WPS RESOURCES CORPORATION
and
WISCONSIN PUBLIC SERVICE CORPORATION
FORM 10-K
ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION
For the Year Ended December 31, 2001

    WPS Resources was incorporated in Wisconsin in 1993 as a holding company for regulated utility and nonregulated business units. Principal operating subsidiaries and their approximate percentages of revenues, net income, and assets are:

    * The percentages above do not total 100% due to intercompany transactions.

    Wisconsin Public Service, WPS Energy Services, and WPS Power Development are all Wisconsin corporations. Upper Peninsula Power is a Michigan corporation. Wisconsin Public Service and Upper Peninsula Power are regulated utilities. WPS Energy Services and WPS Power Development are nonregulated entities.

    Wisconsin Public Service, which began operations in 1883, is a regulated electric and natural gas utility serving an 11,000 square mile service territory in northeastern Wisconsin and an adjacent portion of the Upper Peninsula of Michigan. In 2001, Wisconsin Public Service served 400,862 electric retail customers and 290,353 natural gas retail customers. Wholesale electric service is provided to various customers including municipal utilities, electric cooperatives, energy marketers, other investor-owned utilities, and a municipal joint action agency.

    Upper Peninsula Power is a regulated utility providing electric service to a 4,500 square mile area of Michigan's Upper Peninsula. Electric service was provided to 50,724 retail customers. Wholesale electric service was provided to various municipal utilities, electric cooperatives, and other investor-owned utilities. Total revenues consisted of 90% retail sales and 10% wholesale sales.

    WPS Resources Capital Corporation was created in 1999 as an intermediate holding company for the nonregulated subsidiaries of WPS Resources. At the end of 2001, WPS Resources Capital Corporation had total assets of $1.0 billion, consisting primarily of its investments in WPS Energy Services and WPS Power Development.

    WPS Energy Services is a nonregulated subsidiary of WPS Resources Capital Corporation. WPS Energy Services provides energy and related products and services in the nonregulated energy market throughout the Midwest and northeastern United States. WPS Energy Services had revenues of $1.6 billion and assets of $720 million in 2001. Revenues in 2001 have risen significantly over 2000 due to increased natural gas and electric sales volumes and higher natural gas prices in the first half of 2001.

    WPS Power Development is also a nonregulated subsidiary of WPS Resources Capital Corporation. Energy-related services provided by WPS Power Development include project development, engineering and management services, and operations and maintenance services. WPS Power Development currently owns, through its subsidiaries, electric generation facilities in Wisconsin, Maine, Pennsylvania, and New Brunswick, Canada, a synthetic fuel processing facility located in Kentucky, and steam production facilities located in Arkansas and Oregon. WPS Power Development had revenues of $141.5 million in 2001 and assets of $323.1 million at December 31, 2001.

    Except for historical data and statements of current fact, the information contained or incorporated by reference in this document constitutes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Any references to plans, goals, beliefs or expectations in respect to future events and conditions or to estimates are forward-looking statements. Although we believe that statements of our expectations are based on reasonable assumptions, forward-looking statements are inherently uncertain and subject to risks and should be viewed with caution. Actual results or experience could differ materially from the forward-looking statements as a result of many factors. Forward-looking statements included or incorporated in this document include, but are not limited to statements regarding:

    We cannot predict the course of future events or anticipate the interaction of multiple factors beyond our control and their effect on revenues, project timing, and costs. Some risk factors that could cause results different from any forward-looking statement include:

    WPS Resources electric utility operations are provided through Wisconsin Public Service and Upper Peninsula Power. In Wisconsin, the largest communities served by Wisconsin Public Service at the electric retail level are the cities of Green Bay, Oshkosh, Wausau, and Stevens Point. In Michigan, the largest community served at the electric retail level is the Houghton/Hancock area, which is served by Upper Peninsula Power.

    For additional information regarding our generation facilities, see "UTILITY" in Part I, Item 2, PROPERTIES.

    In 2001, Upper Peninsula Power purchased 87% of its total energy requirements. Remaining energy requirements were supplied by hydroelectric and combustion turbine facilities owned by Upper Peninsula Power. During 2001, Upper Peninsula Power purchased 65 megawatts of firm power from Wisconsin Public Service. Upper Peninsula Power also purchased non-firm power from Wisconsin Public Service and Alliant Energy Corporation among others. The purchases from Wisconsin Public Service represented 78% of Upper Peninsula Power's total energy requirements in 2001. Upper Peninsula Power has contracted for 65 megawatts of capacity and energy from Wisconsin Public Service for 2002.

    In 2001, Wisconsin Public Service sold 25% of its ownership interest in Wisconsin River Power Company to Wisconsin Power and Light Company. This transaction decreased the ownership interest of Wisconsin Public Service in Wisconsin River Power from 66.88% to 50% and increased the ownership percentage of Wisconsin Power and Light from 33.12% to 50%. The disposition was effective December 31, 2001. Wisconsin River Power is the owner and operator of two dams and related hydroelectric plants, on the Wisconsin River, which have an aggregate installed capacity of approximately 39 megawatts.

    The Kewaunee plant is a pressurized water reactor plant with a nameplate capacity of 562 megawatts. Since September 24, 2001, the Kewaunee plant has been jointly-owned by Wisconsin Public Service (59%) and Wisconsin Power and Light (41%). The plant is operated by Nuclear Management Company LLC. Nuclear Management Company is owned by five utilities in the upper Midwest and operates these utilities six nuclear power plants. The plants are located in Iowa, Minnesota, Wisconsin, and Michigan. WPS Resources owns a 20% interest in Nuclear Management Company. The plant's operating license expires in 2013. Wisconsin Public Service is considering whether or not to seek extension of the plant operating license to 2033.

    On September 24, 2001 Wisconsin Public Service acquired Madison Gas and Electric Company's 17.8% share of the Kewaunee plant for $15.8 million.

    Madison Gas and Electric also agreed to:

1) transfer its qualified decommissioning trust to Wisconsin Public Service,

2) transfer all securities and cash balances in the Madison Gas and Electric Non-Qualified Fund without reduction for any imputed tax liability, to the Wisconsin Public Service Non-Qualified Trust, and

3) continue to make contributions to its Non-Qualified Fund as required by its funding plan for the period September 24, 2001 through December 31, 2002. The fund's investments will be transferred to the Wisconsin Public Service Non-Qualified Trust on January 2, 2003.

    These funds and contributions are expected to fully fund Madison Gas and Electric's share of total expected plant decommissioning costs. 

    Madison Gas and Electric will retain its obligation for its share of the costs for final disposal of spent nuclear fuel created up to the time of ownership transfer.

    On September 23, 2001, Wisconsin Public Service began its scheduled 72-day outage to refuel the plant and replace its two steam generators. The refueling and steam generator replacement were completed and the plant was back in service on December 4, 2001. Total gross cost of the replacement was approximately $121 million, of which Wisconsin Public Service's share is $71 million. The steam generator replacement recaptured production capacity that had been lost due to degradation of the steam generators over their life, increasing the net production capacity of the plant by 35 megawatts. There were no material unexpected repairs identified during the outage. In response to a general bulletin from the Nuclear Regulatory Commission, the reactor vessel head was inspected and no damage was found.

    The Kewaunee plant has been implementing a plan over the last several years to make improvements to plant processes and procedures. Assessments performed by Nuclear Management Company and Kewaunee staff, the Nuclear Regulatory Commission, the Institute of Nuclear Plant Operations, and others reinforced the need to continue this improvement plan.

    In 2000, the Nuclear Regulatory Commission issued a Revised Oversight Process. Although the Oversight Process did not revise any Commission regulations, it provided, for the first time, objective measures of performance, some of which the Nuclear Regulatory Commission had not monitored closely in the past. The Nuclear Regulatory Commission performance measures expanded from solving equipment performance issues to the procedural causes underlying such performance issues. As industry standards evolved toward more rigorous and structured processes, the Kewaunee plant procedures required improvement to remain in compliance. Management has now identified certain areas for improvement in order to ensure the Kewaunee plant operates in accordance with evolving industry and regulatory standards and to minimize the potential for a significant event or regulatory shutdown in light of the new Oversight Process. In 2001, approximately $19 million was spent to address these issues, of which $9.9 million was deferred. Wisconsin Public Service was responsible for its 59% share of these costs.

    We estimate that additional incremental costs for these improvements over the period of 2002 through 2005 to be approximately $52 million. These costs will be included in future rate requests of the Kewaunee co-owners. The Kewaunee co-owners received approval from the Public Service Commission of Wisconsin and the Michigan Public Utility Commission for deferral of the 2001 and 2002 incremental costs associated with these improvements. Wisconsin Public Service will include its 59% share of these costs in its future rate requests.

    Total additional plant capital costs associated with these improvements, over the 2002 through 2003 period are estimated to be $5 million. Wisconsin Public Service will be responsible for its 59% share of these costs.

    Nuclear Management Company is considering the possibility of implementing improved instrumentation and other changes at the Kewaunee plant to increase net production capacity at the plant by as much as 30 megawatts. The potential improvements, estimated to cost approximately $12 million, could be completed in 2003 or 2004. Wisconsin Public Service would be responsible for its 59% share of these costs.

    Wisconsin Public Service's current rate order requires the investment in the new steam generators to be recovered using the sum-of-the-years-digits depreciation method over an 8.5-year period beginning with completion of installation of the new steam generators in 2001. The unrecovered plant investment at the end of 2000 and future plant additions will be recovered over a period ending 8.5 years after the installation of the steam generators using a straight-line depreciation methodology. The order further provides for the funding period for decommissioning to be extended from 2002 to the end of 2010.

    At December 31, 2001, the net carrying amount of our investment in Kewaunee plant, including construction work in progress, was approximately $88.5 million. The cost in current dollars for our 59% share of the estimated costs to decommission the Kewaunee plant is $319 million. Wisconsin Public Service decommissioning trust assets at December 31, 2001 totaled $311.3 million. The increases from 2000, in the decommissioning costs and the trust assets are due to the acquisition of Madison Gas and Electric's 17.8% interest in the plant and its decommissioning assets.

    During 2001, $3.3 million of depreciation expense related to unrecovered plant investment was recognized compared with $8.9 million recognized in 2000. As a result of the extension of our funding period through the end of 2010, the 2001 decommissioning funding requirements decreased to $2.6 million compared with $8.9 million in 2000.

    Additional discussion of Kewaunee plant matters is included in MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION and the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

    Wisconsin Public Service's electric generation mix for 2001 and 2000 was:

    Purchased power represents short-term energy purchases.

    Wisconsin Public Service's fuel costs for 2001 and 2000 were:

    Coal is the primary fuel source for Wisconsin Public Service, most of which is from the Powder River Basin mines located in Wyoming. Powder River Basin coal is very low in sulfur and meets the standards of the 1990 Clean Air Act for 2001 and beyond. This coal has been our least-cost coal source from any of the subbituminous coal-producing regions in the United States.

    Wisconsin Public Service continues to test alternative coal sources for its Pulliam and Weston plants. Alternative sources could provide more competitive market pricing and higher Btu content. Coal with higher Btu content will increase generation output and provide flexibility in meeting peak electric demands.

    Most of the coal purchased by Wisconsin Public Service for its wholly-owned plants and purchased by Wisconsin Power and Light for the jointly-owned Edgewater and Columbia plants is done through relatively short-term contracts of up to five years duration. Historically, Wisconsin Public Service has purchased the subbituminous coal directly from the producer. For 2002 and 2003, approximately 23% of the coal requirements for the wholly-owned plants and 13% for the jointly-owned plants have been awarded to a marketer. For 2002, 99% of the wholly-owned and jointly-owned plant requirements are under contract. One long-term contract, for our wholly-owned plants, covers approximately 23% of total requirements and has take-or-pay obligations totaling $83.7 million for the years 2002 through 2016.

    Wisconsin Public Service contracts for coal transportation for its plants under contracts of up to five years duration. Over 90% of our coal transportation is under competitive transportation agreements, which we expect to continue to contribute to competitive fuel costs.

    See NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, COMMITMENTS AND CONTINGENCIES regarding "Coal Contracts."

    Wisconsin Public Service purchases uranium concentrates, conversion services, enrichment services, and fabrication services for nuclear fuel assemblies at the Kewaunee plant. Wisconsin Public Service removes and replaces approximately one-third of the 121 fuel assemblies from the reactor every 18 months. Wisconsin Public Service stores spent fuel assemblies at the plant site pending permanent disposal by the United States Department of Energy.

    Wisconsin Public Service purchases uranium concentrates, conversion services, and enrichment services either on the spot market, through a bidding process, or using existing contracts.

    Nuclear Management Company's uranium inventory policy's to maintain sufficient inventory for up to two reactor refuelings. As of December 31, 2001, after the November 2001 refueling, approximately 563,000 pounds of yellowcake (a processed form of uranium ore), or its equivalent, were held in inventory for the plant. Each refueling requires approximately 450,000 pounds of yellowcake. Approximately 350,000 pounds of yellowcake will be acquired in 2002 to meet the requirements of the inventory policy. Inventory includes uranium under contract.

    Conversion services are complete for the nuclear fuel reload scheduled in 2003.

    Wisconsin Public Service has contracted for a fixed quantity of enrichment services through the year 2004. Wisconsin Public Service has the option of purchasing future enrichment services under an existing contract or purchasing from the spot market.

    Wisconsin Public Service has contracted for fuel fabrication services for the next six reloads.

    If, for any reason, the Kewaunee plant is forced to terminate operations, we do not expect the maximum exposure, to the co-owners, related to fuel contracts to exceed $6.5 million. This exposure is due to a long-term fuel fabrication contract with Westinghouse. No financial penalties associated with the present uranium supply, conversion service, or enrichment agreements exist. Uranium inventories could be sold on the spot market.

    The federal government is responsible for the disposal or permanent storage of spent nuclear fuel. Legislation is being considered on the federal level to provide for the establishment of a permanent storage facility.

    Spent nuclear fuel is currently being stored at the Kewaunee plant. In 2001, the plant added storage capacity for 215 spent fuel assemblies. At current production levels, this is sufficient storage for all fuel assemblies until the expiration of our current operating license in 2013. Additional capacity will be needed in 2013 for fuel assemblies in use at shutdown or if the plant license is extended.

    The Energy Policy Act of 1992 requires nuclear power companies to fund the decontamination and decommissioning of Department of Energy facilities relating to the processing of nuclear fuel. As a result, we are required to pay a surcharge for uranium enrichment services purchased from the Federal government prior to October 23, 1992. On an inflation-adjusted basis, our portion of the obligation related to the Kewaunee plant is approximately $600,000 per year through the year 2007. Madison Gas and Electric has agreed to continue to pay its portion of this annual assessment through 2007.

    Wisconsin Public Service and a number of other nuclear power companies sued the Department of Energy in the United States Court of Federal Claims seeking a refund of the previously paid decontamination and decommissioning surcharge payments. This claim continues in the Court of Federal Claims pending the resolution of other litigation.

    Electric reliability was the primary issue for the Public Service Commission of Wisconsin in 2001. The Public Service Commission of Wisconsin in 2001 focused on:

    The Public Service Commission of Wisconsin issued an order in 2001 approving the proposed Wausau to Duluth transmission line. The Wausau to Duluth transmission line is a proposed 220-mile, 345-kilovolt transmission line from Wausau, Wisconsin to Duluth, Minnesota. The line will be constructed by Wisconsin Public Service and Minnesota Power and Light Company. Wisconsin Public Service will transfer its portion of the construction project to American Transmission Company in exchange for an additional equity interest in American Transmission Company. Wisconsin Public Service is responsible for the management and construction of the Wisconsin portion of this project for American Transmission Company.

    The Commission initiated a generic docket to address the potential recovery of deferred 2000 and 2001 start-up costs and increased transmission operating costs of American Transmission Company by the member Wisconsin utilities; Madison Gas and Electric Company, Wisconsin Electric Power Company, Wisconsin Power and Light Company and Wisconsin Public Service. We anticipate completion of the docket in the summer of 2002 , which should identify the costs to be recovered and the method for recovery. Wisconsin Public Service began recovering some of these costs, as a result of its interim rate case order, which was implemented January 1, 2002. The interim recovery of these costs is subject to refund should the costs in the final generic docket be less than the costs included in the interim rates.

    The Commission began evaluating proposals from Wisconsin Electric Power, Customer's First! Coalition (a group of environmental and customer groups), municipal utilities, and cooperative energy providers regarding future construction and ownership of generation facilities in the state. In its first ruling on these proposals, the Commission indicated that Wisconsin Electric Power may proceed with its planning for generation construction and will be able to recover prudent planning expenditures from its customers. On February 1, 2002, Wisconsin Electric Power applied for Certificates of Public Convenience and Necessity for its generation construction proposals.

    Although the summer of 2001 was generally warmer than normal, the regional electric system did not experience electric shortages and price spikes as experienced in the late 1990s. Purchased power, generation capacity, low natural gas prices and transmission capacity were sufficient to satisfy customer demand. In the summer of 2001, Wisconsin Public Service offered On Line Power Exchange, a new option for its largest customers. On Line Power Exchange is a customer buyback program, which allows Wisconsin Public Service to repurchase capacity from its customers during peak demand periods. This option allows customers to voluntarily sell back all or a portion of their supply. The program allows customers to set the price for their capacity on the Internet in real time based on current, day ahead, or hourly prices. There was significant customer interest in this program, but due to adequate power supply on the system at reasonable prices during the summer, there were very few periods of supply shortages and higher prices for there to be a benefit to the customer or Wisconsin Public Service in 2001.

    In 2001, Wisconsin Public Service's electric rates were 93% of the state average for residential rates, 81% for commercial rates, and 79% for large industrial rates.

    In 2001, Wisconsin Public Service filed for a 16.1% electric rate increase for 2002, the second year of the biennial rate case filed in 2000. Primary reasons for requesting higher rates in the second year of the biennial period were the costs relating to the Kewaunee steam generator replacement completed in 2001, process improvements necessary to bring the Kewaunee plant operations up to evolving industry standards, deferred startup and higher operating costs from American Transmission Company, transmission and generation infrastructure, customer information system improvements, facilities management system enhancements, security costs at the Kewaunee plant and continuation of the automated meter reading installation project. These increased costs were partially offset by decreased costs for fuel and purchased power due to increased generation from the Kewaunee plant and lower natural gas prices. Wisconsin Public Service requested a 12.6% return on equity, based on a capital structure consisting of 55% equity.

    Due to the fact that a rate order could not be issued by January 1, 2002, Wisconsin Public Service filed for interim rate relief to be effective January 1, 2002. On December 19, 2001, the Commission issued its order for interim rate relief authorizing a $55.5 million, or 10.3%, increase in electric rates effective January 1, 2002. Interim rates are based on a 12.1% return on equity and a 55% common equity capital structure. The interim rates are subject to refund in the event that the revenue requirement in the final rate case is less than the authorized interim revenue requirement. The interim rates will continue until a final rate order is issued. A final decision on the original rate request is expected in April 2002.

    On June 2, 2000, a law became effective in Michigan, providing all electric customers of investor-owned and cooperative utilities the right to choose their generation supplier by January 1, 2002. This law allows customers to choose their supplier; it did not deregulate utility generation services.

    Wisconsin Public Service and Upper Peninsula Power, along with other Michigan Electric and Gas Association electric utility members, jointly developed and filed open-access tariffs and business practices with the Michigan Public Service Commission. The Commission approved the tariffs with minimal changes. All of the Michigan Electric and Gas Association Companies had open-access tariffs available for customer choice on January 1, 2002. The Michigan Public Service Commission also completed initial orders during 2001 on Slamming and Cramming, Code-of-Conduct, Distribution Performance Standards, Environmental Disclosure, Customer Choice Education, Transition Cost Recovery, Stranded Cost Recovery, a Market Power Study and Supplier Licensing. Some of these orders are or will be challenged for rehearing or in court proceedings. Orders related to Slamming and Cramming are intended to minimize the ability of suppliers to switch customers or add services and associated charges without the customer's consent.

    In 2001, Wisconsin Public Service continued to be the lowest-cost provider of electric service in Michigan for all customer classes, although one other Upper Peninsula utility had equally low rates for residential and small commercial customers. Wisconsin Public Service rates were 77% of the state average for residential rates, 75% for commercial rates, and 63% for large industrial rates.

    In 2001, Upper Peninsula Power's rates were similar to other small Michigan utilities serving predominantly rural service territories. In comparison to the major utilities in Michigan, Upper Peninsula Power Company rates were 123% of the state average for residential rates, 108% for commercial rates, and 106% for large industrial rates.

    Wisconsin Public Service and Upper Peninsula Power have one-for-one recovery mechanisms for electric fuel and purchased power in Michigan. Although a number of utilities froze their one-for-one recovery mechanisms during the 1990s, Wisconsin Public Service and Upper Peninsula Power did not request a freeze. In the current volatile electric energy market, we feel that passing through these one-for-one costs of energy encourages a competitive market and sends appropriate price signals to customers.

    Other than power supply recovery adjustments, Wisconsin Public Service has not had a Michigan electric rate increase since 1987.

    In August 2001, Upper Peninsula Power's application for a $5.7 million rate increase which had been pending before the Michigan Public Service Commission since October 2000 was dismissed at Upper Peninsula Power's request. Upper Peninsula Power requested a dismissal of this rate case because the information filed in the case was outdated. Upper Peninsula Power intends to submit a new application for rate increases sometime in 2002. Upper Peninsula Power has not experienced a rate increase since 1994.

    In December 2001, Midwest Independent Transmission System Operator received approval from the Federal Energy Regulatory Commission as the first Regional Transmission Organization in the nation and became operational in the first quarter of 2002. The Federal Energy Regulatory Commission will require several additional compliance filings as part of the approval order.

    As required by Wisconsin Act 9, American Transmission Company joined the Midwest Independent Transmission System Operator. American Transmission Company is made up of the transmission systems formerly owned by Wisconsin Public Service, Upper Peninsula Power, Wisconsin Power and Light Company, Wisconsin Electric Power Company, Madison Gas and Electric Company, Edison Sault Electric Company, South Beloit Water, Gas and Electric Company, and a number of electric municipal and cooperative utilities.

    In a companion order, the Federal Energy Regulatory Commission also denied approval of Alliance Regional Transmission Operator's application to become the second Regional Transmission Company in the Midwest. Alliance proposed to serve the Midwest in portions of Illinois, Michigan, Ohio, the Virginias, and the Carolinas. During 2000, three major members of Midwest Independent Transmission System Operator Illinois Power, Commonwealth Edison, and Ameren, received approval from the Federal Energy Regulatory Commission to withdraw from Midwest Independent Transmission System Operator and join Alliance. The December 2001 Federal Energy Regulatory Commission order strongly encourages Alliance member companies to join the Midwest Independent Transmission System Operator.

    In 2001, additional utilities joined the Midwest Independent Transmission System Operator, extending its market to the Rocky Mountains. Discussions are underway on a combination of Midwest Independent Transmission System Operator with Southwest Power Pool, which covers portions of Louisiana, Mississippi, Arkansas, Oklahoma, Texas, Kansas and New Mexico. Discussions are also underway for a merger of Pennsylvania, Jersey, Maryland Regional Transmission Organization and Midwest Independent Transmission System Operator, which would add portions of Pennsylvania, New Jersey, Maryland and West Virginia.

    Other than transmission open access tariff cases, ancillary service rates, and adjustments for fuel buyouts, Wisconsin Public Service has not had a Federal Energy Regulatory Commission wholesale rate case since 1987. Wisconsin Public Service anticipates filing a Federal Energy Regulatory Commission general rate case by the end of 2003.

    On January 1, 2001, Wisconsin Public Service turned over its transmission system to American Transmission Company in exchange for an equity interest in American Transmission Company. Upper Peninsula Power Company also transferred its transmission system to American Transmission Company on June 28, 2001. Wisconsin Public Service filed for new transmission open access tariffs with the Federal Energy Regulatory Commission to eliminate the transmission provisions in its current rates, which are now a part of American Transmission Company's open access transmission tariff. The remaining portions of the Wisconsin Public Service tariff are ancillary service and distribution service provisions. The Upper Peninsula Power portion of this open access transmission tariff will be revised in a similar manner.

    During 2000, the Federal Energy Regulatory Commission accepted American Transmission Company's open access transmission tariff effective January 1, 2001, subject to refund and set it for hearing. The Commission identified four issues that were not approved as filed:

Settlements on all four issues were reached with all interveners in this case and the Federal Energy Regulatory Commission approving the settlements in late 2001. The settlements reduced American Transmission Company rates for Wisconsin Public Service by approximately $7.5 million during the 2001 through 2005 phase-in period. The settlements provided for a 12.2% return on common equity. WPS Resources has a 15% equity investment in American Transmission Company.

    In late 2001, the Federal Energy Regulatory Commission started a new initiative to develop a standard wholesale market design. This initiative so far has included preliminary orders on:

    This initiative is expected to affect almost all aspects of utility regulation on the wholesale level. Wisconsin Public Service has filed for a triennial review of its market-based rate authority using the new market power test and has also filed comments on the issue of setting market-based rates subject to refunds and the development of electric market design and structure.

    All the Federal Energy Regulatory Commission hydroelectric facility licenses held by Wisconsin Public Service, Upper Peninsula Power, and Wisconsin River Power have been renewed, with the exception of the licenses for Upper Peninsula Power's Bond Falls and Dead River facilities. The Federal Energy Regulatory Commission issued 30-year licenses for the Petenwell and Castle Rock facilities, owned by Wisconsin River Power effective December 7, 2001. Wisconsin Public Service owns 50% of the stock of Wisconsin River Power.

    In 1998, Upper Peninsula Power reached a settlement agreement with federal and state agencies and special interest groups regarding its Bond Falls license. All parties signed the agreement early in 2001. The agreement is the basis for a new license from the Federal Energy Regulatory Commission. Issuance of the new license is expected in late 2002. The license will have a term of 30 to 50 years from the date it is granted.

    Licensing of the Upper Peninsula Power Dead River facility is also progressing. During 2000, Upper Peninsula Power obtained long-term water-power easements from adjacent landowners providing flowage rights required by the Federal Energy Regulatory Commission and the Clean Water Act. Upper Peninsula Power expects issuance of the license in late 2002. The license will have a 30 to 50-year term beginning in August 1991, the date the Federal Energy Regulatory Commission claimed jurisdiction over the Dead River facility.

Research and Development

    Electric research and development expenditures for Wisconsin Public Service totaled $1.1 million for 2001, $1.8 million for 2000, and $1.7 million for 1999. These expenditures were primarily charged to electric operations as incurred.

    Twenty-nine paper mills account for 11% of Wisconsin Public Service's electric revenues. There is no single customer, or small group of customers, the loss of which would have a materially adverse effect on the electric business of Wisconsin Public Service in the current regulatory environment.

 Natural Gas Market

    WPS Resources' natural gas utility operations are provided by Wisconsin Public Service. As of December 31, 2001, Wisconsin Public Service provided natural gas distribution service to 285,047 customers in 278 municipalities in northeastern and central Wisconsin, and 5,306 customers in and around the City of Menominee, Michigan, for a total of 290,353 natural gas distribution customers. This represents an increase of 54,883 customers, or 23.3%, compared with December 31, 2000. The large increase is due mainly to the acquisition of approximately 50,595 customers as a result of the merger of Wisconsin Fuel and Light into Wisconsin Public Service. The principal cities served by Wisconsin Public Service include Green Bay, Oshkosh, Manitowoc, Sheboygan, Two Rivers, Marinette, Stevens Point, Wausau, and Rhinelander, in Wisconsin, and the City of Menominee in Michigan.

    The natural gas distribution business of Wisconsin Public Service has a significant seasonal component and is impacted by varying weather conditions from year-to-year. In the calendar year 2001, 64% of its natural gas sales and 54% of its total natural gas system throughput occurred during the five winter months of November through March. Total natural gas throughput includes natural gas sales and natural gas delivered for transportation customers. Competition with other forms of energy exists in varying degrees, particularly for large commercial and industrial customers who have the ability to switch between natural gas and alternate fuels. Wisconsin Public Service offers interruptible natural gas sales and natural gas transportation service for these customers to enable them to reduce their energy costs through the use of natural gas. Transportation customers purchase their natural gas from other suppliers and contract with Wisconsin Public Service to transport the natural gas from interstate natural gas pipelines to their facilities. Additionally, customers still purchase their natural gas commodity directly from Wisconsin Public Service, but have elected to do so on an interruptible basis. These customers continue to switch from firm system supply to either interruptible system supply or transportation service each year as the economics and service options become attractive for them.

    Natural gas operations also provide interruptible natural gas service to Wisconsin Public Service electric operations for its combustion turbine peaking generators and for start-up, flame stabilization, and peaking use at its Weston and Pulliam coal-fired plants.

    Natural gas sales for customer-owned power generation use are provided on an interruptible basis, with the power plants maintaining alternate fuel capability.

    Natural gas supply has been adequate in Wisconsin, with the only significant constraints being created by the demand of electric generation peakers. While the cost of natural gas increased four fold during the winter of 2000-2001 due to tight supplies nationwide, the cost of natural gas has decreased significantly for the winter of 2001-2002. As a result of the purchased natural gas adjustment clause, Wisconsin Public Service passes all prudently incurred increases and decreases in natural gas purchase costs directly to customers on a current basis.

    Total natural gas deliveries in 2001 for Wisconsin Public Service, including customer-owned natural gas transported, were 74,272,193 dekatherms, a 5.7% increase over 2000. A dekatherm is equivalent to 10 therms or 1 million Btus of energy. Natural gas transported for end-user transport customers made up approximately 45% or 33,718,400 dekatherms of natural gas delivered.

    Peak day natural gas throughput for 2001 occurred on Wednesday, February 21, 2001, with 413,465 dekatherms total natural gas throughput at an average Green Bay temperature of 5.4 degrees Fahrenheit. This compares with the previously reported record natural gas system throughput of 432,928 dekatherms set on February 2, 1996 at an average Green Bay temperature of -23.8 degrees Fahrenheit.

General

    Wisconsin Public Service manages a portfolio of natural gas supply contracts, pipeline transportation services, and storage services designed to meet its varying load pattern at the lowest reasonable cost.

    The service territory of Wisconsin Public Service is primarily served by a single interstate pipeline, ANR Pipeline Company. Through ANR's system, Wisconsin Public Service directly or indirectly accesses North American natural gas supplies from three major natural gas-supply areas:

    Wisconsin Public Service holds firm long-term transportation capacity on the pipeline from each of these three supply areas through November 2010. Wisconsin Public Service holds firm transportation capacity with Viking Gas Transmission Company, to deliver natural gas on a firm basis from its interconnection with TransCanada Pipelines at Emerson, in the Canadian Province of Manitoba, to the interconnection with ANR at Marshfield, Wisconsin. These Canadian natural gas suppliers hold firm capacity on TransCanada Pipelines from Emerson back into the production areas in Alberta, Canada.

    Besides providing the ability to manage significant changes in daily natural gas demand, storage also provides the ability to purchase natural gas from the production areas at high load factors, thus minimizing supply costs. During the summer, natural gas purchased in excess of market demand is injected into storage. During the winter, natural gas is withdrawn from storage and combined with natural gas purchased in the production areas to meet the increased winter demand. Natural gas from storage provides up to 52% of our supply on winter peak days, approximately 30% of our winter sales volumes, and approximately 20% of our total annual sales volumes.

    For winter peak day needs, Wisconsin Public Service also contracts with third-party suppliers for high deliverability storage in production areas. This high deliverability storage service provides a back-up supply of natural gas for our transportation contracts when other supplies cannot be delivered due to production supply losses caused by extremely cold weather in the production areas.

    Wisconsin Public Service contracts for fixed-term firm supplies with between 10 and 15 suppliers each year for natural gas produced in each of the three production areas. Due to the current uncertainty regarding the future role of natural gas utilities in continuing the natural gas supply function, Wisconsin Public Service has continued to pursue contracting for domestic natural gas supplies for terms of one year or less. This will minimize potential stranded natural gas supply contract costs if retail natural gas deregulation should proceed quickly in Wisconsin. Our supply portfolio, as of December 31, 2001, contained domestic contracts with remaining terms of up to ten months, and Canadian contracts with remaining terms of up to 22 months.

    Wisconsin Public Service purchases additional supplies on the monthly spot market as required to supplement supplies from fixed-term firm contracts. Wisconsin Public Service has been an active spot market purchaser since 1985 and has contracts in place with a number of suppliers of spot market natural gas.

    Wisconsin Public Service acquired the natural gas supply and transportation contracts of Wisconsin Fuel and Light on April 1, 2001. Because Wisconsin Public Service and Wisconsin Fuel and Light held similar natural gas supply and transportation contracts, the acquisition of the Wisconsin Fuel and Light contracts is expected to have no significant impact on the combined company's cost of natural gas.

    Little progress was made on natural gas restructuring in Wisconsin over the last year. The timing and details of implementation could have an impact on Wisconsin Public Service because of potential stranded costs associated with interstate pipeline capacity contracts. It is expected that the Public Service Commission of Wisconsin will allow for stranded cost recovery from customers or direct assignment to specific customers of applicable ongoing fixed costs of stranded pipeline capacity contracts should restructuring progress.

    In its 2001-2002 rate application, Wisconsin Public Service proposed to facilitate customer choice of natural gas suppliers through the use of its new automated meter reading system. This customer choice program was approved by the Public Service Commission of Wisconsin to provide customer choice of natural gas suppliers for commercial customers using between 20,000 and 75,000 therms per year beginning November 1, 2001. In its 2002 rate application, Wisconsin Public Service proposes to expand the natural gas customer choice program to all commercial customers using more than 15,000 therms per year beginning November 1, 2002. Wisconsin Public Service expects approval for this expansion from the Public Service Commission of Wisconsin in April 2002. Wisconsin Public Service anticipates expanding this program in the future to all customers, including residential natural gas customers, as the automated meter reading system is installed on its entire system.

    Wisconsin Public Service implemented a modified one-for-one natural gas cost recovery mechanism in January 1999, in response to Public Service Commission of Wisconsin requirements. This method allows for the recovery of all prudent natural gas supply costs provided those costs meet index-based benchmarks. Under this method, Wisconsin Public Service has been authorized to recover all natural gas commodity costs incurred to date.

    On June 29, 2001, Wisconsin Public Service filed a three-year natural gas supply plan with the Public Service Commission of Wisconsin detailing its plans to purchase and transport the necessary natural gas supplies for the period November 2001 through October 2004. The Commission approved the Natural Gas Supply Plan in October 2001.

    In 2001, Wisconsin Public Service filed for a 4.5% natural gas rate increase for 2002, the second year of the biennial rate case filed in 2000. The primary reasons for requesting higher rates in the second year of the biennium included the cost of improvements to the natural gas infrastructure, the customer information system, the facilities management system and the continuation of the automated meter reading project.

    Due to the fact that a rate order could not be issued by January 1, 2002, Wisconsin Public Service filed for interim rate relief to be effective January 1, 2002. In December 2001, the Public Service Commission of Wisconsin issued an order for interim rate relief, authorizing an $11.2 million, or 4.7%, natural gas rate increase starting January 1, 2002. The interim rates will continue until the final rates go into affect, which is expected in April 2002, and are subject to refund with interest if the final authorized revenue requirement is less than the interim authorized revenue requirement. The Commission's interim order included the current authorized return on equity of 12.1% and a capital structure consisting of 55% equity, and several other minor adjustments to the current Commission staff audit revenue requirements in the case.

    Wisconsin Public Service's 2001 natural gas rates were competitive in Wisconsin. Rates were 76% of the state average for commercial and industrial rates, and 101% of the state average for residential rates.

Industry Restructuring

    In Michigan, the majority of the largest natural gas customers have had a choice of their natural gas commodity supplier since the 1980s. In 2001, the Michigan Public Service Commission approved permanent choice programs for smaller customers for the two largest natural gas utilities in Michigan.

    The small natural gas utilities in the state, including Wisconsin Public Service, are to propose a customer choice program for all customer classes when it is in the best interests of each utility and its customers. There is no timetable for moving this process to the smaller utilities in the state, such as Wisconsin Public Service, but we intend to provide for customer choice of natural gas suppliers for all customers following installation of our automated meter reading system in Michigan.

    As required, on December 20, 2001, Wisconsin Public Service filed a five-year Natural Gas Cost Recovery Plan with the Michigan Public Service Commission detailing its plan to purchase and transport the necessary natural gas supplies for the April 2002 through March 2007 period. Wisconsin Public Service expects approval of the Natural Gas Cost Recovery Plan, by the Michigan Public Service Commission, in April 2002.

    Wisconsin Public Service had some of the lowest commercial and industrial natural gas rates in Michigan during 2001. Its rates were 84% of the state average for commercial and industrial rates, and 114% of the state average for residential rates.

    Wisconsin Public Service has not had a natural gas rate case in Michigan since 1986.

    Most of Wisconsin Public Service's involvement in federal regulatory activities in the natural gas area has been through the Wisconsin Distributor Group. This group is made up of several Wisconsin natural gas utilities.

    In 2001, the Wisconsin Distributor Group has been working with ANR and other interested parties to come to an agreement on ANR's compliance filing in response to Order 637 regarding capacity release and intra-day nominations. In July 2001, ANR filed a settlement with the Federal Energy Regulatory Commission that was supported by the Wisconsin Distributor Group and Wisconsin Public Service. In late December, the Federal Energy Regulatory Commission issued an order in this docket. ANR has concerns with some of the changes to the settlement agreement imposed by the Federal Energy Regulatory Commission, and ANR is currently working with interested parties, including the Wisconsin Distributor Group and Wisconsin Public Service, to resolve these issues.

    Also during the past year, Wisconsin Public Service has been working on its own and through the Wisconsin Distributor Group to resolve issues with ANR and the Federal Energy Regulatory Commission concerning negotiated rate agreements. Wisconsin Public Service and ANR negotiated new contracts which both companies felt were in compliance with the then stated policies of the Federal Energy Regulatory Commission. However, after ANR filed the new contracts, the Commission rejected the filing and required ANR to make changes, which reflected changes in Commission policy. Wisconsin Public Service will continue to work with ANR and the Federal Energy Regulatory Commission to resolve the issues concerning negotiated rate agreements in order to maintain the economic and other benefits that it gained through its negotiation with ANR.

    On-going activities in which Wisconsin Public Service will be participating as a member of the Wisconsin Distributor Group include:

1) ANR's compliance filings made in response to Federal Energy Regulatory Commission Orders 637, 637-A and 637-B,

2) a new Viking rate case that was filed in December 2001,

3) the resolution of negotiated rate issues, and

4) the continued monitoring of various dockets filed by ANR Pipeline Company and Viking Gas Transmission Company at the Federal Energy Regulatory Commission.

 

    WPS Power Development develops, owns, and operates nonregulated electric generation facilities and provides services to the electric power generation industry nationwide and in Canada. Services include project development, engineering and management services, and operation and maintenance services. WPS Power Development has expertise in cogeneration, distributed generation, generation from renewables, and generation plant repowering projects. As of December 31, 2001, WPS Power Development had 175 employees, the majority of whom are members of the International Brotherhood of Electrical Workers Local 1600 Union.

    WPS Power Development owns:

    The 50-megawatt single cycle Combined Locks facility was completed and began generating electricity in October of 2001. WPS Power Development is converting it to a combined cycle system in 2002. Upon completion of the project, which is expected in the second quarter of 2002, the facility will deliver steam energy to Appleton Coated LLC. This will bring the total cost of the facility to approximately $40 million.

    In December 2001, WPS Power Development entered into a stock purchase agreement to acquire CH Resources, Inc. WPS Power Development expects to close this $62 million transaction in the second quarter of 2002. WPS Resources expects to provide temporary financing for this transaction through short-term debt. CH Resources owns three power plants, with a combined capacity of 257 megawatts, and other assets in New York. The power plants are:

    In October 2000, WPS Power Development signed an asset purchase agreement with Sierra Pacific Resources to acquire its 545-megawatt natural gas and oil-fired Tracy/Pinon Power Station. In 2001, before the transaction was finalized, the Nevada legislature passed legislation prohibiting divestiture of utility generation assets in the State of Nevada until July 2003. WPS Power Development is currently working with Sierra Pacific to evaluate the engineering and economic feasibility of modifying the coal gasification unit at the site in order to achieve commercial operation. The original asset purchase agreement does not contain an automatic termination provision if closing does not occur. The agreement does allow either party to terminate the agreement after specified dates in 2002.

    In November 2001 WPS Power Development, through its subsidiary ECO Coal Pelletization #12 LLC, entered into a transaction with a subsidiary of a public company resulting in ECO #12 contributing its synthetic fuel producing machinery to Synfuel Solutions Operating, LLC, a newly formed entity, in exchange for cash and a one-third interest in Synfuel Solutions LLC. The synthetic fuel produced by this facility qualifies for tax credits under Section 29 of the Internal Revenue Code. WPS Power Development entered into this transaction to optimize the economic value of the project, due to the fact that at full capacity the facility generates more tax credits than can be used by WPS Resources on a consolidated basis.

    The transaction generated a pre-tax gain of $40.1 million of which $38.0 million has been deferred as of December 31, 2001, as a result of certain rights of rescission and puts being granted to the transaction's buyer. As these rights of rescission expire and the value of the economic put options to the buyer diminish, WPS Power Development will recognize through earnings the deferred gain on the transaction. The primary contingency in 2002 relates to the receipt of a new private letter ruling from the Internal Revenue Service for this facility. If this ruling is not received, the buyer has the right to rescind the transaction; although, in the event of rescission, WPS Power Development would receive a breakage fee based upon overall production of the facility from the date of the transaction through the date of rescission. In addition, if annualized production at the facility is less than a specified level, the purchase price will be reduced. Conversely, if production levels are higher than a previously negotiated level, WPS Power Development will receive a royalty payment for excess production. WPS Power Development will also receive a royalty payment if Section 29 is extended beyond 2007. The contingency requiring deferral of a portion of the gain until 2003, relates to a series of put options available to the buyer in the event that the facility is destroyed and under IRS regulations would not qualify for tax credits if rebuilt. All such options expire in 2003.

    The annual coal requirements for WPS Power Development owned plants are estimated at 1.2 million tons. Of this amount, approximately 50% will be met through the burning of coal silt. In 2001, WPS Power Development purchased all of its coal supplies through the spot market and short-term contracts due to the breach of a coal supply contract. In 2002, WPS Power Development expects to supply approximately 80% of its annual coal needs through annual coal contracts and its reserves of coal and coal silt. WPS Power Development has approximately a 9-year reserve of coal silt. The remaining coal requirements will be purchased through the spot market.

    In 2002, coal transportation for approximately 25% of annual coal requirements will be supplied under a two-year contract with Norfolk Southern Railroad. The remaining coal transportation is contracted through short term agreements with a variety of transportation providers.

    All the Federal Energy Regulatory Commission hydroelectric facility licenses held by WPS Power Development are current. The 33-megawatt hydroelectric facility owned in New Brunswick, Canada is not subject to licensing.

    Although identifiable price peaks do not occur at any certain time of the year, WPS Power Development believes the nonregulated energy market is subject to seasonal impacts. Generally in the summer months, the demand for electric energy is high, which increases the price at which energy can be sold. In periods of high fuel consumption, generally the winter months, the purchase price of coal and natural gas increase.

    Equity and working capital requirements of WPS Power Development are generally financed through WPS Resources. Project nonrecourse debt financing has been put in place for the Sunbury, Maine, and Canadian generation plants owned by WPS Power Development.

    WPS Power Development acquired the Sunbury generating plant in November of 1999. As a result of both market conditions and issues related to the physical performance of the plant, the project to date has not met management's projected near-term financial performance levels. Due to this lower level of performance in 2001, WPS Resources infused additional capital of $24.5 million into the project to fund operating expenses, capital expenditures, and to ensure the project is in compliance with its project financing debt covenants. Projections going forward indicate that Sunbury will produce adequate cash flows for its operations, with capital contributions being required for capital expenditures. In 2002, capital contributions will be required primarily to fund the project to reduce NOx emissions from the plant by 2003. Those expenditures are estimated to be approximately $13 million. WPS Power Development anticipated these costs when it acquired the plant.

    Of WPS Power Development's approximately 650 megawatts of existing capacity, fixed price contracts are in place to sell approximately 350 megawatts. Of this, 250 megawatts are firm commitments. The remainder of the energy production of WPS Power Development is sold on the spot market. Although WPS Power Development operates in the nonregulated energy market, the existence of various long-term out-take contracts entered into as part of the generation asset acquisition agreements mitigates some of the impact of spot market competition.

    The generation assets of WPS Power Development are subject to regulations on sulfur dioxide and nitrogen oxide emissions similar to those that apply to Wisconsin Public Service. In addition, the Sunbury generation facilities of WPS Power Development are located in an ozone non-attainment area. As a result, these generation facilities are subject to additional restrictions on emissions of nitrogen oxide. WPS Power Development has acquired emission credits sufficient to meet all emission requirements through the year 2002. Although WPS Power Development has emission credits for 2003, it is unknown whether these will be sufficient to meet its requirements. WPS Power Development estimates that it will incur $16 million in capital costs over the next two years to address environmental regulations at its Sunbury facility.

    WPS Energy Services is a diversified, nonregulated energy supply and services company with its principal operations in Illinois, Maine, Michigan, Ohio, and Wisconsin. WPS Energy Services operates in the retail and wholesale nonregulated energy marketplace. Its emphasis is on servicing commercial, industrial, and wholesale customers, as well as "aggregated" residential customers, in the northeast quadrant of the United States and adjacent portions of Canada. Aggregated residential customers are associations or groups of residential customers, which have joined together to negotiate purchases of electric or natural gas energy as a larger group. These associations and groups, in turn, may consist of individuals, municipalities or other types of customers. WPS Energy Services had 103 employees as of December 31, 2001.

    WPS Energy Services provides individualized energy supply options and strategies that allow customers to manage energy needs while capitalizing on opportunities resulting from deregulation. WPS Energy Services provides natural gas, electric and alternate fuel products, real-time energy management services, energy utilization consulting, and project management.

    WPS Energy Services operates in nonregulated energy markets. Its competitors consist of regulated utilities, large energy traders, and other energy marketers. WPS Energy Services competes with other energy providers on the basis of price, reliability, service, consumer convenience, performance, and reputation.

    On January 8, 2002, WPS Energy Services received a license to operate as an alternative electric supplier to sell electric energy to Michigan retail customers. WPS Energy Services became 1 of 14 licensed alternative electric suppliers in the state. Beginning January 1, 2002, the majority of Michigan retail customers of electric utilities will be able to choose an alternative supplier. WPS Energy Services is also a Federal Energy Regulatory Commission licensed marketer and is transacting business in Maine, Ohio, Pennsylvania, Illinois, and Wisconsin and will soon be in the New York market.

    Since May 2000, WPS Resources has provided limited financial support and energy supply services to a third party, Quest Energy, LLC, a Michigan limited liability company. Quest is a retail electricity marketing entity, doing business as a registered Alternative Electric Supplier in the state of Michigan. Financial support is in the form of an interest-bearing note with an initial maturity date of May 2005, secured by the assets of Quest. On December 31, 2001, the loan amount remaining was $1.0 million. The note contains certain restrictions on Quest's ability to enter into additional debt instruments. WPS Resources also provides corporate guaranties on behalf of Quest that are not included in its consolidated financial statements. Guaranties have been made to Quest's transmission providers in the amount of $4.5 million. These guaranties assure Quest's ability to pay for the transmission services it purchases from these entities.

    WPS Energy Services provides substantially all of the electric energy supply to Quest on a wholesale basis without requiring the credit assurances required of other wholesale customers. WPS Energy Services exercises its right to evaluate Quest's sales portfolio to verify the portfolio's ability to generate the revenues necessary to pay for purchased wholesale supply. WPS Energy Services further provides computational infrastructure and support services related to the daily operational activities of Quest. At year-end, Quest was current in its payables to WPS Energy Services. On occasion, however, payments from Quest have been late and WPS Energy Services imposes payment penalties on these late payments.

    Although WPS Energy Services is an energy marketer, it has experienced little impact on day-to-day operations as a result of the bankruptcy of Enron Corporation, and is in a net payable position with Enron affiliates. WPS Energy Services has liquidated all open positions with the Enron affiliates and replaced them with other suppliers. The forward contracts with the Enron affiliates provided for payments representing the net liquidation value of the contracts at the time of liquidation, and this net liquidation amount is recorded on the balance sheet as a current accounts payable, contingent upon the outcome of Enron's bankruptcy proceedings. Management believes WPS Energy Services has properly recorded these liabilities. The Enron bankruptcy is expected to have an effect on other companies throughout the industry. As a result, WPS Energy Services is more closely monitoring its credit exposure with other trading partners.

    WPS Energy Services applies mark-to-market accounting in accordance with EITF 98-10. There are no contracts with a term longer than 4 years and most mature within the next 24 months. Contracts are valued on a forward curve derived from exchange based or liquid over-the-counter market quotations. A reserve is created for potential costs and risks, which is netted against expected profits. WPS Energy Services recorded operating reserves, which it deemed sufficient to cover its market positions. WPS Energy has no off balance sheet liabilities related to these contracts.

    WPS Energy is party to a lease, with an independent third party, related to its corporate offices.

    WPS Energy Services works with WPS Power Development to supply fuel for its production facilities and sell the electric energy produced for its current operations as well as future acquisitions.

    WPS Energy Services believes that its business, in the aggregate, is not seasonal, even though certain products sell more heavily in some seasons than in others. Sales of natural gas generally peak in the winter months, while sales of electric energy generally peak in the summer months. Currently, WPS Energy Services' gross margin mix is between 40% and 50% for both electric and natural gas.

    Currently, capital requirements of WPS Energy Services are financed through the holding company, WPS Resources.

    Although WPS Energy Services is not dependent on any one customer, a significant percentage of its retail sales volume is derived from the paper and forest products industry. WPS Energy Services' concentration of sales in any single market sector is decreasing as it expands into the electric aggregation sector of the market.

    WPS Energy Services has a majority interest in a Michigan natural gas storage field, which has been in a test mode and is expected to be commercially operational in April 2002. The storage field will allow for additional flexibility in supplying retail and wholesale customers, sale of storage services to the market, and potential power peaking services.

    WPS Energy Services is not directly subject to significant environmental regulations at this time.

    See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION for additional information regarding nonregulated operations.

    WPS Resources and its subsidiaries are subject to federal, state, and local regulations regarding environmental impacts of their operations on air and water quality and solid waste. The application of federal and state restrictions to protect the environment can involve review, certification, or issuance of permits by various federal and state authorities, including the United States Environmental Protection Agency and the various states' environmental agencies, including the Wisconsin Department of Natural Resources. These restrictions may limit, prevent, or substantially increase the cost of the operation of generation facilities and may require substantial investments in new equipment at existing installations. Such restrictions may require substantial additional investments for new projects and may delay or prevent completion of projects. We cannot forecast the effects of such regulation on our generation, transmission, and other facilities or operations.

    Wisconsin Public Service is subject to regulation by the United States Environmental Protection Agency and the Wisconsin Department of Natural Resources with respect to thermal and other discharges from its power plants into Lake Michigan and other waters of Wisconsin. Wastewater discharge permits, with a term of five years, were re-issued by the Wisconsin Department of Natural Resources for the Kewaunee plant in 2000, for the Pulliam plant and Weston Unit 3 in 2002, and for Weston Units 1 and 2 in 2001.

    The ash disposal site for Upper Peninsula Power's John H. Warden Station was closed in 1993. Subsequent groundwater testing indicated elevated levels of boron and lithium. Supplemental remedial investigations were performed and a revised remedial action plan was developed. The plan was submitted to the Michigan Department of Environmental Quality for approval in 2001. A liability of $1.5 million and an associated regulatory asset of $1.5 million have been recorded for estimated future expenditures associated with remediation of this site. Upper Peninsula Power received an order permitting deferral and future recovery of these costs.

    Wisconsin Public Service continues to investigate the environmental cleanup of 10 manufactured gas plant sites, two of which were previously owned by Wisconsin Fuel and Light. The cleanup of the Stevens Point manufactured gas plant site is substantially complete with monitoring of the site continuing. As of August 2001, cleanup of the land portion of both of the Sheboygan sites was substantially complete. Sediment remains to be addressed at the Sheboygan-Campmarina site. Wisconsin Public Service anticipates that work will commence on the land portion of the Oshkosh site in 2002. Costs of these cleanups are within the range expected for these sites. Wisconsin Public Service estimates future undiscounted investigation and cleanup costs to be in the range of $43.0 million to $49.8 million. Wisconsin Public Service may adjust these estimates in the future contingent upon remedial technology, regulatory requirements and the assessment of natural resource damages.

    Effective with the Wisconsin Fuel and Light merger, Wisconsin Public Service acquired two former manufactured gas plant sites - Manitowoc and Wausau. Wisconsin Fuel and Light performed the cleanup of the land portion of the Manitowoc site in 1994, and the cleanup is substantially complete. Groundwater treatment and monitoring of the Manitowoc site continue. Wisconsin Public Service has not addressed river sediments near the former Manitowoc gas plant site or any portion of the Wausau site.

    Wisconsin Public Service currently has a $43.4 million liability recorded for gas plant cleanup with an offsetting regulatory asset. Wisconsin Public Service expects to recover cleanup costs net of insurance recoveries in future customer rates. Wisconsin Public Service will not recover carrying costs associated with the cleanup expenditures. Wisconsin Public Service has received $12.7 million in insurance recoveries, which have been recorded as a reduction in the regulatory asset.

    The United States Environmental Protection Agency has designated southeastern Wisconsin as an ozone non-attainment area. As part of the State of Wisconsin's plan to reduce ozone levels in the non-attainment area, the state mandated nitrogen oxide reductions for large emission sources. The nitrogen oxide reductions begin in 2003, and the requirements are gradually increased through 2007. This reduction plan affects Edgewater Unit 4. Wisconsin Public Service owns 31.8% of this unit. Edgewater Unit 4 initiated a compliance plan in 2000. The plan includes a combination of combustion optimization and emission trading at a potential cost of approximately $5.0 million for Wisconsin Public Service's share. The State of Wisconsin is also seeking voluntary reductions from utilities with generating facilities located in Wisconsin, but outside the United States Environmental Protection Agency designed ozone non-attainment area, which may lead to additional expenditures for nitrogen oxide reductions at other units. Wisconsin Public Service is participating in voluntary efforts to reduce nitrogen oxide levels at the Columbia Energy Center. Wisconsin Public Service owns 31.8% of Columbia. The Public Service Commission of Wisconsin has approved recovery of the costs associated with nitrogen oxide compliance.

    Based on recent ambient air testing, the State of Wisconsin will be petitioning the United States Environmental Protection Agency to redesignate the ozone non-attainment area to attainment status. The effect the redesignation will have on mandated future nitrogen oxide reduction requirements for Edgewater Unit 4 is uncertain.

    The Wisconsin Department of Natural Resources initiated a rulemaking effort aimed at the control of mercury emissions. Coal-fired generation plants are the primary targets of this effort. The proposed rule was open to comment in October 2001. A Technical Advisory Committee and a Citizen Advisory Committee are reviewing the comments and the proposed rule. A final rule could become effective in 2002. As proposed, the rule requires phased in mercury emission reductions reaching 90% reduction in 15 years. Wisconsin Public Service estimates that it could cost it $105 million per year to achieve the proposed 90% reduction.

    On November 3, 1999, the United States Environmental Protection Agency announced that it was pursuing an enforcement initiative against seven utilities, or their subsidiaries, located in the Midwest and South, as well as the Tennessee Valley Authority. The enforcement initiative alleges that the utilities may have undertaken projects at certain coal-fired generation plants in violation of the Clean Air Act. The United States Environmental Protection Agency is seeking penalties and the installation of additional pollution control equipment at these plants.

    As a continuation of this initiative, the United States Environmental Protection Agency requested on December 14, 2000, that Wisconsin Public Service provide information related to projects undertaken at its Pulliam and Weston plants. Wisconsin Public Service submitted this information on January 16, 2001. Wisconsin Power and Light Company, the operator of the Columbia and Edgewater units co-owned with Wisconsin Public Service, also submitted information related to projects undertaken at the Columbia and Edgewater plants. The United States Environmental Protection Agency requested additional information on February 26, 2001, relating to the Columbia and Edgewater plants. Wisconsin Power and Light Company submitted this information on March 28, 2001, and April 27, 2001. To date, United States Environmental Protection Agency has not requested any additional information for the Pulliam or Weston plants.

    Early compliance with the federal Clean Air Act has generated surplus sulfur dioxide allowances at Wisconsin Public Service. Wisconsin Public Service has sold and will continue to consider the sale of any allowances in excess of its own needs. The Public Service Commission of Wisconsin has ordered that Wisconsin Public Service pass on profits from the sale of allowances to its customers.

    WPS Power Development acquired emission allowances as a result of the purchase of the Sunbury plant in 1999 and the Westwood plant in 2000. The costs assigned to these allowances are charged to expense as the allowances are used. The Sunbury plant also purchases incremental emission allowances on the open market to comply with air regulations. WPS Power Development is installing additional technology to comply with 2003 nitrogen oxide standards. Expenditures for this technology could be significant.

    Other matters pertaining to the environment regarding gas plant cleanup and air quality issues are discussed in Legal Proceedings, MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, and to the Financial Statements.

    WPS Resources and Wisconsin Public Service will make large investments in capital assets. Construction expenditures for Wisconsin Public Service are expected to be approximately $565 million for the period 2002 through 2004. This includes expenditures for investment in an automated meter reading system, corporate software and systems, and beginning construction projects for new generating facilities. Additional expenditures will be needed through 2007 to complete these generating facilities. Other Wisconsin Public Service capital requirements for the 2002-2004 period include Kewaunee decommissioning trust fund contributions of $7.8 million.

    WPS Resources expects to make capital contributions of up to $92 million to fund construction of our portion of the Wausau to Duluth transmission line which will be transferred to American Transmission Company in exchange for an increase in our equity ownership in American Transmission Company.

    Upper Peninsula Power will incur construction expenditures of approximately $37 million for the period 2002 through 2004, primarily for electric distribution improvements and repairs at hydroelectric facilities.

    There are no commitments for additional acquisition expenditures for the nonregulated subsidiaries at this time other than commitments made under the stock purchase agreement to acquire CH Resources, which is expected to close in the second quarter of 2002, and the asset purchase agreement to acquire the Tracy/Pinon Power Station, which is currently subject to a legislative moratorium and may be terminated before the moratorium expires. WPS Resources expects to provide temporary financing for the CH Resources transaction through short term debt. Future nonregulated projects will be financed through nonrecourse project financings to the extent possible.

    WPS Resources uses internally generated funds and short-term borrowing to temporarily satisfy its capital requirements. WPS Resources may periodically issue additional long-term debt and common stock to reduce short-term debt and maintain desired capitalization ratios.

    WPS Resources filed a shelf registration with the Securities and Exchange Commission, which allows the issuance of an aggregate of $400 million of long-term debt and common stock. Long-term debt of $150 million was issued under the shelf registration in November 1999 to reduce short-term debt and provide equity contributions to its subsidiaries. In December 2001, WPS Resources issued 2.3 million shares of common stock for $79 million under the shelf registration. In August 2001, Wisconsin Public Service issued $150 million of notes at 6.125% due in 2011, the proceeds of which were partially used to refund $53.1 million of 8.8% bonds. In January 2001, WPS Resources began issuing new shares of its common stock under its Stock Investment Plan. In 2001, approximately 545,000 shares were issued under the Stock Investment Plan for approximately $18.6 million.

    At this time, WPS Resources does not anticipate issuing additional debt or equity financing in 2002, although the need for additional financing may change due to the availability of projects, market conditions, or other factors.

    See NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, regarding "Future Capital Expenditures."

H. EMPLOYEES

    At December 31, 2001, WPS Resources and its subsidiaries employed 2,856 people. Of this number, 2,380 were employees of Wisconsin Public Service, 156 were employed by Upper Peninsula Power, 175 were employed by WPS Power Development, and 103 were employed by WPS Energy Services, with the remainder employed by WPS Resources and its remaining subsidiaries.

    Of the Wisconsin Public Service employees, 1,832 were electric utility employees and 548 were gas utility employees. Local 310 of the International Union of Operating Engineers represents 1,306 of these employees. The current collective bargaining agreement with Local 310 expires on October 25, 2003.

    Local 510 of the International Brotherhood of Electrical Workers, AFL-CIO represents 123 employees of Upper Peninsula Power. The current collective bargaining agreement with Local 510 expires on April 30, 2002. A new agreement has been reached extending the contract to April 30, 2005.

    Local 1600 of the International Brotherhood of Electrical Workers, AFL-CIO represents approximately 104 employees at the Sunbury generation station owned and operated by a subsidiary of WPS Power Development. The current collective bargaining agreement with Local 1600, which was to expire on May 12, 2002, has been extended to May 12, 2003.

I. RISK FACTORS

    You should carefully consider the following risk factors, as well as the other information included or incorporated by reference in this document in connection with any investment in the common stock of WPS Resources or other securities of WPS Resources or Wisconsin Public Service. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known or that we currently believe to be immaterial may also adversely affect us.

    The energy industry has been undergoing dramatic structural change for several years, resulting in increasing competitive pressure on electric and natural gas utility companies. Increased competition may create greater risks to the stability of utility earnings generally and may in the future reduce our utility earnings from retail electric and natural gas sales. The future of deregulation in the utility industry and its impact on our future is uncertain. At the present time, Wisconsin has not adopted legislation or regulations that would allow customers to choose their electric supplier. All Michigan electric customers were able to choose their electric generation suppliers by January 1, 2002 as a result of the Customer Choice Act. The utility industry expects increased competition for generation services in Michigan with the introduction of retail direct access in that state.

    To the extent competitive pressures increase and the pricing and sale of electricity assumes more of the characteristics of a commodity business, the economics of our business may come under increasing pressure. In addition, regulatory changes may increase access to electricity transmission grids by utility and nonutility purchasers and sellers of electricity, thus potentially resulting in a significant number of additional competitors in wholesale power generation.

    Our strategy for the growth of our nonregulated generation business depends upon our ability to identify and complete acquisitions and development projects at appropriate prices. Our nonregulated electric generation segment has achieved growth through acquisition and we expect that it will continue to grow through acquisition. There can be no assurance that the projects we have acquired to date or projects that we may acquire in the future will perform as expected or that the returns from those projects will support the indebtedness incurred to acquire them or the capital expenditures needed to maintain or develop them. In addition, many of our competitors are seeking opportunities to acquire or develop energy assets. This competition may adversely affect our ability to make investments or acquisitions.

    The Federal Energy Regulatory Commission has authorized us to sell generation from our nonregulated facilities at market prices. The Federal Energy Regulatory Commission retains the authority to modify or withdraw our market based rate authority. If the Federal Energy Regulatory Commission determines that the market is not workably competitive, that we possess market power or that we are not charging just and reasonable rates, then the Federal Energy Regulatory Commission may require us to sell power at a price based upon the costs we incur in producing the power. Our revenues and profit margins will be negatively affected by any reduction by the Federal Energy Regulatory Commission of the rates we may receive.

    Our nonregulated subsidiaries, WPS Power Development and WPS Energy Services, may experience increased expenses, including interest costs and uncollectibles, higher working capital requirements and possibly some level of price sensitive reduction in volumes sold as a result of increases in the cost of fuel or purchased power. Our regulated utilities, however, are able to pass on higher natural gas costs, electric production fuel costs and purchased power costs to their customers.

    We remain liable for the safe operation, maintenance, and decommissioning of our 59% share of the Kewaunee plant even though we transferred operation of the plant to Nuclear Management Company. In addition, we will be liable for our 59% share of the costs of implementing the process improvements currently underway at the plant. The Kewaunee co-owners received approval from the Public Service Commission of Wisconsin and the Michigan Public Utility Commission for deferral of the 2001 and 2002 incremental costs associated with these improvements. Wisconsin Public Service will include its 59% share of these costs in its future rate requests.

    We are subject to extensive environmental regulations in connection with the ongoing conduct of our business and to civil and criminal liability for failure to comply with these regulations. We are also generally responsible for all on site liabilities associated with the environmental condition of our power generation facilities, former manufactured gas plant sites and other facilities which we have previously owned and/or operated or currently own and/or operate regardless of when the liabilities arose and whether they are currently known or unknown.

    In addition, as part of an industry wide focus, capital expenditures at two of our coal fired facilities have been the subject of a formal request for information from the Environmental Protection Agency. If an enforcement proceeding or litigation in connection with this request, or in connection with any proceeding for noncompliance with environmental laws, were commenced and resolved against us, we could be required to invest significantly in new emission control equipment, accelerate the timing of other capital expenditures, pay penalties and/or halt certain operations. Moreover, new environmental laws and regulations, or new interpretations of existing laws and regulations, affecting our operations or facilities may be adopted which may cause us to incur additional material expenses.

    In general, any claim of WPS Resources against the assets of its subsidiaries is subject to the prior rights of the creditors of those subsidiaries. In addition, the Wisconsin public utility holding company law prohibits public utility subsidiaries from making loans to, or pledging their credit for, nonutility members of a Wisconsin public utility holding company system, including the holding company.

    Orders of the Public Service Commission of Wisconsin limit the amount of ordinary dividends that Wisconsin Public Service may pay to WPS Resources and require that the debt-to-equity ratio of Wisconsin Public Service remain within a specified range. The articles of incorporation of Wisconsin Public Service also limit the amount of dividends it may pay on its common stock if its common stock and common stock surplus account are less than 25% of its total capitalization. Bond indenture provisions currently limit the amount of dividends, which may be paid by Upper Peninsula Power to WPS Resources.

    Substantially all of the physical assets of Wisconsin Public Service and Upper Peninsula Power secure outstanding bond issues of Wisconsin Public Service and Upper Peninsula Power. Substantially all of the generating assets of WPS Power Development's subsidiaries have been mortgaged to secure acquisition financing.

    Subject to an exception for certain holding companies organized or created before November 28, 1985, the Wisconsin public utility holding company law requires that any corporation that is a direct or indirect holding company of a Wisconsin public utility be incorporated under the laws of Wisconsin, thereby limiting the number of potential acquirers of WPS Resources. This provision is currently being challenged by another Wisconsin holding company in the federal courts. The Wisconsin public utility holding company law also precludes the acquisition of 10% or more of the voting shares of a holding company of a Wisconsin public utility unless the Public Service Commission of Wisconsin has first determined that the acquisition is in the best interests of utility consumers, investors and the public. Those interests may, to some extent, be mutually exclusive. These provisions of the Wisconsin public utility holding company law may delay, or reduce the likelihood of, a sale or change of control of WPS Resources, thus reducing the likelihood that shareholders will receive a takeover premium for their shares.

    Our articles of incorporation, bylaws and shareholder rights plan, as well as provisions of the Wisconsin Business Corporation Law, also contain provisions that could delay or prevent a change of control or changes in our management that a shareholder might consider favorable and may prevent you from receiving a takeover premium for your shares.

    We have significantly reduced our consolidated federal income tax liability for the past three years through tax credits available to us under Section 29 of the Internal Revenue Code for the production and sale of solid synthetic fuel from coal. Our ability to further utilize these credits and maximize the value of our synthetic fuel production facility is limited by Section 29. As a result, we have sold a portion of our synthetic fuel facility to a third party, which can utilize the additional credits available given the production capacity of the facility. The IRS strictly enforces compliance with all of the technical requirements of Section 29. The purchaser has the right to rescind the contract if it is unable to obtain a new private letter ruling from the IRS confirming the continuing availability of tax credits from the facility within a specified time frame.  In addition, compliance with Section 29 is likely to be audited by the IRS.

    The following table summarizes information on the electric generation facilities of Wisconsin Public Service, including jointly-owned facilities:

    As of December 31, 2001, Wisconsin Public Service owned 110 distribution substations and 20,701 miles of electric distribution lines. Effective January 1, 2001, all transmission property of Wisconsin Public Service was transferred to American Transmission Company.

    Gas properties include approximately 6,505 miles of main, 82 gate and city regulator stations, and 268,763 lateral services. All natural gas facilities are located in Wisconsin except for distribution facilities in and near the City of Menominee, Michigan.

    Substantially all of Wisconsin Public Service's utility plant is subject to a first mortgage lien.

    The following table summarizes information on the electric generation facilities of Upper Peninsula Power:

(a) Based on summer 2002 rated capacity.

(b) The J. H. Warden station was taken out of service on January 1, 1994 and is in standby or inactive reserve status.

(c) Included in the nine hydroelectric plants are Escanaba 1, Escanaba 3, and Boney Falls, which generate a total of 7.9 megawatts. All energy produced at these facilities is sold directly to a paper industry customer located in Escanaba, Michigan.

    Upper Peninsula Power owns 2,826 miles of electric distribution lines.

    Effective June 28, 2001 all transmission property of Upper Peninsula Power was transferred to American Transmission Company.

    Substantially all of Upper Peninsula Power's utility plant is subject to a first mortgage lien.

B.  NONREGULATED

    In 2001 WPS Resources initiated a 5 to 7 year program involving the assessment of all assets of its subsidiaries, primarily, Wisconsin Public Service and Upper Peninsula Power, which are no longer needed for operations, identifying alternative uses to maximize their value. The program began with an initial agreement with the State of Wisconsin to ultimately transfer forest and waterfront land along the Peshtigo River in northeastern Wisconsin to the State over a 4-year period.

    The following table summarizes information on the electric generation facilities of WPS Power Development, including jointly-owned facilities:

(a) Mid-American Power, LLC, owns the Stoneman facility. PDI Stoneman, Inc. (a wholly-owned subsidiary of WPS Power Development, Inc.) and B. M. Stoneman, Inc., (a wholly-owned subsidiary of Burns and McDonnell) own 66-2/3% and 33-1/3%, respectively, of Mid-American Power, LLC. The amount reported in the above table represents our two-thirds interest in the plant.

(b) WPS Power Development owns a 3.3455% interest in the Wyman plant. The plant is a 619-megawatt oil-fired facility.

ITEM 3. LEGAL PROCEEDINGS

    See the section titled Spent Nuclear Fuel Disposal under Part I, Item 1B, ELECTRIC UTILITY MATTERS, Fuel Supply, for a description of various proceedings relating to spent nuclear fuel.

Funding Decontamination and Decommissioning of Federal Facilities

    See the section titled Funding Decontamination and Decommissioning of Federal Facilities under Part I, Item 1B, ELECTRIC UTILITY MATTERS, Fuel Supply, for a description of various proceedings relating to decontamination and decommissioning liabilities.

    No matters were submitted to a vote of the security holders of either WPS Resources or Wisconsin Public Service during the fourth quarter of the fiscal year.

    Information about outside directors is included in our proxy statement for the Annual Meeting of Shareholders of WPS Resources, which is scheduled to be held on May 9, 2002.

PART II

Dividend Restrictions

    WPS Resources' principal subsidiary, Wisconsin Public Service, is restricted by a Public Service Commission of Wisconsin order limiting the payment of normal common stock dividends to no more than 109% of the previous year's common stock dividend, without prior notice to the Public Service Commission of Wisconsin. Return of capital payments may be declared in order to maintain Wisconsin Public Service's common equity levels consistent with those allowed by the Public Service Commission of Wisconsin. Wisconsin law prohibits Wisconsin Public Service from making loans to WPS Resources and its nonregulated subsidiaries and guaranteeing their obligations.

    Wisconsin Public Service's Articles of Incorporation contain certain limitations on the payment of cash dividends. These limitations are not expected to limit any dividend payments in the foreseeable future.

    At December 31, 2001, WPS Resources had $365.8 million of retained earnings available for dividends.

    Upper Peninsula Power's indentures relating to first mortgage bonds contain certain limitations on the payment of cash dividends on common stock. Under the most restrictive of these provisions, approximately $4.5 million of consolidated retained earnings were available at December 31, 2001, for the payment of common stock cash dividends by Upper Peninsula Power.

    Effective with the close of trading on February 8, 2002, WPS Resources was added to the Standard & Poor's MidCap 400 Index.

    As of December 31, 2001, there were 23,478 common stock shareholders of record.