The following discussion should be read in conjunction with our consolidated financial statements, notes to those statements, management's discussion and analysis from the 2007 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 heading: "Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995" located on page 5 and "Risk Factors" located in Part I, Item 1A, page 22 of our 2007 Form 10-K. The risks and uncertainties described in this Form 10-Q and our 2007 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.

OVERVIEW

ALLETE is a diversified company that has provided fundamental products and services since 1906. These include our former operations in the water, paper, telecommunications and automotive industries and the Energy and Real Estate businesses we operate today.

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.

ALLETE is incorporated under the laws of Minnesota. Our corporate headquarters are in Duluth, Minnesota. Statistical information is presented as of September 30, 2008, unless otherwise indicated. All subsidiaries are wholly owned unless otherwise specifically indicated. References in this report to "we," "us" and "our" are to ALLETE and its subsidiaries, collectively.

OVERVIEW (Continued)

                                               Quarter Ended   Nine Months Ended
                                               September 30,     September 30,
      Kilowatt-hours Sold                      2008    2007     2008      2007
      Millions

      Regulated Utility
          Retail and Municipals
              Residential                       252.1   258.8     853.9     832.1
              Commercial                        360.5   360.5   1,027.7   1,033.6
              Municipals                        243.0   255.7     742.5     751.3
              Industrial                      1,854.1 1,775.8   5,466.2   5,215.2
              Other                              20.5    21.5      62.0      62.8
                  Total Retail and Municipals 2,730.2 2,672.3   8,152.3   7,895.0

          Other Power Suppliers                 464.8   571.9   1,244.0   1,608.8
                  Total Regulated Utility     3,195.0 3,244.2   9,396.3   9,503.8

          Nonregulated Energy Operations         60.6    60.7     168.9     184.2

                   Total Kilowatt-hours Sold  3,255.6 3,304.9   9,565.2   9,688.0




                                Quarter Ended             Nine Months Ended
                                September 30,               September 30,
       Real Estate            2008         2007          2008          2007
       Revenue and Sales
       Activity (a)        Qty  Amount  Qty   Amount  Qty  Amount   Qty   Amount
       Dollars in
       Millions

       Town Center Sales
       Non-residential
       Sq. Ft.                -      - 50,000   $1.8     -      - 474,476  $14.5
       Residential Units      -      -      -      -     -      -     130    1.6

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

       Other Land Sales
       Acres (b)              1   $0.7     83   $3.0    52   $4.6     450   $8.9

       Contract Sales
       Price (c)                   0.7           4.8          4.6           38.1

       Revenue Recognized
       from Previously
       Deferred Sales              2.6           0.1          2.6            2.4

       Deferred Revenue              -         (1.1)            -          (4.2)

       Revenue from Land
       Sales                       3.3           3.8          7.2           36.3

       Other Revenue (d)           1.0           1.0          7.7            4.7

                                  $4.3          $4.8        $14.9          $41.0

(a) Quantity amounts are approximate until final build-out.
(b) Acreage amounts are shown on a gross basis, including wetlands and minority interest.
(c) Reflected total contract sales price on closed land transactions.
(d) Other Revenue includes traffic impact fees, forfeited deposits, investment income and the sale of a shopping center.

OVERVIEW (Continued)

Financial Overview

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

The following net income discussion summarizes, by segment, a comparison of the nine months ended September 30, 2008, to the nine months ended September 30, 2007.

Regulated Utility contributed income of $40.0 million in 2008 ($37.9 million in 2007). The increase in earnings is primarily the result of higher rates. Higher rates resulted from a March 1, 2008 increase in FERC approved wholesale rates, an August 1, 2008 interim rate increase for retail customers in Minnesota, and current cost recovery on our environmental retrofit projects. Rate increases were partially offset by the expiration of sales contracts to Other Power Suppliers, and higher operations and maintenance expense, depreciation expense and interest expense.

Nonregulated Energy Operations contributed income of $2.3 million in 2008 ($3.4 million in 2007). The decrease is primarily due to higher gains from land sales in Minnesota during 2007.

Investment in ATC contributed income of $6.5 million in 2008 ($5.6 million in 2007).

Real Estate contributed income of $2.2 million in 2008 ($15.2 million in 2007). Income was lower in 2008 due to the continued weak real estate market.

Other contributed income of $8.0 million in 2008 ($3.3 million in 2007). The increase is primarily due to a $3.8 million after-tax gain realized from the sale of certain available for sale securities in the first quarter of 2008, tax benefits, and the related interest recognized in the third quarter 2008. The gain on the sale of certain available for sale securities was triggered when securities were sold to reallocate investments to meet defined investment allocations based upon an approved investment strategy.

COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2008 AND 2007

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

Regulated Utility

Operating revenue increased slightly from 2007 primarily as a result of higher rates and kilowatt-hour sales to retail and municipal customers. The increase was mostly offset by decreased fuel clause recoveries and the expiration of sales contracts to Other Power Suppliers.

Higher rates resulted from the August 1, 2008 interim rate increase subject to refund for retail customers in Minnesota of $7.1 million, current cost recovery on our environmental retrofit projects of $2.7 million, and the March 1, 2008 increase in FERC approved wholesale rates of $1.5 million.

Fuel clause recoveries decreased $27.5 million in 2008 primarily as a result of decreased purchased power expenses reflecting higher Company hydro and wind generation, and additional generation from Square Butte (see Fuel and Purchased Power Expense discussion below).

Revenue from sales to Other Power Suppliers decreased $3.7 million from 2007 due to the expiration of sales contracts.

Kilowatt-hour sales to our retail and municipal customers increased 2 percent from 2007, primarily due to a 4 percent increase in industrial load. The increase in industrial sales in 2008 primarily reflects increased sales to one taconite customer that was partially idled in 2007. Total regulated utility kilowatt-hour sales were down 2 percent as the expiration of sales contracts to Other Power Suppliers more than offset the increased retail and municipal sales.

Revenue from electric sales to taconite customers accounted for 28 percent of consolidated operating revenue in 2008 (26 percent in 2007). Revenue from electric sales to paper and pulp mills accounted for 10 percent of consolidated operating revenue in 2008 and 2007. Revenue from electric sales to pipelines and other industrials accounted for 7 percent of consolidated operating revenue in 2008 and 2007.

COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2008 AND 2007 (Continued)

Operating expenses decreased $8.4 million from 2007.

Fuel and Purchased Power Expense decreased $10.8 million, or 12 percent, from 2007, primarily due to a decrease in purchase power expense reflecting higher generation and fewer scheduled outages.

Operating and Maintenance Expense increased $1.0 million, or 2 percent, from 2007 due to higher gas prices and higher salaries and wages, reflecting inflationary increases.

Depreciation Expense increased $1.4 million from 2007 reflecting higher property, plant and equipment balances as a result of increased property placed in service due to the Company's construction activity.

Interest Expense increased $0.8 million, or 15 percent, from 2007 primarily due to higher long term debt balances as a result of increased construction activity.

Nonregulated Energy Operations

Operating revenue increased $1.3 million, or 8 percent, from 2007 primarily due to higher coal sales at BNI Coal.

Operating expenses increased $0.4 million, or 2 percent, from 2007 primarily due to higher fuel expense and dragline repairs at BNI Coal.

Investment in ATC

Equity Earnings increased $1.0 million, or 31 percent, from 2007 resulting from our pro-rata share of ATC's earnings on an increased investment balance as discussed in Note 3.

Real Estate

Operating revenue decreased $0.5 million from 2007. Revenue from land sales was $3.3 million in 2008 and included $2.6 million in previously deferred revenue. In 2007, revenue from land sales was $3.8 million, which included $0.1 million in previously deferred revenue. There were no sales at Town Center or Palm Coast Park for the quarter ended September 30, 2008. For the quarter ended September 30, 2007, 50,000 non-residential square feet were sold at Town Center.

Operating expenses decreased $0.2 million, or 5 percent, from 2007 reflecting a decrease in the cost of real estate sold and decreased selling expenses.

Other

Other income increased $0.8 million from 2007 primarily due to interest income related to tax benefits recognized in the third quarter of 2008 partially offset by lower earnings on cash and short-term investments.

Income Taxes

For the quarter ended September 30, 2008, the effective tax rate on income before minority interest and income taxes was 25.2 percent (32.7 percent for the quarter ended September 30, 2007). The effective rate was lower in 2008 due to the recognition of a non-recurring benefit on a previously uncertain tax position for $1.7 million due to the closing of a tax year and the reversal of a state valuation allowance for $2.4 million due to the completion of an IRS review. The effective tax rate of 25.2 percent for the quarter ended September 30, 2008, deviated from the statutory rate (approximately 40 percent) primarily due to the two tax benefit items previously discussed as well as deductions for Medicare health subsidies, AFUDC-Equity, investment tax credits and wind production tax credits.

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

Regulated Utility

Operating revenue decreased $2.3 million from 2007 primarily as a result of decreased fuel clause recoveries and the expiration of sales contracts to Other Power Suppliers. The decrease was offset by higher rates, increased gas sales, and kilowatt-hour sales to retail and municipal customers.

Higher rates resulted from current cost recovery on our environmental retrofit projects of $12.8 million, the August 1, 2008 interim rate increase subject to refund for retail customers in Minnesota of $7.1 million, and the March 1, 2008 increase in FERC approved wholesale rates of $3.9 million.

Fuel clause recoveries decreased $42.6 million in 2008 primarily as a result of decreased purchased power expenses reflecting higher Company steam, hydro and wind generation and additional generation from Square Butte (see Fuel and Purchased Power Expense discussion below).

Revenue from sales to Other Power Suppliers decreased $17.1 million from 2007 due to the expiration of sales contracts.

Kilowatt-hour sales to our retail and municipal customers increased 3 percent from 2007, primarily due to a 5 percent increase in industrial sales. The increase in industrial sales in 2008 primarily reflects increased sales to one taconite customer that was partially idled in 2007 and another customer that was shutdown due to weather related issues in 2007. Total regulated utility kilowatt-hour sales are down 1 percent as the expiration of sales contracts to Other Power Supplier more than offset the increased retail and municipal sales.

Revenue from electric sales to taconite customers accounted for 27 percent of consolidated operating revenue in 2008 (24 percent in 2007). Revenue from electric sales to paper and pulp mills accounted for 9 percent of consolidated operating revenue in 2008 and 2007. Revenue from electric sales to pipelines and other industrials accounted for 7 percent of consolidated operating revenue in 2008 and 2007.

Operating expenses decreased $8.1 million from 2007.

Fuel and Purchased Power Expense decreased $20.1 million, or 8 percent, from 2007, primarily due to a decrease in purchase power expense. In 2007, scheduled and unscheduled outages drove the higher purchased power.

Operating and Maintenance Expense increased $8.7 million, or 5 percent, over 2007 primarily due to increased gas purchases reflecting a colder 2008, transmission expense, and higher salaries and wages relating to annual inflationary increases.

Depreciation Expense increased $3.3 million from 2007 reflecting higher property, plant, and equipment balances as a result of increased property placed in service due to the Company's construction activity.

Interest Expense increased $1.8 million, or 11 percent, from 2007 primarily due to higher long term debt balances from increased construction activity.

Other income increased $0.4 million from 2007 due to higher earnings from the capitalization of AFUDC-Equity reflecting increased construction activity.

Nonregulated Energy Operations

Operating revenue increased $3.9 million, or 8 percent, from 2007, primarily due to higher coal sales and prices at BNI Coal.

Operating expenses increased $3.0 million, or 6 percent, from 2007 primarily due to higher fuel expense and dragline repairs at BNI Coal.

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (Continued)

Nonregulated Energy Operations (Continued)

Other income decreased $2.5 million from 2007 due to higher gains from land sales in Minnesota during 2007.

Investment in ATC

Equity Earnings increased $1.9 million, or 20 percent, from 2007 resulting from our pro-rata share of ATC's earnings on an increased investment balance as discussed in Note 3.

Real Estate

Operating revenue decreased $26.1 million from 2007. Revenue from land sales was $7.2 million in 2008 and included $2.6 million in previously deferred revenue. In 2007, revenue from land sales was $36.3 million, which included $2.4 million in previously deferred revenue and reflected two large sales that closed during the second quarter of 2007. Operating revenue in 2008 also included the pre-tax gain of $4.5 million resulting from the sale of the retail shopping center in Winter Haven, Florida on May 1, 2008.

There were no sales at Town Center or Palm Coast Park for the nine months ended September 30, 2008. Through September 30, 2007, 474,476 non-residential square feet were sold at Town Center and 40,000 non-residential square feet were sold at Palm Coast Park. Also in 2007, Town Center sold 130 residential units and Palm Coast Park sold 406 residential units. For the nine months ended September 30, 2008, 52 acres of Other Land was sold (450 acres in 2007).

Operating expenses decreased $4.0 million, or 26 percent, from 2007 reflecting a decrease in the cost of real estate sold and decreased selling expenses.

Other

Operating expenses increased $0.3 million from 2007 as a result of additional expense related to our Georgia Water dispute as discussed in Note 11.

Other income increased $4.4 million from 2007 primarily due to a $3.8 million after-tax gain realized from the sale of certain available for sale securities in the first quarter of 2008 and interest income related to tax benefits recognized in the third quarter of 2008. The gain was triggered when securities were sold to reallocate investments to meet defined investment allocations based upon an approved investment strategy. The increase was partially offset by lower earnings on cash and short-term investments reflecting lower average cash balances, lower average interest rates, and the 2007 release from a loan guarantee for Northwest Airlines Corporation of $1.0 million.

Income Taxes

For the nine months ended September 30, 2008, the effective tax rate on income before minority interest and income taxes was 32.3 percent (34.6 percent for nine months ended September 30, 2007). The effective rate was lower in 2008 due to the recognition of a non-recurring benefit on a previously uncertain tax position for $1.7 million due to the closing of a tax year and the reversal of a state valuation allowance for $2.4 million due to the completion of an IRS review. The effective tax rate of 32.3 percent for the nine months ended September 30, 2008, deviated from the statutory rate (approximately 40 percent) primarily due to the two tax benefit items previously discussed as well as deductions for Medicare health subsidies, AFUDC-Equity, investment tax credits and wind production tax credits. We expect that the effective tax rate on income before minority interest and income taxes to be approximately 34 percent for 2008.

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: real estate revenue and expense recognition, pension and postretirement health and life actuarial assumptions, regulatory accounting, the valuation of investments and taxation. 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 2007 Form 10-K.

OUTLOOK

Earnings Guidance. ALLETE reaffirms its previously stated earnings guidance of a range from $2.70 to $2.90 per share for 2008.

Energy. As part of our strategy, we will leverage the strengths of our Regulated Utility business to improve our strategic and financial outlook and seek growth opportunities in close proximity to existing operations in the Midwest. We believe electric industry deregulation is unlikely in Minnesota and Wisconsin in the next five years.

Minnesota Power expects significant rate base growth over the next several years as it makes capital expenditures to comply with renewable energy requirements and environmental mandates. In addition, significant investment will be made in our existing low-cost generation fleet to provide for continued future operations as we continue to believe ownership of low-cost generation is a competitive advantage. Minnesota Power will also look for transmission opportunities which strengthen and enhance the regional transmission grid and take advantage of our geographic location between sources of renewable energy and growing energy markets. Our capital investments will be recovered through a combination of current cost recovery riders and anticipated increased base electric rates. We may experience kilowatt-hour growth due to the potential for up to 400 MW of additional growth from several new industrial customers planning projects in our service territory.

Our energy strategy is to be a leader in the movement toward renewable energy and cleaner power plants. We believe we can meet our customers' electric energy needs for the next decade while achieving real reductions in total carbon emissions. We are aggressively pursuing our renewable energy resources and expect to comply with Minnesota's renewable energy requirements prior to the 2025 deadline.

Renewable Generation Sources. The areas in which we operate have strong wind, water and biomass resources, and provide us with opportunities to develop a number of renewable forms of generation. Our electric service area in northeastern Minnesota is well situated for delivery of renewable energy that is generated here and in adjoining regions. We intend to secure the most cost competitive and geographically advantageous renewable energy resources available. We believe that the demand for these resources is likely to grow, and the costs of the resources to generate renewable energy will continue to escalate. While we intend to maintain our disciplined approach to developing generation assets, we also believe that by acting sooner rather than later we can deliver lower cost power to our customers and maintain or improve our cost competitiveness among regional utilities. We will continue to work cooperatively with our customers, our regulators and the communities we serve to develop generation options that reflect the needs of our customers as well as the environment. We believe that our location and our proactive leadership in developing renewable generation provide us with a competitive advantage. For more than a century, we have been Minnesota's leading producer of renewable hydroelectric energy.

We have already begun executing our renewable energy and cleaner power plant strategy. Taconite Ridge Wind I, a $50 million, 25-MW wind facility located in northeastern Minnesota became operational in July 2008. Costs related to the construction of this facility have been included in our May 2, 2008 rate filing.

On May 13, 2008, we announced plans to develop several hundred megawatts of wind energy in North Dakota and purchase an existing 250 kV DC transmission line to transport this wind energy to customers while gradually reducing the supply of energy currently delivered to our system on this same transmission line from Square Butte's coal-fired Milton R. Young Unit 2. The North Dakota wind project is expected to complete the mandated 2025 renewable energy supply requirements for our retail load. In September 2008, we signed an agreement to purchase the transmission line from Square Butte Electric Cooperative for approximately $80 million. The transaction is subject to regulatory approvals and is anticipated to close in 2009.

OUTLOOK (Continued)
Energy (Continued)

Integrated Resource Plan (IRP). On October 31, 2007, we filed our IRP, a comprehensive estimate of future capacity needs within the Minnesota Power service territory. On July 25, 2008, we filed a request with the MPUC for approval to re-file our IRP by October 1, 2009, in order to incorporate the North Dakota wind project and otherwise update our load forecasting and modeling in the IRP. In October 2008, the MPUC issued an order approving the request to re-file the IRP by October 1, 2009.

Climate Change. A key component of our energy strategy is a goal to reduce overall GHG emissions. While there continues to be debate about the causes and extent of global warming, certain scientific evidence suggests that emissions from fossil fuel generation facilities are a contributing factor. Minnesota Power has a long history of environmental stewardship.

We believe that future regulations may restrict the emissions of GHGs from our generation facilities. Several proposals on the federal level to "cap" the amount of GHG emissions have been made. Other proposals consider establishing emissions allowances or taxes as economic incentives to address the GHG emissions issue.

In 2007, Minnesota passed legislation establishing non-binding targets for GHG reductions. This legislation establishes a goal of reducing statewide GHG emissions across all sectors producing those emissions to a level at least 15 percent below 2005 levels by 2015, at least 30 percent below 2005 levels by 2025, and at least 80 percent below 2005 levels by 2050. Minnesota is also participating in the Midwestern Greenhouse Gas Accord, a regional effort to develop a multi-state approach to GHG emission reductions. We are proactively taking steps to strategically engage the GHG emission issue and the impact of climate change regulation on our business.

Minnesota Power is addressing this environmental challenge by taking the following steps that also ensure reliable and competitive generation resources to continue to meet our customer's requirements:

· We will consider only carbon minimizing resources to supply power to our customers. We will not consider a new coal resource without a reasonable carbon emission solution.

· We will aggressively pursue Minnesota's Renewable Energy Standard by adding significant renewable resources to our portfolio of generation facilities and power supply agreements.

· We will continue to improve the efficiency of coal-based generation facilities.

· We plan to implement aggressive demand side conservation efforts.

· We will continue to support research of technologies to reduce carbon emissions from generation facilities and support carbon sequestration efforts.

· We plan to achieve overall carbon emission reductions while maintaining competitively priced electric service to our customers.

. . .