<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549


                                    FORM 10-Q

(Mark One)

/X/  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934

     For the quarterly period ended JUNE 30, 2007

                                       or

/ /  Transition  Report  Pursuant  to  Section  13  or  15(d)  of the Securities
     Exchange Act of 1934

     For the transition period from ______________ to ______________


                          Commission File Number 1-3548


                                  ALLETE, INC.
             (Exact name of registrant as specified in its charter)

       MINNESOTA                                                41-0418150
(State or other jurisdiction                                  (IRS Employer
   of incorporation or                                      Identification No.)
     organization)

                             30 WEST SUPERIOR STREET
                          DULUTH, MINNESOTA 55802-2093
                    (Address of principal executive offices)
                                   (Zip Code)

                                 (218) 279-5000
              (Registrant's telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.  /X/ Yes  / / No

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

Large Accelerated Filer /X/   Accelerated Filer / /    Non-Accelerated Filer / /

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).  / / Yes  /X/ No

                           Common Stock, no par value,
                          30,701,629 shares outstanding
                               as of June 30, 2007

<PAGE>

                                   INDEX
                                                                            Page

Definitions                                                                    2

Safe Harbor Statement Under the Private Securities Litigation Reform Act
of 1995                                                                        3

Part I.  Financial Information

         Item 1.   Financial Statements

              Consolidated Balance Sheet -
                   June 30, 2007 and December 31, 2006                         4

              Consolidated Statement of Income -
                   Quarter and Six Months Ended June 30, 2007 and 2006         5

              Consolidated Statement of Cash Flows -
                   Six Months Ended June 30, 2007 and 2006                     6

              Notes to Consolidated Financial Statements                       7

         Item 2.   Management's Discussion and Analysis of Financial
                   Condition and Results of Operations                        17

         Item 3.   Quantitative and Qualitative Disclosures about Market
                   Risk                                                       28

         Item 4.   Controls and Procedures                                    29

Part II. Other Information

         Item 1.   Legal Proceedings                                          30

         Item 1A.  Risk Factors                                               30

         Item 2.   Unregistered Sales of Equity Securities and Use of
                   Proceeds                                                   30

         Item 3.   Defaults Upon Senior Securities                            30

         Item 4.   Submission of Matters to a Vote of Security Holders        30

         Item 5.   Other Information                                          31

         Item 6.   Exhibits                                                   32

Signatures                                                                    33


1                     ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

                                   DEFINITIONS

The following abbreviations or acronyms are used in the text. References in this
report  to "we,"  "us" and  "our"  are to  ALLETE,  Inc.  and its  subsidiaries,
collectively.

ABBREVIATION OR ACRONYM                 TERM
--------------------------------------------------------------------------------

2006 Form 10-K                          ALLETE's Annual Report on Form 10-K for
                                             the Year Ended December 31, 2006
ALLETE                                  ALLETE, Inc.
ALLETE Properties                       ALLETE Properties, LLC
AREA                                    Arrowhead Regional Emission Abatement
                                             Plan
ATC                                     American Transmission Company LLC
BNI Coal                                BNI Coal, Ltd.
Boswell                                 Boswell Energy Center
Company                                 ALLETE, Inc. and its subsidiaries
DOC                                     Minnesota Department of Commerce
EITF                                    Emerging Issues Task Force Issue No.
EPA                                     Environmental Protection Agency
ESOP                                    Employee Stock Ownership Plan
FASB                                    Financial Accounting Standards Board
FERC                                    Federal Energy Regulatory Commission
FIN                                     FASB Interpretations
GAAP                                    Accounting Principles Generally Accepted
                                             in the United States of America
Heating Degree Days                     Measure of the extent to which the
                                             average daily temperature is below
                                             65 degrees  Fahrenheit, increasing
                                             demand for heating
Laskin                                  Laskin Energy Center
Minnesota Power                         An operating division of ALLETE, Inc.
Minnkota Power                          Minnkota Power Cooperative, Inc.
MISO                                    Midwest Independent Transmission System
                                             Operator, Inc.
Moody's                                 Moody's Investors Service, Inc.
MPCA                                    Minnesota Pollution Control Agency
MPUC                                    Minnesota Public Utilities Commission
MW                                      Megawatt(s)
Note ___                                Note ___ to the consolidated financial
                                             statements in this Form 10-Q
NOX                                     Nitrogen Oxide
Palm Coast Park                         Palm Coast Park development project in
                                             northeast Florida
Palm Coast Park District                Palm Coast Park Community Development
                                             District
PSCW                                    Public Service Commission of Wisconsin
Resource Plan                           Integrated Resource Plan
SEC                                     Securities and Exchange Commission
SFAS                                    Statement of Financial Accounting
                                             Standards No.
SO2                                     Sulfur Dioxide
Square Butte                            Square Butte Electric Cooperative
Standard & Poor's                       Standard & Poor's Ratings Group, a
                                             division of McGraw-Hill Companies
SWL&P                                   Superior Water, Light and Power Company
Taconite Harbor                         Taconite Harbor Energy Center
Town Center                             Town Center at Palm Coast development
                                             project in northeast Florida
Town Center District                    Town Center at Palm Coast Community
                                             Development District
WDNR                                    Wisconsin Department of Natural
                                             Resources

                      ALLETE Second Quarter 2007 Form 10-Q                     2

<PAGE>

                              SAFE HARBOR STATEMENT
           UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

In  connection  with  the  safe  harbor  provisions  of the  Private  Securities
Litigation  Reform  Act of 1995,  we are  hereby  filing  cautionary  statements
identifying  important  factors  that could  cause our actual  results to differ
materially from those projected in  forward-looking  statements (as such term is
defined in the Private  Securities  Litigation Reform Act of 1995) made by or on
behalf of ALLETE in this  Quarterly  Report on Form 10-Q, in  presentations,  in
response to questions or otherwise.  Any  statements  that  express,  or involve
discussions as to expectations,  beliefs,  plans,  objectives,  assumptions,  or
future events or performance (often, but not always, through the use of words or
phrases such as "anticipates,"  "believes,"  "estimates,"  "expects," "intends,"
"plans,"  "projects,"  "will likely  result," "will  continue,"  "could," "may,"
"potential,"  "target," "outlook" or similar  expressions) are not statements of
historical facts and may be forward-looking.

Forward-looking   statements   involve   estimates,   assumptions,   risks   and
uncertainties,  which are beyond our  control  and may cause  actual  results or
outcomes to differ materially from those that may be projected. These statements
are  qualified in their  entirety by reference to, and are  accompanied  by, the
following  important  factors,  in addition to any assumptions and other factors
referred to specifically:

    -    our ability to successfully implement our strategic objectives;
    -    our ability to manage expansion and integrate acquisitions;
    -    prevailing  governmental policies,  regulatory actions, and legislation
         including those of the United States Congress, state legislatures,  the
         FERC, the MPUC, the PSCW, and various local and county regulators,  and
         city  administrators,   about  allowed  rates  of  return,  financings,
         industry  and rate  structure,  acquisition  and disposal of assets and
         facilities,  real estate  development,  operation and  construction  of
         plant facilities,  recovery of purchased power and capital investments,
         present or prospective wholesale and retail competition  (including but
         not limited to transmission costs),  zoning and permitting of land held
         for resale and environmental regulation;
    -    effects of restructuring initiatives in the electric industry;
    -    economic  and  geographic  factors,  including  political  and economic
         risks;
    -    changes in and compliance with laws and policies;
    -    weather conditions;
    -    natural disasters and pandemic diseases;
    -    war and acts of terrorism;
    -    wholesale power market conditions;
    -    population growth rates and demographic patterns;
    -    effects of competition,  including competition for retail and wholesale
         customers;
    -    changes in the real estate market;
    -    pricing and transportation of commodities;
    -    changes in tax rates or policies or in rates of inflation;
    -    unanticipated project delays or changes in project costs;
    -    availability of construction  materials and skilled  construction labor
         for capital projects;
    -    unanticipated changes in operating expenses and capital expenditures;
    -    global and domestic economic conditions;
    -    our ability to access capital markets and bank financing;
    -    changes in interest rates and the performance of the financial markets;
    -    our ability to replace a mature workforce and retain qualified, skilled
         and experienced personnel; and
    -    the outcome of legal and administrative  proceedings  (whether civil or
         criminal) and settlements that affect the business and profitability of
         ALLETE.

Additional  disclosures  regarding  factors  that could  cause our  results  and
performance to differ from results or performance anticipated by this report are
discussed in Item 1A under the heading "Risk Factors" in Part I of our 2006 Form
10-K.  Any  forward-looking  statement  speaks only as of the date on which such
statement is made, and we undertake no obligation to update any  forward-looking
statement  to  reflect  events or  circumstances  after  the date on which  that
statement is made or to reflect the  occurrence  of  unanticipated  events.  New
factors  emerge from time to time,  and it is not  possible  for  management  to
predict  all of these  factors,  nor can it assess  the  impact of each of these
factors  on the  businesses  of ALLETE or the  extent  to which any  factor,  or
combination of factors, may cause actual results to differ materially from those
contained  in any  forward-looking  statement.  Readers  are urged to  carefully
review and consider the various  disclosures made by us in this Form 10-Q and in
our other reports filed with the SEC that attempt to advise  interested  parties
of the factors that may affect our business.

3                     ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

PART I.    FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS

<TABLE>
                                                    ALLETE
                                           CONSOLIDATED BALANCE SHEET
                                             MILLIONS - UNAUDITED
<CAPTION>
                                                                                    JUNE 30,         DECEMBER 31,
                                                                                      2007               2006
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>              <C>
ASSETS

Current Assets
     Cash and Cash Equivalents                                                      $   37.1           $   44.8
     Short-Term Investments                                                            121.8              104.5
     Accounts Receivable (Less Allowance of $1.1 at June 30, 2007 and                   67.7               70.9
                          December 31, 2006)
     Inventories                                                                        46.9               43.4
     Prepayments and Other                                                              33.5               23.8
     Deferred Income Taxes                                                                 -                0.3
-------------------------------------------------------------------------------------------------------------------

         Total Current Assets                                                          307.0              287.7

Property, Plant and Equipment - Net                                                    977.2              921.6

Investments                                                                            207.8              189.1

Other Assets                                                                           137.7              135.0

-------------------------------------------------------------------------------------------------------------------

TOTAL ASSETS                                                                        $1,629.7           $1,533.4
-------------------------------------------------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY

LIABILITIES

Current Liabilities
     Accounts Payable                                                               $   47.7           $   53.5
     Accrued Taxes                                                                      19.9               23.3
     Accrued Interest                                                                    7.9                8.6
     Long-Term Debt Due Within One Year                                                 29.5               29.7
     Deferred Profit on Sales of Real Estate                                             5.0                4.1
     Other                                                                              20.5               24.3
-------------------------------------------------------------------------------------------------------------------

         Total Current Liabilities                                                     130.5              143.5

Long-Term Debt                                                                         409.2              359.8

Deferred Income Taxes                                                                  130.5              130.8

Other Liabilities                                                                      237.4              226.1

Minority Interest                                                                        8.8                7.4
-------------------------------------------------------------------------------------------------------------------

         Total Liabilities                                                             916.4              867.6
-------------------------------------------------------------------------------------------------------------------

COMMITMENTS AND CONTINGENCIES
-------------------------------------------------------------------------------------------------------------------

SHAREHOLDERS' EQUITY

Common Stock Without Par Value, 43.3 Shares Authorized,
     30.7 and 30.4 Shares Outstanding                                                  455.0              438.7

Unearned ESOP Shares                                                                   (68.2)             (71.9)

Accumulated Other Comprehensive Loss                                                    (7.3)              (8.8)

Retained Earnings                                                                      333.8              307.8
-------------------------------------------------------------------------------------------------------------------

         Total Shareholders' Equity                                                    713.3              665.8
-------------------------------------------------------------------------------------------------------------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                          $1,629.7           $1,533.4
-------------------------------------------------------------------------------------------------------------------

                        The accompanying notes are an integral part of these statements.
</TABLE>

                      ALLETE Second Quarter 2007 Form 10-Q                     4

<PAGE>

<TABLE>
                                                             ALLETE
                                               CONSOLIDATED STATEMENT OF INCOME
                                        MILLIONS EXCEPT PER SHARE AMOUNTS - UNAUDITED
<CAPTION>
                                                                     QUARTER ENDED                     SIX MONTHS ENDED
                                                                       JUNE 30,                            JUNE 30,
                                                                  2007            2006               2007            2006
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>             <C>                 <C>             <C>
OPERATING REVENUE                                               $ 223.3         $ 178.3             $ 428.6         $ 370.8
-----------------------------------------------------------------------------------------------------------------------------

OPERATING EXPENSES
     Fuel and Purchased Power                                      92.9            63.0               170.6           132.4
     Operating and Maintenance                                     84.6            76.8               159.2           151.3
     Depreciation                                                  11.9            12.2                23.6            24.4
-----------------------------------------------------------------------------------------------------------------------------

         Total Operating Expenses                                 189.4           152.0               353.4           308.1
-----------------------------------------------------------------------------------------------------------------------------

OPERATING INCOME FROM CONTINUING OPERATIONS                        33.9            26.3                75.2            62.7
-----------------------------------------------------------------------------------------------------------------------------

OTHER INCOME (EXPENSE)
     Interest Expense                                              (6.1)           (6.4)              (12.4)          (12.8)
     Other                                                          7.3             3.4                14.8             5.1
-----------------------------------------------------------------------------------------------------------------------------

         Total Other Income (Expense)                               1.2            (3.0)                2.4            (7.7)
-----------------------------------------------------------------------------------------------------------------------------

INCOME FROM CONTINUING OPERATIONS
     BEFORE MINORITY INTEREST AND INCOME TAXES                     35.1            23.3                77.6            55.0

MINORITY INTEREST                                                   1.3             0.8                 1.4             2.1
-----------------------------------------------------------------------------------------------------------------------------

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES                                           33.8            22.5                76.2            52.9

INCOME TAX EXPENSE                                                 11.2             8.9                27.3            20.5
-----------------------------------------------------------------------------------------------------------------------------

INCOME FROM CONTINUING OPERATIONS                                  22.6            13.6                48.9            32.4

LOSS FROM DISCONTINUED OPERATIONS                                     -            (0.4)                  -            (0.4)
-----------------------------------------------------------------------------------------------------------------------------

NET INCOME                                                      $  22.6         $  13.2             $  48.9         $  32.0
-----------------------------------------------------------------------------------------------------------------------------

AVERAGE SHARES OF COMMON STOCK
     Basic                                                         28.2            27.7                28.1            27.6
     Diluted                                                       28.3            27.9                28.2            27.8
-----------------------------------------------------------------------------------------------------------------------------

BASIC EARNINGS PER SHARE OF COMMON STOCK
     Continuing Operations                                        $0.80           $0.50               $1.74           $1.18
     Discontinued Operations                                          -           (0.02)                  -           (0.02)
-----------------------------------------------------------------------------------------------------------------------------

                                                                  $0.80           $0.48               $1.74           $1.16
-----------------------------------------------------------------------------------------------------------------------------

DILUTED EARNINGS PER SHARE OF COMMON STOCK
     Continuing Operations                                        $0.80           $0.49               $1.73           $1.17
     Discontinued Operations                                          -           (0.02)                  -           (0.02)
-----------------------------------------------------------------------------------------------------------------------------

                                                                  $0.80           $0.47               $1.73           $1.15
-----------------------------------------------------------------------------------------------------------------------------

DIVIDENDS PER SHARE OF COMMON STOCK                             $0.4100         $0.3625             $0.8200         $0.7250
-----------------------------------------------------------------------------------------------------------------------------

                                  The accompanying notes are an integral part of these statements.
</TABLE>

5                     ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

<TABLE>
                                                       ALLETE
                                        CONSOLIDATED STATEMENT OF CASH FLOWS
                                               MILLIONS - UNAUDITED
<CAPTION>
                                                                                          SIX MONTHS ENDED
                                                                                              JUNE 30,
                                                                                      2007               2006
-----------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>                <C>
OPERATING ACTIVITIES
     Net Income                                                                      $ 48.9             $ 32.0
     Loss from Discontinued Operations                                                    -                0.4
     Income from Equity Investments                                                    (1.6)                 -
     Gain on Sale of Assets                                                            (2.1)                 -
     Depreciation                                                                      23.6               24.4
     Deferred Income Taxes                                                             (1.1)              (4.7)
     Minority Interest                                                                  1.4                2.1
     Stock Compensation Expense                                                         1.0                0.9
     Bad Debt Expense                                                                   0.5                0.4
     Changes in Operating Assets and Liabilities
         Accounts Receivable                                                            5.6               17.7
         Inventories                                                                   (3.5)              (9.0)
         Prepayments and Other                                                         (9.7)               2.2
         Accounts Payable                                                              (6.9)             (10.9)
         Other Current Liabilities                                                     (9.7)             (10.1)
     Other Assets                                                                       1.0               (1.1)
     Other Liabilities                                                                  4.9                5.1
     Net Operating Activities for Discontinued Operations                                 -              (13.0)
-----------------------------------------------------------------------------------------------------------------

         Cash from Operating Activities                                                52.3               36.4
-----------------------------------------------------------------------------------------------------------------

INVESTING ACTIVITIES
     Proceeds from Sale of Available-For-Sale Securities                              187.2              410.6
     Payments for Purchase of Available-For-Sale Securities                          (204.5)            (414.1)
     Changes to Investments                                                           (17.8)             (11.2)
     Additions to Property, Plant and Equipment                                       (70.1)             (35.3)
     Proceeds from Sale of Assets                                                       1.4                  -
     Other                                                                              1.5                2.5
     Net Investing Activities from Discontinued Operations                                -                2.2
-----------------------------------------------------------------------------------------------------------------

         Cash for Investing Activities                                               (102.3)             (45.3)
-----------------------------------------------------------------------------------------------------------------

FINANCING ACTIVITIES
     Issuance of Common Stock                                                          15.4                8.8
     Issuance of Debt                                                                 110.2               50.0
     Payments of Long-Term Debt                                                       (61.0)             (52.0)
     Dividends on Common Stock and Distributions to Minority Shareholders             (22.3)             (21.3)
     Net Decrease in Book Overdrafts                                                      -               (3.4)
-----------------------------------------------------------------------------------------------------------------

         Cash from (for) Financing Activities                                          42.3              (17.9)
-----------------------------------------------------------------------------------------------------------------

CHANGE IN CASH AND CASH EQUIVALENTS                                                    (7.7)             (26.8)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                       44.8               89.6
-----------------------------------------------------------------------------------------------------------------

CASH AND CASH EQUIVALENTS AT END OF PERIOD                                           $ 37.1             $ 62.8
-----------------------------------------------------------------------------------------------------------------

                        The accompanying notes are an integral part of these statements.
</TABLE>

                      ALLETE Second Quarter 2007 Form 10-Q                     6

<PAGE>

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying unaudited consolidated financial statements and notes should be
read in  conjunction  with our 2006 Form 10-K. In our opinion,  all  adjustments
necessary for a fair statement of the results for the interim  periods have been
made and have  occurred  in the  normal  course  of  business.  The  results  of
operations for an interim period are not  necessarily  indicative of the results
to be expected for the full year.

NOTE 1.    OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

INVENTORIES.  Inventories  are  stated at the lower of cost or  market.  Cost is
determined by the average cost method.

<TABLE>
<CAPTION>
                                                                                    JUNE 30,         DECEMBER 31,
INVENTORIES                                                                           2007               2006
-----------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                                 <C>              <C>
Fuel                                                                                  $22.1              $18.9
Materials and Supplies                                                                 24.8               24.5
-----------------------------------------------------------------------------------------------------------------

Total Inventories                                                                     $46.9              $43.4
-----------------------------------------------------------------------------------------------------------------
</TABLE>

ASSET  RETIREMENT  OBLIGATION (ARO). At June 30, 2007, our ARO balance was $35.9
million, ($27.2 million at December 31, 2006). This increase is primarily due to
the establishment of an ARO for our Taconite Harbor facility  resulting from the
MPUC's approval of our decommissioning estimate.

SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION.  Amount presented for June 30,
2006,  which  was $19.4  million  has been  revised  to  eliminate  intercompany
interest  payments of $7.0 million from cash paid during the period for Interest
- Net of Amounts Capitalized.

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF CASH FLOWS
SUPPLEMENTAL DISCLOSURE
FOR THE SIX MONTHS ENDED JUNE 30,                                                     2007               2006
-----------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                                   <C>                <C>
Cash Paid During the Period for
     Interest - Net of Amounts Capitalized                                            $14.3              $12.4
     Income Taxes                                                                     $20.3              $31.1

Noncash Investing Activities
     Accounts Payable for Capital Additions to
         Property Plant and Equipment                                                  $1.2                  -
-----------------------------------------------------------------------------------------------------------------
</TABLE>

NEW ACCOUNTING STANDARDS. SFAS 157. In September 2006, the FASB issued SFAS 157,
"Fair Value  Measurements,"  to increase  consistency and  comparability in fair
value  measurements  by  defining  fair  value,  establishing  a  framework  for
measuring fair value in generally accepted accounting principles,  and expanding
disclosures about fair value  measurements.  SFAS 157 emphasizes that fair value
is a market-based measurement,  not an entity-specific measurement. It clarifies
the  extent  to  which  fair  value is used to  measure  recognized  assets  and
liabilities,  the inputs  used to develop  the  measurements,  and the effect of
certain  measurements  on earnings  for the period.  SFAS 157 is  effective  for
financial  statements issued for fiscal years beginning after November 15, 2007,
and is applied on a prospective  basis.  We are currently  evaluating the impact
that the adoption of SFAS 157 would have on our consolidated financial position,
results of operations and cash flows.

SFAS 159. In February 2007, the FASB issued SFAS 159, "The Fair Value Option for
Financial Assets and Financial  Liabilities," which is an elective,  irrevocable
election to measure eligible financial  instruments and certain other assets and
liabilities at fair value on an instrument-by-instrument basis. The election may
only be applied at specified election dates and to instruments in their entirety
rather  than to portions  of  instruments.  Upon  initial  election,  the entity
reports the difference  between the  instruments'  carrying value and their fair
value as a  cumulative-effect  adjustment  to the  opening  balance of  retained
earnings. At each subsequent reporting date, an entity shall report in earnings,
unrealized  gains and losses on items for which the fair  value  option has been
elected.  SFAS 159 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and is applied on a prospective  basis. Early
adoption of SFAS 159 is  permitted  provided the entity also elects to adopt the
provisions  of SFAS 157 as of the early  adoption date selected for SFAS 159. We
are currently  evaluating the impact that the adoption of SFAS 159 would have on
our consolidated financial position, results of operations and cash flows.

7                     ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

NOTE 2.     BUSINESS SEGMENTS

<TABLE>
<CAPTION>
                                                                     ENERGY
                                                      --------------------------------------
                                                                  NONREGULATED
                                                       REGULATED     ENERGY      INVESTMENT      REAL
                                      CONSOLIDATED      UTILITY    OPERATIONS      IN ATC       ESTATE       OTHER
--------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                   <C>              <C>        <C>            <C>            <C>          <C>
FOR THE QUARTER ENDED JUNE 30, 2007

Operating Revenue                        $223.3         $179.0       $16.2             -        $ 28.0       $ 0.1
Fuel and Purchased Power                   92.9           92.9           -             -             -           -
Operating and Maintenance                  84.6           61.2        14.9             -           7.8         0.7
Depreciation                               11.9           10.7         1.1             -             -         0.1
--------------------------------------------------------------------------------------------------------------------

Operating Income (Loss) from
    Continuing Operations                  33.9           14.2         0.2             -          20.2        (0.7)
Interest Expense                           (6.1)          (5.2)       (0.2)            -          (0.2)       (0.5)
Other Income                                7.3            0.9         0.4          $3.2             -         2.8
--------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Minority Interest
    and Income Taxes                       35.1            9.9         0.4           3.2          20.0         1.6
Minority Interest                           1.3              -           -             -           1.3           -
--------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Income Taxes                    33.8            9.9         0.4           3.2          18.7         1.6
Income Tax Expense (Benefit)               11.2            3.8        (0.2)          1.3           7.2        (0.9)
--------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations          22.6         $  6.1       $ 0.6          $1.9        $ 11.5       $ 2.5
                                                       -------------------------------------------------------------
Loss from
    Discontinued Operations -
        Net of Tax                            -
-------------------------------------------------

Net Income                               $ 22.6
-------------------------------------------------



FOR THE QUARTER ENDED JUNE 30, 2006

Operating Revenue                        $178.3         $146.5      $ 16.5             -        $ 15.2       $ 0.1
Fuel and Purchased Power                   63.0           63.0           -             -             -           -
Operating and Maintenance                  76.8           57.2        14.1             -           4.9         0.6
Depreciation                               12.2           11.1         1.0             -             -         0.1
--------------------------------------------------------------------------------------------------------------------

Operating Income (Loss) from
    Continuing Operations                  26.3           15.2         1.4             -          10.3        (0.6)
Interest Expense                           (6.4)          (4.9)       (0.5)            -             -        (1.0)
Other Income                                3.4            0.5           -             -             -         2.9
--------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Minority Interest
    and Income Taxes                       23.3           10.8         0.9             -          10.3         1.3
Minority Interest                           0.8              -           -             -           0.8           -
--------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Income Taxes                    22.5           10.8         0.9             -           9.5         1.3
Income Tax Expense                          8.9            4.0           -             -           3.9         1.0
--------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations          13.6         $  6.8      $  0.9             -        $  5.6       $ 0.3
                                                       -------------------------------------------------------------
Loss from
    Discontinued Operations -
        Net of Tax                         (0.4)
-------------------------------------------------

Net Income                               $ 13.2
-------------------------------------------------
</TABLE>

                      ALLETE Second Quarter 2007 Form 10-Q                     8

<PAGE>

NOTE 2.     BUSINESS SEGMENTS (CONTINUED)
<TABLE>
<CAPTION>
                                                                       ENERGY
                                                        --------------------------------------
                                                                    NONREGULATED
                                                         REGULATED     ENERGY      INVESTMENT      REAL
                                        CONSOLIDATED      UTILITY    OPERATIONS      IN ATC       ESTATE       OTHER
----------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                     <C>             <C>         <C>            <C>            <C>         <C>
FOR THE SIX MONTHS ENDED JUNE 30, 2007

Operating Revenue                          $428.6         $359.2       $33.0             -        $ 36.2       $ 0.2
Fuel and Purchased Power                    170.6          170.6           -             -             -           -
Operating and Maintenance                   159.2          118.1        29.3             -          10.7         1.1
Depreciation                                 23.6           21.3         2.2             -             -         0.1
----------------------------------------------------------------------------------------------------------------------

Operating Income (Loss) from
    Continuing Operations                    75.2           49.2         1.5             -          25.5        (1.0)
Interest Expense                            (12.4)         (10.4)       (0.8)            -          (0.2)       (1.0)
Other Income                                 14.8            1.4         2.7          $6.1             -         4.6
----------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Minority Interest
    and Income Taxes                         77.6           40.2         3.4           6.1          25.3         2.6
Minority Interest                             1.4              -           -             -           1.4           -
----------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Income Taxes                      76.2           40.2         3.4           6.1          23.9         2.6
Income Tax Expense (Benefit)                 27.3           15.3         0.6           2.4           9.3        (0.3)
----------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations            48.9         $ 24.9       $ 2.8          $3.7        $ 14.6       $ 2.9
                                                         -------------------------------------------------------------
Loss from
    Discontinued Operations -
        Net of Tax                              -
--------------------------------------------------

Net Income                                 $ 48.9
--------------------------------------------------


AT JUNE 30, 2007

Total Assets                             $1,629.7       $1,218.9       $79.7         $64.4         $88.1      $178.6
Property, Plant and Equipment - Net        $977.2         $925.2       $48.6             -             -        $3.4
Accumulated Depreciation                   $833.6         $790.7       $41.1             -             -        $1.8
Capital Expenditures                        $71.3          $70.4        $0.9             -             -           -


FOR THE SIX MONTHS ENDED JUNE 30, 2006

Operating Revenue                          $370.8         $308.9      $ 32.8             -        $ 28.9       $ 0.2
Fuel and Purchased Power                    132.4          132.4           -             -             -           -
Operating and Maintenance                   151.3          113.0        28.2             -           8.3         1.8
Depreciation                                 24.4           22.2         2.1             -             -         0.1
----------------------------------------------------------------------------------------------------------------------

Operating Income (Loss) from
    Continuing Operations                    62.7           41.3         2.5             -          20.6        (1.7)
Interest Expense                            (12.8)         (10.0)       (1.0)            -             -        (1.8)
Other Income                                  5.1            0.5         0.3             -             -         4.3
----------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Minority Interest
    and Income Taxes                         55.0           31.8         1.8             -          20.6         0.8
Minority Interest                             2.1              -           -             -           2.1           -
----------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations
    Before Income Taxes                      52.9           31.8         1.8             -          18.5         0.8
Income Tax Expense (Benefit)                 20.5           12.0           -             -           7.9         0.6
----------------------------------------------------------------------------------------------------------------------

Income from Continuing Operations            32.4         $ 19.8      $  1.8             -        $ 10.6       $ 0.2
                                                         -------------------------------------------------------------
Loss from
    Discontinued Operations -
        Net of Tax                           (0.4)
--------------------------------------------------

Net Income                                 $ 32.0
--------------------------------------------------


AT JUNE 30, 2006

Total Assets                             $1,386.1         $995.0      $104.6             -         $72.4      $214.1
Property, Plant and Equipment - Net        $871.6         $813.6       $53.2             -             -        $4.8
Accumulated Depreciation                   $807.4         $769.4       $36.4             -             -        $1.6
Capital Expenditures                        $35.3          $34.5        $0.8             -             -           -

</TABLE>

9                     ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

NOTE 3.    INVESTMENTS

SHORT-TERM  INVESTMENTS.  At June 30, 2007 and December 31, 2006, we held $121.8
million and $104.5 million, respectively, of Short-Term Investments,  consisting
of  auction  rate  bonds  and  variable   rate  demand   notes   classified   as
available-for-sale  securities. Our investments in these securities are recorded
at cost;  however,  their cost  approximates  fair value  because  the  variable
interest rates for these securities  typically reset every 7 to 35 days. Despite
the long-term nature of their stated contractual maturities, we have the ability
to quickly liquidate these  securities.  As a result, we had no cumulative gross
unrealized  holding gains  (losses) or gross  realized  gains  (losses) from our
short-term  investments.  All income generated from these short-term investments
was recorded as interest income.

LONG-TERM  INVESTMENTS.  At June 30, 2007,  Investments included the real estate
assets of ALLETE  Properties,  our investment in ATC, debt and equity securities
consisting  primarily  of  securities  held to fund  employee  benefits  and our
emerging technology investments.

We account  for our  investment  in ATC under the equity  method of  accounting,
pursuant  to EITF  03-16,  "Accounting  for  Investments  in  Limited  Liability
Companies,"  which  requires  the use of the  equity  method of  accounting  for
investments in limited liability companies.

<TABLE>
<CAPTION>
                                                                            JUNE 30,                 DECEMBER 31,
INVESTMENTS                                                                   2007                       2006
------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                         <C>                      <C>
Real Estate Assets                                                           $ 88.1                     $ 89.8
Debt and Equity Securities                                                     46.3                       36.4
Investment in ATC                                                              64.4                       53.7
Emerging Technology Investments                                                 9.0                        9.2
------------------------------------------------------------------------------------------------------------------

Total Investments                                                            $207.8                     $189.1
------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                                            JUNE 30,                 DECEMBER 31,
REAL ESTATE ASSETS                                                            2007                       2006
------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                         <C>                      <C>
Land Held for Sale Beginning Balance                                          $58.0                      $48.0
    Additions during period:  Capitalized Improvements                          5.6                       18.8
                              Purchases                                           -                        1.4
    Deductions during period: Cost of Real Estate Sold                         (5.0)                     (10.2)
------------------------------------------------------------------------------------------------------------------

Land Held for Sale Ending Balance                                              58.6                       58.0
Long-Term Finance Receivables                                                  16.0                       18.3
Other <F1>                                                                     13.5                       13.5
------------------------------------------------------------------------------------------------------------------

Total Real Estate Assets                                                      $88.1                      $89.8
------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Consisted primarily of a shopping center.
</FN>
</TABLE>

Finance  receivables have maturities  ranging up to 7 years,  accrue interest at
market-based  rates and are net of an allowance  for  doubtful  accounts of $0.2
million at June 30, 2007 ($0.2 million at December 31, 2006).

INVESTMENT IN ATC. In December 2005, we entered into an agreement with Wisconsin
Public  Service  Corporation  and WPS  Investments,  LLC that  provides  for our
Wisconsin subsidiary,  Rainy River Energy Corporation - Wisconsin, to invest $60
million in ATC. In the first six months of 2007, we invested an additional  $8.7
million ($51.4 million invested through December 31, 2006) in ATC,  reaching our
approximate $60 million investment  commitment.  As of June 30, 2007, our equity
investment  balance in ATC was $64.4  million  ($53.7  million at  December  31,
2006), representing an 8.3 percent ownership interest.

                      ALLETE Second Quarter 2007 Form 10-Q                    10

<PAGE>

NOTE 4.    SHORT-TERM AND LONG-TERM DEBT

On February 1, 2007, we issued $60 million in principal amount of First Mortgage
Bonds,  5.99%  Series due  February 1, 2027,  in the private  placement  market.
Proceeds were used to retire $60 million in principal  amount of First  Mortgage
Bonds, 7% Series due on February 15, 2007.

On June 8, 2007, we issued $50 million of senior  unsecured notes (Notes) in the
private  placement  market.  The Notes bear an interest rate of 5.99 percent and
will  mature on June 1,  2017.  The  Company  has the  option to prepay all or a
portion of the Notes at its discretion,  subject to a make-whole provision.  The
Company  intends to use the proceeds  from the sale of the Notes to fund utility
capital projects and for general corporate purposes.


NOTE 5.     OTHER INCOME (EXPENSE)

<TABLE>
<CAPTION>
                                                                          QUARTER ENDED            SIX MONTHS ENDED
                                                                            JUNE 30,                   JUNE 30,
                                                                       2007         2006         2007          2006
----------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                    <C>          <C>         <C>           <C>
Gain (Loss) on Emerging Technology Investments                         $ 0.1           -        $ (0.8)       $(1.2)
Income from Investment in ATC (See Note 3)                               3.2           -           6.1            -
Investment and Other Income                                              4.0        $3.4           9.5          6.3
----------------------------------------------------------------------------------------------------------------------

Total Other Income                                                     $ 7.3        $3.4        $ 14.8        $ 5.1
----------------------------------------------------------------------------------------------------------------------
</TABLE>


NOTE 6.    INCOME TAX EXPENSE

<TABLE>
<CAPTION>
                                                                          QUARTER ENDED            SIX MONTHS ENDED
                                                                            JUNE 30,                   JUNE 30,
                                                                       2007         2006          2007         2006
----------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                   <C>          <C>          <C>          <C>
Current Tax Expense
     Federal                                                          $ 10.1       $ 9.6        $ 22.0       $ 20.4
     State                                                               2.5         2.3           6.4          4.8
----------------------------------------------------------------------------------------------------------------------

                                                                        12.6        11.9          28.4         25.2
----------------------------------------------------------------------------------------------------------------------

Deferred Tax Expense (Benefit)
     Federal                                                            (1.5)       (1.9)         (1.3)        (3.5)
     State                                                               0.3        (0.7)          0.7         (0.5)
----------------------------------------------------------------------------------------------------------------------

                                                                        (1.2)       (2.6)         (0.6)        (4.0)
----------------------------------------------------------------------------------------------------------------------

Deferred Tax Credits                                                    (0.2)       (0.4)         (0.5)        (0.7)
----------------------------------------------------------------------------------------------------------------------

Income Tax Expense from Continuing Operations                           11.2         8.9          27.3         20.5
Income Tax Benefit from Discontinued Operations                            -        (0.3)            -         (0.3)
----------------------------------------------------------------------------------------------------------------------

Total Income Tax Expense                                              $ 11.2       $ 8.6        $ 27.3       $ 20.2
----------------------------------------------------------------------------------------------------------------------
</TABLE>

For the six months ended June 30, 2007,  the  effective  tax rate on income from
continuing  operations  before minority  interest was 35.1 percent (37.3 percent
for six months ended June 30, 2006).  The effective rate of 35.1 percent for the
six months ended June 30, 2007,  deviated from the statutory rate (approximately
40 percent) primarily due to a state income tax audit settlement ($1.5 million),
deductions for Medicare  health  subsidies,  domestic  manufacturing  deduction,
allowance for funds used during construction (AFUDC) and depletion.

11                    ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

NOTE 6. INCOME TAX EXPENSE (CONTINUED)

UNCERTAIN TAX POSITIONS. Effective January 1, 2007, we adopted the provisions of
FIN 48,  "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109." As a result of the implementation of FIN 48, we recognized a
$1.0 million  increase in the  liability  for  unrecognized  tax  benefits.  The
adoption of FIN 48 also  resulted in a  reduction  in retained  earnings of $0.7
million, a reduction of deferred tax liabilities of $0.8 million and an increase
in accrued interest of $0.5 million. Subsequent to the implementation of FIN 48,
ALLETE's gross unrecognized tax benefits were $10.4 million. Of this total, $6.8
million (net of federal tax benefit on state  issues)  represents  the amount of
unrecognized  tax benefits  that,  if  recognized,  would  favorably  affect the
effective income tax rate.

Included in the liability for unrecognized tax benefits balance as of January 1,
2007,  are $0.8  million  (net of federal  tax  benefit on state  issues) of tax
positions for which the ultimate  deductibility is highly certain, but for which
there is  uncertainty  about the timing of  deductibility.  Due to the impact of
deferred tax  accounting,  other than the accounting for interest and penalties,
the disallowance of the shorter deductibility period would not affect the annual
effective tax rate. The disallowance would,  however,  accelerate the payment of
cash to the taxing authority to an earlier period.

We recognize  interest  related to unrecognized tax benefits in interest expense
and penalties in operating expenses in the Consolidated  Statement of Income. As
of January 1, 2007,  the Company  had $1.3  million of accrued  interest  and no
accrued   penalties  related  to  unrecognized  tax  benefits  included  in  the
Consolidated  Balance  Sheet.  The liability for the payment of interest is $0.8
million as of June 30, 2007.

In May 2007,  we settled a state audit  resulting  in the  recognition  of a tax
benefit of $1.5 million.  After the reversal of  unrecognized  tax benefits upon
the audit settlement, ALLETE's gross unrecognized tax benefits were $4.7 million
at June 30, 2007. Of this total,  $3.1 million (net of federal  benefit on state
issues) represented the amount of unrecognized tax benefits that, if recognized,
would favorably affect the effective tax rate.

We, along with our subsidiaries, file income tax returns in the U.S. federal and
various state jurisdictions. With few exceptions, ALLETE is no longer subject to
federal examination for years before 2003 or state examinations for years before
2001.

We expect that the amount of unrecognized tax benefits as of June 30, 2007, will
change in the next 12  months;  however,  we do not  expect the change to have a
significant  impact on our  financial  position,  results of  operations or cash
flows.


NOTE 7.    DISCONTINUED OPERATIONS

In early 2005, we completed the exit from our Water Services businesses with the
sale of our wastewater assets in Georgia,  which resulted in an immaterial gain.
In 2005, the Florida Public Service Commission approved the transfer of 63 water
and wastewater systems from Florida Water Services Corporation to Aqua Utilities
Florida,  Inc. (Aqua  Utilities)  and ordered a $1.7 million  reduction to plant
investment.  The Company  reserved for the reduction in 2005. On March 15, 2006,
the Company paid Aqua Utilities the adjustment refund amount of $1.7 million.

For the  quarter and six months  ended June 30,  2007,  there were no  financial
results to report as discontinued operations.

<TABLE>
<CAPTION>

                                                                      QUARTER ENDED            SIX MONTHS ENDED
DISCONTINUED OPERATIONS                                                  JUNE 30,                  JUNE 30,
SUMMARY INCOME STATEMENT                                                   2006                      2006
----------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                   <C>                      <C>
Loss on Disposal
     Water Services                                                       $(0.7)                    $(0.7)
----------------------------------------------------------------------------------------------------------------

Income Tax Benefit
     Water Services                                                         0.3                       0.3
----------------------------------------------------------------------------------------------------------------

         Net Loss on Disposal                                              (0.4)                     (0.4)
----------------------------------------------------------------------------------------------------------------

Loss from Discontinued Operations                                         $(0.4)                    $(0.4)
----------------------------------------------------------------------------------------------------------------
</TABLE>

                      ALLETE Second Quarter 2007 Form 10-Q                    12

<PAGE>

NOTE 8.    COMPREHENSIVE INCOME (LOSS)

For the quarter ended June 30, 2007, total  comprehensive  income (loss), net of
tax, was $23.9 million ($13.2 million for the quarter ended June 30, 2006).  For
the six months ended June 30, 2007, total  comprehensive  income (loss),  net of
tax, was $50.4 million of  comprehensive  income ($32.3 million of comprehensive
loss, net of tax, for the six months ended June 30, 2006).  Total  comprehensive
income  (loss)  includes  net  income  (loss),  unrealized  gains and  losses on
securities   classified  as   available-for-sale,   and  our  unfunded   pension
liabilities.

<TABLE>
<CAPTION>
ACCUMULATED OTHER COMPREHENSIVE                                                          JUNE 30,
INCOME (LOSS) - NET OF TAX                                                    2007                       2006
----------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                                         <C>                         <C>
Unrealized Gain on Securities                                               $  5.0                      $  2.4
Defined Benefit Pension and Other Postretirement Plans                       (12.3)                          -
Additional Pension Liability                                                     -                       (14.9)
----------------------------------------------------------------------------------------------------------------

Total Accumulated Other Comprehensive Loss                                  $ (7.3)                     $(12.5)
----------------------------------------------------------------------------------------------------------------
</TABLE>

NOTE 9.     EARNINGS PER SHARE

The  difference  between  basic  and  diluted  earnings  per share  arises  from
outstanding  stock  options  and  performance  share  awards  granted  under our
Executive and Director  Long-Term  Incentive  Compensation  Plans. In accordance
with SFAS 128,  "Earnings  Per Share," for the quarter and six months ended June
30, 2007, 0.1 million  options to purchase  shares of common stock were excluded
from the  computation of diluted  earnings per share because the option exercise
prices were greater than the average market prices, and therefore,  their effect
would be  anti-dilutive.  For the quarter and six months ended June 30, 2006, no
options to purchase shares of common stock were excluded from the computation of
diluted earnings per share.

<TABLE>
<CAPTION>

                                                            2007                                2006
                                                -------------------------------------------------------------------
RECONCILIATION OF BASIC AND DILUTED                       DILUTIVE                            DILUTIVE
EARNINGS PER SHARE                               BASIC   SECURITIES    DILUTED       BASIC   SECURITIES    DILUTED
-------------------------------------------------------------------------------------------------------------------
MILLIONS EXCEPT PER SHARE AMOUNTS
<S>                                              <C>     <C>           <C>           <C>     <C>           <C>
FOR THE QUARTER ENDED JUNE 30,

Income from Continuing Operations                $22.6         -        $22.6        $13.6         -        $13.6
Common Shares                                     28.2       0.1         28.3         27.7       0.2         27.9
Per Share from Continuing Operations             $0.80         -        $0.80        $0.50         -        $0.49
-------------------------------------------------------------------------------------------------------------------

FOR THE SIX MONTHS ENDED JUNE 30,

Income from Continuing Operations                $48.9         -        $48.9        $32.4         -        $32.4
Common Shares                                     28.1       0.1         28.2         27.6       0.2         27.8
Per Share from Continuing Operations             $1.74         -        $1.73        $1.18         -        $1.17
-------------------------------------------------------------------------------------------------------------------
</TABLE>

13                    ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

NOTE 10.    PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

<TABLE>
<CAPTION>

                                                                                               POSTRETIREMENT
                                                                  PENSION                      HEALTH AND LIFE
                                                       -------------------------------------------------------------
COMPONENTS OF NET PERIODIC BENEFIT EXPENSE                 2007            2006             2007            2006
--------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                       <C>             <C>              <C>             <C>
FOR THE QUARTER ENDED JUNE 30,

Service Cost                                              $ 1.3           $  2.3           $ 0.9           $  1.1
Interest Cost                                               5.7              5.6             1.8              1.8
Expected Return on Plan Assets                             (7.6)            (7.2)           (1.6)            (1.4)
Amortization of Prior Service Costs                         0.1              0.2               -                -
Amortization of Net Loss                                    0.8              1.2             0.1              0.5
Amortization of Transition Obligation                         -             (0.1)            0.6              0.6
--------------------------------------------------------------------------------------------------------------------

Net Periodic Benefit Expense                              $ 0.3           $  2.0           $ 1.8           $  2.6
--------------------------------------------------------------------------------------------------------------------

FOR THE SIX MONTHS ENDED JUNE 30,

Service Cost                                              $ 2.6           $  4.6           $ 1.9           $  2.2
Interest Cost                                              11.4             11.1             3.7              3.7
Expected Return on Plan Assets                            (15.3)           (14.3)           (3.2)            (2.8)
Amortization of Prior Service Costs                         0.3              0.4               -                -
Amortization of Net Loss                                    1.6              2.4             0.3              0.9
Amortization of Transition Obligation                         -             (0.1)            1.2              1.2
--------------------------------------------------------------------------------------------------------------------

Net Periodic Benefit Expense                              $ 0.6           $  4.1           $ 3.9           $  5.2
--------------------------------------------------------------------------------------------------------------------
</TABLE>

In 2005,  we  determined  that our  postretirement  health  care  plans meet the
requirements   of  the  Centers  for  Medicare  and  Medicaid   Services'  (CMS)
regulations  and  enrolled  with the CMS to begin  recovering  the  subsidy.  We
received our first subsidy payment of $0.3 million in 2007 for 2006 credits.

EMPLOYER  CONTRIBUTIONS.  For the quarter ended June 30, 2007, no  contributions
were made to our pension or  postretirement  health and life plans.  For the six
months ended june 30, 2007, no contributions  were made to our pension plans and
$2.8 million of contributions  were made to our  postretirement  health and life
plans. We do not expect to make any additional contributions to fund our pension
or postretirement health and life plans in 2007.

NOTE 11.     COMMITMENTS, GUARANTEES AND CONTINGENCIES

OFF-BALANCE SHEET ARRANGEMENTS. Square Butte Power Purchase Agreement. Minnesota
Power has a power purchase agreement with Square Butte that extends through 2026
(Agreement).  It provides a long-term  supply of low-cost energy to customers in
our electric  service  territory and enables  Minnesota Power to meet power pool
reserve requirements. Square Butte, a North Dakota cooperative corporation, owns
a 455-MW coal-fired  generating unit (Unit) near Center,  North Dakota. The Unit
is  adjacent  to a  generating  unit owned by  Minnkota  Power,  a North  Dakota
cooperative  corporation whose Class A members are also members of Square Butte.
Minnkota Power serves as the operator of the Unit and also purchases  power from
Square Butte.

Minnesota  Power was entitled to  approximately  71 percent of the Unit's output
under the Agreement prior to 2006.  Beginning in 2006,  Minnkota Power exercised
its option to reduce  Minnesota  Power's  entitlement by approximately 5 percent
annually.   We  received   notices  from  Minnkota  Power  reducing  our  output
entitlement by  approximately 5 percent  annually to 60 percent as of January 1,
2007,  55 percent on  January  1, 2008,  and 50 percent on January 1, 2009,  and
thereafter.  Minnkota  Power has no further option to reduce  Minnesota  Power's
entitlement  below 50 percent.  Minnesota Power is obligated to pay its pro-rata
share of Square  Butte's costs based on Minnesota  Power's  entitlement  to Unit
output.  Minnesota Power's payment  obligation will be suspended if Square Butte
fails to deliver any power,  whether produced or purchased,  for a period of one
year. Square Butte's fixed costs consist primarily of debt service.  At June 30,
2007,  Square Butte had total debt  outstanding of $324.2 million.  Total annual
debt  service for Square  Butte is expected to be  approximately  $26 million in
each of the years 2007 through 2011.  Variable operating costs include the price
of coal purchased from BNI Coal, our subsidiary, under a long-term contract.


                      ALLETE Second Quarter 2007 Form 10-Q                    14

<PAGE>

NOTE 11. COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)

LEASING AGREEMENTS.  BNI Coal is obligated to make lease payments for a dragline
totaling  $2.8 million  annually for the lease term which  expires in 2027.  BNI
Coal has the  option at the end of the  lease  term to renew the lease at a fair
market  rental,  to purchase the dragline at fair market value,  or to surrender
the dragline and pay a $3.0 million  termination  fee. We lease other properties
and equipment under operating lease agreements with terms expiring through 2013.
The aggregate  amount of minimum lease payments for all operating leases is $8.2
million in 2007,  $7.6 million in 2008,  $7.0  million in 2009,  $6.5 million in
2010, $6.0 million in 2011 and $51.2 million thereafter.

COAL,  RAIL AND SHIPPING  CONTRACTS.  We have three coal supply  agreements with
various  expiration  dates ranging from December 2008 to December  2009. We also
have rail and shipping  agreements  for the  transportation  of all of our coal,
with various  expiration  dates ranging from December 2007 to December 2011. Our
minimum  annual  payment   obligations  under  these  coal,  rail  and  shipping
agreements  are currently  $42.0 million in 2007,  $16.0 million in 2008,  $10.7
million in 2009 and no specific  commitments  beyond  2009.  Our minimum  annual
payment  obligations  will  increase when annual  nominations  are made for coal
deliveries in future years.

EMERGING  TECHNOLOGY  PORTFOLIO.  We have  investments in emerging  technologies
through  minority  investments  in venture  capital funds  structured as limited
liability  companies,   and  direct  investments  in  privately-held,   start-up
companies.  We have committed to make additional investments in certain emerging
technology  venture capital funds. The total future  commitment was $1.8 million
at June 30, 2007 ($2.5  million at December 31,  2006),  and will be invested in
2007.  We do not have  plans  to make any  additional  investments  beyond  this
commitment.

ENVIRONMENTAL MATTERS. Our businesses are subject to regulation of environmental
matters  by  various  federal,  state and  local  authorities.  Due to  stricter
environmental  requirements through legislation and/or rulemaking in the future,
we anticipate  that potential  expenditures  for  environmental  matters will be
material  and  will  require   significant   capital   investments.   We  review
environmental  matters on a quarterly basis.  Accruals for environmental matters
are  recorded  when it is probable  that a liability  has been  incurred and the
amount of the liability can be  reasonably  estimated,  based on current law and
existing  technologies.  These accruals are adjusted  periodically as assessment
and remediation efforts progress or as additional technical or legal information
becomes  available.  Accruals for environmental  liabilities are included in the
balance sheet at  undiscounted  amounts and exclude claims for  recoveries  from
insurance or other third parties.  Costs related to environmental  contamination
treatment and cleanup are charged to expense  unless  recoverable  in rates from
customers.

SWL&P  MANUFACTURED  GAS PLANT. In May 2001, SWL&P received notice from the WDNR
that the City of Superior had found soil  contamination on property  adjoining a
former  Manufactured  Gas Plant (MGP) site owned and operated by SWL&P from 1889
to 1904. A report submitted in 2003 identified some MGP-like chemicals that were
found in the soil  near the  former  plant  site.  The  investigation  continued
through the fall of 2006.  The final Phase II report was issued on June 7, 2007,
confirming our  understanding of the issues involved.  The final Phase II Report
and Risk Assessment were sent to the WDNR for review on June 18, 2007.  Although
it  is  not  possible  to  quantify  the  potential   clean-up  cost  until  the
investigation  is completed,  a $0.5 million  liability was recorded in December
2003 to address the known  areas of  contamination.  The Company has  recorded a
corresponding  dollar amount as a regulatory asset to offset this liability.  In
May 2005,  the PSCW  approved the  collection  through rates of $150,000 of site
investigation costs that had been incurred at the time SWL&P filed its 2005 rate
request.  On December 11, 2006,  the PSCW approved the recovery of an additional
$186,000 of site  investigation  costs that were incurred  through 2005.  ALLETE
maintains  pollution  liability  insurance  coverage that includes  coverage for
SWL&P. A claim has been filed with respect to this matter. The insurance carrier
has issued a reservation of rights letter and the Company continues to work with
the insurer to determine the availability of insurance coverage.

15                     ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

NOTE 11.   COMMITMENTS, GUARANTEES AND CONTINGENCIES (CONTINUED)

EPA CLEAN AIR INTERSTATE RULE AND CLEAN AIR MERCURY RULE. In March 2005, the EPA
announced  the  final  Clean  Air  Interstate   Rule  (CAIR)  that  reduces  and
permanently caps emissions of SO2 and NOX in the eastern United States. The CAIR
includes  Minnesota  as one of the 28  states  it  considers  as  "significantly
contributing" to air quality standards  non-attainment in other states.  The EPA
also  announced  the final  Clean Air  Mercury  Rule  (CAMR)  that  reduces  and
permanently caps electric utility mercury emissions nationwide. The CAIR and the
CAMR  regulations  have been  challenged in the federal court system,  which may
delay implementation or modify provisions. Minnesota Power is participating in a
legal  challenge  to the CAIR,  but is not  participating  in a challenge to the
CAMR.  However,  if the  CAMR and the CAIR do go into  effect,  Minnesota  Power
expects to be required to: (1) make emissions reductions;  (2) purchase mercury,
SO2 and NOX  allowances  through the EPA's  cap-and-trade  system;  or (3) use a
combination of both.

Minnesota Power petitioned the EPA to review its CAIR  determinations  affecting
Minnesota.  In July 2005,  Minnesota Power also filed a Petition for Review with
the U.S.  Court of  Appeals  for the  District  of  Columbia  Circuit  (Court of
Appeals).  In November 2005, the EPA agreed to reconsider certain aspects of the
CAIR, including the Minnesota Power petition addressing emissions applied to air
quality modeling used to determine  Minnesota's inclusion in the CAIR region and
our claims about inequities in the SO2 allowance methodology. In March 2006, the
EPA announced  that it would not make any changes to the CAIR as a result of the
petitions  for  reconsideration.   Petitions  for  Review,  including  Minnesota
Power's,  remain  pending at the Court of Appeals.  If the  Petitions for Review
filed with the Court of Appeals are successful, we expect to incur significantly
lower  compliance  costs,  consistent with the rules  applicable to those states
determined to not be "significant contributors" to air quality non-attainment as
addressed  under the CAIR.  Resolution  of the CAIR Petition for Review with the
Court of Appeals is anticipated in 2008.

COMMUNITY DEVELOPMENT DISTRICT OBLIGATIONS. TOWN CENTER. In March 2005, the Town
Center  District  issued $26.4  million of  tax-exempt,  6% Capital  Improvement
Revenue  Bonds,  Series 2005,  which are payable over 31 years (by May 1, 2036).
The bond proceeds (less  capitalized  interest,  a debt service reserve fund and
cost of  issuance)  were used to pay for the  construction  of a portion  of the
major infrastructure improvements at Town Center. The bonds are payable from and
secured by the revenue derived from assessments imposed, levied and collected by
the Town Center District.  The assessments  represent an allocation of the costs
of the  improvements,  including bond financing  costs,  to the lands within the
Town Center District  benefiting  from the  improvements.  The assessments  were
billed to Town Center landowners  beginning in November 2006. To the extent that
we still own land at the time of the assessment,  in accordance with EITF 91-10,
we  recognize  the cost of our  portion  of these  assessments,  based  upon our
ownership of benefited  property.  At June 30, 2007,  we owned 69 percent of the
assessable land in the Town Center District (73 percent at December 31, 2006).

PALM COAST PARK. In May 2006, the Palm Coast Park District  issued $31.8 million
of tax-exempt,  5.7% Special  Assessment  Bonds,  Series 2006, which are payable
over 31 years (by May 1, 2037). The bond proceeds (less capitalized  interest, a
debt service  reserve  fund and cost of issuance)  are being used to pay for the
construction of the major infrastructure  improvements at Palm Coast Park and to
mitigate  traffic and  environmental  impacts.  The bonds are  payable  from and
secured by the revenue derived from assessments imposed, levied and collected by
the Palm Coast Park  District.  The  assessments  represent an allocation of the
costs of the  improvements,  including bond financing costs, to the lands within
the Palm Coast Park District  benefiting from the improvements.  The assessments
will be billed to Palm Coast Park landowners  beginning in November 2007. To the
extent that we still own land at the time of the assessment,  in accordance with
EITF 91-10,  we will  recognize  the cost of our  portion of these  assessments,
based upon our  ownership of benefited  property.  At June 30, 2007, we owned 89
percent of the  assessable  land in the Palm Coast Park  District (97 percent at
December 31, 2006).

OTHER.  We are involved in litigation  arising in the normal course of business.
Also in the normal course of business,  we are involved in tax,  regulatory  and
other  governmental  audits,  inspections,  investigations and other proceedings
that involve state and federal taxes, safety, compliance with regulations,  rate
base and cost of service  issues,  among other things.  While the  resolution of
such matters could have a material effect on earnings and cash flows in the year
of  resolution,  none of these  matters are  expected to  materially  change our
present  liquidity  position or have a material  adverse effect on our financial
condition.

                     ALLETE Second Quarter 2007 Form 10-Q                     16

<PAGE>

ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
           CONDITION AND RESULTS OF OPERATIONS

The following  discussion  should be read in conjunction  with our  consolidated
financial  statements,  notes to those  statements,  management,  discussion and
analysis from the 2006 Form 10-K and the other financial  information  appearing
elsewhere in this report. In addition to historical  information,  the following
discussion and other parts of this Form 10-Q contain forward-looking information
that   involves   risks  and   uncertainties.   Readers   are   cautioned   that
forward-looking statements should be read in conjunction with our disclosures in
this Form 10-Q under the  headings:  "Safe  Harbor  Statement  Under the Private
Securities  Litigation  Reform Act of 1995" located on page 3 and "Risk Factors"
located  in Part I,  Item 1A,  page 24 of our 2006  Form  10-K.  The  risks  and
uncertainties  described  in this  Form  10-Q and our 2006 Form 10-K are not the
only risks facing our Company.  Additional risks and  uncertainties  that we are
not  presently  aware of, or that we  currently  consider  immaterial,  may also
affect our business operations. Our business,  financial condition or results of
operations could suffer if the concerns set forth are realized.

EXECUTIVE SUMMARY

ALLETE is a  diversified  company  providing  fundamental  products and services
since 1906. This includes our two core  businesses--ENERGY  and REAL ESTATE,  as
well as our  former  operations  in the  water,  paper,  telecommunications  and
automotive industries.

ENERGY is comprised of Regulated  Utility,  Nonregulated  Energy  Operations and
Investment in ATC.

   -  REGULATED UTILITY includes retail and wholesale rate  regulated  electric,
      natural  gas and water services in northeastern Minnesota and northwestern
      Wisconsin  under  the  jurisdiction  of  state   and   federal  regulatory
      authorities.

   -  NONREGULATED  ENERGY  OPERATIONS  includes  our  coal mining activities in
      North Dakota, approximately 50 MW of nonregulated generation and Minnesota
      land sales.

   -  INVESTMENT IN ATC includes our equity ownership interest in ATC.

REAL ESTATE includes our Florida real estate operations.

OTHER includes our  investments in emerging  technologies,  and earnings on cash
and short-term investments.


17                   ALLETE Second Quarter 2007 Form 10-Q


<PAGE>

EXECUTIVE SUMMARY (CONTINUED)

<TABLE>
<CAPTION>
                                                                 QUARTER ENDED                 SIX MONTHS ENDED
                                                                   JUNE 30,                        JUNE 30,
KILOWATTHOURS SOLD                                           2007           2006             2007           2006
------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                                        <C>             <C>             <C>            <C>
     Regulated Utility
         Retail and Municipals
              Residential                                    231.7           229.1           573.3          537.1
              Commercial                                     320.9           315.5           673.1          644.2

              Municipals                                     229.2           216.1           495.6          435.4
              Industrial                                   1,734.0         1,769.9         3,439.4        3,592.2
              Other                                           19.0            18.6            41.3           38.6
------------------------------------------------------------------------------------------------------------------

                  Total Retail and Municipals              2,534.8         2,549.2         5,222.7        5,247.5
         Other Power Suppliers                               513.0           515.5         1,036.9        1,020.6
------------------------------------------------------------------------------------------------------------------

                  Total Regulated Utility                  3,047.8         3,064.7         6,259.6        6,268.1
     Nonregulated Energy Operations                           59.8            55.3           123.5          120.9
------------------------------------------------------------------------------------------------------------------

                                                           3,107.6         3,120.0         6,383.1        6,389.0
------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>

                                                 QUARTER ENDED                          SIX MONTHS ENDED
                                                   JUNE 30,                                 JUNE 30,
REAL ESTATE                                2007                2006                 2007                2006
REVENUE AND SALES ACTIVITY              QTY    AMOUNT     QTY     AMOUNT        QTY    AMOUNT       QTY    AMOUNT
------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
<S>                                   <C>      <C>      <C>       <C>         <C>      <C>        <C>      <C>
Town Center Sales
    Commercial Sq. Ft.                435,000  $ 12.6   170,695   $  4.7      435,000  $ 12.6     250,695  $ 6.2
    Residential Units                     130     1.6       186      5.6          130     1.6         186    5.6

Palm Coast Park
    Commercial Sq. Ft.                 40,000     2.0         -        -       40,000     2.0           -      -
    Residential Units                     406    11.1         -        -          406    11.1           -      -

Other Land Sales
    Acres <F1>                              -       -        10      5.2          367     6.0         466   15.5
    Lots                                    -       -         -        -            -       -           -      -
------------------------------------------------------------------------------------------------------------------

Contract Sales Price <F2>                        27.3               15.5                 33.3               27.3

Revenue Recognized from
    Previously Deferred Sales                     1.0                2.7                  2.3                4.3

Deferred Revenue                                 (3.1)              (3.2)                (3.1)              (4.0)

Adjustments <F3>                                    -               (1.4)                   -               (1.5)
------------------------------------------------------------------------------------------------------------------

Revenue from Land Sales                          25.2               13.6                 32.5               26.1

Other Revenue                                     2.8                1.6                  3.7                2.8
------------------------------------------------------------------------------------------------------------------

                                               $ 28.0             $ 15.2               $ 36.2              $28.9
------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Acreage amounts are shown on a gross basis, including wetlands and minority interest.
<F2> Reflected total contract sales price on closed land transactions.
<F3> Contributed development dollars, which are credited to cost of real estate sold.
</FN>
</TABLE>

                     ALLETE Second Quarter 2007 Form 10-Q                     18
<PAGE>

NET INCOME

The following income discussion summarizes,  by segment, a comparison of the six
months ended June 30, 2007, to the six months ended June 30, 2006.

REGULATED UTILITY  contributed income of $24.9 million in 2007 ($19.8 million in
2006). The increase in earnings for 2007 reflects:

   -  increased  electric  sales  to  residential,   commercial  and   municipal
      customers,  as well as  increased gas sales at SWL&P due to colder weather
      in the first quarter of 2007;
   -  rate increases effective January 1, 2007, at SWL&P;
   -  increased sales to other power suppliers under long-term contracts; and
   -  increased  operations and maintenance expense relating to the Boswell Unit
      4 outage.

NONREGULATED  ENERGY  OPERATIONS  reported  income of $2.8 million in 2007 ($1.8
million in 2006), reflecting a $1.2 million after tax gain on land sold that was
part of our purchase of Taconite Harbor.

INVESTMENT  IN ATC  contributed  income of $3.7  million  in 2007.  Our  initial
investment in ATC was in May 2006.

REAL ESTATE contributed income of $14.6 million in 2007 ($10.6 million in 2006).
Income was  higher in 2007 due to the  timing  and mix of land sale  transaction
closings.  Two large sales closed during the second  quarter of 2007. The timing
of the  closing of real  estate  sales  varies from period to period and impacts
comparisons between years.

OTHER  reflected net income of $2.9 million in 2007 ($0.2 million in 2006),  due
to a state tax audit  settlement  for $1.5  million and the release  from a loan
guarantee for Northwest Airlines Corporation of $0.6 million after tax.


COMPARISON OF THE QUARTERS ENDED JUNE 30, 2007 AND 2006

(See Note 2. Business Segments for financial results by segment.)

REGULATED UTILITY

     OPERATING  REVENUE  increased  $32.5  million,  or 22  percent,  from  2006
     primarily  due  to  increased  fuel  clause  recoveries,   increased  power
     marketing prices, and rate increases at SWL&P.

     Fuel clause  recoveries  increased  $30.4  million in 2007  primarily  as a
     result of increased  purchased power expenses (see Fuel and Purchased Power
     Expense discussion below).

     Revenue from other  power suppliers  increased $2.3 million, or 11 percent,
     from  2006  primarily  due  to  an 11 percent  increase  in  the  price per
     kilowatthour.

     New rates at SWL&P,  which became effective January 1, 2007,  reflect a 2.8
     percent increase in electric rates, a 1.4 percent increase in gas rates and
     an 8.6 percent increase in water rates.  These rate increases resulted in a
     $0.3 million increase in operating revenue.

     Revenue from electric sales to taconite customers  accounted for 24 percent
     of consolidated  operating  revenue in each of 2007 and 2006.  Revenue from
     electric  sales  to  paper  and  pulp  mills  accounted  for 9  percent  of
     consolidated  operating  revenue  in each of 2007 and  2006.  Revenue  from
     electric  sales  to  pipelines  accounted  for 7  percent  of  consolidated
     operating revenue in 2007 (6 percent in 2006).

     Overall  kilowatthour sales were similar to 2006.  Residential,  commercial
     and municipal kilowatthour sales increased 21.1 million, or 3 percent, from
     2006, while industrial  kilowatthour sales decreased by 35.9 million,  or 2
     percent. The increase in residential, commercial and municipal kilowatthour
     sales was primarily due to two existing municipal  customers  converting to
     full-energy  requirements.  The reduction in industrial  kilowatthour sales
     was  primarily  due  to  production  scheduling  at  one  of  our  taconite
     customers. Minor fluctuations in industrial kilowatthour sales generally do
     not have a large  impact on  revenue  due to a fixed  demand  component  of
     revenue that is less sensitive to changes in kilowatthours sales.

19                   ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

REGULATED UTILITY (CONTINUED)

     OPERATING EXPENSES increased $33.5 million, or 26 percent, from 2006.

     FUEL  AND  PURCHASED  POWER  EXPENSE  increased  $29.9  million  from  2006
     primarily due to a $30.1 million  increase in purchased power  reflecting a
     48  percent  increase  in  kilowatthours  purchased.  Scheduled  outages at
     Boswell Unit 3 and Taconite  Harbor Unit 2, low hydro  generation and lower
     Square Butte  entitlement  contributed to higher  purchased power expenses.
     The  replacement  power costs are recovered  through the regulated  utility
     fuel adjustment clause in Minnesota.

     Boswell Unit 4 completed  generator repairs and returned to service May 13,
     2007 as scheduled. The cost of the replacement coils was  covered under the
     original manufacturer's warranty.

     OPERATING AND  MAINTENANCE  EXPENSE  increased $4.0 million,  or 7 percent,
     from 2006 due to planned outages at Boswell Unit 3 and Taconite Harbor Unit
     2, which resulted in higher plant maintenance.

     DEPRECIATION  decreased  $0.4 million from 2006  primarily  due to the life
     extension of Boswell Unit 3.

     OTHER  INCOME  increased  $0.4 million  from 2006  primarily  due to higher
     earnings  from the  capitalization  of  AFUDC due to increased construction
     activity.

NONREGULATED ENERGY OPERATIONS

     OPERATING  REVENUE  decreased  $0.3  million,  or  2  percent,   from  2006
     reflecting a decrease in sales prices due to BNI Coal's cost plus contract.

     OPERATING  EXPENSES  increased  $0.9  million,  or  6  percent,  from  2006
     primarily due to increased property taxes.

INVESTMENT IN ATC

     OTHER INCOME  reflected  $3.2 million of income in 2007  resulting from our
     pro-rata  share of ATC's earnings as discussed in Note 3. Our investment in
     ATC began in May 2006.

REAL ESTATE

     OPERATING REVENUE increased $12.8 million, or 84 percent,  from 2006 due to
     the  timing  and mix of land sale  transaction  closings.  Two large  sales
     closed during the second  quarter of 2007.  Revenue from land sales in 2007
     was $25.2  million,  which  included  $1.0 million in  previously  deferred
     revenue. In 2006, revenue from land sales was $13.6 million, which included
     $2.7 million in previously deferred revenue.

     For the quarter ended June 30, 2007, 435,000 commercial square feet sold at
     Town Center (170,695 in 2006),  and 40,000  commercial  square feet sold at
     Palm Coast Park (none in 2006). Town Center sold 130 residential units (186
     in 2006) and Palm Coast  Park sold 406  residential  units  (none in 2006).
     There  were no acres of other land sold  during the second  quarter of 2007
     (10 acres in 2006).

     OPERATING  EXPENSES  increased  $2.9  million,  or 59  percent,  from  2006
     reflecting  an  increase  in selling  expenses  and the cost of real estate
     sold.

INCOME TAXES

For the  quarter  ended June 30,  2007,  the  effective  tax rate on income from
continuing  operations  before minority  interest was 31.9 percent (38.2 percent
for the quarter ended June 30, 2006). The effective rate of 31.9 percent for the
quarter ended June 30, 2007,  deviated from the statutory rate (approximately 40
percent)  primarily due to a state income tax audit  settlement  ($1.5 million).
Excluding  this $1.5  million  item,  the  effective  rate  would have been 36.1
percent for the quarter ended June 30, 2007. Other items affecting the deviation
from the  statutory  rate  include  deductions  for Medicare  health  subsidies,
domestic manufacturing deduction, AFUDC and depletion.

                     ALLETE Second Quarter 2007 Form 10-Q                     20

<PAGE>

COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006

REGULATED UTILITY

     OPERATING  REVENUE  increased  $50.3  million,  or 16  percent,  from  2006
     primarily due to increased fuel clause recoveries,  increased  kilowatthour
     sales to residential,  commercial and municipal customers,  increased power
     marketing prices, and rate increases at SWL&P.

     Fuel  clause  recoveries  increased  $37.7  million  in 2007 as a result of
     increased  purchased  power expenses (see Fuel and Purchased  Power Expense
     discussion below).

     Revenue from other power suppliers  increased $4.4 million,  or 10 percent,
     from  2006  primarily  due to an 8.3  percent  increase  in the  price  per
     kilowatthour.

     New rates at SWL&P,  which became effective January 1, 2007,  reflect a 2.8
     percent increase in electric rates, a 1.4 percent increase in gas rates and
     an 8.6 percent increase in water rates.  These rate increases resulted in a
     $0.8 million increase in operating revenue.

     Revenue from electric sales to taconite customers  accounted for 23 percent
     of  consolidated  operating  revenue in 2007 (24 percent in 2006).  Revenue
     from  electric  sales to paper and pulp  mills  accounted  for 9 percent of
     consolidated  operating  revenue  in each of 2007 and  2006.  Revenue  from
     electric  sales  to  pipelines  accounted  for 7  percent  of  consolidated
     operating revenue in 2007 (6 percent in 2006).

     Overall  kilowatthour sales were similar to 2006.  Residential,  commercial
     and municipal  kilowatthour  sales increased  125.3 million,  or 8 percent,
     from 2006 while industrial  kilowatthour  sales decreased by 152.8 million,
     or 4  percent.  The  increase  in  residential,  commercial  and  municipal
     kilowatthour  sales was primarily  due to a 12 percent  increase in Heating
     Degree Days  (primarily in February) and two existing  municipal  customers
     converting  to  full-energy  requirements.   The  reduction  in  industrial
     kilowatthour  sales was primarily  weather related.  Minor  fluctuations in
     industrial  kilowatthour  sales  generally  do not have a large  impact  on
     revenue due to a fixed demand  component of revenue that is less  sensitive
     to changes in kilowatthours sales.

     OPERATING EXPENSES increased $42.4 million, or 16 percent, from 2006.

     FUEL  AND  PURCHASED  POWER  EXPENSE  increased  $38.2  million  from  2006
     primarily due to a $38.0 million  increase in purchased power  reflecting a
     60 percent increase in kilowatthours  purchased.  The increase in purchased
     power was primarily due to the following outages at our generation units:

        -  scheduled  outage  at  Boswell  Unit  3  relating  to   environmental
           upgrades;
        -  scheduled  outages  at  Laskin  Unit  1  and  Taconite  Harbor Unit 2
           relating to AREA plan environmental upgrades; and
        -  unplanned outages at Boswell Unit 4.

     Additionally,  low hydro  generation  and lower  Square  Butte  entitlement
     contributed to higher purchased power expense.  The replacement power costs
     are  recovered  through the  regulated  utility fuel  adjustment  clause in
     Minnesota.

     Boswell Unit 4 completed  generator repairs and returned to service May 13,
     2007 as scheduled. The cost of the replacement coils were covered under the
     original manufacturer's warranty.

     OPERATING AND  MAINTENANCE  EXPENSE  increased $5.1 million,  or 5 percent,
     from 2006 due to a $4.7 million increase in plant maintenance primarily due
     to planned outages at our generating facilities.

     DEPRECIATION  decreased  $0.9 million from 2006  primarily  due to the life
     extension of Boswell Unit 3.

     OTHER  INCOME  increased  $0.9 million  from 2006  primarily  due to higher
     earnings  from the  capitalization  of AFUDC due to increased  construction
     activity.

21                   ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

NONREGULATED ENERGY OPERATIONS

     OPERATING REVENUE increased $0.2 million, or 1 percent, from 2006 primarily
     due to increased coal sales at BNI Coal.

     OPERATING EXPENSES increased $1.2 million,  or 4 percent,  from 2006 due to
     primarily due to increased property taxes.

     OTHER INCOME  increased  $2.4  million from 2006  reflecting a $1.9 million
     gain on land sold which was part of Taconite Harbor purchase.

INVESTMENT IN ATC

     OTHER INCOME  reflected  $6.1 million of income in 2007  resulting from our
     pro-rata  share of ATC's earnings as discussed in Note 3. Our investment in
     ATC began in May 2006.

REAL ESTATE

     OPERATING REVENUE increased $7.3 million,  or 25 percent,  from 2006 due to
     the  timing  and mix of land sale  transaction  closings.  Two large  sales
     closed during the second  quarter of 2007.  Revenue from land sales in 2007
     was $32.5  million,  which  included  $2.3 million in  previously  deferred
     revenue.  In 2006, revenue from land sales was $26.1 million which included
     $4.3 million in previously deferred revenue.

     Through June 30,  2007,  435,000  commercial  square feet were sold at Town
     Center (250,695 in 2006),  and 40,000  commercial  square feet were sold at
     Palm Coast Park (none in 2006).  Town Center has sold 130 residential units
     (186 in 2006) and Palm Coast Park has sold 406  residential  units (none in
     2006).  During the first six  months of 2007,  367 acres of other land were
     sold (466 acres in 2006).

     OPERATING  EXPENSES  increased  $2.4  million,  or 29  percent,  from  2006
     reflecting  an  increase  in selling  expenses  and the cost of real estate
     sold.

OTHER

     OPERATING  EXPENSES  decreased  $0.7  million  from 2006  reflecting  lower
     general and administrative expenses.

     OTHER INCOME  increased $0.3 million from 2006 primarily due to the release
     from a loan guarantee for Northwest  Airlines  Corporation of $1.0 million,
     partially offset by less investment income.

INCOME TAXES

For the six months ended June 30, 2007,  the  effective  tax rate on income from
continuing  operations  before minority  interest was 35.1 percent (37.3 percent
for six months ended June 30, 2006).  The effective rate of 35.1 percent for the
six months ended June 30, 2007,  deviated from the statutory rate (approximately
40 percent) primarily due to a state income tax audit settlement ($1.5 million).
Excluding  this $1.5  million  item,  the  effective  rate  would have been 37.1
percent  for the six months  ended June 30,  2007.  Other  items  affecting  the
deviation  from the  statutory  rate  include  deductions  for  Medicare  health
subsidies, domestic manufacturing deduction, AFUDC and depletion.


CRITICAL ACCOUNTING ESTIMATES

Certain  accounting  measurements  under  applicable  GAAP involve  management's
judgment  about  subjective  factors  and  estimates,  the  effects of which are
inherently uncertain.  Accounting measurements that we believe are most critical
to  our  reported  results  of  operations  and  financial   condition  include:
impairment  of long-lived  assets,  pension and  postretirement  health and life
actuarial  assumptions,  regulatory  accounting,  valuation of  investments  and
provisions for environmental  remediation.  These policies are reviewed with the
Audit  Committee of our Board of Directors on a regular basis and  summarized in
Part II, Item 7 of our 2006 Form 10-K.

                     ALLETE Second Quarter 2007 Form 10-Q                     22

<PAGE>

OUTLOOK

EARNINGS GUIDANCE.  ALLETE expects that its full-year 2007 earnings  performance
will be between $3.00 and $3.05 per share in 2007.  This guidance  assumes lower
real estate sales during the second half of 2007  compared to the same period in
2006, normal weather patterns in Minnesota Power's service territory compared to
a  warmer  than  normal  third  quarter  in 2006,  and  higher  income  from the
investment in ATC due to a larger  investment  balance in 2007. Due to difficult
market conditions in Florida, some sales originally anticipated to close in 2007
are now being  deferred.  As a result of these sales  deferrals,  total year net
income from Real Estate is expected to be less than 2006; net income in 2006 was
the largest ever for our real estate business.  This earnings  guidance does not
include an impact from any investment we may make in new growth opportunities.

ENERGY.

LARGE POWER  CUSTOMERS.  Electric power is a key component in the mining,  paper
production and pipeline  industries.  Sales to our Large Power Customers  within
these industries represent more than half of Minnesota Power's regulated utility
electric  sales.  On April 25, 2007,  the MPUC  approved  our  electric  service
agreement  with  PolyMet  Mining,  Inc.  (PolyMet).  In  2006,  a  contract  for
approximately 70 MW was successfully  negotiated with PolyMet,  a new industrial
customer  planning to start a copper,  nickel and precious metals  (non-ferrous)
mining operation in late 2008. If PolyMet's  environmental  permits are received
and  start-up is achieved,  the contract  with PolyMet will run through at least
2018.

AREA AND BOSWELL 3 EMISSION  REDUCTION  PLAN.  As of June 30, 2007 we have spent
$28.6  million of the  expected  $60 million on the AREA  project.  On April 15,
2007,  Laskin Unit 1 was placed back in service and  cost-recovery  began May 1,
2007.  On June 24,  2007  Taconite  Harbor Unit 2 was placed back in service and
cost-recovery  began  July 1,  2007.  As of June 30,  2007 we have  spent  $33.4
million of the expected  $200  million on the Boswell Unit 3 emission  reduction
plan.  In late March 2007,  the Boswell Unit 3 project  received  the  necessary
construction  permits.  On April 25, 2007, the MPCA issued its assessment of the
Boswell Unit 3 emission reduction plan under the Mercury Emissions Reduction Act
of 2006.  The MPCA  found  that  Minnesota  Power's  plan  meets  the  statutory
requirements,  found it cost effective and groundbreaking for the Boswell Unit 3
project  occurred  on May 9,  2007.  On June 8,  2007  the  DOC  filed  comments
recommending  approval  of the  cost  recovery  filing  for the  Boswell  Unit 3
emission reduction plan. An MPUC hearing on the Boswell Unit 3 plan is scheduled
for October 2007.

MINNESOTA FUEL CLAUSE.  In June 2003, the MPUC initiated an  investigation  into
the continuing  usefulness of the fuel clause as a regulatory  tool for electric
utilities.  Minnesota  Power's  initial  comments  on  the  proposed  scope  and
procedure of the  investigation  were filed in July 2003. In November  2003, the
MPUC  approved  the  initial  scope  and  procedure  of the  investigation.  The
investigation's  purpose was to focus on whether the fuel clause continues to be
an appropriate  regulatory tool. Subsequent comments were filed during 2004. The
fuel clause docket then became  dormant while the MISO Day 2 docket,  which held
many fuel clause  considerations,  became very active.  In March 2007,  the MPUC
solicited  comments on whether the  original  fuel clause  investigation  should
continue  and,  if so,  what issues  should be  pursued.  Minnesota  Power filed
comments in April  2007,  suggesting  that if the  investigation  continued,  it
should focus on remaining key elements of the fuel clause,  beyond the purchased
power transactions examined in the MISO Day 2 proceeding, such as fuel purchases
and  outages.  Additionally,  Minnesota  Power's  comments  suggested  that more
specialized  fuel clause issues be addressed in separate dockets on an as needed
basis.  The fuel clause  investigation  docket is awaiting further action by the
MPUC.

23                   ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

OUTLOOK (CONTINUED)

ENERGY. (Continued)

RENEWABLE  ENERGY.  In February  2007, the Minnesota  Legislature  enacted a law
requiring most electric utilities to generate 25 percent of their energy through
renewable energy sources by 2025. Minnesota Power worked with other stakeholders
to ensure the legislation included provisions for allowing regulatory assessment
of the ratepayer  cost for and  technical  feasibility  of individual  utilities
meeting  the 25 percent  standard.  Minnesota  Power was  developing  and making
renewable supply additions as part of its generation  planning strategy prior to
this legislation and this activity continues.

In December  2006, we began  purchasing  the output from a 50-MW wind  facility,
Oliver Wind I, located in North Dakota, under a 25-year power purchase agreement
with an affiliate of FPL Energy, LLC.

On May 11,  2007,  the  MPUC  approved  a second  25-year  wind  power  purchase
agreement to purchase an additional 48-MW of wind energy from Oliver Wind II, an
expansion  of  Oliver  Wind I located  in North  Dakota.  The MPUC also  allowed
immediate  recovery  of the  costs for  associated  transmission  upgrades.  The
project is expected to be operational by the end of 2007.

On  May  29,  2007,  the  MPUC  approved  two  20-year   Community-Based  Energy
Development  Project  power  purchase  agreements.  The  2.5-MW  Wing River Wind
project,  with Wing River Wind,  LLC,  became  operational  on July 6, 2007. The
30-MW Bear Creek Wind Partners project,  with Bear Creek Wind Partners,  LLC, is
expected to be operational by the end of 2008.

In the fall of 2007, we intend to begin  construction of the $50 million,  25-MW
Taconite Ridge Wind Facility, to be located in northeastern  Minnesota.  On June
14, 2007, the MPUC issued a draft site permit,  beginning the regulatory  review
process.  A public  meeting  was held July 11,  2007.  The  Taconite  Ridge Wind
Facility is expected to become operational in mid-2008.

Minnesota Power continues to investigate  additional  renewable energy resources
including biomass,  hydroelectric and wind generation that will help it meet the
Minnesota 25 percent renewable energy standard.  In particular,  Minnesota Power
is  conducting a  feasibility  study for  construction  of a 40 to 50-MW biomass
generating unit at its Laskin Energy Center, as well as looking at opportunities
to expand  biomass  energy  production  at  existing  facilities.  Additionally,
Minnesota  Power is  pursuing a  potential  10-MW  expansion  of its Fond du Lac
hydroelectric  station.  The Company will submit plans  regarding the additional
renewable  energy options  currently  under study as a part of its Resource Plan
filing  with the State of  Minnesota  by  November  1,  2007.  We will also make
specific renewable project filings for regulatory approval as needed.

INVESTMENT IN ATC. In February 2007, we completed our $60 million  investment in
ATC. As of June 30, 2007, our equity investment was $64.4 million,  representing
an 8.3 percent  ownership  interest.  As  opportunities  arise,  we plan to make
additional  investments  in ATC  through  general  capital  calls based upon our
pro-rata ownership interest in ATC. (See Note 3.)

REAL  ESTATE.  In June 2005,  we began  selling  property  from our Town  Center
development  project.  In August 2006, we began  selling  property from our Palm
Coast Park development  project.  Since land is being sold before  completion of
the project  infrastructure,  revenue and cost of real estate sold are  recorded
using a  percentage-of-completion  method.  As of June  30,  2007,  we had  $5.0
million  ($6.5  million  revenue;  $1.2 million  cost of real estate sold;  $0.3
million  selling  expense) of deferred  profit on sales of real  estate,  before
taxes and minority interest,  on our consolidated balance sheet. The majority of
deferred profit relates to sales at Town Center.

                     ALLETE Second Quarter 2007 Form 10-Q                     24

<PAGE>

OUTLOOK (CONTINUED)

<TABLE>
<CAPTION>
REAL ESTATE
PENDING CONTRACTS                                                                                     CONTRACT
AT JUNE 30, 2007                                                QUANTITY <F1>                        SALES PRICE
-----------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
<S>                                                             <C>                                  <C>
Town Center
     Commercial Sq. Ft.                                           442,200                              $  15.1
     Residential Units                                                910                                 14.6

Palm Coast Park
     Commercial Sq. Ft.                                                 -                                    -
     Residential Units                                              1,981                                 39.1

Other Land
     Acres                                                            220                                 11.0
-----------------------------------------------------------------------------------------------------------------

                                                                                                       $  79.8
-----------------------------------------------------------------------------------------------------------------
<FN>
<F1> Acreage amounts  are  approximate  and  shown on  a  gross  basis, including wetlands and minority interest.
     Acreage amounts  may  vary due to platting  or surveying activity. Wetland amounts vary by property and  are
     often not formally determined prior  to  sale.  Commercial square feet and  residential units  are estimated
     and include minority  interest. The actual  property  allocation  at  full build-out  may be  different than
     these estimates.
</FN>
</TABLE>

At June 30, 2007,  total  pending land sales under  contract  were $79.8 million
($113.8  million at December 31, 2006) and are  anticipated  to close at various
times through  2012.  Pending land sales under  contract for  properties at Town
Center and Palm Coast Park totaled $29.7 million  ($40.1 million at December 31,
2006) and $39.1 million ($62.8 million at December 31, 2006), respectively.  The
decrease in pending  land sales under  contract is mainly due to two large sales
that closed during the second quarter of 2007. In April 2007, Palm Coast Center,
LLC and Target  Corporation  closed for $12.6 million at Town Center and in June
2007, LRCF Palm Coast, LLC (Lowe Enterprises)  closed on the first parcel of the
Sawmill Creek  project at Palm Coast Park for $13.1 million  pursuant to revised
contract  terms.  Under the amended  contract,  the total  purchase  price under
contract was reduced  from $52.5  million to $42.0  million.  In addition to the
base price, the amended contract allows us to receive participation revenue from
land sales to third  parties if various  formula  based  criteria are  achieved.
Current  contract  terms  with  Lowe  Enterprises  allow for  extensions  on the
remaining three closings. The final closings will occur through 2011.

Prices on these  contracts  range from $20 to $60 per  commercial  square  foot,
$8,000 to $30,000 per residential  unit and $11,000 to $830,000 per acre for all
other  properties.  Prices per acre are stated on a gross  acreage basis and are
dependent on the type and location of the  properties  sold. The majority of the
other  properties  under contract are zoned commercial or mixed use. In addition
to minimum-base price contracts,  certain contracts,  including the amended Lowe
Enterprises contract,  allow us to receive participation revenue from land sales
to third parties if various formula-based criteria are achieved.

If a  purchaser  defaults  under  terms of a contract,  our  remedies  generally
include  retention  of the  purchaser's  deposit and the ability to remarket the
property to other  prospective  buyers.  In many cases,  the  purchaser has also
incurred significant costs in planning,  designing and marketing of the property
under contract before the contract closes.

Conditions in the Florida real estate market may fluctuate  over time.  The real
estate market has been difficult  across the United States,  including  Florida.
The  difficult  market  conditions  for Florida real estate have not improved as
quickly as we had originally expected,  cauing some sales originally planned for
2007 to be deferred.  We expect that Florida will continue to  experience  above
average  long-term  population  growth and that current market  conditions  will
improve over time. We believe our entitled  inventory of land,  most of which is
located in one of the  fastest  growing  areas of Florida,  will  continue to be
attractive to buyers.

25                   ALLETE Second Quarter 2007 Form 10-Q
<PAGE>

OUTLOOK (CONTINUED)

<TABLE>
<CAPTION>
SUMMARY OF DEVELOPMENT PROJECTS
FOR THE SIX MONTHS ENDED                                     TOTAL              RESIDENTIAL          COMMERCIAL
JUNE 30, 2007                           OWNERSHIP           ACRES <F1>            UNITS <F2>          SQ. FT. <F2><F3>
-------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                 <C>                 <C>                  <C>
Town Center                                 80%
     At December 31, 2006                                    1,356                2,222              2,705,310
     Property Sold                                             (81)                (130)              (435,000)
     Change in Estimate <F1>                                    17                  177                 72,736
-------------------------------------------------------------------------------------------------------------------------

                                                             1,292                2,269              2,343,046
-------------------------------------------------------------------------------------------------------------------------

Palm Coast Park                            100%
     At December 31, 2006                                    4,337                3,760              3,156,800
     Property Sold                                            (863)                (406)               (40,000)
     Change in Estimate <F1>                                   112                    -                      -
-------------------------------------------------------------------------------------------------------------------------

                                                             3,586                3,354              3,116,800
-------------------------------------------------------------------------------------------------------------------------

Ormond Crossings                           100%
     At December 31, 2006                                    5,960                 <F4>                   <F4>
     Change in Estimate <F1>                                     8
-------------------------------------------------------------------------------------------------------------------------

                                                             5,968
-------------------------------------------------------------------------------------------------------------------------

                                                            10,846                5,623              5,459,846
-------------------------------------------------------------------------------------------------------------------------
<FN>
<F1>  Acreage amounts are approximate  and  shown  on  a  gross  basis, including wetlands and minority interest. Acreage
      amounts may  vary  due  to  platting  or surveying activity. Wetland amounts vary  by  property  and are  often not
      formally determined prior to sale.
<F2>  Estimated and includes  minority  interest. The actual property breakdown at full build-out may  be  different than
      these estimates.
<F3>  Includes industrial, office and retail square footage.
<F4>  A  development  order  approval  from the  city of Ormond Crossings was received in December 2006, for up to  3,700
      residential  units and 5 million commercial square feet. A development order from Flagler County is currently under
      review,  and if  approved,  Ormond Crossings will  receive entitlements for up to 700 additional residential units.
      Actual build-out, however, will consider market demand as well as infrastructure and mitigation costs.
</FN>
</TABLE>

<TABLE>
<CAPTION>
SUMMARY OF OTHER LAND INVENTORIES
FOR THE SIX MONTHS ENDED
JUNE 30, 2007                         OWNERSHIP     TOTAL     MIXED USE    RESIDENTIAL   COMMERCIAL   AGRICULTURAL
-------------------------------------------------------------------------------------------------------------------
ACRES <F1>
<S>                                   <C>           <C>       <C>          <C>           <C>          <C>
Palm Coast Holdings                      80%
     At December 31, 2006                            2,136       1,404          346           247          139
     Change in Estimate <F1>                          (666)       (474)        (244)          101          (49)
-------------------------------------------------------------------------------------------------------------------

                                                     1,470         930          102           348           90
-------------------------------------------------------------------------------------------------------------------

Lehigh                                   80%
     At December 31, 2006                              223           -          140            74            9
     Change in Estimate <F1>                             -           -            -             -            -
-------------------------------------------------------------------------------------------------------------------

                                                       223           -          140            74            9
-------------------------------------------------------------------------------------------------------------------

Cape Coral                              100%
     At December 31, 2006                               30           -            1            29            -
     Property Sold                                      (3)          -            -            (3)           -
-------------------------------------------------------------------------------------------------------------------

                                                        27           -            1            26            -
-------------------------------------------------------------------------------------------------------------------

Other <F2>                              100%
     At December 31, 2006                              934           -            -             -          934
     Property Sold                                    (364)          -            -             -         (364)
     Change in Estimate <F1>                          (113)          -            -             -         (113)
-------------------------------------------------------------------------------------------------------------------

                                                       457           -            -             -          457
-------------------------------------------------------------------------------------------------------------------

                                                     2,177         930          243           448          556
-------------------------------------------------------------------------------------------------------------------
<FN>
<F1>  Acreage amounts are approximate and shown on a gross basis, including wetlands and minority interest. Acreage
      amounts may vary due to platting or surveying activity. Wetland amounts vary by property and  are  often  not
      formally  determined  prior to sale. The  actual property allocation at full  build-out may be different than
      these estimates.
<F2>  Includes land located in Palm Coast, Florida not included in development projects.
</FN>
</TABLE>

                     ALLETE Second Quarter 2007 Form 10-Q                     26
<PAGE>

OUTLOOK (CONTINUED)

INCOME TAXES.  ALLETE's aggregate federal and multi-state  statutory tax rate is
expected to be  approximately  40% for 2007.  On an ongoing  basis  ALLETE,  has
certain  tax  credits and other tax  adjustments  that will reduce the  expected
effective  tax  rate to  approximately  37% for  2007.  These  tax  credits  and
adjustments  historically  have included  items such as investment  tax credits,
depletion  allowances,  Medicare  health  subsidies as well as other items.  The
effective  rate will also be  impacted  by such items as changes in income  from
operations before minority interest and income taxes,  state and federal tax law
changes  that  become  effective  during  the year,  business  combinations  and
configuration  changes,  tax planning initiatives and resolution of prior years'
tax matters.  Based upon our earnings per share guidance for 2007, we now expect
our effective tax rate for 2007 to be approximately 37%.


LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW ACTIVITIES

We believe our  financial  condition  is strong,  as  evidenced by cash and cash
equivalents and short-term  investments of $158.9  million,  and a debt to total
capital ratio of 38 percent at June 30, 2007.

OPERATING  ACTIVITIES.  Cash flows from operating  activities were $52.3 million
for the six months  ended June 30, 2007 ($36.4  million for the six months ended
June 30, 2006). Cash from operating activities was higher in 2007, primarily due
to increased  earnings from continuing  operations  compared to 2006 and no cash
used for discontinued  operations in 2007. Cash used for discontinued operations
was higher in 2006 due to the  payment of $13.0  million of accrued  liabilities
from 2005. Cash flow from accounts receivable collections in 2006 was higher due
to the  collection  of deferred  fuel cost  billings  related to outages in late
2005.  Cash  used for  prepayments  and  other is higher in 2007 due to an $11.2
million  change in  deferred  fuel  costs  yet to be  recovered  through  future
billings. The increases in deferred fuel costs are a result of higher  purchased
power expenses due to generation outages relating to the AREA Plan environmental
retrofits, lower hydro generation and lower Square Butte entitlement.

INVESTING ACTIVITIES.  Cash flow used in investing activities was $102.3 million
for the six months  ended June 30, 2007 ($45.3  million for the six months ended
June 30,  2006).  Cash used in  investing  activities  was higher in 2007 due to
additions to property,  plant and equipment and activity  within our  short-term
investment portfolio.  Additions to property, plant and equipment were higher in
2007  than  2006  by  $34.8  million   primarily  due  to  major   environmental
construction  projects.  Activity  within our  short-term  investment  portfolio
reflected increased net purchases of short-term  investments of $17.3 million in
2007, while 2006 included $3.5 million of net purchases.

FINANCING ACTIVITIES.  Cash flow from financing activities was $42.3 million for
the six months  ended June 30,  2007 (used for  financing  activities  was $17.9
million for the six months ended June 30, 2006). The increase in cash flows from
financing  activities  is due to $50 million of  unsecured  notes  issued in the
private placement market in June 2007. (See Securities below and Note 4.)

WORKING CAPITAL.  Additional working capital,  if and when needed,  generally is
provided by the sale of commercial  paper.  We have 0.3 million  original  issue
shares of our common stock  available for issuance  through Invest  Direct,  our
direct  stock  purchase and dividend  reinvestment  plan.  We have bank lines of
credit aggregating $170.0 million, the majority of which expire in January 2012.
The amount and timing of future sales of our securities  will depend upon market
conditions  and our  specific  needs.  We may sell  securities  to meet  capital
requirements,  to provide for the  retirement  or early  redemption of issues of
long-term debt, to reduce short-term debt and for other corporate purposes.

SECURITIES

On June 8, 2007, we issued $50 million of senior  unsecured notes (Notes) in the
private  placement  market.  The Notes bear an interest rate of 5.99 percent and
will  mature on June 1,  2017.  The  Company  has the  option to prepay all or a
portion of the Notes at its discretion,  subject to a make-whole provision.  The
Company  intends to use the proceeds  from the sale of the Notes to fund utility
capital projects and for general corporate purposes.

27                   ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)

OFF-BALANCE SHEET ARRANGEMENTS

Off-balance  sheet  arrangements  are  summarized  in our 2006 Form  10-K,  with
additional disclosure discussed in Note 11 of this Form 10-Q.

CAPITAL REQUIREMENTS

For the six months  ended June 30, 2007,  capital  expenditures  for  continuing
operations  totaled $71.3 million ($35.3  million in 2006),  which were spent in
the Regulated Utility segment using a combination of internally  generated funds
and debt issuances.

Real  estate  development  expenditures  are and will be funded with a revolving
development loan, tax-exempt bonds issued by community development districts and
internally generated funds.  Additional disclosure regarding the Town Center and
Palm Coast Park  district  tax-exempt  bonds is included in Note 11 of this Form
10-Q.


ENVIRONMENTAL MATTERS AND OTHER

As  previously  discussed  in our  Critical  Accounting  Policies  section,  our
businesses  are  subject  to  regulation  of  environmental  matters  by various
federal,  state  and  local  authorities.   Due  to  restrictive   environmental
requirements  through legislation and/or rulemaking in the future, we anticipate
that potential  expenditures for environmental matters will be material and will
require significant capital investments. We are unable to predict the outcome of
the matters discussed in Note 11 of this Form 10-Q.

NEW ACCOUNTING STANDARDS

New accounting standards are discussed in Note 1.


ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

SECURITIES INVESTMENTS

AVAILABLE-FOR-SALE  SECURITIES.  As of June  30,  2007,  our  available-for-sale
securities  portfolio  consisted of securities in a grantor trust established to
fund certain employee benefits included in Investments, and various auction rate
bonds and variable  rate demand notes  included in Short-Term  Investments.  Our
available-for-sale  securities  portfolio had a fair value of $151.7  million at
June 30, 2007  ($130.1  million at  December  31,  2006) and a total  unrealized
after-tax  gain of $5.0  million at June 30, 2007 ($4.0  million at December 31,
2006).

We use the specific  identification method as the basis for determining the cost
of  securities   sold.  Our  policy  is  to  review,   on  a  quarterly   basis,
available-for-sale  securities for other than temporary  impairment by assessing
such factors as share price trends and the impact of overall market  conditions.
As a result of our periodic  assessments,  we did not record any  impairments on
our available-for-sale securities for the quarter ended June 30, 2007.

EMERGING TECHNOLOGY PORTFOLIO.  As part of our emerging technology portfolio, we
have  several   minority   investments  in  venture  capital  funds  and  direct
investments  in  privately-held,   start-up   companies.   We  account  for  our
investments in venture capital funds under the equity method and account for our
direct  investments  in  privately-held  companies  under the cost method  based
primarily on our ownership percentages. The total carrying value of our emerging
technology portfolio was $9.0 million at June 30, 2007 ($9.2 million at December
31, 2006). Our policy is to review these investments quarterly for impairment by
assessing such factors as continued commercial viability of products,  cash flow
and earnings.  Any impairment would reduce the carrying value of the investment.
As a result of our periodic  assessments,  we did not record any  impairments on
our emerging technology portfolio for the quarter ended June 30, 2007. Our basis
in direct  investments  in  privately-held  companies  included in the  emerging
technology portfolio was zero at both June 30, 2007 and December 31, 2006.

                     ALLETE Second Quarter 2007 Form 10-Q                     28

<PAGE>

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)

COMMODITY PRICE RISK

Our regulated utility operations in Minnesota and Wisconsin incur costs for fuel
(primarily  coal),  power and natural gas  purchased for resale in our regulated
service  territories,  and  related  transportation.  Our  regulated  utilities'
exposure to price risk for these  commodities is significantly  mitigated by the
current ratemaking process and regulatory environment,  which generally allows a
fuel clause  surcharge  if costs are in excess of those in our last rate filing.
Conversely, costs below those in our last rate filing resulted in a rate credit.
We seek to prudently  manage our  customers'  exposure to price risk by entering
into contracts of various durations and terms for the purchase of coal and power
(in Minnesota), power and natural gas (in Wisconsin), and related transportation
costs.

POWER MARKETING

Our power marketing activities consist of (1) purchasing energy in the wholesale
market  for resale in our  regulated  service  territories  when  retail  energy
requirements   exceed   generation  output  and  (2)  selling  excess  available
generation and purchased power.

From time to time,  our utility  operations may have excess  generation  that is
temporarily  not required by retail and  municipal  customers  in our  regulated
service  territory.  We actively sell this generation to the wholesale market to
optimize the value of our generating  facilities.  This  generation is typically
sold in the MISO market at market prices.

Approximately 200 MW of generation from our Taconite Harbor facility in northern
Minnesota has been sold through various long-term capacity and energy contracts.
Long-term, we have entered into two capacity and energy sales contracts totaling
175 MW (201 MW  including a 15 percent  reserve),  which were  effective  May 1,
2005,  and  expire on April 30,  2010.  Both  contracts  contain  fixed  monthly
capacity charges and fixed minimum energy charges.  One contract provides for an
annual  escalator  to the energy  charge based on increases in our cost of coal,
subject to a small minimum annual  escalation.  The other contract provides that
the energy  charge  will be the greater of a fixed  minimum  charge or an amount
based on the variable production cost of a combined-cycle, natural gas unit. Our
exposure  in the  event  of a full or  partial  outage  at our  Taconite  Harbor
facility  is  significantly  limited  under  both  contracts.  When the buyer is
notified at least two months prior to an outage,  there is no exposure.  Outages
with less than two months  notice are subject to an annual  duration  limitation
typical of this type of contract. We also have a 50-MW capacity and energy sales
contract that extends through April 2008, with formula pricing based on variable
production cost of a combustion-turbine, natural gas unit.


ITEM 4.    CONTROLS AND PROCEDURES

We maintain a system of controls and procedures  designed to provide  reasonable
assurance  as  to  the  reliability  of  the  financial   statements  and  other
disclosures  included  in  this  report,  as well as to  safeguard  assets  from
unauthorized  use or disposition.  We evaluated the  effectiveness of the design
and operation of our disclosure  controls and procedures  under the  supervision
and with the participation of management,  including our chief executive officer
and chief  financial  officer,  as of the end of the period covered by this Form
10-Q.  Based  upon  that  evaluation,  our  chief  executive  officer  and chief
financial  officer  concluded  that our  disclosure  controls and procedures are
effective.  While we continue to enhance our  internal  control  over  financial
reporting,  there has been no  change in our  internal  control  over  financial
reporting  that  occurred  during  our  most  recent  fiscal  quarter  that  has
materially affected,  or is reasonably likely to materially affect, our internal
control over financial reporting.

29                   ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

PART II.   OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

Material  legal and  regulatory  proceedings  are included in the  discussion of
Other  Information  in Part II, Item 5 and/or Note 11 of this Form 10-Q, and are
incorporated by reference herein.

ITEM 1A.    RISK FACTORS

There have been no material  changes from the risk factors  disclosed  under the
heading "Risk Factors" in Part I, Item 1A of our 2006 Form 10-K.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a)  We held our Annual Meeting of Shareholders on May 8, 2007.

(b)  Included in (c) below.

(c)  The election of directors  and  the  ratification  of  the  appointment  of
     PricewaterhouseCoopers LLP, as the Company's independent registered  public
     accounting firm for 2007, were voted on  at  the  2007  Annual  Meeting  of
     Shareholders.

     The results were as follows:

<TABLE>
<CAPTION>
                                                                    VOTES
                                              VOTES FOR           WITHHELD
------------------------------------------------------------------------------------------------------------------
<S>                                          <C>                 <C>
     DIRECTORS

     Kathleen A. Brekken                     25,871,813            418,468
     Heidi J. Eddins                         23,456,099          2,834,183
     Sidney W. Emery, Jr.                    25,848,429            441,853
     James J. Hoolihan                       23,331,033          2,959,249
     Madeleine W. Ludlow                     23,456,062          2,834,220
     George L. Mayer                         23,319,274          2,971,008
     Roger D. Peirce                         23,298,748          2,991,533
     Jack I. Rajala                          22,694,844          3,595,438
     Donald J. Shippar                       23,247,493          3,042,789
     Bruce W. Stender                        23,319,884          2,970,398
------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
                                                                    VOTES                                 BROKER
                                              VOTES FOR            AGAINST          ABSTENTIONS          NONVOTES
------------------------------------------------------------------------------------------------------------------
<S>                                          <C>                   <C>              <C>                  <C>
     INDEPENDENT REGISTERED
     PUBLIC ACCOUNTING FIRM

     PricewaterhouseCoopers LLP              25,633,128            516,411             140,740               -
------------------------------------------------------------------------------------------------------------------
</TABLE>

(d) Not applicable.

                      ALLETE Second Quarter 2007 Form 10-Q                    30
<PAGE>

ITEM 5.    OTHER INFORMATION

Reference  is made to our 2006  Form  10-K  for  background  information  on the
following updates. Unless otherwise indicated,  cited references are to our 2006
Form 10-K.

Ref. Page 17 - Real Estate, First Full Paragraph

In June 2007, LRCF Palm Coast, LLC (Lowe Enterprises) closed on the first parcel
of the Sawmill Creek  project at Palm Coast Park for $13.1  million  pursuant to
revised  contract terms.  Under the amended  contract,  the total purchase price
under contract was reduced from $52.5 million to $42.0  million.  In addition to
the base price, the amended contract allows us to receive  participation revenue
from land sales to third parties if various formula based criteria are achieved.
Current  contract  terms  with  Lowe  Enterprises  allow for  extensions  on the
remaining three closings. The final closings will occur through 2011.

Ref. Page 49 - Contractual Obligations, First Full Paragraph and First Table

Unconditional  purchase  obligations  represent our Square Butte power  purchase
agreements, minimum purchase commitments under coal and rail contracts, and have
been updated to reflect additional purchase obligations for capital expenditures
related  to  the  Taconite  Ridge  Wind  Facility,   AREA  and  Boswell  Unit  3
environmental  upgrade  projects.  The amounts  included in the less than 1 year
column include amounts already paid in 2007.

<TABLE>
<CAPTION>
                                                                       PAYMENTS DUE BY PERIOD
                                            -------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS                                     LESS THAN         1 TO 3         4 TO 5           AFTER
AS OF DECEMBER 31, 2006                        TOTAL         1 YEAR            YEARS          YEARS          5 YEARS
---------------------------------------------------------------------------------------------------------------------
MILLIONS
<S>                                          <C>            <C>              <C>             <C>             <C>
Long-Term Debt <F1>                          $  639.7        $ 46.7           $ 65.1          $31.2          $496.7
Operating Lease Obligations                      86.5           8.2             21.1           11.4            45.8
Unconditional Purchase Obligations              487.5         177.9            100.1           26.2           183.3
Investment in ATC                                 8.6           8.6                -              -               -
---------------------------------------------------------------------------------------------------------------------

                                             $1,222.3        $241.4           $186.3          $68.8          $725.8
---------------------------------------------------------------------------------------------------------------------
<FN>
<F1> Includes interest and assumes variable interest rate in effect at December 31, 2006,  remains  constant  through
     remaining term.
</FN>
</TABLE>


Ref. Page 76 - Fuel Clause Recovery of MISO Day 2 Costs, First Full Paragraph

On January 8, 2007,  the Minnesota  Office of Attorney  General  petitioned  for
reconsideration  of the MPUC's  December 20, 2006,  order. On February 15, 2007,
the MPUC declined to address the Minnesota Office of Attorney  General's request
for reconsideration. On April 10, 2007, the Minnesota Office of Attorney General
filed an appeal with the Minnesota  Court of Appeals.  The appeal does not alter
current  cost  recovery of MISO  charges in  accordance  with the MPUC's  order.
Minnesota Power timely responded to the Minnesota  Office of Attorney  General's
notice of filing.  On June 25, 2007,  the Minnesota  Office of Attorney  General
filed its initial brief. Minnesota Power filed reply briefs on July 30, 2007.

31                   ALLETE Second Quarter 2007 Form 10-Q

<PAGE>

ITEM 6.    EXHIBITS

EXHIBIT
NUMBER

 10(a)     Note Purchase  Agreement, dated  as of June 8, 2007,  between  ALLETE
           and Thrivent Financial for Lutherans and The Northwestern Mutual Life
           Insurance Company.

 31(a)     Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
           Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.

 31(b)     Rule  13a-14(a)/15d-14(a)  Certification   by  the  Chief   Financial
           Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.

    32     Section 1350 Certification  of Periodic Report by the Chief Executive
           Officer and Chief  Financial  Officer  Pursuant to Section 906 of the
           Sarbanes-Oxley Act of 2002.

    99     ALLETE   News   Release dated  July 27, 2007, announcing  2007 second
           quarter  earnings.  (THIS EXHIBIT HAS BEEN FURNISHED AND SHALL NOT BE
           DEEMED "FILED" FOR PURPOSES OF SECTION 18 OF THE SECURITIES  EXCHANGE
           ACT OF 1934, NOR SHALL IT BE DEEMED  INCORPORATED BY REFERENCE IN ANY
           FILING UNDER THE SECURITIES ACT OF 1933, EXCEPT AS SHALL BE EXPRESSLY
           SET FORTH BY SPECIFIC REFERENCE IN SUCH FILING.)


                     ALLETE Second Quarter 2007 Form 10-Q                     32

<PAGE>

                                   SIGNATURES


Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.




                                                   ALLETE, INC.





July 26, 2007                                    Mark A. Schober
                               -------------------------------------------------
                                                 Mark A. Schober
                               Senior Vice President and Chief Financial Officer





July 26, 2007                                   Steven Q. DeVinck
                               -------------------------------------------------
                                                Steven Q. DeVinck
                                                    Controller