Board and Management Changes
James F. Cordes was elected to our Board of Directors in 2009. He was formerly the executive vice president of The Coastal Corp., president of American Natural Resources Co. and chairman and chief executive officer of ANR Pipeline Co. Sara Martinez Tucker, former undersecretary of the U.S. Department of Education, president and chief executive officer of the Hispanic Scholarship Fund and regional vice president for AT&T Global Business Communications Systems, also was elected to the Board in 2009.

The independence of our Board is integral to our corporate governance. I am pleased to say that, of our 13 directors, I am the only director from within AEP.

Brian X. Tierney was named executive vice president and chief financial officer in 2009. After 41 years of service to AEP, J. Craig Baker, senior vice president -- Regulatory Services, retired. Richard E. Munczinski succeeds him. These appointments were among several management changes made last year, some of which were part of our succession planning process.

Financial Performance
In a year of many uncertainties, AEP outperformed expectations in 2009 and ended the year in a strong financial position. Our $2.97 ongoing earnings per share were well within our guidance range. During the year, the management team demonstrated its commitment to maintaining the company’s investment-grade ratings by issuing $1.6 billion of equity. Our action was well received in the market.

We had many regulatory successes, securing $725 million of incremental rate increases in 2009 that helped earnings by providing cost recovery for environmental compliance, tree trimming, energy efficiency programs, construction and other operating costs. Our customers and investors also benefited as we continue to be among the lowest-cost providers of electric service while delivering a 10.4 percent total return, including reinvested dividends, to our shareholders.

The strength of our balance sheet and our liquidity point to our financial health. We are disciplined about our operations and maintenance (O&M) and capital spending. We are moving forward in a financially responsible way, recognizing there are many demands and limited resources. Our employees did not receive merit increases in 2009.With the exception of senior leadership, whose salaries remain frozen, we will be awarding modest pay increases to most employees in 2010. As part of our commitment to being financially disciplined, we have announced a cost reduction initiative that includes reducing our work force by up to 10 percent.

We reduced our utility operations’ capital budget by $1.4 billion, from $3.8 billion in 2008 to $2.4 billion in 2009. We plan to hold it at $2 billion in 2010 and 2011. Investments in new infrastructure will increase future earnings strength and potential while allowing us to provide safe, reliable electricity to our customers. Our anticipated $2 billion in capital investments, factoring in depreciation of $1.3 billion, create potential growth in our rate base of $700 million.

Like many businesses, we faced financial challenges. Electricity demand was down significantly, especially among industrial customers in the metals, transportation, plastics, rubber and paper sectors. Off-system sales volumes – the excess power we sell in the wholesale power markets – dropped by half in 2009.

As the economies in our service territories improve, we expect our retail and wholesale sales to recover as well.

Operational Performance
We had many successes in 2009, but we also did not meet our expectations in some important areas. The lowest points of the year were when two AEP employees and two AEP contractors lost their lives while on the job. Although we make efforts to educate the public about electrical safety, nine members of the public also died after coming into contact with our electrical facilities.

There is simply nothing more important to me, and to our company, than the safety and health of our employees, contractors and the public. We missed critical safety goals, tragically, and everyone at AEP regards this as unacceptable. One reason the Board of Directors awarded no incentive compensation to me and my senior management team was because safety is a strategic goal we failed to achieve. All other employees also lost a portion of their incentive compensation.

We will learn from these experiences and take corrective and preventive actions, but the pain of these losses cannot be erased. I am determined that we will achieve our goal of zero harm. We will not settle for less; I know our employees feel the same way.

Eight employees went above and beyond the call of duty in 2009 to protect the safety of the public outside of their normal jobs. These employees demonstrated the value we place on safety, and we honored them with the Chairman’s Life Saving Award.

Maintaining compliance with laws and regulations is complex and ever changing. We strive for superior performance and recognize that compliance is the cornerstone of everything that we do.

Our business has significant environmental impacts, and managing them responsibly is both our legal obligation and moral responsibility. We devote significant resources to compliance, we have checks and balances in place to measure our performance, and we think our overall record is excellent. We constantly challenge ourselves to be best in class, setting the bar at zero for significant enforcement actions from regulators. Given the complexities of our business, this goal is very difficult to meet, but having it helps us to ensure continuous improvement.

We were involved in five significant enforcement actions related to landfill issues and wastewater discharges in 2009, among other matters. We have learned from these events and have changed practices or procedures to prevent recurrences. Heightened regulatory focus on coal ash presents potentially significant financial and operational challenges. We must maintain beneficial use of this material or dispose of millions of additional tons of coal ash each year. We take strong measures to ensure the safe and proper operation of our coal ash impoundments. Even so, we recently have enhanced our practices around monitoring, inspecting and auditing our performance and will continue to strive to improve these activities. We oppose classifying coal ash as a hazardous waste, but we understand and agree with the need for greater oversight. As we move toward greater certainty around federal classification of coal ash products and how they affect our facilities, we will work with neighbors so they better understand our operations.

The $5.4 billion environmental investment program has resulted in the lowest emissions of sulfur dioxide (SO2) and nitrogen oxide (NOx) from our system in two decades. We will further reduce our SO2 and NOx emissions through emissions caps we agreed to in our New Source Review consent decree. Regulators also recognize the importance of this program and have supported it in customer rates.

Our greatest success in 2009 was the commissioning of the world’s first fully integrated carbon dioxide capture and storage validation facility at our Mountaineer Plant in West Virginia. Our next project is to take this technology to commercial scale at Mountaineer and we have been awarded federal funding for 50 percent of the project costs, up to $334 million. We also will seek regulatory support and additional investment partners.

We succeeded in securing the needed permits from the U.S. Army Corps of Engineers and the U.S. Environmental Protection Agency (EPA) for the construction of the 600-megawatt (MW) John W. Turk Jr. Plant in southwest Arkansas. Although legal challenges to our permits are pending, this ultra-supercritical coal plant will be among the most efficient coal plants in the world when it becomes operational in 2012. A new 500-MW natural gas combined- cycle plant begins operation in 2010 in Shreveport, La., to serve the needs of our customers in Arkansas, Texas and Louisiana. Both of these plants are critical to meeting the growing demand for electricity in that region and reflect our strategy to use advanced technologies and resources that lessen our carbon emissions.

Our Cook Nuclear Plant Unit 1 came back on line at reduced power at the end of 2009, which is good news for customers and the environment. It is expected to return to full power by the end of 2011, after new low-pressure turbine rotors are installed. The scope of the restoration exceeded anything previously attempted in our industry. 

As we consider ways to reduce our carbon emissions, we are studying potential improvements that would allow us to increase the output of the Cook Plant while operating it safely and reliably for its extended operating life. A separate project is addressing the prospects for long-term spent nuclear fuel storage, which continues to be a concern and could challenge the plant’s long-term operation.

We rounded out our transmission strategy with the creation of AEP Transmission Co. (AEP Transco). This allows us to pursue new, on-system transmission opportunities within our service area while preserving the credit quality of our operating companies. Our vision for a national interstate extra-high voltage transmission system, similar to our nation’s interstate highway system, is unchanged. We believe the modernization of our transmission system is imperative to our nation’s energy future and we are continuing to advance this vision.

Our gridSMART^SM initiative received significant support last year with additional deployment of “smart” meters and other supporting technologies in four states. Two of our companies were awarded federal aid to support these deployments, which help us learn how gridSMART^SM technology works, improve the efficiency of the grid and give our customers more control over their energy use. We set a goal to install 5 million smart meters by 2015. This will be very challenging to achieve absent regulatory support but is necessary if we want to change how consumers use electricity and to reduce demand. Therefore, we will continue to press forward.

We have an obligation to provide safe, reliable electricity to our customers. The reliability of our system improved in 2009; there were fewer nonstorm-related outages, and they were shorter in duration. Customer satisfaction also improved.

We began evaluating the environmental, safety and health performance of our non-fuel suppliers in 2008 and extended that assessment to our coal suppliers in 2009. We conducted our first survey of coal suppliers and brought many of them together with environmental groups, regulators and community leaders for an unprecedented stakeholder meeting. It was the beginning of a dialogue on coal issues that we intend to continue with suppliers, stakeholders and regulators.

Global Warming
In the public policy arena, the debate about global warming continues to dominate our thinking because of the significant financial and operational implications it will have on our business and our customers. Global warming is a controversial issue, and the public policymakers and influencers in Washington, D.C., and in the 11 states we serve have conflicting views. Regardless of the debate over science and solutions, our position has not changed. We are taking actions that make sense for AEP and our customers, such as improving energy efficiency, investing in cost-effective and less carbon-intensive technologies and evaluating our options across a range of possible outcomes.

We believe that global warming requires global action that does not disproportionately compromise American jobs or our economy, which will be the case if our trading partners do not follow and participate in a solution. We are encouraged by China’s and India’s participation in the discussions; it is a step in the right direction.

The U.S. EPA is moving ahead with rules to regulate greenhouse gas (GHG) emissions, which would affect our power plants. We prefer a legislative solution with an economy-wide cap-and-trade approach, and we supported the Waxman-Markey bill approved last summer by the U.S. House of Representatives. The bill includes several provisions that would help our customers and our company transition to a lower-carbon environment, including the allocation of carbon allowances, use of carbon offsets and incentives for moving carbon capture and storage technology forward. Under EPA regulations, we would lose these benefits for our customers and shareholders. We do not support a sector-by-sector carbon bill because it would unfairly affect customers of coal-based electric utilities.

We are making progress toward achieving our goals in energy efficiency and boosting the use of renewable energy on our system. We have identified the potential for more than 900 MW of energy efficiency and demand-reduction opportunities to help meet our 2012 goal and have contracted to add 1,013 MW of renewable energy to meet a 2011 goal. These important milestones are an integral part of our carbon reduction strategy.

We are considering several options that protect the reliability of the electric system while reducing our carbon emissions. The outcome of the global climate change debate is only one factor that will drive change in how we operate our business. Other considerations include potential new or more stringent regulations on coal plants; the shift toward greater use of natural gas, including shale gas; and the age and efficiency of some of our coal-fired units. But if we are forced to move too quickly in any direction without having sufficient new resources in place, the reliability of our electricity system would be jeopardized and the economy would be imperiled.

Our Vision for the Future
We believe that reliable, safe and reasonably priced energy is a key to the global economic recovery. Through our state legislatures and public utility commissions and with the collaboration of our partners and many stakeholders, AEP is helping to change the way that electricity is generated, distributed and consumed. We are at the beginning of a new era; we know that bold changes are around the corner, and we embrace them. The men and women of AEP are moving forward. We invite you to join us.

Thank you for your interest in American Electric Power.

Michael G. Morris
Chairman, President, and Chief Executive Officer
April 2010