** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

**FORM 10-K**

(Mark One)

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934(NO FEE REQUIRED)

**Forthe fiscal year ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934(NO FEE REQUIRED)

Registrant, State ofIncorporation,

Address, and TelephoneNumber

 

**LouisvilleGas and Electric Company**

(A Kentucky Corporation)

220 West Main Street

P. O. Box 32010

Louisville, Kentucky40232

(502) 627-2000

 

| Commission  |   | IRS Employer           |
|-------------|--------|------------------------|
| File Number |   | Identification  Number |
|        |   |                   |
| **1-2893**  |   | **61-0264150**         |

 

**Securitiesregistered pursuant to Section 12(b) of the Act:**

** **

**None.**

Securities registered pursuant to section 12(g) of theAct:

Louisville Gas and Electric Company

5% Cumulative Preferred Stock, $25 Par Value

$5.875 Cumulative Preferred Stock, Without Par Value

Auction Rate Series A Preferred Stock, Without ParValue

Indicate by check mark if the registrant is a well-known seasonedissuer, as defined in Rule 405 of the Securities Act. Yes  o  No  x

Indicate by check mark if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the Act. Yes  o  No  x

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x  No  o

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12-b2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer x |
|---------------------------|---------------------|-------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Exchange Act Rule12b-2). Yes  o  No  x

As of June 30,2006, the aggregate market value of the common stock of Louisville Gas andElectric Company held by non-affiliates was $0. As of February 28, 2007,Louisville Gas and Electric Company had 21,294,223 shares of common stockoutstanding, all held by E.ON U.S. LLC.

DOCUMENTS INCORPORATED BYREFERENCE

Louisville Gas and ElectricCompany’s proxy statement, as applicable, to be filed with the Commission duringApril 2007, is incorporated by reference into Part III of thisForm 10-K.

 

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**TABLE OF CONTENTS**
| PART I                  |                                                                                                                    |       |
|-------------------------|-------------------------------------------------------------------------------------------------------------------------|------------|
|                    | Page                                                                                                                    |
|                    |                                                                                                                    |
| Item 1.                 | Business                                                                                                                |  4    |
|                    | General                                                                                                                 |  5    |
|                    | Electric Operations                                                                                                     |  6    |
|                    | Gas Operations                                                                                                          |  7    |
|                    | Rates and Regulations                                                                                                   |  8    |
|                    | Construction Program and Financing                                                                                      | 11         |
|                    | Coal Supply                                                                                                             | 11         |
|                    | Gas Supply                                                                                                              | 12         |
|                    | Environmental Matters                                                                                                   | 13         |
|                    | Competition                                                                                                             | 13         |
|                    | Employees  and Labor Relations                                                                                          | 14         |
|                    | Executive Officers                                                                                                      | 15         |
| Item  1A.               | Risk  Factors                                                                                                           | 17         |
| Item  1B.               | Unresolved  Staff Comments                                                                                              | 20         |
| Item  2.                | Properties                                                                                                              | 21         |
| Item 3.                 | Legal Proceedings                                                                                                       | 23         |
| Item 4.                 | Submission of Matters  to a Vote of Security Holders                                                                    | 24         |
|                    |                                                                                                                    | ** ** |
| PART II                 | ** **                                                                                                              |
|                    | ** **                                                                                                              |
| Item  5.                | Market for the Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities | 25         |
| Item 6.                 | Selected Financial  Data                                                                                                | 25         |
| Item 7.                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             | 26         |
| Item 7A.                | Quantitative  and Qualitative Disclosures About Market Risk                                                             | 46         |
| Item 8.                 | Financial Statements  and Supplementary Data                                                                            | 47         |
| Item 9.                 | Changes and  Disagreements with Accountants on Accounting and Financial Disclosure                                      | 88         |
| Item 9A.                | Controls and Procedures                                                                                                 | 88         |
| Item 9B.                | Other Information                                                                                                       | 88         |
|                    |                                                                                                                    | ** ** |
| PART III                | ** **                                                                                                              |
|                    | ** **                                                                                                              |
| Item 10,11,12,13 and 14 |                                                                                                                    | 88         |
|                    |                                                                                                                    | ** ** |
| PART IV                 | ** **                                                                                                              |
|                    | ** **                                                                                                              |
| Item  15.               | Exhibits,  Financial Statement Schedules                                                                                | 89         |
| Signatures              |                                                                                                                    | 97         |
|                         |                                                                                                                         |            |  |  |  |

 

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INDEX OF ABBREVIATIONS
| AG                  |   | Attorney General of Kentucky                                             |
|---------------------|--------|--------------------------------------------------------------------------|
| ARO                 |   | Asset Retirement Obligation                                              |
| CAIR                |   | Clean Air Interstate Rule                                                |
| CAMR                |   | Clean Air Mercury Rule                                                   |
| CCN                 |   | Certificate of Public  Convenience and Necessity                         |
| Clean Air Act       |   | The Clean Air Act, as amended  in 1990                                   |
| Company             |   | LG&E                                                                 |
| DOE                 |   | Department of Energy                                                     |
| DSM                 |   | Demand Side Management                                                   |
| ECR                 |   | Environmental Cost Recovery                                              |
| E.ON                |   | E.ON AG                                                                  |
| E.ON U.S.           |   | E.ON U.S. LLC. (formerly  LG&E Energy LLC and LG&E Energy Corp.) |
| E.ON U.S. Services  |   | E.ON U.S. Services Inc.  (formerly LG&E Energy Services Inc.)        |
| EPA                 |   | U.S. Environmental Protection  Agency                                    |
| EPAct 2005          |   | Energy Policy Act of 2005                                                |
| ESM                 |   | Earnings Sharing Mechanism                                               |
| FAC                 |   | Fuel Adjustment Clause                                                   |
| FASB                |   | Financial Accounting Standards  Board                                    |
| FERC                |   | Federal Energy Regulatory  Commission                                    |
| Fidelia             |   | Fidelia Corporation (an E.ON  affiliate)                                 |
| FIN                 |   | FASB Interpretation No.                                                  |
| FT and FT-A         |   | Firm Transportation                                                      |
| GHG                 |   | Greenhouse Gas                                                           |
| GSC                 |   | Gas Supply Clause                                                        |
| IBEW                |   | International Brotherhood of  Electrical Workers                         |
| IMEA                |   | Illinois Municipal Electric  Agency                                      |
| IMPA                |   | Indiana Municipal Power Agency                                           |
| IRC                 |   | Internal Revenue Code of 1986,  as amended                               |
| IRP                 |   | Integrated Resource Plan                                                 |
| Kentucky Commission |   | Kentucky Public Service  Commission                                      |
| KIUC                |   | Kentucky Industrial Utility  Consumers, Inc.                             |
| KU                  |   | Kentucky Utilities Company                                               |
| Kwh                 |   | Kilowatt hours                                                           |
| LG&E            |   | Louisville Gas and Electric  Company                                     |
| LG&E Energy     |   | LG&E Energy LLC (now E.ON  U.S. LLC)                                 |
| Mcf                 |   | Thousand Cubic Feet                                                      |
| MGP                 |   | Manufactured Gas Plant                                                   |
| MISO                |   | Midwest Independent  Transmission System Operator, Inc.                  |
| MMBtu               |   | Million British thermal units                                            |
| Mva                 |   | Megavolt-ampere                                                          |
| Mw                  |   | Megawatts                                                                |
| Mwh                 |   | Megawatt hours                                                           |
| NNS                 |   | No-Notice Service                                                        |
| NOx                 |   | Nitrogen Oxide                                                           |
| OVEC                |   | Ohio Valley Electric  Corporation                                        |
| PBR                 |   | Performance-Based Ratemaking                                             |
| Powergen            |   | Powergen Limited (formerly  Powergen plc)                                |
| PUHCA 1935          |   | Public Utility Holding Company Act of 1935                               |
| PUHCA 2005          |   | Public Utility Holding Company Act of 2005                               |
| SEC                 |   | Securities and Exchange Commission                                       |
| SFAS                |   | Statement of Financial  Accounting Standards                             |
| SO2                 |   | Sulfur Dioxide                                                           |
| TC1                 |   | Trimble County Unit 1                                                    |
| TC2                 |   | Trimble County Unit 2                                                    |
| Tennessee Gas       |   | Tennessee Gas Pipeline Company                                           |
| Texas Gas           |   | Texas Gas Transmission LLC                                               |
| VDT                 |   | Value Delivery Team Process                                              |
| WNA                 |   | Weather Normalization  Adjustment                                        |

 

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# **PART I**

## Item 1. Business.

LG&E is a subsidiary of E.ON U.S. LLC (E.ON U.S.)(formerly known as LG&E Energy LLC and LG&E Energy Corp.). E.ON U.S. isa subsidiary of E.ON AG (E.ON), a German corporation. E.ON acquired LG&EEnergy through its July 1, 2002 acquisition of Powergen plc, now PowergenLimited, a United Kingdom company and holding company for E.ON UK plc, E.ON’sUnited Kingdom market unit operating parent. As contemplated in theirregulatory filings in connection with the E.ON acquisition, E.ON, Powergen andE.ON U.S. completed an administrative reorganization to move the E.ON U.S.group from an indirect Powergen subsidiary to an indirect E.ON subsidiary. Thisreorganization was effective in March 2003. In early 2004, E.ON U.S. begandirect reporting arrangements to E.ON.

LG&E is now anindirect subsidiary of E.ON. As a result of these acquisitions and otherwise,E.ON and E.ON U.S. registered as holding companies under PUHCA 2005 in June2006, and were formerly registered holding companies under PUHCA 1935.

LG&E’saffiliate, KU, is a regulated public utility engaged in the generation,transmission, distribution and sale of electric energy in Kentucky, Virginiaand Tennessee.

In order to complywith PUHCA 1935, E.ON U.S. Services (formerly LG&E Energy Services), whichwas formed as a subsidiary service company of E.ON U.S., provides services toaffiliated entities, including LG&E, at cost as permitted under PUHCA 1935and PUHCA 2005.

E.ON, its utilitysubsidiaries, including LG&E, and certain of its non-utility subsidiariesare subject to certain regulation by the FERC under the Federal Power Act,PUHCA 2005 and the EPAct 2005, including with respect to record-keeping andreporting, acquisitions and sales of utility securities and properties,financial matters and intra-system sales of goods and services. LG&E believesthat it has adequate authority (including financing authority) under existingFERC orders and regulations to conduct its business. LG&E will seekadditional authorization when necessary.

LG&E has continued its separate identity and itspreferred stock and debt securities were not affected by these transactions.

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General

LG&E,incorporated in 1913 in Kentucky, is a regulated public utility that suppliesnatural gas to approximately 324,000 customers and electricity to approximately398,000 customers in Louisville and adjacent areas in Kentucky. LG&E’sservice area covers approximately 700 square miles in 17 counties and has anestimated population of one million. Included in this area is the Fort KnoxMilitary Reservation, to which LG&E transports natural gas and provideselectric service, but does not provide any distribution services. LG&E alsoprovides natural gas service in limited additional areas. LG&E’s coal-firedelectric generating stations, all equipped with systems to reduce SO2 emissions, produce most of LG&E’selectricity. The remainder is generated by a hydroelectric power plant andcombustion turbines. Underground natural gas storage fields help LG&Eprovide economical and reliable natural gas service to customers. See Item 2,Properties.

Operating Revenues

For the year endedDecember 31, 2006, 70% of total operating revenues were derived from electricoperations and 30% from natural gas operations. Electric and gas operatingrevenues and the percentages by class of service on a combined basis for thisperiod were as follows:

| (in millions) | ** ** | **Electric** | ** ** | **Gas** | ** ** | **Combined** | ** ** | **% Combined** | ** ** |
|--------------------|------------|--------------|------------|---------|------------|--------------|------------|---------------------|------------|
| Residential        |       | $            | 272        |    | $          | 248          |       | $                   | 520        |   | 48 | % |
| Commercial         |       | 227          |       | 103     |       | 330          |       | 30                  | %          |
| Industrial         |       | 134          |       | 16      |       | 150          |       | 14                  | %          |
| Public authorities |       | 69           |       | 19      |       | 88           |       | 8                   | %          |
| Total retail       |       | 702          |       | 386     |       | 1,088        |       | 100                 | %          |
| Wholesale sales    |       | 224          |       | 1       |       | 225          |       |                |       |
| Gas transported    |       | —       |       | 5       |       | 5            |       |                |       |
| Miscellaneous      |       | 17           |       | 3       |       | 20           |       |                |       |
| Total              |       | $            | 943        |    | $          | 395          |       | $                   | 1,338      |   |   |   |

 

See Note 11 ofNotes to Financial Statements under Item 8 for financial information concerningsegments of business for the three years ended December 31, 2006.

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ElectricOperations

The sources ofLG&E’s electric operating revenues and the sales volumes for the threeyears ended December 31, 2006, were as follows:
| **(in millions)**                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ELECTRIC OPERATING  REVENUES              |       |     |       |     |       |     |       |
| Residential                               |       | $        | 272        |     | $          | 276      |       | $ | 241 |   |
| Commercial                                |       | 227      |       | 221      |       | 202      |       |
| Industrial                                |       | 134      |       | 128      |       | 120      |       |
| Public authorities                        |       | 69       |       | 66       |       | 62       |       |
| Total retail                              |       | 702      |       | 691      |       | 625      |       |
| Wholesale sales                           |       | 224      |       | 259      |       | 185      |       |
| Provision for rate  collections (refunds) |       | —   |       | —   |       | (11      | )          |
| Miscellaneous                             |       | 17       |       | 37       |       | 17       |       |
| Total                                     |       | $        | 943        |     | $          | 987      |       | $ | 816 |   |

 
| **(Thousands of Mwh)** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ELECTRIC SALES                   |       |     |       |     |       |     |       |
| Residential                      |       | 4,018    |       | 4,265    |       | 3,923    |       |
| Commercial                       |       | 3,614    |       | 3,682    |       | 3,534    |       |
| Industrial                       |       | 3,068    |       | 3,077    |       | 3,019    |       |
| Public authorities               |       | 1,265    |       | 1,268    |       | 1,248    |       |
| Total retail                     |       | 11,965   |       | 12,292   |       | 11,724   |       |
| Wholesale sales                  |       | 7,621    |       | 8,704    |       | 7,819    |       |
| Total                            |       | 19,586   |       | 20,996   |       | 19,543   |       |

 

LG&E set itsannual peak load of 2,729 Mw on August 3, 2006, when the temperature reached 94degrees Fahrenheit in Louisville. LG&E’s record peak load of 2,754 Mwoccurred in July 2005.

The electricutility business is affected by seasonal weather patterns. As a result,operating revenues (and associated operating expenses) are not generated evenlythroughout the year. See Results of Operations under Item 7.

LG&E currentlymaintains a 12% - 14% reserve margin range. At December 31, 2006, LG&Eowned steam and combustion turbine generating facilities with a net summercapability of 3,083 Mw and an 80 Mw nameplate-rated hydroelectric facility onthe Ohio River with a net summer capability of 48 Mw. See Item 2, Properties.LG&E also obtains power from other utilities under bulk power purchase andinterchange contracts. At December 31, 2006, LG&E’s system net summercapability, including purchases from others and excluding the hydroelectricfacility, was 3,207 Mw.

LG&E usesefficient coal-fired boilers, fully equipped with SO2 removal systems, to generate most of itselectricity. LG&E’s weighted-average system-wide emission rate for SO2 in 2006 was approximately 0.50 lbs./MMBtu ofheat input, with every generating unit below its emission limit established bythe Kentucky Division for Air Quality.

LG&E and 11 other electricutilities are participating owners of OVEC, located in Piketon, Ohio. OVEC ownsand operates two power stations that burn coal to generate electricity, KygerCreek Station in Ohio and Clifty 

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Creek Station in Indiana.LG&E owns 5.63% of OVEC’s common stock. Pursuant to current contractualarrangements, LG&E’s share of OVEC’s output is 5.63%, approximately 124 Mwof generation capacity.

LG&E wasformerly a member of the MISO, a non-profit independent transmission systemoperator that serves the electrical transmission needs of much of the Midwest.Following receipt of applicable FERC, Kentucky Commission and other regulatoryorders, LG&E withdrew from the MISO effective September 1, 2006. Specificproceedings regarding the costs and benefits of the MISO and exit matters hadbeen underway since July 2003. Since its exit from the MISO, LG&E has beenoperating under a FERC-approved open access-transmission tariff. LG&Efurther contracted with the Tennessee Valley Authority to act as its reliabilitycoordinator and Southwest Power Pool, Inc. to function as its independenttransmission operator, pursuant to FERC requirements, with respect totransmission matters.

LG&E haschanged its regional reliability council membership from the Reliability FirstCorporation to the SERC Reliability Corporation, effective January 1, 2007.Regional reliability councils are industry consortiums that promote, coordinateand ensure the reliability of the bulk electric supply systems in NorthAmerica.

GasOperations

Thesources of LG&E’s natural gas operating revenues and the sales volumes forthe three years ended December 31, 2006, were as follows:

| (in millions)     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| GAS OPERATING REVENUES |       |     |       |     |       |     |       |
| Residential            |       | $        | 248        |     | $          | 265      |       | $ | 223 |   |
| Commercial             |       | 103      |       | 108      |       | 89       |       |
| Industrial             |       | 16       |       | 19       |       | 15       |       |
| Public authorities     |       | 19       |       | 19       |       | 15       |       |
| Total retail           |       | 386      |       | 411      |       | 342      |       |
| Wholesale sales        |       | 1        |       | 19       |       | 7        |       |
| Gas transported        |       | 5        |       | 5        |       | 6        |       |
| Miscellaneous          |       | 3        |       | 2        |       | 2        |       |
| Total                  |       | $        | 395        |     | $          | 437      |       | $ | 357 |   |

 

| (Millions of cu. ft.) | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| GAS SALES                            |       |       |       |       |       |       |       |
| Residential                          |       | 17,816     |       | 20,801     |       | 21,402     |       |
| Commercial                           |       | 8,130      |       | 9,131      |       | 9,144      |       |
| Industrial                           |       | 1,491      |       | 1,711      |       | 1,736      |       |
| Public authorities                   |       | 1,499      |       | 1,574      |       | 1,646      |       |
| Total retail                         |       | 28,936     |       | 33,217     |       | 33,928     |       |
| Wholesale sales                      |       | 149        |       | 2,652      |       | 1,221      |       |
| Gas transported                      |       | 12,000     |       | 12,549     |       | 13,692     |       |
| Total                                |       | 41,085     |       | 48,418     |       | 48,841     |       |

 

The natural gas utilitybusiness is affected by seasonal weather patterns. As a result, operatingrevenues (and associated operating expenses) are not generated evenly throughoutthe year. While natural gas usage patterns are seasonal, LG&E receivedapproval from the Kentucky Commission for a WNA mechanism. The WNA 

7

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mechanism adjusts thedistribution cost recovery component of the natural gas billings of residentialand commercial customers to normal temperatures during the heating seasonmonths of November through April, somewhat mitigating the effect of weatherextremes. In October 2006, the Kentucky Commission approved LG&E’s requestto extend the current WNA mechanism through April 30, 2009. See Results ofOperations under Item 7.

LG&E has fiveunderground natural gas storage fields that help provide economical andreliable natural gas service to ultimate consumers. By using natural gasstorage facilities, LG&E avoids the costs associated with typically moreexpensive pipeline transportation capacity to serve peak winter space-heatingloads. LG&E stores natural gas in the summer season for withdrawal in thesubsequent winter heating season. Without its storage capacity, LG&E wouldbe forced to buy additional natural gas and pipeline transportation servicesduring the winter months when customer demand increases and when the prices fornatural gas supply and transportation services are typically at their highest.Currently, LG&E buys competitively priced natural gas from several largesuppliers under contracts of varying duration. LG&E’s underground storagefacilities, in combination with its purchasing practices, enable it to offernatural gas sales service at competitive rates. At December 31, 2006, LG&Ehad an inventory balance of natural gas stored underground of approximately11.6 million Mcf of working natural gas valued at approximately $83 million.

A number ofindustrial customers purchase their natural gas requirements directly fromalternate suppliers for delivery through LG&E’s distribution system. Theselarge industrial customers account for approximately one-fourth of LG&E’sannual throughput.

During 2006, themaximum daily gas sendout was approximately 380,000 Mcf, occurring on December7, 2006, when the average temperature for the day was 19 degrees Fahrenheit.Supply on that day consisted of approximately 226,000 Mcf from purchases,approximately 84,000 Mcf delivered from underground storage and approximately70,000 Mcf transported for industrial customers. For a further discussion, seeGas Supply under Item 1.

Rates andRegulation

E.ON, LG&E’sultimate parent, is a registered holding company under PUHCA 2005 and was aregistered holding company under PUHCA 1935. As a registered holding company,E.ON, its utility subsidiaries, including LG&E, and certain of itsnon-utility subsidiaries have been subject to extensive regulation by the SECand the FERC with respect to numerous matters, including: electric utilityfacilities and operations, wholesale sales of power and related transactions,accounting practices, issuances and sales of securities, acquisitions and salesof utility properties, payments of dividends out of capital and surplus,financial matters and inter-system sales of non-power goods and services.LG&E believes that it has adequate authority (including financingauthority) under existing FERC orders and regulations to conduct its businessand will seek additional authorization when necessary.

In August 2005,President Bush signed into law the EPAct 2005, significantly changing manyfederal statutes, repealing PUHCA 1935 as of February 8, 2006 and enactingPUHCA 2005. As part of the repeal of PUHCA 1935, the FERC was given moreauthority over the merger and acquisition of public utilities and moreauthority over the books and records of public utilities. Despite theseincreases in the FERC’s authority, LG&E believes that the repeal of PUHCA1935 will lessen its regulatory burdens and provide more flexibility in theevent of expansion.

Besides repealingPUHCA 1935, the EPAct 2005 is also expected to have substantial long-termeffects on 

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energy markets,energy investment and regulation of public utilities and holding companysystems by the FERC and the DOE. The FERC and the DOE are in various stages ofrulemaking in implementing the EPAct 2005. While the precise impact of theserulemakings cannot be determined at this time, LG&E generally views theEPAct 2005 as legislation that will enhance the utility industry going forward.

The KentuckyCommission has regulatory jurisdiction over LG&E’s retail rates andservice, and over the issuance of certain of its securities. The KentuckyCommission has the ability to examine the rates LG&E charges its retailcustomers at any time.

Pursuant toKentucky law, the Kentucky Commission has established the boundaries of theservice territory or area of each retail electric supplier in Kentucky(including LG&E), other than municipal corporations. Within this serviceterritory each such supplier has the exclusive right to render retail electricservice.

LG&E’s retailelectric rates contain an FAC, whereby increases and decreases in the cost offuel for electric generation are reflected in the rates charged to retailelectric customers. The Kentucky Commission requires public hearings atsix-month intervals to examine past fuel adjustments, and at two-year intervalsto review past operations of the fuel clause and transfer of the then currentfuel adjustment charge or credit to the base charges. The Kentucky Commissionalso requires that electric utilities, including LG&E, file documentsrelating to fuel procurement and the purchase of power and energy from otherutilities.

Prior to 2004,LG&E’s retail electric rates were subject to an ESM which set an upper(12.5%) and lower (10.5%) limit for rate of return on equity. Any earningsexcess or deficiency was shared 40% with ratepayers and 60% with shareholders.LG&E filed its final 2003 ESM calculations with the Kentucky Commission inMarch 2004 and applied for recovery of $13 million which was challenged byintervenors. In June 2004, the Kentucky Commission issued an Order largelyaccepting proposed settlement agreements by LG&E and the intervenorsregarding the ESM. Under the settlements, LG&E continued to collect the $13million of previously requested 2003 ESM revenue through March 2005. As part ofthe settlements, the parties agreed to a termination of the ESM relating to allperiods after 2003. For discussion of current ESM matters, see Note 2 of Notesto Financial Statements under Item 8.

In June 2001,LG&E filed an application (“VDT case”) with the Kentucky Commission tocreate a regulatory asset relating to first quarter 2001 charges for aworkforce reduction program. In December 2001, the Kentucky Commission approveda settlement in the VDT case and allowed LG&E to establish a regulatoryasset of  $141 million for the workforcereduction costs and begin amortizing these costs over a five year periodstarting in April 2001. The settlement reduced revenues by approximately $26million through a surcredit on bills to ratepayers over the same five-yearperiod, reflecting a sharing (40% to the ratepayers and 60% to LG&E) of thestipulated savings, net of amortization costs, of the workforce reduction. Fordiscussion of current VDT matters, see Note 2 of Notes to Financial Statementsunder Item 8.

LG&E’s retailrates contain an ECR surcharge which recovers costs incurred by LG&E thatare required to comply with the Clean Air Act and other environmentalregulations. See Note 2 of Notes to Financial Statements under Item 8.

LG&E’s naturalgas rates contain a GSC, whereby increases or decreases in the cost of naturalgas supply are reflected in LG&E’s rates, subject to approval by theKentucky Commission. The GSC procedure prescribed by Order of the KentuckyCommission provides for quarterly rate adjustments to reflect the expected costof natural gas supply in that quarter. In addition, the GSC contains amechanism whereby any over- or under-

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recoveries ofnatural gas supply cost from prior quarters are to be refunded to or recoveredfrom customers through the adjustment factor determined for subsequentquarters.

Integratedresource planning regulations in Kentucky require LG&E and the other majorutilities to make triennial filings with the Kentucky Commission of varioushistorical and forecasted information relating to load, capacity margins andDSM techniques. LG&E filed its most recent IRP in April 2005. The AG andKIUC were granted intervention in the IRP proceeding. The Kentucky Commissionissued its staff report with no substantive issues noted and closed the case byOrder in February 2006.

In December 2003,LG&E filed an application with the Kentucky Commission requestingadjustments in LG&E’s electric and natural gas rates. In June 2004, theKentucky Commission issued an Order approving increases in LG&E’s annualelectric base rates of approximately $43 million (7.7%) and annual natural gasbase rates of approximately $12 million (3.4%). The rate increases took effecton July 1, 2004.

Subsequently during 2004 and 2005, the AG conducted an investigationregarding the proceedings resulting in the rate increases. The AG requestedinformation from LG&E and the Kentucky Commission and its staff regardingalleged improper communications between LG&E and the Kentucky Commissionrelated to the rate proceedings. The AG also requested rehearing of the rateincrease orders on the basis of these allegations, as well as calculationalaspects of the increased rates. In February 2005, the AG submitted aconfidential report on its investigation with the Kentucky Commission and fileda motion summarizing the report as containing evidence of impropercommunications and record-keeping errors by LG&E in respect of itsactivities with state governmental agencies, including the Kentucky Commission.

In December 2005, the Kentucky Commission issued an Order notingcompletion of its inquiry, including review of the AG’s investigative report.The Order concluded that no improper communications occurred during the rateproceedings. Final proceedings took place during the first quarter of 2006concerning the sole remaining open issue relating to state income tax ratesused in calculating the granted rate increase. In March 2006, theKentucky Commission issued an Order resolving this issue in LG&E’s favorconsistent with the original rate increase order.

In August 2006,LG&E filed an application with the Kentucky Commission requesting approvalfor sale of the Waterside property to the Louisville Arena Authority, anon-profit corporation, in connection with the development and construction ofa new multi-purpose arena in downtown Louisville. The Kentucky Commissionissued an Order in September 2006, approving the proposed transaction. InNovember 2006, LG&E entered into a definitive relocation agreement with theLouisville Arena Authority providing for the reimbursement of the costs to beincurred in moving certain facilities related to the arena transaction. Thosecosts are currently estimated to be approximately $63 million. The partiesfurther entered into a definitive property sale agreement providing for thesale of LG&E’s downtown site to the Louisville Arena Authority forapproximately $10 million, representing the appraised value of the parcel, lesscertain agreed upon demolition costs. The amounts specified in the agreementsare subject to certain adjustments. Depending upon continuing progress of theproposed arena, the transactions contemplated by the agreements are anticipatedto occur between 2006 and 2010.

For a furtherdiscussion of regulatory matters, see Note 2 of Notes to Financial Statementsunder Item 8.

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ConstructionProgram and Financing

LG&E’sconstruction program is designed to ensure that there will be adequate capacityand reliability to meet the electric and natural gas needs of its service area.These needs are continually being reassessed and appropriate revisions aremade, when necessary, in construction schedules. LG&E’s estimates of itsconstruction expenditures can vary substantially due to numerous items beyondLG&E’s control, such as changes in interest rates, economic conditions,construction costs and new environmental or other governmental laws andregulations.

During the fiveyears ended December 31, 2006, gross property additions amounted toapproximately $872 million. Internally generated funds and external financingsfor the five-year period were utilized to provide for these gross additions.The gross additions during this period amounted to approximately 21% of totalutility plant at December 31, 2006, and consisted of $698 million forelectric properties and $174 million for natural gas properties. Grossretirements during the same period were $171 million, consisting of $138million for electric properties and $33 million for natural gas properties.

Capitalexpenditures during the three years ending December 31, 2009, are estimated tobe approximately $665 million. The major expenditures during this period relateto the development and construction of TC2, of which LG&E’s portion totalsapproximately $150 million (including $40 million for environmental controls),other environmental control equipment of approximately $80 million andapproximately $30 million for the redevelopment of the Ohio Falls hydrofacility.

Coal Supply

Coal-firedgenerating units provided approximately 97% of LG&E’s net kilowatt-hourgeneration for 2006. The remaining net generation for 2006 was provided bynatural gas and oil-fueled combustion turbine peaking units and a hydroelectricplant. Coal is expected to be the predominant fuel used by LG&E in theforeseeable future, with natural gas and oil being used for peaking capacityand flame stabilization in coal-fired boilers or in emergencies. LG&E hasno nuclear generating units and has no plans to build any in the foreseeablefuture.

LG&E maintainsits fuel inventory at levels estimated to be necessary to avoid operationaldisruptions at its coal-fired generating units. Reliability of coal deliveriescan be affected from time to time by a number of factors, includingfluctuations in demand, coal mine production issues and other supplier ortransporter operating difficulties.

LG&E hasentered into coal supply agreements with various suppliers for coal deliveriesfor 2007 and beyond and normally augments its coal supply agreements with spotmarket purchases. LG&E has a coal inventory policy which it believesprovides adequate protection under most contingencies. A coal inventory ofapproximately one million tons, or a 47-day supply, was on hand at December 31,2006.

LG&E expectsto continue purchasing most of its coal, which has sulfur content in the 2% -3.5% range, from western Kentucky, southern Indiana, southern Illinois, Ohioand West Virginia for the foreseeable future. This supply, in combination withthe Company’s SO2 removal systems, is expected to enableLG&E to continue to provide electric service in compliance with existingenvironmental laws and regulations.

Coal is deliveredto LG&E’s Mill Creek station by rail and barge, Trimble County station bybarge and Cane Run station by rail.

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The historicalaverage delivered cost of coal purchased and the percentage of spot coalpurchases were:

|                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Per ton                                 |       | $        | 34.83      |     | $          | 30.37    |       | $ | 26.25 |   |
| Per MMBtu                               |       | $        | 1.51       |     | $          | 1.32     |       | $ | 1.15 |   |
| Spot purchases as % of all sources |       | 8        | %          | 14       | %          | 7        | %          |

 

Gas Supply

LG&E purchasesnatural gas supplies from multiple sources under contracts for varying periodsof time, while transportation services are purchased from Texas Gas andTennessee Gas.

LG&Etransports natural gas on the Texas Gas system under Rate Schedules NNS and FTservice. LG&E’s winter season NNS levels are 184,900 MMBtu/day and itswinter season FT levels are 28,000 MMBtu/day. LG&E’s summer season NNS levels are60,000 MMBtu/day and its summer season FT levels are 28,000 MMBtu/day. Eachof the NNS agreements with Texas Gas is subject to termination by LG&E inequal portions during 2008, 2010 and 2011. Each of the FT agreements with TexasGas is subject to termination by LG&E during 2008 and 2011. LG&E alsotransports on the Tennessee Gas system under Tennessee Gas’ Rate Schedule FT-A.LG&E’s contract levels withTennessee Gas are 51,000 MMBtu/day throughout the year. The FT-A agreement withTennessee Gas expires during 2012.

LG&Eparticipates in rate and other proceedings affecting the regulated interstatenatural gas pipelines that provide it service. Both Texas Gas and Tennessee Gashave active proceedings at the FERC in which LG&E is participating. During2005, Texas Gas filed an application with the FERC to increase its base rates.Texas Gas began billing its rates subject to refund in that same year, pendingapproval of final rates by the FERC. Along with other interested parties,LG&E participated in this proceeding. The intervening parties reached asettlement of the issues, and the FERC approved the settlement in 2006. Shortlythereafter, Texas Gas refunded all amounts collected in excess of the finalapproved rates and refunded the applicable amounts to all customers. LG&Eis in the process of refunding its portion of those refunded amounts to itsretail customers through the GSC. The rates of Tennessee Gas are not beingbilled subject to refund.

LG&E also hasa portfolio of supply arrangements of various terms with a number of suppliersdesigned to meet its firm sales obligations. These natural gas supplyarrangements include pricing provisions that are market-responsive. These firmnatural gas supplies, in tandem with pipeline transportation services, providethe reliability and flexibility necessary to serve LG&E’s natural gascustomers.

LG&E owns andoperates five underground natural gas storage fields with a current workingnatural gas capacity of approximately 15.1 million Mcf. Natural gas ispurchased and injected into storage during the summer season and is thenwithdrawn to supplement pipeline supplies to meet the gas-system load requirementsduring the winter heating season. See Gas Operations under Item 1.

The estimatedmaximum deliverability from storage during the early part of the heating seasonis expected to be in excess of 350,000 Mcf/day. Under mid-winter designconditions, LG&E expects to be able to withdraw in excess of 300,000Mcf/day from its storage facilities. The deliverability of natural gas fromLG&E’s storage facilities decreases as storage inventory levels are reducedby seasonal withdrawals.

LG&E reliesupon its significant underground storage to mitigate the price volatility towhich customers might otherwise be exposed. In 2000, the Kentucky Commissionissued an Order establishing Administrative Case 

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No. 384 — *An Investigation of Increasing Wholesale Natural Gas Prices and theImpacts of such Increase on the Retail Customers Served by Kentucky’s JurisdictionalNatural Gas Distribution Companies*. Subsequent to thisinvestigation, the Kentucky Commission issued an Order in July 2001,encouraging natural gas distribution companies in Kentucky to take variousactions, among them to propose a natural gas hedge plan. LG&E currentlyoperates under a hedge plan proposed by LG&E beginning with the 2004/2005winter heating season. This hedge plan relies upon LG&E’s undergroundnatural gas storage to mitigate customer exposure to price volatility. In 2004,the Kentucky Commission approved LG&E’s proposed hedge plan, validating theeffectiveness of storage to mitigate potential volatility associated with highwinter natural gas prices. The Kentucky Commission also ordered that LG&Eneed not file hedge plans in the future unless it intended to utilize financialhedging instruments.

The average costper Mcf of natural gas purchased by LG&E was $7.80 in 2006, $10.23 in 2005and $7.18 in 2004. For further discussion of wholesale natural gas prices, seeNote 2 of Notes to Financial Statements under Item 8.

EnvironmentalMatters

Protection of theenvironment is a major priority for LG&E. Federal, state and localregulatory agencies have issued LG&E permits for various activities subjectto air quality, water quality and waste management laws and regulations. Forthe five-year periodending with 2006 expenditures for pollution control facilities represented $179million or 20% of total construction expenditures. LG&E estimates thatconstruction expenditures for environmental control equipment from 2007 through2009 will be approximately $120 million. For a discussion of environmentalmatters, see Note 9 of Notes to Financial Statements under Item 8.

In October 2006, E.ON U.S., LG&E and KU announced plans to provideup to $25 million over a period of up to twelve years to FutureGen IndustrialAlliance, Inc. (“FutureGen”), a non-profit consortium. FutureGen will conductresearch, development and demonstration activities relating to advanced coaltechnologies, including proposed construction of the world’s first coal-fired, “nearzero emissions” power plant. Among the members of FutureGen are companies withinterests in coal-fired electric power generation or coal production. FutureGenhas signed an initial cooperative agreement with the DOE and expects to sign afull-scope cooperative agreement in 2007. Beyond their initial aggregatemembership amount and contributions paid through 2006 of approximately $1million, E.ON U.S., LG&E and KU have rights at sequential future times toterminate participation prior to incurring the obligation to contribute therelevant remaining contribution amounts.

Competition

At this time,neither the Kentucky General Assembly nor the Kentucky Commission has adoptedor approved a plan or timetable for retail electric industry competition inKentucky. The nature or timing of the ultimate legislative or regulatoryactions regarding industry restructuring and their impact on LG&E, whichmay be significant, cannot currently be predicted. Some states that have alreadyderegulated have begun discussions that could lead to re-regulation.

Over the lastseveral years, LG&E has taken many steps to maintain efficient ratestructures while achieving high levels of customer satisfaction, including: anincrease in focus on commercial, industrial and residential customers; anincrease in employee involvement and training; and continuous modifications ofits organizational structure. LG&E also strives to control costs throughcompetitive bidding and process improvements. LG&E’s performance innational customer satisfaction surveys continues to be high.

 

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EMPLOYEES AND LABOR RELATIONS

LG&E had approximately 917 full-time regularemployees at February 28,2007. Of the total, 632 operating,maintenance and construction employees were represented by the IBEW Local 2100.LG&E and employees represented by the IBEW Local 2100 signed a three-yearcollective bargaining agreement in November 2005 with annual benefitsre-openers.

E.ON U.S. Servicesprovides services to affiliated entities, including LG&E, at cost aspermitted under PUHCA 2005. On February 28, 2007, approximately 993 employeesworked for E.ON U.S. Services.

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**ExecutiveOfficers of LG&E**at February 28, 2007:
| **Name**            | ** ** | **Age**  | ** ** | **Position**                                                            | ** ** | **Effective Date of   Election to Present   Position** |
|---------------------|------------|----------|------------|-------------------------------------------------------------------------|------------|--------------------------------------------------------|
| Victor A. Staffieri |       | 51  |       | Chairman of the Board, President and Chief  Executive Officer      |       | May 1, 2001                                       |
| John R. McCall      |       | 63  |       | Executive Vice President, General Counsel and  Corporate Secretary |       | July 1, 1994                                      |
| S. Bradford Rives   |       | 48       |       | Chief Financial Officer                                                 |       | September 15, 2003                                     |
| Paul W. Thompson    |       | 50       |       | Senior Vice President - Energy Services                                 |       | June 7, 2000                                           |
| Chris Hermann       |       | 59       |       | Senior Vice President - Energy Delivery                                 |       | February 14, 2003                                      |
| Wendy C. Welsh      |       | 53       |       | Senior Vice President - Information Technology                          |       | December 11, 2000                                      |
| Martyn Gallus       |       | 42       |       | Senior Vice President - Energy Marketing                                |       | December 11, 2000                                      |
| Paula H. Pottinger  |       | 50       |       | Senior Vice President - Human Resources                                 |       | January 2, 2006                                        |

 

Other Officers ofLG&E at February 28, 2007:

 
| David A. Vogel*     |   | 41 |   | Vice President - Retail and Gas Storage Operations |   | March 1, 2003      |
|---------------------|--------|----|--------|----------------------------------------------------|--------|--------------------|
| Michael S. Beer     |   | 48 |   | Vice President - Federal Regulation and Policy     |   | September 27, 2004 |
| George R. Siemens   |   | 57 |   | Vice President - External Affairs                  |   | January 11, 2001   |
| D. Ralph Bowling    |   | 49 |   | Vice President - Power Operations WKE              |   | August 1, 2002     |
| R. W. Chip Keeling  |   | 50 |   | Vice President - Communications                    |   | March 18, 2002     |
| John N. Voyles, Jr. |   | 52 |   | Vice President - Regulated Generation              |   | June 16, 2003      |
| Daniel K. Arbough   |   | 45 |   | Treasurer                                          |   | December 11, 2000  |
| Valerie L. Scott    |   | 50 |   | Controller                                         |   | January 1, 2005    |

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Officers generally serve in the same capacities atLG&E and its affiliates, E.ON U.S. and KU.

*                    Mr.Vogel announced his resignation from the Company during March 2007.

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The present termof office of each of the above executive and other officers extends to themeeting of the Board of Directors following the 2007 Annual Meeting ofShareholders.

There are nofamily relationships between or among executive and other officers of LG&E.The above tables indicate officers serving as executive officers of LG&E atFebruary 28, 2007.

Before he was elected to his current position, Mr. Staffieri wasPresident and Chief Operating Officer of LG&E Energy from March 1999 to April2001 (including President of LG&E from June 2000 to April 2001).

Mr. McCall has been Executive Vice President, General Counsel andCorporate Secretary of LG&E Energy and LG&E since July 1994.

Before he was elected to his current position, Mr. Rives was SeniorVice President - Finance and Controller of LG&E Energy and LG&E fromDecember 2000 to September 2003.

Before he was elected to his current position, Mr. Thompson was SeniorVice President - Energy Services for LG&E Energy from August 1999 to June2000.

Before he was elected to his current position, Mr. Hermann was SeniorVice President - Distribution Operations, from December 2000 to February 2003.

Before she was elected to her current position, Ms. Welsh was VicePresident - Information Technology from February 1998 to December 2000 forLG&E Energy.

Before he was elected to his current position, Mr. Gallus was VicePresident, Energy Marketing from August 1998 to December 2000 for LG&EEnergy.

Before she was elected to her current position, Ms. Pottinger wasDirector, Human Resources from June 1997 to June 2002 and Vice President -Human Resources from June 2002 to January 2006.

Before he was elected to his current position, Mr. Vogel was VicePresident - Retail Services from December 2000 to March 2003.

In addition to being elected to his current position, Mr. Arbough hasheld the positions of Director, Corporate Finance of LG&E Energy andLG&E from May 1998 to present.

Before he was elected to his current position, Mr. Beer was SeniorCounsel Specialist, Regulatory from February 2000 to February 2001 and VicePresident - Rates and Regulatory from February 2001 to September 2004.

Before he was elected to his current position, Mr. Siemens held theposition of Director of External Affairs for LG&E Energy from August 1982to January 2001.

Before he was elected to his current position, Mr. Bowling was GeneralManager Black Fossil Operations for E.ON U.K. in the United Kingdom fromJanuary 2002 to August 2002.

Before he was elected to his current position, Mr. Keeling wasDirector, Corporate Communications for LG&E 

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Energy from February 2000 to March 2002.

Before he was elected to his current position, Mr. Voyles was GeneralManager, Cane Run, Ohio Falls and Combustion Turbines, November 1998 toFebruary 2003 and Director, Generation Services, February 2003 to June 2003.

Before she was elected to her current position, Ms. Scott was Director,Trading Controls and Energy Marketing Accounting from February 1999 toSeptember 2002 and Director, Financial Planning and Accounting - UtilityOperations from September 2002 to December 2004.

## Item 1A. Risk Factors

In addition to the other information in this Form 10-K and otherdocuments furnished to or filed by LG&E with the SEC from time to time, thefollowing factors should be carefully considered in evaluating the Company.Such factors could affect actual results and cause results to differ materiallyfrom those expressed in any forward-looking statements made by, or on behalfof, the Company.

****The electric and gas rates that LG&E charges customers, as well asother aspects of the business, are subject to significant state and FERCregulation.****

The rates that the Company is allowed to charge for its services are aprimary item influencing the results of operations, financial position andliquidity of the Company. The regulation of the rates that are collected fromcustomers is determined, in large part, by governmental organizations outsidethe Company’s control, including the Kentucky Commission. This commissionregulates many aspects of utility operations, including financial and capitalstructure matters, siting and construction of facilities, terms and conditionsof service, safety and operations, accounting and cost allocation methodologiesand other matters. While rate regulation is premised on recovery of prudentlyincurred costs and reasonable rate of return on capital, such cannot beassured. R****egulatory proceedings regarding all matters of operations can thussignificantly affect the earnings, liquidity and business activities of theCompany.****

**Transmission and interstate market activities of LG&E, as well asother aspects of the business, are subject to significant FERC regulation.**

The Company’s business is subject to regulation under the FERC coveringmatters including rates charged to transmission users and wholesale customers,interstate market structure and design, construction and operation oftransmission facilities, acquisition and disposal of utility assets andsecurities, Standards of Conduct, Codes of Conduct, cost allocations andfinancial matters. Existing FERC regulation, changes thereto or issuance of newrules in these areas, can affect the earnings, operations and other activitiesof the Company.

**LG&E’s exit from the MISO, as well as changes intransmission and wholesale power market structures, could increase costs orreduce revenues.**

LG&E withdrew fromthe MISO effective September 1, 2006. The resulting changes to transmission andwholesale power market structures and prices are not completely estimable andmay result in unforeseen effects on energy purchases and sales, transmissionand related costs or revenues. As required by the FERC, in connection with itsexit, the Company has engaged two independent third parties to perform certainoversight and functional control activities relating to transmission andrelated activities. Such activities may have an 

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effect on the Company’sability to access the transmission system for wholesale, native load andoff-system power activities. The Company will save certain MISO membershipcosts and charges, but is subject to MISO charges for off-system transactions in the MISO day-ahead and real-timeenergy markets as well as fees related to the new transmission service vendors.The Company believes that, over time, the benefits and savings from its exit ofthe MISO will outweigh the costs and expenses. However, until post-MISO marketconditions and operations have matured, the effects on financial condition,liquidity or results of operations will remain difficult to fully predict.

**LG&E undertakes significant capital projects andis subject to unforeseen costs, delays or failures in such projects, as well asrisk of full recovery of such costs.**

In the ordinary course of business, the Company is continuallydeveloping, permitting and constructing new generation and transmissionfacilities, as well as maintaining and improving existing facilities. Thecompletion of these facilities without delays or cost overruns is subject torisks in many areas including approval and licensing; permitting; constructionproblems or delays; increases in commodity or equipment prices or in laborrates; contractor performance; weather and geological issues and political,labor and regulatory developments. Delays, additional costs or unsatisfactoryregulatory treatment can result in reduced earnings. Further, if constructionprojects are not completed according to specifications, the Company may incurreduced plant efficiency, higher operating costs or continued capital costs.

Projects underway at LG&E include plans to construct a newbase-load generating unit, TC2, and associated transmission facilities; theupgrade or construction of other transmission facilities and upgrades toemissions reduction equipment. These projects are in varying stages of construction,planning or regulatory approval.

**LG&E’s costs of compliance with environmental lawsare significant and are subject to continuing changes.**

LG&E is subject to extensive federal, state and local environmentalrequirements which, among other things, regulate air emissions, waterdischarges and the management of hazardous and solid waste in order toadequately protect the environment. Compliance by the Company requiressignificant expenditures for installation of pollution control equipment,environmental monitoring, emission fees and permits at all of its facilities.If the Company fails to comply with environmental laws and regulations, even ifcaused by factors beyond its control, civil or criminal penalties and fines canresult. Revised or additional laws and regulations could result in significantadditional expense and operating restrictions on LG&E’s facilities orincreased compliance costs which may not be fully recoverable from customers.The cost impact of such changes would depend upon the specific requirementsenacted and cannot be determined at this time.

LG&E is undertaking significant emissions construction projectsrelating to upcoming compliance with the Clean Air Act, CAIR and CAMRstandards, among others. Rate recovery and other regulatory proceedingsregarding these matters occur periodically and will continue for some time.

**LG&E’s operating results are affected by weatherconditions, including storms and seasonal temperature variations, as well as bysignificant man-made or accidental disturbances.**

Customer demand for electricity and natural gas is seasonal and cancause extreme variability in load due to higher or lower than normaltemperatures. Generally, demandfor electricity peaks during the summer and demand for natural gas peaks duringthe winter. As a result, LG&E’s overall operating results can fluctuate 

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substantially on a seasonal basis. LG&E maintains adequategenerating and natural gas supply resources to accommodate system demands forelectricity and natural gas. Inaddition, the Company has generally sold less electricity or natural gas, asapplicable, and consequently earned lower revenues, when weather conditionshave been milder. However, the natural gas rates contain a WNA mechanism which adjusts the distribution costrecovery component of the natural gas billings of residential and commercialcustomers to normal temperatures during the heating season months of Novemberthrough April, somewhat mitigating the effect of weather extremes. Severe weather, such as tornadoes, icestorms, thunderstorms, high wind or floods could also significantly affect theCompany’s operations by causing power outages, damaging infrastructure andrequiring significant repair costs. Terrorism, explosions or fires pose similarrisks. LG&E maintains a comprehensive storm management plan forefficient and timely restoration of service to customers after major stormevents.

**LG&E is subject to risksregarding potential developments concerning global climate change matters.**

LG&E is exposed torisks related to possible developments concerning climate change or globalwarming, including regulations relating to GHG. Such developments could includepotential federal or state legislation or industry initiatives limiting GHGemissions, establishing costs or charges on GHG emissions or on fuels relatingto such emissions, requiring remediation, sequestration or generationfleet-diversification to address GHG emissions, promoting energy efficiency orother measures. These actions could have substantial effects on the Company’sfinancial condition or results of operations, including increased capitalexpenditures or operating costs and changes in rate structures, fuel prices orcustomer demand levels. The Company’s generation fleet is predominantly coal-firedand may, as a relative matter, be highly impacted by developments in this area.

**LG&E’s business is concentrated in the MidwestUnited States, specifically Kentucky.**

The operations of the Company are located in Kentucky and are thereforeimpacted by changes in the Midwest United States economy in general, and theKentucky economy in particular. General economic conditions, such as populationgrowth, industrial growth or expansion and economic development, as well as theoperational or financial performance of major industries or customers in theCompany’s service territory can affect the demand for electricity and naturalgas.

**LG&E is subject to operational risksrelating to its generating plants, transmission facilities and distributionequipment.**

Operation of power plants, transmission and distribution facilitiessubjects LG&E to many risks, including the breakdown or failure ofequipment, accidents, labor disputes, delivery/transportation problems,disruptions of fuel supply and performance below expected levels. BecauseLG&E’s transmission facilities are interconnected with those of thirdparties, the operation of its facilities may be adversely affected byunexpected or uncontrollable events occurring on the systems of such thirdparties. Operation of the Company’s power plants below expected capacity levelscould result in lost revenues or increased expenses, including highermaintenance costs that may not be recovered from customers. Unplanned outagesmay result in significant replacement power costs. While LG&Ebelieves appropriate prevention or mitigation measures are in place, wherepossible, with respect to these potential business disruptions, no assurancescan be given that such events will not occur in the future or will notnegatively affect its financial condition or results of operations.

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**LG&E could be negatively affected by rising interest rates,downgrades to credit ratings or other negative developments in its ability toaccess capital markets.**

In the ordinary course of business, the Company has significantlong-term and short-term financing requirements to fund its capitalexpenditures, debt interest or maturities and operating needs. If ratingagencies were to downgrade the Company’s credit ratings, particularly belowinvestment grade, or withdraw such ratings, it could significantly limit accessto the capital market and the Company’s borrowing costs could increase. Inaddition, the Company’s financing costs can be affected by financial mattersinvolving its parent holding company, including its overall credit rating, itsprovision of intra-company financing and the terms and rates of such financing.

**LG&E is subject to commodity price risk, credit risk, counterpartyrisk and other risks associated with the energy business.**

LG&E is exposed to market, operating and financial risks common toutility operations. Although the Company operates largely in regulated markets,increases in the cost of power and fuel, such as coal or natural gas, as wellas other major inputs and supplies, can affect its margins because authorizedrate structures and pass-through cost mechanisms may include timing lags orregulatory discretion which do not lead to full cost recovery. Changes in thewholesale market price for electricity can impact LG&E’s financial resultsby altering the revenues from off-system sales of excess power from period toperiod. LG&E is also exposed to risk that counterparties could fail toperform their obligations to provide energy, fuel, goods, services or paymentsresulting in potential increased costs to the Company.

**LG&Eis subject to risks associated with defined benefit retirement plans, healthcare plans, wages and other employee-related benefits.**

The Company’s funding obligations concerning defined benefit pensionand postretirement plans are subject to risks relating to developments infuture costs, returns on investments, interest rates and other actuarialmatters which may differ from assumptions currently in effect for the plans andmay lead to higher required funding outlays. Further, higher wage levels,whether related to collective bargaining agreements or employment marketconditions, and costs of providing health care benefits to employees mayadversely affect LG&E’s results of operations, financial position orliquidity.

## Item 1B. Unresolved StaffComments.

None.

 

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## **ITEM 2.Properties**.

LG&E’s powergenerating system consists of the coal-fired units operated at its three steamgenerating stations. Combustion turbines supplement the system during peak oremergency periods. LG&E owns and operates the following electric generatingstations unless otherwise stated:
| ** **                                           | ** ** | **Summer Capability  Rating (Mw)** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|
| Steam Stations:                                      |       |                                         |       |
| Mill Creek — Jefferson  County, KY              |       |                                         |       |
| Unit 1                                               |       | 303                                          |       |
| Unit 2                                               |       | 301                                          |       |
| Unit 3                                               |       | 391                                          |       |
| Unit 4                                               |       | 477                                          |       |
| Total Mill Creek                                     |       | 1,472                                        |       |
| Cane Run — Jefferson  County, KY                |       |                                         |       |
| Unit 4                                               |       | 155                                          |       |
| Unit 5                                               |       | 168                                          |       |
| Unit 6                                               |       | 240                                          |       |
| Total Cane Run                                       |       | 563                                          |       |
|                                                 |       |                                         |       |
| Trimble County —  Trimble County, KY (a)        |       | 383                                          |       |
|                                                 |       |                                         |       |
| Combustion Turbine  Generators (Peaking capability): |       |                                         |       |
|                                                 |       |                                         |       |
| Zorn — Jefferson  County, KY                    |       | 14                                           |       |
| Paddy’s Run — Jefferson  County, KY (b)    |       | 119                                          |       |
| Cane Run — Jefferson  County, KY                |       | 14                                           |       |
| Waterside — Jefferson  County, KY (c)           |       | —                                       |       |
| E.W. Brown — Mercer  County, KY (d)             |       | 190                                          |       |
| Trimble County —  Trimble County, KY (e)        |       | 328                                          |       |
| Total combustion  turbine generators                 |       | 665                                          |       |
|                                                 |       |                                         |       |
| Total capability rating                              |       | 3,083                                        |       |

 

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(a)          Amount shown representsLG&E’s 75% interest. See Notes 9 and 10of Notes to Financial Statements under Item 8 for further discussion onownership.

(b)         Amount shown representsLG&E’s 53% interest in Unit 13 and 100% ownership of Units 11 and 12. SeeNotes 9 and 10 of Notes to Financial Statements, under Item 8 for furtherdiscussion on ownership. Unit 12 was mothballed in November 2006. Lifeassessment (repair or retire) studies are ongoing.

(c)          Pursuant to theDefinitive Property Sale Agreement entered into with the Louisville ArenaAuthority in 2006, the Waterside property will be sold to the Louisville ArenaAuthority when the relocation of the LG&E assets has been completed, whichis expected to occur by the end of 2008. The Waterside units were retired inDecember 2006.

(d)         Amount shown representsLG&E’s 53% interest in Unit 5, 38% interest in Units 6 and 7 and 10% of theInlet Air Cooling system, attributable to Unit 5. See Notes 9 and 10 of Notes to Financial Statements,under Item 8 for further discussion on ownership. KU operates these units onbehalf of LG&E.

(e)          Amount shown representsLG&E’s 29% interest in Units 5 and 6 and LG&E’s 37% interest in Units7, 8, 9 and 10. See Notes 9 and 10 ofNotes to Financial Statements, under Item 8 for further discussion on ownership.

LG&E also ownsan 80 Mw nameplate-rated hydroelectric generating station located in JeffersonCounty, Kentucky (Ohio Falls), with an expected summer capability rating of 48Mw, operated under a license issued by the FERC.

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At December 31,2006, LG&E’s electric transmission system included 41 substations (26 ofwhich are shared with the distribution system) with a total capacity ofapproximately 11,900 Mva and approximately 894 miles of lines. The electricdistribution system included 93 substations (26 of which are shared by thetransmission system) with a total capacity of approximately 4,940 Mva, 3,931miles of overhead lines and 2,161 miles of underground conduit.

LG&E’s naturalgas transmission system includes 260 miles of transmission mains and thenatural gas distribution system includes 4,175 miles of distribution mains.

LG&E operatesunderground natural gas storage facilities with a current working gas capacityof approximately****15.1****millionMcf. See Gas Supply under Item 1.

In 1990, LG&Eentered into an operating lease for its corporate office building located indowntown Louisville, Kentucky. The lease was renegotiated in 2002 and isscheduled to expire July 31, 2015.

Other propertiesowned by LG&E include office buildings, service centers, warehouses,garages and other structures and equipment, the use of which is common to boththe electric and gas departments.

The trustindenture securing LG&E’s first mortgage bonds constitutes a direct firstmortgage lien upon much of the property owned by LG&E. In addition, Fideliahas a second secured lien on the property subject to the first mortgage bondlien for certain of its intercompany loans to LG&E.

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ITEM 3. LegalProceedings.

Ratesand Regulatory Matters

Fora discussion of current rate and regulatory matters, including electric andnatural gas base rate increase proceedings, the Kentucky AG investigation, VDTproceedings, TC2 proceedings, various Kentucky Commission, FERC and MISO proceedingsand other rate or regulatory matters affecting LG&E, see Rates andRegulation under Item 1 and Note 2 of Notes to Financial Statements under Item8.

Environmental

Fora discussion of environmental matters including additional reductions in SO2, NOx and other emissions mandated by recent regulations; itemsregarding the Cane Run generating station, MGP sites; global warming or climatechange matters and other environmental items affecting LG&E, see ExecutiveSummary (Environmental Matters) and Note 9 of Notes to Financial Statementsunder Item 8.

FERC Audit Results

In July 2006, the FERC issued a final report under a routine audit thatits Office of Enforcement (formerly its Office of Market Oversight andInvestigations) had conducted regarding the compliance of E.ON U.S. andsubsidiaries, including LG&E, under the FERC’s standards of conduct andcodes of conduct requirements, as well as other areas. The final reportcontained certain findings calling for improvements in E.ON U.S. andsubsidiaries’ structures, policies and procedures relating to transmission,generation dispatch, energy marketing and other practices. E.ON U.S. andaffiliates have agreed to certain corrective actions and have submittedprocedures related to such corrective actions to the FERC. The correctiveactions are in the nature of organizational and operational improvements asdescribed above and are not expected to have a material adverse impact on theCompany’s results of operations or financial condition.

EmploymentDiscrimination Case

InOctober 2001, approximately 30 employees or former employees filed a complaintagainst LG&E claiming past and current instances of employmentdiscrimination. LG&E has removed the case to the U.S. District Court forthe Western District of Kentucky and filed an answer denying all plaintiffs’claims. To date, the U.S. Equal Employment Opportunity Commission has declinedto proceed to litigation on any claims reviewed. Through continuing mediation,settlements have been reached with the majority of plaintiffs, including thelead plaintiff. In November 2006, LG&E obtained dismissal orders on all buttwo remaining plaintiffs. The complaint contains a claimed damage amount of$100 million as well as requests for injunctive relief, however, all priorsettlements have been for non-material amounts and LG&E does not anticipatethat the remaining outcome will have a material impact on its operations orfinancial condition.

Other

Inthe normal course of business, other lawsuits, claims, environmental actionsand other governmental proceedings arise against LG&E. To the extent thatdamages are assessed in any of these lawsuits, LG&E believes that itsinsurance coverage is adequate. Management, after consultation with legalcounsel, does not anticipate that liabilities arising out of other currentlypending or threatened lawsuits and claims will have a material adverse effecton LG&E’s financial position or results of operations, respectively.

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ITEM 4. Submission ofMatters to a Vote of SecurityHolders.

None.

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PART II.

**ITEM 5. Market for the Registrant’s Common Equity, RelatedStockholder Matters** and Issuer

Purchases ofEquity Securities.

All LG&Ecommon stock, 21,294,223 shares, is held by E.ON U.S. Therefore, there is nopublic market for LG&E’s common stock.

The followingtable sets forth LG&E’s cash distributions on common stock paid to E.ONU.S. during 2006:
| **(in millions)** | ** ** | ** ** | ** ** |
|------------------------|------------|------------|------------|
| First quarter          |       | $          | 40         |   |
| Second quarter         |       | 20         |       |
| Third quarter          |       | 35         |       |
| Fourth quarter         |       | —     |       |
|                        |            |            |            |  |

 

LG&E paid cashdistributions on common stock to E.ON U.S. in the amount of $39 million in 2005and $57 million in 2004.

# ITEM 6. SelectedFinancial Data.

| ** **                                                       | ** ** | **Years Ended December 31** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(in millions)**                                           | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Operating  revenues                                              |       | $                                          | 1,338      |   | $ | 1,424 |   | $ | 1,173 |   | $ | 1,094 |   | $ | 1,004 |   |
|                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Net operating  income                                            |       | $                                          | 223        |   | $ | 230 |   | $ | 185 |   | $ | 179 |   | $ | 173 |   |
|                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income                                                       |       | $                                          | 117        |   | $ | 129 |   | $ | 96 |   | $ | 91 |   | $ | 89 |   |
|                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Total assets                                                     |       | $                                          | 3,184      |   | $ | 3,146 |   | $ | 2,967 |   | $ | 2,882 |   | $ | 2,769 |   |
|                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Long-term  obligations

(including  amounts due within one year) |       | $                                          | 820        |   | $ | 821 |   | $ | 872 |   | $ | 798 |   | $ | 617 |   |

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations and Notes to Financial Statements should be read in conjunctionwith the above information.

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**ITEM 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**.

GENERAL

The following discussion and analysis by management focuses on thosefactors that had a material effect on LG&E’s financial results ofoperations and financial condition during 2006, 2005 and 2004 and should be read in connection with thefinancial statements and notes thereto.

Some of thefollowing discussion may contain forward-looking statements that are subject torisks, uncertainties and assumptions. Such forward-looking statements areintended to be identified in this document by the words “anticipate,” “expect,”“estimate,” “objective,” “possible,” “potential” and similar expressions.Actual results may materially vary. Factors that could cause actual results tomaterially differ include: general economic conditions; business andcompetitive conditions in the energy industry; changes in federal or statelegislation; unusual weather; actions by state or federal regulatory agencies;actions by credit rating agencies and other factors described from time to timein LG&E’s reports to the SEC, including Risk Factors in Item 1A of thisreport on Form 10-K and in Exhibit No. 99.01 to this report on Form 10-K.

EXECUTIVE SUMMARY

Business

LG&E is a wholly-owned subsidiary of E.ON U.S., which is an indirect subsidiary of E.ON, a Germancompany. LG&E maintains a separate corporate identity and serves customersin Kentucky.

LG&E,incorporated in 1913 in Kentucky, is a regulated public utility that suppliesnatural gas to approximately 324,000 customers and electricity to approximately398,000 customers in Louisville and adjacent areas in Kentucky. LG&E’sservice area covers approximately 700 square miles in 17 counties and has anestimated population of one million. Included in this area is the Fort KnoxMilitary Reservation, to which LG&E transports natural gas and provideselectric service, but does not provide any distribution services. LG&E alsoprovides natural gas service in limited additional areas. LG&E’s coal-firedelectric generating plants, all equipped with systems to reduce SO2 emissions, produce most of LG&E’selectricity. The remainder is generated by a hydroelectric power plant andcombustion turbines. Underground natural gas storage fields help LG&E provideeconomical and reliable natural gas service to customers.

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Customers

The followingtable provides statistics regarding LG&E’s retail customers:

Customers (in thousands)
| ** **                         | ** ** | **Electric** | ** ** | **Gas**  | ** ** | **2006% Retail   Revenues** | ** ** |
|------------------------------------|------------|--------------|------------|----------|------------|---------------------------------------|------------|
| **Retail Customer Data** | ** ** | **2006**     | ** ** | **2005** | ** ** | **2004**                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **Electric** | ** ** | **Gas** | ** ** |
|                               |       |         |       |     |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Residential                        |       | 350          |       | 347      |       | 343                                   |       | 298 |   | 296 |   | 293 |   | 39 | % | 64 | % |
| Industrial &  Commercial       |       | 42           |       | 41       |       | 41                                    |       | 25 |   | 24 |   | 24 |   | 51 | % | 31 | % |
| Other                              |       | 6            |       | 6        |       | 6                                     |       | 1 |   | 1 |   | 1 |   | 10 | % | 5 | % |
| Total Retail                       |       | 398          |       | 394      |       | 390                                   |       | 324 |   | 321 |   | 318 |   | 100 | % | 100 | % |

 

Mission

The mission ofLG&E is to build on our tradition and achieve world-class status providingreliable, low-cost energy services and superior customer satisfaction; and topromote safety, financial success and quality of life for our employees,communities and other stakeholders.

Strategy

LG&E’s strategyfocuses on the following:

·                  Achievescale as an integrated U.S. electric and gas business through organic growthand acquisitions;

·                  Maintainexcellent customer satisfaction;

·                  Maintainbest-in-class cost position versus U.S. utility companies;

·                  Developand transfer best practices throughout the company;

·                  Investin infrastructure to meet expanding load and comply with increasingenvironmental requirements;

·                  Achieveappropriate regulated returns on all investment;

·                  Attract,retain and develop the best people; and

·                  Actwith a commitment to corporate social responsibility that enhances the wellbeing of our employees, demonstrates environmental stewardship, promotesquality of life in our communities and reflects the diversity of the society weserve.

Low Rates

LG&E believesit is well positioned in the regulated Kentucky market. LG&E continues tosustain high customer satisfaction, ranking first among all large Midwestutilities for the seventh time in eight years in the J.D. Power and Associates2006 survey of residential electric customers. This excellent performance isbalanced with cost control. The customer benefits of the LG&E culture ofcost management are evident in rate comparisons among U.S. utilities. As ofJuly 1, 2006, the average residential rate per thousand Kwh for LG&Ecustomers was 6.54 cents versus the national average of U.S. investor-ownedutilities of 10.98 cents.

LG&E must continue to address new cost pressures. The KentuckyCommission accepted the settlement agreements reached by the majority of theparties in the rate cases filed by LG&E in December 2003. New rates,implemented in July 2004, produced approximately $55 million of revenue forLG&E for a full year. Under the settlement agreements, the Company’s baseelectric rates increased approximately $43 million

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(7.7%) and base natural gas rates increased approximately $12 million(3.4%) annually. The 2004 increases were the first increases in electric baserates for LG&E in 13 years; the last natural gas rate increase for theCompany took effect in September 2000. Competitors also face the same costpressures that caused LG&E to initiate rate cases (e.g., pensions, benefitsand reliability expenditures) and many other utility companies recently hadrate cases. Despite theseincreases, LG&E’s rates remain significantly lower than the nationalaverage.

### Commodity Prices: Fuel and Electricity

Nationally, coal priceincreases continued during 2006, up approximately 10% from 2005, with modestincreases projected over the near term. Nationwide coal stockpiles grew during2006, due to a surplus of 37 million tons of coal production over consumption,driven by a 1.4% decline in power generation usage of coal and a 3% increase incoal supply.

During 2006, natural gas prices declined significantlyfrom the record levels reached the prior year. During 2005, natural gas pricesaveraged over $8/MMBtu and spiked as high as $15/MMBtu in late Septemberfollowing hurricanes that interrupted natural gas production activities in theGulf of Mexico. Prices in 2006 averaged just over $7/MMBtu and fell as low as$4/MMBtu. Price declines are in part the result of ample national gas storageinventories, which are the result of a warmer-than-normal winter in 2005/2006and the absence of any hurricanes during 2006 that could have otherwisedisrupted natural gas supplies in the Gulf of Mexico. Although the supplysituation has improved from 2005, the underlying and fundamental U.S.supply/demand imbalance shows no significant signs of immediate or significantimprovement.

LG&E’s  average coal and natural gas purchase prices for the lastfive years are as follows:

|                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Coal (per MMBtu)        |       | $        | 1.51       |     | $          | 1.32     |       | $        | 1.15       |     | $          | 1.12 |   | $ | 1.11 |   |
| Natural gas (per MMBtu) |       | $        | 7.80       |     | $          | 10.23    |       | $        | 7.18       |     | $          | 6.30 |   | $ | 4.19 |   |

 

Actual fuel costs associated with retail electric sales are recoveredfrom customers through the FAC. The FAC allows the Company to adjust customers’accounts for the difference between the fuel cost component of base rates andthe actual fuel cost, including transportation costs. Refunds to customersoccur if the actual costs are below the embedded cost component. Additionalcharges to customers occur if the actual costs exceed the embedded costcomponent.

Actual natural gascosts are recovered from customers through the GSC. The GSC also contains anincentive component, the PBR component, which is determined for each 12-monthperiod ending October 31.

Generation Reliability

Generation reliability also remains a key aspect to meeting the Company’sstrategy. LG&E believes that it has maintained good performance andreliability in the key area of utility generation operation. While maintaininglow cost levels, LG&E has also been able to generate increasing volumes andexpect to continue high levels of availability and low outage levels. Thisperformance is also important to maintaining margins from off-system sales.

 

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Generation Capacity

The installation of Trimble County Units 7-10, completed in 2004,increased LG&E’s total system capability by 9%. However, the joint IRPsubmitted by LG&E and KU to the Kentucky Commission in 2005, outlining theleast cost alternative to meet Kentucky’s needs, indicated the requirement foradditional base-load capacity by 2010. Consequently, LG&E and KU have begunconstruction of another base-load coal-fired unit at the Trimble County site.LG&E believes this is the least cost alternative to meet the future needsof its customers. TC2, with a 750 MW capacity rating, will be jointly owned byLG&E (14.25%) and KU (60.75%) and IMEA and IMPA (25% owners). TC2 isexpected to cost $1.1 billion and be completed by 2010. LG&E’s and KU’saggregate 75% share of the total TC2 capital cost is approximately $880million, of which LG&E will spend approximately $180 million through 2009.Through December 2006, LG&E’s expenditures for TC2 have been $32 million.See Note 10 of Notes to Financial Statements.

InJune 2006, LG&E and KU entered into a construction contract regarding theTC2 project. The contract is generally in the form of a lump-sum,turnkey agreement for the design, engineering, procurement, construction,commissioning, testing and delivery of the project, according to designatedspecifications, terms and conditions. The contract price and its components aresubject to a number of potential adjustments which may serve to increase ordecrease the ultimate construction price paid or payable to the contractor. Thecontract also contains standard representations, covenants, indemnities,termination and other provisions for arrangements of this type, includingtermination for convenience or for cause rights.

A CCN application for TC2 construction was filed with the KentuckyCommission in December 2004, and initial CCN applications for threetransmission lines were filed in early 2005, with further applicationssubmitted in December 2005. The proposed air permit was filed with the KentuckyDivision for Air Quality in December 2004. In November 2005, the KentuckyCommission approved the application to expand the Trimble County generatingstation. Kentucky Commission approval for one transmission line CCN was grantedin September 2005, and a ruling that a second transmission line was not subjectto the CCN process was received in February 2006. The Kentucky Commissiongranted approval for the remaining transmission line CCN in May 2006. In August2006, LG&E and KU obtained dismissal of a judicial review of such CCNapproval by certain property owners. A further appeal of such dismissal wasthereafter filed, which action remains pending. The transmission lines are alsosubject to routine regulatory filings and the right-of-way acquisition process.In November 2005, the Kentucky Division for Air Quality issued the final airpermit, which was challenged via a request for remand in December 2005 by threeenvironmental advocacy groups, including the Sierra Club. Administrativeproceedings with respect to the challenge continued throughout 2006. A rulingmay occur during the first half of 2007.

In October 2005, LG&E received from the FERC a new license toupgrade, operate and maintain the Ohio Falls Hydroelectric Project. The licenseis for a period of 40 years, effective November 2005. LG&E intends to spendapproximately $76 million to refurbish the facility and add approximately 20 Mwof generating capacity over the next six years.

Environmental Matters

In addition to the TC2 project, the second major area of utilityinvestment is environmental expenditures. LG&E is subject to SO2 and NOx emission limits on itselectric generating units pursuant to the Clean Air Act. LG&E placed intooperation significant NOx controls for its generating units prior to the 2004summer ozone season. As of December 31, 2006, LG&E has incurred totalcapital costs of approximately $187 million since

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2000 to reduce its NOx emissions below required levels. In addition,LG&E has incurred additional operating and maintenance costs in operatingthe new NOx controls.

In March 2005, the EPA issued the final CAIR which requires substantialadditional reductions in SO2 and NOx emissions from electric generatingunits. The CAIR provides for a two-phased reduction program with Phase Ireductions in NOx and SO2 emissions in 2009 and 2010, respectively, andPhase II reductions in 2015. In March 2005, the EPA issued a relatedregulation, the final CAMR, which requires substantial mercury reductions fromelectric generating units. The CAMR also provides for a two-phased reduction,with the Phase I target in 2010 achieved as a “co-benefit” of the controlsinstalled to meet the CAIR. Additional control measures will be required tomeet the Phase II target in 2018. Both the CAIR and CAMR establish a cap andtrade framework, in which limits are set on total emissions and allowances canbe bought or sold on the open market, to be used for compliance, unless thestate chooses another approach. LG&E currently has flue gas desulfurizationequipment on all its units but will continue to evaluate improvements tofurther reduce SO2 emissions.

Kentucky law permits LG&Eto recover the costs of complying with the Federal Clean Air Act, including areturn of operating expenses, and a return of and on capital invested, throughthe ECR mechanism once approved by the Kentucky Commission. A majority of theapplicable environmental costs, those related to servicing our native load, includinginvestment and operating costs, are recoverable through the ECR. The remaining costs,attributable to off-system sales, are not recoverable through the ECR, however,these costs are recoverable in coordination with a general rate case.

COMPANY STRUCTURE

As contemplated in theirregulatory filings in connection with the E.ON acquisition of Powergen in 2002,E.ON, Powergen and E.ON U.S. completed an administrative reorganization to movethe LG&E Energy Corp. group from an indirect Powergen subsidiary to anindirect E.ON subsidiary. This reorganization was effective in March 2003. Inearly 2004, E.ON U.S. began direct reporting arrangements to E.ON.

Effective December30, 2003, LG&E Energy LLC became the successor, by assignment andsubsequent merger, to all the assets and liabilities of LG&E Energy Corp.

Effective December1, 2005, LG&E Energy LLC was renamed E.ON U.S. LLC.

LG&E hascontinued its separate identity and the preferred stock and debt securities ofLG&E were not affected by these transactions.

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RESULTS OFOPERATIONS

Net Income

LG&E’s netincome in 2006 decreased $12 million (9%) compared to 2005. The primary driversof the decrease were lower wholesale and retail electric sales volumes due tocooler summer weather in 2006 and increased interest expense. Partiallyoffsetting the lower revenues were lower operation and maintenance expensesprimarily from the expiration of the VDT amortization and lower costsassociated with MISO Day 2.

LG&E’s net income related to theelectric business in 2006 decreased $12 million (10%) compared to 2005.Electric operating revenues decreased $44 million (4%) primarily due to lowerwholesale and retail sales volumes associated with cooler summer weather in2006 and lower MISO revenues. Partially offsetting the lower revenues werelower operation and maintenance expenses of $20 million (8%) primarily from theexpiration of the VDT amortization and lower costs from MISO Day 2. Combinedfuel and power purchased expenses in 2006 also declined $15 million (4%) from2005. Interest expense increased $3 million (10%) in 2006.

LG&E’s net income related to thenatural gas business was unchanged from 2005.

LG&E’s net income in 2005 increased$33 million (34%) compared to 2004. The increase resulted primarily from higherelectric revenues due to increased retail sales volumes resulting from warmer summerweather and increased base rates implemented for service rendered on and afterJuly 1, 2004. Wholesale revenues also increased due to higher volumes andhigher prices. These increases were partially offset by increased fuel andpower purchased costs largely due to MISO Day 2 costs.

LG&E’s net income in 2005 related tothe electric business increased $32 million (37%) compared to 2004. Electricoperating revenues increased $171 million (21%), partially offset by higherfuel for electric generation and power purchased of $123 million (41%). Incometax and depreciation expense increased $12 million (25%) and $6 million (6%),respectively.

LG&E’s net income in 2005 related tothe natural gas business increased $1 million (11%) compared to 2004. Naturalgas operating revenues increased $80 million (22%) offset by higher natural gassupply expenses of $73 million (27%). Other natural gas operation andmaintenance expenses increased $4 million (7%) and depreciation expenseincreased $1 million (6%).

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Revenues

The following table presents a comparisonof operating revenues for the years 2006 and 2005 with the immediatelypreceding year.

Increase (Decrease) From Prior Period
| **(in millions)**                     | ** ** | **Electric Revenues** | ** ** | **Gas Revenues** | ** ** |
|---------------------------------------|------------|-----------------------|------------|------------------|------------|
| **Cause**                             | ** ** | **2006**              | ** ** | **2005**         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Retail sales:                         |       |                  |       |             |       |   |   |   |   |
| Fuel and gas supply adjustments       |       | $                     | 23         |             | $          | 23 |   | $ | 20 |   | $ | 67 |   |
| LG&E/KU merger surcredit          |       | 3                     |       | (1               | )          | — |   | — |   |
| Environmental cost recovery surcharge |       | 3                     |       | 10               |       | — |   | — |   |
| Earnings sharing mechanism            |       | —                |       | (6               | )          | — |   | — |   |
| Weather normalization adjustment      |       | —                |       | —           |       | 4 |   | (3 | ) |
| Rate changes                          |       | —                |       | 25               |       | — |   | 5 |   |
| Variation in sales volumes and other  |       | (18                   | )          | 27               |       | (48 | ) | (1 | ) |
| Total retail sales                    |       | 11                    |       | 78               |       | (24 | ) | 68 |   |
| Wholesale sales                       |       | (35                   | )          | 73               |       | (18 | ) | 12 |   |
| MISO Day 2                            |       | (20                   | )          | 18               |       | — |   | — |   |
| Other                                 |       | —                |       | 2                |       | — |   | — |   |
| Total                                 |       | $                     | (44        | )                | $          | 171 |   | $ | (42 | ) | $ | 80 |   |

 

Electric revenuesin 2006 decreased $44 million (4%) primarily due to:

·      Decreasedwholesale sales ($35 million) primarily resulting from lower sales volumes dueto decreased regional demand

·      DecreasedMISO related revenue ($20 million) due to exit from the MISO

·      Decreasedsales volumes and other ($18 million) resulting from a 12% decrease in coolingdegree days in 2006 as compared to the same period in 2005 (the number ofcooling degree days in 2006 was 9% below the 20-year average)

·      Increasedfuel costs ($23 million) billed to customers through the FAC

·      Increasedrevenue due to lower merger surcredit given to customers based on lower salesvolumes ($3 million)

·      IncreasedECR surcharge ($3 million) billed to customers

Electric revenuesin 2005 increased $171 million (21%) primarily due to:

·      Increasedwholesale sales ($73 million) primarily due to an 11% higher sales volume dueto increased regional demand and a 29% increase in prices caused by higher fuelprices

·      Increasedretail sales volumes and other ($27 million) primarily due to warmer summerweather resulting from a 13% increase in cooling degree days (the number ofcooling degree days in 2005 was 14% above the 20-year average)

·      Increasedrates ($25 million) implemented in July 2004

·      Increasedfuel costs ($23 million) billed to customers through the FAC

·      IncreasedMISO related revenue ($18 million) due to the inception of MISO Day 2 on April1, 2005

·      IncreasedECR surcharge ($10 million) billed to customers

·      DecreasedESM revenues ($6 million) billed to customers due to termination of the ESMprogram

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Natural gasrevenues in 2006 decreased $42 million (10%) primarily due to:

·      Decreasedsales volumes and other ($48 million) resulting from a 9% decrease in heatingdegree days in 2006 as compared to the same period in 2005 (the number ofheating degree days in 2006 was 10% below the 20-year average)

·      Decreasedwholesale sales ($18 million) due to limited market opportunities to sellnatural gas off-system

·      Increasednatural gas supply costs ($20 million) billed to customers through the GSC

·      Increasedweather normalization revenue ($4 million)

Natural gasrevenues in 2005 increased $80 million (22%) primarily due to:

·      Increasednatural gas supply costs ($67 million) billed to customers through the GSC

·      Increasedwholesale sales ($12 million) due to increased market opportunities to sellnatural gas off-system

·      Increasedrates ($5 million) implemented in July 2004

·      Decreasedweather normalization revenue ($3 million)

Expenses

Fuel for electricgeneration and natural gas supply expenses comprise a large component ofLG&E’s total operating expenses. Increases or decreases in the cost of fueland natural gas supply are reflected in LG&E’s electric and natural gasretail rates, through the FAC and GSC, subject to the approval of the KentuckyCommission.

Fuel for electricgeneration increased $12 million (4%) in 2006 primarily due to:

·       Increasedcost of fuel burned ($15 million) due to higher prices for coal

·       Decreasedgeneration ($3 million) due to lower demand

Fuel for electricgeneration increased $74 million (36%) in 2005 primarily due to:

·      Increasedcost of fuel burned ($62 million) due to the MISO’s dispatch of naturalgas-fired units and higher coal and natural gas prices

·      Increasedgeneration ($12 million) due to increased demand and the dispatch of units forMISO Day 2

Power purchasedexpense decreased $27 million (19%) in 2006 primarily due to:

·       Decreasedvolumes purchased ($35 million) due to lower demand

·       Increasedunit cost per Mwh of purchases ($9 million) due to higher fuel prices

Power purchasedexpense increased $49 million (53%) in 2005 primarily due to:

·       Increasedunit cost per Mwh of purchases ($41 million) due to higher fuel prices

·      Increasedvolumes purchased ($8 million) due to increased demand and unit outages

·                  Purchasedpower costs from the MISO due to unit outages totaled $10 million

Gas supplyexpenses decreased $44 million (13%) in 2006 primarily due to:

·      Decreasedvolumes of natural gas delivered to the distribution system ($64 million) dueto milder winter weather

·       Increasedcost of net gas supply ($20 million) due to higher inventory unit cost

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Gas supplyexpenses increased $73 million (27%) in 2005 primarily due to:

·      Increasedcost of net gas supply ($62 million) due to the increase in natural gas prices

·      Increasedvolumes of natural gas delivered to the distribution system ($12 million)

Other operationand maintenance expenses decreased $20 million (6%) in 2006 primarily due todecreased other operation expenses ($37 million) partially offset by increasedmaintenance expenses ($15 million) and property and other taxes ($1 million).

Other operationexpenses decreased $37 million (16%) in 2006 primarily due to:

·      Decreasedadministrative and general expense ($21 million) primarily due to thecompletion of the VDT amortization

·      Decreasedother power supply costs ($11 million) resulting from lower MISO Day 2 costs

·      Decreasedelectrical transmission costs ($9 million) due to lower MISO related expenses

·      Increasedsteam generation expense ($2 million) primarily for scrubber reactant and wastedisposal

·      Increaseddistribution operations costs ($1 million) primarily due to higher stormrestoration costs

·      Increasedunderground storage costs ($1 million) due to higher costs of materials andcontractor expenses

Maintenanceexpenses increased $15 million (24%) in 2006 primarily due to:

·      Increased steam maintenance ($8 million) primarily related to Mill Creek Unit 4

·      Increased distribution maintenance ($5 million) primarily related to vegetation management and storm restoration

·       Increasedadministrative and general maintenance ($2 million)

Other operationand maintenance expenses increased $3 million (1%) in 2005 primarily due tohigher other operation expenses ($11 million) and higher property taxes ($2million), partially offset by lower maintenance expenses ($9 million).

Other operation expenses increased $11 million (5%) in2005 primarily due to:

·      Increasedother power supply costs ($17 million) due largely to MISO Day 2 costs ($18million) for administrative and allocated charges from the MISO for Day 2operations

·      Increasedsteam generation expense ($4 million) primarily for scrubber reactant and wastedisposal

·      Increasedemployee benefit costs ($3 million)

·       Increasedcustomer service and collection expenses ($2 million)

·      Decreasedtransmission costs ($11 million), due largely to MISO Day 2 ($13 million).Prior to the MISO Day 2 market, most bilateral transactions required thepurchase of transmission; however, with the Day 2 market, most transactions arehandled directly with the MISO and no additional transmission is necessary

·       Decreaseddistribution operating costs ($5 million) due to fewer storms

Maintenanceexpenses decreased $9 million (13%) in 2005 primarily due to:

·      Decreaseddistribution maintenance ($9 million) due to fewer storms

·      Decreasedsteam generation expense ($2 million)

·      Increasedadministrative and general maintenance ($1 million)

Other expense(income) — net decreased $4 million in 2006 primarily due to:

·      Decreasedother income ($2 million)

·      Increasedother expense ($2 million)

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Other expense(income) expense - net increased $4 million in 2005 primarily due to:

·      Increasedother income ($2 million)

·      Decreasedother expense ($1 million)

Interest expense,including interest expense to affiliated companies, increased $4 million (11%)in 2006 primarily due to:

·      Increasedinterest rates on variable rate debt ($5 million)

·      Increasedinterest on tax deficiencies ($2 million)

·      Decreasedinterest expense on swaps ($2 million)

Interest expense,including interest expense to affiliated companies, increased $4 million (12%)in 2005 primarily due to:

·      Increasedinterest rates on variable rate debt ($6 million)

·      Increasedborrowing from the money pool ($2 million)

·      Decreasedcost of interest rate swaps ($3 million)

·      Decreasedcosts due to refinancing fixed rate debt with variable rate debt ($1 million)

Details of exposure to variable interest rates onlong-term debt are shown in the table below:
| ** **                                                                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Debt exposed to  interest rate risk (in millions)                                                                            |       | $        | 363        |     | $          | 363      |       | $ | 306 |   |
| Debt exposed to  interest rate risk as a percentage of long-term debt                                                        |       | 44.3     | %          | 44.2     | %          | 35.1     | %          |
| Weighted average  interest rate on variable rate debt for the year                                                           |       | 3.47     | %          | 2.49     | %          | 1.28     | %          |
| Weighted average  interest rate on total long-term debt at year-end, including expense  amortization and interest rate swaps |       | 4.33     | %          | 4.13     | %          | 3.92     | %          |
|                                                                                                                              |            |          |            |          |            |          |            |  |  |  |

 

See Note 7 ofNotes to Financial Statements under Item 8.

Variations inincome tax expenses are largely attributable to changes in pre-tax income. SeeNote 6 of Notes to Financial Statements under Item 8.

The rate ofinflation may have a significant impact on LG&E’s operations, its ability tocontrol costs and the need to seek timely and adequate rate adjustments.However, relatively low rates of inflation in the past few years have moderatedthe impact on current operating results.

CRITICAL ACCOUNTING POLICIES/ESTIMATES

Preparation offinancial statements and related disclosures in compliance with generallyaccepted accounting principles requires the application of appropriatetechnical accounting rules and guidance, as well as the use of estimates. Theapplication of these policies necessarily involves judgments regarding futureevents, including legal and regulatory challenges and anticipated recovery ofcosts. These judgments, in and of themselves, could materially impact thefinancial statements and disclosures based on varying assumptions, which may beappropriate to use. In addition, the financial and operating environment alsomay have a significant effect, not only on the operation of the business, buton the results reported through the application of accounting measures used inpreparing the financial statements and related disclosures, even if the natureof the accounting policies applied has not changed. Specific risks for thesecritical accounting policies are described in the following paragraphs. Each ofthese has a higher likelihood of resulting in materially different reported amountsunder different conditions or using different assumptions. Events rarelydevelop exactly as forecasted and the best

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estimatesroutinely require adjustment. See also Note 1 of Notes to Financial Statementsunder Item 8.

**UnbilledRevenue.** At each month-end LG&E prepares a financialestimate that projects electric and natural gas usage by customers that has notbeen billed. The estimated usage is based on allocating the daily system netdeliveries between billed volumes and unbilled volumes. The allocation is basedon a daily ratio of the number of meter reading cycles remaining in the monthto the total number of meter reading cycles in each month. Each day’s ratio isthen multiplied by each day’s system net deliveries to determine an estimatedbilled and unbilled volume for each day of the accounting period. At December31, 2006, a 10% change in these estimated quantities would cause revenue andaccounts receivable to change by approximately $5 million ($3 million forelectric usage and $2 million for natural gas usage). See also Note 1 of Notesto Financial Statements under Item 8.

**Allowancefor Doubtful Accounts.**At December 31, 2006 and 2005, theLG&E allowance for doubtful accounts was $2 million and $1 million,respectively. The allowance is based on the ratio of the amounts charged-offduring the last twelve months to the retail revenues billed over the sameperiod multiplied by the retail revenues billed over the last four months.Accounts with no payment activity are charged-off after four months, althoughcollection efforts continue thereafter.

**Pension and Postretirement Benefits.**LG&E has both funded and unfundednon-contributory defined benefit pension and postretirement benefit plans thattogether cover substantially all of its employees. The plans are accounted forunder SFAS No. 158, *Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans*, whichamended SFAS No. 106, *Employers’ Accounting forPostretirement Benefits Other than Pensions* and SFAS No. 87, *Employers’ Accounting for Pensions*.

The pension and other postretirement benefit plan costs and liabilitiesare determined on an actuarial basis and are dependent upon numerous economicassumptions, such as discount rates, rates of compensation increases, estimatesof the expected return on plan assets and health care cost trend rates anddemographic and economic assumptions. The actuarial assumptions used may differmaterially from actual results due to changing market and economic conditions,higher or lower health care costs or turnover or longer or shorter life spansof participants. These differences may result in a significant impact on theamount of expenses recorded in future periods. The underlying assumptions andestimates related to the pension and postretirement benefit plan costs andliabilities are reviewed annually.

The assumed discount rate, expected return on assets and rate ofcompensation increases generally have the most significant impact on thepension costs and liabilities. The discount rate is used to calculate theactuarial present value of the benefits provided by the plans. LG&E basesits discount rate assumption on the November Mercer Pension Discount YieldCurve, adjusted by the basis point change in the Moody’s Investors Services,Inc. Aa Corporate Bond Rate in December. The Mercer Pension Discount YieldCurve provides a more refined estimate of the discount by matching the plan’sspecific cash flow to a spot-rate yield curve based on high-quality,fixed-income investments.

The expected long-term rate of return on assets is used to calculatethe net periodic pension costs for the plans. To develop the expected long-termrate of return on assets assumption, consideration is given to the currentlevel of expected returns on risk free investments (primarily governmentbonds), the historical performance of the asset managers versus theirrespective benchmarks, the historical level of the risk premium associated withthe other asset classes in which the portfolio is invested and the expectationsfor future returns of each asset class. The expected return for each assetclass is then weighted based on a target asset allocation. For 2006, the actualreturn

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on pension assets was favorable compared to the assumed expected rateof return.

The following describes the effects on pension benefits by changing themajor actuarial assumptions discussed above:

·                  A 1% change in the assumed discount rate couldhave an approximate $47 million positive or negative impact to the 2006accumulated benefit obligation and an approximate $51 million positive ornegative impact to the 2006 projected benefit obligation.

·                  A 25 basis point change in the expected rate ofreturn on assets would have an approximate $1 million positive or negativeimpact on 2006 pension expense.

Compensation rate increases are used to calculate service costs and theprojected benefit obligation. Such rates are based on a review of LG&E’shistorical salaries, promotion and bonus increases. For 2006 net periodicpension benefit costs, LG&E used an assumption of 5.25%.

The assumptions related to the discount rate, retirement, turnover andhealthcare cost trends, which represent expected rates of increase in healthcare claim payments, generally have the most significant impact onpostretirement benefit plan costs and liabilities. Unlike pensions, however,assumptions about per capita claims cost by age and participation rates alsosignificantly impact postretirement liability computations. A 1% change in thehealthcare cost trend rates could have a positive or negative impact on the2006 postretirement benefit obligation and postretirement expense ofapproximately $3 million and less than $1 million, respectively.

Additionally, demographic and other economic assumptions affect thepension and postretirement computations. Beginning with the December 31, 2005liability, LG&E replaced the 1983 Group Annuity Mortality tables for malesand females with the RP 2000 combined tables for males and females projected to2006. These updated mortality tables were used for the 2006 calculation andwill be used in subsequent periods.

The benefit obligation is compared with the plan asset values todetermine a net position. Asset values are increased primarily by actual ratesof return on plan assets and by employer contributions. For an explanation ofthe investment policy including targeted asset allocations, see Note 5 of Notesto Financial Statements under Item 8.

The pension plansare funded in accordance with all applicable requirements of the EmployeeRetirement Income Security Act of 1974 and the IRC. In accordance with theseguidelines, LG&E made discretionary contributions to the pension plans of$18 million in 2006 and $35 million in 2004. No contributions were made in2005. LG&E anticipates making additional contributions as deemed necessary.Additionally, LG&E made contributions of approximately $11 million, $10million and $9 million to the postretirement plans in 2006, 2005 and 2004,respectively. LG&E may continue to make subsequent contributions inaccordance with the maximum funding limitation governed by tax laws. In January2007, LG&E made a discretionary contribution to the pension plan in theamount of $56 million, which was slightly more than the $52 million accruedbenefit liability as of December 31, 2006. In 2007, LG&E anticipates makingvoluntary contributions to fund the Voluntary Employee Beneficiary Association(VEBA) trusts to match the annual postretirement expense and funding the 401(h)plan up to the maximum amount allowed by law. See Note 15 of Notes toFinancial Statements under Item 8.

As prescribed by SFAS No. 87, LG&E was required to recognize anadditional minimum pension liability of $19 million during 2005 since the fairvalue of the plan assets was less than the accumulated benefit obligation atthat time. This additional minimum pension liability was recorded as areduction to other comprehensive income and

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did not affect net income. Historically low corporate bond rates, usedto determine the discount rate, significantly increased the potential value ofthe pension liabilities above the actual value of the plan assets. Theseprovisions of SFAS No. 87 were not applicable to 2006 due to the implementationof SFAS No. 158.

Should poor market conditions return or should interest rates decline,LG&E’s unfunded accumulated benefit obligations and future pension expensecould increase. The Company believes that such increases are recoverable inwhole or in part under future rate proceedings or mechanisms.

See also Notes 5 and 13 of Notes to Financial Statements under Item 8.

**RegulatoryMechanisms.**Judgments and uncertainties include futureregulatory decisions, the impact of deregulation and competition on theratemaking process and external regulatory decisions. Regulatory assets generally represent incurred costs that have beendeferred because they are probable of future recovery in customer rates.Regulatory liabilities generally represent obligations to make refunds tocustomers for previous collections. Management believes, based on KentuckyCommission Orders and historical precedents, the existing regulatory assets andliabilities are probable of recovery. This determination reflects the currentregulatory climate in the state. If future recovery of costs ceases to beprobable, the assets and liabilities would be required to be recognized incurrent period earnings. See also Note 2 of Notes to Financial Statements underItem 8.

**IncomeTaxes.**Income taxesare accounted for under SFAS No. 109, *Accounting for IncomeTaxes*. In accordance with this statement, deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases, as measured byenacted tax rates that are expected to be in effect in the periods when thedeferred tax assets and liabilities are expected to be settled or realized.Significant judgment is required in determining the provision for incometaxes, and there are transactions for which the ultimate tax outcome isuncertain.

To provide for these uncertaintiesor exposures, an allowance is maintained for tax contingencies based onmanagement’s best estimate of probable loss. Tax contingencies areanalyzed periodically and adjustments are made when events occur towarrant a change. In September 2005, LG&E received notice from theCongressional Joint Committee on Taxation approving the Internal RevenueService’s audit of LG&E’s income tax returns for the periods December 1999through December 2003. As a result of resolving numerous tax matters duringthese periods, LG&E reduced income tax accruals by $4 million during 2005.

H. R.4520, known as the “American Jobs Creation Act of 2004” allows electricutilities to take a deduction of up to 3% of their qualified productionactivities income starting in 2005. This deduction reduced LG&E’s effectivetax rate by less than 1% for 2006.

Kentucky House Bill 272, also known as “Kentucky’s Tax ModernizationPlan,” was signed into law in March 2005. This bill contains a number ofchanges in Kentucky’s tax system, including the reduction of the Corporateincome tax rate from 8.25% to 7% effective January 1, 2005, and a furtherreduction to 6% effective January 1, 2007. As a result of the income tax ratechange, LG&E’s deferred tax reserve amount will exceed its actual deferredtax liability attributable to existing temporary differences since the newstatutory rates are lower than the rates were when the deferred tax liabilityoriginated. This excess amount is referred to as excess deferred income taxes.In June 2005 and December 2006, LG&E received approval from the KentuckyCommission to establish and amortize a regulatory liability ($16 million) forits net excess deferred income tax balances.

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Under this accounting treatment, LG&E will amortize itsdepreciation-related excess deferred income tax balances under the average rateassumption method. The average rate assumption method matches the amortizationof the excess deferred income taxes with the life of the timing differences towhich it relates. Excess deferred income tax balances related tonon-depreciation timing differences were expensed in 2005 and 2006.

LG&Eexpects to have adequate levels of taxable income to realize its recorded deferredtaxes.

Forfurther discussion of income tax issues, see Notes 1 and 6 of Notes toFinancial Statements under Item 8.

RECENT ACCOUNTING PRONOUNCEMENTS

The following arerecent accounting pronouncements affecting LG&E:

FIN 48

In July 2006, the FASB issued FIN 48, *Accounting for Uncertainty in Income Taxes, an Interpretation of SFASNo. 109*. FIN 48 clarifies the accounting for the uncertainty ofincome taxes recognized in an enterprise’s financial statements in accordancewith SFAS No. 109. This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.

The evaluation of a tax position inaccordance with FIN 48 is a two-step process. The first step is recognitionbased on the determination of whether it is “more likely than not” that a taxposition will be sustained upon examination. The second step is to measure atax position that meets the “more likely than not” threshold. The tax positionwill be measured as the amount of potential benefit that exceeds 50% likelihoodof being realized.

FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. FIN 48 was adopted effective January 1,2007. The impact of FIN 48 on the statements of operations, financial positionand cash flows is not expected to be material.

SFAS No. 157

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*. SFAS No. 157 is effective forfiscal years beginning after November 15, 2007. This statement defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements.LG&E is now analyzing the future impacts of SFAS No. 157 on results ofoperations and financial condition.

SFAS No. 158

In September 2006, the FASB issued SFAS No.158, which is effective for fiscal years ending after December 15, 2006 foremployers with publicly traded equity securities and for employers controlled byentities with publicly traded equity securities, which is applicable forLG&E. This statement requires employers to recognize the over-funded orunder-funded status of a defined benefit pension and postretirement plan as anasset or a liability in the balance sheet and to recognize changes in thatfunded status in the year in which the changes occur through comprehensiveincome. This statement also requires employers to measure the funded status ofa plan as of the date of its year-end balance sheet. This statement amendedSFAS No. 87, SFAS No. 88, *Employers’ Accounting forSettlements and Curtailments of Defined Benefit Pension Plans and forTermination*

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*Benefits*, SFAS No. 106 and SFAS No. 132, *Employers’ Disclosures about Pensions and Other Postretirement Benefits*.

SFAS No. 71, *Accountingfor the Effects of Certain Types of Regulation*, provides guidance toregulated utilities for deferring costs that would otherwise be charged toexpense or equity by non-regulated enterprises. In applying the provisions ofthis statement to the requirements of SFAS No. 158, LG&E recorded aregulatory asset representing the adjustment to the pension liability inrecognizing the funded status of the pension liability. This adjustment wouldhave been represented in Accumulated Other Comprehensive Income without theapplication of SFAS No. 71.

LG&E has adopted SFAS No. 158 effectivefor the fiscal year ending December 31, 2006. The incremental effects ofapplying SFAS No. 158 are shown in the following table:

 
| **(in millions)**                                   | ** ** | **Before Adoption  of SFAS  No. 158*** | ** ** | **Adjustments** | ** ** | **After Adoption  of SFAS  No. 158** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------|------------|-----------------------------------------------------|------------|
| Accrued pension  and postretirement liability-noncurrent |       | $                                                     | (102       | )               | $          | (47                                                 | )          | $ | (149 | ) |
| Accrued pension  and postretirement liability-current    |       | —                                                |       | (2              | )          | (2                                                  | )          |
| Pension and postretirement  regulatory asset             |       | 77                                                    |       | 49              |       | 126                                                 |       |
|                                                          |            |                                                       |            |                 |            |                                                     |            |  |  |  |

 

*Balances before the application of SFAS No. 158 include the effects of2006 plan experience and changes in actuarial assumptions on the additionalminimum liability, coupled with the regulatory impacts of SFAS No. 71.

LIQUIDITY AND CAPITAL RESOURCES

LG&E uses netcash generated from its operations and external financing (including financingfrom affiliates) to fund construction of plant and equipment and the payment ofdividends. LG&E believes that such sources of funds will be sufficient tomeet the needs of its business in the foreseeable future.

As of December 31,2006, LG&E is in a negative working capital position in part because of theclassification of certain variable-rate pollution control bonds totaling $246million that are subject to tender for purchase at the option of the holder ascurrent portion of long-term debt. Backup credit facilities totaling $185million are in place to fund such tenders, if necessary. LG&E has neverneeded to access these facilities. LG&E expects to cover any workingcapital deficiencies with cash flow from operations, money pool borrowings andborrowings from Fidelia.

OperatingActivities

Cash provided byoperations was $320 million, $150 million and $171 million in 2006, 2005 and2004, respectively.

The 2006 increaseof $170 million was primarily the result of increases in cash due to changesin:

·                  Accountsreceivable ($183 million) primarily from decreased natural gas prices andmilder December weather

·                  Materialsand supplies ($107 million) primarily resulting from decreased natural gasprices

·                  Propertyand other taxes payable ($21 million)

·                  GSCrecovery ($20 million)

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These increaseswere partially offset by cash used for changes in:

·                  Accountspayable ($102 million) due to lower natural gas prices

·                  Earnings,net of non-cash items ($22 million)

·                  Pensionand postretirement funding ($19 million)

·                  Paymentof the fee required to exit the MISO ($13 million)

·                  ECRrecovery ($7 million)

The 2005 decreaseof $21 million was primarily the result of decreases in cash due to changes in:

·                  Materialsand supplies ($61 million) largely the result of increased coal and natural gasprices

·                  Accountsreceivable ($17 million) primarily due to colder December weather

·                  Gassupply recovery ($13 million) primarily due to higher natural gas prices

·                  ESMrecovery ($8 million) due to termination of the ESM program

·                  Propertyand other taxes payable ($7 million)

These decreaseswere partially offset by cash provided by changes in:

·                  Accountspayable ($49 million) primarily from the increase in natural gas prices

·                  Pensionand postretirement funding ($34 million)

InvestingActivities

LG&E’s primary use of funds for investing activitiescontinues to be for capital expenditures. Capital expenditures were $146million, $139 million and $148 million in 2006, 2005 and 2004, respectively.LG&E expects its capital expenditures for the three-year period endingDecember 31, 2009, to total approximately $665 million, which consistsprimarily of construction estimates associated with the construction of TC2totaling approximately $150 million (including $40 million for environmentalcontrols), other environmental control equipment of approximately $80 million,redevelopment of the Ohio Falls hydro facility totaling approximately $30million and on-going construction related to generation and distributionassets.

Net cash used forinvesting activities in 2006 increased $9 million in 2006 compared to 2005 anddecreased $21 million in 2005 compared to 2004, primarily due to the level ofconstruction expenditures.

FinancingActivities

Net cash outflowsfor financing activities were $173 million, $12 million and $7 million in 2006,2005 and 2004, respectively.

Redemptions and maturities of long-term debt for 2006, 2005 and 2004are summarized below:
| **($ in millions)** | ** ** | ** **                              | ** ** | **Principal**        | ** ** | ** ** | ** ** | **Secured/**  | ** ** | ** **   | ** ** | ** ** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|----------------------|------------|------------|------------|---------------|------------|--------------|------------|------------|------------|
| **Year**                      | ** ** | **Description**                         | ** ** | **Amount**           | ** ** | **Rate**   | ** ** | **Unsecured** | ** ** | **Maturity** | ** ** |
| 2006                          |       | Mandatorily  Redeemable Preferred Stock |       | $   1 |       | 5.875      | %          | Unsecured     |       | Jul          | 2006       |       |
| 2005                          |       | Pollution  control bonds                |       | $ 40            |       | 5.90       | %          | Secured       |       | Apr          | 2023       |       |
| 2005                          |       | Due  to Fidelia                         |       | $ 50            |       | 1.53       | %          | Secured       |       | Jan          | 2005       |       |
| 2005                          |       | Mandatorily  Redeemable Preferred Stock |       | $   1 |       | 5.875      | %          | Unsecured     |       | Jul          | 2005       |       |
| 2004                          |       | Due  to Fidelia                         |       | $ 50            |       | 1.53       | %          | Secured       |       | Jan          | 2005       |       |
| 2004                          |       | Mandatorily Redeemable  Preferred Stock |       | $   1 |       | 5.875      | %          | Unsecured     |       | Jul          | 2004       |       |
|                               |            |                                         |            |                      |            |            |            |               |            |              |            |            |            |  |

 

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LG&Edid not issue any long-term debt in 2006. Issuances of long-term debt for 2005and 2004 are summarized below:

 
| **($ in millions)** | ** ** | ** **               | ** ** | **Principal** | ** **     | ** ** | ** ** | **Secured/**  | ** ** | ** **   | ** **                             |
|-------------------------------|------------|--------------------------|------------|---------------|----------------|------------|------------|---------------|------------|--------------|----------------------------------------|
| **Year**                      | ** ** | **Description**          | ** ** | **Amount**    | ** **     | **Rate**   | ** ** | **Unsecured** | ** ** | **Maturity** | ** **                             |
| 2005                          |       | Pollution  control bonds |       | $             |   40 |       | Variable   |          | Secured    |         | Feb     2035       |   |
| 2004                          |       | Due to Fidelia           |       | $             |   25 |       | 4.33%      |          | Secured    |         | Jan      2012 |   |
| 2004                          |       | Due to Fidelia           |       | $             | 100            |       | 1.53%      |          | Secured    |         | Jan      2005 |   |

 

Seealso Notes 7 and 15 of Notes to Financial Statements under Item 8.

FutureCapital Requirements

Future capitalrequirements may be affected in varying degrees by factors such as electricenergy demand load growth, changes in construction expenditure levels, rateactions by regulatory agencies, new legislation, market entry of competingelectric power generators, changes in commodity prices and labor rates, changesin environmental regulations and other regulatory requirements. See Note 9 ofNotes to Financial Statements under Item 8 for current commitments. LG&Eanticipates funding future capital requirements through operating cash flow,debt and/or infusions of capital from its parent.

LG&E has a variety of funding alternativesavailable to meet its capital requirements. LG&E maintains a series of bilateralcredit facilities with banks totaling $185 million. Several intercompanyfinancing arrangements are also available. LG&E participates in anintercompany money pool agreement wherein E.ON U.S. and/or KU make funds of upto $400 million available to LG&E at market-based rates. Fidelia alsoprovides long-term intercompany funding to LG&E. See Note 8 of Notes toFinancial Statements under Item 8.

Regulatory approvals are required for LG&E to incur additionaldebt. The FERC authorizes the issuance of short-term debt while the KentuckyCommission authorizes issuance of long-term debt. In February 2006, LG&Ereceived a two-year authorization from the FERC to borrow up to $400 million inshort-term funds.

LG&E’s debt ratings from Moody’s Investor Services, Inc. (“Moody’s”)and Standard and Poor’s Rating Services (“S&P”) as of December 31, 2006,were:

|                          | ** ** | **Moody’s** | ** ** | **S&P** |
|--------------------------|------------|------------------|------------|-------------|
| First mortgage  bonds    |       | A1               |       | A-          |
| Preferred stock          |       | Baa1             |       | BBB-        |
| Issuer rating            |       | A2               |       | —      |
| Corporate credit  rating |       | —           |       | BBB+        |

 

These ratingsreflect the views of Moody’s and S&P. A security rating is not arecommendation to buy, sell or hold securities and is subject to revision orwithdrawal at any time by the rating agency.

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ContractualObligations

The following isprovided to summarize contractual cash obligations for periods after December31, 2006. LG&E anticipates cash from operations and external financing willbe sufficient to fund future obligations. Future interest obligations cannot bequantified because most of LG&E’s debt is variable rate. (See Statements ofCapitalization)
| **(in millions)**                        | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contractual Cash Obligations**    | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Short-term debt  (a)                          |       |                                      | $          | 68 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 68 |   |   |
| Long-term debt                                |       |                                      | 1          |   |   |   | 19 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 800 | (b) |   | 820 |   |   |
| Operating leases  (c)                         |       |                                      | 2          |   |   |   | 2 |   |   |   | 2 |   |   |   | 2 |   |   |   | 2 |   |   |   | 8 |   |   |   | 18 |   |   |
| Unconditional  power purchase obligations (d) |       |                                      | 11         |   |   |   | 13 |   |   |   | 16 |   |   |   | 17 |   |   |   | 17 |   |   |   | 328 |   |   |   | 402 |   |   |
| Coal and gas  purchase obligations (e)        |       |                                      | 266        |   |   |   | 249 |   |   |   | 202 |   |   |   | 207 |   |   |   | 200 |   |   |   | 3 |   |   |   | 1,127 |   |   |
| Retirement  obligations (f)                   |       |                                      | 36         |   |   |   | 37 |   |   |   | 36 |   |   |   | 35 |   |   |   | 34 |   |   |   | 168 |   |   |   | 346 |   |   |
| Other  obligations (g)                        |       |                                      | 89         |   |   |   | 70 |   |   |   | 20 |   |   |   | 1 |   |   |   | — |   |   |   | — |   |   |   | 180 |   |   |
| Total contractual cash  obligations           |       |                                      | $          | 473 |   |   |   | $ | 390 |   |   |   | $ | 276 |   |   |   | $ | 262 |   |   |   | $ | 253 |   |   |   | $ | 1,307 |   |   |   | $ | 2,961 |   |   |

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(a)          Represents borrowingsfrom affiliated company due within one year.

(b)         Includes long-term debtof $246 million classified as current liabilities because these bonds aresubject to tender for purchase at the option of the holder and to mandatorytender for purchase upon the occurrence of certain events. Maturity dates forthese bonds range from 2013 to 2027. LG&E does not expect to pay theseamounts in 2007.

(c)          Represents futureoperating lease payments.

(d)         Represents future minimumpayments under OVEC power purchase agreements through 2024.

(e)          Represents contracts topurchase coal and natural gas.

(f)            Represents currentlyprojected cash flows for pension plans and other post-employment benefits ascalculated by the actuary.

(g)         Represents constructioncommitments, including commitments for TC2.

Off-BalanceSheet Arrangements

In theordinary course of business LG&E has operating leases for various vehicles,equipment and real estate. See Note 9 of Notes to Financial Statements underItem 8 for further discussion of leases.

Saleand Leaseback Transaction

LG&E is a participant in a sale and leasebacktransaction involving its 38% interest in two jointly-owned combustion turbinesat KU’s E.W. Brown generating station (Units 6 and 7). Commencing in December1999, LG&E and KU entered into a tax-efficient, 18-year lease of thecombustion turbines. LG&E and KU have provided funds to fully defease thelease, and have executed an irrevocable notice to exercise an early purchaseoption contained in the lease after 15.5 years. The financial statementtreatment of this transaction is no different than if LG&E had retained itsownership. The leasing transaction was entered into following receipt ofrequired state and federal regulatory approvals.

In case of default under the lease, LG&E isobligated to pay to the lessor its share of certain fees or amounts. Primaryevents of default include loss or destruction of the combustion turbines,failure to insure or maintain the combustion turbines and unwinding of thetransaction due to governmental actions. No events of default 

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currently exist with respect to the lease. Upon anytermination of the lease, whether by default or expiration of its term, titleto the combustion turbines reverts jointly to LG&E and KU.

At December 31, 2006, the maximum aggregate amount ofdefault fees or amounts was $9 million, of which LG&E would be responsiblefor 38% (approximately $3 million). LG&E has made arrangements with E.ONU.S., via guarantee and regulatory commitment, for E.ON U.S. to pay LG&E’sfull portion of any default fees or amounts.

PotentialPreferred Stock Transaction

In October2006, LG&E submitted an application to the Kentucky Commission seekingauthorization for various potential financial transactions, including a requestfor approval of certain funding arrangements which could provide a source offunds for the possible redemption of LG&E’s three existing series ofpreferred stock having an aggregate book value of approximately $90 million. InJanuary 2007, the Kentucky Commission issued an Order granting approval ofLG&E’s application and in March 2007, a committee of LG&E’s boardauthorized the redemption of the preferred stock, effective in April 2007. Seealso Note 15 of Notes to Financial Statements under Item 8.

MARKET RISKS

LG&E isexposed to market risks from changes in interest rates and commodity prices. Tomitigate changes in cash flows attributable to these exposures, LG&E usesvarious financial instruments including derivatives. Derivative positions aremonitored using techniques that include market value and sensitivity analysis.See Notes 1 and 3 of Notes to Financial Statements under Item 8.

InterestRate Sensitivity

LG&E hasshort-term and long-term variable-rate debt obligations outstanding. AtDecember 31, 2006, the potential change in interest expense associated with a 1% change in base interest rates of LG&E’s unhedged debt is estimatedat $4million.

Interest rate swapsare used to hedge LG&E’sunderlying variable-rate debt obligations. These swaps hedge specificdebt issuances and, consistent with management’s designation, are accordedhedge accounting treatment. See Note 3 of Notes to Financial Statements underItem 8.

As of December 31,2006, LG&E had swaps with an aggregate notional value of $211 million. The swaps exchangefloating-rate interest payments for fixed rate interest payments to reduce theimpact of interest rate changes on LG&E’s pollution control bonds. The potential loss in fairvalue resulting from a hypothetical 1% adverse movement in base interest ratesis estimated at approximately $21millionas of December 31, 2006. This estimate is derived from third-party valuations.Changes in the market value of these swaps if held to maturity, as LG&Eintends to do, will have no effect on LG&E’snet income or cash flow. See Note 3 of Notes to Financial Statementsunder Item 8.

Commodity andOther Price Sensitivities

LG&E isexposed to the market price volatility of coal, natural gas and oil (the fuelsused to generate electricity) in its wholesale activities. It has limitedexposure to such market price volatility as the result of its retail FAC andGSC commodity price pass-through mechanisms. LG&E can also be exposed tothe market price volatility 

44

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of othersignificant input commodities, including but not limited to costs of steel,copper and specialized equipment or machinery used in the industry, as well aslabor rates, in elements of its capital construction or operating andmaintenance activities. In some cases, elements of these risks are mitigatedvia periodic rate or other regulatory recovery mechanisms or via the terms ofapplicable contractual arrangements.

# Energy & RiskManagement Activities

LG&E conducts energy trading and risk management activities tomaximize the value of power sales from physical assets it owns. Energy tradingactivities are principally forward financial transactions to hedge price riskand are accounted for on a mark-to-market basis in accordance with SFAS No.133, *Accounting for Derivative Instruments and HedgingActivities*, as amended. Prior to the MISO establishing its Day 2energy market in April 2005, wholesale forward transactions were primarilyphysically settled and thus were treated as normal sales under SFAS No. 133, asamended, and were not marked to market.

The table belowsummarizes LG&E’s energy trading and risk management activities for 2006and 2005:
| (in millions)                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Fair value of  contracts at beginning of period, net asset   |       |     | $          | 1        |       |   |   | $ | — |   |   |
| Fair value of contracts when entered into during the  period |       |     | 3          |     |       |   | 1 |   |   |
| Contracts realized or otherwise settled during the  period   |       |     | (6         | )        |       |   | — |   |   |
| Changes in fair values due to changes in assumptions         |       |     | 3          |     |       |   | — |   |   |
| Fair value of contracts  at end of period, net asset         |       |     | $          | 1        |       |   |   | $ | 1 |   |   |

 

The fair value of LG&E’s energy trading and risk managementcontracts as of December 31, 2006 and 2005, was less than $1 million. Nochanges to valuation techniques for energy trading and risk managementactivities occurred during 2006 or 2005. Changes in market pricing, interestrate and volatility assumptions were made during both years. The outstandingmark-to-market value is sensitive to changes in prices, price volatilities andinterest rates. The Company estimates that a movement in prices of $1 and achange in interest and volatilities of 1% would result in a change of less than$1 million. All contracts outstanding at December 31, 2006 and 2005 have amaturity of less than one year and are valued using prices actively quoted forproposed or executed transactions or quoted by brokers.

LG&E maintainspolicies intended to minimize credit risk and revalues credit exposures dailyto monitor compliance with those policies. At December 31, 2006, 100% of thetrading and risk management commitments were with counterparties ratedBBB-/Baa3 equivalent or better.

RATES ANDREGULATION

LG&E issubject to the jurisdiction of the Kentucky Commission in virtually all mattersrelated to electric and natural gas utility regulation, and as such, itsaccounting is subject to SFAS No. 71. Given LG&E’s competitive position in themarketplace and the status of regulation in Kentucky, LG&E has no plans orintentions to discontinue its application of SFAS No. 71. See Notes 2 and 9 ofNotes to Financial Statements under Item 8 for a discussion of rates andregulation.

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FUTURE OUTLOOK

Competition and Customer Choice

At this time,neither the Kentucky General Assembly nor the Kentucky Commission has adoptedor approved a plan or timetable for retail electric industry competition inKentucky. The nature or timing of the ultimate legislative or regulatoryactions regarding industry restructuring and their impact on LG&E, whichmay be significant, cannot currently be predicted. Some states that havealready deregulated have begun discussions that could lead to re-regulation.

Over the last several years,LG&E has taken many steps to maintain efficient rate structures whileachieving high levels of customer satisfaction, including: an increase in focuson commercial, industrial and residential customers; an increase in employeeinvolvement and training; and continuous modifications of its organizationalstructure. LG&E also strives to control costs through competitive biddingand process improvements. LG&E’s performance in national customersatisfaction surveys continues to be high.

# **ITEM 7A.********Quantitative and Qualitative Disclosures About MarketRisk****.**

# See Management’sDiscussion and Analysis of Financial Condition and Results of Operations,Market Risks, under Item 7.

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# ITEM 8. FinancialStatements and SupplementaryData.

Louisville Gas andElectric CompanyStatements of Income(Millions of $)
| ** **                                          | ** ** | **Years Ended December 31** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| OPERATING REVENUES:                                 |       |                                       |       |   |   |   |   |
| Electric (Note  12)                                 |       | $                                          | 943        |   | $ | 987 |   | $ | 816 |   |
| Gas                                                 |       | 395                                        |       | 437 |   | 357 |   |
| Total operating  revenues                           |       | 1,338                                      |       | 1,424 |   | 1,173 |   |
|                                                |       |                                       |       |   |   |   |   |
| OPERATING EXPENSES:                                 |       |                                       |       |   |   |   |   |
| Fuel for  electric generation                       |       | 294                                        |       | 282 |   | 208 |   |
| Power purchased  (Notes 9 and 12)                   |       | 114                                        |       | 141 |   | 92 |   |
| Gas supply  expenses                                |       | 295                                        |       | 339 |   | 266 |   |
| Other operation  and maintenance expenses           |       | 288                                        |       | 308 |   | 305 |   |
| Depreciation and  amortization (Note 1)             |       | 124                                        |       | 124 |   | 117 |   |
| Total operating  expenses                           |       | 1,115                                      |       | 1,194 |   | 988 |   |
|                                                |       |                                       |       |   |   |   |   |
| Net operating income                                |       | 223                                        |       | 230 |   | 185 |   |
|                                                |       |                                       |       |   |   |   |   |
| Other expense (income)  - net                       |       | 3                                          |       | (1 | ) | 3 |   |
| Interest expense (Notes  7 and 8)                   |       | 28                                         |       | 24 |   | 21 |   |
| Interest expense to  affiliated companies (Note 12) |       | 13                                         |       | 13 |   | 12 |   |
|                                                |       |                                       |       |   |   |   |   |
| Income before income  taxes                         |       | 179                                        |       | 194 |   | 149 |   |
|                                                |       |                                       |       |   |   |   |   |
| Federal and state  income taxes (Note 6)            |       | 62                                         |       | 65 |   | 53 |   |
|                                                |       |                                       |       |   |   |   |   |
| Net income                                          |       | $                                          | 117        |   | $ | 129 |   | $ | 96 |   |

 

The accompanyingnotes are an integral part of these financial statements.

Statements ofRetained Earnings(Millions of $)
| ** **                                                  | ** ** | **Years Ended December 31** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                        |       |                                       |       |   |   |   |   |
| Balance January  1                                          |       | $                                          | 621        |   | $ | 534 |   | $ | 497 |   |
| Add net income                                              |       | 117                                        |       | 129 |   | 96 |   |
|                                                        |       | 738                                        |       | 663 |   | 593 |   |
| Deduct:   Cash  dividends declared on stock: |       |                                       |       |   |   |   |   |
| 5% cumulative preferred                                     |       | 1                                          |       | 1 |   | 1 |   |
| Auction rate cumulative preferred                           |       | 3                                          |       | 2 |   | 1 |   |
| Common                                                      |       | 95                                         |       | 39 |   | 57 |   |
|                                                        |       | 99                                         |       | 42 |   | 59 |   |
|                                                        |       |                                       |       |   |   |   |   |
| Balance December 31                                         |       | $                                          | 639        |   | $ | 621 |   | $ | 534 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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Louisville Gas and Electric CompanyStatements of Comprehensive Income(Millions of $)
| ** **                                                                                                                                                            | ** ** | **Years Ended December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                                                                                                                            |       |                                       | $          | 117 |   |   |   | $ | 129 |   |   |   | $ | 96 |   |   |
|                                                                                                                                                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Gain (loss) on  derivative instruments and hedging activities, net of tax benefit (expense)  of $(1), $0 and $1 for 2006, 2005 and 2004, respectively (Notes 1 and 3) |       |                                       | 2          |   |   |   | — |   |   |   | (2 | ) |   |
|                                                                                                                                                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Additional  minimum pension liability adjustment, net of tax benefit (expense) of $(30),  $6 and $4 for 2006, 2005 and 2004, respectively (Note 5)                    |       |                                       | 47         |   |   |   | (13 | ) |   |   | (6 | ) |   |
|                                                                                                                                                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Other  comprehensive income (loss), net of tax (Note 13)                                                                                                              |       |                                       | 49         |   |   |   | (13 | ) |   |   | (8 | ) |   |
|                                                                                                                                                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Comprehensive income                                                                                                                                                  |       |                                       | $          | 166 |   |   |   | $ | 116 |   |   |   | $ | 88 |   |   |

 

The accompanyingnotes are an integral part of these financial statements.

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Louisville Gas and ElectricCompanyBalance Sheets(Millions of $)
| ** **                                                                                | ** ** | **December 31** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                | ** ** | **2006**             | ** ** | **2005** | ** ** |
| ASSETS:                                                                                   |       |                 |       |   |   |
| Current assets:                                                                           |       |                 |       |   |   |
| Cash and cash equivalents (Note 1)                                                        |       | $                    | 7          |   | $ | 7 |   |
| Accounts receivable - less reserve of $2 million in  2006 and $1 million in 2005 (Note 1) |       | 165                  |       | 231 |   |
| Accounts receivable from affiliated companies (Note  12)                                  |       | 19                   |       | 36 |   |
| Materials and supplies (Note 1):                                                          |       |                 |       |   |   |
| Fuel (predominantly coal)                                                                 |       | 38                   |       | 39 |   |
| Gas stored underground                                                                    |       | 83                   |       | 125 |   |
| Other materials and supplies                                                              |       | 30                   |       | 28 |   |
| Prepayments and other current assets                                                      |       | 6                    |       | 6 |   |
| Total current  assets                                                                     |       | 348                  |       | 472 |   |
|                                                                                      |       |                 |       |   |   |
| Utility plant,  at original cost (Note 1):                                                |       |                 |       |   |   |
| Electric                                                                                  |       | 3,200                |       | 3,180 |   |
| Gas                                                                                       |       | 526                  |       | 511 |   |
| Common                                                                                    |       | 180                  |       | 199 |   |
| Total utility plant, at original cost                                                     |       | 3,906                |       | 3,890 |   |
|                                                                                      |       |                 |       |   |   |
| Less: reserve for depreciation                                                            |       | 1,534                |       | 1,509 |   |
| Total utility plant, net                                                                  |       | 2,372                |       | 2,381 |   |
|                                                                                      |       |                 |       |   |   |
| Construction work in progress                                                             |       | 217                  |       | 159 |   |
| Total utility  plant and construction work in progress                                    |       | 2,589                |       | 2,540 |   |
|                                                                                      |       |                 |       |   |   |
| Deferred debits  and other assets:                                                        |       |                 |       |   |   |
| Restricted cash (Note 1)                                                                  |       | 16                   |       | 10 |   |
| Regulatory assets (Notes 1 and 2):                                                        |       |                 |       |   |   |
| Pension and postretirement benefits                                                       |       | 126                  |       | — |   |
| Other                                                                                     |       | 93                   |       | 84 |   |
| Intangible pension asset                                                                  |       | —               |       | 31 |   |
| Other assets                                                                              |       | 12                   |       | 9 |   |
| Total deferred  debits and other assets                                                   |       | 247                  |       | 134 |   |
|                                                                                      |       |                 |       |   |   |
| Total Assets                                                                              |       | $                    | 3,184      |   | $ | 3,146 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

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Louisville Gas and ElectricCompanyBalance Sheets (continued)(Millions of $)
| ** **                                                                                      | ** ** | **December 31** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                      | ** ** | **2006**             | ** ** | **2005** | ** ** |
| LIABILITIES AND  EQUITY:                                                                        |       |                 |       |   |   |
| Current  liabilities:                                                                           |       |                 |       |   |   |
| Current portion of long term debt (Note 7)                                                      |       | $                    | 248        |   | $ | 248 |   |
| Notes payable to affiliated companies (Notes 8 and  12)                                         |       | 68                   |       | 141 |   |
| Accounts payable                                                                                |       | 103                  |       | 141 |   |
| Accounts payable to affiliated companies (Note 12)                                              |       | 55                   |       | 56 |   |
| Customer deposits                                                                               |       | 18                   |       | 17 |   |
| Other current liabilities                                                                       |       | 40                   |       | 17 |   |
| Total current  liabilities                                                                      |       | 532                  |       | 620 |   |
|                                                                                            |       |                 |       |   |   |
| Long-term debt:                                                                                 |       |                 |       |   |   |
| Long-term bonds (Note 7)                                                                        |       | 328                  |       | 328 |   |
| Long-term notes to affiliated company (Note 7)                                                  |       | 225                  |       | 225 |   |
| Mandatorily redeemable preferred stock (Note 7)                                                 |       | 19                   |       | 20 |   |
| Total long-term  debt                                                                           |       | 572                  |       | 573 |   |
| Deferred credits  and other liabilities:                                                        |       |                 |       |   |   |
| Accumulated deferred income taxes (Note 6)                                                      |       | 333                  |       | 322 |   |
| Accumulated provision for pensions and related  benefits (Note 5)                               |       | 149                  |       | 143 |   |
| Investment tax credit, in process of amortization                                               |       | 41                   |       | 42 |   |
| Asset retirement obligations                                                                    |       | 28                   |       | 27 |   |
| Regulatory liabilities (Note 2):                                                                |       |                 |       |   |   |
| Accumulated cost of removal of utility plant                                                    |       | 232                  |       | 219 |   |
| Regulatory liability deferred income taxes                                                      |       | 54                   |       | 42 |   |
| Other regulatory liabilities                                                                    |       | 35                   |       | 20 |   |
| Other liabilities                                                                               |       | 44                   |       | 41 |   |
| Total deferred  credits and other liabilities                                                   |       | 916                  |       | 856 |   |
|                                                                                            |       |                 |       |   |   |
| Commitments and  contingencies (Note 9)                                                         |       |                 |       |   |   |
|                                                                                            |       |                 |       |   |   |
| Cumulative  preferred stock                                                                     |       | 70                   |       | 70 |   |
|                                                                                            |       |                 |       |   |   |
| COMMON EQUITY:                                                                                  |       |                 |       |   |   |
| Common stock, without par value -   Authorized 75,000,000 shares, outstanding 21,294,223 shares |       | 424                  |       | 424 |   |
| Additional paid-in capital                                                                      |       | 40                   |       | 40 |   |
| Accumulated other comprehensive income (Note 13)                                                |       | (9                   | )          | (58 | ) |
| Retained earnings                                                                               |       | 639                  |       | 621 |   |
| Total common equity                                                                             |       | 1,094                |       | 1,027 |   |
|                                                                                            |       |                 |       |   |   |
| Total Liabilities and  Equity                                                                   |       | $                    | 3,184      |   | $ | 3,146 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

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Louisville Gas and Electric Company

Statements of Cash Flows

(Millions of $)
| ** **                                                  | ** ** | **Years Ended December 31** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                      |       |                                       |       |   |   |   |   |
| Net income                                                  |       | $                                          | 117        |   | $ | 129 |   | $ | 96 |   |
| Items not  requiring cash currently:                        |       |                                       |       |   |   |   |   |
| Depreciation and  amortization                              |       | 124                                        |       | 119 |   | 117 |   |
| Deferred income  taxes - net                                |       | 22                                         |       | (14 | ) | 5 |   |
| Investment tax  credit - net                                |       | (1                                         | )          | (4 | ) | (4 | ) |
| VDT amortization                                            |       | 8                                          |       | 30 |   | 30 |   |
| Provision for  pension and postretirement plans             |       | (13                                        | )          | 14 |   | 25 |   |
| Other                                                       |       | 3                                          |       | 8 |   | 1 |   |
| Change in  certain current assets and liabilities:          |       |                                       |       |   |   |   |   |
| Accounts  receivable                                        |       | 83                                         |       | (100 | ) | (83 | ) |
| Materials and  supplies                                     |       | 41                                         |       | (66 | ) | (5 | ) |
| Accounts payable                                            |       | (47                                        | )          | 55 |   | 6 |   |
| Accrued income  taxes                                       |       | 8                                          |       | — |   | (5 | ) |
| Property and  other taxes payable                           |       | 14                                         |       | (7 | ) | — |   |
| Prepayments and  other                                      |       | 2                                          |       | 4 |   | 7 |   |
| Pension and  postretirement funding                         |       | (29                                        | )          | (10 | ) | (44 | ) |
| Gas supply  clause receivable, net                          |       | 17                                         |       | (3 | ) | 10 |   |
| Litigation  settlement                                      |       | —                                     |       | — |   | 7 |   |
| Earnings sharing  mechanism receivable                      |       | —                                     |       | 2 |   | 10 |   |
| MISO exit fee                                               |       | (13                                        | )          | — |   | — |   |
| Environmental  cost recovery mechanism receivable           |       | (7                                         | )          | — |   | — |   |
| Other                                                       |       | (9                                         | )          | (7 | ) | (2 | ) |
| Net cash  provided by operating activities                  |       | 320                                        |       | 150 |   | 171 |   |
|                                                        |       |                                       |       |   |   |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                      |       |                                       |       |   |   |   |   |
| Construction  expenditures                                  |       | (146                                       | )          | (139 | ) | (148 | ) |
| Change in  restricted cash                                  |       | (1                                         | )          | 1 |   | (11 | ) |
| Net cash used  for investing activities                     |       | (147                                       | )          | (138 | ) | (159 | ) |
|                                                        |       |                                       |       |   |   |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                      |       |                                       |       |   |   |   |   |
| Long-term  borrowings from affiliated company               |       | —                                     |       | — |   | 125 |   |
| Repayment of  long-term borrowings from affiliated company  |       | —                                     |       | (50 | ) | (50 | ) |
| Short-term  borrowings from affiliated company              |       | 700                                        |       | 789 |   | 553 |   |
| Repayment of  short-term borrowings from affiliated company |       | (773                                       | )          | (706 | ) | (575 | ) |
| Issuance of  pollution control bonds                        |       | —                                     |       | 40 |   | — |   |
| Issuance expense  on pollution control bonds                |       | —                                     |       | (2 | ) | — |   |
| Retirement of  pollution control bonds                      |       | —                                     |       | (40 | ) | — |   |
| Retirement of  mandatorily redeemable preferred stock       |       | (1                                         | )          | (1 | ) | (1 | ) |
| Payment of  dividends                                       |       | (99                                        | )          | (42 | ) | (59 | ) |
| Net cash used  for financing activities                     |       | (173                                       | )          | (12 | ) | (7 | ) |
| Change in cash and cash  equivalents                        |       | —                                     |       | — |   | 5 |   |
| Cash and cash  equivalents at beginning of year             |       | 7                                          |       | 7 |   | 2 |   |
| Cash and cash  equivalents at end of year                   |       | $                                          | 7          |   | $ | 7 |   | $ | 7 |   |
|                                                        |       |                                       |       |   |   |   |   |
| Supplemental  disclosures of cash flow information:         |       |                                       |       |   |   |   |   |
| Cash paid during  the year for:                             |       |                                       |       |   |   |   |   |
| Income taxes                                                |       | $                                          | 64         |   | $ | 83 |   | $ | 52 |   |
| Interest on  borrowed money                                 |       | 24                                         |       | 21 |   | 18 |   |
| Interest to affiliated  companies on borrowed money         |       | 11                                         |       | 13 |   | 11 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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Louisville Gas and Electric Company

Statements ofCapitalization

(Millions of $)
| ** **                                                                | ** ** | **December 31** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                | ** ** | **2006**             | ** ** | **2005** | ** ** |
| LONG-TERM DEBT  (Note 7):                                                 |       |                 |       |   |   |
| Pollution control series:                                                 |       |                 |       |   |   |
| S due September 1, 2017, variable %                                       |       | $                    | 31         |   | $ | 31 |   |
| T due September 1, 2017, variable %                                       |       | 60                   |       | 60 |   |
| U due August 15, 2013, variable %                                         |       | 35                   |       | 35 |   |
| Y due May 1, 2027, variable %                                             |       | 25                   |       | 25 |   |
| Z due August 1, 2030, variable %                                          |       | 83                   |       | 83 |   |
| AA due September 1, 2027, variable %                                      |       | 10                   |       | 10 |   |
| BB due September 1, 2026, variable %                                      |       | 23                   |       | 23 |   |
| CC due September 1, 2026, variable %                                      |       | 28                   |       | 28 |   |
| DD due November 1, 2027, variable %                                       |       | 35                   |       | 35 |   |
| EE due November 1, 2027, variable %                                       |       | 35                   |       | 35 |   |
| FF due October 1, 2032, variable %                                        |       | 42                   |       | 42 |   |
| GG due October 1, 2033, variable %                                        |       | 128                  |       | 128 |   |
| HH due February 1, 2035, variable %                                       |       | 40                   |       | 40 |   |
| Notes payable to Fidelia:                                                 |       |                 |       |   |   |
| Due January 16, 2012, 4.33%, secured                                      |       | 25                   |       | 25 |   |
| Due April 30, 2013, 4.55%, unsecured                                      |       | 100                  |       | 100 |   |
| Due August 15, 2013, 5.31%, secured                                       |       | 100                  |       | 100 |   |
| Mandatorily redeemable preferred stock:                                   |       |                 |       |   |   |
| $5.875 series, outstanding shares of 200,000 in 2006  and 212,500 in 2005 |       | 20                   |       | 21 |   |
| Total long-term debt outstanding                                          |       | 820                  |       | 821 |   |
| Less current portion of long-term debt                                    |       | 248                  |       | 248 |   |
| Long-term debt                                                            |       | 572                  |       | 573 |   |
|                                                                           |            |                      |            |  |  |  |  |

 
| CUMULATIVE  PREFERRED STOCK:                                   |        |   |                |   |   |   |   |   |
|----------------------------------------------------------------|-------------|--------|---------------------|--------|--------|--------|--------|--------|
|                                                           | Shares      |   | Current             |   |   |   |   |   |
|                                                           | Outstanding |   | Redemption Price    |   |   |   |   |   |
| $25 par value, 1,720,000 shares authorized - 5%  series        | 860,287     |   | $28.00              |   | 21     |   | 21     |   |
| Without par value, 6,750,000 shares authorized - Auction  rate | 500,000     |   | $100.00   |   | 49     |   | 49     |   |
|                                                           |        |   |                |   | 70     |   | 70     |   |

 
| COMMON EQUITY:                                               |   |   |   |   |   |
|--------------------------------------------------------------|--------|--------|--------|--------|--------|
| Common stock, without par value -                            |   |   |   |   |   |
| Authorized 75,000,000 shares, outstanding 21,294,223  shares |   | 424    |   | 424    |   |
| Additional paid-in capital                                   |   | 40     |   | 40     |   |
| Accumulated other comprehensive income (Note 13)             |   | (9     | )      | (58    | )      |
| Retained earnings                                            |   | 639    |   | 621    |   |
| Total common equity                                          |   | 1,094  |   | 1,027  |   |
|                                                         |   |   |   |   |   |
| Total capitalization                                         |   | $      | 1,736  |   | $      | 1,670 |   |
|                                                              |        |        |        |        |        |  |  |

 

The accompanyingnotes are an integral part of these financial statements.

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**Louisville Gas and Electric CompanyNotes to Financial Statements**

**Note 1 -Summary of Significant Accounting Policies**

LG&E,incorporated in 1913 in Kentucky, is a regulated public utility engaged in thegeneration, transmission, distribution and sale of electric energy and thestorage, distribution and sale of natural gas. LG&E supplies natural gas toapproximately 324,000 customers and electricity to approximately 398,000customers in Louisville and adjacent areas in Kentucky. LG&E’s coal-firedelectric generating stations, all equipped with systems to reduce SO2 emissions, produce most of LG&E’selectricity. The remainder is generated by a hydroelectric power plant andcombustion turbines.

LG&E is a wholly-owned subsidiary of E.ON U.S.,formerly known as LG&E Energy LLC. E.ON U.S. is a wholly-owned subsidiaryof E.ON AG (E.ON), a German corporation, making LG&E a wholly-ownedsubsidiary of E.ON. LG&E’s affiliate, KU, is a regulated public utilityengaged in the generation, transmission, distribution and sale of electricenergy in Kentucky, Virginia and Tennessee.

Certain reclassification entries have been made to theprevious years’ financial statements to conform to the 2006 presentation withno impact on net assets, liabilities and capitalization or previously reportednet income and cash flows.

**Regulatory Accounting.**LG&E is subject to SFASNo. 71, under which costs that would otherwise be charged to expense aredeferred as regulatory assets based on expected recovery from customers infuture rates. Likewise, credits that would otherwise be reflected as income aredeferred as regulatory liabilities based on expected return to customers infuture rates. LG&E’s currentor expected recovery of deferred costs and expected return of deferred creditsis based on specific ratemaking decisions or precedent for each item asprescribed by the FERC or the Kentucky Commission. See Note 2, Rates andRegulatory Matters, for additional detail regarding regulatory assets andliabilities.

**Cash and Cash Equivalents.**LG&E considers all debt instruments purchased with an originalmaturity of three months or less to be cash equivalents.

**Allowance for Doubtful Accounts.**The allowance for doubtful accounts is based on the ratio of the amountscharged-off during the last twelve months to the retail revenues billed overthe same period multiplied by the retail revenues billed over the last fourmonths. Accounts with no payment activity are charged-off after four months,although collection efforts continue thereafter. The amounts charged to expenseto accrue for estimated bad debts were $4 million, $3 million and $2 millionand the net of accounts written off against the reserve were $3 million, $3million and $5 million in 2006, 2005 and 2004, respectively.

**Materials and Supplies.**Fuel, natural gas stored underground and other materials and suppliesinventories are accounted for using the average-cost method. Emissionallowances are included in other materials and supplies at cost and are notcurrently traded by LG&E. At December 31, 2006 and 2005, the emissionallowances inventory was less than $1 million.

**Other Property and Investments.**Other property and investments on the balancesheet consists of LG&E’s investment in OVEC and non-utility plant. LG&Eand 11 other electric utilities are participating owners of OVEC, located inPiketon, Ohio. OVEC owns and operates two power plants that burn coal togenerate electricity, Kyger Creek Station in Ohio and Clifty Creek Station inIndiana. LG&E’s share of OVEC’s output is 5.63%, approximately 124 Mw ofgeneration capacity.

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As of December 31,2006 and 2005, LG&E’s investment in OVEC totaled less than $1 million. LG&E is not the primarybeneficiary of OVEC; therefore, it is not consolidated into the financialstatements of LG&E and is accounted for under the cost method ofaccounting. LG&E’s maximum exposure to loss as a result of its involvementwith OVEC is limited to the value of its investment. In the event of theinability of OVEC to fulfill its power provision requirements, LG&Eanticipates substituting such power supply with either owned generation ormarket purchases and believes it would generally recover associated incrementalcosts through regulatory rate mechanisms. See Note 9, Commitments andContingencies, for further discussion of developments regarding LG&E’sownership interest and power purchase rights.

**Utility Plant.**LG&E’sutility plant is stated at original cost, which includes payroll-related costssuch as taxes, fringe benefits and administrative and general costs. Constructionwork in progress has been included in the rate base for determining retailcustomer rates. LG&E has not recorded any allowance for funds used duringconstruction, in accordance with Kentucky Commission regulations.

The cost of plant retired or disposed of in the normal course ofbusiness is deducted from plant accounts and such cost, plus removal expenseless salvage value, is charged to the reserve for depreciation. When completeoperating units are disposed of, appropriate adjustments are made to thereserve for depreciation and gains and losses, if any, are recognized.

**Depreciation and Amortization.**Depreciation is provided on the straight-linemethod over the estimated service lives of depreciable plant. The amountsprovided were approximately 3.2% in 2006 (3.0% electric, 2.9% gas, and 7.8% common);3.2% in 2005 (3.0% electric, 2.4% gas and 8.0% common); and 3.1% for 2004 (2.9%electric, 2.8% gas and 7.6% common), of average depreciable plant. Of theamount provided for depreciation, at December 31, 2006, approximately 0.4%electric, 0.9% gas and 0.4% common were related to the retirement, removal anddisposal costs of long lived assets. Of the amount provided fordepreciation, at December 31, 2005, approximately 0.4% electric, 0.8% gasand 0.02% common were related to the retirement, removal and disposal costs oflong lived assets.

**Restricted Cash.**A deposit in the amount of $11 million, used as collateral for an $83million interest rate swap expiring in 2020, is classified as restricted cashon LG&E’s balance sheet. An advance deposit of $5 million from theLouisville Arena Authority is also restricted for equipment purchases relatedto relocating transmission facilities.

**Unamortized Debt Expense.**Debt expense is capitalized in deferred debits and amortized over thelives of the related bond issues.

**Income Taxes.**Incometaxes are accounted for under SFAS No. 109. In accordance with this statement,deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respectivetax bases, as measured by enacted tax rates that are expected to be in effectin the periods when the deferred tax assets and liabilities are expected to besettled or realized. Significant judgment is required in determiningthe provision for income taxes, and there are transactions for whichthe ultimate tax outcome is uncertain. To provide for these uncertaintiesor exposures, an allowance is maintained for tax contingencies based onmanagement’s best estimate of probable loss. Tax contingencies are analyzedperiodically and adjustments are made when events occur towarrant a change. See Note 6, Income Taxes.

**Deferred Income Taxes.**Deferred income taxes are recognized at currently enacted tax rates forall material temporary differences between the financial reporting and incometax bases of assets and liabilities.

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**Investment Tax Credits.**The EPAct 2005 added Section 48A to the Internal Revenue Code, whichprovides for an investment tax credit to promote the commercialization ofadvanced coal technologies that will generate electricity in an environmentallyresponsible manner.  LG&E and KUreceived an investment tax credit related to TC2, for more details, see Note 6,Income Taxes.

Investment tax credits prior to 2006 resulted from provisions of thetax law that permitted a reduction of LG&E’s tax liability based on creditsfor construction expenditures. Deferred investment tax credits are being amortizedto income over the estimated lives of the related property that gave rise tothe credits.

**Revenue Recognition.**Revenuesare recorded based on service rendered to customers through month-end. LG&Eaccrues an estimate for unbilled revenues from each meter reading date to theend of the accounting period based on allocating the daily system netdeliveries between billed volumes and unbilled volumes. The allocation is basedon a daily ratio of the number of meter reading cycles remaining in the month tothe total number of meter reading cycles in each month. Each day’s ratio isthen multiplied by each day’s system net deliveries to determine an estimatedbilled and unbilled volume for each day of the accounting period. The unbilledrevenue estimates included in accounts receivable were approximately $53million and $82 million at December 31, 2006 and 2005, respectively.

**Fuel and Gas Costs.**Thecost of fuel for electric generation is charged to expense as used, and thecost of natural gas supply is charged to expense as delivered to thedistribution system. LG&E implemented a Kentucky Commission-approvedperformance-based ratemaking mechanism related to natural gas procurementactivity. See Note 2, Rates and RegulatoryMatters.

**Management’s Use of Estimates.**The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported assets and liabilities and disclosure of contingent items at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Accrued liabilities, including legal andenvironmental, are recorded when they are probable and estimable. Actualresults could differ from those estimates.

**Recent Accounting Pronouncements.**The following are recent accountingpronouncements affecting LG&E:

FIN 48

In July 2006, the FASB issued FIN 48, whichclarifies the accounting for the uncertainty of income taxes recognized in anenterprise’s financial statements in accordance with SFAS No. 109. Thisinterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return.

The evaluation of a tax position inaccordance with FIN 48 is a two-step process. The first step is recognitionbased on the determination of whether it is “more likely than not” that a taxposition will be sustained upon examination. The second step is to measure atax position that meets the “more likely than not” threshold. The tax positionwill be measured as the amount of potential benefit that exceeds 50% likelihoodof being realized.

FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. FIN 48 was adopted effective January 1,2007. The impact of FIN 48 on the statements of operations, financialposition, and cash flows is not expected to be material.

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SFAS No. 157

In September 2006, the FASB issued SFAS No. 157,which is effective for fiscal years beginning after November 15, 2007. Thisstatement defines fair value, establishes a framework for measuring fair valuein generally accepted accounting principles and expands disclosures about fairvalue measurements. LG&E is now analyzing the future impacts of SFAS No.157 on results of operations and financial condition.

SFAS No. 158

In September 2006, the FASB issued SFAS No.158, which is effective for fiscal years ending after December 15, 2006 foremployers with publicly traded equity securities, and for employers controlledby entities with publicly traded equity securities, which is applicable forLG&E. This statement requires employers to recognize the over-funded orunder-funded status of a defined benefit pension and postretirement plan as anasset or a liability in the balance sheet and to recognize changes in thatfunded status in the year in which the changes occur through comprehensiveincome. This statement also requires employers to measure the funded status ofa plan as of the date of its year-end balance sheet. This statement amendedSFAS No. 87, SFAS No. 88, SFAS No. 106 and SFAS No. 132.

SFAS No. 71, provides guidance to regulatedutilities for deferring costs that would otherwise be charged to expense orequity by non-regulated enterprises. In applying the provisions of thisstatement to the requirements of SFAS No. 158, LG&E recorded a regulatoryasset representing the adjustment to the pension liability in recognizing thefunded status of the pension liability. This adjustment would have beenrepresented in Accumulated Other Comprehensive Income without the applicationof SFAS No. 71.

LG&E has adopted SFASNo. 158 effective for fiscal year ending December 31, 2006. The incrementaleffects of applying SFAS No. 158 are shown in the following table:
| **(in millions)**                                   | ** ** | **Before   Adoption   of SFAS   No. 158*** | ** ** | **Adjustments** | ** ** | **After   Adoption   of SFAS   No. 158** | ** ** |   |
|----------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-----------------|------------|-------------------------------------------------------------------|------------|--------|
| Accrued pension  and postretirement liability-noncurrent |       | $                                                                   | (102       | )               | $          | (47                                                               | )          | $      | (149 | ) |
| Accrued pension  and postretirement liability-current    |       | —                                                              |       | (2              | )          | (2                                                                | )          |
| Pension and  postretirement regulatory asset             |       | 77                                                                  |       | 49              |       | 126                                                               |       |
|                                                          |            |                                                                     |            |                 |            |                                                                   |            |        |  |  |  |  |  |  |  |  |

 

* Balances beforethe application of SFAS No. 158 include the effects of 2006 plan experience andchanges in actuarial assumptions on the additional minimum liability, coupledwith the regulatory impacts of SFAS No. 71.

**Note 2 -Rates and Regulatory Matters**

The KentuckyCommission has regulatory jurisdiction over LG&E’s retail rates andservice, and over the issuance of certain of its securities. The KentuckyCommission has the ability to examine the rates LG&E charges its retailcustomers at any time.

Electric and GasRate Cases

In December 2003,LG&E filed an application with the Kentucky Commission requestingadjustments in LG&E’s electric and natural gas rates. LG&E asked forgeneral adjustments in electric and natural gas rates based on the twelve monthtest period ended September 30, 2003. The revenue increases requested were $64 

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million forelectric and $19 million for natural gas. In June 2004, the Kentucky Commissionissued an Order approving increases in LG&E’s annual electric base rates ofapproximately $43 million (8%) and annual natural gas base rates ofapproximately $12 million (3%). The rate increases took effect on July 1, 2004.

During 2004 and 2005, the AG conducted an investigation of LG&E, aswell as of the Kentucky Commission and its staff, requesting informationregarding allegedly improper communications between LG&E and the KentuckyCommission, particularly during the period covered by the rate cases. Concurrently,the AG had filed pleadings with the Kentucky Commission requesting rehearing ofthe rate cases on computational components of the increased rates, includingincome taxes, cost of removal and depreciation amounts. In August 2004, theKentucky Commission denied the AG’s rehearing request on the cost of removaland depreciation issues and granted rehearing on the income tax component. TheKentucky Commission further agreed to hold in abeyance further proceedings inthe rate cases, until the AG filed its investigative report regardingthe allegations of improper communication.

In January 2005 and February2005, the AG filed a motion summarizing its investigative report as containingevidence of improper communications and record-keeping errors by LG&E inits conduct of activities before the Kentucky Commission or other stategovernmental entities and forwarded such report to the Kentucky Commissionunder continued confidential treatment to allow it to consider the report,including its impact, if any, on completing its investigation and any remainingsteps in the rate cases. To date, LG&E has neither seen nor requestedcopies of the report or its contents.

In December 2005, the Kentucky Commission issued an Order notingcompletion of its inquiry, including review of the AG’s investigative report.The Order concluded that no improper communications occurred during the rateproceedings. Final proceedings took place during the first quarter of 2006concerning the sole remaining open issue relating to state income tax ratesused in calculating the granted rate increase. On March 31, 2006, theKentucky Commission issued an Order resolving this issue in LG&E’s favorconsistent with the original rate increase order.

LG&Ebelieves no improprieties have occurred in its communications with the KentuckyCommission and has cooperated with the proceedings before the AG and theKentucky Commission. LG&E is currently unable to predict whether there willbe any remaining actions or consequences as a result of the AG’s report or investigation.

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Regulatory Assetsand Liabilities

The followingregulatory assets and liabilities were included in LG&E’s Balance Sheets as ofDecember 31:

| (in millions)                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| ARO                                           |       | $        | 22         |     | $          | 20 |   |
| Gas supply adjustments                        |       | 21       |       | 25       |       |
| Unamortized loss on  bonds                    |       | 20       |       | 21       |       |
| MISO exit                                     |       | 13       |       | —   |       |
| ECR                                           |       | 9        |       | 2        |       |
| Merger surcredit                              |       | 2        |       | 3        |       |
| VDT costs                                     |       | —   |       | 8        |       |
| Other                                         |       | 6        |       | 5        |       |
| Subtotal                                      |       | 93       |       | 84       |       |
|                                          |       |     |       |     |       |
| Pension and  postretirement benefits          |       | 126      |       | —   |       |
|                                          |       |     |       |     |       |
| Total regulatory assets                       |       | $        | 219        |     | $          | 84 |   |
|                                          |       |     |       |     |       |
| Accumulated cost of  removal of utility plant |       | $        | 232        |     | $          | 219 |   |
| Deferred income taxes -  net                  |       | 54       |       | 42       |       |
| Gas supply adjustments                        |       | 31       |       | 18       |       |
| Other                                         |       | 4        |       | 2        |       |
| Total regulatory liabilities                  |       | $        | 321        |     | $          | 281 |   |

 

LG&E does notcurrently earn a rate of return on the gas supply adjustments, FAC (included inother regulatory assets) and gas performance-based ratemaking regulatoryassets, all of which are separate recovery mechanisms with recovery withintwelve months. No return is earned on the pension and postretirement benefitsregulatory asset which represents the changes in funded status of the plansthat the Company will seek recovery of in future proceedings with the KentuckyCommission. No return is currently earned on the ARO asset. This regulatoryasset will be offset against the associated regulatory liability, ARO asset andARO liability at the time the underlying asset is retired. The MISO exit amountrepresents the costs relating to the withdrawal from MISO membership. LG&Eexpects to seek recovery of this asset in future proceedings with the KentuckyCommission. LG&E currently earns a rate of return on the remainingregulatory assets. Other regulatory liabilities include DSM and MISO Schedule10. See Note 1, Summary of Significant Accounting Policies.

**Pensionand Postretirement Benefits.** LG&E adopted SFAS No. 158 in2006. This statement requires employers to recognize the over-funded orunder-funded status of a defined benefit pension and postretirement plan as anasset or liability in the balance sheet and to recognize through comprehensiveincome the changes in the funded status in the year in which the changes occur.Under SFAS No. 71, LG&E can defer recoverable costs that would otherwise becharged to expense or equity by non-regulated entities. Current rate recoveryin Kentucky is based on SFAS No. 87 and SFAS No. 106, both of which wereamended by SFAS No. 158. Regulators have been clear and consistent with theirhistorical treatment of such rate recovery; therefore, LG&E has recorded aregulatory asset representing the probable recovery of the portion of thechange in funded status of the postretirement and pension plans that isexpected to be recovered. The regulatory asset will be adjusted annually asprior service cost and actuarial losses are recognized in net periodic benefitcost.

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**ARO.**Asummary of LG&E’s net ARO assets, regulatory assets, liabilities and costof removal established under FIN 47 and SFAS No. 143, *Accountingfor Asset Retirement Obligations* follows:
| ** **                  | ** ** | **ARO Net** | ** ** | **ARO**         | ** ** | **Regulatory** | ** ** | **Accumulated**               | ** ** |
|-----------------------------|------------|------------------|------------|-----------------|------------|----------------|------------|-------------------------------|------------|
| **(in millions)**      | ** ** | **Assets**       | ** ** | **Liabilities** | ** ** | **Assets**     | ** ** | **Cost of Removal** | ** ** |
| As of December 31, 2004     |       |             | $          | 3               |       |           |       | $                             | (11        | ) |   |   | $ | 7 |   |   |   | $ | — |   |   |
| FIN 47 net asset  additions |       |             | 1          |            |       |           | (15        | )                             |       |   | 12 |   |   |   | 3 |   |   |
| ARO accretion               |       |             | —     |            |       |           | (1         | )                             |       |   | 1 |   |   |   | — |   |   |
| As of December 31, 2005     |       |             | 4          |            |       |           | (27        | )                             |       |   | 20 |   |   |   | 3 |   |   |
| ARO accretion               |       |             | —     |            |       |           | (1         | )                             |       |   | 2 |   |   |   | — |   |   |
| As of December 31, 2006     |       |             | $          | 4               |       |           |       | $                             | (28        | ) |   |   | $ | 22 |   |   |   | $ | 3 |   |   |

 

ARO depreciation, removal cost incurred and cost ofremoval depreciation during 2005 and 2006 and FIN 47 net asset additions for2006 were less than $1 million. In addition, regulatory liabilities and cost ofremoval depreciation as of December 31, 2005 and 2006 were less than $1million.

Pursuant to regulatory treatment prescribed under SFASNo. 71, an offsetting regulatory credit was recorded in depreciation andamortization in the income statement of $2 million in 2006 and $1 million in2005 for the ARO accretion and depreciation expense. LG&E AROs areprimarily related to the final retirement of assets associated with generatingunits and natural gas wells. For assets associated with AROs, the removal costaccrued through depreciation under regulatory accounting is established as aregulatory asset or liability pursuant to regulatory treatment prescribed underSFAS No. 71. For the years ended December 31, 2006 and 2005, LG&Erecorded less than $1 million of depreciation expense related to the cost ofremoval of ARO related assets. An offsetting regulatory liability wasestablished pursuant to regulatory treatment prescribed under SFAS No. 71.

LG&E transmission and distribution lines largelyoperate under perpetual property easement agreements which do not generallyrequire restoration upon removal of the property. Therefore, under SFAS No.143, no material asset retirement obligations are recorded for transmission anddistribution assets.

**GasSupply Cost Adjustments.**LG&E’s natural gas rates containa GSC, whereby increases or decreases in the cost of natural gas supply arereflected in LG&E’s rates, subject to approval by the Kentucky Commission.The GSC procedure prescribed by Order of the Kentucky Commission provides forquarterly rate adjustments to reflect the expected cost of natural gas supplyin that quarter. In addition, the GSC contains a mechanism whereby any over- orunder-recoveries of natural gas supply cost from prior quarters is to berefunded to or recovered from customers through the adjustment factordetermined for subsequent quarters. In late 2005, as wholesale natural gasprices began to decrease, a one-time interim adjustment in the GSC wasrequested by LG&E and approved by the Kentucky Commission to pass the lowernatural gas costs to the customers on a more timely basis.

LG&E’sGSC was modified in 1997 to incorporate an experimental natural gas procurementincentive mechanism. Since November 1, 1997, LG&E has operated under thisexperimental PBR mechanism related to its natural gas procurement activities.LG&E’s rates are adjusted annually to recover (or refund) its portion ofthe expense (or savings) incurred during each PBR year (12 months endingOctober 31). During the PBR year ending in 2006, LG&E achieved $17 millionin savings. Of that total savings amount, LG&E’s portion was approximately$5 million and the ratepayers’ portion was approximately $12 million. Pursuantto the extension of LG&E’s natural gas supply cost PBR mechanism effectiveNovember 1, 2001, the sharing mechanism under the PBR requires savings (andexpenses) to be shared 25% with shareholders and 75% with ratepayers up to 4.5%of the benchmarked natural gas costs. Savings (and expenses) in excess of 4.5%of the benchmarked 

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naturalgas costs are shared 50% with shareholders and 50% with ratepayers. The currentnatural gas supply cost PBR mechanism was extended through 2010 without furthermodification.

**UnamortizedLoss on Bonds.**The****costs of earlyextinguishment of debt, including****call premiums,legal****and other expenses, and anyunamortized balance of debt expense are amortized over the life of eitherreplacement debt (in the case of refinancing) or the original life of theextinguished debt.

**MISOExit.**Following receipt of applicable FERC, KentuckyCommission and other regulatory orders, LG&E withdrew from the MISOeffective September 1, 2006. Specific proceedings regarding the costs andbenefits of the MISO and exit matters had been underway since July 2003. Sincethe exit from the MISO, LG&E has been operating under a FERC-approved openaccess-transmission tariff. LG&E has further contracted with the TennesseeValley Authority to act as its reliability coordinator and Southwest PowerPool, Inc. to function as its independent transmission operator, pursuant toFERC requirements, with respect to transmission matters.

LG&E and theMISO have agreed upon overall calculation methods for the contractual exit feeto be paid by the Company following its withdrawal. In October 2006, LG&Epaid approximately $13 million to the MISO pursuant to an invoice regarding theexit fee and made related FERC compliance filings. The Company’s payment ofthis exit fee amount was with reservation of its rights to contest the amount,or components thereof, following a continuing review of its calculation andsupporting documentation. In December 2006, LG&E provided notice to theMISO of its disagreement with the calculation of the exit fee. LG&E and theMISO continue to discuss the specifics of the exit fee calculation. The outcomeof these discussions and the eventual settlement of the disputed amount cannotbe estimated at this time. Orders of the Kentucky Commission approving theCompany’s exit from the MISO have authorized the establishment of a regulatoryasset for the exit fee, subject to adjustment for possible future MISO credits,and a regulatory liability for certain revenues associated with former MISOSchedule 10 charges, which may continue to be collected via base rates. Thetreatment of the regulatory asset and liability will be determined in LG&E’snext rate case; however, the Company historically has received approval torecover and refund regulatory assets and liabilities.

**ECR.** Kentucky law permits LG&E to recover thecosts of complying with the Federal Clean Air Act, including a return ofoperating expenses, and a return of and on capital invested, through the ECRmechanism. The amount of the regulatory asset or liability is the amount thathas been under- or over-recovered due to timing or adjustments to the mechanismonce approved by the Kentucky Commission.

In April 2006, theKentucky Commission initiated six-month and two-year reviews of LG&E’senvironmental surcharge. A final order was received in January 2007, approvingthe changes and credits billed through the ECR during the review period as wellas approving billing adjustments, a roll-in to base rates, revisions to themonthly surcharge filing and a rate of return on capital.

In June 2004, theKentucky Commission issued an Order approving a settlement agreement that,among other things, revised the rate of return for LG&E’s post-1995 plan.The Order also approved the elimination of LG&E’s 1995 plan from its ECRbilling mechanism, with all remaining costs associated with that plan to beincluded in their entirety in base rates.

In December 2004,LG&E filed an application with the Kentucky Commission to amend itscompliance plan to allow recovery of costs associated with new and additionalenvironmental compliance facilities, including the expansion of the landfillfacility at the Mill Creek station. The estimated capital cost of theadditional facilities over the next three years is approximately $25 million. A final Order was issuedin June 2005, granting approval of the amendments to LG&E’s complianceplan.

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In June 2006, LG&E filed an application toamend its ECR plan with the Kentucky Commission seeking approval to recoverinvestments in environmental upgrades at the Company’s generating facilities.The estimated capital cost of the upgrades for the years 2007 through 2009 isapproximately $50 million, of which $40 million is for the Air Quality ControlSystem at TC2. A final Order was issued by the Kentucky Commission in December2006 approving all expenditures and investments as submitted.

**MergerSurcredit.**As part of the LG&E Energy merger with KUEnergy Corporation in 1998, LG&E estimated non-fuel savings over a ten-yearperiod following the merger. Costs to achieve these savings were deferred andamortized over a five-year period pursuant to regulatory orders. In approvingthe merger, the Kentucky Commission adopted LG&E’s proposal to reduce itsretail customers’ bills based on one-half of the estimated merger-relatedsavings, net of deferred and amortized amounts, over a five-year period. Thesurcredit mechanism provides that 50% of the net non-fuel cost savingsestimated to be achieved from the merger be provided to ratepayers through amonthly bill credit, and 50% be retained by LG&E and KU, over a five-yearperiod. The surcredit was allocated 47% to LG&E and 53% to KU. In that sameorder, the Kentucky Commission required LG&E and KU, after the end of thefive-year period, to present a plan for sharing with ratepayers the then-projectednon-fuel savings associated with the merger. The Companies submitted thisfiling in January 2003, proposing to continue to share with ratepayers, on a50%/50% basis, the estimated fifth-year gross level of non-fuel savingsassociated with the merger. In October 2003, the Kentucky Commission issued anOrder approving a settlement agreement reached with the parties in the case.LG&E’s merger surcredit will remain in place for another five-year termbeginning July 1, 2003 and the merger savings will continue to be shared 50%with ratepayers and 50% with shareholders.

**VDT.**In December 2001, the Kentucky Commission issued an Order approving asettlement agreement allowing LG&E to set up a regulatory asset of $141million for workforce reduction costs and begin amortizing it over a five-yearperiod starting in April 2001. Some employees rescinded their participation inthe voluntary enhanced severance program, which thereby decreased the charge tothe regulatory asset from $144 million to $141 million. The Order reducedrevenues by approximately $26 million through a surcredit on bills toratepayers over the same five-year period, reflecting a sharing (40% to theratepayers and 60% to LG&E) of savings as stipulated by LG&E, net ofamortization costs of the workforce reduction. The five-year VDT amortizationperiod expired in March 2006.

As part of thesettlement agreements in the electric and natural gas rate cases, in September2005, LG&E filed with the Kentucky Commission a plan for the futureratemaking treatment of the VDT surcredit and costs. In February 2006, the AG,KIUC and LG&E reached a settlement agreement on the future ratemakingtreatment of the VDT surcredits and costs and subsequently submitted a jointmotion to the Kentucky Commission to approve the unanimous settlementagreement. Under the terms of the settlement agreement, the VDT surcredit willcontinue at the current level until such time as LG&E files for a change inelectric or natural gas base rates. The Kentucky Commission issued an Order inMarch 2006, approving the settlement agreement.

**FAC.**LG&E’s retail electricrates contain an FAC, whereby increases and decreases in the cost of fuel forelectric generation are reflected in the rates charged to retail electriccustomers. The FAC allows the Companyto adjust customers’ accounts for the difference between the fuel costcomponent of base rates and the actual fuel cost, including transportationcosts. Refunds to customers occur if the actual costs are below the embeddedcost component. Additional charges to customers occur if the actual costsexceed the embedded cost component. The amount of the regulatory asset orliability is the amount that has been under- or over-recovered due to timing oradjustments to the mechanism.

In January 2003,the Kentucky Commission reviewed KU’s FAC and, as part of the Order in thatcase, required that an independent audit be conducted to examine operationaland management aspects of both LG&E’s and KU’s fuel procurement functions.The final report was issued in February 2004. The report’s recommendations 

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related todocumentation and process improvements. Management Audit Action Plans wereagreed upon by LG&E and the Kentucky Commission Staff in the second quarterof 2004. LG&E filed its first Audit Progress Report with the KentuckyCommission Staff in November 2004. The second Audit Progress Report was filedMay 2005. The third Audit Progress Report was filed in December 2005. InJanuary 2006, the Kentucky Commission staff informed LG&E and KU that reportingon all of the original recommendations, but one, has been concluded. LG&Efiled another Audit Progress Report on the remaining open recommendation inAugust 2006.

The KentuckyCommission requires public hearings at six-month intervals to examine past fueladjustments, and at two-year intervals to review past operations of the fuelclause and transfer of the then current fuel adjustment charge or credit to thebase charges. In July 2006, the Kentucky Commission initiated a six-monthreview of the FAC for LG&E for the period of November 1, 2005 through April30, 2006. The Kentucky Commission issued an Order in November 2006 approvingthe charges and credits billed through the FAC during the review period.

In December 2006, the Kentucky Commission initiated atwo-year review of LG&E’s past operations of the fuel clause and transferof fuel costs from the FAC to base rates. LG&E anticipates KentuckyCommission approval of thecharges and credits billed and the fuel procurement practices of LG&Eduring the second quarter of 2007.

**ESM.**Prior to 2004, LG&E’s retail electric rates were subject to an ESM whichset an upper (12.5%) and lower (10.5%) limit for rate of return on equity. Anyearnings excess or deficiency was shared 40% with ratepayers and 60% with shareholders.LG&E filed its final 2003 ESM calculations with the Kentucky Commission inMarch 2004, and applied for recovery of $13 million which was challenged byintervenors. In June 2004, the Kentucky Commission issued an Order largelyaccepting proposed settlement agreements by LG&E and the intervenorsregarding the ESM. Under the settlements, LG&E continued to collect the $13million of previously requested 2003 ESM revenue through March 2005. As part ofthe settlements, the parties agreed to a termination of the ESM relating to allperiods after 2003.

**DSM.**LG&E’s rates contain aDSM provision. The provision includes a rate mechanism that provides forconcurrent recovery of DSM costs and provides an incentive for implementing DSMprograms. The provision allows LG&E to recover revenues from lost salesassociated with the DSM programs based on program plan engineering estimatesand post-implementation evaluations.

**AccumulatedCost of Removal of Utility Plant.**As of December 31, 2006 and2005, LG&E has segregated the cost of removal, embedded in accumulateddepreciation, of $232 million and $219 million, respectively, in accordancewith FERC Order No. 631. This cost of removal component is for assets that donot have a legal ARO under SFAS No. 143. For reporting purposes in the balancesheets, LG&E has presented this cost of removal as a regulatory liabilitypursuant to SFAS No. 71.

**DeferredIncome Taxes — Net.**Deferred income taxes represent thefuture income tax effects of recognizing the regulatory assets and liabilitiesin the income statement. Deferred incometaxes are recognized at currently enacted tax rates for all material temporarydifferences between the financial reporting and income tax bases of assets andliabilities.

Other RegulatoryMatters

**RegionalReliability Council.**LG&E has changed its regionalreliability council membership from the Reliability First Corporation to theSoutheastern Electric Reliability Council, effective January 1, 2007. 

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Regionalreliability councils are industry consortiums that promote, coordinate andensure the reliability of the bulk electric supply systems in North America.

**Arena.**InAugust 2006, LG&E filed an application with the Kentucky Commissionrequesting approval for sale of the Waterside property to the Louisville ArenaAuthority. The Kentucky Commission issued an Order in September 2006, approvingthe proposed transaction. In November 2006, LG&E completed certainagreements pursuant to its August 2006 Memorandum of Understanding with theLouisville Arena Authority regarding the proposed construction of an arena indowntown Louisville. LG&E entered into a relocation agreement with theLouisville Arena Authority providing for the reimbursement to LG&E of thecosts to be incurred in moving certain LG&E facilities related to the arenatransaction. Those costs are currently estimated to be approximately $63million. The parties further entered into a property sale contract providingfor LG&E’s sale of a downtown site to the Louisville Arena Authority forapproximately $10 million, which represents the appraised value of the parcel,less certain agreed upon demolition costs. The amounts specified in thecontracts are subject to certain adjustments. Depending upon continuingprogress of the proposed arena, the transactions contemplated by the contractswill occur between 2006 and 2010.

**TC2 CCNApplication.**A CCNapplication for TC2 construction was filed with the Kentucky Commission inDecember 2004, and initial CCN applications for three transmission lines werefiled in early 2005, with further applications submitted in December 2005. Theproposed air permit was filed with the Kentucky Division for Air Quality inDecember 2004. In November 2005, the Kentucky Commission approved theapplication to expand the Trimble County generating station. KentuckyCommission approval for one transmission line CCN was granted in September2005, and a ruling that a second transmission line was not subject to the CCNprocess was received in February 2006. The Kentucky Commission granted approvalfor the remaining transmission line CCN in May 2006. In August 2006, LG&Eand KU obtained dismissal of a judicial review of such CCN approval by certainproperty owners. A further appeal of such dismissal was thereafter filed, whichaction remains pending. The transmission lines are also subject to routineregulatory filings and the right-of-way acquisition process. In November 2005,the Kentucky Division for Air Quality issued the final air permit, which waschallenged via a request for remand in December 2005 by three environmentaladvocacy groups, including the Sierra Club. Administrative proceedings withrespect to the challenge continued throughout 2006. A ruling may occur duringthe first half of 2007.

**Market-BasedRate Authority.**Beginning in April 2004, the FERC initiatedproceedings to modify its methods used to assess generation market power andhas established more stringent interim market screen tests. During 2005, inconnection with LG&E’s tri-annual market-based rate tariff renewals, theFERC continued to contend that the Company failed such market screens incertain regions. LG&E disputed this contention.

In July 2006, the FERCissued an Order in LG&E’s market-based rate proceeding accepting LG&E’sfurther proposal to address certain market power issues the FERC had claimedwould arise upon an exit from the MISO. In particular, LG&E receivedpermission to sell power at market-based rates at the interface of controlareas in which they may be deemed to have market power, subject to a restrictionthat such power not be collusively re-sold back into such control areas.  However, restrictions exist on sales byLG&E of power at market-based rates in the LG&E/KU and Big RiverElectric Corporation control areas.  Certaingeneral FERC proceedings continue with respect to market-based rate matters,and LG&E’s market-based rate authority is subject to such future developments.

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LG&E cannot predictthe ultimate impact of the current or potential mitigation mechanisms on itsfuture wholesale power sales.

**IRP.**Integratedresource planning regulations in Kentucky require major utilities to maketriennial IRP filings with the Kentucky Commission. In April 2005, LG&E andKU filed their joint 2005 IRP with the Kentucky Commission. The IRP provideshistorical and projected demand, resource and financial data, and otheroperating performance and system information. The AG and the KIUC were grantedintervention in the IRP proceeding. The Kentucky Commission issued itsstaff report, with no substantive issues noted and closed the case by Order inFebruary 2006.

**PUHCA2005.** E.ON, LG&E’s ultimate parent, is a registeredholding company under PUHCA 2005 and was a registered holding company underPUHCA 1935. E.ON, its utility subsidiaries, including LG&E, and certain ofits non-utility subsidiaries are subject to extensive regulation by the SEC andthe FERC with respect to numerous matters, including: electric utilityfacilities and operations, wholesale sales of power and related transactions,accounting practices, issuances and sales of securities, acquisitions and salesof utility properties, payments of dividends out of capital and surplus,financial matters and inter-system sales of non-power goods and services.LG&E believes that it has adequate authority (including financingauthority) under existing FERC orders and regulations to conduct its businessand will seek additional authorization when necessary.

**EPAct2005.**The EPAct 2005 was enacted in August 2005. Among othermatters, this comprehensive legislation contains provisions mandating improvedelectric reliability standards and performance; providing economic and otherincentives relating to transmission, pollution control and renewable generationassets; increasing funding for clean coal generation incentives; repealingPUHCA 1935; enacting PUHCA 2005 and expanding FERC jurisdiction over publicutility holding companies and related matters via the Federal Power Act andPUHCA 2005.

The FERC was directed by the EPAct 2005 to adopt rulesto address many areas previously regulated by the other agencies under otherstatutes, including PUHCA 1935. The FERC is in various stages of rulemaking onthese issues and LG&E is monitoring these rulemaking activities andactively participating in these and other rulemaking proceedings. LG&E isstill evaluating the potential impacts of the EPAct 2005 and the associatedrulemakings and cannot predict what impact the EPAct 2005, and any suchrulemakings, will have on its operations or financial position.

In February 2006, the Kentucky Commission initiated anadministrative proceeding to consider the requirements of the EPAct 2005,Subtitle E Section 1252, Smart Metering, which concerns time-based metering anddemand response, and Section 1254, Interconnections. EPAct 2005 requires eachstate regulatory authority to conduct a formal investigation and issue adecision on whether or not it is appropriate to implement certain Section 1252,Smart Metering standards within eighteen months after the enactment of EPAct2005 and to commence consideration of Section 1254, Interconnection standardswithin one year after the enactment of EPAct 2005. The Kentucky Commission helda public hearing in July 2006, in this proceeding with all Kentuckyjurisdictional electric utilities. In December 2006, the Kentucky Commissionissued an Order in this proceeding indicating that the EPAct 2005 Section 1252,Smart Metering and Section 1254, Interconnection standards should not beadopted. However, all five Kentucky Commission jurisdictional utilities are requiredto file real-time pricing pilot programs for their large commercial andindustrial customers.  LG&E willdevelop a real-time pricing pilot for large industrial and commercial customersand file the details of the plan with the Kentucky Commission in April 2007.

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As part of the rate case settlement agreements, and asreferred to in the EPAct 2005 administrative order, LG&E made its pilotprogram filing, which addresses real-time pricing for residential and generalservice customers, in March 2007.

**Hydro Upgrade.**In October 2005, LG&E received from theFERC a new license to upgrade, operate and maintain the Ohio FallsHydroelectric Project. The license is for a period of 40 years, effectiveNovember 2005. LG&E intends to spend approximately $76 million to refurbishthe facility and add approximately 20 Mw of generating capacity over the nextsix years.

**Note 3 -Financial Instruments**

The cost and estimated fair values of LG&E’s non-trading financial instruments as of December 31 follow:

|                                                                                            | ** ** | **2006**     | ** ** | **2005**  | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------|------------|-----------|------------|
| ** **                                                                                 | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(in millions)**                                                                     | ** ** | **Value**    | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| Preferred stock  subject to mandatory redemption (including current portion of $1 million) |       | $            | 20         |      | $          | 20 |   | $ | 21 |   | $ | 21 |   |
| Long-term debt  (including current portion)                                                |       | $            | 574        |      | $          | 574 |   | $ | 574 |   | $ | 574 |   |
| Long-term debt from affiliate                                                              |       | $            | 225        |      | $          | 222 |   | $ | 225 |   | $ | 225 |   |
| Interest-rate swaps -  liability                                                           |       | $            | (15        | )         | $          | (15 | ) | $ | (19 | ) | $ | (19 | ) |

 

All of the above valuations reflect prices quoted by exchanges exceptfor the swaps and intercompany loans. The fair values of the swaps andintercompany loans reflect price quotes from dealers or amounts calculatedusing accepted pricing models. The fair values of cash and cash equivalents,accounts receivable, accounts payable and notes payable are substantially thesame as their carrying values.

**Interest Rate Swaps (hedging derivatives).**  LG&E uses over-the-counter interestrate swaps to hedge exposure to market fluctuations in certain of its debtinstruments. Pursuant to Company policy, use of these financial instruments isintended to mitigate risk, earnings and cash flow volatility and is notspeculative in nature. Management has designated all of the interest rate swapsas hedge instruments. Financial instruments designated as cash flow hedges haveresulting gains and losses recorded within other comprehensive income andstockholders’ equity. See Note 13, Accumulated Other Comprehensive Income.Financial instruments designated as fair value hedges and the underlying hedgeditems are periodically marked to market with the resulting net gains and lossesrecorded directly into net income. Upon termination of any fair value hedge,the resulting gain or loss is recorded into net income.

LG&E was partyto various interest rate swap agreements with aggregate notional amounts of$211 million as of December 31, 2006 and 2005. Under these swap agreements,LG&E paid fixed rates averaging 4.38% and received variable rates based onLondon Interbank Borrowing Offer Rate or the Bond Market Association’s municipalswap index averaging 3.75% and 3.15% at December 31, 2006 and 2005,respectively. The swap agreements in effect at December 31, 2006 have beendesignated as cash flow hedges and mature on dates ranging from 2020 to 2033.The cash flow designation was assigned because the underlying variable ratedebt has variable future cash flows. The hedges have been deemed to be fullyeffective resulting in a pretax gain of $3millionfor 2006 and a pre-tax loss of less than $1 million in 2005, recorded in othercomprehensive income. Upon expiration of these hedges, the amount recorded inother comprehensive income will be reclassified into earnings. The amountexpected to be reclassified from other comprehensive income to earnings in thenext 

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twelve months isless than $1 million. Adeposit in the amount of $11 million, used as collateral for one of theinterest rate swaps, is classified as restricted cash on the balance sheet. Theamount of the deposit required is tied to the market value of the swap.

**EnergyRisk Management Activities (non-hedging derivatives).** LG&E conducts energy trading and riskmanagement activities to maximize the value of power sales from physical assetsit owns. Energy trading activities are principally forward financialtransactions to hedge price risk and are accounted for on a mark-to-marketbasis in accordance with SFAS No. 133, as amended. Prior to the MISOestablishing its Day 2 energy market in April 2005, wholesale forwardtransactions were primarily physically settled and thus were treated as normalsales under SFAS No. 133, as amended, and were not marked to market.

The table belowsummarizes LG&E’s energy trading and risk management activities:

| (in millions)                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Fair value of  contracts at beginning of period, net asset   |       | $        | 1          |     | $          | — |   |
| Fair value of contracts when entered into during the  period |       | 3        |       | 1        |       |
| Contracts realized or otherwise settled during the  period   |       | (6       | )          | —   |       |
| Changes in fair values due to changes in assumptions         |       | 3        |       | —   |       |
| Fair value of contracts  at end of period, net asset         |       | $        | 1          |     | $          | 1 |   |

 

No changes to valuation techniques for energy trading and riskmanagement activities occurred during 2006 or 2005. Changes in market pricing,interest rate and volatility assumptions were made during both years. All contractsoutstanding at December 31, 2006 and 2005, have a maturity of less than oneyear and are valued using prices actively quoted for proposed or executedtransactions or quoted by brokers.

LG&E maintainspolicies intended to minimize credit risk and revalues credit exposures dailyto monitor compliance with those policies. At December 31, 2006, 100% of thetrading and risk management commitments were with counterparties ratedBBB-/Baa3 equivalent or better.

LG&E hedgesthe price volatility of its forecasted electric off-system sales with the salesof market-traded electric forward contracts for periods of less than one year.These electric forward sales have been designated as cash flow hedges and arenot speculative in nature. Gains or losses on these instruments, to the extentthat the hedging relationship has been effective, are deferred in othercomprehensive income. Gains and losses resulting from ineffectiveness are shownin the statements of income in other expense (income)-net. Upon completion ofthe underlying hedge transaction, the amount recorded in other comprehensiveincome is recorded in earnings. No material pre-tax gains and losses resultedfrom these cash flow hedges in 2006, 2005 and 2004. See Note 13, AccumulatedOther Comprehensive Income.

**Note 4 -Concentrations of Credit and Other Risk**

Credit risk represents the accounting loss that would be recognized atthe reporting date if counterparties failed to perform as contracted.Concentrations of credit risk (whether on- or off-balance sheet) relate togroups of customers or counterparties that have similar economic or industrycharacteristics that would cause their ability to meet contractual obligationsto be similarly affected by changes in economic or other conditions.

LG&E’s customer receivablesand natural gas and electric revenues arise from deliveries of natural gas toapproximately 324,000 customers and electricity to approximately 398,000customers in Louisville and adjacent areas in Kentucky. For the year endedDecember 31, 2006, 70% of total revenue was derived from electric operationsand 30% from natural gas operations. For the year ended December 31, 2005, 69%of total revenue was derived from electric operations and 31% from natural gasoperations.

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In November 2005, LG&E and IBEW Local 2100 employees, thatrepresent approximately 69% of LG&E’s workforce atFebruary 28, 2007, entered into a three-year collective bargainingagreement with annual benefits re-openers.

**Note 5 - Pension and Other Postretirement Benefit Plans**

LG&E has both funded and unfundednon-contributory defined benefit pension plans and other postretirement benefitplans that together cover substantially all of its employees. The healthcareplans are contributory with participants’ contributions adjusted annually.LG&E uses December 31 as the measurement date for its plans.

**Obligations and Funded Status.**The following tables provide a reconciliationof the changes in the plans’ benefit obligations and fair value of assets overthe three-year period ending December 31, 2006, and a statement of the fundedstatus as of December 31 for LG&E’s sponsored defined benefit plans:
| ** **                                     | ** ** | **Pension Benefits** | ** ** | **Other Postretirement Benefits** | ** ** |
|------------------------------------------------|------------|---------------------------|------------|---------------------------------------------|------------|
| **(in millions)**                         | ** ** | **2006**                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Change  in benefit obligation**              |       |                      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Benefit obligation at beginning of year        |       |                      | $          | 427                                         |       |   |   | $ | 402 |   |   |   | $ | 379 |   |   |   | $ | 106 |   |   |   | $ | 113 |   |   |   | $ | 108 |   |   |
| Service cost                                   |       |                      | 4          |                                        |       |   | 4 |   |   |   | 3 |   |   |   | 1 |   |   |   | 1 |   |   |   | 1 |   |   |
| Interest cost                                  |       |                      | 23         |                                        |       |   | 22 |   |   |   | 23 |   |   |   | 6 |   |   |   | 6 |   |   |   | 7 |   |   |
| Plan amendments                                |       |                      | 4          |                                        |       |   | 3 |   |   |   | 3 |   |   |   | — |   |   |   | 2 |   |   |   | — |   |   |
| Benefits paid                                  |       |                      | (29        | )                                           |       |   | (30 | ) |   |   | (31 | ) |   |   | (8 | ) |   |   | (8 | ) |   |   | (7 | ) |   |
| Actuarial (gain) or loss and other             |       |                      | (21        | )                                           |       |   | 26 |   |   |   | 25 |   |   |   | — |   |   |   | (8 | ) |   |   | 4 |   |   |
| Benefit obligation at end of year              |       |                      | $          | 408                                         |       |   |   | $ | 427 |   |   |   | $ | 402 |   |   |   | $ | 105 |   |   |   | $ | 106 |   |   |   | $ | 113 |   |   |
|                                           |       |                      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Change  in plan assets**                     |       |                      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Fair value of plan assets at beginning of year |       |                      | $          | 333                                         |       |   |   | $ | 338 |   |   |   | $ | 298 |   |   |   | $ | 3 |   |   |   | $ | 1 |   |   |   | $ | 1 |   |   |
| Actual return on plan assets                   |       |                      | 36         |                                        |       |   | 27 |   |   |   | 39 |   |   |   | — |   |   |   | — |   |   |   | (2 | ) |   |
| Employer contributions                         |       |                      | 18         |                                        |       |   | — |   |   |   | 35 |   |   |   | 11 |   |   |   | 10 |   |   |   | 9 |   |   |
| Benefits paid                                  |       |                      | (29        | )                                           |       |   | (30 | ) |   |   | (31 | ) |   |   | (8 | ) |   |   | (8 | ) |   |   | (7 | ) |   |
| Administrative expenses and other              |       |                      | (2         | )                                           |       |   | (2 | ) |   |   | (3 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Fair value of plan assets at end of year       |       |                      | $          | 356                                         |       |   |   | $ | 333 |   |   |   | $ | 338 |   |   |   | $ | 6 |   |   |   | $ | 3 |   |   |   | $ | 1 |   |   |
|                                           |       |                      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Funded status at  end of year                  |       |                      | $          | (52                                         | )          |   |   | $ | (94 | ) |   |   | $ | (64 | ) |   |   | $ | (99 | ) |   |   | $ | (103 | ) |   |   | $ | (112 | ) |   |

 

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**Amounts Recognized in Statement of Financial Position.**The following tablesprovide the amounts recognized in the balance sheet and information for planswith benefit obligations in excess of plan assets as of December 31:

|                                       | ** ** | **PensionBenefits ** | ** ** | **Other Postretirement**    Benefits  | ** ** |
|--------------------------------------------|------------|---------------------------|------------|-----------------------------------------------------------|------------|
| **(in millions)**                     | ** ** | **2006**                  | ** ** | **2005**                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Prior to the  application of SFAS No. 158: |       |                      |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                 | ** ** | ** **                | ** ** |                                                      | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** |   |   |
| Accrued benefit  liability                 |       |                      | $          | (35                                                       | )          |   |   | $ | (77 | ) |   |   | $ | (66 | ) |   |   | $ | (67 | ) |   |
| Intangible asset                           |       |                      | 27         |                                                      |       |   | 31 |   |   |   | — |   |   |   | — |   |   |
| Accumulated other  comprehensive income    |       |                      | 49         |                                                      |       |   | 77 |   |   |   | — |   |   |   | — |   |   |
|                                       |       |                      |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| After the application  of SFAS No. 158:    |       |                      |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                       |       |                      |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Regulatory assets                          |       |                      | 93         |                                                      |       |   | — |   |   |   | 33 |   |   |   | — |   |   |
| Accrued benefit liability  (current)       |       |                      | —     |                                                      |       |   | — |   |   |   | (2 | ) |   |   | — |   |   |
| Accrued benefit liability (non-current)    |       |                      | (52        | )                                                         |       |   | (77 | ) |   |   | (97 | ) |   |   | (67 | ) |   |
|                                            |            |                           |            |                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table shows the calculation of the accrued benefitliability at December 31:

| ** **                          | ** ** | **Pension Benefits ** | ** ** | **Other Postretirement**  Benefits  | ** ** |
|-------------------------------------|------------|---------------------------------|------------|----------------------------------------------------|------------|
| **(in millions)**              | ** ** | **2006**                        | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Funded status                       |       |                            | $          | (52                                                | )          |   |   | $ | (94 | ) |   |   | $ | (99 | ) |   |   | $ | (103 | ) |   |
| Unrecognized prior  service costs   |       |                            | N/A        |                                               |       |   | — |   |   |   | N/A |   |   |   | 10 |   |   |
| Unrecognized actuarial  loss        |       |                            | N/A        |                                               |       |   | 94 |   |   |   | N/A |   |   |   | 21 |   |   |
| Unrecognized transition  obligation |       |                            | N/A        |                                               |       |   | — |   |   |   | N/A |   |   |   | 5 |   |   |
| Other comprehensive  income         |       |                            | N/A        |                                               |       |   | (77 | ) |   |   | N/A |   |   |   | — |   |   |
| Accrued benefit liability           |       |                            | $          | (52                                                | )          |   |   | $ | (77 | ) |   |   | $ | (99 | ) |   |   | $ | (67 | ) |   |

 

Additional year-end information for plans with  accumulated benefit obligations in excess of plan assets:

|                            | ** ** | **Pension Benefits ** | ** ** | **Other Postretirement**  Benefits  | ** ** |
|---------------------------------|------------|---------------------------------|------------|----------------------------------------------------|------------|
| **(in millions)**          | ** ** | **2006**                        | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Benefit  obligation             |       |                            | $          | 408                                                |       |   |   | $ | 427 |   |   |   | $ | 105 |   |   |   | $ | 106 |   |   |
| Accumulated  benefit obligation |       |                            | 391        |                                               |       |   | 410 |   |   |   | — |   |   |   | — |   |   |
| Fair value of plan  assets      |       |                            | 356        |                                               |       |   | 333 |   |   |   | 6 |   |   |   | 3 |   |   |

 

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**Components of Net Periodic Benefit Cost.**The following table provides the componentsof net periodic benefit cost for the plans:

|                                          | ** ** | **Pension Benefits** | ** ** | **Other Postretirement Benefits** | ** ** |
|------------------------------------------|------------|---------------------------|------------|---------------------------------------------|------------|
| **(in millions)**                   | ** ** | **2006**                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                             |       |                      | $          | 4                                           |       |   |   | $ | 4 |   |   |   | $ | 3 |   |   |   | $ | 1 |   |   |   | $ | 1 |   |   |   | $ | 1 |   |   |
| Interest cost                            |       |                      | 23         |                                        |       |   | 22 |   |   |   | 23 |   |   |   | 6 |   |   |   | 5 |   |   |   | 6 |   |   |
| Expected return  on plan assets          |       |                      | (27        | )                                           |       |   | (26 | ) |   |   | (27 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of  prior service costs     |       |                      | 4          |                                        |       |   | 4 |   |   |   | 4 |   |   |   | 2 |   |   |   | 2 |   |   |   | 2 |   |   |
| Amortization of  transitional asset      |       |                      | (1         | )                                           |       |   | (1 | ) |   |   | (1 | ) |   |   | — |   |   |   | 1 |   |   |   | 1 |   |   |
| Amortization of  actuarial loss          |       |                      | 4          |                                        |       |   | 2 |   |   |   | 2 |   |   |   | — |   |   |   | — |   |   |   | 1 |   |   |
| Amortization of  transitional obligation |       |                      | —     |                                        |       |   | — |   |   |   | — |   |   |   | 1 |   |   |   | — |   |   |   | — |   |   |
| Benefit cost at end of  year             |       |                      | $          | 7                                           |       |   |   | $ | 5 |   |   |   | $ | 4 |   |   |   | $ | 10 |   |   |   | $ | 9 |   |   |   | $ | 11 |   |   |

 

The assumptions used in the measurement of LG&E’s pension benefitobligation are shown in the following table:

|                                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  assumptions as of December 31: |       |     |       |     |       |     |       |
| Discount  rate-Union plan                        |       | 5.91     | %          | 5.50     | %          | 5.75     | %          |
| Discount  rate-Non-union plan                    |       | 5.96     | %          | 5.50     | %          | 5.75     | %          |
| Rate of compensation  increase                   |       | 5.25     | %          | 5.25     | %          | 4.50     | %          |

 

The assumptions used in the measurement of LG&E’s net periodicbenefit cost are shown in the following table:

|                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount rate                             |       | 5.50     | %          | 5.75     | %          | 6.25     | %          |
| Expected  long-term return on plan assets |       | 8.25     | %          | 8.25     | %          | 8.50     | %          |
| Rate of compensation  increase            |       | 5.25     | %          | 4.50     | %          | 3.50     | %          |

 

To develop the expected long-term rate of return on assets assumption,LG&E considered the current level of expected returns on risk freeinvestments (primarily government bonds), the historical level of the riskpremium associated with the other asset classes in which the portfolio isinvested and the expectations for future returns of each asset class. Theexpected return for each asset class was then weighted based on the target assetallocation to develop the expected long-term rate of return on assetsassumption for the portfolio.

**Assumed Healthcare Cost Trend Rates.**For measurement purposes, a 10% annualincrease in the per capita cost of covered healthcare benefits was assumed for2006. The rate was assumed to decrease gradually to 5% by 2015 and remain atthat level thereafter.

Assumed healthcare cost trend rates have a significant effect on theamounts reported for the healthcare plans. A 1% change in assumed healthcarecost trend rates would have resulted in an increase or decrease of less than $1million on the 2006 total of service and interest costs components and anincrease or decrease of $3 million in year-end 2006 postretirement benefitobligations.

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**Expected Future Benefit Payments.**The following list provides the amount ofexpected future benefit payments, which reflect expected future service, asappropriate:

|                        | ** ** | ** **  | ** ** | **Other**          | ** ** |
|------------------------|------------|-------------|------------|--------------------|------------|
| ** **             | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
| **(in millions)** | ** ** | **Plans**   | ** ** | **Benefits**       | ** ** |
| 2007                   |       |        | $          | 28                 |       |   |   | $ | 8 |   |   |
| 2008                   |       |        | $          | 28                 |       |   |   | $ | 9 |   |   |
| 2009                   |       |        | $          | 27                 |       |   |   | $ | 9 |   |   |
| 2010                   |       |        | $          | 26                 |       |   |   | $ | 9 |   |   |
| 2011                   |       |        | $          | 25                 |       |   |   | $ | 9 |   |   |
| 2012-16                |       |        | $          | 124                |       |   |   | $ | 44 |   |   |

 

**Plan Assets.**The following table shows LG&E’s weighted-average asset allocationby asset category at December 31:

|                    | ** ** | **Target Range** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------|------------|-----------------------|------------|----------|------------|----------|------------|----------|------------|
| Pension Plans:     |       |                  |       |     |       |     |       |     |       |
| Equity  securities |       | 4  5%- 75%            |       |     | 61         | %        |       |     | 57         | % |   |   | 66 | % |   |
| Debt securities    |       | 30%  - 50%            |       |     | 39         | %        |       |     | 42         | % |   |   | 33 | % |   |
| Other              |       | 0%  - 10%             |       |     | 0          | %        |       |     | 1          | % |   |   | 1 | % |   |
| Totals             |       |                  |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

 

The investment policy of the pension plans was developed in conjunctionwith financial consultants, investment advisors and legal counsel. The goal ofthe investment policy is to preserve the capital of the fund and maximizeinvestment earnings. The return objective is to exceed the benchmark return forthe policy index comprised of the following: Russell 3000 Index, MSCI-EAFE Index, Lehman Aggregate and Lehman LongDuration Gov/Corporate Bond Index in proportions equal to the targeted assetallocation.

**Evaluation of performance focuseson a long-term investment time horizon of at least three to five years or acomplete market cycle. The assets of the pension plans are broadly diversifiedwithin different asset classes (equities, fixed income securities and cashequivalents).**

To minimize the risk of large losses in asingle asset class, no more than 5% of the portfolio will be invested in thesecurities of any one issuer with the exclusion of the U.S. government and itsagencies. The equity portion of the fund is diversified among the market’svarious subsections to diversify risk, maximize returns and avoid undueexposure to any single economic sector, industry group or individual security.The equity subsectors include, but are not limited to, growth, value, smallcapitalization and international.

In addition, the overall fixed incomeportfolio may have an average weighted duration, or interest rate sensitivitywhich is within +/- 20% of the duration of the overall fixed income benchmark.Foreign bonds in the aggregate shall not exceed 10% of the total fund. Theportfolio may include a limited investment of up to 20% in below investmentgrade securities provided that the overall average portfolio quality remains “AA”or better. The below investment grade securities include, but are not limitedto, medium-term notes, corporate debt, non-dollar and emerging market debt andasset backed securities. The cash investments should be in securities thateither are of short maturities (not to exceed 180 days) or readily marketablewith modest risk.

Derivative securities are permitted only to improve the portfolio’srisk/return profile, to modify the portfolio’s duration or to reduce transactioncosts and must be used in conjunction with underlying physical assets in theportfolio. Derivative securities that involve speculation, leverage, interestrate anticipation, or any undue risk whatsoever are not deemed appropriateinvestments.

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The investment objective for the postretirement benefit plan is toprovide current income consistent with stability of principal and liquiditywhile maintaining a stable net asset value of $1.00 per share. Thepostretirement funds are invested in a prime cash money market fund thatinvests primarily in a portfolio of short-term, high-quality fixed incomesecurities issued by banks, corporations and the U.S. government.

**Contributions.**LG&E made discretionary contributions tothe pension plan of $18 million in January 2006 and $35 million in January2004. There were no contributions during 2005. LG&E made an additionaldiscretionary contribution to the pension plan of $56 million in January 2007,which was slightly more than the $52 million accrued benefit liability as ofDecember 31, 2006. LG&E does not expect to make any further contributionsin 2007. See Note 15, Subsequent Events.

In addition, LG&E made contributions to other postretirementbenefit plans of approximately $11 million, $10 million and $9 million in 2006,2005 and 2004, respectively. In 2007, LG&E anticipates making voluntarycontributions to fund the Voluntary Employee Beneficiary Association (VEBA)trusts to match the annual postretirement expense and funding the 401(h) planup to certain maximum applicable amounts under law or regulation.

**Pension Legislation.**The Pension Protection Act of 2006 was enacted in August 2006. The newrules are generally effective for plan years beginning after 2008. Among othermatters, this comprehensive legislation contains provisions applicable todefined benefit plans which generally (i) mandate 100% funding of currentliabilities within seven years; (ii) increase tax-deduction levels regardingcontributions; (iii) revise certain actuarial assumptions, such as mortalitytables and discount rates; and (iv) raise federal insurance premiums and otherfees for under-funded and distressed plans. The legislation also containssimilar provisions relating to defined-contribution plans and qualified andnon-qualified executive pension plans and other matters. While LG&Econtinues to examine the potential impacts of the Pension Protection Act of2006, its $56 million contribution in January 2007 was slightly more than theaccrued benefit liability as of December 31, 2006.

**FSP 106-2.**FSP106-2, *Accounting and Disclosure Requirements Related tothe Medicare Prescription Drug Improvement and Modernization Act of 2003*,which provided guidance on accounting for subsidies provided under the MedicareAct, was effective for the first interim or annual period beginning after June15, 2004. The impact of the subsidy in 2004 was a reduction in the accumulatedpostretirement benefit obligation of $3 million. The effect of the subsidy onthe measurement of the net periodic postretirement benefit cost was less than$1 million.

**Thrift Savings Plans.**LG&E has a thrift savings plan under section401(k) of the IRC. Under the plan, eligible employees may defer and contributeto the plan a portion of current compensation in order to provide futureretirement benefits. LG&E makes contributions to the plan by matching aportion of the employee contributions. The costs of this matching wereapproximately $2 million for 2006 and $1 million for 2005 and 2004,respectively.

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**Note 6 -Income Taxes**

Components ofincome tax expense are shown in the table below:
| **(in millions)**                | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Current                               |       | - federal            |       |     | $          | 60       |       |   |   | $ | 73 |   |   |   | $ | 34 |   |   |
|                                  |       | - state              |       |     | 11         |     |       |   | 10 |   |   |   | 13 |   |   |
| Deferred                              |       | - federal — net |       |     | (7         | )        |       |   | (12 | ) |   |   | 11 |   |   |
|                                  |       | - state — net   |       |     | (1         | )        |       |   | (2 | ) |   |   | (1 | ) |   |
| Investment tax credit — deferred |       |                 | 3          |     |       |     | —     |   |   |   | — |   |   |
| Amortization of investment tax credit |       |                 | (4         | )        |       |     | (4         | ) |   |   | (4 | ) |   |
|                                  |       |                 |       |     |       |     |       |   |   |   |   |   |   |
| Total income tax  expense             |       |                 | $          | 62       |       |     |       | $ | 65 |   |   |   | $ | 53 |   |   |

 

Deferred federal income tax expense during 2004 included significantdeductions attributable to federal bonus depreciation which ended afterDecember 2004.

In June 2006, LG&E and KU filed a joint application with the DOErequesting certification to be eligible for investment tax credits applicableto the construction of TC2. The EPAct 2005 added Section 48A to the InternalRevenue Code, which provides for an investment tax credit to promote thecommercialization of advanced coal technologies that will generate electricityin an environmentally responsible manner. LG&E’s and KU’s applicationrequested up to a maximum amount of “advanced coal project” credit allowed pertaxpayer, or $125 million, based on an estimate of 15% of projected qualifyingTC2 expenditures.

In November 2006, the DOE and Internal Revenue Service announced thatLG&E and KU were selected to receive the tax credit. LG&E’s portion ofthe tax credit will be approximately $24 million over the construction periodof TC2. This tax credit will be amortized to income over the life of therelated property. In 2006, based on eligible construction expenditures incurredin 2006, LG&E recorded a federal investment tax credit, decreasing currentfederal income taxes in 2006 by $3 million.

H. R.4520, known as the “American Jobs Creation Act of 2004” allows electricutilities to take a deduction of up to 3% of their qualified productionactivities income starting in 2005. This deduction reduced LG&E’s effectivetax rate by less than 1% for 2006.

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Components of netdeferred tax liabilities included in the balance sheet are shown below:

| (in millions)                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  liabilities:                 |       |     |       |     |       |
| Depreciation and other plant-related items |       | $        | 367        |     | $          | 391 |   |
| Regulatory assets and other                |       | 22       |       | 23       |       |
| Pension and related benefits               |       | 6        |       | —   |       |
| Total deferred tax liabilities             |       | 395      |       | 414      |       |
|                                       |       |     |       |     |       |
| Deferred tax  assets:                      |       |     |       |     |       |
| Investment tax credit                      |       | 15       |       | 17       |       |
| Income taxes due to customers              |       | 21       |       | 17       |       |
| Pensions and related benefits              |       | —   |       | 39       |       |
| Liabilities and other                      |       | 26       |       | 19       |       |
| Total deferred tax assets                  |       | 62       |       | 92       |       |
|                                       |       |     |       |     |       |
| Net deferred  income tax liability         |       | $        | 333        |     | $          | 322 |   |

 

A reconciliationof differences between the statutory U.S. federal income tax rate and LG&E’s effective income tax ratefollows:

|                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory  federal income tax rate          |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| State income  taxes, net of federal benefit |       | 3.8      |       | 4.3      |       | 5.3      |       |
| Reduction of  income tax accruals           |       | (0.4     | )          | (2.0     | )          | (0.7     | )          |
| Amortization of  investment tax credits     |       | (2.2     | )          | (2.1     | )          | (3.6     | )          |
| Other differences                           |       | (1.6     | )          | (1.7     | )          | (0.4     | )          |
|                                        |       |     |       |     |       |     |       |
| Effective income tax rate                   |       | 34.6     | %          | 33.5     | %          | 35.6     | %          |

 

State income taxes net of federal benefit in 2006 reflect Kentucky CoalTax Credits earned.

Other differences primarily relate to excessdeferred taxes which reflect the benefits of deferred taxes reversing at taxrates that differ from statutory rates and various other permanent differences.

In September 2005, LG&E received noticefrom the Congressional Joint Committee on Taxation approving the InternalRevenue Service’s audit of LG&E’s income tax returns for the periodsDecember 1999 through December 2003. As a result of resolving numerous taxmatters during these periods, LG&E reduced income tax accruals by $4million during 2005.

Kentucky House Bill 272,also known as “Kentucky’s Tax Modernization Plan”, was signed into law in March2005. This bill contains a number of changes in Kentucky’s tax system,including the reduction of the Corporate income tax rate from 8.25% to 7%effective January 1, 2005, and a further reduction to 6% effective January 1,2007. As a result of the income tax rate change, LG&E’s deferred taxreserve amount will exceed its actual deferred tax liability attributable toexisting temporary differences, since the new statutory rates are lower thanthe rates were when the deferred tax liability originated. This excess amountis referred to as excess deferred income taxes. In June 2005 and December 2006,LG&E received approval from the Kentucky Commission to establish andamortize a regulatory liability ($16 million) for its net excess deferredincome tax balances. LG&E will amortize its depreciation-related excessdeferred income tax balances under the average rate assumption method. Theaverage rate assumption method matches the amortization of the excess deferred 

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income taxes with the lifeof the timing differences to which they relate. Excess deferred income taxbalances related to non-depreciation timing differences were expensed in 2005and 2006 due to their immaterial amount.

LG&E expects to have adequate levels oftaxable income to realize its recorded deferred tax assets.

**Note 7 -Long-Term Debt**

As of December 31,2006 and 2005, long-term debt and the current portion of long-term debt consistprimarily of pollution control bonds and long-term loans from affiliatedcompanies as summarized below.

|                                    | ** ** | **Stated**              | ** ** | ** **     | ** ** | **Principal** | ** ** |
|------------------------------------|------------|-------------------------|------------|----------------|------------|---------------|------------|
| **(in millions)**             | ** ** | **Interest Rates** | ** ** | **Maturities** | ** ** | **Amounts**   | ** ** |
| Outstanding at  December 31, 2006: |       |                    |       |           |       |          |       |
| Noncurrent  portion                |       | Variable  - 5.875       | %          | 2008-2035      |       | $             | 572        |   |
| Current portion                    |       | Variable                |       | 2007-2027      |       | 248           |       |
| Outstanding at December 31, 2005:  |       |                    |       |           |       |          |       |
| Noncurrent  portion                |       | Variable  - 5.875       | %          | 2008-2035      |       | $             | 573        |   |
| Current portion                    |       | Variable                |       | 2006-2027      |       | 248           |       |

 

Under the provisions for LG&E’s variable-rate pollutioncontrol bonds, Series S, T, U, BB, CC, DD and EE, the bonds are subject totender for purchase at the option of the holder and to mandatory tender forpurchase upon the occurrence of certain events, causing the bonds to beclassified as current portion of long-term debt in the balance sheets. Theaverage annualized interest rate for these bonds during 2006 and 2005 was 3.50%and 2.50%, respectively.

Pollution control seriesbonds are first mortgage bonds that have been issued by LG&E in connectionwith tax-exempt pollution control revenue bonds issued by various governmentalentities, principally counties in Kentucky. A loan agreement obligates LG&Eto make debt service payments to the county that equate to the debt service duefrom the county on the related pollution control revenue bonds. The county’sdebt is also secured by LG&E’s first mortgage bonds of an equal amount (thepollution control series bonds) that are pledged to the trustee for thepollution control revenue bonds, and that matches the terms and conditions ofthe county’s debt, but require no payment of principal and interest unlessLG&E defaults on the loan agreement.

Substantially allof LG&E’s utilityassets are pledged as collateral for its first mortgage bonds. LG&E’s first mortgage bondindenture, as supplemented, provides that portions of retained earnings willnot be available for the payment of dividends on common stock, under certainspecified conditions. No portion of retained earnings was restricted by thisprovision as of either December 31, 2006 or 2005.

Interest rate swaps are used to hedge LG&E’s underlying variable-ratedebt obligations. These swaps hedge specific debt issuances and, consistentwith management’s designation, are accorded hedge accounting treatment. Theswaps exchange floating-rate interest payments for fixed rate interest paymentsto reduce the impact of interest rate changes on LG&E’s pollution control bonds. As of December 31, 2006 and2005, LG&E had swaps with an aggregate notional value of $211million. See Note 3, FinancialInstruments.

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Redemptions and maturities of long-term debt for 2006, 2005 and 2004are summarized below:

| ($ in millions) | ** ** | ** **                              | ** ** | **Principal** | ** ** | ** ** | ** ** | **Secured/**  | ** ** | ** **   | ** ** |
|---------------------------|------------|-----------------------------------------|------------|---------------|------------|------------|------------|---------------|------------|--------------|------------|
| **Year**                  | ** ** | **Description**                         | ** ** | **Amount**    | ** ** | **Rate**   | ** ** | **Unsecured** | ** ** | **Maturity** | ** ** |
| 2006                      |       | Mandatorily  Redeemable Preferred Stock |       |          | $          | 1          |       |          |       | 5.875        | %          |   | Unsecured |   | Jul | 2006 |   |
| 2005                      |       | Pollution  control bonds                |       |          | $          | 40         |       |          |       | 5.90         | %          |   | Secured |   | Apr | 2023 |   |
| 2005                      |       | Due to Fidelia                          |       |          | $          | 50         |       |          |       | 1.53         | %          |   | Secured |   | Jan | 2005 |   |
| 2005                      |       | Mandatorily  Redeemable Preferred Stock |       |          | $          | 1          |       |          |       | 5.875        | %          |   | Unsecured |   | Jul | 2005 |   |
| 2004                      |       | Due to Fidelia                          |       |          | $          | 50         |       |          |       | 1.53         | %          |   | Secured |   | Jan | 2005 |   |
| 2004                      |       | Mandatorily Redeemable  Preferred Stock |       |          | $          | 1          |       |          |       | 5.875        | %          |   | Unsecured |   | Jul | 2004 |   |

 

LG&Edid not issue any new long-term debt in 2006. Issuances of long-term debt for2005 and 2004 are summarized below:

| ($ in millions) | ** ** | ** **               | ** ** | **Principal** | ** ** | ** ** | ** ** | **Secured/**  | ** ** | ** **   | ** ** |
|---------------------------|------------|--------------------------|------------|---------------|------------|------------|------------|---------------|------------|--------------|------------|
| **Year**                  | ** ** | **Description**          | ** ** | **Amount**    | ** ** | **Rate**   | ** ** | **Unsecured** | ** ** | **Maturity** | ** ** |
| 2005                      |       | Pollution  control bonds |       |          | $          | 40         |       |          | Variable   |         | Secured    |   | Feb | 2035 |   |
| 2004                      |       | Due to Fidelia           |       |          | $          | 25         |       |          | 4.33%      |         | Secured    |   | Jan | 2012 |   |
| 2004                      |       | Due to Fidelia           |       |          | $          | 100        |       |          | 1.53%      |         | Secured    |   | Jan | 2005 |   |

 

LG&E has existing $5.875 series mandatorily redeemable preferredstock outstanding having a current redemption price of $100 per share. Thepreferred stock has a sinking fund requirement sufficient to retire a minimumof 12,500 shares on July 15 of each year commencing with July 15, 2003, and theremaining 187,500 shares on July 15, 2008 at $100 per share. LG&E redeemed12,500 shares in accordance with these provisions on July 15, 2006, 2005, 2004and 2003, leaving 200,000 shares currently outstanding.

# Long-term debtmaturities for LG&E are shown in the following table:

| (in millions) | ** ** | ** ** | ** ** |
|--------------------|------------|------------|------------|
| 2007               |       | $          | 1          |   |
| 2008               |       | 19         |       |
| 2009-11            |       | —     |       |
| Thereafter         |       | 800        | (a)        |
| Total              | ** ** | $          | 820        | ** ** |

 

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(a) Includeslong-term debt of $246 million classified as current liabilities because thesebonds are subject to tender for purchase at the option of the holder and tomandatory tender for purchase upon the occurrence of certain events. Maturitydates for these bonds range from 2013 to 2027. LG&E does not expect to paythese amounts in 2007.

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**Note 8 -Notes Payable and Other Short-Term Obligations**

LG&Eparticipates in an intercompany money pool agreement wherein E.ON U.S. and/orKU make funds available to LG&E at market-based rates (based on an index ofhighly rated commercial paper issues) up to $400 million.
| ** **                    | ** ** | **Total Money**    | ** ** | **Amount**      | ** ** | **Balance**   | ** ** | **Average**            | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------|------------|---------------|------------|------------------------|------------|
| **($ in millions)** | ** ** | **Pool Available** | ** ** | **Outstanding** | ** ** | **Available** | ** ** | **Interest Rate** | ** ** |
| December 31, 2006             |       |                    | $          | 400             |       |          |       | $                      | 68         |   |   |   | $ | 332 |   |   |   | 5.25 | % |   |
| December 31, 2005             |       |                    | $          | 400             |       |          |       | $                      | 141        |   |   |   | $ | 259 |   |   |   | 4.21 | % |   |

 

At December 31, 2006 and 2005, E.ON U.S. maintained a revolving creditfacility totaling $200 million with an affiliated company, E.ON North America,Inc., to ensure funding availability for the money pool. The balance is asfollows:
| ** **                    | ** ** | **Total**     | ** ** | **Amount**      | ** ** | **Balance**   | ** ** | **Average**            | ** ** |
|-------------------------------|------------|---------------|------------|-----------------|------------|---------------|------------|------------------------|------------|
| **($ in millions)** | ** ** | **Available** | ** ** | **Outstanding** | ** ** | **Available** | ** ** | **Interest Rate** | ** ** |
| December 31, 2006             |       |          | $          | 200             |       |          |       | $                      | 102        |   |   |   | $ | 98 |   |   |   | 5.49 | % |   |
| December 31, 2005             |       |          | $          | 200             |       |          |       | $                      | 105        |   |   |   | $ | 95 |   |   |   | 4.49 | % |   |

 

During June 2006,LG&E renewed five revolving lines of credit with banks totaling $185million. These credit facilities expire in June 2007, and there was nooutstanding balance under any of these facilities at December 31, 2006 and2005.

The covenantsunder these revolving lines of credit include:

·                  Thedebt/total capitalization ratio must be less than 70%;

·                  E.ONAG must own at least 66.667% of voting stock of LG&E directly orindirectly;

·                  Thecorporate credit rating of the Company must be at or above BBB- and Baa3; and

·                  Alimitation on disposing of assets aggregating more than 15% of total assets asof December 31, 2005.

**Note 9 -Commitments and Contingencies**

**OperatingLeases.**LG&E leasesoffice space, office equipment and vehicles and accounts for theseleases as operating leases. Total leaseexpense for 2006, 2005 and 2004, less amounts contributed by affiliatedcompanies occupying a portion of the office space leased by LG&E, was $5million for 2006 and $3 million each for 2005 and 2004. The future minimumannual lease payments for operating leases for years subsequent to December 31,2006, are shown in the following table:

| (in millions) | ** ** | ** ** | ** ** |
|--------------------|------------|------------|------------|
| 2007               |       | $          | 2          |   |
| 2008               |       | 2          |       |
| 2009               |       | 2          |       |
| 2010               |       | 2          |       |
| 2011               |       | 2          |       |
| Thereafter         |       | 8          |       |
|               |       |       |       |
| Total              |       | $          | 18         |   |

** **

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**Sale and Leaseback Transaction.**LG&Eis a participant in a sale and leaseback transaction involving its 38% interestin two jointly-owned combustion turbines at KU’s E.W. Brown generating station(Units 6 and 7). Commencing in December 1999, LG&E and KU entered into atax-efficient, 18-year lease of the combustion turbines. LG&E and KU haveprovided funds to fully defease the lease, and have executed an irrevocablenotice to exercise an early purchase option contained in the lease after 15.5years. The financial statement treatment of this transaction is no differentthan if LG&E had retained its ownership. The leasing transaction wasentered into following receipt of required state and federal regulatoryapprovals.

In case of default under the lease, LG&E isobligated to pay to the lessor its share of certain fees or amounts. Primaryevents of default include loss or destruction of the combustion turbines,failure to insure or maintain the combustion turbines and unwinding of thetransaction due to governmental actions. No events of default currently existwith respect to the lease. Upon any termination of the lease, whether bydefault or expiration of its term, title to the combustion turbines revertsjointly to LG&E and KU.

At December 31, 2006, the maximum aggregate amount ofdefault fees or amounts was $9 million, of which LG&E would be responsiblefor 38% (approximately $3 million). LG&E has made arrangements with E.ONU.S., via guarantee and regulatory commitment, for E.ON U.S. to pay LG&E’sfull portion of any default fees or amounts.

**Letters of Credit.**LG&E hasprovided letters of credit totaling $3 million to support certain obligationsrelated to landfill reclamation and a letter of credit totaling less than $1million to support certain obligations related to workers’ compensation.

**PurchasedPower.**LG&E has a contract for purchased power with OVECfor various Mw capacities. LG&E has an investment of 5.63% ownership inOVEC’s common stock, which is accounted for on the cost method of accounting.LG&E’s share of OVEC’s output is 5.63%, approximately 124 Mw of generationcapacity. Future obligations for powerpurchases are shown in the following table:

| (in millions) | ** ** | ** ** | ** ** |
|--------------------|------------|------------|------------|
| 2007               |       | $          | 11         |   |
| 2008               |       | 13         |       |
| 2009               |       | 16         |       |
| 2010               |       | 17         |       |
| 2011               |       | 17         |       |
| Thereafter         |       | 328        |       |
|               |       |       |       |
| Total              |       | $          | 402        |   |

 

**Construction Program.**LG&E had approximately $180 million ofcommitments in connection with its construction program at December 31, 2006.

InJune 2006, LG&E and KU entered into a construction contract regarding theTC2 project. The contract is generally in the form of a lump-sum,turnkey agreement for the design, engineering, procurement, construction,commissioning, testing and delivery of the project, according to designatedspecifications, terms and conditions. The contract price and its components aresubject to a number of potential adjustments which may serve to increase ordecrease the ultimate construction price paid or payable to the contractor. Thecontract also contains standard representations, covenants, indemnities,termination and other provisions for arrangements of this type, includingtermination for convenience or for cause rights.

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**Environmental Matters.**LG&E’s operations are subject to a numberof environmental laws and regulations, governing, among other things, airemissions, wastewater discharges, the use, handling and disposal of hazardoussubstances and wastes, soil and groundwater contamination and employee healthand safety.

*Clean Air Act Requirements.*The Clean Air Act establishes a comprehensiveset of programs aimed at protecting and improving air quality in the UnitedStates by, among other things, controlling stationary sources of air emissionssuch as power plants. While the general regulatory framework for these programsis established at the federal level, most of the programs are implemented andadministered by the states under the oversight of the EPA. The key Clean AirAct programs relevant to LG&E’s business operations are described below.

*Ambient Air Quality.* The Clean Air Act requires the EPA toperiodically review the available scientific data for six criteria pollutantsand establish concentration levels in the ambient air sufficient to protect thepublic health and welfare with an extra margin for safety. These concentrationlevels are known as national ambient air quality standards (“NAAQS”). Eachstate must identify “nonattainment areas” within its boundaries that fail tocomply with the NAAQS and develop a State Implementation Plan (“SIP”) to bringsuch nonattainment areas into compliance. If a state fails to develop anadequate plan, the EPA must develop and implement a plan. As the EPA increasesthe stringency of the NAAQS through its periodic reviews, the attainment statusof various areas may change, thereby triggering additional emission reductionobligations under revised SIPs aimed to achieve attainment.

In 1997, the EPA establishednew NAAQS for ozone and fine particulates that required additional reductionsin SO2 andNOx emissions from power plants. In 1998, the EPA issued its final “NOx SIPCall” rule requiring reductions in NOx emissions of approximately 85 percentfrom 1990 levels in order to mitigate ozone transport from the midwestern U.S.to the northeastern U.S. To implement the new federal requirements, in 2002,Kentucky amended its SIP to require electric generating units to reduce theirNOx emissions to 0.15 pounds weight per MMBtu on a company-wide basis. In 2005,the EPA issued the CAIR which requires additional SO2 emission reductions of 70 percent and NOxemission reductions of 65 percent from 2003 levels. The CAIR provides for atwo-phase cap and trade program, with initial reductions of NOx and SO2 emissions due by 2009 and 2010,respectively, and final reductions due by 2015. The final rule is currentlyunder challenge in a number of federal court proceedings. In 2006, Kentuckyproposed to amend its SIP to adopt state requirements similar to those underthe federal CAIR. Depending on the level of action determined necessary tobring local nonattainment areas into compliance with the new ozone and fineparticulate standards, LG&E’s power plants are potentially subject toadditional reductions in SO2 andNOx emissions.

*Hazardous Air Pollutants.* As provided in the 1990 amendments to theClean Air Act, the EPA investigated hazardous air pollutant emissions fromelectric utilities and submitted a report to Congress identifying mercuryemissions from coal-fired power plants as warranting further study. In 2005,the EPA issued the CAMR establishing mercury standards for new power plants andrequiring all states to issue new SIPs including mercury requirements forexisting power plants. The EPA issued a model rule which provides for atwo-phase cap and trade program with initial reductions due by 2010 and finalreductions due by 2018. The CAMR provides for reductions of 70 percent from2003 levels. The EPA closely integrated the CAMR and CAIR programs to ensurethat the 2010 mercury reduction targets will be achieved as a “co-benefit” ofthe controls installed for purposes of compliance with the CAIR. The final ruleis also currently under challenge in the federal courts. In 2006, Kentuckyproposed to amend its SIP to adopt state requirements similar to those underthe federal CAMR. In addition, in 2005 and 2006, state and local air agenciesin Kentucky have proposed or adopted rules aimed at regulating additionalhazardous air pollutants from sources including power plants. To the extentthose rules are final, they are not expected to have a material impact onLG&E’s power plant operations.

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*Acid Rain Program.*****The 1990 amendments to the Clean Air Act**imposed a two-phased cap and trade program to reduce SO2 emissions from power plants thatwere thought to contribute to “acid rain” conditions in the northeastern U.S.The 1990 amendments also contained requirements for power plants to reduce NOxemissions through the use of available combustion controls.

*Regional Haze.* The Clean Air Act also includes visibilitygoals for certain federally designated areas, including national parks, andrequires states to submit SIPs that will demonstrate reasonable progress towardpreventing future impairment and remedying any existing impairment ofvisibility in those areas. In 2005, the EPA issued its Clean Air VisibilityRule detailing how the Clean Air Act’s best available retrofit technology (“BART”)requirements will be applied to facilities, including power plants, builtbetween 1962 and 1974 that emit certain levels of visibility impairingpollutants. Under the final rule, as the CAIR will result in more visibilityimprovement than BART, states are allowed to substitute CAIR requirements intheir regional haze SIPs in lieu of controls that would otherwise be requiredby BART. The final rule has been challenged in the courts.

*Installation of PollutionControls.*Many of theprograms under the Clean Air Act utilize cap and trade mechanisms that requirea company to hold sufficient emissions allowances to cover its authorizedemissions on a company-wide basis and do not require installation of pollutioncontrols on every generating unit. Under cap and trade programs, companies arefree to focus their pollution control efforts on plants where such controls areparticularly efficient and utilize the resulting emission allowances forsmaller plants where such controls are not cost effective. LG&E hadpreviously installed flue gas desulfurization equipment on all of itsgenerating units prior to the effective date of the acid rain program. LG&E’sstrategy for its Phase II SO2 requirements, which commenced in 2000, is touse accumulated emissions allowances to defer additional capital expendituresand LG&E will continue to evaluate improvements to further reduce SO2 emissions. In order to achievethe NOx emission reductions mandated by the NOx SIP Call, LG&E installedadditional NOx controls, including selective catalytic reduction technology,during the 2000 to 2006 time period at a cost of $187 million. In 2001, theKentucky Commission granted recovery in principal of these costs incurred byLG&E under its periodic environmental surcharge review mechanisms.

In order to achieve theemissions reductions mandated by the CAIR and CAMR, LG&E expects to incuradditional operating and maintenance costs in operating such controls. In 2005,the Kentucky Commission granted recovery in principal of these costs incurredby LG&E under its periodic environmental surcharge review mechanisms.LG&E believes its costs in reducing SO2,NOx and mercury emissions to be comparable to those of similarly situatedutilities with like generation assets. LG&E’s compliance plans are subjectto many factors including developments in the emission allowance and fuelsmarkets, future legislative and regulatory enactments, legal proceedings andadvances in clean air technology. LG&E will continue to monitor thesedevelopments to ensure that its environmental obligations are met in the mostefficient and cost-effective manner.

*Potential GHG Controls.*****In2005, the Kyoto Protocol for reducing GHG emissions took effect, obligating 37industrialized countries to undertake substantial reductions in GHG emissions.The U.S. has not ratified the Kyoto Protocol and there are currently nomandatory GHG emission reduction requirements at the federal level. Legislationmandating GHG reductions has been introduced in the Congress, but no federallegislation has been enacted to date. In the absence of a program at thefederal level, various states have adopted their own GHG emission reductionprograms. Such programs have been adopted in various states including 11northeastern U.S. states under the Regional GHG Initiative program andCalifornia. Substantial efforts to pass federal GHG legislation are ongoing. Inaddition, litigation is currently pending before various courts to determinewhether the EPA and the states have the authority to regulate GHG emissionsunder existing law. LG&E is monitoring ongoing efforts to enact GHGreduction requirements at the state and federal level. LG&E is unable topredict whether mandatory GHG reduction requirements will ultimately be enactedor to determine the reduction

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targets and deadlines thatwould be applicable under such programs. As a Company with significantcoal-fired generating assets, LG&E could be substantially impacted byprograms requiring mandatory reductions in GHG emissions, although the preciseimpact on the operations of LG&E cannot be determined prior to theenactment of such programs.

*General EnvironmentalProceedings.*****From time to time, LG&E appears beforethe EPA, various state or local regulatory agencies and state and federalcourts regarding matters involving compliance with applicable environmentallaws and regulations. Such matters include remediation obligations for formerMGP sites; liability under the Comprehensive Environmental Response,Compensation and Liability Act for cleanup at various off-site waste sites;ongoing claims regarding alleged particulate emissions from LG&E’s Cane Runstation; and ongoing claims regarding GHG emissions from LG&E’s generatingstations. With respect to the former MGP sites, LG&E has estimated that itcould incur additional costs of less than $1 million for remaining clean-upactivities under existing approved plans or agreements. An accrual for thisamount had been recorded in the accompanying financial statements at December31, 2005, which accrual was reversed as of December 31, 2006 upon theevaluation that the likelihood of such occurrence is remote. Based on analysisto date, the resolution of the other matters is also not expected to have amaterial impact on the operations of LG&E.

**Note 10 -Jointly Owned Electric Utility Plant**

LG&E owns a 75% undivided interest in TC1 which the KentuckyCommission has allowed to be reflected in customer rates. Of theremaining 25% of the Unit, IMEA owns a 12.12% undivided interest, and IMPA ownsa 12.88% undivided interest. Each company is responsible for its proportionateownership share of fuel cost, operation and maintenance expenses andincremental assets. The following datarepresent shares of the jointly owned property:                                                            

|                     | ** ** | **TC1**      | ** ** |
|---------------------|------------|--------------|------------|
| ** **          | ** ** | **LG&E** | ** ** | **IMPA** | ** ** | **IMEA** | ** ** | **Total** | ** ** |
| Ownership  interest |       | 75           | %          | 12.88 | % | 12.12 | % | 100 | % |
| Mw capacity         |       | 383          |       | 66 |   | 62 |   | 511 |   |

 

| (in millions)                                 | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|------------|
| LG&E’s 75% ownership:                     |       |       |       |
| Cost                                               |       | $          | 604        |   |
| Accumulated depreciation                           |       | (231       | )          |
| Net book value                                     |       | $          | 373        |   |
|                                               |       |       |       |
| Construction work in  progress (included in above) |       | $          | 9          |   |

 

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LG&E and KU have begun construction of another jointly owned unitat the Trimble County site. LG&Eand KU own undivided 14.25% and 60.75% interests, respectively, in TC2. Of theremaining 25% of TC2, IMEA owns a 12.12% undivided interest and IMPA owns a12.88% undivided interest. Each company is responsible for its proportionateshare of capital cost during construction, and fuel, operation and maintenancecost when TC2 begins operation, which is expected to occur in 2010.

|                     | ** ** | **TC2**      | ** ** |
|---------------------|------------|--------------|------------|
| ** **          | ** ** | **LG&E** | ** ** | **KU** | ** ** | **IMPA** | ** ** | **IMEA** | ** ** | **Total** | ** ** |
| Ownership  interest |       | 14.25        | %          | 60.75 | % | 12.88 | % | 12.12 | % | 100 | % |
| Mw capacity         |       | 107          |       | 455 |   | 97 |   | 91 |   | 750 |   |

 

| (in millions)             | ** ** | **LG&E** | ** ** | **KU** |
|--------------------------------|------------|--------------|------------|--------|
| Construction  work in progress |       | $            | 25         |   | $ | 96 |
|                                |            |              |            |        |  |  |

 

LG&E and KUjointly own the following combustion turbines and related equipment:
| **($ in millions)**       | ** ** | **LG&E**     | ** ** | **KU**        | ** ** | **Total**                | ** ** |
|-------------------------------------|------------|------------------|------------|---------------|------------|--------------------------|------------|
| ** Ownership Percentage** | ** ** | **Mw  Capacity** | ** ** | **($)  Cost** | ** ** | **($)  Depre-  ciation** | ** ** | **($)  Net  Book  Value** | ** ** | **Mw  Capacity** | ** ** | **($)  Cost** | ** ** | **($)  Depre-  ciation** | ** ** | **($)  Net  Book  Value** | ** ** | **Mw  Capacity** | ** ** | **($)  Cost** | ** ** | **($)  Depre-  ciation** | ** ** | **($)  Net  Book  Value** | ** ** |
|  LG&E 53%, KU 47% (1)      |       | 146              |       | 58            |       | (10                      | )          | 48 |   | 129 |   | 51 |   | (10 | ) | 41 |   | 275 |   | 109 |   | (20 | ) | 89 |   |
|  LG&E 38%, KU 62% (2)      |       | 118              |       | 46            |       | (8                       | )          | 38 |   | 190 |   | 72 |   | (12 | ) | 60 |   | 308 |   | 118 |   | (20 | ) | 98 |   |
|  LG&E 29%, KU 71% (3)      |       | 92               |       | 32            |       | (4                       | )          | 28 |   | 228 |   | 80 |   | (12 | ) | 68 |   | 320 |   | 112 |   | (16 | ) | 96 |   |
|  LG&E 37%, KU 63% (4)      |       | 236              |       | 79            |       | (8                       | )          | 71 |   | 404 |   | 137 |   | (12 | ) | 125 |   | 640 |   | 216 |   | (20 | ) | 196 |   |
|  LG&E 29%, KU 71% (5)      |       | n/a              |       | 3             |       | (0                       | )          | 3 |   | n/a |   | 9 |   | (1 | ) | 8 |   | n/a |   | 12 |   | (1 | ) | 11 |   |

 

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(1) Comprised ofPaddy’s Run 13 and E.W. Brown 5.  Inaddition to the above jointly owned utility plant, there is an inlet aircooling system attributable to Unit 5 and Units 8-11 at the E.W. Brownfacility. This inlet air cooling system is not jointly owned, however it isused to increase production on the units to which it relates, resulting in anadditional 10Mw of capacity for LG&E.

(2) Comprised ofunits 6 and 7 at the E.W. Brown facility.

(3) Comprised ofunits 5 and 6 at the Trimble County facility.

(4) Comprised ofCT Substation 7-10 and units 7, 8, 9 and 10 at the Trimble County facility.

(5) Comprised ofCT Substation 5 and 6 and CT Pipeline at the Trimble County facility.

Both LG&E’sand KU’s participating share of direct expenses of the joint fuel plants isincluded in the corresponding operating expenses on its respective income statement(e.g., fuel, maintenance of plant, other operating expense).

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**Note 11 -Segments of Business and Related Information**

LG&E is a regulated public utility engaged in the generation,transmission, distribution and sale of electricity and the storage, distributionand sale of natural gas. LG&E is regulated by the Kentucky Commission andfiles electric and natural gas financial information separately with theKentucky Commission. The Kentucky Commission establishes rates specifically forthe electric and natural gas businesses. Therefore, management reports andanalyzes financial performance based on the electric and natural gas segmentsof the business. Financial data for business segments follow:
| **(in millions)**         | ** ** | **Electric** | ** ** | **Gas** | ** ** | **Total** | ** ** |
|--------------------------------|------------|--------------|------------|---------|------------|-----------|------------|
| 2006                           |       |         |       |    |       |      |       |   |   |   |   |   |   |
| Operating  revenues            |       |         | $          | 943     |       |      |       | $ | 395 |   |   |   | $ | 1,338 |   |   |
| Depreciation and  amortization |       |         | 105        |    |       |      | 19         |   |   |   | 124 |   |   |
| Income taxes                   |       |         | 57         |    |       |      | 5          |   |   |   | 62 |   |   |
| Interest income                |       |         | 1          |    |       |      | —     |   |   |   | 1 |   |   |
| Interest expense               |       |         | 33         |    |       |      | 8          |   |   |   | 41 |   |   |
| Net income                     |       |         | 107        |    |       |      | 10         |   |   |   | 117 |   |   |
| Total assets                   |       |         | 2,520      |    |       |      | 664        |   |   |   | 3,184 |   |   |
| Construction  expenditures     |       |         | 111        |    |       |      | 35         |   |   |   | 146 |   |   |
|                           |       |         |       |    |       |      |       |   |   |   |   |   |   |
| 2005                           |       |         |       |    |       |      |       |   |   |   |   |   |   |
| Operating  revenues            |       |         | $          | 987     |       |      |       | $ | 437 |   |   |   | $ | 1,424 |   |   |
| Depreciation and  amortization |       |         | 106        |    |       |      | 18         |   |   |   | 124 |   |   |
| Income taxes                   |       |         | 60         |    |       |      | 5          |   |   |   | 65 |   |   |
| Interest income                |       |         | 1          |    |       |      | —     |   |   |   | 1 |   |   |
| Interest expense               |       |         | 30         |    |       |      | 7          |   |   |   | 37 |   |   |
| Net income                     |       |         | 119        |    |       |      | 10         |   |   |   | 129 |   |   |
| Total assets                   |       |         | 2,475      |    |       |      | 671        |   |   |   | 3,146 |   |   |
| Construction  expenditures     |       |         | 97         |    |       |      | 42         |   |   |   | 139 |   |   |
|                           |       |         |       |    |       |      |       |   |   |   |   |   |   |
| 2004                           |       |         |       |    |       |      |       |   |   |   |   |   |   |
| Operating  revenues            |       |         | $          | 816     |       |      |       | $ | 357 |   |   |   | $ | 1,173 |   |   |
| Depreciation and  amortization |       |         | 100        |    |       |      | 17         |   |   |   | 117 |   |   |
| Income taxes                   |       |         | 48         |    |       |      | 5          |   |   |   | 53 |   |   |
| Interest income                |       |         | —     |    |       |      | —     |   |   |   | — |   |   |
| Interest expense               |       |         | 27         |    |       |      | 6          |   |   |   | 33 |   |   |
| Net income                     |       |         | 87         |    |       |      | 9          |   |   |   | 96 |   |   |
| Total assets                   |       |         | 2,417      |    |       |      | 550        |   |   |   | 2,967 |   |   |
| Construction  expenditures     |       |         | 113        |    |       |      | 35         |   |   |   | 148 |   |   |

 

**Note 12 -****Related Party Transactions**

LG&E and othersubsidiaries of E.ON engage in related party transactions. Transactions betweenLG&E and E.ON U.S. subsidiaries are eliminated upon consolidation of E.ONU.S. Transactions between LG&E and E.ON subsidiaries are eliminated uponconsolidation of E.ON. These transactions are generally performed at cost andare in accordance with FERC regulations under PUHCA 2005 and the applicableKentucky Commission regulations. The significant related party transactions aredisclosed below.

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Electric Purchases

LG&E and KUpurchase energy from each other in order to effectively manage the load oftheir retail and off-system customers. In 2004, LG&E also had sales toLG&E Energy Marketing Inc., another E.ON U.S. subsidiary, of less than $1million. These sales and purchases are included in the statements of income aselectric operating revenues and purchased power operating expense. LG&Eintercompany electric revenues and purchased power expense for the years endedDecember 31, 2006, 2005 and 2004 were as follows:

| (in millions)                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Electric operating revenues from KU |       | $        | 99         |     | $          | 92       |       | $ | 59 |   |
| Purchased power from KU             |       | 77       |       | 96       |       | 62       |       |
|                                     |            |          |            |          |            |          |            |  |  |  |

 

Interest Charges

See Note 8, NotesPayable and Other Short-Term Obligations, for details of intercompany borrowingarrangements. Intercompany agreements do not require interest payments forreceivables related to services provided when settled within 30 days.

LG&E’sintercompany interest income and expense for the years ended December 31, 2006,2005 and 2004 were as follows:

| (in millions)            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest on  money pool loans |       | $        | 2          |     | $          | 2        |       | $ | — |   |
| Interest on Fidelia  loans    |       | 11       |       | 11       |       | 12       |       |
|                               |            |          |            |          |            |          |            |  |  |  |

 

OtherIntercompany Billings

E.ON U.S. Servicesprovides LG&E with a variety of centralized administrative, management andsupport services. These charges include payroll taxes paid by E.ON U.S. onbehalf of LG&E, labor and burdens of E.ON U.S. Services employeesperforming services for LG&E and vouchers paid by E.ON U.S. Services onbehalf of LG&E. The cost of these services are directly charged toLG&E, or for general costs which cannot be directly attributed, chargedbased on predetermined allocation factors, including the following ratios:number of customers, total assets, revenues, number of employees and otherstatistical information. These costs are charged on an actual cost basis.

In addition,LG&E and KU provide services to each other and to E.ON U.S. Services.Billings between LG&E and KU relate to labor and overheads associated withunion employees performing work for the other utility, charges related tojointly-owned combustion turbines and other miscellaneous charges. Billingsfrom LG&E to E.ON U.S. Services relate to information technology-relatedservices provided by LG&E employees, cash received by E.ON U.S. Services onbehalf of LG&E and services provided by LG&E to other non-regulatedbusinesses which are paid through E.ON U.S. Services.

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Intercompanybillings to and from LG&E for the years ended December 31, 2006, 2005 and2004 were as follows:

| (in millions)                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| E.ON U.S.  Services billings to LG&E |       | $        | 230        |     | $          | 208      |       | $ | 191 |   |
| LG&E  billings to KU                 |       | 53       |       | 101      |       | 60       |       |
| KU billings to  LG&E                 |       | 56       |       | 29       |       | 7        |       |
| LG&E billings to  E.ON U.S. Services |       | 7        |       | 8        |       | 13       |       |
|                                          |            |          |            |          |            |          |            |  |  |  |

 

**Note 13 —Accumulated Other Comprehensive Income**

Accumulated othercomprehensive income (loss) consisted of the following:
| **(in millions)**                    | ** ** | **Minimum  Pension  Liability  Adjustment** | ** ** | **Accumulated  Derivative  Gain or Loss** | ** ** | **Pre-Tax** | ** ** | **Income  Taxes** | ** ** | **Net** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------|------------|-------------|------------|-------------------|------------|---------|------------|
| Balance at  December 31, 2003             |       |                                        | $          | (48                                                 | )          |        |       | $                 | (16        | )       |       |   | $ | (64 | ) |   |   | $ | 27 |   |   |   | $ | (37 | ) |   |
|                                      |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| Minimum pension  liability adjustment     |       |                                        | (10        | )                                                   |       |        | —     |              |       |    | (10        | ) |   |   | 4 |   |   |   | (6 | ) |   |
| Gains (losses)  on derivative instruments |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| designated and qualifying as cash flow    |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| hedging instruments                       |       |                                        | —     |                                                |       |        | (2         | )                 |       |    | (2         | ) |   |   | — |   |   |   | (2 | ) |   |
| Balance at  December 31, 2004             |       |                                        | (58        | )                                                   |       |        | (18        | )                 |       |    | (76        | ) |   |   | 31 |   |   |   | (45 | ) |   |
|                                      |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| Minimum pension  liability adjustment     |       |                                        | (19        | )                                                   |       |        | —     |              |       |    | (19        | ) |   |   | 6 |   |   |   | (13 | ) |   |
| Balance at  December 31, 2005             |       |                                        | (77        | )                                                   |       |        | (18        | )                 |       |    | (95        | ) |   |   | 37 |   |   |   | (58 | ) |   |
|                                      |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| Minimum pension  liability adjustment     |       |                                        | 77         |                                                |       |        | —     |              |       |    | 77         |   |   |   | (30 | ) |   |   | 47 |   |   |
| Gains (losses)  on derivative instruments |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| designated and qualifying as cash flow    |       |                                        |       |                                                |       |        |       |              |       |    |       |   |   |   |   |   |   |   |   |   |   |
| hedging instruments                       |       |                                        | —     |                                                |       |        | 3          |              |       |    | 3          |   |   |   | (1 | ) |   |   | 2 |   |   |
| Balance at December 31,  2006             |       |                                        | $          | —                                              |       |        |       | $                 | (15        | )       |       |   | $ | (15 | ) |   |   | $ | 6 |   |   |   | $ | (9 | ) |   |

 

**Note 14 -Selected Quarterly Data (Unaudited)**

Selected financial data for the four quarters of 2006 and 2005 areshown below. Because of seasonal fluctuations in temperature and other factors,results for quarters may fluctuate throughout the year.
| ** **             | ** ** | **Quarters Ended** | ** ** |
|------------------------|------------|-------------------------|------------|
| **(in millions)** | ** ** | **March**               | ** ** | **June** | ** ** | **September** | ** ** | **December** | ** ** |
| 2006                   |       |                    |       |   |   |   |   |   |   |
| Operating  revenues    |       |                    | $          | 413 |   |   |   | $ | 277 |   |   |   | $ | 303 |   |   |   | $ | 345 |   |   |
| Net operating  income  |       |                    | 50         |   |   |   | 47 |   |   |   | 71 |   |   |   | 55 |   |   |
| Net income             |       |                    | 26         |   |   |   | 25 |   |   |   | 40 |   |   |   | 26 |   |   |
|                   |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 2005                   |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating  revenues    |       |                    | $          | 402 |   |   |   | $ | 281 |   |   |   | $ | 319 |   |   |   | $ | 422 |   |   |
| Net operating  income  |       |                    | 62         |   |   |   | 53 |   |   |   | 66 |   |   |   | 49 |   |   |
| Net income             |       |                    | 34         |   |   |   | 28 |   |   |   | 42 |   |   |   | 25 |   |   |

 

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**Note 15 -Subsequent Events**

On January 16,2007, LG&E made a discretionary contribution to the pension plan in theamount of $56 million, which was slightly more than the $52 million accruedbenefit liability as of December 31, 2006.

On January 31,2007, LG&E received an Order from the Kentucky Commission approving thecharges and credits billed through the ECR during the review period as well asapproving billing adjustments, a roll-in to base rates, revisions to themonthly surcharge filing and a rate of return on capital.

On January 31,2007, the Kentucky Commission issued an Order approving LG&E’s applicationfor certain financial transactions, including arrangements which provide asource of funds for the possible redemption of LG&E’s preferred stock. InMarch 2007, a committee of LG&E’s board authorized the redemption of thepreferred stock, effective in April 2007, pursuant to existing redemptionprovisions applicable to such series. LG&E will redeem on such redemptiondate all of its outstanding shares of its series of preferred stock at thefollowing redemption prices, respectively, plus an amount equal to accrued andunpaid dividends to the redemption date:

·    860,287shares of 5% cumulative preferred stock (par value $25 per share) at $28 pershare;

·    200,000shares of $5.875 cumulative preferred stock (without par value) at $100 pershare; and

·    500,000shares of auction rate, series A, cumulative preferred stock (without parvalue) at $100 per share.

Dividends onthe shares of preferred stock shall cease to accumulate on the redemption dateand no further dividends will be paid or will accrue on such preferred stockthereafter.

On February 9,2007, LG&E filed with the Kentucky Commission an application for approvalof a “green energy” rider. This application details LG&E’s plans to offerits customers a “green energy” program that contributes funds to themaintenance and growth of renewable energy in Kentucky and contiguous states.An Order is expected during the second quarter of 2007.

On March 21, 2007, LG&E filed a real-time pilotprogram for residential and general service customers with the KentuckyCommission as agreed to in the Rate Case settlement agreement and in responseto additional requirements ordered by the Kentucky Commission resulting fromnot adopting the Smart-Metering and Interconnection standards included in theEPAct 2005. An order from the Kentucky Commission is anticipated before the endof 2007.

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Louisville Gas and Electric Company

REPORT OF MANAGEMENT

The management of Louisville Gas and Electric Company (“LG&E”) isresponsible for the preparation and integrity of the financial statements andrelated information included in this Annual Report. These statements have beenprepared in accordance with accounting principles generally accepted in theUnited States applied on a consistent basis and, necessarily, include amountsthat reflect the best estimates and judgment of management.

LG&E’s financialstatements for the three years ended December 31, 2006, have been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm.Management made available to PricewaterhouseCoopers LLP all LG&E’s financial records and related data as well as the minutes ofshareholders’ and directors’ meetings.

Management has established and maintains a system of internal controlsthat provides reasonable assurance that transactions are completed inaccordance with management’s authorization, that assets are safeguarded andthat financial statements are prepared in conformity with generally acceptedaccounting principles. Management believes that an adequate system of internalcontrols is maintained through the selection and training of personnel,appropriate division of responsibility, establishment and communication ofpolicies and procedures and by regular reviews of internal accounting controlsby LG&E’s internal auditors. Management reviews andmodifies its system of internal controls in light of changes in conditions andoperations, as well as in response to recommendations from the internal andexternal auditors. These recommendations for the year ended December 31, 2006,did not identify any material weaknesses in the design and operation of LG&E’s internal control structure.

LG&E is not anaccelerated filer under the Sarbanes-Oxley Act of 2002 and associated rules(the “Act”) and consequently has not issued Management’s Report on InternalControls over Financial Reporting pursuant to Section 404 of the Act.

In carrying out its oversight role for the financial reporting and internalcontrols of LG&E, the Board of Directors meets regularly with LG&E’s independent registered public accounting firm, internal auditors andmanagement. The Board of Directors reviews the results of the independentregistered public accounting firm’s audit of the financial statements and theiraudit procedures, and discusses the adequacy of internal accounting controls.The Board of Directors also approves the annual internal auditing program andreviews the activities and results of the internal auditing function. Both theindependent registered public accounting firm and the internal auditors haveaccess to the Board of Directors at any time.

LG&E maintains and internally communicates a written code ofbusiness conduct and a senior financial officer code of ethics which address,among other items, potential conflicts of interest, compliance with laws,including those relating to financial disclosure, and the confidentiality ofproprietary information.

S. Bradford Rives

Chief Financial Officer

Louisville Gas and Electric Company

Louisville, Kentucky

Date:March 21, 2007

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### Report of Independent Registered Public Accounting Firm

To the Shareholderof Louisville Gas and Electric Company:

In our opinion, the accompanying balance sheet and the related statementsof capitalization, income, retained earnings, cash flows and comprehensiveincome present fairly, in all material respects, the financial position ofLouisville Gas and Electric Company at December 31, 2006 and December 31, 2005,and the results of****its****operations and its****cash flows foreach of the three years in the period ended December 31, 2006 in conformitywith accounting principles generally accepted in the United States of America.These financial statements are the responsibility of the Company’s management.Our responsibility is to express an opinion on these financial statements basedon our audits. We conducted our audits of these statements in accordance withthe standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

As discussed inNote 1 to the financial statements, Louisville Gas and Electric Companychanged the manner in which it accounts for defined benefit pension and otherpostretirement benefit plans as of December 31, 2006 and the manner in which itaccounts for conditional asset retirement obligations as of December 31, 2005.
| /s/ PricewaterhouseCoopers  LLP |   |
|---------------------------------|--------|
| Louisville, Kentucky            |
| February 8, 2007                |

 

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# ITEM 9. Changes in andDisagreements with Accountants on Accounting and Financial Disclosure.

Not applicable.

# ITEM 9A. Controls andProcedures.

Disclosure Controls

LG&E maintainsa system of disclosure controls and procedures designed to ensure thatinformation required to be disclosed by the Company in reports they file orsubmit under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission rules and forms. LG&E conducted an evaluation of suchcontrols and procedures under the supervision and with the participation of theCompany’s Management, including the Chairman, President and Chief ExecutiveOfficer (“CEO”) and the Chief Financial Officer (“CFO”). Based upon thatevaluation, the CEO and CFO are of the conclusion that the Company’s disclosurecontrols and procedures are effective as of the end of the period covered bythis report.

In preparation forrequired reporting under Section 404 of the Sarbanes-Oxley Act of 2002, theCompany is conducting a thorough review of its internal control over financialreporting, including disclosure controls and procedures. Based on this review,the Company has made internal control enhancements and will continue to makefuture enhancements to its internal control over financial reporting. There hasbeen no change in the Company’s internal control over financial reporting thatoccurred during the fiscal year ended December 31, 2006, that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

LG&E is not anaccelerated filer under the Sarbanes-Oxley Act of 2002 and associated rules(the “Act”) and consequently has not issued Management’s Report on InternalControls over Financial Reporting pursuant to Section 404 of the Act.

ITEM 9B. Other Information.

Not applicable.

# PARTIII

Certaininformation for ITEMS 10, 11, 12, 13 and 14is omitted pursuant to General Instruction G of Form 10-K. The informationrequired by ITEMS 10, 11, 12, 13 and 14 for LG&E is incorporated herein byreference to its definitive proxy statements and/or Form 10-K/A amendmentswhich may be filed during April 2007 with the SEC pursuant to Regulation 14A ofthe Securities and Exchange Act of 1934. Additionally, in accordance withGeneral Instruction G, certain information required by ITEM 10 relating toexecutive officers of LG&E has been included in Part I of this Form 10-K.

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PART IV

**ITEM 15.Exhibits,**Financial Statement Schedules.

(a)           1.  Financial Statements(included in Item 8):

Statements of Income forthe three years ended December 31, 2006 (page 47).

Statements of RetainedEarnings for the three years ended December 31, 2006 (page 47).

Statements ofComprehensive Income for the three years ended December 31, 2006 (page 48).

Balance Sheets-December31, 2006, and 2005 (page 49).

Statements of Cash Flowsfor the three years ended December 31, 2006 (page 51).

Statements ofCapitalization-December 31, 2006, and 2005 (page 52).

Notes to FinancialStatements (pages 53-85).

Report of Management(page 86).

Report of IndependentRegistered Public Accounting Firm (page 87).

2.  FinancialStatement Schedules (included in Part IV):

All schedules have been omitted as not applicable ornot required or because the information required to be shown is included in theFinancial Statements or the accompanying Notes to Financial Statements.

3.  Exhibits:
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                               |
|--------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                                                                                                          |
| 2.01         |       | Copy of Agreement and Plan of Merger, dated as of  February 27, 2000, by and among Powergen plc, LG&E Energy Corp., US  Subholdco2 and Merger Sub, including certain exhibits thereto.  [Filed  as Exhibit 1 to LG&E’s Current Report on Form 8-K filed February 29,  2000 and incorporated by reference herein.] |
|         |       |                                                                                                                                                                                                                                                                                                                                          |
| 2.02         |       | Amendment No. 1 to Agreement and Plan of Merger,  dated as of December 8, 2000, among LG&E Energy Corp., Powergen plc,  Powergen US Investments Corp. and Powergen Acquisition Corp. [Filed as  Exhibit 2.01 to LG&E’s Current Report on Form 8-K filed December 11,  2000 and incorporated by reference herein.]      |
|         |       |                                                                                                                                                                                                                                                                                                                                          |
| 2.03         |       | Copy of Agreement and Plan of Merger, dated as of  May 20, 1997, by and between LG&E Energy and KU Energy, including certain  exhibits thereto.  [Filed as Exhibit 2 to LG&E’s Current Report on  Form 8-K filed May 30, 1997 and incorporated by reference herein.]                                                        |
|         |       |                                                                                                                                                                                                                                                                                                                                          |
| 3.01         |       | Copy of Restated Articles of Incorporation of  LG&E, dated November 6, 1996. [Filed as Exhibit 3.06 to LG&E’s  Quarterly Report on Form 10-Q for the quarter ended September 30, 1996,  and incorporated by reference herein.]                                                                                         |
|         |       |                                                                                                                                                                                                                                                                                                                                          |
| 3.02         |       | Copy of Amendment to Articles of Incorporation of  LG&E, dated February 6, 2004. [Filed as Exhibit 3.02 to LG&E’s  Annual Report on Form 10-K for the year ended December 31, 2003, and  incorporated by reference herein.]                                                                                                 |

 

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| 3.03   |   | Copy of By-Laws of LG&E, as amended through  December 16, 2003. [Filed as Exhibit 3.03 to LG&E’s Annual Report on  Form 10-K for the year ended December 31, 2003, and incorporated by reference  herein.]                                                              |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.01   |   | Copy of Trust Indenture dated November 1, 1949,  from LG&E to Harris Trust and Savings Bank, Trustee.  [Filed as  Exhibit 7.01 to LG&E’s Registration Statement 2-8283 and incorporated  by reference herein.]                                                |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.02   |   | Copy of Supplemental Indenture dated  September 1, 1992, which is a supplemental instrument to Exhibit 4.01  hereto.  [Filed as Exhibit 4.32 to LG&E’s Annual Report on Form 10-K  for the year ended December 31, 1992, and incorporated by reference  herein.]  |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.03   |   | Copy of Supplemental Indenture dated  September 2, 1992, which is a supplemental instrument to Exhibit 4.01  hereto.  [Filed as Exhibit 4.33 to LG&E’s Annual Report on Form 10-K  for the year ended December 31, 1992, and incorporated by reference  herein.]  |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.04   |   | Copy of Supplemental Indenture dated August 16,  1993, which is a supplemental instrument to Exhibit 4.01 hereto.  [Filed  as Exhibit 4.35 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1993, and incorporated by reference herein.]     |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.05   |   | Copy of Supplemental Indenture dated August 1, 2000,  which is a supplemental instrument to Exhibit 4.01 hereto.  [Filed as  Exhibit 4.38 to LG&E’s Annual Report on Form 10-K/A for the year ended  December 31, 2000, and incorporated by reference herein.]         |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.06   |   | Copy of Supplemental Indenture dated September 1,  2001, which is a supplemental instrument to Exhibit 4.01 hereto.  [Filed  as Exhibit 4.42 to LG&E’s Annual Report on Form 10-K/A for the year ended  December 31, 2001, and incorporated by reference herein.] |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.07   |   | Copy of Supplemental Indenture dated March 1,  2002, which is a supplemental instrument to Exhibit 4.01 hereto.  [Filed  as Exhibit 4.39 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2002, and incorporated by reference herein.]       |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.08   |   | Copy of Supplemental Indenture dated March 15,  2002, which is a supplemental instrument to Exhibit 4.01 hereto.  [Filed  as Exhibit 4.40 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2002, and incorporated by reference herein.]      |
|   |   |                                                                                                                                                                                                                                                                                      |
| 4.09   |   | Copy of Supplemental Indenture dated October 1,  2002, which is a supplemental instrument to Exhibit 4.01 hereto.  [Filed  as Exhibit 4.41 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2002, and incorporated by reference herein.]     |

 

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| 4.10        |   | Copy of Supplemental Indenture dated October 1,  2003, which is a supplemental instrument to Exhibit 4.01 hereto. [Filed as  Exhibit 4.22 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2003, and incorporated by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.11        |   | Supplemental Indenture dated as of April 1, 2005,  from Louisville Gas and Electric Company to BNY Midwest Trust Company, as  Trustee, which is a supplemental instrument to Exhibit 4.01 hereto. [Filed as  Exhibit 4.1 to LG&E’s Form 8-K filed on April 13, 2005, and incorporated  by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.12        |   | Copy of Loan Agreement between LG&E and Fidelia  Corporation, dated April 30, 2003. [Filed as Exhibit 4.24 to LG&E’s  Annual Report on Form 10-K for the year ended December 31, 2003, and  incorporated by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.13        |   | Copy of Loan Agreement between LG&E and Fidelia  Corporation, dated January 15, 2004. [Filed as Exhibit 4.27 to  LG&E’s Annual Report on Form 10-K for the year ended December 31, 2004,  and incorporated by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.14        |   | Copy of Loan and Security Agreement between LG&E  and Fidelia Corporation, dated as of August 15, 2003. [Filed as Exhibit 4.27  to LG&E’s Annual Report on Form 10-K for the year ended December 31,  2003, and incorporated by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.01       |   | Copies of (i) Inter-Company Power Agreement, dated  July 10, 1953, between Ohio Valley Electric Corporation and Sponsoring  Companies (which Agreement includes as Exhibit A the Power Agreement, dated  July 10, 1953, between Ohio Valley Electric Corporation and  Indiana-Kentucky Electric Corporation); (ii) First Supplementary Transmission  Agreement, dated July 10, 1953, between Ohio Valley Electric Corporation  and Sponsoring Companies; (iii) Inter-Company Bond Agreement, dated  July 10, 1953, between Ohio Valley Electric Corporation and Sponsoring  Companies; (iv) Inter-Company Bank Credit Agreement, dated July 10,  1953, between Ohio Valley Electric Corporation and Sponsoring  Companies.  [Filed as Exhibit 5.02f to LG&E’s Registration Statement  2-61607 and incorporated by reference herein.] |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|  10.02 |   | Copy of Modification No. 1 and No. 2 dated  June 3, 1966 and January 7, 1967, respectively, to Inter-Company  Power Agreement dated July 10, 1953.  [Filed as Exhibits 4(a)(8)  and 4(a)(10) to LG&E’s Registration Statement 2-26063 and incorporated by  reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.03       |   | Copies of Amendments to Agreements (iii) and (iv)  referred to under 10.01 above as follows:  (i) Amendment to  Inter-Company Bond Agreement and (ii) Amendment to Inter-Company Bank Credit  Agreement.  [Filed as Exhibit 5.02h to LG&E’s Registration Statement  2-61607 and incorporated by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.04       |   | Copy of Modification No. 1, dated August 20,  1958, to First Supplementary Transmission Agreement, dated July 10,  1953, among Ohio Valley Electric Corporation and the Sponsoring  Companies.  [Filed as Exhibit 5.02i to LG&E’s Registration Statement  2-61607 and incorporated by reference herein.]                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

 

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| 10.05  |   | Copy of Modification No. 2, dated April 1,  1965, to the First Supplementary Transmission Agreement, dated July 10,  1953, among Ohio Valley Electric Corporation and the Sponsoring  Companies.  [Filed as Exhibit 5.02j to LG&E’s Registration Statement  2-61607 and incorporated by reference herein.]                            |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.06  |   | Copy of Modification No. 3, dated January 20,  1967, to First Supplementary Transmission Agreement, dated July 10,  1953, among Ohio Valley Electric Corporation and the Sponsoring  Companies.  [Filed as Exhibit 4(a)(7) to LG&E’s Registration  Statement 2-26063 and incorporated by reference herein.]                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.07  |   | Copy of Modification No. 3 dated November 15,  1967, to the Inter-Company Power Agreement dated July 10, 1953.   [Filed as Exhibit 4.02m to LG&E’s Registration Statement 2-37368 and  incorporated by reference herein.]                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.08  |   | Copy of Modification No. 4 dated November 5,  1975, to the Inter-Company Power Agreement dated July 10, 1953.   [Filed as Exhibit 5.02o to LG&E’s Registration Statement 2-56357 and  incorporated by reference herein.]                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.09  |   | Copy of Modification No. 4 dated April 30,  1976, to First Supplementary Transmission Agreement, dated July 10,  1953, among Ohio Valley Electric Corporation and the Sponsoring  Companies.  [Filed as Exhibit 5.02p to LG&E’s Registration  Statement 2-61607 and incorporated by reference herein.]                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.10  |   | Copy of Modification No. 5 dated September 1,  1979, to Inter-Company Power Agreement dated July 5, 1953, among Ohio  Valley Electric Corporation and Sponsoring Companies.  [Filed as Exhibit  4 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1979, and incorporated by reference herein.]             |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.11  |   | Copy of Modification No. 6 dated August 1,  1981, to Inter-Company Power Agreement dated July 5, 1953, among Ohio  Valley Electric Corporation and Sponsoring Companies.  [Filed as Exhibit  10.26 to LG&E’s Annual Report on Form 10-K for the year ended December 31,  1981, and incorporated by reference herein.]            |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.12  |   | * Copy of Non-Qualified Savings Plan covering  officers of the Company, effective January 1, 1992.  [Filed as  Exhibit 10.43 to the Company’s Annual Report on Form 10-K for the year ended  December 31, 1992, and incorporated by reference herein.]                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.13  |   | Copy of Modification No. 7 dated January 15,  1992, to Inter-Company Power Agreement dated July 10, 1953, among Ohio  Valley Electric Corporation and Sponsoring Companies.  [Filed as Exhibit  10.44 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1993, and incorporated by reference herein.]         |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.14  |   | Copy of Modification No. 8 dated January 19,  1994, to Inter-Company Power Agreement, dated July 10, 1953, among Ohio  Valley Electric Corporation and the Sponsoring Companies.  [Filed as  Exhibit 10.43 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1995, and incorporated by reference herein.]    |
|   |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.15  |   | Copy of Modification No. 9, dated August 17,  1995, to the Inter-Company Power Agreement dated July 10, 1953, among  Ohio Valley Electric Corporation and the Sponsoring Companies.  [Filed  as Exhibit 10.39 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1996, and incorporated by reference herein.] |

 

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| 10.16       |   | * Copy of Amendment to the Non-Qualified Savings  Plan, effective January 1, 1992.  [Filed as Exhibit 10.55 to  LG&E’s Annual Report on Form 10-K for the year ended December 31,  1995, and incorporated by reference herein.]                                                                                                   |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.17       |   | * Copy of Amendment to the Non-Qualified Savings  Plan, effective January 1, 1995.  [Filed as Exhibit 10.56 to  LG&E’s Annual Report on Form 10-K for the year ended December 31,  1995, and incorporated by reference herein.]                                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.18       |   | * Copy of Amendment to the Non-Qualified Savings  Plan, effective January 1, 1995.  [Filed as Exhibit 10.57 to  LG&E’s Annual Report on Form 10-K for the year ended December 31,  1995, and incorporated by reference herein.]                                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.19       |   | * Copy of Supplemental Executive Retirement Plan as  amended through January 1, 1998, covering officers of LG&E  Energy.  [Filed as Exhibit 10.74 to LG&E Energy’s Annual Report on  Form 10-K for the year ended December 31, 1997, and incorporated by  reference herein.]                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.20       |   | * Copy of Amendment to LG&E Energy’s  Supplemental Executive Retirement Plan, effective September 2, 1998.  [Filed as Exhibit 10.90 to LG&E Energy’s Annual Report on Form 10-K for  the year ended December 31, 1998 and incorporated by reference herein.]                                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.21       |   | * Copy of Employment and Severance Agreement, dated  as of February 25, 2000, by and among LG&E Energy, Powergen plc and  an executive officer of the Company.  [Filed as Exhibit 10.54 to  LG&E’s Annual Report on Form 10-K for the year ended December 31,  2002, and incorporated by reference herein.]                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.22       |   | * Copy of Amendment, effective October 1, 1999,  to LG&E Energy’s Non-Qualified Savings Plan. [Filed as Exhibit 10.96 to  LG&E’s Annual Report on Form 10-K for the year ended December 31,  1999, and incorporated by reference herein.]                                                                                     |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.23       |   | * Copy of Amendment, effective December 1,  1999, to LG&E Energy’s Non-Qualified Savings Plan. [Filed as Exhibit  10.97 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1999, and incorporated by reference herein.]                                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
| 10.24       |   | Copy of Modification No. 10, dated January 1,  1998, to the Inter-Company Power Agreement dated July 10, 1953, among  Ohio Valley Electric Corporation and the Sponsoring Companies. [Filed as  Exhibit 10.102 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1999, and incorporated by reference herein.] |
|        |   |                                                                                                                                                                                                                                                                                                                                                      |
|  10.25 |   | Copy of Modification No. 11, dated April 1,  1999, to the Inter-Company Power Agreement dated July 10, 1953, among  Ohio Valley Electric Corporation and the Sponsoring Companies. [Filed as  Exhibit 10.103 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 1999, and incorporated by reference herein.]   |

 

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| 10.26  |   | * Copy of Powergen Short-Term Incentive Plan,  effective January 1, 2001, applicable to certain employees of LG&E  Energy Corp. and its subsidiaries. [Filed as Exhibit 10.109 to LG&E’s  Annual Report on Form 10-K for the year ended December 31, 2000, and  incorporated herein by reference.]                                                                        |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.27  |   | * Copy of two forms of Change-In-Control Agreement  applicable to certain employees of LG&E Energy Corp. and its  subsidiaries. [Filed as Exhibit 10.110 to LG&E’s Annual Report on Form  10-K for the year ended December 31, 2000, and incorporated by reference  herein.]                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.28  |   | * Copy of Employment and Severance Agreement, dated  as of February 25, 2000, and amendments thereto dated December 8,  2000 and April 30, 2001, by and among LG&E Energy, Powergen plc and  Victor A. Staffieri. [Filed as Exhibit 10.74 to LG&E’s Annual Report on  Form 10-K/A for the year ended December 31, 2001, and incorporated by  reference herein.] |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.29  |   | * Copy of Amendment, dated as of December 8,  2000, to Employment and Severance Agreement dated as of February 25,  2000, by and among LG&E Energy, Powergen plc and an executive officer of  the Company. [Filed as Exhibit 10.63 to LG&E’s Annual Report on Form 10-K  for the year ended December 31, 2002, and incorporated by reference  herein.]               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.30  |   | * Copy of Third Amendment, dated July 1, 2002,  to Employment and Severance Agreement dated as of February 25, 2000 by  and among E.ON AG, LG&E Energy, Powergen and Victor A. Staffieri.   [Filed as Exhibit 10.74 to LG&E’s Annual Report on Form 10-K for the year  ended December 31, 2002, and incorporated by reference herein.]                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.31  |   | * Copy of form of Retention and Severance Agreement  dated April/May, 2002 by and among LG&E Energy, E.ON AG and certain  executive officers of the Companies.  [Filed as Exhibit 10.75 to  LG&E’s Annual Report on Form 10-K for the year ended December 31,  2002, and incorporated by reference herein.]                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.32  |   | * Copy of Second Amendment, dated May 20, 2002, to  Employment and Severance Agreement, dated February 25, 2000, by and  among E.ON AG, LG&E Energy Corp., Powergen plc and an executive of the  Companies.  [Filed as Exhibit 10.76 to LG&E’s Annual Report on Form  10-K for the year ended December 31, 2002, and incorporated by reference  herein.]             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.33  |   | * Copy of Representative Terms and Conditions for  Stock Appreciation Rights Issued as part of E.ON Group’s Stock Appreciation  Rights Programs, applicable to certain executive officers of the Companies.   [Filed as Exhibit 10.79 to LG&E’s Annual Report on Form 10-K for the year  ended December 31, 2002, and incorporated by reference herein.]                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.34  |   | * Copy of LG&E Energy Corp. Long-Term  Performance Unit Plan, adopted April 25, 2003, effective January 1, 2003.  [Filed as Exhibit 10.65 to LG&E Annual Report on Form 10-K for the year  ended December 31, 2003, and incorporated by reference herein.]                                                                                                                               |

 

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| 10.35       |   | Copy of Modification No. 12 dated as of  November 1, 1999, to Inter-Company Power Agreement dated July 10,  1953, among Ohio Valley Electric Corporation and Sponsoring Companies. [Filed  as Exhibit 10.69 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2003, and incorporated by reference herein.] |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.36       |   | Copy of Modification No. 13 dated as of May 24,  2000, to Inter-Company Power Agreement dated July 10, 1953, among Ohio  Valley Electric Corporation and Sponsoring Companies. [Filed as Exhibit 10.70  to LG&E’s Annual Report on Form 10-K for the year ended December 31,  2003, and incorporated by reference herein.]          |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.37       |   | Copy of Modification No. 14 dated as of  April 1, 2001, to Inter-Company Power Agreement dated July 10, 1953,  among Ohio Valley Electric Corporation and Sponsoring Companies. [Filed as  Exhibit 10.71 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2003, and incorporated by reference herein.]    |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
|  10.38 |   | Copy of Amended and Restated Inter-Company Power  Agreement dated as of March 13, 2006, among Ohio Valley Electric Corporation  and Sponsoring Companies, including LG&E. [Filed as Exhibit 10.1 to  LG&E’s Form 10-Q for the period ended June 30, 2004, and incorporated by  reference herein.]                                    |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.39       |   | * Copy of Fourth Amendment dated as of February 1,  2004 to Employment and Severance Agreement dated as of February 25, 2000 by  and among E.ON AG, LG&E’s Energy, Powergen and Victor A. Staffieri.  [Filed as Exhibit 10.02 to LG&E’s Form 10-Q for the period ended June 30,  2004, and incorporated by reference herein.]   |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.40       |   | Copy of Modification No. 15, dated as of April 30,  2004, to Inter-Company Power Agreement dated July 10, 1953, among Ohio Valley  Electric Corporation and Sponsoring Companies. [Filed as Exhibit 10.03 to  LG&E’s Form 10-Q for the period ended June 30, 2004, and incorporated by  reference herein.]                               |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.41       |   | Participation Agreement between LG&E and  Illinois Municipal Electric Agency, dated as of September 24, 1990. [Filed as  Exhibit 10.42 to LG&E’s Annual Report on Form 10-K for the year ended  December 31, 2004, and incorporated by reference herein.]                                                                            |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.42       |   | Participation Agreement between LG&E and Indiana  Municipal Power Agency, dated as of February 1, 1993. [Filed as Exhibit 10.43  to LG&E’s Annual Report on Form 10-K for the year ended December 31,  2004, and incorporated by reference herein.]                                                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.43       |   | Participation Agreement by and among LG&E and KU  and Illinois Municipal Electric Agency and Indiana Municipal Power Agency,  dated as of February 9, 2004. [Filed as Exhibit 10.44 to LG&E’s Annual  Report on Form 10-K for the year ended December 31, 2004, and incorporated by  reference herein.]                              |
|        |   |                                                                                                                                                                                                                                                                                                                                              |
| 10.44       |   | Copy of Barge Transportation Agreement between LG&E,  effective January 1, 2002, and KU, effective July 1, 2002, and Crounse  Corporation. [Filed as Exhibit 10.45 to LG&E’s Annual Report on Form 10-K  for the year ended December 31, 2004, and incorporated by reference herein.]                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                              |

 

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| 10.45  |   | Amendment No. 1 to Barge Transportation Agreement  between Louisville Gas and Electric Company and Kentucky Utilities Company  and Crounse Corporation, dated as of January 1, 2005. [Filed as Exhibit 10.46  to LG&E’s Annual Report on Form 10-K for the year ended December 31,  2005, and incorporated by reference herein.] |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 10.46  |   | * Copy of LG&E Energy LLC Nonqualified Savings  Plan, effective January 1, 2005. [Filed as Exhibit 10.47 to LG&E’s Annual  Report on Form 10-K for the year ended December 31, 2005, and incorporated by  reference herein.]                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 10.47  |   | * Executive Officer Salary Information.                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 10.48  |   | * Form of Representative Specimen Award under  LG&E Energy Long-Term Performance Unit Plan. [Filed as Exhibit 10.47 to  LG&E’s Annual Report on Form 10-K for the year ended December 31, 2004,  and incorporated by reference herein.]                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 10.49  |   | * Form of Representative Specimen Award under E.ON  Group Stock Appreciation Rights Program. [Filed as Exhibit 10.48 to  LG&E’s Annual Report on Form 10-K for the year ended December 31, 2004,  and incorporated by reference herein.]                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 10.50  |   | * Copies of E.ON Share Performance Plan (i) Terms  and Conditions for the 1. Tranche (2006-2008) and (ii) Technical Annex, each  dated as of June 2006. [Filed as Exhibit 10.01 to LG&E’s Form 10-Q for  the quarter ended September 30, 2006 and incorporated by reference herein.]                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 10.51  |   | * Copies of form representative specimen Certificate  Award under E.ON Share Performance Plan. [Filed as Exhibit 10.02 to  LG&E’s Form 10-Q for the quarter ended September 30, 2006 and  incorporated by reference herein.]                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 12     |   | Computation of Ratio of Earnings to Fixed Charges  for LG&E.                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 21     |   | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 24     |   | Power of Attorney.                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 31.1   |   | Certification of Chief Executive Officer, Pursuant  to Section 302 of Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 31.2   |   | Certification of Chief Financial Officer, Pursuant  to Section 302 of Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 32     |   | Certifications pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                      |
| 99.01  |   | Cautionary Statement for purposes of the “Safe  Harbor” provisions of the Private Securities Litigation Reform Act of 1995.                                                                                                                                                                                                     |

 

 

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# **SIGNATURES** — LOUISVILLE GAS AND ELECTRIC COMPANY

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|                | LOUISVILLE GAS AND  ELECTRIC COMPANY |
|----------------|--------------------------------------|
|           | Registrant                           |   |
|           |                                 |   |
| March 21, 2007 | By:                                  | /s/ S. Bradford Rives |   |
| (Date)         | S. Bradford Rives                    |   |
|           | Chief Financial Officer              |   |
|           |                                 |   |
|                |                                      |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the date indicated.
| Signature           | ** **            | **Title**                                                       | ** ** | **Date** |
|---------------------|-----------------------|-----------------------------------------------------------------|------------|----------|
|                |                  |                                                            |       |     |
| Victor A. Staffieri |                  | Chairman of the Board,                                          |       |     |
|                |                  | President and Chief  Executive Officer                          |       |     |
|                |                  | (Principal Executive  Officer)                                  |       |     |
|                |                  |                                                            |       |     |
| S. Bradford Rives   |                  | Director and Chief  Financial Officer                           |       |     |
|                |                  | (Principal Financial  Officer and Principal Accounting Officer) |       |     |
|                |                  |                                                            |       |     |
| John R. McCall      |                  | Director and Executive  Vice President,                         |       |     |
|                |                  | General Counsel and  Corporate Secretary                        |       |     |
|                |                  |                                                            |       |     |
| Chris Hermann       |                  | Director and Senior  Vice President, Energy Delivery            |       |     |
|                |                  |                                                            |       |     |
| Paul W. Thompson    |                  | Director and Senior  Vice President, Energy Services            |       |     |
|                |                  |                                                            |       |     |
|                |                  |                                                            |       |     |
|                |                  |                                                            |       |     |
|                |                  |                                                            |       |     |
| By:                 | /s/ S. Bradford Rives |                                                            |       |     | March 21, 2007 |
|                | (Attorney-In-Fact)    |                                                            |       |     |   |

 

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