The following discussion and analysis should be read in conjunction with the Financial Statements and Notes to Financial Statements included in this report, as well as the Financial Statements and Supplementary Data and Management's Discussion and Analysis of Financial Condition and Results of Operations included in Allegheny's Annual Report on Form 10-K for the year ended December 31, 2008 (the "2008 Annual Report on Form 10-K").

Forward-Looking Statements

In addition to historical information, this report contains a number of forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve estimates, expectations and projections and, as a result, are subject to risks and uncertainties. Forward-looking statements often may be identified by the use of words such as anticipate, expect, project, intend, plan, believe and words and terms of similar substance used in connection with any discussion of future plans, actions or events identify forward-looking statements. However, the absence of these or similar words does not mean that any particular statement is not forward-looking. Forward-looking statements herein may relate to, among other matters:

• regulatory issues, including but not limited to environmental regulation, state rate regulation, and the status of retail generation service supply competition in states served by the Distribution Companies;

• financing plans;

• market demand and prices for energy, capacity, coal and natural gas;

• the cost and availability of raw materials, including coal, and Allegheny's ability to enter into, modify and enforce long-term fuel purchase agreements;

• provider-of-last-resort ("PLR") and power supply contracts;

• results of litigation;

• results of operations;

• internal controls and procedures;

• capital expenditures;

• status and condition of plants and equipment;

• changes in technology and their effects on the competitiveness of Allegheny's generation facilities;

• work stoppages by Allegheny's unionized employees; and

• capacity purchase commitments.

There can be no assurance that actual results will not differ materially from expectations. Actual results have varied materially and unpredictably from past expectations. Factors that could cause actual results to differ materially include, among others, the following:

• the results of regulatory proceedings, including proceedings related to rates;

• plant performance and unplanned outages;

• volatility and changes in the price and demand for energy and capacity and changes in the value of financial transmission rights ("FTRs");

• volatility and changes in the price of coal, natural gas and other energy-related commodities;

• Allegheny's ability to enter into, modify and enforce supplier performance under long-term fuel purchase agreements;

• changes in Allegheny's requirements for, and the ability and/or price of, emission allowances;

• changes in industry capacity, development and other activities by Allegheny's competitors;

• changes in market rules, including changes to the participant rules and tariffs for PJM Interconnection, L.L.C. ("PJM");

• the loss of any significant customers or suppliers;

• changes in customer switching behavior and their resulting effects on existing and future PLR load requirements;

• dependence on other electric transmission and gas transportation systems and their constraints on availability;

• environmental regulations;

• changes in other laws and regulations applicable to Allegheny, its markets or its activities;

• changes in the underlying inputs and assumptions, including market conditions, used to estimate the fair values of commodity contracts;

• complications or other factors that make it difficult or impossible to obtain necessary lender consents or regulatory authorizations on a timely basis;

• recent and any future disruptions in the financial markets and changes in access to capital markets;

• the availability of credit;

• actions of rating agencies;

• inflationary and deflationary trends and interest rate trends;

• the effect of accounting pronouncements issued periodically by accounting standard-setting bodies;

• entry into, any failure to consummate, or any delay in the consummation of, contemplated asset sales or other strategic transactions;

• general economic and business conditions; and

• other risks, including the effects of global instability, terrorism and war.

A detailed discussion of certain factors affecting Allegheny's risk profile is provided under Item 1A, "Risk Factors," in the 2008 Annual Report on Form 10-K.

Allegheny is an integrated energy business that owns and operates electric generation facilities and delivers electric services to customers in Pennsylvania, West Virginia, Maryland and Virginia. Allegheny operates its business primarily through AE's various directly and indirectly owned subsidiaries. These operations are aligned in two operating segments, the Delivery and Services segment and the Generation and Marketing segment. Selected financial measures for each segment for the three and nine months ended September 30, 2009 and 2008 were as follows:

                                                         Three Months Ended                                               Three Months Ended
                                                         September 30, 2009                                               September 30, 2008
                                     Delivery      Generation                                       Delivery         Generation
                                        and           and                                              and              and
(In millions)                        Services      Marketing       Eliminations          Total      Services         Marketing       Eliminations          Total
Operating revenues                   $   783.5    $      450.0    $       (439.8 )     $   793.7    $   692.7       $      589.3    $       (432.4 )     $   849.6
Operating income                     $    80.7    $      125.2    $           -        $   205.9    $    20.5       $      166.4    $           -        $   186.9
Income (loss) before income taxes    $    56.2    $       66.5    $           -        $   122.7    $    (1.2 )     $      134.7    $           -        $   133.5

                                                          Nine Months Ended                                               Nine Months Ended
                                                         September 30, 2009                                               September 30, 2008
                                     Delivery      Generation                                       Delivery         Generation
                                        and           and                                              and              and
(In millions)                        Services      Marketing       Eliminations          Total      Services         Marketing       Eliminations          Total
Operating revenues                   $ 2,417.6    $    1,531.5    $     (1,383.4 )     $ 2,565.7    $ 2,139.6       $    1,842.0    $     (1,303.5 )     $ 2,678.1
Operating income                     $   259.7    $      415.1    $           -        $   674.8    $   113.8       $      618.3    $           -        $   732.1
Income before income taxes           $   185.1    $      294.3    $           -        $   479.4    $    53.2       $      519.2    $           -        $   572.4

The information for the Delivery and Services segment includes the operations of the Virginia distribution business, which is expected to be sold following the completion of applicable regulatory proceedings, as described in Note 3, "Assets Held For Sale" to the Consolidated Financial Statements.

The performance of Allegheny's Delivery and Services segment is significantly impacted by customer demand for electricity, regulatory ratemaking actions and the progress of transmission expansion projects. Retail electricity sales for the three and nine months ended September 30, 2009 and 2008 were as follows:

Three Months Ended Nine Months Ended September 30, September 30, 2009 2008 Change 2009 2008 Change Retail electricity sales (million kWhs) 10,277 10,749 (4.4 )% 31,533 33,023 (4.5 )%

The decreases in retail electricity sales shown in the table above are due largely to significant decreases in industrial demand relating to the weak economic climate and, to a lesser degree, decreases in residential demand. These trends continued through September 30, 2009, and future retail electricity sales will continue to be affected by economic conditions, load fluctuations, conservation measures and weather.

During the three and nine months ended September 30, 2008, Potomac Edison's Virginia distribution operations reported significant losses due to increased costs of purchased power that could not be passed on to its customers. As a result of rate making decisions, Potomac Edison began to recover the majority of its actual purchased power costs in Virginia beginning January 1, 2009, and this resulted in increased pre-tax earnings of $38.4 million and $95.5 million for the three and nine months ended September 30, 2009, respectively, compared to the corresponding periods in the prior year.

Capital expenditures on Allegheny's PATH, TrAIL and other expansion transmission projects are continuing. Accumulated accrual-basis expenditures for these projects were $656.3 million at September 30,

2009 and $244.8 million at December 31, 2008. Increased capital spending on these projects directly impacts earnings and resulted in increases in pre-tax income, excluding the amount of such income attributable to our joint venture partner's noncontrolling interest in PATH, of $7.3 million and $14.2 million for the three and nine months ended September 30, 2009, respectively, compared to the corresponding periods in the prior year.

The performance of Allegheny's Generation and Marketing segment is significantly impacted by changes in prices for power and for commodities that underlie the generation of electric power, such as coal and natural gas. Changes in such prices result from changes in supply and demand, fuel costs, market liquidity, weather, environmental regulation and other factors. Market prices for power and related commodities are volatile and difficult to predict. Trends in reduced demand and significantly lower market prices for electricity and related commodities that began during the third quarter of 2008 have continued to date. Allegheny cannot predict when economic conditions will improve and to what extent an economic recovery will impact future energy and commodity prices. The following table shows market prices for certain commodities in Allegheny's region:

                                     Average Actual Market Prices                   Forward Market Prices
                                                        Nine Months         Three Months
                                   Year Ended              Ended               Ending                 Year Ending
                                  December 31,         September 30,        December 31,              December 31,
                                      2008                 2009                 2009                      2010
Round-the-clock energy
price - PJM Western Hub
($/MWh)                          $         69.81      $         39.12      $        36.97  (a)       $       48.38  (a)
Natural gas price - Henry
Hub NYMEX ($/MM Btu)             $          8.84      $          3.80      $         4.73  (a)       $        6.21  (a)

(a) Based on forward market prices as of September 30, 2009.

Certain operating statistics for Allegheny's generation operations for the three and nine months ended September 30, 2009 and 2008 were as follows:

                                          Three Months Ended                          Nine Months Ended
                                             September 30,                              September 30,
                                   2009           2008         Change          2009           2008         Change
Round-the-clock energy price
(PJM Western Hub)                 $ 33.78       $  76.89        (56.1 )%     $  39.12       $  75.40        (48.1 )%
All coal-fired unit kWhs
generated (in millions)             6,308         11,462        (45.0 )%       23,951         33,690        (28.9 )%
Supercritical Coal Units:
kWhs generated (in millions)
(a)                                 5,791         10,115        (42.7 )%       22,231         29,303        (24.1 )%
Equivalent Availability Factor
(EAF) (b)                            88.9 %         90.2 %       (1.3 )%         81.4 %         86.1 %       (4.7 )%
Net Capacity Factor (NCF) (c)        44.1 %         77.1 %      (33.0 )%         56.4 %         74.0 %      (17.6 )%
All Generating Units:
kWhs generated (in millions)
(a)                                 7,008         11,904        (41.1 )%       25,417         35,048        (27.5 )%
Equivalent Availability Factor
(EAF) (b)                            89.6 %         90.5 %       (0.9 )%         83.1 %         86.4 %       (3.3 )%
Net Capacity Factor (NCF) (c)        35.2 %         62.0 %      (26.8 )%         43.5 %         60.3 %      (16.8 )%

(a) Excludes kWhs consumed by pumping at the Bath County, Virginia hydroelectric station.

(b) EAF represents the average available generating capacity expressed as a percentage of total generating capacity. This measure is commonly less than 100% primarily due to planned and unplanned outages and derates.

(c) NCF is a measure of actual net electricity generated compared to the amount of electricity that could have been generated at maximum operating capacity. This measure is less than 100% due to periods during which generating capacity is not available due to planned and unplanned outages as well as periods during which generating capacity is available but is not dispatched because of the availability of lower cost generation in amounts sufficient to meet demand.

Decreased demand for power and lower prices for power significantly impacted Allegheny's Generation and Marketing segment during the three and nine months ended September 30, 2009. Decreases in Allegheny's

power output reflect, among other things, reduced demand for power and the displacement of certain of Allegheny's coal-fired units by gas-fired units due to low natural gas prices. In lower power price environments, Allegheny generates less power because of the increased amount of time during which it is not economical to run its generating units and utilizes the flexibility afforded in certain of its coal purchase contracts to cancel or defer coal deliveries.

To manage exposure to market price changes, Allegheny sells and purchases physical energy at the wholesale level and enters into financial contracts within established risk management objectives and policies. The impacts of weak demand and low commodity prices on operating performance during the three and nine months ended September 30, 2009 were partially mitigated by power sale hedges, including Allegheny's PLR contracts and financial hedges. The following table shows the percentages of Allegheny's estimated future power sales and coal purchases that were hedged as of September 30, 2009:

                                                                    Year Ending           Year Ending
                                       Three Months Ending          December 31,          December 31,
                                        December 31, 2009               2010                  2011
Percentage of expected
coal-fired generation sales
hedged                                                85.0 %                85.0 %                20.0 %
Percentage of expected coal
purchases hedged                                     100.0 %                99.0 %                67.0 %

Allegheny relies on access to the financial markets as a source of liquidity. Allegheny strengthened its liquidity position and significantly reduced its intermediate term refinancing risk during September and early October 2009. Approximately $843 million of debt due in 2011 and 2012 was refinanced with debt due in 10 and 30 years. In addition, AE Supply entered into a new, $1 billion revolving credit facility that matures in 2012, which replaced its previous $400 million revolving credit facility that was scheduled to mature in 2011.

Current priorities include continued management of the expiration of generation rate caps in Pennsylvania, seeking equitable rate treatment in the various jurisdictions in which Allegheny operates, additional hedging of expected power output, particularly for 2011 and 2012, as deemed appropriate, completing the Scrubber project at the Fort Martin generating facility, addressing the potential impacts on Allegheny of environmental legislation and regulation, continued progress on the TrAIL and PATH projects and controlling or reducing costs.

RESULTS OF OPERATIONS

Income Summary



                                                             Three Months Ended                                                 Three Months Ended
                                                             September 30, 2009                                                 September 30, 2008
                                         Delivery        Generation                                         Delivery        Generation
                                           and              and                                               and              and
(In millions)                            Services        Marketing         Eliminations        Total        Services        Marketing         Eliminations        Total
Operating revenues                      $    783.5      $      450.0      $       (439.8 )    $ 793.7      $    692.7      $      589.3      $       (432.4 )    $ 849.6

Fuel                                            -              188.0                  -         188.0              -              299.2                  -         299.2
Purchased power and transmission             545.1              26.8              (437.7 )      134.2           512.9              25.7              (430.5 )      108.1
Deferred energy costs, net                    (5.0 )            (9.3 )                -         (14.3 )           1.5             (20.2 )                -         (18.7 )
Operations and maintenance                    85.3              68.0                (2.1 )      151.2            83.6              70.6                (1.9 )      152.3
Depreciation and amortization                 38.0              33.3                  -          71.3            39.2              28.2                  -          67.4
Taxes other than income taxes                 39.4              18.0                  -          57.4            35.0              19.4                  -          54.4

Total operating expenses                     702.8             324.8              (439.8 )      587.8           672.2             422.9              (432.4 )      662.7

Operating income                              80.7             125.2                  -         205.9            20.5             166.4                  -         186.9
Other income (expense), net                    1.4               0.5                  -           1.9             3.1               1.6                (0.2 )        4.5
Interest expense                              25.9              59.2                  -          85.1            24.8              33.3                (0.2 )       57.9

Income (loss) before income taxes             56.2              66.5                  -         122.7            (1.2 )           134.7                  -         133.5
Income tax expense (benefit)                  24.3              21.0                  -          45.3            (5.7 )            50.0                  -          44.3

Net income                                    31.9              45.5                  -          77.4             4.5              84.7                  -          89.2
Less: net income attributable to
noncontrolling interest                       (0.4 )              -                   -          (0.4 )          (0.2 )              -                   -          (0.2 )

Net income attributable to Allegheny
Energy, Inc.                            $     31.5      $       45.5      $           -       $  77.0      $      4.3      $       84.7      $           -       $  89.0

                                                              Nine Months Ended                                                   Nine Months Ended
                                                              September 30, 2009                                                  September 30, 2008
                                        Delivery        Generation                                          Delivery        Generation
                                           and             and                                                 and             and
(In millions)                           Services        Marketing         Eliminations         Total        Services        Marketing         Eliminations         Total
Operating revenues                      $ 2,417.6      $    1,531.5      $     (1,383.4 )    $ 2,565.7      $ 2,139.6      $    1,842.0      $     (1,303.5 )    $ 2,678.1

Fuel                                           -              663.8                  -           663.8             -              794.2                  -           794.2
Purchased power and transmission          1,671.2              86.8            (1,377.6 )        380.4        1,522.5              77.7            (1,297.5 )        302.7
Deferred energy costs, net                   (5.9 )           (33.0 )                -           (38.9 )          7.8             (35.9 )                -           (28.1 )
Operations and maintenance                  263.1             261.6                (5.8 )        518.9          267.4             249.6                (6.0 )        511.0
Depreciation and amortization               116.4              90.6                  -           207.0          122.6              83.9                  -           206.5
Taxes other than income taxes               113.1              46.6                  -           159.7          105.5              54.2                  -           159.7

Total operating expenses                  2,157.9           1,116.4            (1,383.4 )      1,890.9        2,025.8           1,223.7            (1,303.5 )      1,946.0

Operating income                            259.7             415.1                  -           674.8          113.8             618.3                  -           732.1
Other income (expense), net                   4.0               2.1                  -             6.1           10.1               7.6                (2.4 )         15.3
Interest expense                             78.6             122.9                  -           201.5           70.7             106.7                (2.4 )        175.0

Income before income taxes                  185.1             294.3                  -           479.4           53.2             519.2                  -           572.4
Income tax expense                           79.0             116.1                  -           195.1           10.0             182.5                  -           192.5

Net income                                  106.1             178.2                  -           284.3           43.2             336.7                  -           379.9
Less: net income attributable to
noncontrolling interest                      (0.8 )              -                   -            (0.8 )         (0.7 )              -                   -            (0.7 )

Net income attributable to Allegheny
Energy, Inc.                            $   105.3      $      178.2      $           -       $   283.5      $    42.5      $      336.7      $           -       $   379.2

CONSOLIDATED RESULTS

This section provides a discussion of Allegheny's consolidated results of operations. A more detailed discussion of results for each business segment follows this consolidated discussion.

The following tables reconcile income before income taxes for the three and nine months ended September 30, 2008 to income before income taxes for the three and nine months ended September 30, 2009.