Annual Report

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Securities registered pursuant to Section 12(g) of the Exchange Act: None

Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.

UniSource Energy Corporation		Yes þ		No o
Tucson Electric Power Company		Yes o		No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (Exchange Act).

UniSource Energy Corporation		Yes o		No þ
Tucson Electric Power Company		Yes þ		No o

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

UniSource Energy Corporation		Yes þ		No o
Tucson Electric Power Company (1)		Yes o		No þ

(1) As indicated above, Tucson Electric Power Company is not required to file reports under the Exchange Act. However, Tucson Electric Power Company has filed all Exchange Act reports for the preceding 12 months.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

UniSource Energy Corporation		Yes o		No o
Tucson Electric Power Company		Yes o		No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of each registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

UniSource Energy Corporation		Large Accelerated Filer þ		Accelerated Filer o		Non-accelerated filer o		Smaller Reporting Company o

Tucson Electric Power Company		Large Accelerated Filer o		Accelerated Filer o		Non-accelerated filer þ		Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

UniSource Energy Corporation		Yes o		No þ
Tucson Electric Power Company		Yes o		No þ

The aggregate market value of UniSource Energy Corporation voting Common Stock held by non-affiliates of the registrant was $933,280,480 based on the last reported sale price thereof on the consolidated tape on June 30, 2009.

At February 23, 2010, 35,941,414 shares of UniSource Energy Corporation Common Stock, no par value (the only class of Common Stock), were outstanding.

At February 23, 2010, 32,139,434 shares of Tucson Electric Power Company’s common stock, no par value, were outstanding, all of which were held by UniSource Energy Corporation.

Tucson Electric Power Company meets the conditions set forth in General Instructions (I)(1)(a) and (b) on Form 10-K and is therefore filing this report with the reduced disclosure format.

Documents incorporated by reference: Specified portions of UniSource Energy Corporation’s Proxy Statement relating to the 2010 Annual Meeting of Shareholders are incorporated by reference into Part III.

 

 

Table of Contents

Definitions			v
— PART I —
Item 1. — Business			1
Overview of Consolidated Business			1
TEP			2
Service Area and Customers			2
Generating and Other Resources			4
Fuel Supply			7
Water Supply			8
Transmission Access			8
Rates and Regulation			9
TEP’s Utility Operating Statistics			11
Environmental Matters			12
UNS Gas			14
Service Territory and Customers			14
Gas Supply and Transmission			14
Rates and Regulation			15
Environmental Matters			15
UNS Electric			15
Service Territory and Customers			15
Power Supply and Transmission			16
Rates and Regulation			16
Environmental Matters			17
Other			18
Employees			18
Executive Officers of the Registrants			19
SEC Reports Available on UniSource Energy’s Website			20
Item 1A. — Risk Factors			20
Item 1B. — Unresolved Staff Comments			26
Item 2. — Properties			27
TEP Properties			27
UES Properties			28
UED Properties			28
Item 3. — Legal Proceedings			28
Item 4. — Submission of Matters to a Vote of Security Holders			29
— PART II —
Item 5. — Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Common Equity			29
Item 6. — Selected Consolidated Financial Data			31
UniSource Energy			31
TEP			32
Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations			33
UniSource Energy Consolidated			33
Outlook and Strategies			33
Results of Operations			35
Contribution by Business Segment			36
Liquidity and Capital Resources			36
Tucson Electric Power Company			41
Results of Operations			41

Factors Affecting Results of Operations			49
Liquidity and Capital Resources			53
UNS Gas			60
Results of Operations			60
Factors Affecting Results of Operations			61
Liquidity and Capital Resources			62
UNS Electric			65
Results of Operations			65
Factors Affecting Results of Operations			66
Liquidity and Capital Resources			68
Other Non-Reportable Business Segments			70
Results of Operations			70
Factors Affecting Results of Operations			71
Critical Accounting Policies			71
Recently Issued Accounting Standards			76
Safe Harbor for Forward-Looking Statements			76
Item 7A. — Quantitative and Qualitative Disclosures about Market Risk			77
Item 8. — Consolidated Financial Statements and Supplementary Data			83
Management’s Report on Internal Controls Over Financial Reporting			83
Reports of Independent Registered Public Accounting Firm			84
UniSource Energy Corporation
Consolidated Statements of Income			86
Consolidated Statements of Cash Flows			87
Consolidated Balance Sheets			88
Consolidated Statements of Capitalization			90
Consolidated Statements of Changes in Stockholders’ Equity			91
Tucson Electric Power Company
Consolidated Statements of Income			92
Consolidated Statements of Cash Flows			93
Consolidated Balance Sheets			94
Consolidated Statements of Capitalization			96
Consolidated Statements of Changes in Stockholder’s Equity			97
Notes to Consolidated Financial Statements
Note 1. Nature of Operations and Summary of Significant Accounting Policies			98
Note 2. Regulatory Matters			108
Note 3. Segment and Related Information			119
Note 4. Commitments and Contingencies			122
Note 5. Utility Plant and Jointly-Owned Facilities			129
Note 6. Debt, Credit Facilities and Capital Lease Obligations			131
Note 7. Fair Value of Financial Instruments Not Carried at Fair Value			138
Note 8. Stockholders’ Equity			139
Note 9. Income Taxes			141
Note 10. Employee Benefit Plans			144
Note 11. Share-Based Compensation Plans			153
Note 12. Fair Value Measurements			157
Note 13. UniSource Energy Earnings Per Share (EPS)			161
Note 14. Related Party Transactions			162
Note 15. Sale of Millennium’s Investment in Sabinas			163
Note 16. Recently Issued Accounting Pronouncements			163
Note 17. Supplemental Cash Flow Information			164
Note 18. Accounting for Derivative Instruments, Trading Activities and Hedging Activities			166
Note 19. Quarterly Financial Data (Unaudited)			169
Item 9. — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			177
Item 9A. — Controls and Procedures			177
Item 9B. — Other Information			177

— PART III —
Item 10. — Directors, Executive Officers and Corporate Governance of the Registrants			178
Item 11. — Executive Compensation			180
Item 12. — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			180
Item 13. — Certain Relationships and Related Transactions, and Director Independence			181
Item 14. — Principal Accountant Fees and Services			181
— PART IV —
Item 15. — Exhibits and Financial Statements Schedules			182
Signatures			183
Exhibit Index			186
Exhibit 4(i)(10)
Exhibit 4(aa)(9)
Exhibit 12(a)
Exhibit 12(b)
Exhibit 21
Exhibit 23
Exhibit 24(a)
Exhibit 24(b)
Exhibit 31(a)
Exhibit 31(b)
Exhibit 31(c)
Exhibit 31(d)
Exhibit 32

PART I

This combined Form 10-K is being filed separately by UniSource Energy Corporation and Tucson Electric Power Company (collectively, the Registrants). Information contained herein relating to any individual registrant is filed by such registrant on its own behalf. TEP does not make any representation as to information relating to any other subsidiary of UniSource Energy.

This Annual Report on Form 10-K contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. You should read forward-looking statements together with the cautionary statements and important factors included in this Form 10-K. (See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Safe Harbor for Forward-Looking Statements ). Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions. Forward-looking statements are not statements of historical facts. Forward-looking statements may be identified by the use of words such as “anticipates,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” and similar expressions. We express our expectations, beliefs and projections in good faith and believe them to have a reasonable basis. However, we make no assurances that management’s expectations, beliefs or projections will be achieved or accomplished. In addition, UniSource Energy and TEP disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this report.

References in this report to “we” and “our” are to UniSource Energy and its subsidiaries, collectively.

Rates and Regulation of Business Segments

The Arizona Corporation Commission (ACC) regulates portions of TEP, UNS Gas and UNS Electric’s utility accounting practices and electricity rates. The ACC has authority over rates charged to retail customers, the issuance of securities, and transactions with affiliated parties. Our regulated utilities’ rates for retail electric and natural gas service are determined on a “cost of service” basis. Rates are designed to provide, after recovery of allowable operating expenses, an opportunity for us to earn a reasonable return on rate base. Rate base is generally determined by reference to the original cost and reconstruction (net of depreciation) of utility plant in service to the extent deemed used and useful, and to various adjustments for deferred taxes and other items plus a working capital component. Over time, additions to utility plant in service increase rate base and depreciation and retirement of utility plant reduce the rate base.

The Federal Energy Regulatory Commission (FERC) regulates the terms and prices of transmission services and wholesale electricity sales, wholesale transport and purchases of natural gas and portions of our accounting practices. TEP and UNS Electric have FERC tariffs to sell power at market based rates.

TEP

TEP was incorporated in the State of Arizona in 1963. TEP is the principal operating subsidiary of UniSource Energy. In 2009, TEP’s electric utility operations contributed 79% of UniSource Energy’s operating revenues and comprised 81% of its assets.

SERVICE AREA AND CUSTOMERS

TEP is a vertically integrated utility that provides regulated electric service to approximately 402,000 retail customers in Southeastern Arizona. TEP’s service territory consists of a 1,155 square mile area and includes a population of approximately 1 million in the greater Tucson metropolitan area in Pima County, as well as parts of Cochise County. TEP holds franchises to provide electric distribution service to customers in the Cities of Tucson and South Tucson. These franchises expire in 2026 and 2017, respectively. TEP also sells electricity to other utilities and power marketing entities in the Western U.S.

Retail Customers

TEP provides electric utility service to a diverse group of residential, commercial, industrial, and public sector customers. Major industries served include copper mining, cement manufacturing, defense, health care, education, military bases and other governmental entities. TEP’s retail sales are influenced by several factors, including seasonal weather patterns and overall economic climate.

The table below shows the percentage distribution of TEP’s energy sales by major customer class over the last three years. The retail energy consumption by customer class through 2012 is expected to be similar to the historical distribution.

Two of TEP’s largest retail customers are in the copper mining industry. TEP’s kWh sales to mining customers depend on a variety of factors including changes in supply and demand in the world copper market and the economics of self-generation.

Local, regional, and national economic factors can impact the level of customer growth and the financial condition and operations of TEP’s large commercial and industrial customers and as a result directly impact energy consumption. Economic conditions can also impact sales to residential and small commercial customers if employment and consumer spending levels change.

As a result of weak economic conditions during 2008 and 2009, retail customer growth and energy usage by retail customers at TEP were below the average levels experienced in prior years. In 2008 and 2009, TEP’s average number of retail customers increased by less than 1% per year. This compares with average annual increases of 2% from 2003 to 2007.

TEP’s total retail kWh sales decreased by 1.4% in 2008 compared with 2007. This was the first year-over-year decrease in TEP’s retail kWh sales since 2002. In 2009, TEP’s kWh sales once again declined by 1.4% over the prior year’s levels. This compares with average annual increases in retail kWh sales of 4% from 2003 to 2007. We cannot predict if the customer growth rate or sales volumes will return to historic levels. However, we expect TEP’s customer base to grow at a rate of less than 1% in 2010 and approximately 1% in 2011.

Energy Service Providers

In 2001, all of TEP’s retail customers became eligible to choose an alternative energy service provider (ESP); however, none of TEP’s retail customers are currently being serviced by an alternative ESP. See Rates and Regulation, below for more information regarding the status of retail competition in Arizona.

Wholesale Business

TEP’s electric utility operations include the wholesale marketing of electricity to other utilities and power marketers. Wholesale sales transactions are made on both a firm and interruptible basis. A firm contract requires TEP to supply power on demand (except under limited emergency circumstances), while an interruptible contract allows TEP to stop supplying power under defined conditions. See Purchases and Interconnections , below.

Generally, TEP commits to future sales based on expected excess generating capability, forward prices and generation costs, using a diversified portfolio approach to provide a balance between long-term, mid-term and spot energy sales. When TEP expects to have excess generating capacity and energy (usually in the first, second and fourth calendar quarters), its wholesale sales consist primarily of two types of sales:

Long-term sales

Long-term wholesale sales contracts are for periods of more than one year. TEP typically uses its own generation to serve the requirements of its long-term wholesale customers. TEP currently has long-term contracts with three entities to sell firm capacity and energy:

•		Salt River Project Agricultural Improvement and Power District (SRP), 100 MW, expires in May 2016. Under the current terms of the contract, TEP receives an annual demand charge of approximately $22 million, while the cost of the energy sold is based on TEP’s average generation cost. Beginning in June 2011, SRP will purchase 876 MWhs annually, TEP will not receive a demand charge and the price of energy will be based on a slight discount to the Dow Jones Palo Verde Electricity Price Indexes (Palo Verde Index).
•		Navajo Tribal Utility Authority (NTUA) expires in December 2015. TEP serves the portion of NTUA’s load that is not served from NTUA’s allocation of federal hydroelectric power. Over the last three years, sales to NTUA averaged 225 MWh. Beginning in 2010, the price of 50% of the kWh sales from June to September will be based on the Palo Verde Index.
•		Tohono O’odham Utility Authority, 2 MW, expires in 2014.

Short-term sales

Under forward contracts, TEP commits to sell a specified amount of capacity or energy at a specified price over a given period of time, typically for one-month, three-month or one-year periods. Under short-term sales, TEP sells energy in the daily or hourly markets at fluctuating spot market prices and makes other non-firm energy sales. Beginning January 1, 2009, all revenues from short-term wholesale sales offset fuel and purchased power costs that are passed through to TEP retail customers. TEP uses short-term wholesale sales as part of its hedging strategy to reduce customer exposure to fluctuating power prices. See Rates and Regulation, below.

See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Tucson Electric Power Company, Factors Affecting Results of Operations, for additional discussion of TEP’s wholesale marketing activities.

Springerville Generating Station

Springerville Unit 1 is leased by TEP. The Springerville Generating Station also includes the Springerville Coal Handling Facilities and the Springerville Common Facilities.

The terms of the Springerville Unit 1 Leases, which include a 50% interest in the Springerville Common Facilities, expire in 2015, but have optional fair market value renewal and purchase provisions. In 1985, TEP sold and leased back a 50% interest in the Springerville Common Facilities. The Springerville Common Facilities Leases, which expire in 2017 and 2021, have a fixed price purchase provision. The fixed prices to acquire the leased interests in the Springerville Common Facilities are $38 million in 2017 and $68 million in 2021. In 1984, TEP sold and leased back the Springerville Coal Handling Facilities. The terms of the Springerville Coal Handling Facilities Leases expire in 2015, but have a fixed price purchase provision of $120 million.

Since entering into the Springerville leases, TEP has purchased a 14% equity ownership interest in the Springerville Unit 1 Leases and a 13% equity ownership interest in the Springerville Coal Handling Facilities Leases.

Sundt Generating Station

The Sundt Generating Station and the internal combustion turbines located in Tucson are designated as “must-run generation” facilities. Must-run generation units are required to run in certain circumstances to maintain distribution system reliability and to meet local load requirements.

Sundt Unit 4 is leased by TEP and the term of the lease expires in 2011. In January 2010, TEP entered into an agreement to purchase 100% of the equity interest in Sundt Unit 4 from the equity owner for approximately $52 million. The purchase price is subject to increase by 0.75% of the purchase price per month in the event that the purchase occurs after March 31, 2010. TEP expects the purchase to occur prior to March 31, 2010. Following the completion of the transaction, TEP expects to redeem the outstanding Sundt Unit 4 lease obligation of $5 million, terminate the lease and cause the title of Sundt Unit 4 to be transferred to TEP.

See Note 6 of Notes to Consolidated Financial Statements, Debt, Credit Facilities, and Capital Lease Obligations, and Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Tucson Electric Power Company, Liquidity and Capital Resources, Contractual Obligations , for more information regarding the Springerville and Sundt leases.

Renewable Energy Resources

Owned Resources

The Springerville Solar Generating Station includes 34,980 photovoltaic (PV) modules located near TEP’s coal-fired Springerville Generating Station in eastern Arizona. TEP began building the system in 2000 and continued to expand it for several years until its capacity reached 4.6 megawatts in 2004. A proposal to expand its capacity to 6.4 MW in 2010 is pending before the ACC.

TEP also has proposed a 1.6 MW PV installation in Tucson, Arizona. If approved by the ACC, the project is expected to be completed in the second half of 2010.

Purchased Power Agreements

In September 2009, TEP filed two 20 year purchased power agreements with the ACC in order to meet the requirements of the ACC’s Renewable Energy Standard and Tariff (REST). The first agreement would provide TEP with 25 MW of energy from a single axis tracking PV installation. The second agreement would provide TEP with 5 MW of energy from a parabolic trough concentrating solar facility. Each agreement contains an option that would allow TEP to purchase all or part of the project at a future period. TEP cannot predict when or if the ACC will approve the agreements. See Renewable Energy Standard and Tariff, below for more information.

Purchases and Interconnections

TEP purchases power from other utilities and power marketers. TEP may enter into contracts: (a) to purchase energy under long-term contracts to serve retail load and long-term wholesale contracts, (b) to purchase capacity or energy during periods of planned outages or for peak summer load conditions, and (c) to purchase energy for resale to certain wholesale customers under load and resource management agreements.

TEP typically uses generation from its gas-fired units supplemented by purchased power to meet the summer peak demands of its retail customers. Some of these purchased power contracts are price indexed to natural gas prices. Due to its increasing seasonal gas and purchased power usage, TEP hedges a portion of its total natural gas exposure from plant fuel and gas-indexed purchased power with fixed price contracts for a maximum of three years. TEP also purchases energy in the daily and hourly markets to meet higher than anticipated demands, to cover unplanned generation outages, or when it is more economical than generating its own energy.

TEP is a member of various regional reserve sharing, reliability and power sharing organizations. These relationships allow TEP to call upon other utilities during emergencies, such as plant outages and system disturbances, and reduce the amount of reserves TEP is required to carry.

As a result of the Energy Policy Act of 2005, owners and operators of bulk power transmission systems, including TEP, are subject to mandatory reliability standards that are developed and enforced by the North American Electric Reliability Corporation (NERC) subject to the oversight of the Federal Energy Regulatory Commission (FERC). TEP is reviewing its operating policies and procedures to ensure continued compliance with these standards.

Springerville Units 3 and 4

Springerville Units 3 and 4 are each 400 MW coal-fired generating facilities located at the same site as Springerville Units 1 and 2 that are operated, but not owned by TEP. Tri-State is leasing 100% of Unit 3 from a financial owner. Unit 4 began commercial operation in December 2009 and is owned by SRP. For operating Units 3 and 4, TEP receives rental payments and other fees, including the allocation of a portion of the fixed costs of the existing common facilities to Units 3 and 4. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations. Tucson Electric Power Company, Factors Affecting Results of Operations, Springerville Units 3 and 4 .

Peak demand occurs during the summer months due to the cooling requirements of TEP’s retail customers. Retail peak demand varies from year-to-year due to weather, economic conditions and other factors. TEP’s retail demand peaked in 2007 and subsequently declined in 2008 and 2009 due primarily to weak economic conditions.

The chart above shows the relationship over a five-year period between TEP’s peak demand and its energy resources. TEP’s total margin is the difference between total energy resources and coincident peak demand, and the reserve margin is the ratio of margin to coincident peak demand. TEP’s reserve margin in 2009 was in compliance with reliability criteria set forth by the Western Electricity Coordinating Council, a regional council of NERC.

Forecasted retail peak demand for 2010 is approximately 2,284 MW, compared with actual peak demand of 2,354 MW in 2009. In 2009, cooling degree days were 13% above the ten year average. TEP’s 2010 estimated retail peak demand is based on normal weather patterns and total retail kWh sales similar to 2009 levels. TEP believes it will have sufficient resources to meet expected demand in 2010 with its existing generation capacity and power purchase agreements.

Future Generating Resources

TEP will continue to add peaking resources to serve the Tucson area as needed based upon our forecasts of retail and firm wholesale load, as well as statewide transmission infrastructure. TEP projects that additional import capacity and/or additional local generation resources of 75 to 150 MW may be required in 2015.

TEP Operated Generating Facilities

TEP is the operator, and the sole owner (or lessee), of the Springerville Units 1 and 2 and Sundt Unit 4 Generating Stations. The coal supplies for the Springerville Units 1 and 2 are transported approximately 200 miles by railroad from Northwestern New Mexico. TEP expects coal reserves to be sufficient to supply the estimated requirements for Springerville Units 1 and 2 for their presently estimated remaining lives.

The coal supplies for Sundt are transported approximately 1,300 miles by railroad from Colorado and approximately 500 miles from New Mexico. In the past, Sundt Unit 4 has been fueled by coal; however, the generating station can also be operated with natural gas or landfill gas. Both fuels are combined with methane, a renewable energy resource, piped from a nearby landfill. From January through October 2009, TEP used natural gas to fuel Sundt Unit 4. TEP hedged the price of natural gas such that it became more economic to use natural gas instead of coal to fuel the plant. TEP had agreements for the purchase and transportation of coal to Sundt through 2009 and has adequate coal inventory through 2010. TEP will continue to analyze natural gas prices to determine the fuel it will use to run Sundt Unit 4.

See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UniSource Energy Consolidated, Contractual Obligations and Note 4 of Notes to Consolidated Financial Statements — Commitments and Contingencies, TEP Commitments, Firm Purchase and Transportation Commitments.

Generating Facilities Operated by Others

TEP also participates in jointly-owned generating facilities at Four Corners, Navajo and San Juan. Four Corners and San Juan, operated by PNM, are mine mouth generating stations located adjacent to the coal reserves. Navajo, operated by SRP, obtains its coal supply from a nearby coal mine and a dedicated rail delivery system. The coal supplies are under long-term contracts administered by the operating agents. TEP expects coal reserves available to these three jointly-owned generating facilities to be sufficient for the remaining presently estimated lives of the stations.

Natural Gas Supply

TEP typically uses generation from its facilities fueled by natural gas and purchased power, in addition to energy from its coal-fired facilities, to meet the summer peak demands of its retail customers and local reliability needs. Some of these purchased power contracts are price indexed to natural gas prices. Short-term and spot power purchase prices are also closely correlated to natural gas prices. Due to its increasing seasonal gas and purchased power usage, TEP hedges a portion of its total natural gas exposure from plant fuel, gas-indexed purchased power and spot market purchases with fixed price contracts for a maximum of three years.

TEP purchases gas from Southwest Gas Corporation (SWG) under a retail tariff for North Loop, a 95 MW internal combustion turbine located in Tucson, Arizona, and receives distribution service under a transportation agreement for DeMoss Petrie, a 122 MW internal combustion turbine located in Tucson, Arizona. TEP completed a bypass of SWG and connected the Sundt plant directly to El Paso Natural Gas Company (ENPG) in the first quarter of 2008. TEP purchases capacity from EPNG for transportation from the San Juan and Permian Basins to its Sundt plant under a contract that expires in April 2013, with right-of-first refusal for continuation thereafter. TEP buys gas from third party suppliers for Sundt and DeMoss Petrie.

TEP purchases gas transportation for Luna from EPNG from the Permian Basin to the plant site under an agreement that expires in January 2012, with right-of-first refusal for continuation thereafter. TEP purchases gas for its share of Luna from various suppliers in the Permian Basin region.

WATER SUPPLY

The Four Corners region of New Mexico, where the San Juan and Four Corners Generating Stations (San Juan and Four Corners) are located, experiences drought conditions periodically that could affect the water supply for these plants. The operating agents for San Juan and Four Corners have negotiated supplemental water contracts with BHP Billiton and the Jicarilla Apache Nation to assist the generating plants in meeting their water requirements in the event of a shortage.

Drought conditions within the Southwestern United States, combined with increased water usage in Arizona, Nevada and Southern California, have periodically caused water levels to recede at Lake Powell, which supplies operating water for the Navajo Generating Station (Navajo). TEP has a 7.5% ownership interest in Navajo Units 1, 2 and 3 (168 MW capacity). A project was completed in December 2009, which lowered the water intake structures to ensure adequate water supply at Navajo in the event drought conditions adversely affect the water level at Lake Powell.

TRANSMISSION ACCESS

TEP has transmission access and power transaction arrangements with over 120 electric systems or suppliers. TEP is taking steps to increase the capacity and reliability of its transmission and distribution system. TEP also has various ongoing projects that are designed to increase access to the regional wholesale energy market and improve the reliability and efficiency of its existing transmission and distribution systems.

In 2008, TEP completed construction of a new 500 kV transmission line from the Palo Verde regional market hub to the Pinal West substation along with a new 345 kV TEP substation at Pinal West connecting to TEP’s 345kV transmission line between Phoenix and Tucson. These projects provide TEP with additional access to energy resources.

TEP is participating in the continuation of the 500 kV transmission line from the Pinal West substation to the Pinal Central substation. TEP is also in the process of obtaining permits to construct a 40 mile 500-kV transmission line from the Pinal Central substation to the Tortolita substation northwest of Tucson to further enhance its ability to access the region’s energy resources. TEP expects the transmission lines to be in-service in 2014. As a result of these high voltage transmission additions, TEP anticipates that its ability to import energy into its service territory should increase by at least 250 MW.

Tucson to Nogales Transmission Line

TEP and UNS Electric are parties to a project development agreement initiated in 2000 for the joint construction of a 62-mile transmission line from Tucson to Nogales, Arizona. The project was initiated in response to an order by the ACC to improve reliability to UNS Electric’s retail customers in Nogales, Arizona. Since receiving ACC approval of the location and construction of the proposed 345-kV transmission line along a specified route, TEP has been working to obtain all other required permits from state and federal agencies. The Department of Energy completed a Final Environmental Impact Statement (FEIS) for the project accepting any of the routes identified in the FEIS. The U.S. Forest Service, however, prefers a route that was not approved by the ACC.

Based on the alternative proposals and passage of time since the ACC approved the location of the line, in 2006 the Line Siting Committee of the ACC was directed to gather facts related to options for improving service reliability in Nogales, Arizona. TEP continues to evaluate alternatives for improving service reliability in Nogales, Arizona. In 2007 and 2008, TEP met with major property owners and impacted governmental agencies along the proposed transmission line routes to discuss alternatives. If all regulatory approvals are received and the project moves forward, the future costs to construct the transmission line from Tucson to Nogales, Arizona are expected to be approximately $120 million. As of December 31, 2009, TEP had capitalized $11 million related to the project, including $2 million of land and land rights. If TEP does not receive the required approvals or abandons the project, TEP believes that cost recovery is probable for prudent and reasonably incurred costs related to the project as a consequence of the ACC’s requirement for a second transmission line serving the Nogales, Arizona area.

TEP met with the Federal Electricity Commission of Mexico (CFE) and other transmission developers in 2009 to develop a schedule for performing transmission studies to interconnect the proposed Tucson to Nogales transmission line to a new CFE proposed 400-kV transmission line in Mexico. The studies are scheduled to be completed in 2010.

RATES AND REGULATION

2008 TEP Rate Order

On November 25, 2008, the ACC issued an order that resolved a rate case filed by TEP in July 2007. The ACC order included an average base retail rate increase of approximately 6% effective December 1, 2008 and a Purchased Power and Fuel Adjustment Clause (PPFAC) that began January 1, 2009. Prior to the 2008 TEP Rate Order, TEP’s rates had remained unchanged since 2000.

The 2008 TEP Rate Order requires TEP to credit $58 million of previously collected Fixed CTC true-up revenues to customers through the PPFAC. TEP expects the PPFAC charge to be zero until the Fixed CTC true-up revenues are fully credited over an estimated period of 36 to 48 months, which began on April 1, 2009.

For a more detailed description of the terms of the 2008 TEP Rate Order, see Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Tucson Electric Power Company , Factors Affecting Results of Operations , 2008 TEP Rate Order , below.

Renewable Energy Standard and Tariff

The ACC’s REST requires TEP and other affected utilities to generate or purchase at least 15% of their total annual retail energy requirements from renewable energy technologies by 2025, with smaller amounts required in earlier years. The REST rules provide for recovery of above market costs a utility incurs in providing the renewable energy. TEP met the 2009 REST rules’ target of generating or purchasing renewable energy for at least 2.0% of TEP’s total retail energy requirements; TEP expects to meet the REST rules’ 2010 target of 2.5%.

For more information see Renewable Energy Resources, above, and Item 7. Management’s Discussion and Analysis, Tucson Electric Power, Factors Affecting Results of Operations, Renewable Energy Standard and Tariff.

Electric Energy Efficiency Standards

In December 2009, the ACC established a process to adopt new Electric Energy Efficiency Standards (EE Standards) designed to require TEP, UNS Electric and other affected utilities to implement demand-side management (DSM) programs, to the extent that they are cost effective. If the ACC approves EE Standards, they must be certified by the Arizona Attorney General before taking effect. TEPs DSM programs and customer surcharge to recover the costs incurred to implement these proposed programs are subject to ACC approval. See Item 7. – Management’s Discussion and Analysis of Financial Condition and Results of Operations , TEP, Factors Affecting Results of Operations, Electric Energy Efficiency Standards, for more information.

Retail Electric Competition Rules

In 1999, the ACC approved the Retail Electric Competition Rules (Rules) that provided a framework for the introduction of retail electric competition in Arizona. Certain portions of the ACC rules that enabled ESPs to compete in the retail market were invalidated by an Arizona Court of Appeals decision in 2005. In 2008, the ACC opened an administrative proceeding to address the Rules. Unless and until the ACC clarifies the competition rules and ESPs offer to provide energy in TEP’s service area, it is not possible for TEP’s retail customers to use alternative ESPs. We cannot predict what changes, if any, the ACC will make to the Rules. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Tucson Electric Power Company, Factors Affecting Results of Operations, Competition, for more information.

Line Extension Policy

In 2008, the ACC approved a policy requiring TEP to charge customers for the total cost of line extensions, eliminating TEP’s prior practice of providing a portion of line extensions free of charge to its customers. The policy became effective June 1, 2009. Prior to this ruling by the ACC, a portion of the cost of line extensions was capitalized by TEP and eligible for inclusion in rate base.

ENVIRONMENTAL MATTERS

Air and water quality, resource extraction, waste disposal and land use are regulated by federal, state and local authorities. TEP believes that its facilities are in substantial compliance with existing regulations.

Clean Air Act Requirements

TEP generating facilities are subject to EPA limits on the amount of sulfur dioxide (SO ₂ ), nitrogen oxide (NOx) and other emissions into the atmosphere. TEP capitalized $24 million in 2009, $73 million in 2008 and $7 million in 2007 in construction costs to comply with environmental requirements, including TEP’s share of new pollution control equipment installed at San Juan described below. TEP expects to capitalize environmental compliance costs of $8 million in 2010 and $5 million in 2011. In addition, TEP recorded operating expenses of $13 million in 2009, $14 million in 2008 and $10 million in 2007 related to environmental compliance. TEP expects environmental expenses to be $11 million in 2010. TEP may incur additional costs to comply with future changes in federal and state environmental laws, regulations and permit requirements at existing electric generating facilities. Compliance with these changes may reduce operating efficiency.

As a result of a 2005 settlement agreement between PNM, environmental activist groups, and the New Mexico Environment Department (PNM Consent Decree), the co-owners of San Juan installed new pollution control equipment at the generating station to reduce mercury, particulate matter, NOx, and SO ₂ emissions. TEP owns 50% of San Juan Units 1 and 2. The PNM Consent Decree includes stipulated penalties for non-compliance with specified emissions limits at San Juan. In 2008 and 2007, TEP’s share of stipulated penalties at San Juan was $1 million and $2 million, respectively. TEP’s share of stipulated penalties at San Juan during 2009 was less than $1 million. TEP cannot deduct these penalties for income tax purposes. With the installation of new pollution control equipment designed to remedy emission violations, we do not expect to incur similar penalties in the future.

In April 2009, APS received a request from the EPA under section 114 of the Clean Air Act seeking information about Four Corners. Four Corners, which is operated by APS, is comprised of five coal-fired generating units. TEP has a 7% ownership interest in two units, totaling 110 MW. APS has responded to the EPA’s request. TEP cannot predict the timing or outcome of this matter.

In 1993, the EPA allocated TEP’s generating units SO ₂ Emission Allowances based on past operational history. Beginning in 2000, TEP’s generating units were required to hold Emission Allowances equal to the level of emissions in the compliance year or pay penalties and offset excess emissions in future years. To date, TEP has held sufficient Emission Allowances to comply with the SO ₂ regulations.

Hazardous Air Pollutant Requirements

The Clean Air Act requires the EPA to develop an emission limit for hazardous air pollutants that represents the maximum achievable control technology. In October 2009, EPA entered into a consent order to develop a final rule by November 2011.

Depending on the stringency of the EPA rule, emission controls for mercury may be required at some or all coal fired units by 2014 or later. Whether controls are required at a particular unit, the level of control required, and the cost to achieve that level of control will not be known until the rule has been promulgated.

As stipulated in the PNM Consent Decree described above, the co-owners of San Juan installed new pollution control equipment at the generating station to reduce mercury emissions. The installation of mercury emissions controls for San Juan Units 1 and 2 were completed in 2009. These controls are expected to be adequate to achieve compliance with the federal standard.

Arizona adopted mercury emission rules in 2007 requiring a 90% reduction in emission from coal fired units. Due to potential inconsistency between the Arizona rule and the pending EPA rule, in January, 2009, TEP and ADEQ reached an agreement that (1) defers the 90% reduction requirement to 2016, (2) improves regulatory certainty regarding mercury compliance obligations under existing Arizona rules, and (3) achieves mercury reductions substantially similar to those that would be required by the existing Arizona rules. This agreement relates to the Springerville and Sundt generating stations.

In order to comply with the Arizona rule, TEP expects mercury emission control equipment may be required at Springerville by 2016. The associated capital cost for this equipment is estimated to be $6 million at Springerville Units 1 and 2. If the emission control equipment is installed, TEP expects the annual operating expenses to be approximately $3 million, once all installations are completed.

Climate Change

In 2007, the Supreme Court ruled in Commonwealth of Massachusetts, et al v. EPA, that carbon dioxide (CO ₂ ) and other greenhouse gases (GHG) are air pollutants under the Clean Air Act. In December 2009, EPA issued a final Endangerment Finding, stating that greenhouse gases endanger public health and welfare. This finding allows EPA to promulgate regulations limiting emissions of greenhouse gases. EPA is in the process of developing regulation limiting greenhouse gases, which once finalized, may impact future generation or modifications of existing plants.

Several pieces of legislation have been introduced at the federal level. In June 2009, the House of Representatives passed the American Clean Energy and Security legislation which included a cap and trade program for GHG. The Senate is considering similar cap and trade legislation with the September 2009 introduction of the Clean Energy Jobs and American Power bill. While debate continues at the national level over the direction of domestic climate policy, several states have developed state-specific policies or regional initiatives to reduce greenhouse gas emissions. In 2007, the governors of several western states, including the then-governor of Arizona, signed the Western Regional Climate Action Initiative (the Western Climate Initiative) that directed their respective states to develop a regional target for reducing greenhouse gases. The states in the Western Climate Initiative announced a target of reducing greenhouse gas emissions by 15% below 2005 levels by 2020. In 2008, the Western Climate Initiative participants submitted their design recommendation for the Western Climate Initiative cap-and-trade program for greenhouse gas emissions, with an implementation date set for 2012. In February 2010, the Governor of Arizona issued an executive order which, among other things, stated that Arizona will not implement the GHG cap-and-trade proposal advanced by the Western Climate Initiative. The executive order expires December 31, 2012.

Based on the competing proposals to regulate greenhouse gas emissions by federal, state, and local regulatory and legislative bodies and uncertainty in the regulatory and legislative processes, the scope of such requirements and initiatives and their effect on our operations cannot be determined at this time.

Regional Haze

The EPA’s regional haze rules require emission controls known as Best Available Retrofit Technology (BART) for certain industrial facilities emitting air pollutants that reduce visibility. The operators of the San Juan, Four Corners, and Navajo generating stations submitted BART analyses in 2007 and early 2008. PNM, operator of San Juan, believes the controls being installed at San Juan as a result of the PNM Consent Decree constitute BART and did not recommend installation of any additional pollution control equipment. APS and SRP, the operators of the Four Corners and Navajo generating stations, respectively recommended installing certain additional pollution control equipment in their respective BART analyses. TEP’s share of the cost for the APS recommended pollution control upgrades at Four Corners is estimated to be $6 million. SRP has initiated the pollution control upgrades at Navajo on a voluntary basis. TEP’s $3 million share of these costs is included in the cost estimates section on Clean Air Act Requirements above.

In August 2009, EPA issued an Advanced Notice of Proposed Rulemaking requesting comment on the cost effectiveness and expected visibility improvements of different levels of air pollution controls at Four Corners and Navajo including Selective Catalytic Reduction (SCR). If SCR is determined by the EPA to be BART, the capital cost impact to TEP is estimated to be $42 million for Four Corners, and $50 million for Navajo. The exact level and cost of pollution control required will not be known until final determinations are made by the regulatory agencies. Under the current proposal, controls would need to be in place no earlier than five years following the final determination.

The Four Corners and Navajo Plant participants’ obligations to comply with the EPA’s BART determinations, coupled with the financial impact of future climate change legislation, other environmental regulations and other business considerations, could jeopardize the economic viability of these plants or the ability of individual participants to meet their obligations and continue their participation in these plants.

Coal Combustion Byproducts

The EPA is expected to issue proposed regulations governing the handling and disposal of coal combustion byproducts (CCBs), such as fly ash. The EPA is evaluating options that include regulation of CCBs under solid waste standards, hazardous waste standards, or a combination of both. A proposed rule is expected during the first quarter of 2010. The financial impact to TEP, if any, cannot be determined at this time.

Ozone National Ambient Air Quality Standard

In January 2010, EPA issued a proposed rule to reduce the National Ambient Air Quality Standard for Ozone. Based on the proposed standard, certain counties in which TEP conducts operations could be in violation of the standard. The financial impact to TEP, if any, cannot be determined at this time.

UNS GAS

SERVICE TERRITORY AND CUSTOMERS

UNS Gas is a gas distribution company serving approximately 146,000 retail customers in Mohave, Yavapai, Coconino, and Navajo counties in Northern Arizona, as well as Santa Cruz County in Southeast Arizona. These counties comprise approximately 50% of the territory in the state of Arizona, with a population of approximately 700,000. From 2003 to 2007, customer growth in UNS Gas’ service territory averaged 3% per year, compared with zero growth in 2008 and less than 1% growth in 2009 in the number of retail customers. As a result of weak economic conditions and mild weather, the average energy use by retail customers during 2008 and 2009 was below the average levels experienced by UNS Gas in prior periods.

UNS Gas’ customer base is primarily residential. Revenues derived from residential customers were approximately 61% of total revenues in 2009, while sales to other retail customer classes accounted for approximately 28% of total revenues. Approximately 11% of total revenues in 2009 were derived from gas transportation services and a Negotiated Sales Program (NSP). UNS Gas supplies natural gas transportation service to the 600 MW Griffith Power Plant located near Kingman, Arizona, under a 20-year contract which expires in 2021. UNS Gas also supplies natural gas to some of its large transportation customers through an NSP approved by the ACC. One half of the margin earned on these NSP sales is retained by UNS Gas, while the other half benefits retail customers through a credit to the purchased gas adjustor (PGA) mechanism which reduces the gas commodity price.

In 2008, UNS Gas and UNS Electric entered into a 20-year gas transportation agreement and a 20-year natural gas sales agreement, whereby UNS Gas will purchase natural gas for UNS Electric and transport it to BMGS.

GAS SUPPLY AND TRANSMISSION

UNS Gas directly manages its gas supply and transportation contracts. The market price for gas varies based upon the period during which the commodity is purchased. UNS Gas hedges its gas supply prices by entering into fixed price forward contracts and financial swaps at various times during the year to provide more stable prices to its customers. These purchases and hedges are made up to three years in advance with the goal of hedging at least 45% of the expected monthly gas consumption with fixed prices prior to entering into the month.

UNS Gas buys most of the gas it distributes from the San Juan Basin in the Four Corners region. The gas is delivered on the El Paso Natural Gas Company (EPNG) and Transwestern Pipeline Company (Transwestern) interstate pipeline systems under firm transportation agreements with combined capacity sufficient to meet UNS Gas’ customers’ demands.

With EPNG, the average daily capacity right of UNS Gas is approximately 655,000 therms per day, with an average of 1,095,000 therms per day in the winter season (November through March) to serve its Northern and Southern Arizona service territories. UNS Gas has capacity rights of 250,000 therms per day on the San Juan Lateral and Mainline of the Transwestern pipeline. The Transwestern pipeline principally delivers gas to the portion of UNS Gas’ distribution system serving customers in Flagstaff and Kingman, Arizona, and also delivers gas to UNS Gas’ facilities serving the Griffith Power Plant in Mohave County.

UNS Gas signed a separate transportation agreement with Transwestern for transportation capacity rights on the Phoenix Lateral Extension Line. The 15-year agreement began in March 2009, when construction of that pipeline was completed. UNS Gas’ average daily capacity right will be 126,100 therms per day, with an average of 221,900 therms per day in the winter season (November through March).

See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Gas, Liquidity and Capital Resources, Contractual Obligations, UNS Gas Supply Contracts , for more information.

RATES AND REGULATION

The ACC regulates UNS Gas with respect to retail gas rates, the issuance of securities, and transactions with affiliated parties. UNS Gas’ retail gas rates include a monthly customer charge, a base rate charge for delivery services and the cost of gas (expressed in cents per therm), and a PGA.

Purchased Gas Adjustor

The PGA mechanism is intended to address the volatility of natural gas prices and allow UNS Gas to recover its actual commodity costs, including transportation, through a price adjustor. The difference between UNS Gas’ actual monthly gas and transportation costs and the rolling 12-month average cost of gas and transportation is deferred and recovered or returned to customers through the PGA mechanism. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Gas, Factors Affecting Results of Operations, Rates and Regulation, Energy Cost Adjustment Mechanism , for more information.

2008 General Rate Case

In November 2008, UNS Gas filed a general rate case with the ACC on a cost of service basis. Below is a table that summarizes UNS Gas’ request:

On June 8, 2009, the ACC staff and other intervenors filed testimony in this proceeding. The ACC staff recommended a rate increase of $3.4 million based on an original cost rate base of $178 million and a 10% ROE. Hearings before an administrative law judge concluded in August 2009. UNS Gas expects the ACC to issue a final order in the first half of 2010. UNS Gas cannot predict the outcome of this general rate case proceeding. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Gas, Rates , 2008 General Rate Case Filing, for more information.

ENVIRONMENTAL MATTERS

UNS Gas is subject to environmental regulation of air and water quality, resource extraction, waste disposal and land use by federal, state and local authorities. UNS Gas believes that its facilities are in substantial compliance with all existing regulations. See Item. 1 — Business, TEP, Environmental Matters , for more information.

UNS ELECTRIC

SERVICE TERRITORY AND CUSTOMERS

UNS Electric is an electric transmission and distribution company serving approximately 90,000 retail customers in Mohave and Santa Cruz counties. These counties have a combined population of approximately 240,000. As a result of weak economic conditions, retail customer growth and average energy use by retail customers is below the average levels experienced by UNS Electric in prior periods. From 2003 to 2007, customer growth in UNS Electric’s service territory averaged 3% per year, compared with no change in the average number of retail customers during 2008 and less than 1% growth 2009. UNS Electric’s customer base is primarily residential, with some small commercial and both light and heavy industrial customers. Peak demand for 2009 was 559 MW.

POWER SUPPLY AND TRANSMISSION

Power Supply

In 2008, UNS Electric and UED entered into a Power Purchase and Sales Agreement (PPA) under which UED sells all the output of the 90 MW gas-fired Black Mountain Generating Station (BMGS) to UNS Electric over a five-year term. The PPA is a tolling arrangement in which UNS Electric operates BMGS and assumes all risk of operation and maintenance costs, including fuel. Under the terms of the PPA, UNS Electric pays UED a capacity charge. The costs associated with the PPA are recoverable through UNS Electric’s PPFAC.

UNS Gas and UED have a 20-year gas transportation agreement and a 20-year natural gas sales agreement, whereby UNS Gas will purchase and transport natural gas for UED to BMGS.

UNS Electric owns and operates the Valencia Power Plant (Valencia), located in Nogales, Arizona. Valencia consists of four gas and diesel-fueled combustion turbine units and provides approximately 68 MW of peaking resources. The facility is directly interconnected with the distribution system serving the city of Nogales and the surrounding areas.

In addition to the PPA with UED and the output from Valencia, UNS Electric relies on a portfolio of long, intermediate and short-term purchases to meet customer load requirements.

See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Electric, Liquidity and Capital Resources, Contractual Obligations and Other Non-Reportable Business Segments, UED , below for more information.

Transmission

UNS Electric imports the power it purchases from UED into its Mohave County and Santa Cruz County service territories over Western Area Power Administration’s (WAPA) transmission lines. UNS Electric has a network transmission service agreement for its primary transmission capacity with WAPA for the Parker-Davis system that expires in May 2017. UNS Electric also has a long-term electric point to point transmission capacity agreement with WAPA for the Southwest Intertie system that expires in 2011.

UNS Electric currently plans to upgrade its existing 115 kV transmission line to 138 kV by the end of 2012 to improve the reliability of service in Santa Cruz County. This upgrade is included in UNS Electric’s current capital expenditures forecast. See Item 7. – Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Electric, Liquidity and Capital Resources for more information.

RATES AND REGULATION

UNS Electric is regulated by the ACC with respect to retail electric rates, quality of service, the issuance of securities, and transactions with affiliated parties, and by the FERC with respect to wholesale power contracts and interstate transmission service. In 2007, UNS Electric was granted a FERC tariff to sell power at market based rates. UNS Electric’s retail electric rates include a PPFAC, which allows for UNS Electric to recover the actual costs of its fuel and power purchases.

The filing also included a proposal to acquire, and put into its rate base, BMGS, the gas-fired facility in UNS Electric’s service territory that is owned by UED. The proposed acquisition and inclusion of BMGS in rate base would not impact the amount of the total rate increase requested by UNS Electric.

On November 6, 2009, the ACC staff and other intervenors filed testimony in this proceeding. The ACC staff recommended a rate increase of $7.5 million based on an original cost rate base of $168 million and a 10% return on equity. A hearing before an ACC administrative law judge concluded in February 2010. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Electric, Factors Affecting Results of Operations, Rates , for more information.

Electric Energy Efficiency Standards

In December 2009, the ACC established a process to adopt new Electric Energy Efficiency Standards (EE Standards) designed to require TEP, UNS Electric and other affected utilities to implement demand-side management (DSM) programs, to the extent that they are cost effective. If the ACC approves EE Standards, they must be certified by the Arizona Attorney General before taking affect. TEP’s DSM programs and customer surcharge to recover the costs incurred to implement these proposed programs are subject to ACC approval.

See Item 7. – Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Electric, Factors Affecting Results of Operations, Electric Energy Efficiency Standards , for more information.

Line Extension Policy

As part of the May 2008 ACC order, UNS Electric is required to charge customers for the total cost of line extensions beginning in March 2010. Prior to this ruling by the ACC, a portion of the cost of line extensions was capitalized by UNS Electric and eligible for inclusion in rate base.

ENVIRONMENTAL MATTERS

UNS Electric is subject to environmental regulation of air and water quality, resource extraction, waste disposal and land use by federal, state and local authorities. UNS Electric believes that its facilities are in substantial compliance with all existing regulations and will be in compliance with expected environmental regulations. See Item. 1 — Business, TEP, Environmental Matters , for more information.

Renewable Energy Standard and Tariff

The REST rules require UNS Electric to generate or purchase at least 15% of its total annual retail energy requirements from renewable energy technologies by 2025, with smaller amounts required in earlier years. UNS Electric began implementing its ACC approved REST plan on June 1, 2008. UNS Electric met the REST rules’ 2009 target of generating or purchasing renewable energy for at least 2% of UNS Electric’s total retail energy requirements; UNS Electric expects to meet the 2010 requirement of 2.5%. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UNS Electric, Factors Affecting Results of Operations, Renewable Energy Standard and Tariff , for more information.

Renewable Energy Resources

In February 2010, UNS Electric requested the ACC approve a power purchase agreement that would provide UNS Electric with 11 MW of energy from wind turbine installation near Kingman, Arizona over a 20 year period. The above market cost of power under the agreement would be funded through UNS Electric’s REST surcharge. UNS Electric cannot predict when or if the ACC will approve the agreement. See Renewable Energy Standard and Tariff, above for more information.

OTHER

UED

UED completed construction of the 90 MW BMGS in May 2008. See UNS Electric, Power Supply and Transmission , above for more information regarding BMGS.

Millennium Investments

Through affiliates, Millennium holds investments in unregulated energy and emerging technology companies. At December 31, 2009, Millennium had an investment balance of $10 million, a $7 million cash balance and a $15 million note, which in total represented less than 1% of UniSource Energy’s total consolidated assets. UniSource Energy has ceased making loans or equity contributions to Millennium and has less than $1 million of remaining funding commitments. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Other Non-Reportable Business Segments, Millennium Investments, for more information.

Sabinas

In June 2009, Millennium finalized a sale of its 50% interest in Sabinas. Millennium received an upfront $5 million cash payment in January 2009. Other key terms of the transaction included a three year, 6% interest-bearing, collateralized $15 million note. In June 2009, Millennium recorded a $6 million pre-tax gain on the sale.

EMPLOYEES (As of December 31, 2009)

TEP had 1,358 employees, of which approximately 54% are represented by the International Brotherhood of Electrical Workers (IBEW) Local No. 1116. A collective bargaining agreement between the IBEW and TEP expires in January 2013.

UNS Gas had 197 employees, of which 117 employees were represented by IBEW Local No. 1116 and 6 employees were represented by IBEW Local No. 387. The agreements with the IBEW Local No. 1116 and No. 387 expire in June 2012 and February 2011, respectively.

UNS Electric had 167 employees, of which 29 employees were represented by the IBEW Local No. 387 and 107 employees were represented by the IBEW Local No. 769. The existing agreement with the IBEW Local No. 387 and No. 769 expire in February 2011 and August 2010, respectively.

Southwest Energy Solutions, a wholly-owned subsidiary of Millennium, had 254 employees, of which approximately 95% are represented by unions. Of the employees represented by unions, 226 are represented by IBEW Local No. 1116 and 15 by IBEW Local No. 570; these agreements expire on February 2, 2012, and May 31, 2012, respectively.

Executive Officers — TEP

The executive officers of TEP are the same as UniSource Energy. See Executive Officers — UniSource Energy, above , for a listing and description of TEP’s executive officers.

SEC REPORTS AVAILABLE ON UNISOURCE ENERGY’S WEBSITE

UniSource Energy and TEP make available their annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after they electronically file them with, or furnish them to, the Securities and Exchange Commission (SEC). These reports are available free of charge through UniSource Energy’s website address: http://www.uns.com. A link from UniSource Energy’s website to these SEC reports is accessible as follows: At the UniSource Energy main page, select Investors from the menu shown at the top of the page; next select SEC filings from the menu shown on the Investor Relations page. UniSource Energy’s code of ethics, and any amendments made to the code of ethics, is also available on UniSource Energy’s website.

Information contained at UniSource Energy’s website is not part of any report filed with the SEC by UniSource Energy or TEP.

Similar impacts were felt at UNS Gas and UNS Electric. The retail customer bases at both companies did not grow during 2008 or 2009 compared with average annual growth rates of 3 to 4% from 2003 to 2007. We estimate that a 1% decrease in annual retail sales at UNS Gas and UNS Electric could reduce pre-tax net income and pre-tax cash flows by less than $1 million.

TEP’s base rates are frozen through December 31, 2012, which could limit our ability to cope with the impact of risks and uncertainties and negatively affect TEP’s results of operations, net income and cash flows.

Under the terms of the 2008 TEP rate order, TEP is prohibited from submitting a base rate application before June 30, 2012 and new rates cannot go into effect prior to December 31, 2012. If the cost of serving TEP’s customers rises more quickly than the revenues collected from customers, TEP’s results of operations, net income and cash flows could be negatively impacted.

New technological developments and increasing use of more energy efficient products may have a significant impact on retail sales, which could negatively impact UniSource Energy’s results of operations, net income and cash flows.

Heightened awareness of energy costs and general public support for energy efficiency has increased demand for products intended to reduce consumers’ use of electricity. TEP and UNS Electric also are promoting Demand Side Management programs designed to help customers reduce their energy use, and these efforts may increase significantly under new energy efficiency rules given preliminary approval in 2009 by the ACC. Unless the ACC makes specific provision for the recovery of usage-based revenues lost to these energy efficiency programs, the reduced retail sales that would result from the success of these efforts would negatively impact the results of operations, net income and cash flows of TEP and UNS Electric.

The revenues, results of operations and cash flows of TEP, UNS Gas and UNS Electric are seasonal, and are subject to weather conditions and customer usage patterns, beyond the companies’ control.

TEP typically earns the majority of its operating revenue and net income in the third quarter because retail customers increase their air conditioning usage during Tucson’s hot summer weather. Conversely, TEP’s first quarter net income is typically limited by relatively mild winter weather in its retail service territory. UNS Electric’s earnings follow a similar pattern, while UNS Gas’ sales peak in the winter during home heating season. Cool summers or warm winters may affect customer usage at all three companies, adversely affecting operating revenues, cash flows and net income by reducing sales.

REGULATORY

TEP, UNS Gas and UNS Electric are subject to regulation by the ACC, which sets the companies’ retail rates and oversees many aspects of their business in ways that could negatively affect the companies’ results of operations, net income and cash flows.

The ACC is a constitutionally created body composed of five elected commissioners. Commissioners are elected state-wide for staggered four-year terms and are limited to serving a total of two terms. As a result, the composition of the commission, and therefore its policies, are subject to change every two years.

The ACC is charged with setting retail electric and gas rates that provide utility companies with an opportunity to recover their costs of service and earn a reasonable rate of return. The decisions these elected officials make on such matters impact the net income and cash flows of TEP, UNS Gas and UNS Electric.

Changes in federal energy regulation may negatively affect TEP, UNS Gas and UNS Electric’s results of operations, net income and cash flows.

TEP, UNS Gas and UNS Electric are subject to comprehensive and changing governmental regulation at the federal level that continues to change the structure of the electric and gas utility industries and the ways in which these industries are regulated. UniSource Energy’s electric utility subsidiaries are subject to regulation by the FERC. The FERC has jurisdiction over rates for electric transmission in interstate commerce and rates for wholesale sales of electric power, including terms and prices of transmission services and sales of electricity at wholesale prices.

FINANCIAL

Financial market disruptions and volatility may increase our financing costs, limit our access to the credit markets and increase our pension funding obligations, which may adversely affect our liquidity and our ability to carry out our financial strategy.

We rely on access to the bank markets and capital markets as a significant source of liquidity and for capital requirements not satisfied by the cash flow from our operations. Market disruptions such as those recently experienced in the United States and abroad may increase our cost of borrowing or adversely affect our ability to access sources of liquidity needed to finance our operations and satisfy our obligations as they become due. These disruptions may include turmoil in the financial services industry, including substantial uncertainty surrounding particular lending institutions and counterparties we do business with, unprecedented volatility in the markets where our outstanding securities trade, and general economic downturns in our utility service territories. If we are unable to access credit at competitive rates, or if our borrowing costs dramatically increase, our ability to finance our operations, meet our short-term obligations and execute our financial strategy could be adversely affected.

Changing market conditions could negatively affect the market value of assets held in our pension and other postretirement pension plans and may increase the amount and accelerate the timing of required future funding contributions.

Financial market disruptions and volatility may increase our financing costs and adversely affect our ability to refinance debt obligations and credit agreements totaling $671 million that expire or come due in 2011 at UniSource Energy, TEP, UNS Gas and UNS Electric.

UniSource Energy, TEP, UNS Gas and UNS Electric are each party to a revolving credit agreement with a group of lenders. We rely on these agreements for working capital requirements not provided by cash flow from our operations. We cannot be assured that there will be sufficient lender interest and capacity to refinance these facilities prior to their expiration dates. The following credit agreements and debt obligations mature in August 2011:

UniSource Energy, TEP, UNS Gas and UNS Electric could have difficulty obtaining funding under their respective revolving credit facilities when required if lenders in the bank group file for bankruptcy or refuse to fund when requested. If sufficient liquidity is not available to meet short-term working capital needs, if we are unable pay off or refinance our debt obligations or if borrowing costs dramatically increase, UniSource Energy, TEP, UNS Gas and UNS Electric’s results of operations, net income and cash flows could be negatively impacted.

Regulatory rules and other restrictions limit the ability of TEP, UNS Gas and UNS Electric to make distributions to UniSource Energy.

As a holding company, UniSource Energy is dependent on the earnings and distributions of funds from its subsidiaries to service its debt and pay dividends to shareholders.

Restrictions include:

	•		TEP, UNS Gas and UNS Electric are restricted from lending or transferring funds or issuing securities without ACC approval;
	•		The Federal Power Act restricts electric utilities’ ability to pay dividends out of funds that are properly included in their capital account. TEP has an accumulated deficit rather than positive retained earnings. Although the terms of the Federal Power Act are unclear, we believe there is a reasonable basis for TEP to pay dividends from current year earnings. However, the FERC could attempt to stop TEP from paying further dividends or could seek to impose additional restrictions on the payment of dividends; and
	•		TEP, UNS Gas and UNS Electric must be in compliance with their respective debt agreements to make dividend payments to UniSource Energy.

Economic conditions could adversely impact our ability to comply with financial covenants in the UniSource Energy and TEP Credit Agreements.

The UniSource Energy and TEP credit and reimbursement agreements include a minimum cash flow to interest coverage ratio and a maximum leverage ratio. The leverage ratios are calculated as the ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization. The ability to comply with these covenants could be adversely impacted by lower customer growth rates or sales during an economic downturn. In the event that we seek to renegotiate these provisions to provide additional flexibility, we may need to pay fees or increased interest rates on borrowings as a condition to any amendments or waivers.

UniSource Energy’s net income and cash flows can be adversely affected by rising interest rates.

As of February 23, 2010, TEP had $329 million of tax-exempt variable rate debt obligations. The interest rates on these debt obligations are set weekly with a maximum interest rate of 20%. The average weekly interest rate ranged from 0.25% to 0.79% in 2009. A 1% increase in the average interest rates on this debt, over a twelve month period, would result in an increase in interest expense by approximately $3 million.

UniSource Energy, TEP, UNS Gas and UNS Electric also are subject to risk resulting from changes in the interest rate on their borrowings under revolving credit facilities. Revolving credit borrowings may be made on a spread over LIBOR or an Alternate Base Rate. Each of these agreements is a committed facility and expires in August 2011.

If capital market conditions result in rising interest rates, the resulting increase in the cost of variable rate borrowings would negatively impact UniSource Energy, TEP, UNS Gas and UNS Electric results of operations, net income and cash flows.

TEP, UNS Gas and UNS Electric may be required to post margin under their power and fuel supply agreements which could negatively impact their liquidity.

TEP, UNS Gas and UNS Electric secure power and fuel supply resources to serve their respective retail customers. The agreements under which TEP, UNS Gas and UNS Electric contract for such resources include requirements to post credit enhancement in the form of cash or letters of credit under certain circumstances, including changes in market prices which affect contract values, or a change in creditworthiness of the respective companies.

In order to post such credit enhancement, TEP, UNS Gas and UNS Electric would have to use available cash, draw under their revolving credit agreements, or issue letters of credit under their revolving credit agreements.

The maximum amount TEP may use under its revolving credit facility is $150 million. As of February 23, 2010, TEP had $99 million available to borrow under its revolving credit facility. The maximum amount UNS Gas or UNS Electric may use under their revolving credit facility is $45 million, so long as the combined amount does not exceed $60 million. As of February 23, 2010, UNS Gas and UNS Electric had $45 million and $33 million, respectively, to borrow under their revolving credit facility. From time to time, TEP, UNS Gas and UNS Electric use their respective revolving credit facilities to post collateral. If additional collateral is required, it may negatively impact TEP, UNS Gas and/or UNS Electric’s ability to fund their capital requirements. As of December 31, 2009, TEP, UNS Gas and UNS Electric had posted $1 million, $2 million, and $11 million, respectively, with counterparties.

UniSource Energy and its subsidiaries have substantial debt which could adversely affect their business and results of operations.

UniSource Energy has no operations of its own and derives all of its revenues and cash flow from its subsidiaries. At December 31, 2009, the ratio of total debt (including capital lease obligations net of investments in lease debt) to total capitalization for UniSource Energy and its subsidiaries was 70%. This substantial debt level:

	•		requires UniSource Energy and its subsidiaries to dedicate a substantial portion of their cash flow to pay principal and interest on their debt, which could reduce the funds available for working capital, capital expenditures, acquisitions and other general corporate purposes; and
	•		could limit UniSource Energy and its subsidiaries’ ability to borrow additional amounts for working capital, capital expenditures, acquisitions, dividends, debt service requirements, execution of its business strategy or other purposes.

The cost of renewing leases or purchasing TEP’s leased assets, or the cost of procuring alternate sources of generation or purchased power, could adversely affect TEP’s results of operations, net income and cash flows.

TEP, under separate sale and leaseback arrangements, leases the following generation facilities:

TEP may renew the leases or purchase the assets when the leases expire at various times between 2011 and 2021. The renewal and purchase options for Springerville Unit 1 are generally for fair market value as determined at that time, whereas fixed purchase price options exist for the coal handling and common facilities leases. Upon expiration of the coal handling and common facilities leases (whether at the end of the initial term or any renewal term), TEP has the obligation under agreements with the Springerville Units 3 and 4 owners to purchase such facilities, and each of the owners of Springerville Units 3 and 4 has the obligation to purchase or continue renting from TEP at 14% and 17% interest, respectively, in these facilities.

ENVIRONMENTAL

UniSource Energy’s utility subsidiaries are subject to numerous environmental laws and regulations that may increase their cost of operations or expose them to environmentally-related litigation and liabilities.

UniSource Energy’s utility subsidiaries are subject to numerous federal, state and local environmental laws and regulations affecting present and future operations, including rules regarding air emissions, water quality, wastewater discharges, solid waste and hazardous waste. Many of these regulations arise from TEP’s reliance on coal as its primary fuel for energy generation.

These laws and regulations can contribute to higher capital, operating and other costs, particularly with regard to enforcement efforts focused on existing power plants and compliance plans with regard to new and existing power plants. These laws and regulations generally require us to obtain and comply with a wide variety of environmental licenses, permits, authorizations and other approvals. Both public officials and private individuals may seek to enforce applicable environmental laws and regulations. Failure to comply with applicable laws and regulations might result in the imposition of fines and penalties by regulatory authorities. We cannot provide assurance that existing environmental laws and regulations will not be revised or that new environmental laws and regulations will not be adopted or become applicable to us. Increased compliance costs or additional operating restrictions from revised or additional regulation could have an adverse effect on our results of operations, particularly if those costs are not fully recoverable from our ratepayers.

TEP also is contractually obligated to pay a portion of the environmental reclamation costs incurred at generating stations in which it has a minority interest and may be obliged to pay similar costs at the mines that supply these generating stations. While TEP has recorded the portion of its costs that can be determined at this time, the total costs for final reclamation at these sites are unknown and could be substantial.

New federal regulations to limit greenhouse gas emissions could increase TEP’s cost of operations and result in a change in the composition of TEP’s coal-dominated generating fleet.

Based on the finding by the EPA in December 2009 stating that greenhouse gases endanger public health and welfare, the agency is in the process of developing regulations limiting greenhouse gas emissions. In addition, there are proposals and ongoing studies at the state, federal and international levels to address global climate change that could also result in the regulation of carbon dioxide (CO ₂ ) and other greenhouse gases. Any future regulatory actions taken to address global climate change represent a business risk to our operations. In 2009, 69% of TEP’s total energy resources came from its coal-fueled generating facilities. Reductions in CO ₂ emissions to the levels specified by some proposals could be materially adverse to our financial position or results of operations if associated costs of control or limitation cannot be recovered from customers. Any future legislation or regulation addressing climate change could produce a number of other results including additional costs to fund energy efficiency activities, costly modifications to, or reexamination of the economic viability of, our existing coal plants or changes in the overall fuel mix of our generating fleet. The impact of legislation or regulation to address global climate change would depend on the specific legislation or regulation enacted and cannot be determined at this time.

UniSource Energy could be subject to physical risks associated with climate change.

Climate change may cause physical risks, including an increase in sea level, intensified storms, water scarcity and changes in weather conditions, such as changes in precipitation, average temperatures and extreme weather conditions. A significant portion of the nation’s oil and gas infrastructure is located in areas susceptible to storm damage that could be aggravated by wetland and barrier island erosion, which could give rise to fuel supply interruptions and price spikes.

These and other physical changes could result in changes in customer demand, increased costs associated with repairing and maintaining generation facilities and transmission and distribution systems resulting in increased maintenance and capital costs (and potential increased financing needs), limits on the company’s ability to meet peak customer demand, increased regulatory oversight, and lower customer satisfaction. Also, to the extent that climate change adversely impacts the economic health of a region, it may adversely impact customer demand and revenues. Such physical risks could have an adverse effect on our financial condition, results of operations and liquidity.

OPERATIONAL

The operation of electric generating stations involves risks that could result in unplanned outages or reduced generating capability that could adversely affect TEP’s results of operations, net income and cash flows.

The operation of electric generating stations involves certain risks, including equipment breakdown or failure, interruption of fuel supply and lower than expected levels of efficiency or operational performance. Unplanned outages, including extensions of planned outages due to equipment failure or other complications occur from time to time and are an inherent risk of our business. If TEP’s generating stations operate below expectations, TEP could be adversely affected.

The operation of electric transmission and distribution systems involves a risk of significant unplanned outages that could adversely affect TEP and UNS Electric’s businesses, results of operations, net income and cash flows.

The operation of electric transmission and distribution systems involves certain risks, including equipment failure and damage caused by storms, fires or other hazards. Unplanned outages occur from time to time and are an inherent risk of our business. If TEP or UNS Electric’s transmission and distribution systems experience a significant failure, TEP or UNS Electric could be adversely affected

TEP could be subject to penalties as a result of mandatory reliability standards.

As a result of the Energy Policy Act of 2005, owners and operators of bulk power transmission systems, including TEP, are subject to mandatory reliability standards that are developed and enforced by NERC, subject to the oversight of FERC. If we fail to comply with the mandatory reliability standards we could be subject to sanctions, including substantial monetary penalties.

UNS Electric may not be able to secure sufficient energy resources to serve its retail customers.

UNS Electric owns 68 MW of peaking generation resources and is purchasing the output of the 90 MW BMGS from UED through a PPA that extends through May 2013. UNS Electric also relies on short and intermediate term purchased power contracts to meet its retail energy demand. In 2009, UNS Electric’s peak retail demand was 559 MW. UNS Electric procures its projected retail peak demand requirements prior to the start of the summer season. In addition to its owned resources and PPA with UED, UNS Electric has acquired other contract capacity to satisfy 90% and 60% of its projected summer peak demand for 2010 and 2011, respectively. However, UNS Electric cannot predict whether it will be able to obtain sufficient resources to meet its retail energy demand for 2010 and beyond. UNS Electric’s cash flows and net income could be negatively impacted if UNS Electric is unable to secure adequate energy resources to sell to its retail customers.

TEP or UNS Electric may not be able to secure adequate right-of-way to construct transmission lines and may be required to find alternate ways to provide adequate sources of energy and maintain reliability in TEP and UNS Electric’s service areas.

TEP and UNS Electric rely on federal, state and local governmental agencies to secure right-of-way and siting permits to construct transmission lines. If adequate right-of-way and siting permits to build new transmission lines cannot be secured:

	•		TEP and UNS Electric may need to rely on more costly alternatives to provide energy to their customers;
	•		TEP and UNS Electric may not be able to maintain reliability in their service areas; or
	•		TEP and UNS Electric’s ability to provide electric service to new customers may be negatively impacted.

TEP may be required to build an estimated $120 million transmission line from Tucson to Nogales or UNS Electric or TEP may be required to find alternate ways to improve reliability in UNS Electric’s Santa Cruz service area.

In 2001, TEP entered into an agreement to build an approximately 60-mile transmission line from Tucson to Nogales, Arizona, in response to an order from the ACC to improve reliability to UNS Electric’s retail customers in Nogales. Required regulatory approvals have delayed the construction of the transmission line, and in 2005, the ACC initiated proceedings to review the status of service in Nogales and need for the 345-kV line. After a hearing on the issue in February 2006, the ACC directed the ALJ to amend the recommendation to direct the Arizona Power Plant and Transmission Line Siting Committee to gather facts related to options for improving service reliability in Santa Cruz County. If all regulatory approvals are received and the project moves forward, the future costs to construct the transmission line from Tucson to Nogales are expected to be $120 million. If TEP is required to build the transmission line, it may negatively impact TEP’s ability to internally fund substantially all of its capital requirements.

If TEP does not receive required approvals or if the project is abandoned, TEP may be required to expense a portion of the $11 million it has incurred through December 31, 2009, in land acquisition, engineering and environmental expenses. In such an event, TEP or UNS Electric may be required to make additional expenditures to improve reliability. In the event TEP or UNS Electric are unable to recover such expenditures, their results of operations and net income could be adversely affected.

ITEM 2. — PROPERTIES

TEP PROPERTIES

TEP’s transmission facilities, located in Arizona and New Mexico, transmit electricity from TEP’s remote electric generating stations at Four Corners, Navajo, San Juan, Springerville and Luna to the Tucson area for use by TEP’s retail customers (see Item 1. — Business — Generating and Other Resources ). The transmission system is interconnected at various points in Arizona and New Mexico with a number of regional utilities. TEP has arrangements with approximately 120 companies to interchange generation capacity and transmission of energy.

As of December 31, 2009, TEP owned or participated in an overhead electric transmission and distribution system consisting of:

•

512 circuit-miles of 500-kV lines;

•

1,087 circuit-miles of 345-kV lines;

•

369 circuit-miles of 138-kV lines;

•

477 circuit-miles of 46-kV lines; and

•

2,622 circuit-miles of lower voltage primary lines.

The underground electric distribution system is comprised of 4,341 cable-miles. TEP owns approximately 76% of the poles on which the lower voltage lines are located. Electric substation capacity consisted of 102 substations with a total installed transformer capacity of 13,170,650 kilovolt amperes.

Substantially all of the utility assets owned by TEP are subject to the lien of the 1992 Mortgage. Springerville Unit 2, which is owned by San Carlos Resources Inc., a wholly-owned subsidiary of TEP (San Carlos), is not subject to the lien.

The electric generating stations (except as noted below), operating headquarters, warehouse and service center are located on land owned by TEP. The electric distribution and transmission facilities owned by TEP are located:

•

on property owned by TEP;

•

under or over streets, alleys, highways and other public places, the public domain and national forests and state lands under franchises, easements or other rights which are generally subject to termination;

•

under or over private property as a result of easements obtained primarily from the record holder of title; or

•

over American Indian reservations under grant of easement by the Secretary of Interior or lease by American Indian tribes.

It is possible that some of the easements, and the property over which the easements were granted, may have title defects or may be subject to mortgages or liens existing at the time the easements were acquired.

Springerville is located on land parcels held by TEP under a long-term surface ownership agreement with the State of Arizona.

Four Corners and Navajo are located on properties held under easements from the United States and under leases from the Navajo Nation, respectively. TEP, individually and in conjunction with PNM in connection with San Juan, has acquired easements and leases for transmission lines and a water diversion facility located on land owned by the Navajo Nation. TEP has also acquired easements for transmission facilities, related to San Juan, Four Corners, and Navajo, across the Zuni, Navajo and Tohono O’odham Indian Reservations. TEP, in conjunction with PNM and Phelps Dodge, holds an undivided ownership interest in the property on which Luna is located.

TEP’s rights under these various easements and leases may be subject to defects such as:

•

possible conflicting grants or encumbrances due to the absence of or inadequacies in the recording laws or record systems of the Bureau of Indian Affairs and the American Indian tribes;

•

possible inability of TEP to legally enforce its rights against adverse claimants and the American Indian tribes without Congressional consent; or

•

failure or inability of the American Indian tribes to protect TEP’s interests in the easements and leases from disruption by the U.S. Congress, Secretary of the Interior, or other adverse claimants.

These possible defects have not interfered and are not expected to materially interfere with TEP’s interest in and operation of its facilities.

TEP, under separate sale and leaseback arrangements, leases the following generation facilities (which do not include land):

•

coal handling facilities at Springerville;

•

a 50% undivided interest in the Springerville Common Facilities;

•

Springerville Unit 1 and the remaining 50% undivided interest in the Springerville Common Facilities; and

•

Sundt Unit 4 and related common facilities.

See Note 6 of Notes to Consolidated Financial Statements, Debt, Credit Facilities, and Capital Lease Obligations and Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Tucson Electric Power Company, Liquidity and Capital Resources, Contractual Obligations , for additional information on TEP’s capital lease obligations.

UES PROPERTIES

UNS Gas

As of December 31, 2009, UNS Gas’ transmission and distribution system consisted of approximately 58 miles of steel transmission mains, 4,173 miles of steel and plastic distribution mains, and 135,920 customer service lines.

UNS Electric

As of December 31, 2009, UNS Electric’s transmission and distribution system consisted of approximately 56 circuit-miles of 115-kV transmission lines, 264 circuit-miles of 69-kV transmission lines, and 3,581 circuit-miles of underground and overhead distribution lines. UNS Electric also owns 39 substations having a total installed capacity of 1,768,050 kilovolt amperes and the 65 MW Valencia plant.

The gas and electric distribution and transmission facilities owned by UNS Gas and UNS Electric are located:

•

on property owned by UNS Gas or UNS Electric;

•

under or over streets, alleys, highways and other public places, the public domain and national forests and state lands under franchises, easements or other rights which are generally subject to termination; or

•

under or over private property as a result of easements obtained primarily from the record holder of title.

It is possible that some of the easements, and the property over which the easements were granted, may have title defects or may be subject to mortgages or liens existing at the time the easements were acquired.

UED PROPERTIES

As of December 31, 2009, UED owned a 90 MW gas-fired generation facility in Kingman, Arizona, known as BMGS, that was completed in May 2008. BMGS is located on property that is owned by UNS Electric and currently leased to UED. BMGS is subject to a lien to secure UED’s obligations under its term loan facility.

Sierra Club San Juan Allegations

In December 2009, the Sierra Club sent TEP, the other owners of the San Juan Generating Station (SJGS), and San Juan Coal Company (SJCC), a Notice of Intent to Sue (RCRA Notice) under the Resource Conservation and Recovery Act (RCRA). The RCRA Notice alleges that certain activities at SJGS and the San Juan mine associated with the treatment, storage and disposal of coal and coal combustion by-products (CCBs) are causing imminent and substantial harm to the environment and that placement of CCBs at the mine constitute “open dumping” in violation of RCRA. Additionally, TEP has been informed that the Sierra Club sent SJCC a separate Notice of Intent to Sue (SMCRA Notice) under the Surface Mine Control and Reclamation Act (SMCRA) in December 2009. The SMCRA Notice similarly alleges damage to the environment due to activities at the San Juan mine, including the placement of CCBs from SJGS in the surface pits at the mine. Both Notices state Sierra Club’s intent to file citizens’ suits to pursue these claims upon expiration of the RCRA and SMRCA statutory notice periods. If suits are filed, potential remedies include the imposition of civil penalties and injunctive relief. TEP and Public Service Company of New Mexico, the SJGS operator, plan an aggressive defense of the RCRA claims. TEP cannot predict the outcome of these matters at this time.

See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Tucson Electric Power Company, Factors Affecting Operations , for litigation related to ACC orders and retail competition.

In addition, see legal proceedings described in Note 4 of Notes to Consolidated Financial Statements, Commitments and Contingencies.

On February 12, 2010, UniSource Energy declared a cash dividend of $0.39 per share on its Common Stock. The dividend will be paid March 8, 2010 to shareholders of record at the close of business February 23, 2010.

TEP’s common stock is wholly-owned by UniSource Energy and is not listed for trading on any stock exchange. TEP declared and paid cash dividends to UniSource Energy of $60 million in 2009, $3 million in 2008, and $53 million in 2007.

Convertible Senior Notes

In 2005, UniSource Energy issued $150 million of 4.50% Convertible Senior Notes due 2035. Each $1,000 of Convertible Senior Notes is convertible into 27.427 shares of our Common Stock at any time, representing a conversion price of approximately $36.46 per share of our Common Stock, subject to adjustment in certain circumstances. See Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, UniSource Energy Consolidated, Liquidity and Capital Resources, Executive Overview, UniSource Energy Consolidated Cash Flows, Financing Activities.

Issuer Purchases of Common Equity

UniSource Energy did not purchase any of its Common Stock during 2009, 2008 or 2007.

ITEM 6. — SELECTED CONSOLIDATED FINANCIAL DATA