UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.  )

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UNISOURCE ENERGY CORPORATION

(Name of Registrant as Specified In Its Charter)

 

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

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One South Church Avenue
Tucson, Arizona 85701

March 23, 2009

Paul J. Bonavia		(520) 571-4000
Chairman of the Board

Dear Shareholders:

You are cordially invited to attend the UniSource Energy Corporation 2009 Annual Shareholders’ Meeting (the “Meeting”) to be held on Friday, May 8, 2009, at the FOX Theatre, 17 West Congress, Tucson, Arizona. The Meeting will begin promptly at 10:00 a.m., Mountain Standard Time, so please plan to arrive earlier. No admission tickets will be required for attendance at the Meeting.

Directors and officers will be available before and after the Meeting to speak with you. During the Meeting, we will answer your questions regarding our business affairs and we will consider the matters explained in the enclosed Proxy Statement.

We have enclosed a proxy card that lists all matters that require your vote. Please complete, sign, date and mail the proxy card as soon as possible, whether or not you plan to attend the Meeting. You may also vote by telephone or the Internet, as explained on the enclosed proxy card. If you attend the Meeting and wish to vote your shares personally, you may revoke your proxy at that time.

Your interest in and continued support of UniSource Energy Corporation are much appreciated.

		Sincerely,
		UNISOURCE ENERGY CORPORATION
		Paul J. Bonavia
		Chairman of the Board, President and
		Chief Executive Officer

NOTICE OF ANNUAL SHAREHOLDERS’ MEETING

To the Holders of Common Stock of
UniSource Energy Corporation

We will hold the 2009 Annual Shareholders’ Meeting of UniSource Energy Corporation at the FOX Theatre, 17 West Congress, Tucson, Arizona, on Friday, May 8, 2009, at 10:00 a.m., Mountain Standard Time (“MST”). The purpose of the Meeting is to:

	1.		elect 14 directors to our Board of Directors for the ensuing year;
	2.		ratify the selection of the Independent Registered Public Accounting Firm for 2009; and
	3.		consider any other matters which properly come before the Meeting.

Only shareholders of record at the close of business on March 16, 2009, are entitled to vote at the Meeting.

We have enclosed with this notice: (i) our 2008 annual report on Form 10-K; (ii) the Proxy Statement; (iii) the Chairman’s letter to shareholders; and (iv) a stock performance chart. Proxy soliciting material is first being made available in electronic form, on or about March 27, 2009. Your proxy is being solicited by our Board of Directors.

Please complete, sign, date and mail the enclosed proxy card as soon as possible, or vote by telephone or the Internet, as explained on the enclosed proxy card.

		Linda H. Kennedy Corporate Secretary

Dated: March 23, 2009

YOUR VOTE IS IMPORTANT

EACH SHAREHOLDER IS URGED TO COMPLETE, SIGN, DATE AND RETURN PROMPTLY THE ENCLOSED PROXY CARD BY MAIL, OR TO VOTE BY TELEPHONE OR THE INTERNET, AS EXPLAINED ON THE ENCLOSED PROXY CARD. IF THE MAIL OPTION IS SELECTED, USE THE ENCLOSED ENVELOPE, WHICH DOES NOT REQUIRE POSTAGE IF MAILED IN THE UNITED STATES. RETURNING A SIGNED PROXY WILL NOT PROHIBIT YOU FROM ATTENDING THE MEETING AND VOTING IN PERSON IF YOU SO DESIRE.

UNISOURCE ENERGY CORPORATION
One South Church Avenue
Tucson, Arizona 85701

ANNUAL SHAREHOLDERS’ MEETING
PROXY STATEMENT

ANNUAL MEETING:

May 8, 2009		FOX Theatre
10:00 a.m., MST		17 West Congress
		Tucson, AZ 85701

RECORD DATE:

The record date is March 16, 2009 (“Record Date”). If you were a shareholder of record at the close of business on the Record Date, you may vote at the 2009 Annual Shareholders’ Meeting (“Meeting”) of UniSource Energy Corporation (“UniSource Energy” as well as references to the “Company,” “we,” “our” and “us”). At the close of business on the Record Date, we had 35,610,300 shares of common stock outstanding.

AGENDA:

1.		Proposal One: Elect 14 directors to our Board of Directors (“Board”) for the ensuing year.
2.		Proposal Two: Ratify the selection of the Independent Registered Public Accounting Firm for 2009.
3.		Proposal Three: Consider any other matters which properly come before the Meeting and any adjournments.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM:

Representatives of PricewaterhouseCoopers, LLP are expected to be present at the Meeting with the opportunity to make a statement and respond to appropriate questions from our shareholders.

PROXIES:

In accordance with rules and regulations recently adopted by the Securities and Exchange Commission (the “SEC”), instead of mailing a printed copy of our proxy materials to each shareholder of record, we are now furnishing proxy materials to our shareholders on the Internet. If you received a Notice of Internet Availability of Proxy Materials by mail, you will not receive a printed copy of the proxy materials other than as described therein. Instead, the Notice of Internet Availability of Proxy Materials will instruct you as to how you may access and review all of the important information contained in the proxy materials. If you received a Notice of Internet Availability of Proxy Materials by mail and would like to receive a printed copy of our proxy materials, you should follow the instructions included in the Notice of Internet Availability of Proxy Materials.

It is anticipated that the Notice of Internet Availability of Proxy Materials is first being sent to shareholders on or about March 27, 2009. The proxy statement and the form of proxy relating to the 2009 Annual Meeting are first being made available to shareholders on or about March 27, 2009.

PROXIES SOLICITED BY:

The Board.

REVOKING YOUR PROXY:

You may revoke your proxy before it is voted at the Meeting. To revoke, follow the procedures listed on page 4 under “Voting Procedures/Revoking Your Proxy.”

COMMENTS:

Your comments about any aspects of our business are welcome. You may use the space provided on the proxy card for this purpose, if desired. Although we may not respond on an individual basis, your comments help us to measure your satisfaction, and we may benefit from your suggestions.

PLEASE VOTE — YOUR VOTE IS IMPORTANT

Prompt return of your proxy will help reduce the costs of re-solicitation.

CONTENTS

VOTING PROCEDURES/REVOKING YOUR PROXY			4
UNISOURCE ENERGY SHARE OWNERSHIP			6
PROPOSAL ONE: ELECTION OF DIRECTORS*			9
PROPOSAL TWO: RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM*			11
COMPENSATION DISCUSSION AND ANALYSIS			12
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION			24
SUMMARY COMPENSATION TABLE — 2008			25
GRANTS OF PLAN-BASED AWARDS — 2008			27
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END — 2008			29
OPTION EXERCISES AND STOCK VESTED			31
PENSION BENEFITS			32
NON-QUALIFIED DEFERRED COMPENSATION			33
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL			34
DIRECTOR COMPENSATION			36
EQUITY COMPENSATION PLAN INFORMATION			38
CORPORATE GOVERNANCE			40
DIRECTOR INDEPENDENCE CRITERIA			40
TRANSACTIONS WITH RELATED PERSONS			44
AUDIT COMMITTEE REPORT			45
SUBMISSION OF SHAREHOLDER PROPOSALS			47
DELIVERY OF PROXY MATERIALS TO HOUSEHOLDS			47
OTHER BUSINESS			48

VOTING PROCEDURES/REVOKING YOUR PROXY

You can vote by telephone, the Internet, mail or in person.

You may vote in person or by a validly designated proxy, or, if you or your proxy will not be attending the meeting, you may vote in one of three ways:

	1.		Vote by Internet. The website address for Internet voting is on your Notice of Internet Availability of Proxy Materials. Internet voting is available 24 hours a day;
	2.		Vote by telephone. The toll-free number for telephone voting is on your proxy card. Telephone voting is available 24 hours a day; or
	3.		Vote by mail. If you have requested and received a copy of our proxy materials, mark, date, sign and mail promptly a proxy card (a postage-paid envelope will be provided for mailing in the United States).

If you vote by telephone or Internet, DO NOT mail a proxy card.

Under Arizona law, a majority of the shares entitled to vote on any single matter which may be brought before the Meeting will constitute a quorum. Business may be conducted once a quorum is represented at the Meeting. If a quorum exists, action on a matter other than the election of directors will be deemed approved if a majority of votes is cast in favor of the matter.

Directors are elected by a plurality of votes.

Directors are elected by a plurality of the votes cast by the shares entitled to vote if a quorum is present. A plurality means receiving the largest number of votes, regardless of whether that is a majority. Withheld votes will be counted as being represented at the Meeting for quorum purposes but will not have an effect on the vote.

You may cumulate your votes for directors.

In the election of directors, each shareholder has the right to cumulate his votes by casting a total number of votes equal to the number of his shares of common stock multiplied by the number of directors to be elected. He may cast all of such votes for one nominee or distribute such votes among two or more nominees. For any other matter that may properly come before the Meeting, each share of common stock will be entitled to one vote.

You can revoke your proxy after sending it in by following these procedures.

Any shareholder giving a proxy has a right to revoke that proxy by giving notice to UniSource Energy in writing directed to the Corporate Secretary, UniSource Energy Corporation, One South Church Avenue, Suite 1820, Tucson, Arizona 85701, or in person at the Meeting at any time before the proxy is exercised. Those who fail to return a proxy or fail to attend the Meeting will not count towards determining any required plurality, majority or quorum.

The shares represented by an executed proxy will be voted for the election of directors or withheld in accordance with the specifications in the proxy. If no specification is made in an executed proxy, the proxy will be voted in favor of the nominees as set forth herein.

Proxy Solicitation

We will bear the entire cost of the solicitation of proxies. Solicitations will be made primarily by mail. In addition, we may make additional solicitation of brokers, banks, nominees and institutional investors pursuant to a special engagement of BNY Mellon Shareholder Services. Solicitations may also be made by telephone, facsimile or personal interview, if necessary, to obtain reasonable representation of shareholders at the Meeting. Our employees may solicit proxies but they will not receive additional compensation for such services. We will request brokers or other persons holding shares in their names, or in the names of their nominees, to forward proxy materials to the beneficial owners of such shares or request authority for the execution of the proxies. We will reimburse brokers and other persons for reasonable expenses they incur in sending these proxy materials to you if you are a beneficial holder of our shares.

UNISOURCE ENERGY SHARE OWNERSHIP

Security Ownership of Management

The following table sets forth the number and percentage of shares of UniSource Energy common stock beneficially owned as of March 1, 2009 and the nature of such ownership by each of our directors (all of whom are nominees), our Chief Executive Officer for 2008 (“CEO” or “Mr. Pignatelli”) and our four other most highly compensated executive officers (together with our CEO, the “Named Executives”) as of March 1, 2009 and all directors and officers as a group. Ownership includes direct and indirect (beneficial) ownership, as defined by the SEC rules.

		Amount and Nature of Beneficial Ownership(1)																				Other(2)
										Shares Subject																Deferred
						Shares				to Options																Shares Under
Name and		Directly				Purchased				Exercisable				Total												Deferred
Title of		Owned				Under the				Within 60				Beneficial				Percent of				Restricted				Compensation
Beneficial Owner		Shares				401(k) Plan				Days				Ownership				Class				Stock Units				Plan				Total
James S. Pignatelli			114,324				21,030				695,089				830,443				2.3	%			0				30,971				861,414
Chairman, President and Chief Executive Officer(3)
Lawrence J. Aldrich			3,912				0				0				3,912				*				5,420				0				9,332
Director
Barbara M. Baumann			0				0				0				0				*				3,869				8,965				12,834
Director
Larry W. Bickle			9,852				0				8,358				18,210				*				4,492				0				22,702
Director
Elizabeth T. Bilby			705				0				8,358				9,063				*				5,876				4,194				19,133
Director
Harold W. Burlingame			4,625				0				8,358				12,983				*				6,636				0				19,619
Director
John L. Carter			23,817				0				0				23,817				*				5,171				11,315				40,303
Director
Robert A. Elliott			1,813				0				1,196				3,009				*				4,324				0				7,333
Director
Daniel W. L. Fessler			2,511				0				2,358				4,869				*				8,942				0				13,811
Director
Louise L. Francesconi			0				0				0				0				*				0				0				0
Director(4)
Kenneth Handy(5)			25,662				0				0				25,662				*				0				0				25,662
Director
Warren Y. Jobe			1,313				0				6,358				7,671				*				6,266				0				13,937
Director
Ramiro G. Peru			1,000				0				0				1,000				*				1,565				0				2,565
Director
Gregory A. Pivirotto			400				0				0				400				*				1,565				0				1,965
Director
Joaquin Ruiz			300				0				0				300				*				3,869				0				4,169
Director
Kevin P. Larson			43,199				2,605				96,235				142,039				*				0				1,323				143,362
Senior Vice President Chief Financial Officer and Treasurer

		Amount and Nature of Beneficial Ownership(1)																				Other(2)
										Shares Subject																Deferred Shares
						Shares				to Options																Under
Name and		Directly				Purchased				Exercisable				Total												Deferred
Title of		Owned				Under the				Within 60				Beneficial				Percent of				Restricted				Compensation
Beneficial Owner		Shares				401(k) Plan				Days				Ownership				Class				Stock Units				Plan				Total
Raymond S. Heyman			6,296				3,455				86,542				96,293				*				0				87				96,380
Senior Vice President and General Counsel
Michael J. DeConcini			13,932				5,480				163,769				183,181				*				27,214				971				211,366
Senior Vice President and Chief Operating Officer, Transmission and Distribution
Karen G. Kissinger			42,789				0				37,037				79,826				*				0				1,985				81,811
Vice President, Controller and Chief Compliance Officer
All directors and executive			358,339				58,635				1,290,400				1,707,374				4.8	%			85,209				62,655				1,855,238
officers as a group

	•		Any shares held in the name of the spouse, minor children or other relatives sharing the home of the director or officer. Except as otherwise indicated below, the directors and officers have sole voting and investment power over the shares shown. Voting power includes the power to direct the voting of the shares held, and investment power includes the power to direct the disposition of the shares held.
	•		Shares subject to options exercisable within 60 days, based on information from E*Trade, UniSource Energy’s stock option plan administrator.
	•		Equivalent share amounts allocated to the individuals’ 401(k) Plan which, since June 1, 1998, has included a UniSource Energy Stock Fund investment option.

Security Ownership of Certain Beneficial Owners

As of March 1, 2009, based on information reported in filings made by the following persons with the SEC or information otherwise known to us, the following persons were known or reasonably believed to be, as more fully described below, the beneficial owners of more than 5% of our common stock:

						Amount and
				Name and Address		Nature of				Percent
Title of Class				of Beneficial Owner		Beneficial Ownership				of Class
Common				Barclays Global Investors, NA			3,321,505	(1)			9.4	%
				45 Fremont Street San Francisco, CA 94105
Common				Luminus Management, LLC			3,296,379	(2)			9.3	%
				1700 Broadway, 38th Floor New York, NY 10019
Common				Prospector Partners, L.L.C.			2,670,686	(3)			7.3	%
				370 Church Street Guilford, CT 06437
Common				T. Rowe Price Associates, Inc.			2,506,350	(4)			7.0	%
				100 E. Pratt Street Baltimore, MD 21202
Common				Wellington Management Co., LLP			2,353,955	(5)			6.8	%
				75 State Street Boston, MA 02109
Common				Duquesne Capital Management, LLC			1,781,000	(6)			5.0	%
				40 W. 57th Street, 25th Floor New York, NY 10019

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, and regulations of the SEC require our executive officers, directors and persons who beneficially own more than 10% of our common stock, as well as certain affiliates of those persons, to file initial reports of ownership and transaction reports covering any changes in ownership with the SEC and the New York Stock Exchange (“NYSE”). SEC regulations require these persons to furnish us with copies of all reports they file pursuant to Section 16(a).

Based solely upon a review of the copies of the reports received by us and on written representations of our directors and officers, we believe that during fiscal year 2008, all filing requirements applicable to executive officers and directors were complied with in a timely manner.

PROPOSAL ONE: ELECTION OF DIRECTORS

General Information

At the Meeting, our shareholders of record will elect 14 directors to serve on our Board for the ensuing year and until their successors are elected and qualified, which include our new Chief Executive Officer, Paul J. Bonavia, who joined UniSource Energy on January 1, 2009. The shares represented by executed proxies in the form provided, unless withheld, will be voted for the 14 nominees listed below, or, in the discretion of the persons acting as proxies, will be voted cumulatively for one or more of such nominees. All of the current nominees are present members of the Board. All of the nominees have consented to serve if elected. If any nominee becomes unavailable to serve for any reason, or a vacancy should occur before the election, it is the intention of the persons designated as proxies to vote, in their discretion, for other nominees.

BOARD NOMINEES

Paul J. Bonavia

Chairman of the Board, President and Chief Executive Officer of UniSource Energy since January 1, 2009; Chairman of the Board, President and Chief Executive Officer of Tucson Electric Power Company (“TEP”) , the principal subsidiary of UniSource Energy, since January 1, 2009; Chairman of the Board, President and Chief Executive Officer of UniSource Energy Services, Inc. (“UES”), a wholly-owned subsidiary of UniSource Energy, since January 1, 2009; former President of the Utilities Group of Xcel Energy, an electric and gas utility, from December 2005-December 2008; and former President of Commercial Enterprises of Xcel Energy from 2004 to December 2005. Board member since January 1, 2009. Age 57.

Lawrence J. Aldrich (2)(4)

President and Chief Executive Officer of University Physicians Healthcare, a healthcare organization, since January 2009; President of Aldrich Capital Company, an acquisition, management and consulting firm, since January 2007; Chief Operating Officer of The Critical Path Institute, a non-profit medical research company focusing in drug development, from January 2006 to December 2006; General Partner of Valley Ventures, LP, a venture capital company, from September 2002 to December 2005; Managing Director and Founder of Tucson Ventures, LLC, a venture capital company, from February 2000 to September 2002; Director of TEP and Millennium since 2000; and Director of UES since 2004. Board member since 2000. Age 56.

Barbara M. Baumann (1)(3)

President and Owner of Cross Creek Energy Corporation, a management consultant and investor company for oil and gas, since 2003; Director of St. Mary Land & Exploration since 2002; and Director of TEP since 2005. Board member since 2005. Age 53.

Larry W. Bickle (2)(3)

Retired private equity investor; Managing Director of Haddington Ventures, LLC, a private equity fund, from 1997 to 2007; Director of St. Mary Land & Exploration, an oil and gas production company, since 1995; Director of Millennium from 1998-2008; and Director of UES since 2004. Board member since 1998. Age 63.

Elizabeth T. Bilby (4)(5)

Retired President of Gourmet Products, Inc., an agricultural product marketing company; retired Director of Marketing of Green Valley Pecans, a pecan producer; Director of TEP since 1995; Director of Millennium from 1998-2008; and Director of UES since 2004. Board member since 1995. Age 69.

Harold W. Burlingame (2)(5)(6)

Former Executive Vice President of AT&T, a telecommunications company; Chairman of ORC Worldwide since December 2004; and Director of TEP since 1998. Board member since 1998. Age 68.

John L. Carter (1)(2)(3)(4)(5)(6)

Retired Executive Vice President and Chief Financial Officer of Burr Brown Corporation, a company that manufactured integrated circuits, in 1996; Director of Global Solar Energy since January 2007, Director of TEP since 1996; Director of Millennium from 1998-2008; Director of UES since 2004; and UniSource Energy Lead Director since 2005. Board member since 1996. Age 74.

Robert A. Elliott (3)(4)(6)

President and owner of The Elliott Accounting Group, an accounting firm, since 1983; Director and Corporate Secretary of Southern Arizona Community Bank since 1998; Television Analyst/Pre-game Show Co-host for Fox Sports Arizona, television broadcasting, since 1999; Chairman of the Board of Tucson Metropolitan Chamber of Commerce from 2002 to 2003; Treasurer of Tucson Urban League from 2002 to 2003; Chairman of the Board of Tucson Urban League from 2003 to 2004; Chairman of the Board of the Tucson Airport Authority from January 2006 to January 2007; and Director of TEP since May 2003. Board member since 2003. Age 53.

Daniel W. L. Fessler (1)(3)(6)

Professor Emeritus of the University of California; Of Counsel for the law firm of Holland & Knight from August 2003-January 2007; Partner in the law firm of LeBoeuf, Lamb, Greene & MacRae LLP from 1997 to 2003; previously served on the UniSource Energy and TEP boards of directors from 1998 to 2003; Managing Principal of Clear Energy Solutions, LLC since December 2004; and Director of TEP since 2005. Board member since 2005. Age 67.

Louise L. Francesconi (2)(4)

Retired President of Raytheon Missile Systems, a defense electronics corporation; Director of Stryker Corporation from July 2006, Director of Global Solar Energy from June 2008, Director of TEP since August 2008; and Director of UES since August 2008; Board member since August 2008. Age 56.

Warren Y. Jobe (1)(4)(6)

Certified Public Accountant (licensed, but not practicing); Senior Vice President of Southern Company, an electric service company, from 1998 to 2001; Director of WellPoint Health Networks, Inc. from 2001 to December 2004; Director of WellPoint, Inc. since December 2004; Trustee of RidgeWorth Funds since 2004; Director of TEP since 2001; and Director of Millennium from 2001 to 2003. Board member since 2001. Age 68.

Ramiro G. Peru (2)(4)

Executive Vice President and Chief Financial Officer of Swift Transportation, a trucking company, from June 2007 to December 2007, Executive Vice President and Chief Financial Officer of Phelps Dodge Corporation, a mining corporation, from 2004 to 2007; Director of WellPoint Health Networks, Inc. since 2003; Director of Southern Peru Copper Corporation from 2002 to 2004; and Director of University of Arizona Foundation since 2005. Board member since January 2008. Age 53.

Gregory A. Pivirotto (1)(3)

President and Chief Executive Officer and Director of University Medical Center Corporation, a hospital, since 1994; Certified Public Accountant since 1978; Director of Arizona Hospital & Healthcare Association from 1997 to 2005; and Director of Tucson Airport Authority since 2008; Board member since January 2008. Age 56.

Joaquin Ruiz (3)(5)

Professor of Geosciences, University of Arizona since 1983; Dean, College of Science, University of Arizona since 2000; Vice President of the Geological Society of America beginning in 2009; Associate Editor, “American Journal of Science” since 2005; Associate Editor, American Presidents Advisory Board of Research Corporation since 2005; Member, Human Resources Committee, American Geological Institute from 2000 to 2005 and 2009-2012; Member, Governing Board, Instituto Nacional de Astronomia, Optica y Electronica, Mexico since 2003; Board Member, Center to Improve Diversity in Earth Systems Sciences, Inc. since 2003; Member of Board of Earth Sciences, National Research Council of the National Academy of Sciences since 2005; TEP Board Member since 2005; and UES Board member since 2005. Board Member since 2005. Age 57.

The Board recommends that you vote “FOR” these nominees.

PROPOSAL TWO: RATIFICATION OF SELECTION OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

The Audit Committee has selected PricewaterhouseCoopers, LLP (“Pricewaterhouse”) as the Company’s Independent Registered Public Accounting Firm for the fiscal year 2009, and the Board is asking the shareholders to ratify that selection. Although current law, rules, and regulations, as well as the charter of the Audit Committee, require the Audit Committee to engage, retain, and supervise the Company’s Independent Registered Public Accounting Firm, the Board considers the selection of the Independent Registered Public Accounting Firm to be an important matter of shareholder concern and is submitting the selection of Pricewaterhouse for ratification by shareholders as a matter of good corporate practice.

Under Arizona law, if a quorum of shareholders is present at the Meeting, the ratification of the selection of PricewaterhouseCoopers as Independent Registered Public Accounting Firm for 2009 will require that the votes cast in favor of its ratification exceed the votes cast against its ratification. Abstentions and broker non-votes are counted for purposes of determining whether a quorum exists at the Meeting but are not counted and have no effect on the results of the vote for Independent Registered Public Accounting Firm.

The Board recommends that you vote “FOR” the ratification of the selection of the Independent Registered
Public Accounting Firm.

COMPENSATION DISCUSSION AND ANALYSIS

The following Compensation Discussion and Analysis contains statements regarding future individual and Company performance targets and goals. These targets and goals are disclosed in the limited context of UniSource Energy’s compensation programs and should not be understood to be statements of management’s estimates of results or other guidance. UniSource Energy specifically cautions investors not to apply these statements to other contexts.

EXECUTIVE SUMMARY

At UniSource Energy, our mission is to deliver safe, reliable service and value to customers and shareholders alike. Our strategy includes enhancing shareholder value, maintaining customer satisfaction, expanding our role in the community, meeting environmental challenges and providing for our employees’ development and well-being. We believe that our executive compensation program must align the interests of all our executive officers with this strategy to achieve our objectives.

UniSource Energy provides a balanced total compensation program that includes four components: base salary, short-term performance-based incentive, long-term performance-based incentive and other employee benefits.

In 2008, our continuing operations consisted mainly of the business conducted in three primary segments — TEP, UNS Gas, Inc., and UNS Electric, Inc. TEP, an electric utility, has provided electric service to the community of Tucson, Arizona, for more than 100 years. UNS Gas and UNS Electric provide natural gas and electric service in northern and southern Arizona. UNS Gas and UNS Electric are operating subsdiaries of UES, which was established in 2003 to oversee gas and electric properties acquired that year from Citizens Communications.

A significant part of our executive officers’ compensation is based on our success in achieving annual corporate goals. These goals are designed to align the interest of our executive officers and all non-bargaining unit employees with our Company’s strategy. The objectives of this incentive program and elements of compensation are discussed in detail below.

In 2008, our pursuit of these goals achieved mixed results. UniSource Energy demonstrated excellent performance relative to its cost containment, core business and customer service goals. The year was marked by a number of key accomplishments, including strong service reliability and customer service metrics and the approval of new rates for TEP and UNS Electric. However, two of the Company’s three financial goals were not met. UniSource Energy’s 2008 results were negatively impacted by higher fuel and purchased power expenses and other cost increases related to power plant maintenance and outages. Customer growth also slowed considerably at both TEP and UES compared to prior years and is expected to remain depressed through 2009 due to economic conditions.

In 2009, TEP will be operating under new rates approved in November 2008 by the Arizona Corporation Commission (“ACC”). The rates, which took effect in December 2008, represent a six-percent increase over the previous base rates and include a new Purchased Power and Fuel Adjustment Clause that will allow the utility to pass along changes in energy costs to customers.

The TEP rate order was the culmination of a multi-year effort led by James S. Pignatelli, who retired as Chairman, President and CEO of UniSource Energy at year’s end. He was succeeded by Paul J. Bonavia, whose appointment as Chairman, President and CEO was effective January 1, 2009.

The objectives of UniSource Energy’s executive compensation program and the elements of compensation are discussed in detail in the sections to follow.

COMPENSATION PHILOSOPHY

Objectives of the Compensation Program

We base our executive compensation policies and decisions with respect to our Named Executives on the achievement of the following objectives:

1.		Attracting, motivating and retaining highly-skilled executives;
2.		Linking the payment of compensation to the achievement of critical short- and long-term financial and strategic objectives, creation of shareholder value and provision of safe, reliable and economically available electric and gas service; and aligning performance objectives of management with those of other Company employees by using similar performance measures;
3.		Aligning the interests of management with those of our stakeholders and encouraging management to think and act like owners, taking into account the interests of the public that the Company serves;
4.		Maximizing the financial efficiency of the compensation program to avoid unnecessary tax, accounting and cash flow costs; and
5.		Encouraging management to achieve outstanding results through appropriate means by delivering compensation in a manner consistent with established and emerging corporate governance best practices.

In support of the above objectives, UniSource Energy provides a balanced total compensation program that consists of four components:

	•		base salary;
	•		short-term performance-based incentive compensation;
	•		long-term performance-based incentive compensation; and
	•		benefits and perquisites.

Decisions made regarding each component of pay are considered in the context of each officer’s total compensation. For example, if a decision is made to increase an executive’s base salary, the resultant impact on short- and long-term performance-based incentive compensation and total compensation levels are evaluated relative to competitive practice (see “Benchmarking” discussion below). We do not consider the value of outstanding equity awards in setting annual total compensation opportunities as we believe that outstanding equity awards represent compensation for past service.

Each of these components is described in more detail below and in the narrative and footnotes to the supporting tables. The following illustrates how the above objectives are reflected in our compensation program:

Attracting, Retaining and Motivating Executive Talent

In support of our objective to attract, retain and motivate highly-skilled employees, we provide our Named Executives with compensation packages that are competitive with those offered by other electric and gas service companies of comparable size and complexity and/or electric and gas service companies thought to be competitors for executive talent.

The Compensation Committee generally targets base salary and short-term incentive opportunities, as well as the allocation among those elements of compensation for the Named Executives, at the median market rates of selected comparable companies identified below under the “Benchmarking” section. Long-term incentive opportunities are targeted at the 75^th percentile of such market rates. Target compensation for individual executives range above or below those benchmarks based on a variety of factors, including each executive’s skill set and experience relative to the general market, the importance of the position to the Company and the difficulty of replacing the executive, and the executive’s past and expected future contribution to our success. Overall, total direct compensation for 2008 (i.e., salary, 2008 target PEP awards, and present value of 2008 long-term incentive awards) for the Named Executives fell between the median and 75^th percentile of market rates.

In addition to providing competitive direct compensation opportunities, the Company also provides certain indirect compensation and benefits programs that are intended to assist in attracting and retaining high quality executives. These programs include pension and retirement programs and are described in more detail below and in the narratives that accompany the tables that follow this Compensation Discussion and Analysis section.

Linking Compensation to Performance

Our compensation program seeks to link the actual compensation earned by our Named Executives to their performance and that of the Company. We achieve this goal primarily through two elements of our compensation package: (i) short-term cash awards and (ii) equity-based compensation. To ensure that the senior executives are held most accountable for achieving our financial, operational and strategic objectives and for creating shareholder value, we believe that the percentage of pay at risk should increase with the level of responsibility within the Company. The target amounts of performance-based pay programs (i.e., cash incentive and equity-based compensation) comprise approximately 55% to 65% of the total direct compensation opportunity for our Named Executives. Of the performance-based compensation, approximately 30-45% is short-term and 55-70% is long-term. Placing a greater emphasis on long-term performance-based compensation encourages executives to focus on the long-term impact of their actions. Non-variable compensation, such as salary and perquisites, is de-emphasized in the total compensation program to reinforce the linkage between compensation and performance.

Aligning the Interests of our Named Executive Officers with Stakeholders

Our compensation program also seeks to align the interests of our Named Executives with those of our key stakeholders, including customers, employees and shareholders. We use the short-term incentive compensation component to focus the Named Executives on the importance of providing safe and reliable customer service, creating a safe work environment for our employees and improving financial performance by linking a significant portion of their short-term cash incentive compensation to achievement of these objectives. We primarily rely on the equity compensation element of our compensation package to align the interests of the Named Executives with those of shareholders through a mix of stock options and stock awards that vest based on the achievement of performance goals set by the Compensation Committee. We also encourage senior executives to accumulate a substantial stake in the Company.

Maximizing the Financial Efficiency of the Program

In structuring the total compensation package for our Named Executives, the Compensation Committee evaluates the accounting cost, cash flow implications and tax deductibility of compensation to mitigate financial inefficiencies to the greatest extent possible. For instance, as part of this process, the Compensation Committee evaluates whether compensation costs are fixed or variable and places a heavier weighting on variable pay elements to calibrate expense with the achievement of operating performance objectives and delivery of value to shareholders. In addition, the Compensation Committee takes into account the objective of having the incentive-based compensation components qualify for tax deductibility under Section 162(m) of the Internal Revenue Code, as amended (the “Code”). See discussion under “Impact of Regulatory Requirements” on page 23. The Compensation Committee also considers the cash flow and share dilution implications of cash versus equity-based incentive plans.

Adhering to Corporate Governance Best Practices

The Compensation Committee seeks to continually update the executive officer compensation program to reflect corporate governance best practices. For example, the Compensation Committee has established formal stock ownership guidelines that encourage each Named Executive to accumulate a meaningful amount of Company stock. Additionally, equity-based awards contain a “double-trigger” vesting provision, which provides for accelerated vesting in the event of a future change in control only if the executive is adversely impacted by the transaction. See discussion under “Potential Payments Upon Termination or Change in Control”.

Benchmarking

The Compensation Committee considers the following factors for purposes of establishing salaries and variable compensation opportunities: (i) the competitive environment for Named Executives and what relevant competitors pay, and (ii) the need to provide each element of compensation and the amounts targeted and delivered.

To provide a foundation for the executive compensation program, UniSource Energy periodically benchmarks its named executive officers’ compensation levels and practices against a peer group of companies intended to represent our competitors for business and talent. The peer group, which is reviewed periodically, includes the 17 electric and gas utility companies named below that are comparable to UniSource Energy in terms of size as measured by annual revenues and market capitalization. Except as described below, this group is the same peer group for 2008 that was used in prior competitive analyses, with the exception of Otter Trail Power Company and Southern Union Co., which were omitted from the peer group for 2008 due to differences in business models, and with the exception of North Western Corp., Piedmont Natural Gas Co., Pinnacle West Capital Corp., and Portland General Electric Co., which were included for 2008 due to similarity of business models, similar size, or because they were thought to be a competitor for executive talent. A review of UniSource Energy’s executive compensation levels relative to the peer group was conducted in October 2008, and a review of aggregate long-term incentive cost and share usage practices relative to the peer group was last conducted in October 2007. UniSource Energy’s 2007 revenues were between the 25^th percentile and the median of the peer companies; market capitalization as of September 2008 was between the 25^th percentile and the median of the peer companies.

2008 Peer Group:

AGL Resources Inc.		DPL Inc.		North Western Corp.		Portland General Electric Co.
Avista Corp.		El Paso Electric Co.		Piedmont Natural Gas Co.		South Jersey Industries Inc.
CH Energy Group Inc.		IDACORP Inc.		Pinnacle West Capital Corp.		Southwest Gas Corp.
Cleco Corporation		Northwest Natural Gas Co.		PNM Resources Inc.		UIL Holdings Corp. Westar Energy Inc.

The benchmark information is supplemented annually with information from Frederic W. Cook and Co., Inc., the independent consultant retained by the Compensation Committee, relating to general market trends, changes in regulatory requirements related to executive compensation and emerging best practices in corporate governance. See discussion relating to compensation consultant under “Compensation Consultant” on page 43.

ELEMENTS OF COMPENSATION

Base Salary

Base salary is used to provide each Named Executive a set amount of money during the year with the expectation that he or she will perform his or her responsibilities to the best of his or her ability and in the best interests of our Company. We believe that competitive base salaries are necessary to attract and retain executive talent critical to achieving the Company’s business goals. In general, our Named Executives’ base salaries are targeted to the median of the peer group described above. However, individual salaries can and do vary from the benchmark median data based on such factors as individual performance, potential for future advancement, the importance of the executive’s position to the Company and the difficulty of replacement, current responsibilities, length of time in the current position, and, for recently hired executives, their prior compensation packages. Currently, all of our Named Executives’ salaries, other than the CEO’s, are within 10 percent of the benchmark median. For 2008, the CEO’s salary approximated the 75^th percentile in recognition of his leadership through the years, contributions to the growth of the Company, long tenure and strong performance.

Increases to Named Executives’ base salaries are considered annually by the Compensation Committee. In approving base pay increases for Named Executives other than the CEO, the Compensation Committee also considers recommendations made by the CEO.

In December 2008, the Compensation Committee approved base salary increases for the Named Executives (other than Mr. Pignatelli, who retired effective as of January 1, 2009), for 2009. The following table indicates the Named Executives’ base salaries for 2008 and 2009:

Name		2008 Base Pay				Approved 2009 Base Pay
James S. Pignatelli		$	726,000			Not applicable
Kevin P. Larson		$	316,000			$	327,000
Michael J. DeConcini		$	321,000			$	332,200
Raymond S. Heyman		$	316,000			$	327,000
Karen G. Kissinger		$	249,000			$	257,400

The salary increases for the Named Executives were consistent with salary increases as a percent of salary for other non-represented employees.

Short-Term Incentive Compensation (Cash Awards)

The Compensation Committee provides for short-term incentive compensation in the form of cash awards under the Performance Enhancement Plan (“PEP”) in order to link a significant portion of the Named Executives’ annual compensation to the Company’s annual financial and operational performance.

Each year, before the end of the first quarter, the Compensation Committee establishes performance objectives that must be met in whole or in part before the Company pays PEP awards. The Compensation Committee generally attempts to align the target opportunity for each Named Executive with the median rate for equivalent positions at the benchmark companies. In 2008, the target incentive opportunity for the Named Executives ranged from 40% to 80% of base salary, depending on position. As described more fully below, the actual amounts paid depend on the achievement of specified performance objectives, and could range from 50% of the target award upon achievement of threshold performance to 150% of the target award upon achievement of outstanding performance. The Compensation Committee has the discretion to increase, reduce or eliminate a PEP award regardless of whether the performance goals applicable to the Named Executive’s incentive award have been achieved.

Financial and Operating Performance Objectives-2008

The PEP performance targets and weighting are based on factors that are essential for the long-term success of the Company and are identical to the performance objectives used in the Company’s performance plan for non-represented employees. In 2008, the financial and operating objectives were diluted earnings per share (“EPS”), operating cash flow, cost containment (“O&M”) and customer service and core business goals relating to customer service, regulatory, reliability, project implementation and safety matters.

The measures and individual weightings for the 2008 PEP were selected by the Compensation Committee to ensure an appropriate focus on profitable growth, cash flow generation and expense control, as well as operational and customer service excellence. We think that this approach encourages all employees to work toward common goals that are in the interests of our various stakeholders including customers, employees and shareholders.

The Compensation Committee selected diluted EPS as a performance measure to work in tandem with the Company’s reporting metrics to the financial community. In 2008, 20% of the PEP award was based on attaining the diluted EPS targets, 20% of the PEP award was based on attaining operating cash flow targets, 20% was based on keeping O&M costs within a specified range, and the remaining 40% was based on the achievement of our customer service and core business goals. The cash flow target, which was not a performance measure in 2007, was selected in 2008 as a performance measure to focus employees on generating cash for the Company during 2008 and in future years.

In developing the PEP performance targets, the Chief Financial Officer (“CFO”) of the Company, with assistance from other personnel, compiles relevant data and makes recommendations to the Compensation Committee for a particular year, but the Compensation Committee ultimately determines the performance objectives that are adopted.

The 2008 quantitative performance objectives included:

2008 Performance Objectives		Threshold		Target		Outstanding
Diluted EPS		$1.70 per share		$1.95 per share		$2.20 per share
Operating Cash Flow		$280 million		$298 million		$315 million
O&M		$294 million		$289 million		$284 million

In addition, the 2008 customer service and core business goals included:

•

Averaging customer service response time at or below 3 minutes;

•

Volunteering community service of at least 38,000 hours by employees;

•

Completing specific departmental project goals;

•

Achieving various operational reliability goals; and

•

Maintaining OSHA incident rates at or below industry average and implementing a safety awareness program.

Short-Term Incentive Award to the CEO

Because the CEO’s total compensation could exceed $1 million, section 162(m) of the Internal Revenue Code (“Section 162(m)”) would deny the Company a tax deduction for the excess over $1 million, unless that excess compensation qualified as performance-based compensation. To comply with the performance-based compensation requirements, and also allow the Compensation Committee to retain some discretion to reduce the PEP award, if appropriate, the Compensation Committee used a different approach from that described above for the Named Executives and other employees, requiring two separate steps, to calculate the CEO’s short-term incentive award.

The first step involved the 2006 Omnibus Stock and Incentive Plan (the “2006 Omnibus Plan”), which permits payment of cash awards up to $2 million. For the CEO’s short-term incentive award to qualify as performance-based compensation, Section 162(m) requires that the award be payable solely upon the attainment of performance goals. If the performance goals are achieved, Section 162(m) would permit the Compensation Committee to pay the amount specified at the time of the award or to pay any lesser amount, but would not allow payment of any greater amount. For the CEO’s short-term incentive award, the Compensation Committee established a minimum attainment of cash from operations of at least $256 million for 2008, which, if achieved, would allow the Committee to pay the CEO the $2 million maximum permitted by the 2006 Omnibus Plan or any lesser amount; however, if the Company failed to achieve $256 million of cash from operations, the CEO would not be entitled to any short-term incentive award payment, regardless of the achievement of other PEP performance objectives as described above. In this respect, the CEO’s performance objective differed significantly from objectives set for the awards to the other Named Executives. The CEO’s award had an absolute minimum performance level that must have been achieved before the CEO received any payment, whereas if the Company failed to achieve the minimum performance on the operating cash flow objective set under the PEP, the other Named Executives could have still received a payment based on the attainment of the remaining performance objectives. Solely for purposes of this first step of determining the CEO’s short-term incentive award, the Committee felt it was appropriate to set the CEO’s operating cash flow performance objective slightly below the operating cash flow threshold used for the other Named Executives, because of the increased importance of the CEO’s operating cash flow target, the increased risk related to that target, and the desire to comply with the performance-based compensation requirement of Code Section 162(m).

The second step for determining the CEO’s short-term incentive award involved applying the PEP performance objectives and methodology. Once the Company achieved the minimum performance objective established pursuant to the 2006 Omnibus Plan for the CEO to receive any payment, the amount of the CEO’s payment, including whether the CEO received the minimum, target or maximum amount as a percentage of base salary, would be determined using the same PEP performance objectives and methodology as described above for the other Named Executives.

As described above, the range of actual payouts would in all cases be less than the maximum amount permitted by the 2006 Omnibus Plan and would satisfy the performance-based compensation requirements of Section 162(m). Using the PEP guidelines, the Compensation Committee determined that the CEO’s threshold, target and maximum annual incentive awards should be $290,400 (50% of his target award), $580,800 (100% of his target award and 80% of his base salary), and $871,200 (150% of his target award), respectively.

PEP Results

In 2008, the Company achieved $0.39 per share of diluted EPS, which was below the threshold level of performance of $1.70 per share. The Company achieved operating cash flow for 2008 of $277 million, which was also below the threshold level of performance of $280 million. In 2008, the Company achieved an O&M spending level for 2008 of $286.1 million, as shown in Table A below, which, because lower O&M spending represented better performance, was better than the target level of performance.

Table A, below, reflects the O&M cost containment goal, which ranged from $294 million (threshold) to $284 million (outstanding), and the corresponding payout levels, which ranged from 50% to 150% of the target award, as well as the O&M spending level achieved for 2008. O&M spending must have been less than $294 million to produce a payout; O&M spending in excess of $294 million would not have paid any amount for that performance target. According to the guidelines set by the Compensation Committee at the time of the award, which required interpolating on a straight-line basis, the achievement of the better than the target level of performance of the O&M spending target resulted in a payout level of 129% of the target amount for that factor.

Table A

Table B, below, reflects the performance on the customer service and core business goals, which ranged from earning 200 points (threshold) to 500 points (outstanding), and the corresponding payout levels, which ranged from 50% to 150% of the target award. A greater number of points earned from the achievement of each goal, resulted in a greater level of performance. As shown in the table below, during 2008 the Company achieved 490 points from the customer service and core business goals.

Table B

The Company had five major categories of customer service and core business goals: Customer Service (which is generally discussed above), Reliability (which pertains to the operational reliability of the generation, transmission and distribution systems), Project Implementation (which pertain to six specific key departmental goals), Safety (which are discussed above), and Regulatory (which pertain to rate cases and compliance with certain regulatory requirements by subsidiary companies, as discussed below). Each category of goals earned points; Regulatory was worth 250 points (50% of the total points possible), with the other categories worth 62.5 points each. Each category of goals contains several sub-goals that share the total points available in each category. Quantitative and qualitative goals are included, and points are accumulated based on achievement of each sub-goal.

In the Regulatory category, there were four sub-goals, which included: (i) obtaining a rate case settlement agreement with the ACC for TEP, one of our electric subsidiaries; (ii) filing and advancing a rate case with the ACC for our gas subsidiary; (iii) obtaining approval from the ACC for the Renewable Energy Standard Tariff implementation, which satisfies Arizona-specific regulations; and (iv) completion by UNS Electric, Inc., which is also one of our electric subsidiaries, of its rate case filed with the ACC.

All Regulatory goals were achieved in 2008, contributing 250 points to the core and customer service business goals. All Safety, Customer Service, Reliability, and five out of the six Project Implementation goals were achieved. In 2008, the Company earned a total of 490 points for the customer service and core business goals, which was close to an outstanding level of performance. According to the guidelines set by the Compensation Committee at the time of the award, which required interpolating on a straight-line basis, the achievement of the these goals resulted in a payout level of 146% of the target amount for that factor.

Overall, these results produced total weighted performance for 2008 of 84.3% of target performance.

The Compensation Committee agreed and approved a PEP payout of 84.3% of target awards for Named Executives other than Mr. Pignatelli.

Mr. Pignatelli was eligible for a payment on account of his annual incentive award because the Company exceeded the minimum threshold of $256 million operating cash flow necessary for him to receive a payment. Having confirmed that Mr. Pignatelli was eligible for a payment, the Compensation Committee used the methodology described above to determine that Mr. Pignatelli was entitled to receive a payment of $500,000, or 86.1% of his target award. This payment, as a percent of the target award, was slightly higher than the payments to other Named Executives and reflects Committee use of discretion to recognize Mr. Pignatelli’s leadership with respect to strategic initiatives and executive transition issues.

Long-Term Incentive Compensation (Equity Awards)

We believe that equity awards, in tandem with our executive stock ownership guidelines discussed below, encourage ownership of Company stock by executive officers and hold executive officers accountable for the long-term impact of their actions, which in turn aligns the interest of those officers with the interest of our shareholders. In addition, the vesting provisions applicable to the awards encourage a focus on long-term operating performance, link compensation expense to the achievement of multi-year financial results and help to retain executive officers.

The long-term incentive opportunity for each Named Executive is based on a multiple of salary. The current long-term incentive multiple, which is 100% of base salary for each Named Executive, was established in 2003 to retain the executives in light of a then pending merger. The value of the Named Executives’ long-term incentive multiples, which is generally consistent with the median to 75^th percentile of benchmark practice, has been maintained for the Named Executives to strengthen the retention value of the compensation program following the termination of the proposed merger transaction in 2004 and to avoid a reduction in Named Executives’ compensation, which would allow some of the Named Executives to terminate employment for “good reason” and receive change in control severance benefits. See “Elements of Post-Employment Compensation — Termination and Change in Control” for greater detail. While Mr. Heyman is not covered under a change in control agreement, the Compensation Committee set his long-term incentive opportunity at 100% of salary to advance internal pay equity with the other Named Executives with comparable responsibility levels. Mr. Pignatelli’s long-term incentive opportunity of 100% of salary is below the targeted 75^th percentile and his total direct compensation falls between the median and 75^th percentile.

In developing the long-term performance targets, the CFO of the Company compiles relevant data and makes recommendations to the Compensation Committee, but the Compensation Committee ultimately determines the performance objectives that are adopted for the applicable long-term plan.

For 2008, management recommended and the Compensation Committee approved long-term incentive awards consisting of equally weighted stock options and performance shares with earnout tied to total shareholder return (“TSR”). Given the difficulty in projecting the outcome of the TEP rate case, which occurred in 2008, and the unpredictable impact of the TEP rate case on diluted EPS, the Compensation Committee decided to use TSR as the performance metric for 2008, rather than cumulative diluted EPS. TSR was selected as the performance objective as it rewards executives for creating value in excess of a broad index of utilities. We believe that this long-term incentive approach consisting of stock options and TSR-based performance shares focuses the Named Executives on increasing both absolute and relative shareholder value creation. Moreover, stock option grants and performance share awards are intended to qualify as performance-based compensation under Section 162(m) of the Code, which is tax deductible by the Company.

Stock Option Grants

Options are designed, in part, to reward longer term success in Company performance that is reflected in increases in share price. The Company’s options, granted with an exercise price equal to the fair market value on the date of grant, help focus executives on long-term growth. In addition, options are intended to help retain key employees because they become exercisable in one-third increments over a three year period. The three-year incremental vesting also keeps executives focused on long-term performance.

Performance Share Awards

Performance shares are designed, in part, to reward achievement of financial performance objectives and/or shareholder value objectives.

2008 Program

The 2008 performance share awards are tied to TSR, relative to the Edison Electric Institute index, over a three-year performance period, commencing in 2008 and ending in 2010. The 2008 performance share criteria were established at the beginning of 2008 and are set forth in the following table.

PERFORMANCE CRITERIA
TSR Percentile Rank		Payout as a Percent of Target Award
75th percentile and above			150	%
60th percentile – 74th percentile			125	%
50th percentile – 59th percentile			100	%
40th percentile – 49th percentile			75	%
35th percentile – 39th percentile			50	%
Below 35th percentile			0	%

2006 Program

The 2006 performance share awards were tied to the achievement of Basic EPS (defined as EPS applied to undiluted outstanding shares), and operating cash flow goals over the 2006-2008 performance period.

The cumulative Basic EPS for the 2006-2008 performance period was $3.96 per share, which is less than threshold, and resulted in no payment on the Basic EPS goal. The cumulative operating cash flow was $882.3 million and resulted in a 33% operating cash flow payout. See the “Outstanding Equity Awards Table” on pages 29-31 for the number and market value of unearned share awards for each of the Named Executives.

Table C, below, reflects the cumulative Basic EPS goal, which ranged from $5.80 per share (threshold) to $6.38 per share (outstanding), and the corresponding payout levels, which ranged from 25% to 75% of the target award. As noted above, the cumulative Basic EPS for the three year period comprising 2006-2008 was less than the threshold level, as shown on the table below; therefore, there was no payout on the Basic EPS goal.

Table C

Table D, below, reflects the operating cash flows goals, which ranged from $879.6 million (threshold) to $901.1 million (outstanding), and the corresponding payout levels which ranged from 25% to 75% of the target award. As shown on the table below, the Company achieved a cumulative operating cash flows level of $882.3 million, which resulted in a payout level of 33% of the target amount for that factor.

Table D

The targets and goals discussed above are disclosed in the limited context of UniSource Energy’s compensation programs and should not be understood to be statements of management’s estimates of results or other guidance. UniSource Energy specifically cautions investors not to apply these statements to other contexts.

Equity Grant Timing and Practice

Generally, during the first quarter following the close of a fiscal year, the Compensation Committee approves the long-term incentive awards to be granted for the upcoming year, including the type of equity to be granted, as well as the size of the awards for Named Executives. In determining the type and aggregate size of awards to be provided, as well as the performance metrics that will apply, the Compensation Committee considers the strategic goals of the Company, trends in corporate governance, accounting impact, tax deductibility, cash flow considerations, the impact on EPS and the number of shares that would be required to be allocated for the award and the resulting impact to shareholders. When the Compensation Committee approves grants of plan-based equity awards, the exercise price is set at the market closing price of UniSource Energy common stock on the date that the grant is made. Awards are not coordinated with the release of material non-public information.

In addition, the Company does not typically provide for off-cycle stock option grants and has no specific number of shares under the 2006 Omnibus Plan set aside for such grants. However, occasionally in connection with a new hire of an executive, such a grant may be made to the extent approved by the Compensation Committee. The exercise price of any off-cycle option granted to a newly hired executive will be the closing market price on the date that the Compensation Committee approves any such award, consistent with the pricing practices associated with on-cycle plan-based equity awards.

STOCK OWNERSHIP POLICY

To further support our objective of aligning management and shareholder interests, the Company maintains a formal stock ownership policy, which encourages all officers to accumulate a substantial ownership stake in Company shares. The policy has the following key features:

•

Participants are encouraged to accumulate Company shares with a target value of a multiple of their base salary, ranging from one times base salary for Vice Presidents, three times for senior Vice Presidents and five times for our CEO.

•

If a participant has not yet reached the applicable target ownership requirement, he or she is expected to retain a portion of the net after-tax shares acquired from any stock option exercise, vesting of restricted stock or payments related to the performance share program. The applicable retention rates are 100% for the CEO, 50% for Named Executives who are senior Vice Presidents and 25% for the other Vice Presidents.

•

Unexercised stock options, unvested stock options and unearned performance shares do not count towards meeting the ownership guidelines.

Annually, management provides a report to the Compensation Committee regarding the number and value of the shares held by each officer subject to the guidelines. As of December 31, 2008, all of the Named Executives who were hired before 2005, including the CEO, have achieved their target ownership level. Raymond S. Heyman, who was hired after 2005, is making progress toward meeting the guideline.

OTHER COMPENSATION

Perquisites

The Company provides Named Executives with limited personal benefits and perquisites. These are not tied to any formal individual or Company performance criteria but are intended to enhance the attraction and overall retention value of the executive compensation program and to be comparable to similar benefits provided to executives and other key personnel in other similar companies in the industry. As a benefit, the Company from time to time reimburses certain executives for business or similar social club initiation fees and periodic special assessments. The Company also reimburses executives for the travel expenses of their spouses incurred in connection with the annual Board strategic retreat. The Company also has a policy of either directly paying or reimbursing certain executives for certain of their relocation costs, since this is a common benefit offered in the market and an additional means of attracting executives. None of our Named Executives benefited from the relocation policy during 2008. For identification of specific perquisites and associated values, refer to the “Summary Compensation Table” on page 25.

Retirement Benefits

Our Named Executives are also eligible to participate in certain employee benefits plans and arrangements offered by the Company. These include the Tucson Electric Power Company 401(k) Plan, the Tucson Electric Power Company Salaried Employees Retirement Plan (the “Retirement Plan”), the Tucson Electric Power Company Excess Benefit Plan (the “Excess Benefit Plan”) and the Management and Directors Deferred Compensation Plan (the “DCP”). A description of the pension and other retirement plans is provided under “Elements of Post-Employment Compensation-Retirement and Other Benefits,” below.

ELEMENTS OF POST-EMPLOYMENT COMPENSATION

Termination and Change in Control

In 1998, TEP, a wholly owned subsidiary of the Company, entered into Change in Control Agreements (“Change in Control Agreements” or “Agreements”) with all of the then Named Executives to help keep them focused on their work responsibilities during the uncertainty that accompanies a change in control, to provide benefits for a period of time following certain terminations of employment after a change in control event or transaction and to help us attract and retain key personnel. Some of these Agreements remain in effect until 2010. See discussion preceding the “Potential Payments Upon Termination or Change in Control Table” on page 34.

Retirement and Other Benefits

Benefits Generally

The Company offers retirement and other core benefits to its employees, including executive officers, in order to provide them with a reasonable level of financial support in the event of illness or injury and to enhance productivity and job satisfaction. The benefits are the same for all employees and executive officers and include medical and dental coverage, disability insurance and life insurance. In addition, the Tucson Electric Power Company 401(k) Plan and the Retirement Plan provide a reasonable level of retirement income reflecting employees’ careers with the Company. All employees, including executive officers, participate in these plans; the cost of these benefits (other than the Retirement Plan) is partially borne by the employee, including each executive officer. To the extent that any officer’s retirement benefit exceeds Internal Revenue Service (“IRS”) limits for amounts that can be paid through a qualified plan, the Company also offers non-qualified retirement plans, including the Excess Benefit Plan and the DCP. These plans provide only the difference between the calculated benefits and the IRS limits. Benefits under the Excess Benefit Plan are provided to officers but, with limited exceptions, are not generally available to other employees. These benefits are not tied to any formal individual or Company performance criteria but are intended to enhance the attraction and retention value of the executive compensation program and are consistent with similar competitive compensation benefits made available to executives in the industry. We believe the DCP assists with our attraction and retention objectives since it provides an industry-competitive and tax-efficient benefit to our executives. The DCP is not funded by the Company and participants have an unsecured contractual commitment by the Company to pay amounts owed under the DCP. For more information on retirement and certain related benefits, see the discussion following the “Pension Benefits Table” on page 33 and the “Non-Qualified Deferred Compensation Table” on page 34.

IMPACT OF REGULATORY REQUIREMENTS

Under Section 162(m) of the Code, compensation paid to the CEO and to certain other most highly compensated executives in excess of $1,000,000 annually is not deductible for federal income tax purposes unless the compensation is awarded under a performance-based plan approved by the shareholders, and satisfies certain other requirements. To the extent that the Company complies with the performance-based compensation provision of Section 162(m), the awards granted to the CEO and other Named Executives are tax deductible by the Company. The Company believes that all executive compensation earned in 2008 will be tax deductible.

The Compensation Committee believes that it is in the best interest of the Company to receive maximum tax deductibility for compensation paid to the Company’s Named Executives, although to maintain flexibility in compensating Named Executives in a manner designed to promote varying corporate goals, the Compensation Committee may award compensation that is not fully deductible under certain circumstances. The Company’s compensation plans reflect the Compensation Committee’s intent and general practice to pay compensation that the Company can deduct for purposes of federal income tax. Executive compensation decisions, however, are multifaceted. The Compensation Committee reserves the right to pay amounts that are not tax deductible to meet the design goals of our executive compensation program.

The Compensation Committee also considers other financial implications when developing and implementing the Company’s compensation program, including accounting costs, cash flow impact and potential share dilution.

COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

The Compensation Committee has reviewed and discussed with management the “Compensation Discussion and Analysis” section required by Item 402(b) of SEC Regulation S-K and contained in this Proxy Statement. Based on such review and discussions, the Compensation Committee recommended to the Board that the “Compensation Discussion and Analysis” section be included in the Company’s annual report on Form 10-K for the year ended December 31, 2008 and the 2009 Proxy Statement.

		Respectfully submitted,
				THE COMPENSATION COMMITTEE
				Harold W. Burlingame, Chair
				Lawrence J. Aldrich
				Larry W. Bickle
				John L. Carter
				Louise L. Francesconi
				Ramiro G. Peru

SUMMARY COMPENSATION TABLE—2008

The following table sets forth summary compensation information for the years ended December 31, 2006, December 31, 2007, and December 31, 2008 for our CEO, our CFO and three other most highly compensated Named Executives:

																						Change in
																						Pension
																						Value and
																		Non-				Non-
																		Equity				Qualified
																		Incentive				Deferred
																		Plan				Compen-				All Other
										Stock				Option				Compen-				sation				Compen-
Name and		Year				Salary				Awards				Awards				sation				Earnings				sation				Total
Principal Position		($)				($)				($)(1)				($)(2)				($)(3)				($)(4)				($)(5)				($)
James S. Pignatelli			2008				724,689				98,305				348,790				500,000				793,548				13,532				2,478,864
Chairman, President and			2007				694,438				97,755				319,336				791,000				0				262,236				2,164,765
Chief Executive Officer			2006				666,923				95,476				339,742				867,500				210,550				17,646				2,197,837
Kevin P. Larson			2008				315,499				46,397				137,107				132,700				28,912				14,366				854,981
Senior Vice President and			2007				299,814				62,731				85,372				237,632				0				49,237				734,786
Chief Financial Officer			2006				288,462				41,317				32,671				259,184				74,313				15,352				711,299
Michael J. DeConcini			2008				320,112				46,910				137,776				134,800				161,064				15,485				816,147
Senior Vice President and			2007				300,178				62,731				85,372				243,608				0				74,960				766,849
Chief Operating Officer,			2006				288,462				41,317				32,671				265,196				38,573				14,768				680,987
Transmission and Distribution
Raymond S. Heyman			2008				319,949				46,397				224,702				132,700				159,468				14,408				897,624
Senior Vice President and			2007				304,077				62,731				208,484				146,000				43,651				14,183				779,126
General Counsel			2006				288,462				41,317				155,783				167,000				65,352				14,020				731,934
Karen G. Kissinger			2008				248,493				36,536				124,994				83,700				205,525				11,182				710,430
Vice President, Controller and			2007				236,731				49,647				67,598				179,648				0				13,011				546,635
Chief Compliance Officer

						Qualified
						Plan 401(k)				Non-Qualified Plan
						Matching				401(k) Matching								Spouse
						Contributions				Contributions				Club Memberships				Travel				Total
Name		Year				($)				($)				($)				($)				($)
James S. Pignatelli			2008				10,350				0				1,080				2,102				13,532
Kevin P. Larson			2008				10,350				3,840				0				176				14,366
Michael J. DeConcini			2008				10,350				4,055				1,080				0				15,485
Raymond S. Heyman			2008				10,350				4,047				0				11				14,408
Karen G. Kissinger			2008				10,350				832				0				0				11,182

The “Club Memberships” and “Spouse Travel” columns include the incremental cost to the Company of such benefits. Spouse travel costs, which may include airfare and meals for the Named Executives’ spouses for the annual Board retreat, and other company-related travel.

Effective January 1, 2009, Mr. Bonavia became Chairman of the Board, President and Chief Executive Officer of UniSource Energy, TEP and UES. Since Mr. Bonavia was not with the Company in 2008, he is not included as a “Named Executive” in this proxy statement. Mr. Bonavia’s initial annual base salary will be $600,000. Mr. Bonavia will participate in UniSource Energy’s annual cash incentive compensation program with a target award for 2009 of 80% of base salary and a maximum award equal to 120% of base salary, and will participate in the 2006 Omnibus Plan as well. Mr. Bonavia will be entitled to severance pay of 200% of his base salary, plus pro rata incentive compensation, if his employment is terminated by UniSource Energy without cause or if he terminates his employment for good reason within three years of his employment. Mr Bonavia will be entitled to a severance payment of 200% of the sum of base salary and bonus, plus pro rata incentive compensation, if UniSource Energy terminates his employment without cause or if he terminates employment for good reason within 24 months of a change in control.

GRANTS OF PLAN-BASED AWARDS—2008

The following table sets forth information regarding plan-based awards to our Named Executives in 2008. The compensation plans under which the grants in the following table were made are generally described in the “Compensation Discussion and Analysis” section, beginning on page 12 and include the UniSource Energy PEP, which provides for non-equity (cash) performance awards, and the 2006 Omnibus Plan, which provides for equity-based performance awards including stock options and performance shares.

All Other

Option

Awards:

Exercise

Estimated Possible Payouts

Estimated Future Payouts

Number of

or Base

Under Non-Equity Incentive Plan

Under Equity Incentive Plan

Securities

Price of

Grant Date

Awards (1)

Awards (2)

Under-

Option

Fair Value of

Thresh-

Maxi-

Thresh-

Maxi-

lying

Awards

Stock and

Grant

old

Target

mum

old

Target

mum

Options

($/Sh)

Option

Name

Date

($)

($)

($)

(#)

(#)

(#)

(#)(3)

(4)

Awards ($)(5)

JAMES S. PIGNATELLI

PEP

2/27/2008

290,400

580,800

871,200

Performance Share

2/27/2008

6,680

13,360

20,040

349,765

Stock Options

2/27/2008

82,470

26.18

349,768

KEVIN P. LARSON

PEP

2/27/2008

79,000

158,000

237,000

Performance Share

2/27/2008

2,905

5,810

8,715

152,106

Stock Options

2/27/2008

35,890

26.18

152,215

MICHAEL J. DECONCINI

PEP

2/27/2008

80,300

160,500

240,800

Performance Share

2/27/2008

2,950

5,900

8,850

154,462

Stock Options

2/27/2008

36,460

26.18

154,633

All Other

Option

Awards:

Exercise

Estimated Possible Payments

Estimated Possible Payments

Number of

or Base

Under Non-Equity Incentive Plan

Under Equity Incentive Plan

Securities

Price of

Grant Date

Awards (1)

Awards (2)

Under-

Option

Fair Value of

Thresh-

Maxi-

Thresh-

Maxi-

lying

Awards

Stock and

Grant

old

Target

mum

old

Target

mum

Options

($/Sh)

Option

Name

Date

($)(1)

($)

($)

(#)

(#)

(#)

(#)(3)

(4)

Awards ($)(5)

RAYMOND S. HEYMAN

PEP

2/27/2008

79,000

158,000

237,000

Performance Share

2/27/2008

2,905

5,810

8,715

152,106

Stock Options

2/27/2008

35,890

26.18

152,215

KAREN G. KISSINGER

PEP

2/27/2008

49,800

99,600

149,400

Performance Share

2/27/2008

2,290

4,580

6,870

119,904

Stock Options

2/27/2008

28,280

26.18

119,940