AMERICAN ELECTRIC POWER CO INC - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-K
---------------------------

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from -------------- to --------------

Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X . No.

Indicate by check mark if disclosure of delinquent filers with respect to
American Electric Power Company, Inc. pursuant to Item 405 of Regulation S-K
(229.405 of this chapter) is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

Indicate by check mark if disclosure of delinquent filers with respect to
Appalachian Power Company, Indiana Michigan Power Company or Ohio Power Company
pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not
contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements of Appalachian Power
Company or Ohio Power Company incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. X

Indicate by check mark whether American Electric Power Company, Inc. is an
accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of
1934). Yes X No __

Indicate by check mark whether AEP Generating Company, AEP Texas Central
Company, AEP Texas North Company, Appalachian Power Company, Columbus Southern
Power Company, Indiana Michigan Power Company, Kentucky Power Company, Ohio
Power Company, Public Service Company of Oklahoma and Southwestern Electric
Power Company are accelerated filers (as defined in Rule 12b-2 of the Securities
Exchange Act of 1934). Yes __ No X

AEP Generating Company, AEP Texas North Company, Columbus Southern Power
Company, Kentucky Power Company and Public Service Company of Oklahoma meet the
conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and are
therefore filing this Form 10-K with the reduced disclosure format specified in
General Instruction I(2) to such Form 10-K.

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

NOTE ON MARKET VALUE OF COMMON EQUITY HELD BY NON-AFFILIATES

American Electric Power Company, Inc. owns, directly or indirectly, all of
the common stock of AEP Generating Company, AEP Texas Central Company, AEP Texas
North Company, Appalachian Power Company, Columbus Southern Power Company,
Indiana Michigan Power Company, Kentucky Power Company, Ohio Power Company,
Public Service Company of Oklahoma and Southwestern Electric Power Company (see
Item 12 herein).

DOCUMENTS INCORPORATED BY REFERENCE

------------------

THIS COMBINED FORM 10-K IS SEPARATELY FILED BY AEP GENERATING COMPANY,
AEP TEXAS CENTRAL COMPANY, AEP TEXAS NORTH COMPANY, AMERICAN ELECTRIC POWER
COMPANY, INC., APPALACHIAN POWER COMPANY, COLUMBUS SOUTHERN POWER COMPANY,
INDIANA MICHIGAN POWER COMPANY, KENTUCKY POWER COMPANY, OHIO POWER COMPANY,
PUBLIC SERVICE COMPANY OF OKLAHOMA AND SOUTHWESTERN ELECTRIC POWER COMPANY.
INFORMATION CONTAINED HEREIN RELATING TO ANY INDIVIDUAL REGISTRANT IS FILED BY
SUCH REGISTRANT ON ITS OWN BEHALF. EXCEPT FOR AMERICAN ELECTRIC POWER COMPANY,
INC., EACH REGISTRANT MAKES NO REPRESENTATION AS TO INFORMATION RELATING TO THE
OTHER REGISTRANTS.

YOU CAN ACCESS FINANCIAL AND OTHER INFORMATION AT AEP'S WEBSITE. THE
ADDRESS IS WWW.AEP.COM. AEP MAKES AVAILABLE, FREE OF CHARGE ON ITS WEBSITE,
COPIES OF ITS ANNUAL REPORT ON FORM 10-K, QUARTERLY REPORTS ON FORM 10-Q,
CURRENT REPORTS ON FORM 8-K AND AMENDMENTS TO THOSE REPORTS FILED OR FURNISHED
PURSUANT TO SECTION 13(A) OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 AS
SOON AS REASONABLY PRACTICABLE AFTER FILING SUCH MATERIAL ELECTRONICALLY OR
OTHERWISE FURNISHING IT TO THE SEC.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

TABLE OF CONTENTS

GLOSSARY OF TERMS

The following abbreviations or acronyms used in this Form 10-K are defined
below:

ii

FORWARD-LOOKING INFORMATION
- --------------------------------------------------------------------------------

This report made by AEP and certain of its subsidiaries contains
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934. Although AEP and each of its subsidiaries believe that
their expectations are based on reasonable assumptions, any such statements may
be influenced by factors that could cause actual outcomes and results to be
materially different from those projected. Among the factors that could cause
actual results to differ materially from those in the forward-looking statements
are:

- Electric load and customer growth.

- Abnormal weather conditions

- Available sources and costs of fuels.

- Availability of generating capacity.

- The speed and degree to which competition is introduced to AEP's power
generation business.

- The ability to recover stranded costs in connection with
possible/proposed deregulation of generation.

- New legislation and government regulation

- Oversight and/or investigation of the energy sector or its participants.

- The ability of AEP to successfully control its costs.

- The success of acquiring new business ventures and disposing of existing
investments that no longer match AEP's corporate profile.

- International and country-specific developments affecting AEP's foreign
investments, including the disposition of any current foreign investments
and potential additional foreign investments.

- The economic climate and growth in AEP's service territory and changes in
market demand and demographic patterns.

- Inflationary trends.

- Electricity and gas market prices.

- Interest rates.

- Liquidity in the banking, capital and wholesale power markets.

- Actions of rating agencies.

- Changes in technology, including the increased use of distributed
generation within AEP's transmission and distribution service territory.

- Other risks and unforeseen events, including wars, the effects of
terrorism, embargoes and other catastrophic events.

1

PART I
- --------------------------------------------------------------------------------

Item 1. BUSINESS
- --------------------------------------------------------------------------------

GENERAL

OVERVIEW AND DESCRIPTION OF SUBSIDIARIES

AEP was incorporated under the laws of the State of New York in 1906 and
reorganized in 1925. It is a registered public utility holding company under
PUHCA that owns, directly or indirectly, all of the outstanding common stock of
its public utility subsidiaries and varying percentages of other subsidiaries.

The service areas of AEP's public utility subsidiaries cover portions of
the states of Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma,
Tennessee, Texas, Virginia and West Virginia. The generating and transmission
facilities of AEP's public utility subsidiaries are interconnected, and their
operations are coordinated, as a single integrated electric utility system.
Transmission networks are interconnected with extensive distribution facilities
in the territories served. The public utility subsidiaries of AEP, which do
business as "American Electric Power," have traditionally provided electric
service, consisting of generation, transmission and distribution, on an
integrated basis to their retail customers. Restructuring legislation in
Michigan, Ohio, Texas and Virginia has caused or will cause AEP public utility
subsidiaries in those states to unbundle previously integrated regulated rates
for their retail customers.

The AEP System is an integrated electric utility system and, as a result,
the member companies of the AEP System have contractual, financial and other
business relationships with the other member companies, such as participation in
the AEP System savings and retirement plans and tax returns, sales of
electricity and transportation and handling of fuel. The member companies of the
AEP System also obtain certain accounting, administrative, information systems,
engineering, financial, legal, maintenance and other services at cost from a
common provider, AEPSC.

At December 31, 2002, the subsidiaries of AEP had a total of 22,083
employees. AEP, because it is a holding company rather than an operating
company, has no employees. The public utility subsidiaries of AEP are:

APCo (organized in Virginia in 1926) is engaged in the generation,
transmission and distribution of electric power to approximately 925,000
retail customers in the southwestern portion of Virginia and southern West
Virginia, and in supplying and marketing electric power at wholesale to other
electric utility companies, municipalities and other market participants. At
December 31, 2002, APCo and its wholly owned subsidiaries had 2,520 employees.
Among the principal industries served by APCo are coal mining, primary metals,
chemicals and textile mill products. In addition to its AEP System
interconnections, APCo also is interconnected with the following unaffiliated
utility companies: Carolina Power & Light Company, Duke Energy Corporation and
Virginia Electric and Power Company. APCo has several points of
interconnection with TVA and has entered into agreements with TVA under which
APCo and TVA interchange and transfer electric power over portions of their
respective systems.

CSPCo (organized in Ohio in 1937, the earliest direct predecessor company
having been organized in 1883) is engaged in the generation, transmission and
distribution of electric power to approximately 689,000 retail customers in
Ohio, and in supplying and marketing electric power at wholesale to other
electric utilities, municipalities and other market participants. At December
31, 2002, CSPCo had 1,171 employees. CSPCo's service area is comprised of two
areas in Ohio, which include portions of twenty-five counties. One area
includes the City of Columbus and the other is a predominantly rural area in
south central Ohio. Among the principal industries served are food processing,
chemicals, primary metals, electronic machinery and paper products. In
addition to its AEP System interconnections, CSPCo also is interconnected with
the following unaffiliated utility companies: CG&E, DP&L and Ohio Edison
Company.

I&M (organized in Indiana in 1925) is engaged in the generation,
transmission and distribution of electric power to approximately 571,000
retail customers in northern and eastern Indiana and southwestern Michigan,
and in supplying and marketing electric power at wholesale to other electric
utility companies, rural electric cooperatives, municipalities and other
market participants. At December 31, 2002, I&M had 2,667 employees. Among the
principal industries served are primary metals, transportation equipment,
electrical and electronic

2

machinery, fabricated metal products, rubber and miscellaneous plastic
products and chemicals and allied products. Since 1975, I&M has leased and
operated the assets of the municipal system of the City of Fort Wayne,
Indiana. In addition to its AEP System interconnections, I&M also is
interconnected with the following unaffiliated utility companies: Central
Illinois Public Service Company, CG&E, Commonwealth Edison Company, Consumers
Energy Company, Illinois Power Company, Indianapolis Power & Light Company,
Louisville Gas and Electric Company, Northern Indiana Public Service Company,
PSI Energy Inc. and Richmond Power & Light Company.

KPCo (organized in Kentucky in 1919) is engaged in the generation,
transmission and distribution of electric power to approximately 174,000
retail customers in an area in eastern Kentucky, and in supplying and
marketing electric power at wholesale to other electric utility companies,
municipalities and other market participants. At December 31, 2002, KPCo had
412 employees. In addition to its AEP System interconnections, KPCo also is
interconnected with the following unaffiliated utility companies: Kentucky
Utilities Company and East Kentucky Power Cooperative Inc. KPCo is also
interconnected with TVA.

Kingsport Power Company (organized in Virginia in 1917) provides electric
service to approximately 46,000 retail customers in Kingsport and eight
neighboring communities in northeastern Tennessee. Kingsport Power Company
does not own any generating facilities. It purchases electric power from APCo
for distribution to its customers. At December 31, 2002, Kingsport Power
Company had 57 employees.

OPCo (organized in Ohio in 1907 and re-incorporated in 1924) is engaged
in the generation, transmission and distribution of electric power to
approximately 702,000 retail customers in the northwestern, east central,
eastern and southern sections of Ohio, and in supplying and marketing electric
power at wholesale to other electric utility companies, municipalities and
other market participants. At December 31, 2002, OPCo had 1,988 employees.
Among the principal industries served by OPCo are primary metals, rubber and
plastic products, stone, clay, glass and concrete products, petroleum refining
and chemicals. In addition to its AEP System interconnections, OPCo also is
interconnected with the following unaffiliated utility companies: CG&E, The
Cleveland Electric Illuminating Company, DP&L, Duquesne Light Company,
Kentucky Utilities Company, Monongahela Power Company, Ohio Edison Company,
The Toledo Edison Company and West Penn Power Company.

PSO (organized in Oklahoma in 1913) is engaged in the generation,
transmission and distribution of electric power to approximately 505,000
retail customers in eastern and southwestern Oklahoma, and in supplying and
marketing electric power at wholesale to other electric utility companies,
municipalities, rural electric cooperatives and other market participants. At
December 31, 2002, PSO had 998 employees. Among the principal industries
served by PSO are natural gas and oil production, oil refining, steel
processing, aircraft maintenance, paper manufacturing and timber products,
glass, chemicals, cement, plastics, aerospace manufacturing,
telecommunications, and rubber goods. In addition to its AEP System
interconnections, PSO also is interconnected with Ameren Corporation, Empire
District Electric Co., Oklahoma Gas & Electric Co., Southwestern Public
Service Co. and Westar Energy Inc.

SWEPCo (organized in Delaware in 1912) is engaged in the generation,
transmission and distribution of electric power to approximately 437,000
retail customers in northeastern Texas, northwestern Louisiana and western
Arkansas, and in supplying and marketing electric power at wholesale to other
electric utility companies, municipalities, rural electric cooperatives and
other market participants. At December 31, 2002, SWEPCo had 1,372 employees.
Among the principal industries served by SWEPCo are natural gas and oil
production, petroleum refining, manufacturing of pulp and paper, chemicals,
food processing, and metal refining. The territory served by SWEPCo also
includes several military installations, colleges, and universities. In
addition to its AEP System interconnections, SWEPCo is also interconnected
with CLECO Corp., Empire District Electric Co., Entergy Corp. and Oklahoma Gas
& Electric Co.

TCC (organized in Texas in 1945) is engaged in the generation,
transmission and sale of power to affiliated and non-affiliated entities and
the distribution of electric power to approximately 689,000 retail customers
through REPs in southern Texas, and in supplying and marketing electric power
at wholesale to other electric utility companies, municipalities, rural
electric cooperatives and other market

3

participants. At December 31, 2002, TCC had 1,248 employees. Among the
principal industries served by TCC are oil and gas extraction, food
processing, apparel, metal refining, chemical and petroleum refining,
plastics, and machinery equipment. In addition to its AEP System
interconnections, TCC is a member of ERCOT.

TNC (organized in Texas in 1927) is engaged in the generation,
transmission and sale of power to affiliated and non-affiliated entities and
the distribution of electric power to approximately 189,000 retail customers
through REPs in west and central Texas, and in supplying and marketing
electric power at wholesale to other electric utility companies,
municipalities, rural electric cooperatives and other market participants. At
December 31, 2002, TNC had 595 employees. The principal industry served by TNC
is agriculture. The territory served by TNC also includes several military
installations and correctional facilities. In addition to its AEP System
interconnections, TNC is a member of ERCOT.

Wheeling Power Company (organized in West Virginia in 1883 and
reincorporated in 1911) provides electric service to approximately 41,000
retail customers in northern West Virginia. Wheeling Power Company does not
own any generating facilities. It purchases electric power from OPCo for
distribution to its customers. At December 31, 2002, Wheeling Power Company
had 59 employees.

AEGCo (organized in Ohio in 1982) is an electric generating company.
AEGCo sells power at wholesale to I&M and KPCo. AEGCo has no employees.

Service Company Subsidiary

AEP also owns a service company subsidiary, AEPSC. AEPSC provides
accounting, administrative, information systems, engineering, financial, legal,
maintenance and other services at cost to the AEP System companies. The
executive officers of AEP and its public utility subsidiaries are all employees
of AEPSC. At December 31, 2002, AEPSC had 6,548 employees.

CLASSES OF SERVICE
The principal classes of service from which the public utility subsidiaries
of AEP derive revenues and the amount of such revenues during the year ended
December 31, 2002 are as follows:

- ---------------

(a) Includes revenues of other subsidiaries not shown. Intercompany transactions
have been eliminated, including AEGCo's total revenues of $213,281,000 for
the year ended December 31, 2002, all of which resulted from its wholesale
business, including its marketing and trading of power.

REGULATION

Except for retail generation sales in Ohio, Virginia and the ERCOT area of
Texas, AEP's public utility subsidiaries' retail rates and certain other matters
are subject to traditional regulation by the state utility commissions. Retail
sales in Michigan, while still regulated, are now made at unbundled rates. Other
states in AEP's service territory have also passed restructuring legislation
that has not been implemented or has been repealed. See Electric Restructuring
and Customer Choice Legislation and Energy Delivery--Regulation--Rates. AEP's
subsidiaries are also subject to regulation by the FERC under the FPA. I&M and
TCC are subject to regulation by the NRC under the Atomic Energy Act of 1954, as
amended, with respect to the operation of the Cook Plant and STP, respectively.
AEP and its subsidiaries are also subject to the broad regulatory provisions of
PUHCA administered by the SEC.

FERC

Under the FPA, FERC regulates rates for interstate sales at wholesale,
transmission of electric power, accounting and other matters, including
construction and operation of hydroelectric projects. FERC regulations require
AEP to provide open access transmission service at FERC-approved rates. The
transmission service regulated by FERC is predominantly wholesale transmission
service, which is service not associated with bundled electricity sales to
retail customers. FERC also regulates unbundled transmission service to retail
customers.

Under the FPA, the FERC regulates the sale of power for resale in
interstate commerce by (i) approving contracts for wholesale sales to municipal
and cooperative utilities and (ii) granting authority to public utilities to
sell power at wholesale at market-based rates upon a showing that the seller
lacks the ability to improperly influence market prices. AEP has

5

market-rate authority from FERC, under which most of its wholesale marketing
activity takes place. In November 2001, the FERC issued an order in connection
with its triennial review of AEP's market based pricing authority requiring (i)
certain actions by AEP in connection with its sales and purchases within its
control area and (ii) posting of information related to generation facility
status on AEP's website. AEP has appealed this order, and the FERC has issued an
order delaying the effective date of the order. See Note 9 to the consolidated
financial statements, entitled Commitments and Contingencies, incorporated by
reference in Item 8, for more information on the current status of this
proceeding.

SEC

The provisions of PUHCA, administered by the SEC, regulate many aspects of
a registered holding company system, such as the AEP System. PUHCA limits the
operations of a registered holding company system to a single integrated public
utility system and such other businesses as are incidental or necessary to the
operations of the system. In addition, PUHCA governs, among other things,
financings, sales or acquisitions of assets and intra-system transactions.

PUHCA and the rules and orders of the SEC currently require that
transactions between associated companies in a registered holding company system
be performed at cost with limited exceptions. Over the years, the AEP System has
developed numerous affiliated service, sales and construction relationships and,
in some cases, invested significant capital and developed significant operations
in reliance upon the ability to recover its full costs under these provisions.

The Division of Investment Management of the SEC has recommended the
conditional repeal of PUHCA. Under its recommendation, certain oversight
authority would be transferred to the FERC. Legislation has since been
introduced in numerous sessions of Congress that would repeal PUHCA, but such
legislation has not passed.

AEP-CSW MERGER

On June 15, 2000, CSW (now known as AEP Utilities, Inc.) merged with and
into a wholly-owned merger subsidiary of AEP. As a result, CSW became a wholly
owned subsidiary of AEP. The four wholly owned public utility subsidiaries of
CSW--PSO, SWEPCo, TCC and TNC--became indirect wholly owned public utility
subsidiaries of AEP as a result of the merger. The merger was approved by the
FERC and the SEC (with respect to PUHCA).

On January 18, 2002, the U.S. Court of Appeals for the District of Columbia
ruled that the SEC failed to properly explain how the merger met the
requirements of PUHCA and remanded the case to the SEC for further review. The
court held that the SEC had not adequately explained its conclusions that the
merger met PUHCA requirements that the merging entities be "physically
interconnected" and that the combined entity was confined to a "single area or
region."

Management believes that the merger meets the requirements of PUHCA and
expects the matter to be resolved favorably.

ELECTRIC RESTRUCTURING AND CUSTOMER CHOICE LEGISLATION

Certain states in AEP's service area have adopted restructuring or customer
choice legislation. In general, this legislation provides for a transition from
bundled cost-based rate regulated electric service to unbundled cost-based rates
for transmission and distribution service and market pricing for the supply of
electricity with customer choice of supplier. At a minimum, this legislation
allows retail customers to select alternative generation suppliers. Electric
restructuring and/or customer choice began on January 1, 2001 in Ohio and on
January 1, 2002 in Michigan, Virginia and the ERCOT area of Texas. Electric
restructuring in the SPP area of Texas, also scheduled to begin on January 1,
2002, has been delayed by the PUCT. AEP's public utility subsidiaries operate in
both the ERCOT and SPP areas of Texas.

Implementation of legislation enacted in Oklahoma and West Virginia to
allow retail customers to choose their electricity supplier is on hold. In 2001
Oklahoma delayed implementation of customer choice indefinitely. Before West
Virginia's choice plan can be effective, tax legislation must be passed to
preserve pre-legislation levels of funding for state and local governments. No
further legislation has been passed related to restructuring in West Virginia.
In February 2003, Arkansas repealed its restructuring legislation.

See Note 7 to the consolidated financial statements, entitled Effects of
Regulation, incorporated by reference in Item 8, for a discussion of the effect
of restructuring and customer choice legislation on accounting procedures. See
Management's Discussion

6

and Analysis of Results of Operations and Financial Condition, under the
headings entitled Industry Restructuring and Corporate Separation for a
discussion of AEP's corporate separation plan filed with the FERC and related
settlement agreements with state commissions and other intervenors.

Michigan Customer Choice

Customer choice commenced for I&M's Michigan customers on January 1, 2002.
Rates for retail electric service for I&M's Michigan customers were unbundled
(though they continue to be regulated) to allow customers the ability to
evaluate the cost of generation service for comparison with other suppliers. At
December 31, 2002, none of I&M's Michigan customers had elected to change
suppliers and no alternative electric suppliers are registered to compete in
I&M's Michigan service territory.

Ohio Restructuring

The Ohio Act requires vertically integrated electric utility companies that
offer competitive retail electric service in Ohio to separate their generating
functions from their transmission and distribution functions. Following the
market development period (which will terminate no later than December 31,
2005), retail customers will receive distribution and, where applicable,
transmission service from the incumbent utility whose distribution rates will be
approved by the PUCO and whose transmission rates will be approved by the FERC.
See General--Regulation--FERC for a discussion of FERC regulation of
transmission rates and Energy Delivery--Regulation--Rates--Ohio for a discussion
of the impact of restructuring on distribution rates.

CSPCo and OPCo are each presently operating as functionally separated
electric utility companies and no longer charge bundled rates for retail
electric service. Each has sought and, from certain regulatory authorities,
obtained regulatory approval to legally separate its transmission and
distribution assets from its generation assets. CSPCo and OPCo are, however,
currently determining the regulatory feasibility of complying with restructuring
legislation through continued functional separation. Assuming regulatory
compliance, it is currently their intention to remain functionally separated.

Texas Restructuring

The Texas Act substantially amends the regulatory structure governing
electric utilities in Texas in order to allow retail electric competition for
all customers and requires each utility to separate into (i) a REP, (ii) a power
generation company and (iii) a transmission and distribution utility. Upon
separation, neither the REP nor the power generation company will be subject to
traditional cost of service rate regulation. See Energy Delivery--Regulation--
Rates--Texas for a discussion of the impact of restructuring on rates.

SWEPCo, TCC and TNC initially filed a restructuring plan in January 2000
(which they subsequently updated) that the PUCT approved in February 2002. The
updated restructuring plan provided for the legal separation of TCC's and TNC's
assets in accordance with the Texas Act into (i) an affiliate power generation
company, (ii) a transmission and distribution utility and (iii) various REPs,
including those subsequently purchased by Centrica (see below). TCC and TNC
continue to pursue legal separation as required by the Texas Act. The PUCT has
delayed the implementation of the plan for SWEPCo operations within the SPP area
of Texas.

Under the Texas Act, a REP, which itself cannot own any generation assets,
obtains its electricity from power generation companies, EWGs and other
generating entities and provides services at generally unregulated rates, except
that the prices that may be charged to residential and small commercial
customers by REPs affiliated with a utility within the affiliated utility's
service area are set by the PUCT until January 1, 2007. This set price is
referred to as the "price to beat" rate (PTB). Affiliate REPs are required to
offer the PTB rate to all residential and small commercial customers (with a
peak usage of less than 1,000 KW) effective January 1, 2002. As described below,
AEP sold its affiliate REPs that must provide PTB service. The PTB rate is still
relevant to AEP, however, in determining (i) the contingent portion of the sales
price of the affiliate REPs AEP sold and (ii) certain of AEP's obligations in
the 2004 true-up proceedings.

Prior to the start of retail competition in January 2002, AEP formed MECPL
and MEWTU to act as affiliate REPs for TCC and TNC respectively. MECPL and MEWTU
were sold in December 2002 to Centrica, which assumed all of the rights and
obligations of an affiliated REP, including the provision of PTB service and the
obligation to provide data necessary for TCC's and TNC's 2004 true-up
proceeding. In connection with the sale, TCC and TNC have contracted to supply
approximately 90% of MECPL's and
7

MEWTU's respective power requirements relating to former TCC and TNC PTB
customers for a two-year period. See Note 12 to the consolidated financial
statements, entitled Acquisitions, Distributions and Discontinued Operations,
incorporated by reference in Item 8, for more information on the sale of these
REPs and AEP's contractual rights and obligations in connection with the sale.

The Texas Act also allows certain transmission and distribution utilities
whose generation assets were unbundled to recover certain regulatory assets and
stranded costs related to their generation assets. For a discussion of (i)
regulatory assets and stranded costs subject to recovery by TCC and (ii) rate
adjustments made after implementation of restructuring to allow recovery of
certain costs by or with respect to TCC and TNC, see Energy Delivery--Regulatory
Assets, Stranded Cost Recovery and Certain Post-Restructuring Rate Adjustments.

Virginia Restructuring

The Virginia Act was enacted in 1999 providing for retail choice of
generation suppliers to be phased in over the January 1, 2002 to January 1, 2004
period. The Virginia Act required jurisdictional utilities to unbundle their
power supply and energy delivery rates and to file functional separation plans
by January 1, 2002. APCo filed its plan and, following VSCC approval of a
settlement agreement, now operates in Virginia as a functionally separated
electric utility charging unbundled rates for its retail sales of electricity.
The settlement agreement addressed functional separation, leaving decisions
related to legal separation for later VSCC consideration.

FINANCING

General

AEP's goal is to use cash from operations to fund capital expenditures,
dividends and working capital. Short-term debt is used as an interim bridge for
timing differences in the need for cash or to fund debt maturities until
permanent financing is arranged.

It has been the practice of AEP's operating subsidiaries to finance current
construction expenditures in excess of available cash from operations by
initially incurring short-term debt, up to levels authorized by regulatory
agencies, and then to reduce the short-term debt with the proceeds of subsequent
sales by such subsidiaries of long-term debt securities and cash capital
contributions by AEP. In the past, short-term debt has come from AEP's
commercial paper program and revolving credit facilities. Proceeds were loaned
to the subsidiaries through intercompany notes under the AEP money pool. The
recent downgrade of AEP's commercial paper rating by Moody's, described below,
may limit AEP's access to commercial paper on terms as favorable as those of
recent years. Therefore, AEP may establish commercial paper programs for certain
of its public utility subsidiaries and AEP Utilities. Certain public utility
subsidiaries of AEP also sell accounts receivable to provide liquidity.

AEP's revolving credit agreements (which backstop the commercial paper
program) include covenants and events of default typical for this type of
facility, including a maximum debt/capital test and a $50 million
cross-acceleration provision. At December 31, 2002, AEP was in compliance with
its debt covenants. With the exception of a voluntary bankruptcy or insolvency,
any event of default has either or both a cure period or notice requirement
before termination of the agreements. A voluntary bankruptcy or insolvency would
be considered an immediate termination event.

AEP's subsidiaries have also utilized, and expect to continue to utilize,
additional financing arrangements, such as leasing arrangements, including the
leasing of utility assets and coal mining and transportation equipment and
facilities.

Credit Ratings

The rating agencies have been conducting credit reviews of AEP and its
registrant subsidiaries. The agencies are also reviewing many companies in the
energy sector due to issues that impact the entire industry.

In February 2003 Moody's completed its review of AEP and its rated
subsidiaries. The results of that review were downgrades of the following
ratings for unsecured debt: AEP from Baa2 to Baa3, APCo from Baa1 to Baa2, TCC
from Baa1 to Baa2, PSO from A2 to Baa1, SWEPCo from A2 to Baa1. TNC, which had
no senior unsecured notes outstanding at the time of the ratings action, had its
mortgage bond debt downgraded from A2 to A3. AEP's commercial paper was also
concurrently downgraded from P-2 to P-3. The completion of this review was a
culmination of earlier ratings action in 2002 that had included a downgrade of
AEP from Baa1 to Baa2. With the completion of the reviews, Moody's has placed
AEP and its rated subsidiaries on stable outlook.

8

In March 2003 S&P completed its review of AEP and its rated subsidiaries.
The results of that review were downgrades of the ratings for unsecured debt for
AEP and its rated subsidiaries from BBB+ to BBB. AEP's commercial paper rating
was affirmed at A-2. With the completion of the reviews, S&P has placed AEP and
its rated subsidiaries on stable outlook.

In March 2003 Fitch completed its review of AEP. The result of that review
was a downgrade of AEP's unsecured debt rating from BBB+ to BBB. AEP's
commercial paper rating was affirmed at F-2. With the completion of the reviews,
Fitch has placed AEP and its rated subsidiaries on stable outlook.

See Management's Discussion and Analysis of Financial Condition, Accounting
Policies and Other Matters, incorporated by reference in Item 7, under the
heading entitled Financial Condition for additional information with respect to
AEP's credit ratings, liquidity and specific financing activities.

ENVIRONMENTAL AND OTHER MATTERS

General

AEP's subsidiaries are currently subject to regulation by federal, state
and local authorities with regard to air and water-quality control and other
environmental matters, and are subject to zoning and other regulation by local
authorities. The environmental issues that are potentially material to the AEP
system include:

- The CAA and CAAA and state laws and regulations (including State
Implementation Plans) that require compliance, obtaining permits and
reporting as to air emissions.

- Litigation with the federal and certain state governments and certain
special interest groups regarding whether modifications to or maintenance
of certain coal-fired generating plants required additional permitting or
pollution control technology. See Management's Discussion and Analysis of
Financial Condition, Accounting Policies and Other Matters under the
heading entitled Federal EPA Complaint and Notice of Violation and Note 9
to the consolidated financial statements entitled Commitments and
Contingencies, incorporated by reference in Items 7 and 8 respectively
for further information.

- Rules issued by the EPA and certain states that require substantial
reductions in NOx emissions. The compliance dates for these rules range
from 2003 to 2005. AEP is installing (or has installed) emission control
technology and is taking other measures to comply with required
reductions. See Management's Discussion and Analysis of Financial
Condition, Accounting Policies and Other Matters and Note 9 to the
consolidated financial statements entitled Commitments and Contingencies,
incorporated by reference in Items 7 and 8 respectively, under the
heading entitled NOx Reductions for further information.

- CERCLA, which imposes upon owners and previous owners of sites, as well
as transporters and generators of hazardous material disposed of at such
sites, costs for environmental remediation. AEP does not, however,
anticipate that any of its currently identified CERCLA-related issues
will result in material costs or penalties to the AEP System. See
Management's Discussion and Analysis of Financial Condition, Accounting
Policies and Other Matters, incorporated by reference in Item 7, under
the heading entitled Superfund for further information.

- The Federal Clean Water Act, which prohibits the discharge of pollutants
into waters of the United States except pursuant to appropriate permits.
There are, however, no matters material to the AEP System currently
pending under the Clean Water Act.

- Solid and hazardous waste laws and regulations, which govern the
management and disposal of certain wastes. The majority of solid waste
created from the combustion of coal and fossil fuels is fly ash and other
coal combustion byproducts, which the EPA has determined are not
hazardous waste governed subject to RCRA.

In addition to imposing continuing compliance obligations, these laws and
regulations authorize the imposition of substantial penalties for noncompliance,
including fines, injunctive relief and other sanctions.

AEP's subsidiaries will confront several new environmental policies and
regulations over the next decade with the potential for substantial control
costs and premature retirement of some generating plants. These could include
(i) new or additional controls on sulfur dioxide, NOx and mercury emissions from
future laws or regulations, or the possibility of an

9

adverse decision in the new source review litigation; (ii) a new Clean Water Act
rule to reduce fish and other aquatic organisms killed at once-through cooled
power plants; (iii) finalization and implementation of more stringent water
quality-based permit limits; and (iv) a possible future requirement to reduce
carbon dioxide emissions. See Management's Discussion and Analysis of Financial
Condition, Accounting Policies and Other Matters, incorporated by reference in
Item 7, under the heading entitled Environmental Concerns and Issues for
information on current environmental issues.

AEP expects costs related to environmental controls to eventually be
reflected in some jurisdictions in the rates of AEP's public utility
subsidiaries. In Michigan, Ohio, Texas and Virginia, those costs may not be
recoverable if future market prices for electricity generated by plants in those
jurisdictions are insufficient to permit AEP to recover such costs. Moreover,
legislation adopted by certain states and proposed at the state and federal
level governing restructuring of the electric utility industry may also affect
the recovery of certain of these costs. There can be no assurance that these
costs will be recovered.

AEP's international operations are subject to environmental regulation by
various authorities within the host countries. Under certain circumstances,
these authorities may require modifications to these facilities and operations
or impose fines and other costs for violations of applicable statutes and
regulations. From time to time, these operations are named as parties to various
legal claims, actions, complaints or other proceedings related to environmental
matters. AEP's UK generation facilities will be subject to additional
environmental constraints in 2008 (which become more stringent after 2015)
because they are subject to regulation governing large combustion plants. In the
fourth quarter of 2002, AEP decided not to install certain emission control
technology on its Fiddler's Ferry and Ferrybridge generation facilities in 2008.
This decision and its legal and regulatory consequences will result in a
significant reduction in the estimated economic life of those facilities.

The cost of complying with applicable environmental laws, regulations and
rules is expected to be material to the AEP System.

See Management's Discussion and Analysis of Results of Operations and
Management's Discussion and Analysis of Financial Condition, Accounting Policies
and Other Matters and Note 9 to the consolidated financial statements entitled
Commitments and Contingencies, incorporated by reference in Items 7 and 8,
respectively, for further information with respect to environmental matters.

Environmental Expenditures

Expenditures related to generation facility compliance with air and water
quality standards during 2001 and 2002 and the current estimate for 2003 are
shown below. Substantial expenditures in addition to the amounts set forth below
may be required by the System in future years in connection with the
modification and addition of facilities at generating plants for environmental
quality controls in order to comply with air and water quality standards which
have been or may be adopted. Future expenditures could be significantly greater
if litigation regarding whether AEP properly installed emission control
equipment on its plants is resolved against AEP. See Note 9 to the consolidated
financial statements, entitled Commitments and Contingencies, incorporated by
reference in Item 8, for more information regarding this litigation and
environmental expenditures in general.

Electric and Magnetic Fields

EMF are found everywhere there is electricity. Electric fields are created
by the presence of electric charges. Magnetic fields are produced by the flow of
those charges. This means that EMF is created by electricity flowing in
transmission and distribution lines, electrical equipment, household wiring, and
appliances.

A number of studies in the past several years have examined the possibility
of adverse health effects from EMF. While some of the epidemiological studies
have indicated some association between exposure to
10

EMF and health effects, none has produced any conclusive evidence that EMF does
or does not cause adverse health effects.

Management cannot predict the ultimate impact of the question of EMF
exposure and adverse health effects. If further research shows that EMF exposure
contributes to increased risk of cancer or other health problems, or if the
courts conclude that EMF exposure harms individuals and that utilities are
liable for damages, or if states limit the strength of magnetic fields to such a
level that the current electricity delivery system must be significantly
changed, then the results of operations and financial condition of AEP and its
operating subsidiaries could be materially adversely affected unless these costs
can be recovered from customers.

WHOLESALE OPERATIONS

GENERAL

AEP conducts its wholesale business operations through its public utility
subsidiaries (through which AEP also conducts its energy delivery operations),
AEPES, AEPR and Pro Serv. Wholesale operations use and manage the following
assets:

- Power generation facilities (or interests therein) owned by AEP's public
utility and other subsidiaries;

- Natural gas pipeline, storage and processing facilities;

- Coal mines and related facilities; and

- Barge, rail and other fuel transportation related assets.

Wholesale operations include the following activities:

- Through AEP's public utility subsidiaries, the generation and sale of
power (i) to retail customers at unbundled or bundled rates regulated at
least in part by state public utility commissions and (ii) at wholesale
at rates regulated, in certain instances, by the FERC.

- Trading and marketing energy commodities in transactions predominantly
limited to risk management around assets used or managed by AEP's
wholesale operations, including electric power, natural gas, natural gas
liquids, oil, coal, and SO(2) allowances in North America and, where
applicable, Europe. Electric power transactions in the United States are
conducted principally through AEP's public utility subsidiaries. Other
energy commodity and allowances transactions are conducted through AEPES
and AEPR.

- Entering into long-term transactions to buy or sell capacity, energy, and
ancillary services of electric generating facilities, either existing or
to be constructed, at various locations in North America and Europe.

- Through Pro Serv, providing engineering, construction, project management
and other consulting services for energy-related projects.

In October 2002 AEP announced its plans to reduce the exposure to energy
trading markets and to downsize the trading and wholesale marketing operations.
It is expected that in the future power trading and marketing operations will be
smaller in scope and size, will generally be limited to risk management around
AEP's assets and, accordingly, focused in those regions in which AEP owns
assets.

POWER GENERATION

General

Power generation accounts for the majority of wholesale operations revenue.
In 2002, on an as-reported basis, power generation revenue included the
following components: (i) 63% from retail sales at predominantly regulated
rates; (ii) 33% from power marketing transactions of a type AEP intends to
continue and which are regulated in certain instances by the FERC; (iii) 3% from
retail sales at rates not regulated by states; and (iv) 1% attributable to power
marketing transactions of a type that management has stated are transitional.
This final category of transactions will be reduced consistent with AEP's
decision to scale back certain trading and marketing operations as described in
the preceding paragraph.

AEP's public utility subsidiaries own approximately 38,000 MW of domestic
generation. See Deactivation and Planned Disposition of Generating Facilities
for a discussion of planned reductions in AEP's generating fleet. Other AEP
subsidiaries hold interests in entities owning 1,879 MW of domestic power
facilities and 5,235 MW of international power facilities. The AEP public
utility subsidiaries operate their generating plants as a single interconnected
and coordinated electric utility system. See Item 2 - Properties for more
information regarding generation facilities.

11

AEP Power Pool and CSW Operating Agreement

APCo, CSPCo, I&M, KPCo and OPCo are parties to the Interconnection
Agreement, dated July 6, 1951, as amended (Interconnection Agreement), defining
how they share the costs and benefits associated with their generating plants.
This sharing is based upon each company's "member-load-ratio."

The member-load ratio is calculated monthly by dividing such company's
highest monthly peak demand for the last twelve months by the aggregate of the
highest monthly peak demand for the last twelve months for all east zone
operating companies. As of December 31, 2002, the member-load ratios were as
follows:

Although the FERC has approved the right of withdrawal of CSPCo and OPCo
from the AEP Power Pool as part of its order approving the settlement agreements
and AEP's FERC restructuring application, CSPCo and OPCo have remained a party
to the AEP Power Pool. If CSPCo and OPCo continue to remain in the AEP Power
Pool, notification to or approval by the FERC may be required. See Management's
Discussion and Analysis of Results of Operations and Financial Condition, under
the headings entitled Industry Restructuring and Corporate Separation for a
discussion of AEP's corporate separation plan filed with the FERC and related
settlement agreements with state commissions and other intervenors.

The following table shows the net credits or (charges) allocated among the
parties under the Interconnection Agreement and AEP System Interim Allowance
Agreement during the years ended December 31, 2000, 2001 and 2002:

PSO, SWEPCo, TCC and TNC, and AEPSC are parties to a Restated and Amended
Operating Agreement originally dated as of January 1, 1997 (CSW Operating
Agreement). The CSW Operating Agreement requires the west zone public utility
subsidiaries to maintain specified annual planning reserve margins and requires
the subsidiaries that have capacity in excess of the required margins to make
such capacity available for sale to other AEP west zone subsidiaries as capacity
commitments. The CSW Operating Agreement also delegates to AEP Service
Corporation the authority to coordinate the acquisition, disposition, planning,
design and construction of generating units and to supervise the operation and
maintenance of a central control center.

The following table shows the net credits or (charges) allocated among the
parties under the CSW Operating Agreement during the years ended December 31,
2000, 2001 and 2002:

Power generated by or allocated or provided under the Interconnection
Agreement or CSW Operating Agreement to any public utility subsidiary is often
sold to customers (or in the case of the ERCOT area of Texas, REPs) by such
public utility subsidiary at rates approved (other than in the ERCOT area of
Texas) by the public utility commission in the jurisdiction of sale. In Ohio,
Virginia and the ERCOT area of Texas, such rates are based on a statutory
formula as those jurisdictions transition to the use of market rates for
generation. See Energy Delivery -- Regulation -- Rates.

Under the Interconnection Agreement, power allocated to a public utility
subsidiary that is not required to serve its native load is sold at wholesale on
behalf of such subsidiary. Under the CSW Operating Agreement, power generated
that is not needed to serve the native load of any public utility subsidiary is
sold at wholesale by the generating subsidiary. See Trading and Marketing of
Energy Commodities for a discussion of the trading and marketing of such power.

AEP's System Integration Agreement provides for the integration and
coordination of AEP's east and west zone operating subsidiaries, joint dispatch
of generation within the AEP System, and the distribu-

12

tion, between the two operating zones, of costs and benefits associated with the
System's generating plants. It is designed to function as an umbrella agreement
in addition to the Interconnection Agreement and the CSW Operating Agreement,
each of which controls the distribution of costs and benefits within each zone.

Competition and Regulation

Retail Sales: AEP's public utility subsidiaries have the right (which in
some cases is exclusive) to sell electric power at retail within their
respective service areas in the states of Arkansas, Indiana, Kentucky,
Louisiana, Oklahoma, Tennessee, West Virginia and the SPP area of Texas. In
Michigan, Ohio and Virginia, AEP's public utility subsidiaries continue to
provide service to customers who have not been offered or have not selected
alternate service from competing suppliers. In those states, service is
currently being provided according to prescribed rules and rates. In the ERCOT
area of Texas, TCC and TNC sell power to Centrica, which provides PTB service to
certain former customers of TCC and TNC and must compete for customers.

AEP's public utility subsidiaries also compete with self-generation and
with distributors of other energy sources, such as natural gas, fuel oil and
coal, within their service areas. The primary factors in such competition are
price, reliability of service and the capability of customers to utilize sources
of energy other than electric power. With respect to competing generators and
self-generation, the public utility subsidiaries of AEP believe that they
generally maintain a favorable competitive position. With respect to alternative
sources of energy, the public utility subsidiaries of AEP believe that the
reliability of their service and the limited ability of customers to substitute
other cost-effective sources for electric power place them in a favorable
competitive position, even though their prices may be higher than the costs of
some other sources of energy.

Significant changes in the global economy in recent years have led to
increased price competition for industrial customers in the United States,
including those served by the AEP System. Some of these industrial customers
have requested price reductions from their suppliers of electric power. In
addition, industrial customers that are downsizing or reorganizing often close a
facility based upon its costs, which may include, among other things, the cost
of electric power. The public utility subsidiaries of AEP cooperate with such
customers to meet their business needs through, for example, providing various
off-peak or interruptible supply options pursuant to tariffs filed with the
various state commissions. Occasionally, these rates are first negotiated, and
then filed with the state commissions. The public utility subsidiaries believe
that they are unlikely to be materially adversely affected by this competition.

See Energy Delivery -- Regulation -- Rates for a description of the setting
of rates for power sold at bundled or unbundled state-regulated rates.

Wholesale Sales: The public utility subsidiaries of AEP, like the electric
industry generally, face increasing competition in the sale of available power
on a wholesale basis, primarily to other public utilities and power marketers.
The Energy Policy Act of 1992 was designed, among other things, to foster
competition in the wholesale market by creating a generation market with fewer
barriers to entry and mandating that all generators have equal access to
transmission services. As a result, there are more generators able to
participate in this market. The principal factors in competing for wholesale
sales are price (including fuel costs), availability of capacity and power and
reliability of service.

The public utility subsidiaries of AEP are subject to regulation by the
FERC under the Federal Power Act in respect of rates for interstate sales at
wholesale. See General -- Regulation -- FERC.

Seasonality

Sale of electric power is generally a seasonal business. In many parts of
the country, demand for power peaks during the hot summer months, with market
prices also peaking at that time. In other areas, power demand peaks during the
winter. The pattern of this fluctuation may change due to the nature and
location of AEP's facilities and the terms of power sale contracts AEP enters
into. In addition, AEP has historically sold less power, and consequently earned
less income, when weather conditions are milder. Unusually mild weather in the
future could diminish AEP's results of operations and may impact its financial
condition.

13

Fuel Supply

The following table shows the sources of power generated by the AEP System:

Variations in the generation of nuclear power are primarily related to
refueling outages and, in a portion of 2000, the shutdown of the Cook Plant to
respond to issues raised by the NRC. Variations in the generation of natural gas
power are primarily related to the availability of cheaper alternatives to
fulfill certain power requirements and to deactivate certain of its gas-fired
plants.

Coal and Lignite: AEP System generating companies procure coal and lignite
under a combination of purchasing arrangements including long-term contracts,
affiliate operations, short-term, and spot agreements with various producers and
coal trading firms. AEP believes, but cannot provide assurances that, it will be
able to secure coal and lignite of adequate quality and in adequate quantities
to operate its coal and lignite-fired units.

The following table shows the amount of coal delivered to the AEP System
during the past three years and the average delivered price of spot coal
purchased by System companies:

The coal supplies at AEP System plants vary from time to time depending on
various factors, including customers' usage of electric power, space
limitations, the rate of consumption at particular plants, labor unrest and
weather conditions which may interrupt deliveries. At December 31, 2002, the
System's coal inventory was roughly 56 days of normal usage. This estimate
assumes that the total supply would be utilized through the operation of plants
that use coal most efficiently.

In cases of emergency or shortage, system companies have developed programs
to conserve coal supplies at their plants. Such programs have been filed and
reviewed with officials of federal and state agencies and, in some cases, the
state regulatory agency has prescribed actions to be taken under specified
circumstances by System companies, subject to the jurisdiction of such agencies.

The FERC has adopted regulations relating, among other things, to the
circumstances under which, in the event of fuel emergencies or shortages, it
might order electric utilities to generate and transmit electric power to other
regions or systems experiencing fuel shortages, and to ratemaking principles by
which such electric utilities would be compensated. In addition, the federal
government is authorized, under prescribed conditions, to allocate coal and to
require the transportation thereof, for the use of power plants or major
fuel-burning installations.

Natural Gas: AEP, through its public utility subsidiaries, consumed over
163 billion cubic feet of natural gas during 2002 for generating power. A
majority of the gas fired electric generation plants are connected to at least
two natural gas pipelines, which provides greater access to competitive supplies
and improves reliability. A portfolio of long-term and short-term purchase and
transportation agreements (that are acquired on a competitive basis and based on
market prices) supplies natural gas requirements for each plant.

Nuclear: I&M and STPNOC have made commitments to meet certain of the
nuclear fuel requirements of the Cook Plant and STP, respectively. Steps
currently are being taken, based upon the planned fuel cycles for the Cook
Plant, to review and evaluate I&M's requirements for the supply of nuclear fuel.
I&M has made and will make purchases of uranium in various forms in the spot,
short-term, and mid-term markets until it decides that deliveries under
long-term supply contracts are warranted. TCC and the other STP participants
have entered into contracts with suppliers for (i) 100% of the uranium
concentrate sufficient for the operation of both STP units through spring 2006
and (ii) 50% of the uranium concentrate needed for STP through spring 2007.

For purposes of the storage of high-level radioactive waste in the form of
spent nuclear fuel, I&M has completed modifications to its spent nuclear fuel
storage pool. AEP anticipates that the Cook Plant has storage capacity to permit
normal operations through 2012. STP has on-site storage facilities with the

14

capability to store the spent nuclear fuel generated by the STP units over their
licensed lives.

Nuclear Waste and Decommissioning

I&M, as the owner of the Cook Plant, and TCC, as a partial owner of STP,
have a significant future financial commitment to safely dispose of SNF and
decommission and decontaminate the plants. The ultimate cost of retiring the
Cook Plant and STP may be materially different from estimates and funding
targets as a result of the:

- Type of decommissioning plan selected;

- Escalation of various cost elements (including, but not limited to,
general inflation);

- Further development of regulatory requirements governing decommissioning;

- Limited availability to date of significant experience in decommissioning
such facilities;

- Technology available at the time of decommissioning differing
significantly from that assumed in these studies; and

- Availability of nuclear waste disposal facilities.

Accordingly, management is unable to provide assurance that the ultimate cost of
decommissioning the Cook Plant and STP will not be significantly different than
current projections.

See Management's Discussion and Analysis of Results of Operations and
Management's Discussion and Analysis of Financial Condition, Accounting Policies
and Other Matters and Note 9 to the consolidated financial statements, entitled
Commitments and Contingencies, which are incorporated by reference in Items 7
and 8, respectively, for information with respect to nuclear waste and
decommissioning and related litigation.

Low-Level Radioactive Waste: The LLWPA mandates that the responsibility for
the disposal of low-level radioactive waste rests with the individual states.
Low-level radioactive waste consists largely of ordinary refuse and other items
that have come in contact with radioactive materials. Michigan and Texas do not
currently have disposal sites for such waste available. AEP cannot predict when
such sites may be available, but South Carolina and Utah operate low-level
radioactive waste disposal sites and accept low-level radioactive waste from
Michigan and Texas. AEP's access to the South Carolina facility is currently
allowed through the end of fiscal year 2008.

Deactivation and Planned Disposition of Generation Facilities

In September 2002, AEP indicated to ERCOT its intent to deactivate 16
gas-fired power plants (8 TCC plants and 8 TNC plants). ERCOT subsequently
conducted reliability studies that determined that seven plants (4 TCC plants
and 3 TNC plants) would be required to ensure reliability of the electricity
grid. As a result of these studies, ERCOT and AEP agreed to enter into
reliability must run agreements (which expired in December 2002, but have been
renewed for all but two units of these plants) to continue operation of these
plants. With ERCOT's approval, AEP proceeded with its planned deactivation of
the remaining nine plants.

TCC has also filed a plan of divestiture with the PUCT proposing to sell
all of its power generation assets in an effort to determine its level of
stranded costs in accordance with the Texas Act. The PUCT has dismissed its
proceeding relating to TCC's plan of divestiture in anticipation of promulgating
rules of general application regarding stranded cost determination for nuclear
facilities. See Energy Delivery-Regulatory Assets and Stranded Cost Recovery and
Post-Restructuring Wires Charges.

The assets to be sold have a generating capacity of 4,497 MW and include
eight gas-fired generating plants, one coal-fired plant, TCC's interest in
another coal-fired plant, a hydroelectric facility and TCC's interest in STP.
See Note 8 to the consolidated financial statements entitled Customer Choice and
Industry Restructuring, incorporated by reference in Item 8, for more
information on the planned disposition of TCC generation facilities.

TRADING AND MARKETING OF ENERGY COMMODITIES

AEP enters into transactions for the purchase and sale of electricity and
natural gas as part of wholesale trading operations. Electric and gas
transactions are executed over-the-counter with counterparties or through
brokers. Gas transactions are also executed through brokerage accounts with
brokers who are registered with the Commodity Futures Trading Commission.
Brokers and counterparties may require cash or cash related instruments to be
deposited on these transactions as margin against open positions.

AEP trades electricity and gas contracts with numerous counterparties.
Since AEP's open energy trading contracts are valued based on changes in
15

market prices of the related commodities, our exposures change daily.

In October 2002, AEP announced its plans to reduce its exposure to energy
trading markets and to downsize the trading and wholesale marketing operations.
It is expected that in the future power trading and marketing operations will be
smaller in scope, will generally be limited to risk management around AEP assets
and, accordingly, focused in regions in which AEP owns assets.

Energy Market Investigations

During 2002, several governmental entities launched investigations of
participants in energy trading markets, including AEP. A number of those
investigations resulted in data requests of AEP. See Management's Discussion and
Analysis of Financial Condition, Accounting Policies and Other Matters,
incorporated by reference in Item 7, under the heading Energy Market
Investigations.

NATURAL GAS PIPELINE, STORAGE AND PROCESSING FACILITIES

AEP, through certain subsidiaries, operates and owns an interest in a
significant amount of gas-related assets, including:

- 6,400 miles of natural gas pipelines between two systems;

- 128 billion cubic feet of storage among two facilities;

- Five natural gas processing plants; and

- Certain gas marketing contracts.

COAL MINES AND RELATED FACILITIES

AEP, through certain subsidiaries, holds various properties, coal reserves,
mining operations and royalty interests in Colorado, Kentucky, Louisiana, Ohio,
Pennsylvania and West Virginia.

BARGE, RAIL AND OTHER FUEL TRANSPORTATION RELATED ASSETS

AEP, through MEMCO Barge Line Inc., is engaged in the transportation of
coal and dry bulk commodities, primarily on the Ohio, Illinois, and Lower
Mississippi rivers for AEP, as well as unaffiliated customers. AEP, through
certain subsidiaries, owns or leases 7,000 railcars, 1,800 barges, 37 tug boats
and two coal handling terminals with 20 million tons of annual capacity.

STRUCTURED ARRANGEMENTS INVOLVING CAPACITY, ENERGY, AND ANCILLARY SERVICES

Dow

AEP has entered into an agreement with The Dow Chemical Company to
construct a 900 MW cogeneration facility at Dow's chemical facility in
Plaquemine, Louisiana. Commercial operation is expected in November 2003. AEP is
entitled to 100% of the facility's capacity and energy over The Dow Chemical
Company's requirements and has contracted to sell the power from this facility
to an unaffiliated party.

Buckeye

In January 2000, OPCo and NPC, an affiliate of Buckeye, entered into an
agreement relating to the construction and operation of a 510 MW gas-fired
electric generating peaking facility to be owned by NPC. From the commercial
operation date (which occurred in 2002) until the end of 2005, OPCo will be
entitled to 100% of the power generated by the facility, and responsible for the
fuel and other costs of the facility. After 2005, NPC and OPCo will be entitled
to 80% and 20%, respectively, of the power of the facility, and both parties
will generally be responsible for the fuel and other costs of the facility. OPCo
will also provide certain back-up power to NPC.

CERTAIN POWER AGREEMENTS

AEGCo

Since its formation in 1982, AEGCo's business has consisted of the
ownership and financing of its 50% interest in Unit 1 of the Rockport Plant and,
since 1989, leasing of its 50% interest in Unit 2 of the Rockport Plant. The
operating revenues of AEGCo are derived from the sale of capacity and energy
associated with its interest in the Rockport Plant to I&M and KPCo pursuant to
unit power agreements.

The I&M Power Agreement provides for the sale by AEGCo to I&M of all the
power (and the energy associated therewith) available to AEGCo at the Rockport
Plant. I&M is obligated, whether or not power is available from AEGCo, to pay as
a demand charge for the right to receive such power (and as an energy charge for
any associated energy taken by I&M). Such amounts, when added to amounts
received by AEGCo from any other sources, will be at least

16

sufficient to enable AEGCo to pay all its operating and other expenses,
including a rate of return on the common equity of AEGCo as approved by FERC,
currently 12.16%. The I&M Power Agreement will continue in effect until the date
that the last of the lease terms of Unit 2 of the Rockport Plant has expired
unless extended in specified circumstances.

Pursuant to an assignment between I&M and KPCo, and a unit power agreement
between KPCo and AEGCo, AEGCo sells KPCo 30% of the power (and the energy
associated therewith) available to AEGCo from both units of the Rockport Plant.
KPCo has agreed to pay to AEGCo the same amounts which I&M would have paid AEGCo
under the terms of the I&M Power Agreement for such entitlement. The KPCo unit
power agreement expires on December 31, 2004. The agreement will be extended
until December 31, 2009 for Unit 1 and December 31, 2022 for Unit 2 if AEP's
restructuring settlement agreement filed with the FERC becomes effective.

AEGCo and AEP have entered into a capital funds agreement pursuant to
which, among other things, AEP has unconditionally agreed to make cash capital
contributions, or in certain circumstances subordinated loans, to AEGCo to the
extent necessary to enable AEGCo to (i) maintain such an equity component of
capitalization as required by governmental regulatory authorities; (ii) provide
its proportionate share of the funds required to permit commercial operation of
the Rockport Plant; (iii) enable AEGCo to perform all of its obligations,
covenants and agreements under, among other things, all loan agreements, leases
and related documents to which AEGCo is or becomes a party (AEGCo Agreements);
and (iv) pay all indebtedness, obligations and liabilities of AEGCo (AEGCo
Obligations) under the AEGCo Agreements, other than indebtedness, obligations or
liabilities owing to AEP. The capital funds agreement will terminate after all
AEGCo Obligations have been paid in full.

OVEC

AEP, CSPCo and several unaffiliated utility companies jointly own OVEC. The
aggregate equity participation of AEP and CSPCo in OVEC is 44.2%. Until
September 1, 2001, OVEC supplied the power requirements of a uranium enrichment
plant near Portsmouth, Ohio owned by the DOE. The sponsoring companies are now
entitled to receive and pay for all OVEC capacity (approximately 2,200 MW) in
proportion to their power participation ratios. The aggregate power
participation ratio of APCo, CSPCo, I&M and OPCo is 42.1%. The proceeds from the
sale of power by OVEC are designed to be sufficient for OVEC to meet its
operating expenses and fixed costs and to provide a return on its equity
capital. The Inter-Company Power Agreement, which defines the rights of the
owners and sets the power participation ratio of each, will expire by its terms
on March 12, 2006.

Buckeye

Contractual arrangements among OPCo, Buckeye and other investor-owned
electric utility companies in Ohio provide for the transmission and delivery,
over facilities of OPCo and of other investor-owned utility companies, of power
generated by the two units at the Cardinal Station owned by Buckeye and back-up
power to which Buckeye is entitled from OPCo under such contractual
arrangements, to facilities owned by 25 of the rural electric cooperatives which
operate in the State of Ohio at 342 delivery points. Buckeye is entitled under
such arrangements to receive, and is obligated to pay for, the excess of its
maximum one-hour coincident peak demand plus a 15% reserve margin over the
1,226,500 kilowatts of capacity of the generating units which Buckeye currently
owns in the Cardinal Station. Such demand, which occurred on August 1, 2002, was
recorded at 1,398,559 kilowatts.

ENERGY DELIVERY

GENERAL

AEP's public utility subsidiaries own and operate transmission and
distribution lines and other facilities to deliver electric power. See Item
2--Properties for more information regarding the transmission and distribution
lines. Most of the transmission and distribution services are sold, in
combination with electric power, to retail customers of AEP's public utility
subsidiaries in their service territories. These sales are made at rates
established by the state utility commissions of the states in which they
operate, and in some instances, the FERC as well. See Regulation-- Rates. The
FERC regulates and approves the rates for wholesale transmission transactions.
See General--Regulation-- FERC. As discussed below, some transmission services
also are separately sold to non-affiliated companies.

AEP's public utility subsidiaries hold franchises or other rights to
provide electric service in various municipalities and regions in their service
areas. In some cases, these franchises provide the utility with the exclusive
right to provide electric service. These franchises have varying provisions and
expiration

17

dates. In general, the operating companies consider their franchises to be
adequate for the conduct of their business. For a discussion of competition in
the sale of power, see Wholesale Operations-- Generation-- Competition and
Regulation.

REGULATION

AEP is in the business of providing generation, transmission and
distribution services. The transmission and distribution functions are part of
AEP's energy delivery segment. The generation function is part of AEP's
wholesale operations segment. This discussion covers the regulation of
transmission and distribution, but also generation sold at retail (which would
otherwise be included in the wholesale operations segment discussion).

Rates

Historically, state utility commissions have established electric service
rates on a cost-of-service basis, which is designed to allow a utility an
opportunity to recover its cost of providing service and to earn a reasonable
return on its investment used in providing that service. A utility's cost of
service is generally comprised of its operating expenses, including operation
and maintenance expense, depreciation expense and taxes. State utility
commissions periodically adjust rates pursuant to a review of (i) a utility's
revenues and expenses during a defined test period and (ii) such utility's level
of investment. Absent a legal limitation, such as a law limiting the frequency
of rate changes or capping rates for a period of time as part of a transition to
customer choice of generation suppliers, a state utility commission can review
and change rates on its own initiative. Some states may initiate reviews at the
request of a utility, customer, governmental or other representative of a group
of customers. Such parties may, however, agree with one another not to request
reviews of or changes to rates for a specified period of time.

The rates of AEP's public utility subsidiaries are generally based on the
cost of providing traditional bundled electric service (i.e., generation,
transmission and distribution service). In Ohio, Virginia and the ERCOT area of
Texas, rates are transitioning from bundled cost-based rates for electric
service to unbundled cost-based rates for transmission and distribution service
on the one hand, and market pricing for and/or customer choice of generation on
the other.

Historically, the state regulatory frameworks in the service area of the
AEP System reflected specified fuel costs as part of bundled (or, more recently,
unbundled) rates or incorporated fuel adjustment clauses in a utility's rates
and tariffs. Fuel adjustment clauses permit periodic adjustments to fuel cost
recovery from customers and therefore provide protection against exposure to
fuel cost changes. While the historical framework remains in a portion of AEP's
service territory, recovery of increased fuel costs (i) is no longer provided
for in Ohio and (ii) may be limited in Indiana and Michigan, which have capped
rates. Fuel recovery is also limited in the ERCOT area of Texas, but because AEP
sold MECPL and MEWTU, there is little impact on AEP of fuel recovery procedures
related to service in ERCOT.

The following state-by-state analysis summarizes the regulatory environment
of each jurisdiction in which AEP operates. Several public utility subsidiaries
operate in more than one jurisdiction.

Indiana: I&M provides retail electric service in Indiana at a bundled rate
approved by the IURC. While rates are set on a cost-of-service basis, utilities
may also generally seek to adjust fuel clause rates quarterly. I&M's base rate
is capped through December 31, 2004 and its fuel recovery rate is capped through
February 29, 2004.

Ohio: CSPCo and OPCo operate as functionally separated utilities and
provide "default" retail electric service to customers at unbundled rates
established by the Ohio Act through December 31, 2005. Thereafter, CSPCo and
OPCo will continue to provide distribution services to retail customers at rates
approved by the PUCO. These rates will be frozen from December 31, 2005 to (i)
December 31, 2008 for CSPCo and (ii) December 31, 2007 for OPCo. Transmission
services will continue to be provided at rates established by the FERC. Default
retail generation service rates will be based on market prices pursuant to rules
currently under consideration by the PUCO.

Oklahoma: PSO provides retail electric service in Oklahoma at a bundled
rate approved by the OCC. PSO's rates are set on a cost-of-service basis. Fuel
and purchased power costs above the amount included in base rates are recovered
by applying a fuel adjustment factor to retail kilowatt-hour sales. The factor
is adjusted quarterly and is based upon forecasted fuel and purchased power
costs. Over or under collections of fuel costs for prior periods can be
recovered when new quarterly factors are established.

Texas: The Texas Act requires the legal separation of generation-related
assets from transmission and
18

distribution assets. TCC and TNC currently operate on a functionally separated
basis. In January 2002, TCC and TNC transferred all their retail customers in
the ERCOT area of Texas to MECPL, MEWTU and AEP Commercial and Industrial REP
(an AEP affiliate). TNC's retail SPP customers were ultimately transferred to
Mutual Energy SWEPCo L.P. (an AEP affiliate). TCC and TNC provide retail
transmission and distribution service on a cost-of-service basis at rates
approved by the PUCT and wholesale transmission service under tariffs approved
by the FERC consistent with PUCT rules.

The implementation of the business separation plan for SWEPCo operations in
the SPP area of Texas was delayed by the PUCT. As such, SWEPCo's Texas
operations continue to operate and to be regulated as a traditional bundled
utility with both base and fuel rates.

Virginia: APCo provides unbundled retail electric service in Virginia.
APCo's unbundled generation, transmission (which reflect FERC approved
transmission rates) and distribution rates as well as its functional separation
plan were approved by the VSCC in December 2001.

The Virginia Act capped base rates at their mid-1999 levels until the end
of the transition period (July 1, 2007), or sooner if the VSCC finds that a
competitive market for generation exists in Virginia. The Virginia Act permits
APCo to seek a one-time change to its capped non-generation rates after January
1, 2004. The Virginia Act allows adjustments to fuel rates during the transition
period and continues to permit utilities to recover their actual fuel costs, the
fuel component of their purchased power costs and certain capacity charges. APCo
recovers its generation capacity charges through capped base rates.

West Virginia: APCo and Wheeling Power Company provide retail electric
service at bundled rates approved by the WVPSC. A plan to introduce customer
choice was approved by the West Virginia Legislature in its 2000 legislative
session. However, implementation of that plan was placed on hold pending
necessary changes to the state's tax laws in a subsequent session. Those changes
have not been made.

While West Virginia generally allows recovery of fuel costs, the most
recent proceeding resulted in the suspension of an active fuel clause for APCo
and WPCo (though they continue to recover fuel costs through fixed bundled
rates). APCo and Wheeling Power Company are currently unable to change the
current level of fuel cost recovery, though this ability could be reinstated in
a future proceeding.

Other Jurisdictions: The public utility subsidiaries of AEP also provide
service at regulated bundled rates in Arkansas, Kentucky, Louisiana and
Tennessee and regulated unbundled rates in Michigan.

19

The table below illustrates the current rate regulation status of the
states in which the public utility subsidiaries of AEP operate: