in light of auncertain at this time. On February 8, 2008, U.S. Court of Appeals decision invalidatingvacated and remanded the rule's cap-and-trade provisions. In March 2007,CAMR. Requests for rehearing were denied. On October 17, 2008, the DNR proposedUS Solicitor General, however, filed a petition for a writ of certiorari with the U.S. Supreme Court on the underlying decision.

Wisconsin has revised its state mercury rules under NRrule (NR 446, to address its requirements under CAMR.effective December 1, 2008). The state's proposed rule is significantly different from the federal CAMR. If the state's version of CAMR as currently proposed becomesThe revised NR 446 will require large coal-fired electric generating units (EGUs larger than 150 MW) to reduce mercury emissions by 90% beginning in 2015, or choose a rule, itmulti-pollutant reduction approach, which allows a stepped approach to mercury reduction while reducing NO_X and SO₂ emissions at prescribed rates. Smaller coal-fired EGUs, those between 25 – 150 MW in size, will increase CAMR compliance costs for Columbia, Blount and Elm Road (those facilities currently subjectneed to CAMR) because it is more restrictive in scope than the federal CAMR. However, it is unknown at this time what those additional costs would be. The Wisconsin DNR has announced that it intendsapply Best Available Control Technology (BACT) to introduce a revised proposed rule some time in 2008. Thus, the economic and operational effect on MGE is not known at this time.achieve mercury reductions.

BART/CAVR

Air modeling indicates that emissionsSO₂ and NO_X emission (and to a lesser extent particulate matter, or PM) from Columbia may impair visibility at certain Class I Scenic Areas and may therefore be subject to Regional Haze andthe Best Available Retrofit Technology (BART) regulations. DNR expectsregulations, a subsection of the EPA's Clean Air Visibility Rule (CAVR). The state of Vermont has asserted that Wisconsin emissions sources contribute to submit rules on BART and/or Regional Haze to EPAvisibility impairment in 2008 with BART becoming effective in 2013.its state. The State of Minnesota has also asserted that Wisconsin emission sources significantly contribute to visibility impairment at the Boundary Water Canoe Wilderness Area and Voyageurs National Park. Minnesota has asked Wisconsin to evaluate reducing the Wisconsin statewide average SO₂ and NO_x emission rates for electric generating units to approximately 0.25 lbs/MMBtu by 2018. If adopted, these rates couldoffset those effects.

Wisconsin has promulgated a BART implementation rule which clarifies that fossil fuel fired electric plants subject to the CAIR trading programs are not required to conduct a BART analysis for SO₂ or NO_X emissions, and the determination of BART shall be made for PM emissions only. However, a remanded CAIR has left open the potential for revisions to Wisconsin's rule. The WDNR is exploring potential revisions. The revisions have a potential to affect capital operational and maintenanceoperating expenses, but exact costs cannot be determined at MGE's generating facilities.this time.

National Ambient Air Quality Standards

In 1998, the EPA issued a rule that imposed a NO_x emission budget for emission sources in Wisconsin. In 2000, the Court of Appeals for the District of Columbia invalidated a portion of the rule as applied to Wisconsin; however, the Court stayed that portion of the challenge concerning Wisconsin's alleged impacts on downwind, eight-hour ozone nonattainment areas. EPA has also stayed that portion of the rule concerning Wisconsin's alleged impacts on downwind eight-hour ozone nonattainment areas. If that portion of the rule concerning eight-hour ozone nonattainment areas is upheld, the resulting NO_x emission budget for Wisconsin could potentially affect the level of permissible NO_x emissions from Blount, Columbia, and WCCF.

TheIn 2006, the EPA recently lowered the acceptable 24-hour National Ambient Air Quality StandardsStandard (NAAQS) for fine particulate matter, or PM2.5 – i.e., particlesa particulate matter air pollutant that areis 2.5 microns or smaller in diameter and states mustsize. States monitor and collect data on fine particulatePM2.5 levels in order to establishand recommend counties/areas within their state for attainment or nonattainment with the NAAQS. The EPA makes the final decision on attainment/nonattainment areas. In mid-December 2008, the EPA designated several areas of the state, including Dane County (where Blount and WCCF are located), a portion of Columbia County (where Columbia is located), and the Milwaukee/Racine area (where Elm Road is located) as nonattainment areas for the new24-hour PM2.5 standard. States (including Wisconsin) determine designation by county and/or areaThe EPA made these initial determinations based on whethermonitoring data for the county/area meetsyears 2005-2007 data. In early 2009, the EPA is expected to reconsider these final designation decisions using 2006-2008 data which may result in Dane and Columbia Counties reverting to an attainment status based upon monitoring results for 2006-2008 which show the NAAQS (designatedbeing met. The State of Wisconsin will need to develop a State Implementation Plan (SIP) by early 2012 for those counties that remain designated as attainment) or the county does not meet the NAAQS (designated as nonattainment), as measured by air monitors placed in that county/area. In mid-December 2007, Wisconsin recommended that the EPA designate all areas in the state as attainment. However, EPA will finalize designations (attainment or nonattainment) in 2009. Updated air monitoring results may play a role in EPA's designation decision. Designations of nonattainment and implementationnonattainment. Implementation of the fine particulate NAAQS could affect capital, operational and maintenance expenses at generating facilities.

Compliance

On March 12, 2008, the U.S. EPA announced a new NAAQS for ozone that is more stringent than the current standard (standard lowered from 0.08 to 0.075 parts per million). States (including Wisconsin) must monitor and collect data on ozone levels in order to determine attainment or nonattainment status on a county and/or area basis. Currently available monitoring data for Dane, Columbia and Milwaukee counties demonstrates attainment with this new standard. However, final attainment designations will not be made until 2010 using the monitoring data collected during the period 2007 through 2009. There is a possibility that future monitoring data for one or all of these and other related environmental initiatives is expected tocounties will demonstrate nonattainment for this new ozone standard, which could result in significant additional operating and capital expenditures at Columbia. The Columbia operator's current estimates show that MGE's share(located in Columbia County), Blount and WCCF (located in Dane County) and Elm Road (located in Milwaukee County).

Boiler MACT

Some boilers at Blount and Columbia may need to meet emission standards for hazardous air pollutants for industrial boilers under Section 112(j) of the capital expenditures requiredClean Air Act (the "Boiler MACT Hammer"). It may be necessary to comply with these environmental initiatives willsubmit permit applications to the WDNR requesting that case specific MACT standards be between $130 milliondeveloped for certain boilers at Blount and $200 million. According to current estimates, compliance with these initiatives is also expected to result in an increase to MGE's pro-rata share of Columbia's on-going operating expenses. The operator and MGE management are continuing to explore various alternatives to comply with these standards. Accordingly, actual capital expenditures may fall above or below the range provided. These standards and initiatives may also result in additional capital and operating expenditures at MGE's other generating facilities. MGE expects that the costs to comply with these standards will be fully recoverable through rates. Pursuant to an order issued by the PSCW on September 14, 2007,Columbia. MGE is permittedexploring whether or not boilers in our operations are subject to defer pre-certificationthese requirements. If any of our boilers are subject to Boiler MACT Hammer, it may require that we limit emissions and/or install additional pollution controls. Whether or not additional compliance steps are needed and pre-construction costs relatedthe cost of such compliance is unclear at this time.

Columbia Air Operating Permit

Citizen groups have pursued claims against utilities and permitting agencies for alleged air permitting violations. WPL, the operator of Columbia, is aware of certain public comments or petitions from citizen groups that have been submitted to compliance with CAIR and CAMR regulationsthe WDNR regarding the renewal of an air operating permit at Columbia. Additionally, MGE is entitledWPL has since received a renewal air permit for Columbia, which contains changes to 100% AFUDC onpermit conditions that resulted from WDNR's review of the related pre-construction costs.comments or petitions. In December 2008, a citizen group submitted a notice of intent to sue the EPA for failure to respond to its petition encouraging EPA to challenge this permit. We are unable to predict what actions, if any, the WDNR, EPA, or the public commenters may take in response to any public comments, petitions for existing permits or draft renewal permits.

Water quality

MGE is subject to water quality regulations issued by the DNR.WDNR. These regulations include categorical-effluent discharge standards, which require the use of effluent-treatment processes equivalent to categorical "best practicable" or "best available" technologies under compliance schedules established under the Federal Water Pollution Control Act. The DNRWDNR has published categorical regulations for chemical and thermal discharges from electric-steam generating plants. The regulations limit discharges from MGE's plants into Lake Monona and other Wisconsin waters.

Proposed Thermal Discharge Rules in Wisconsin

The DNR has also proposedWDNR is promulgating revised rules regardingto regulate thermal discharge which are subject to commenteffluent discharges from point sources in Wisconsin. The current draft rules apply strict standards for thermal discharges into inland lakes, streams, rivers, and further modification. Depending on the terms of the final rules,Great Lakes. While dischargers can apply for variances, MGE may be required to make significantincur additional capital expenditures, butsuch as equipment upgrades at Blount and Columbia, if the variances are expectednot granted. Costs at Blount have not been fully determined, however, capital expenditures may include cooling towers, which in past analyses have been shown to be recoverable in rates.cost prohibitive. Potential costs at Columbia have not been determined at this time. Based on initial reviews of the current revised rules, we do not expect Elm Road to be impacted by this rule.

EPA Cooling Water Discharge Rules (Section 316(b))

In 2004, the EPA promulgated final rules under Section 316(b) of the Clean Water Act addressing cooling water intake structures for existing large power plants (Phase II rule). A challenge to this rule was upheld in a January 2007 court decision and significant parts of the rule were remanded to the EPA for further consideration. In July 2007, EPA suspended the Phase II rule in its entirety and directed states to use their "best professional judgment" in evaluating intake systems. The ruling, and EPA's actions in response, which may change the compliance requirements, may affect the timing and costs associated with MGE's WPDES permit for Blount and possibly the WPDES permit for the Oak Creek/Elm Road facility. At this time, MGE is unable to determine the timing or amount of that impact.

The

WPDES permit for the Oak Creek/– Elm Road facility has been contested.

On November 29, 2007, anthe Administrative Law Judge (the "ALJ") in the proceeding related to the previously issued Wisconsin Pollutant Discharge Elimination System ("WPDES") permit determined that the two additional coal units that are part of the Oak Creek expansion are "new facilities" under Sectionsection 316(b) of the Federal Clean Water Act and therefore are subject to the standards promulgated by EPA for new facilities in the so-called Phase I rule. Unlike the Phase II rule for existing facilities previously discussed, the Phase I rules for new facilities largely withstood judicial review and are valid.Act. The ALJ did not vacate the WPDES permit or any other permit necessary to continue construction of the two additional coal units, pointing out that, based upon the present record, the water intake system currently under construction as part of the Oak Creek expansion may be permittable under the standards that apply to new facilities.

The ALJ remanded the WPDES permit to the Wisconsin Department of Natural Resources (the "WDNR") and directed the WDNR with a direction that itto reissue or modify the permit to reflect "best technology available" to comply with the standards applicable to new facilities under Wisconsin state law. As part of the decision, the ALJ restated his prior opinion that the water intake system currently under construction may not be operated so long as it remains a contested matter regardingmatter.

On May 8, 2008, WDNR issued its public notice that it intended to reissue the WPDES permit. The ALJ's ruling has been appealedpermit to circuit court.

The Operator has advised us that there are alternatives under the EPA's ruleallow for new facilities that would permit the use of the once-through cooling system rather thanthat was under construction by Wisconsin Energy Corporation. On June 6, 2008, EPA issued its concurrence letter on the use of cooling towers. The Operator has requested the WDNR to issue a modifieddraft permit and has submitted additional informationindicating it would not object to the WDNR supporting the request for approvalmodification of the once-through cooling system under this rule. The Operator anticipates the WDNR will complete the WPDES permit modifications processas drafted. A public information hearing on the intended reissued WPDES permit was held on June 9, 2008 and the public comment period closed on June 16, 2008. On July 31, 2008, the WDNR issued the final modified permit, with no substantive changes from the previously issued draft permit. The deadline for a legal challenge to the permit has expired without appeal.

On July 31, 2008, the joint owners of the Oak Creek expansion reached an agreement with Clean Wisconsin, Inc. and Sierra Club, the groups opposing the WPDES permit. Under the settlement agreement, these groups agreed to withdraw their opposition to the modified WPDES permit for the expansion units at Oak Creek. The joint owners committed to various environmental projects, including projects designed to address greenhouse gas emissions and water quality. MGE's share of those commitments would involve a payment of approximately $0.4 million in the first half of 2008. At this time, we cannot predict with certainty what the WDNR's decision will be. A reissued permit would be2009 for greenhouse gas reduction efforts and, subject to public comment and possible administrative and legal review.

While the process for modifying the WPDES permit proceeds, constructionregulatory approval, further payments of the additional coal units will continue on the current schedule.approximately $0.3 million annually over 25 years (2010-2034) to address water quality issues in Lake Michigan.

Solid waste

MGE is listed as a potentially responsible party for a site the EPA has placed on the national priorities Superfund list. The Lenz Oil site in Lemont, Illinois, was used for storing and processing waste oil for several years. This site requires clean up under the Comprehensive Environmental Response, Compensation and Liability Act. A group of companies, including MGE, is currently working on cleaning up the site. Management believes that its share of the final cleanup costs for the Lenz Oil site will not result in any materially adverse effects on MGE's operations, cash flows, or financial position. Insurance may cover a portion of the cleanup costs. Management believes that the cleanup costs not covered by insurance will be recovered in current and future rates. As of December 31, 2007,2008, a $0.1 million gross liability was accrued for this matter.

Global climate change

The United States is currently not a party to the United Nations' Kyoto Protocol that became effective for signatories on February 16, 2005. The Protocol process generally requires developed countries to cap greenhouse gas (GHG) emissions at certain levels during the 2008 to 2012 time period. Although GHG is not currently regulated in the United States, there is public concern (including among many of our customers) about global climate change. MGE shares that concern and is working to address GHG emissions. MGE also recognizes that these gases—particularly carbon dioxide (CO₂), which is released in the burning of fossil fuels—may face future legislative or regulatory restrictions. Environmental-related legislation (including GHG regulation) is regularly introduced in Congress and in the Wisconsin legislature. Such legislationThe myriad of legislative and regulatory options under consideration typically includesinclude various compliance dates and compliance limits. There are several proposed versions of legislation pending in Congress and in the Wisconsin legislature to address global climate changes, includingThey include efforts to reduce and controlcap and/or tax the emission of greenhouse gases, such as carbon dioxide, created inprimarily from power plants, industrial sources and the combustion of fossil fuels, including coal, natural gas, and oil.transportation sector. Bills are also considering releases associated with natural gas pipelines and company fleets. In addition, there could be national, regional, and state mandates to produce increasing percentages of electricity from renewable forms of energy,energy.

On March 27, 2008, the U.S. EPA sent letters to various environmental committees in the U.S. Senate and House of Representatives announcing EPA's plans to address its obligations under the U.S. Supreme Court's ruling inMassachusetts v. EPA. The letters to Congress indicated that the EPA sees any greenhouse gas regulations that they might develop to be far-reaching and likely to include both mobile and stationary sources. In July 2008, the EPA issued an Advance Notice of Proposed Rulemaking (ANPR) seeking comment on a large array of possible regulatory actions that might be possible under the federal Clean Air Act to regulate greenhouse gas emissions. The options would affect virtually all aspects of the economy including electric and natural gas utilities. The ANPR follows theMassachusetts Supreme Court decision, which requires the EPA to regulate greenhouse gas emissions under the Clean Air Act if it finds that such emissions cause, or contribute to, air pollution which may reasonably be anticipated to endanger public health or welfare. It is unknown at this time what specific effect such regulation would have on MGE's operations and future competitive position. It appears likely that GHG regulation will be proposed under the new federal administration either through the Clean Air Act or through separate legislation.

Wisconsin is also participating in the development of a regional GHG Reduction Program through the Midwest Governor's Association. This group continues to work on developing this program and is expected to report back in the fall of 2009.

At the state level, a final report from Governor Doyle's Global Warming Task Force was approved on July 24, 2008, concluding over a year's work by the task force. MGE participated as wind. Such legislation could havean active member of the potential forTask Force. The report contained over 50 recommendations. Some specific recommendations of particular relevance to the utility industry include: (i) a significant financial impactincrease in required energy efficiency efforts and funding; (ii) a State renewable portfolio standard that would require 10% renewables by 2013 and 25% by 2025; (iii) creation of a broad-based multi-sector carbon cap and trade program by 2012 at either the federal or regional level; (iv) investigation and possible adoption of new rate making approaches and innovative rate designs to promote state and utility energy efficiency programs and provide more information to customers; and (v) modification of Wisconsin's current restrictions on nuclear plant construction. Several PSCW proceedings have been commenced as a result of Task Force recommendations. It is also likely that state legislation will be proposed to enact some portion of the Task Force recommendations or otherwise address climate change at the state level. It is unknown at this time the extent to which the Task Force recommendations will actually be adopted and implemented in Wisconsin. Thus the full effect of these recommendations on MGE cannot be reasonably estimated at this time.

MGE is a producer of GHG emissions, primarily from the fossil fuel generating facilities it utilizes to meet customers' energy needs, as well as from leakage from natural gas pipeline system and fleet vehicles. Climate change and the regulatory response to it could significantly affect our operations in a number of ways, including the costbut not limited to, install newincreased operating costs and capital expenditures, restrictions on energy supply options, permitting difficulties and emission control equipment, purchase allowances, or do fuel switching.limits. However, the financial consequences of this compliance cannot be determined until final legislation is passed. MGE management would expect to seek and receive rate recovery of such compliance measures through rate increases,costs, yet the probability and specific impact of such legislationregulation cannot be reasonably estimated at this time. MGE will continue to monitor proposed legislation.GHG legislation and regulation.

MGE is already addressing GHG emissions through voluntary actions. In 2005, MGE announced its Energy 2015 Plan which commits to ensuring a balanced, economic energy supply with reduced environmental emissions. The Plan emphasizes increased renewable energy, energy efficiency and new cleaner generation – three strategies that reduce GHG emissions. Under MGE's Energy 2015 Plan, our CO₂ emissions are projected to decline from 2005 to 2015 even though total system energy is estimated to increase. We are already well under way with implementing our Energy 2015 Plan strategies and are committed to achieving its goals. However, a number of factors, including but not limited to, changes in economic conditions, regulatory actions, customer response, energy supply issues and transmission delays, may require us to update and perhaps refine certain aspects of our Energy 2015 Plan accordingly. The cost of implementing our Energy 2015 Plan is not expected to result in any materially adverse effects on MGE's operations, cash flows, or financial position. Management believes that costs to implement the Energy 2015 Plan will be recoverable through rates.

Employees

As of December 31, 2007,2008, MGE had 724722 employees. MGE employs 247239 employees who are covered by a collective bargaining agreement with Local Union 2304 of the International Brotherhood of Electrical Workers and 10298 employees who are covered by a collective bargaining agreement with Local Union No. 39 of the Office and Professional Employees International Union. Both of these collective bargaining agreements expire on April 30, 2009. There are also five employees covered by a collective bargaining agreement with Local Union No. 2-111 of the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial, and Service Workers International Union. This collective bargaining agreement expires on November 1, 2009.

Financial Information About Segments

See Footnote 24 of the Notes to Consolidated Financial Statements for financial information relating to MGE Energy's and MGE's business segments.

Executive Officers of the Registrants

Note: Ages, years of service, and positions as of December 31, 2007.2008.

(a)

Executive officer of MGE Energy and MGEMGE.

(b)

Executive officer of MGEMGE.

(c) Retired as of January 1, 2009.

(d) Assumed title of Vice President, Chief Financial Officer, Secretary and Treasurer as of January 1, 2009.

Item 1A. Risk Factors.

MGE Energy and its subsidiaries, including MGE, operate in a market environment that involves significant risks, many of which are beyond their control. The following risk factors may adversely affect their results of operations, cash flows and market price for their publicly traded securities. While MGE Energy and MGE believe they have identified and discussed below the key risk factors affecting their business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect their performance or financial condition in the future.

Regulatory Risk

We are subject to extensive government regulation in our business, which affects our costs and responsiveness to changing events and circumstances.

Our business is subject to regulation at the State and Federal levels. We are subject to regulation as a holding company by the PSCW. MGE is regulated by the PSCW as to its rates, terms and conditions of service; various business practices and transactions; financing; and transactions between it and its affiliates, including MGE Energy. MGE is also subject to regulation by the FERC, which regulates certain aspects of its business. The regulations adopted by the State and Federal agencies affect the manner in which we do business, our ability to undertake specified actions since pre-approval or authorization may be required, the costs of operations, and the level of rates charged to recover such costs. Our ability to attract capital is also dependent in part, upon our ability to obtain a fair return from the PSCW.

We face risk for the recovery of fuel and purchased power costs when they exceed the base rate established in MGE's current rate structure.

MGE burns natural gas in several of its peak electric generation facilities, and in many cases, the cost of purchased power is tied to the cost of natural gas. MGE bears significant regulatory risk for the recovery from customers of such fuel and purchased power costs when they are higher than the base rate established in its current rate structure.

We are subject to environmental laws and regulations that affect our costs and business plans.

Our subsidiaries are subject to environmental laws and regulations that affect the manner in which they conduct business, including capital expenditures, operating costs and potential liabilities. Changes and developments in these laws and regulations may change or limit our business plans, make them more costly to implement, or expose us to liabilities for past or current operations.

Numerous environmental regulations govern many aspects of our present and future operations, including air emissions, water quality, wastewater discharges, solid waste, and hazardous waste; and continue to evolve in response to real or perceived concerns, regulatory initiatives, non-governmentalnongovernmental organizational initiatives and private parties and legal process. The development of these regulations can introduce uncertainty into the planning and implementation process for long-lead time projects, such as generating stations, and can introduce costly delays if previous decisions need to be revisited as a result of judicial mandate or regulatory change. These regulations generally require us to obtain and comply with a wide variety of environmental licenses, permits, inspections, and other approvals, and can result in increased capital, operating, and other costs, particularly with regard to enforcement efforts focused on power plant emissions obligations. These effects can be seen not only with respect to new construction, such as our participation in the Elm Road generating units, but could also require the additioninstallation of additional control equipment or the implementation of other compliance measures.measures such as altered operating conditions.

In addition, we may be a responsible party for environmental clean upclean-up at sites identified as containing hazardous materials. It is difficult to predict the costs potentially associated with a site clean-up due to the potential joint and several liability for all potentially responsible parties, the nature of the clean-up required and the availability of recovery from other potentially responsible parties.

We may incur material costs of compliance if federal and/or state legislation is adopted to address climate change.

Various persons, including legislators, regulators, litigants, and private parties, have increasingly expressed concern about the effects of global warming and the effects of greenhouse gases (GHG). These concerns have prompted active discussion on federal and state legislation, as well as regional initiatives, that would regulate or cap such emissions to be actively discussed.emissions. There arehave been several proposed versions of legislation pending in the U.S. Congress and in the Wisconsin legislature to address global climate changes, including efforts to reduce and control and/or tax the emission of GHG, such as carbon dioxide, created in the combustion of fossil fuels, including coal, natural gas, and oil. Bills are also considering releases associated with natural gas pipelines and company fleets. These legislative initiatives are sometime paired with efforts to mandate increasing percentages of electricity from renewable forms of energy, such as wind, or to reduce the demand for electricity. Such legislationlegislative and regulatory initiatives could have the potential for a significant financial impact on MGE, including the cost to install new emission control equipment, purchase allowances, or do fuel switching. However, the financial consequences of this compliance cannot be determined until final legislation is passed.

Our business may be negatively affected by the restructuring of the energy industry.

MGE is a member of the Midwest ISO, a FERC-approved RTO. Effective April 1, 2005, Midwest ISO implemented its bid-based energy market. MGE cannot predict the impact the new market may ultimately have on its electric operations. Also, the ability of Midwest ISO to maintain its members is an important factor in the success of its operations.

Operating Risk

We are affected by weather, which affects customer demand and can affect the operation of our facilities.

The demand for electricity and gas is affected by weather. Very warm and very cold temperatures, especially for prolonged periods, can dramatically increase the demand for electricity for cooling and heating, respectively, as opposed to the softening effect of more moderate temperatures. Our electric revenues are sensitive to the summer cooling season and, to a lesser extent, the winter heating season. Similarly, very cold temperatures can dramatically increase the demand for gas for heating. A significant portion of our gas system demand is driven by heating. Extreme summer conditions or storms may stress electric transmission and distribution systems, resulting in increased maintenance costs and limiting the ability to meet peak customer demand.

We are affected by economic activity within our service area.

Higher levels of development and business activity generally increase the numbers of customers and their use of electricity and gas. Likewise, periods of recessionary economic conditions generally adversely affect our results of operations.

Our ability to manage our purchased power costs is influenced by a number of uncontrollable factors.

We are exposed to additional purchased power costs to the extent that our power needs cannot be fully covered by the supplies available from our existing facilities and contractual arrangements. Those needs, and our costs, could be affected by:

•

Increased demand due to, for example, weather, customer growth, or customer obligations,

•

The inability to transmit our contracted power from its generation source to our customers due to transmission line constraints, outages, or equipment failures,

•

Reductions in the availability of power from our owned or contracted generation sources due to equipment failures, shortages of fuel or environmental limitations on operations, and

•

Failure to perform on the part of any party from which we purchase capacity or energy.

An unexpected change in demand or the availability of generation or transmission facilities can expose us to increased costs of sourcing electricity in the short-term market where pricing may be more volatile.

Our financial performance depends on the equipment and facilities in our distribution system being operational.operational.

Weather conditions, accidents, catastrophic events, and failures of equipment or facilities can disrupt or limit our ability to deliver electricity and gas. Efforts to repair or replace equipment and facilities may not be successful, or we may be unable to make the necessary improvements to our distribution system, causing service interruptions. The resulting interruption of services could result in lost revenues and additional costs.

We face construction risk in connection with the completion of generating units.

We have assumed risks under the agreements related to our ownership interest in two 615 MW coal-fired generating units being constructed in Oak Creek, Wisconsin. The completion of this project is subject to construction risks over which we will have limited or no control and which might adversely affect project costs and completion time. These risks include shortages of,but are not limited to the inability to obtain, or the cost of, labor or materials; the inabilityfailure of the general contractor or subcontractors to perform under their contracts; strikes; adverse weather conditions; the inability to obtain necessary permits in a timely manner, legal challenges and appeals to granted permits, including the WPDES permit, and changes in applicable laws or regulations; governmental actions; and events in the global economy. In addition, in the case of the units being constructed in Oak Creek, if the units' final construction costs exceed the fixed costs allowed in the PSCW order, this excess will not be recoverable from MGE or its customers unless specifically allowed by the PSCW. Any Oak Creek project costs above the authorized amount, but below a 5% cap, will be subject to a prudence determination made by the PSCW.

In December 2008, we received notice from Elm Road Services, LLC (ERS) that it had received a letter from Bechtel Power Corporation (Bechtel) containing Bechtel's formal claim for schedule and cost relief on the construction of the Elm Road units. Bechtel has asserted two claims for cost and schedule relief in its letter to ERS. Although ERS is in the process of analyzing the claims and its responses to them, it has stated its belief that both claims are without merit. It has also stated its view that the only circumstances and events for which the Elm Road units owners currently retain price adjustment risk under the construction contract are force majeure, wage escalation in excess of 4% annually as measured by published wage bulletins, delays caused by ERS, changes in scope or performance requested by ERS, and unforeseen sub-surface ground conditions. ERS has invoked the dispute resolution process provided for in the contract in order to address the claims made by Bechtel under the contract. That process involves an informal resolution process, followed by mediation and then binding arbitration. ERS is currently in the mediation phase with respect to determining the rights of the parties under the contract and the disposition of Bechtel's claims. ERS has expressed its inability to predict the length or ultimate outcome of the claims. As a result, we are unable to predict the results of these claims or their effect on the costs recoverable under the existing facility leases, in the event that the outcome of the claims should cause total construction costs of the Elm Road units to exceed the amounts authorized in the PSCW order. Bechtel continues to target an in-service date for Elm Road unit 1 three months beyond the guaranteed contract date of September 29, 2009, and an in-service date for Elm Road unit 2 one month earlier than the guaranteed contract date of September 29, 2010. However, Bechtel does request schedule relief that would result in six months of relief from liquidated damages beyond the guaranteed contract date for unit 1 and three months of relief from liquidated damages beyond the guaranteed contract date for unit 2. See Footnote 21 for additional information.

Financial Risk

We are exposed to commodity price risk relating to our purchases of natural gas, electricity, coal and oil.

We face commodity price risk exposure with respect to our purchases of natural gas, electricity, coal and oil, SO₂ allowances and risk through our use of derivatives, such as futures, forwards and swaps, to manage that commodity price risk. We could experience increased costs as a result of volatility in the market values of those commodities. We could also experience losses on our derivative contracts as a result of that market value volatility or if a counterparty fails to perform under a contract. In the absence of actively quoted market prices and pricing information from external sources, the valuation of these derivative contracts involves our exercise of judgment and use of estimates. As a result, changes in the underlying assumptions or use of alternative valuation methods could affect the reported fair value of these contracts.

We are exposed to interest rate risk.

We are exposed to interest rate risk on our variable rate financing. MGE Energy had $103.5$124.5 million of variable-rate debt outstanding at December 31, 2007,2008, including $61.0$51.0 million for MGE. Borrowing levels under commercial paper arrangements vary from period to period depending upon capital investments and other factors. Such interest rate risk means that we are exposed to increased financing costs and associated cash payments as a result of changes in the short-term interest rates. Also, interest rates affect discount rates which are a key assumption for our defined benefit pension plans and may impact the amount of expense and timing of contributions to the plan.

Market performance affects our employee benefit plan asset values.

The performance of the capital markets affects the values of the assets that are held in trust to satisfy the future obligations under our pension and postretirement benefit plans. We have significant obligations in these areas and hold significant assets in these trusts. A decline in the market value of those assets may increase our current and longer-term funding requirements for these obligations. The market value of the investments within the employee benefit plans trusts declined by approximately 27.5% during the twelve months ended December 31, 2008. Changes in the value of trust fund assets may affect the level of required contributions to these trusts to meet benefit obligations. Changes in the value of plan assets did not have an impact on the income statement for 2008; however, reduced benefit plan assets could result in increased benefit costs in future years and may increase the amount and accelerate the timing of required future funding contributions.

We are exposed to credit risk primarily through our regulated energy business.

Credit risk is the loss that may result from counterparty nonperformance. We face credit risk primarily through MGE's regulated energy business. Failure of contractual counterparties to perform their obligations under purchase power agreements, commodity supply arrangements or other agreements may result in increased expenses for MGE as a result of being forced to cover the shortfall in the spot or short-term market, where prices may be more volatile.

As a holding company, we are dependent on upstream cash flows from our subsidiaries for the payment of dividends on our common stock.

As a holding company, we have no operations of our own, our ability to pay dividends on our common stock is dependent on the earnings and cash flows of our operating subsidiaries and their ability to pay upstream dividends or to repay funds to us. Prior to funding us, our subsidiaries have financial obligations that must be satisfied, including among others, debt service and obligations to trade creditors, and are subject to contractual and regulatory restrictions on the payment of dividends.

Disruptions in the financial markets as a result of the effects of sub-prime financing and related matters may affect our ability to finance at a reasonable cost and in accordance with our planned schedule.

The credit markets have experienced some disruption and uncertainty as a result of the developments associated with sub-prime mortgage issues. To the extent that such issues affect the ability or willingness of credit providers or investors to participate in the credit markets or particular types of investments, or affect their perception of the risk associated with particular types of investments, our cost of borrowing could be affected.

General economic conditions may affect our operating revenues, our capital costs and our counterparty risks.

Operational

MGE Energy's and MGE's operations are affected by local, national and worldwide economic conditions. The consequences of a prolonged recession may include a lower level of economic activity, uncertainty regarding energy prices and the capital and commodity markets, and increased credit risk. A lower level of economic activity might result in a decline in energy consumption, which may adversely affect our revenues and future growth. Increased credit risk reflects the risk that our retail customers will not pay their bills in a timely manner or at all, which may lead to a reduction in liquidity and an eventual increase in bad debt expense. 

Liquidity

Long-term instability in the financial markets, as a result of recession or otherwise, also may affect the cost of capital and our ability to raise capital. Although MGE Energy and MGE believe they have sufficient liquidity despite the disruption of capital and credit markets, the costs of such funds may increase.

Counterparty creditworthiness

Credit risk also includes the risk that trading counterparties that owe us money or product will breach their obligations. MGE's risk management policy is to limit transactions to a group of high quality counterparties. Should the counterparties to these arrangements fail to perform, we may be forced to enter into alternative arrangements. In that event, our financial results could be adversely affected and we could incur losses.

Item 1B. Unresolved Staff Comments.

MGE Energy and MGE

None.

Item 2. Properties.

Electric Generation

Net generating capabilitysummer rated capacity in service at December 31, 2007,2008, was as follows:

(1)

Baseload generation. Net summer rated capacity is determined by annual testing and may vary from year to year as a result of, but not limited to, the operating and physical conditions of the units.

(2) Baseload generation.

(3) MGE's 22% share of two 512-MW units. The other owners are Alliant,WPL (a subsidiary of Alliant), which operates Columbia, and WPSC.

(3)

(4) On January 19, 2006, MGE announced that it would cease coal-fired generation at Blount in 2011, subject to certain conditions, including regulatory approvals.

(4)

(5) Facility is jointly owned. MGE Power West Campus owns a controlling interest in the electric generation plant and the UW owns a controlling interest in the chilled-water and steam plants. MGE leases the electric generating assets owned by MGE Power West Campus and is responsible for operating the facility. Amounts shown represent MGE's share of the net capability.summer rated capacity.

(5)

(6) Based on the terms of the joint plant agreement between MGE and the UW, the UW has the ability to reduce net capability of these units by approximately 27 MW in the winter and approximately 17 MW in the summer. The net summer rated capacity shown reflects this decrease.

(7) Nameplate capacity rating is 11MW.

(8) Nameplate capacity rating is 30 MW.

(9) These facilities are owned by MGE.

Electric and Gas Distribution Facilities

Major electric distribution lines and substations in service at December 31, 2007,2008, which are owned by MGE, are as follows:

Gas facilities include 2,3982,427 miles of distribution mains, which are owned by MGE.

A significant portion of MGE's electric and gas distribution facilities is located above or underneath highways, streets, other public places or property that others own. MGE believes that it has satisfactory rights to use those places or property in the form of permits, grants, easements and licenses; however, it has not necessarily undertaken to examine the underlying title to the land upon which the rights rest.

Transmission FacilitiesEncumbrances

As required by Wisconsin law,The principal plants and properties of MGE are subject to the lien of its Indenture of Mortgage and other Wisconsin electric utilities transferred their electric transmission assets to ATC onDeed of Trust dated as of January 1, 2001. 1946, as amended and supplemented, under which MGE's first mortgage bonds are issued. As of December 31, 2008, there were $1.2 million of first mortgage bonds outstanding. See Footnote 9d for additional information regarding MGE's first mortgage bonds.

MGE received an ownership interestPower West Campus has collaterally assigned its right to lease payments from MGE for the WCCF in ATC in exchange for its transmission plant and related deferred taxes and deferred investment tax credits. That interest is presently heldorder to secure the repayment of $50 million of senior secured notes issued by MGE Transco. MGE receives a return on its investment in ATC that is approximately equal to the return it would have earned by retaining its transmission facilities.Power West Campus. See Footnote 9c for additional information regarding these senior notes.

Item 3. Legal Proceedings.

MGE Energy and MGE

MGE Energy and its subsidiaries, including MGE, from time to time are involved in various legal proceedings that are handled and defended in the ordinary course of business. While MGE Energy and MGE are unable to predict the outcome of these matters, management does not believe, based upon currently available facts, that the ultimate resolution of any of such proceedings would have a material adverse effect on their overall financial condition or results of operations.

Also see "Environmental" under Item 1, Business, and Footnotes 18d and 18i for a description of several environmental proceedings involving MGE.

Item 4. Submission of Matters to a Vote of Security Holders.

MGE Energy and MGE

None.

PART II.

Item 5. Market for Registrants' Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

Market for Common Equity

MGE Energy

MGE Energy common stock is traded on Nasdaq under the symbol MGEE. On February 1, 2008,2009, there were approximately 18,48035,475 shareholders of record.record, including registered and beneficial shareholders. The following table shows high and low sale prices for the common stock on Nasdaq for each quarter over the past two years.

MGE

As of February 1, 2008,2009, there were 17,347,889 outstanding shares of common stock, all of which were held by MGE Energy. There is no market for shares of common stock of MGE.

Dividends

MGE Energy

The following table sets forth MGE Energy's quarterly cash dividends declared during 20072008 and 2006:2007:

MGE

The following table sets forth MGE's quarterly cash dividends declared during 20072008 and 2006:2007:

See discussion below as well as the "Liquidity and Capital Resources - Financing Activities" under Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, for a description of restrictions applicable to dividend payments by MGE.

Dividend Restrictions

Dividend payments by MGE to MGE Energy are subject to restrictions arising under a PSCW rate order and, to a lesser degree, MGE's first mortgage bonds. The PSCW order limits the amount of dividends that MGE may pay MGE Energy when its common equity ratio, calculated in the manner used in the rate proceeding, is less than 55%. Under those circumstances, MGE may not pay dividends in excess of $26.8 million plus dividends on shares issued in excess of the shares issued in the rate proceeding forecast if the proceeds are invested in MGE. MGE's 13-month rolling average common equity ratio at December 31, 2008, is estimated to be 50.4% as determined under the calculation used in the rate proceeding. While MGE was not restricted from paying cash dividends in 2008, in order to build additional common stock equity in MGE, no cash dividends were paid to MGE Energy. The rate proceeding calculation includes as indebtedness imputed amounts for MGE's outstanding purchase power capacity payments and other PSCW adjustments, but does not include the indebtedness associated with MGE Power West Campus, which is consolidated in accordance with FIN 46(R) into MGE's financial statements.

MGE has covenanted with the holders of its first mortgage bonds not to declare or pay any dividend or make any other distribution on or purchase any shares of its common stock unless, after giving effect thereto, the aggregate amount of all such dividends and distributions and all amounts applied to such purchases, after December 31, 1945, shall not exceed the earned surplus (retained earnings) accumulated subsequent to December 31, 1945. As of December 31, 2008, approximately $218.7 million was available for the payment of dividends under this covenant.

Issuer Purchases of Equity Securities

MGE Energy and MGE

None.

Item 6. Selected Financial Data.

MGE Energy

(In thousands, except per-share amounts)

*Includes current maturities.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

General

MGE Energy is aan investor-owned public utility holding company operating through subsidiaries in five business segments: electric

·

Electric utility operations, gasconducted through MGE,

·

Gas utility operations, nonregulatedconducted through MGE,

·

Nonregulated energy operations, transmissionconducted through MGE Power and its subsidiaries,

·

Transmission investments, representing our equity investment in ATC, and

·

All other, which includes corporate operations and all other. services as well as certain construction services.

Our principal subsidiary is MGE, which conducts ourgenerates and distributes electric utility andenergy, distributes natural gas, utility operations and represents a majority portion of our assets, liabilities, revenues, and expenses. MGE generates and distributes electricity to nearly 136,000approximately 137,000 customers in Dane County, Wisconsin, including the city of Madison, and purchases and distributes natural gas to nearly 140,000approximately 141,000 customers in the Wisconsin counties of Columbia, Crawford, Dane, Iowa, Juneau, Monroe, and Vernon.

Our nonregulated energy operations have been formed to lease and own new electric generating capacity. Ourcapacity to assist MGE. The nonregulated energy operations include the leasingpartial ownership of thea cogeneration project on the UW-Madison campus. Our nonregulated energy operations also includecampus and an undivided 8.33% ownership interest in each of two 615 MW generating units being constructed in Oak Creek, Wisconsin. BothThese ownership interests are leased to MGE pursuant to long-term leases. MGE operates the cogeneration project, and a third party will operate the Oak Creek units. The ownership/leasing structure was adopted to capture some advantages under then applicable state regulatory guidelines for MGE's participation in these generation facilities. Due to the nature of MGE's participation in these facilities, the results of our nonregulated operations are included inalso consolidated into MGE's consolidated financial statements as a resultposition and results of theoperations under applicable accounting requirements of FIN 46R.

The transmission investment segment consists of our investment in ATC and the related equity earnings.

Our all other segment includes corporate operations and services, as well as certain construction services.standards.

Our primary focus today and for the foreseeable future is our core utility customers at MGE.MGE as well as creating long term value for shareholders. MGE continues to face the challenge of providing its customers with reliable power at competitive prices. MGE plans to meet this challenge by buildinginvesting in more efficient generation projects, including renewable energy sources. In the future, MGE will continue to focus on growing earnings while controlling operating and continuing its effortsfuel costs. MGE will continue to control its operational costs.maintain safe and efficient operations in addition to providing customer value. We believe it is critical to continue maintainingmaintain a strong credit standing andconsistent with financial strength in MGE as well as the parent company in order to accomplish these goals.

Overview

We earn our revenue and generate cash from operations by providing electric and natural gas utility services, including electric power generation and electric power and gas distribution. The earnings and cash flows from the utility business are sensitive to various external factors, including, but not limited to:

·

Weather, and its impact on customer sales of electricity and gas,

·

Economic conditions, including current business and financing conditions,

·

Regulation and regulatory issues,

·

Energy commodity prices,

·

Equity price risk pertaining to pension related assets,

·

Interest rates and our debt credit rating,

·

Environmental laws and regulations, including pending environmental rule changes,

·

Construction risk in connection with the Elm Road generating units,

and other factors listed in "Item 1A. Risk Factors."

For the year ended December 31, 2008, MGE Energy's earnings were $52.8 million or $2.38 per share compared to $48.8 million or $2.27 per share for the same period in the prior year. MGE's earnings for the year ended December 31, 2008, were $37.6 million compared to $37.1 million for the same period in the prior year.

That income was derived from our business segments as follows:

Our net income during 2008 primarily reflects the effects of the following factors:

·

A 3.4% increase in electric revenues, reflecting a 4.8% rate increase approved by the PSCW, effective January 1, 2008, offset by lower demand due to cooler summer weather and lower sales for resale due to decreased sales opportunities.

·

Higher gas revenues, reflecting a 14.8% increase in delivered retail gas volumes due to colder winter weather and a 2.8% rate increase approved by the PSCW, effective January 1, 2008, partially offset by a $1.3 million expense (excludes premium) in 2008 on a settlement of a weather hedge (heating degree day collar) as a result of the colder weather. The weather hedge obligated MGE to pay additional costs if the weather was colder than a prescribed ceiling or would have compensated MGE if weather was warmer than a prescribed floor.

·

Higher nonregulated energy revenues primarily attributable to higher carrying costs, due to the greater capital investment, recognized for the Elm Road project. Carrying costs during construction of the nonregulated energy projects, related to the equity portion, are recognized over the period of time the costs are recovered in rates.

·

A $0.7 million increase in earnings from our interest in ATC.

·

$2.9 million in earnings due to interdepartmental interest income recognized as a result of capitalized interest on the Elm Road project and gains on sales of certain investments.

Our income during 2007 primarily reflects the effects of the following factors:

·

A $15.6 million increase in electric revenues, reflecting in large part an increase in sales volumes, $5.6 million of electric revenues attributable to a fuel surcharge authorized by the PSCW in late April 2007 and in effect through the end of 2007, and an increase in sales for resale; partially offset by a $7.5 million, or 15.2%, increase in cost of fuel used for electric generation due to increased internal generation and an increase in the per-unit cost of fuel and, to a lesser degree, a $0.4 million, or 0.6%, increase in purchased power expense due to an increase in the per-unit-cost offset by a decrease in volume of power purchased. Additionally, the electric rates for the twelve months ended December 31, 2007, were higher in comparison to those for the same period in the prior year, which reflected a $19.1 million reduction ordered as a result of a PSCW reconciliation between MGE's lower actual fuel costs during 2006, than those costs provided in the applicable rate order.

·

A $12.7 million increase in gas revenues attributable to increased sales volumes, partially offset by a decline in the costs of gas, which are recovered and included in revenues, and a decrease in other gas revenues. The cost of gas sold increased $11.5 million as a result of an increase in volumes and an increase in the per therm cost.

During 2008, the following events occurred:

·

Top of Iowa III wind generation project: The construction was completed, and the project was placed in service, during the first quarter of 2008. As of December 31, 2008, MGE has incurred approximately $56 million of costs on the 30 MW wind-powered electric generating facility located in Iowa.

·

Elm Road electric generation construction project: Capital expenditures during 2008 totaled $49.9 million. A modified WPDES permit for the project, which had been the subject to legal challenges, was issued in final form, with no substantive changes from the previously issued draft permit, and has now become final. In connection with the resolution of that permit issuance, the Elm Road joint owners entered into a settlement agreement whereunder they committed to various environmental projects, including projects designed to address greenhouse gas emissions and water quality. See Footnote 21d for further information. Also, on December 23, 2008, the project contractor notified the project operator of its claims for additional costs and schedule relief related to severe weather and specified labor-related matters, in the case of one claim, and the alleged effects of operator-directed changes and operator-caused delays, in the case of the other claim. MGE Energy's share of the increased costs, if the claims are sustained in full, would be $34.4 million and $6.0 million, respectively. See Footnote 21a for more information.

·

ATC: MGE Transco contributed $3.4 million for voluntary capital contributions to ATC in the year ended December 31, 2008. An additional voluntary capital contribution of $0.9 million was made in January 2009.

·

Additional Lines of Credit: MGE Energy and MGE each added revolving lines of credit in order to provide additional access to liquidity should such access be needed. On August 29, 2008 and December 30, 2008, MGE Energy entered into additional revolving lines of credit expiring August 28, 2009 and September 30, 2009, respectively, each for $20 million. On August 29, 2008, MGE entered into a $20 million additional line of credit expiring March 31, 2009.

·

Issuance of Securities: MGE Energy issued 954,238 shares of its common stock under the Stock Plan for net proceeds of $31.0 million. On September 11, 2008, MGE issued $40 million of unsecured 5.59% senior notes due September 11, 2018, the proceeds of which were used to repay $30 million of its 6.02% medium-term notes that matured on September 15, 2008 and $10 million of short-term indebtedness consisting of commercial paper.

During 2009, several items may affect us, including:

·

General economic conditions: Economic conditions both inside and outside our service area may affect, among other things, the level of demand for our utility services, the collection of our accounts receivable and the creditworthiness of counterparties with whom we do business. We have in place lines of credit aggregating $195 million for MGE Energy (including MGE) and $75 million for MGE to address our liquidity needs.

·

Elm Road Construction Claim: As noted, the project contractor for the Elm Road units has made claims for additional costs and for relief from the construction schedule. The project operator, ERS, is addressing these claims, although it is expected that the claims may ultimately be resolved through formal arbitration as provided in the construction contract.

·

Environmental Initiatives: Various environmental rules or initiatives are in a state of flux as a result of court decisions and the change in the Presidential Administration. Such rules and initiatives involve matters related to air emissions, water effluent and greenhouse gases, all of which affect generation plant capital expenditures and operating costs as well as future operational planning.

The following discussion is based on the business segments as discussed in Footnote 24.

Results of Operations

Year Ended December 31, 2008, Versus the Year Ended December 31, 2007

Electric Utility Operations - MGE Energy and MGE

Electric sales and revenues

The following table compares MGE's electric revenues and electric kWh sales by customer class for each of the periods indicated:

Electric operating revenues increased $11.5 million or 3.4% for the year ended December 31, 2008, due to the following:

Rates changes. Rates charged to retail customers for the year ended December 31, 2008, were 7.8% or $25.7 million higher than those charged during the same period in the prior year. This increase includes the 4.8% rate increase by the PSCW as well as the surcharge described below.

On December 14, 2007, the PSCW authorized MGE to increase 2008 electric revenue by $16.2 million to cover costs for MGE's new wind energy projects, statewide energy efficiency and renewable energy programs, transmission improvements by ATC, and accelerated costs to discontinue coal use at the Blount Station.

On May 5, 2008, the PSCW approved a $0.00239 per kWh interim fuel surcharge on MGE's electric rates to cover increased fuel and purchased power expenses. During the year ended December 31, 2008, this surcharge resulted in a $5.1 million increase to electric rates. A stipulation between MGE and the intervenors allowed the interim surcharge to remain in effect until the end of the year, but required MGE to review its 2008 monitored fuel costs at year-end and to refund to customers, with interest at 10.8%, any amount by which its actual fuel costs fell short of the monitored fuel costs collected in rates. See "Other revenues" below.

On April 24, 2007, when the PSCW completed their audit of 2006 electric fuel costs and issued a final order on the 2006 fuel credit, $2.4 million (related to 2006 fuel costs and including interest) was applied to customers' accounts.

Electric rates from April 26, 2007 to August 31, 2007, were subject to a $0.00339 per kWh interim fuel surcharge and subject to refund. On August 31, 2007, MGE received a final decision from the PSCW that reduced the fuel surcharge to $0.00242 per kWh effective the date of the order. This fuel surcharge resulted in a $5.6 million increase to electric rates charged to customers during the twelve months ended December 31, 2007.

On December 18, 2008, under a limited reopener, the PSCW authorized MGE to decrease 2009 rates for retail electric customers by 0.74% or $2.7 million from 2008. The decrease in retail electric rates is driven by a decrease in fuel and purchased power costs, decrease in Elm Road costs and a decrease in ATC transmission costs. The PCSW also approved deferred accounting for incremental pension and other postretirement benefit costs above the levels currently included in rates.

Volume. During the year ended December 31, 2008, total retail sales volumes were comparable to the same period in the prior year. Higher usage by other-retail/municipal customers was offset by a decline in residential, commercial and industrial usage.

Sales for resale. Sales for resale represent wholesale sales made to third parties who are not ultimate users of the electricity. These sales may include spot market transactions on the markets operated by MISO or PJM. These sales may also include bilateral sales to other utilities or power marketers. Generating units are dispatched by MISO based on cost considerations as well as reliability of the system. Sales for resale typically occur when MGE has more generation and purchases online than is needed for its own system demand. The excess electricity is then sold to others in the market. For the year ended December 31, 2008, sales for resale decreased $1.8 million when compared to the same period in the prior year. The decrease is primarily due to increased natural gas costs. During 2008, natural gas prices increased fairly rapidly until July before returning to previous levels. Electric prices on the MISO market did not experience the same price movement. MGE's sales for resale into the MISO market were lower as a result of the higher cost of gas fired generation relative to the market prices of electricity.

Other revenues. Other electric revenues decreased $10.6 million for the year ended December 31, 2008, compared to the same period in the prior year.

During the years ended December 31, 2008 and 2007, MGE recovered in electric rates carrying costs and other fees related to WCCF and Elm Road. During the years ended December 31, 2008 and 2007, MGE recorded a $11.0 million and $8.2 million reduction, respectively, to other electric revenues to transfer the revenues from the electric segment to the nonregulated energy operations segment. See discussion of these revenues in the "nonregulated energy operating revenues" section.

As a result of the refund provisions in the interim fuel surcharge order, MGE has recognized an estimated refund to customers totaling $5.5 million (includes interest) during the year ended December 31, 2008 and has reflected this reduction in other electric revenues.

During the year ended December 31, 2007, other electric revenues included a $2.3 million (excludes interest) upward adjustment to negate the impact on overall electric revenues for the 2006 fuel refund provided to customers in April 2007. Note that this refund was accrued in revenues during 2006, and was returned to customers via a reduction in rates in April 2007. See "Rate changes" above for more information on this refund.

Electric fuel and purchased power

The expense for fuel used for electric generation decreased $1.9 million or 3.4% during the year ended December 31, 2008, compared to the same period in the prior year. Lower fuel costs between the two periods resulted in a $1.5 million decrease of this expense and a decline in internal generation resulted in a $0.4 million decrease of this expense.

Purchased power expense decreased by $2.9 million or 3.8% during the year ended December 31, 2008, compared to the same period in the prior year. This decrease in expense reflects a $1.1 million or 1.5% decrease in the per-unit cost of purchased power and a $1.8 million or 2.3% decrease in the volume of power purchased.

Electric operating and maintenance expenses

Electric operating and maintenance expenses increased $14.8 million during the year ended December 31, 2008, compared to the same period in 2007. The following changes contributed to the net change:

As a result of the 2005 Wisconsin Act 141, each Wisconsin utility is required to pay 1.2% of its annual operating revenues to the statewide energy efficiency and renewable resource programs. MGE is allowed to recover these costs in rates through its conservation escrow. For the year ended December 31, 2008, costs associated with funding these programs increased customer service expense by $5.1 million. Transmission costs increased primarily due to network service fees pertaining to ATC.

Electric depreciation expense

Depreciation expense at the electric segment increased by $6.4 million for the year ended December 31, 2008, when compared to the same period in the prior year. This increase is related to higher levels of electric assets, including the Top of Iowa III wind-powered electric generating facility which was placed in service in the first quarter of 2008. Also contributing to the increase is the accelerated depreciation of certain Blount assets. For additional information on the Blount accelerated depreciation, see Footnote 19.

Gas Utility Operations - MGE Energy and MGE

Gas deliveries and revenues

The following table compares MGE's gas revenues and gas therms delivered by customer class during each of the periods indicated:

Gas revenues increased $44.7 million or 22.6% for the year ended December 31, 2008. These changes are related to the following factors:

Gas costs/rates. The average retail rate per therm for the year ended December 31, 2008, increased 6.2% compared to the same period in 2007. The PSCW authorized a 2.8% increase in MGE's gas distribution rates effective January 1, 2008, to cover increased system demands and funding statewide energy programs. Also contributing to this increase is higher natural gas costs.

Retail gas deliveries. The 14.8% increase in retail gas deliveries for the year ended December 31, 2008, was attributable to cooler than normal weather, reflected in an 11.3% increase in the heating degree days between the periods, and increased use by a large commercial/industrial customer.

Transportation and other revenues. Transportation and other revenues increased a total of $1.9 million primarily due to an increase in income realized under the GCIM.

Under MGE's GCIM, if actual gas commodity savings and capacity release revenues are above or below a benchmark set by the PSCW, then MGE's gas sales service customers and shareholders share in any increased costs or savings per percentages set by the PSCW. For the years ended December 31, 2008 and 2007, shareholders received the benefit of $2.4 million and $0.9 million, respectively, from capacity release revenues and commodity savings under the GCIM.

Cost of Gas Sold

For the year ended December 31, 2008, cost of gas sold increased by $30.7 million, compared to the same period in the prior year. The volume of gas purchased increased 13.4% which resulted in $18.9 million of additional expense. In addition, the cost per therm of natural gas increased 7.4% which resulted in $11.8 million of additional expense.

Gas operating and maintenance expenses

Gas operating and maintenance expenses increased $5.5 million for the year ended December 31, 2008, compared to the same period a year ago. The following changes contributed to the net change:

As a result of the 2005 Wisconsin Act 141, each Wisconsin utility is required to pay 1.2% of its annual operating revenues to the statewide energy efficiency and renewable resource programs. MGE is allowed to recover these costs in rates through its conservation escrow. For the year ended December 31, 2008, costs associated with funding these programs increased customer service expense by $3.6 million.

Gas depreciation expense

Gas depreciation expense increased $0.6 million for the year ended December 31, 2008, compared to the same period in the prior year.

Other Income (Deductions), Net

During the year ended December 31, 2008, the gas and electric segments incurred $1.7 million in other deductions. The other deductions included a $1.5 million expense for a heating degree day collar, $1.8 million in charitable contributions, a $0.3 million loss related to an equity investment and $0.1 million of net miscellaneous expenses. See Footnote 16 for further discussion of the HDD collar. These deductions were partially offset by income of $0.9 million in AFUDC-equity, a $0.3 million gain on the sale of property, and a $0.8 million gain on investments.

For the year ended December 31, 2007, the gas and electric segments recognized a total of $1.9 million in AFUDC-equity, $0.2 million in equity earnings from miscellaneous investments, and a $0.8 million gain on the sale of investments. This income was offset by $0.3 million in premium expense for a HDD collar, $2.1 million in charitable contributions, and $0.4 million in net miscellaneous expenses.

Interest Expense, Net

For the year ended December 31, 2008, total interest expense for the electric and gas segments increased $1.4 million when compared to the same period in the prior year. For the year ended December 31, 2008, there was a $0.5 million decrease in AFUDC-debt (which is an increase to interest expense), a $0.5 million increase in interest expense on long-term debt, and a $0.6 million increase in net miscellaneous interest expense. These increases in interest expense were offset by a $0.2 million decrease in interest expense on short-term debt.

Nonregulated Energy Operations - MGE Energy and MGE

Nonregulated energy operating revenues

Operating revenues from nonregulated energy operations increased $2.3 million for the year ended December 31, 2008, when compared to the same period in the prior year. Operating revenues from nonregulated energy operations for both the years ended December 31, 2008 and 2007 include $14.9 million in interdepartmental revenues related to a leasing arrangement between MGE and MGE Power West Campus which commenced on April 26, 2005. Upon consolidation, these interdepartmental revenues are eliminated.

MGE also received approval from the PSCW to collect carrying costs expected to be incurred by MGE Power Elm Road during construction of the Elm Road project. MGE estimates that the total carrying costs on the Elm Road project will be $61.3 million. A portion of this amount is being recognized over the period recovered in rates and a portion is being deferred and will be recognized over the period in which the facility is depreciated. For the years ended December 31, 2008 and 2007, MGE Power Elm Road recognized $6.4 million and $4.1 million, respectively, related to carrying costs on the Elm Road project.

Nonregulated energy interest expense, net

For the years ended December 31, 2008 and 2007, interest expense, net at the nonregulated energy operations segment was $2.6 million and $2.5 million, respectively. Interest expense at the nonregulated energy segment for both the years ended December 31, 2008 and 2007, includes $2.8 million in interest expense incurred on $50 million of long-term, fixed-rate borrowings at MGE Power West Campus.

Also included in the nonregulated interest expense is interdepartmental interest expense and capitalized interest at MGE Power Elm Road. During the year ended December 31, 2008 and 2007, MGE Power Elm Road was charged $4.8 million and $3.9 million, respectively, in interest expense by Corporate on funds borrowed for the Elm Road Project. This expense is eliminated upon consolidation for MGE Energy only. The interest expense at MGE Power Elm Road is offset by $4.8 million and $3.9 million, respectively, in capitalized interest. MGE Power Elm Road is capitalizing interest on the Elm Road project.

During the years ended December 31, 2008 and 2007, MGE Power Elm Road recorded $0.1 million and $0.2 million, respectively, in interest income on cash advanced to Elm Road Services, LLC for construction of transmission equipment and work done by ATC related to the Elm Road project.

Transmission Investment Operations - MGE Energy and MGE

For the years ended December 31, 2008 and 2007, other income at the transmission investment segment was $7.2 million and $6.0 million, respectively. The transmission investment segment holds our interest in ATC, and its income reflects our equity in the earnings of ATC.

All Other Nonregulated Operations - MGE Energy

All other - other income, net

The all other segment recorded $2.5 million in other income for the year ended December 31, 2008, primarily due to gains on sales of certain investments.

All other interest income, net

All other interest income, net for the years ended December 31, 2008 and 2007, was $2.8 million and $2.3 million, respectively. Interest income for the year ended December 31, 2008, represents $4.8 million in interdepartmental interest income from MGE Power Elm Road, partially offset by $2.0 million in interest expense on short-term debt. Interest income for the year ended December 31, 2007, represents $3.9 million in interdepartmental interest income from MGE Power Elm Road and $0.2 million in miscellaneous interest income, partially offset by $1.8 million in interest expense on short-term debt. The interdepartmental interest income is eliminated upon consolidation.

Consolidated Other General Taxes

MGE Energy's and MGE's other general taxes increased $1.0 million or 6.5% in 2008. This increase is primarily attributable to an increase in MGE's license fee tax. The annual license fee tax expense is based on adjusted operating revenues of the prior year.

Consolidated Income Taxes

MGE Energy's effective income tax rate for the year ended December 31, 2008, is 35.5% compared to 36.3% for the same period in 2007. This decrease is primarily attributable to the increased federal wind energy tax credit from the Top of Iowa III wind farm which was placed in service in 2008.

MGE's effective income tax rate for the year ended December 31, 2008, is 35.2% compared to 36.2% for the same period in the prior year. The decrease is also primarily attributable to the increased wind energy tax credit.

Minority Interest, Net of Tax

For the year ended December 31, 2008, MGE Energy (through its wholly owned subsidiary MGE Power) earned $7.6 million and $3.9 million, net of tax, for its interest in MGE Power West Campus and MGE Power Elm Road, respectively. Additionally, MGE Energy earned $0.8 million, net of tax for its interest in MGE Transco. These amounts are recorded as minority interest expense, net of tax, on MGE's consolidated statement of income.

For the year ended December 31, 2007, MGE Energy (through its wholly owned subsidiary MGE Power) had earned $7.7 million and $2.6 million, net of tax, for its interest in MGE Power West Campus and MGE Power Elm Road, respectively. Additionally, MGE Energy had earned $0.5 million, net of tax, for its interest in MGE Transco. These amounts are recorded as minority interest expense, net of tax, on MGE's consolidated statement of income.

Year Ended December 31, 2007, Versus the Year Ended December 31, 2006

Executive Summary- MGE Energy and MGE

In 2007, MGE Energy's earnings were $48.8 million or $2.27 per share compared to $42.4 million or $2.06 per share in the prior year. MGE's earnings for the twelve months ended December 31, 2007, were $37.1 million compared to $32.6 million for the same period in the prior year.

During the twelve month period ended December 31, 2007, our utility operations experienced an increase in electric revenues of $15.6 million. This increase is primarily attributable to an increase in sales volumes, the effect of a fuel surcharge and an increase in sales for resale. Additionally, the electric rates for the twelve months ended December 31, 2007, are higher than those for the same period in the prior year, when the fuel credit and refund in effect during the twelve months ended December 31, 2006, are considered. As a result of lower actual fuel costs during the twelve months ended December 31, 2006, than those costs provided in the applicable rate order, the PSCW issued an interim order implementing a $0.00454 per kWh fuel credit. Additionally, the PSCW stated that MGE's electric rates set in the final order were subject to refund, together with interest, pending a full review of MGE's 2006 actual electric fuel costs. As a result of these actions, MGE recognized an obligation to make refunds to its customers by recording a $19.1 million gross reduction to other electric revenues during the twelve months ended December 31, 2006.

For the twelve months ended December 31, 2007, fuel used for electric generation increased $7.5 million or 15.2% compared to the twelve months ended December 31, 2006. This increase is attributable to an increase in the volume of internal generation and an increase in the per-unit cost of fuel. During this same period, purchased power expense increased by $0.4 million or 0.6%. This increase is attributable to an increase in the per-unit-cost offset by a decrease in volume of power purchased.

On April 26, 2007, the PSCW approved a $0.00339 per kWh fuel surcharge on MGE's electric rates to cover increased fuel and purchased power expenses. The fuel surcharge was applied to electric rates as of the date of the PSCW order. On August 31, 2007, MGE received a final decision from the PSCW which reduced the fuel surcharge to $0.00242 per kWh. This fuel surcharge went into place on the date of the order and remained in place until December 31, 2007. These surcharges resulted in a $5.6 million increase in electric revenue for the twelve months ended December 31, 2007. Pursuant to the provisions of the April 26, 2007, surcharge order, MGE's electric revenues resulting from this surcharge were subject to refund and interest at 11%. During the twelve months ended December 31, 2007, MGE recorded a $1.3 million adjustment to other electric revenue to account for the refund provision. This refund amount was applied to customers' accounts on October 6, 2007.

During the twelve months ended December 31, 2007, gas revenues increased $12.7 million. This increase is a result of increases in sales volumes, partially offset by a decline in the costs of gas and a decrease in other gas revenues. During this period, natural gas purchased increased $11.5 million as a result of an increase in volumes and an increase in the per therm cost.

The following discussion is based on the business segments as discussed in Footnote 24.

Electric Utility Operations

Electric sales and revenues

The following table compares MGE's electric retail revenues and electric kWh sales by customer class during the years ended December 31, 2007 and 2006: