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BKH > SEC Filings for BKH > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for BLACK HILLS CORP /SD/



Annual Report




We are an integrated energy company operating principally in the United States with two major business groups - Utilities and Non-regulated Energy. We report our business groups in the following financial segments:

Business Group       Financial Segment

Utilities            Electric Utilities
                     Gas Utilities

Non-regulated Energy Power Generation
Coal Mining
Oil and Gas

Overview: We are a customer-focused integrated energy company. Our focus on customers - whether they are utility customers or non-regulated energy customers
- provides opportunities to expand our business by constructing additional rate base assets to serve our utility customers and expanding our non-regulated energy holdings to provide additional products and services to our wholesale customers.
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The diversity of our energy operations reduces reliance on any single business segment to achieve our strategic objectives. Our emphasis on our utility business with diverse geography and fuel mix, combined with a conservative approach to our non-regulated energy operations, mitigates our overall corporate risk and enhances our ability to earn stronger returns for shareholders over the long-term. Our long-term strategy focuses on growing both our utility and non-regulated energy businesses, primarily by increasing our customer base and providing superior service to both utility and non-regulated energy customers.

Our objective is to be best-in-class relative to certain operational performance metrics, such as safety, availability, reliability, efficiency, customer service and cost management. Our notable operational performance metrics for 2013 include:

Our power generation fleet achieved 1st Quartile Reliability ranking with less than 65 minutes (SAIDI) in 2013 compared to industry averages^^ (^^2012 Edison Electric Institute, less than 83.96 minutes and IEEE, less than 93 minutes);

Our JD Power Customer Satisfaction Survey indicated our Electric and Gas Utilities were favorable to our peers in the Midwest;

Our power generation fleet achieved a forced outage factor of 2.5 percent for coal-fired plants and 1.3 percent for natural gas plants in 2013, compared to an industry average* of 7 percent and 5 percent, respectively (*NERC GADS 2012 data);

Our natural gas generation fleet achieved a starting reliability of 99 percent in 2013 while the industry averaged** approximately 97 percent (**IEEE Data Base 2012);

Our power generation fleet availability was 97 percent for coal-fired plants, 97 percent for gas-fired plants, 97 percent for diesel-fired plants and 99 percent for wind generation in 2013 while the industry averages^ were 86 percent, 92 percent, 94 percent and 96 percent, respectively (^NERC Data Base, 2012 most recent industry information);

Our safety record is exemplary with a TCIR rate of 1.7 compared to an industry average of 2.8* for TCIR and a DART rate of 0.9 compared to an industry average of 1.4+ for DART (+ Most recent industry averages are 2012);

Our OSHA TCIR rate during construction of our generating facilities is also significantly better than industry average with a TCIR rate of 2 during the construction of the Wygen III coal-fired plant compared to an industry average of 5.1 for coal-fired plants, 1.3 during the construction of the Pueblo Airport Generating Station natural-gas fired plant compared to an industry average of 4.4 for natural-gas fired plants, and 0 during construction of the Busch Ranch wind farm compared to an industry average of 4.4 for wind construction. Our Cheyenne Prairie construction TCIR rate is currently on track to be below industry average;

Our coal mine completed three years with favorable MSHA safety results compared to other mines located in the Powder River Basin and received an award from the State of Wyoming for three years without a lost time accident.

The electric utility industry is facing requirements to upgrade aging infrastructure, deploy smart grid technology and comply with new state and federal environmental regulations and renewable portfolio standards. Increased energy efficiency, new smart grid technologies and changes in the economy, however, suppress demand in many areas of the United States. These competing considerations will present a challenge to energy companies trying to balance capital spending requirements while obtaining satisfactory rate recovery on this capital spending.

State regulatory commissions have become more conservative regarding authorized returns and other regulatory mechanisms for cost recovery due to the general state of the economy and concerns that utility rate increases may cause further harm to local economies. The average awarded return on equity for investor-owned utilities over the past year has been averaging around 10 percent, and the average regulatory lag is less than 12 months, according to the Edison Electric Institute. Falling interest rates account for much of the trend in lower rates of return, along with actions by state commissions to moderate rate increases during a period of financial hardship.

In our natural gas and electric utilities, we will continue to work with regulators in our existing service territories to ensure we meet our obligations to serve projected customer demand and to comply with environmental mandates through expansion of infrastructure and construction of new rate-based power generation facilities needed to provide safe, reliable energy. By maintaining our high customer service and reliability standards in a cost-efficient manner, our goal is to secure appropriate rate recovery to provide fair economic returns on our utility investments.

The proliferation of domestic natural gas production from shale plays in recent years provides the domestic market an abundant new supply of natural gas, and has reduced prevailing natural gas prices. This trend is likely to continue. Therefore, we will continue to prudently grow and develop our existing inventory of crude oil and natural gas reserves, while we strive to maintain strong relationships with mineral owners, landowners and regulatory authorities. We intend to focus our near-term efforts on proving up the substantial Mancos shale gas potential of our San Juan and Piceance Basin properties. Given increased regulatory emphasis on wind and solar power resources, and environmental regulations and legislation that will limit construction of new coal-fired power plants, we believe that natural gas will be the near-term fuel of choice for power generation. Additional gas-fired peaking resources will also be required to provide critical back-up supplies for renewable technologies.

Currently approximately 40 percent of electricity generated in the United States is from coal-fired power plants. It will take decades and significant expense before this generation can be replaced with alternative technologies. As a result, coal-fired resources will remain a necessary component of the nation's electric supply for the foreseeable future. The current regulatory climate, combined with the EPA's proposed and expected GHG regulations, will likely limit construction of new conventional coal-fired power plants, but technologies such as carbon capture and sequestration should provide for the long-term economic use of coal. We have investigated and will continue to investigate the possible deployment of these technologies at our mine site in Wyoming and will continue efforts to develop additional markets for our coal production.

We have expertise in permitting, constructing and operating power generation facilities. These skills, combined with our understanding of electric resource planning and regulatory procedures, provide a significant opportunity for us to add long-term shareholder value. We intend to grow our non-regulated power generation business by continuing to focus on long-term contractual relationships with our affiliates and other load-serving utilities.

Key Elements of our Business Strategy

Provide stable long-term rates for customers and increase earnings by efficiently planning, constructing and operating rate-base power generation facilities needed to serve our electric utilities. Our Company began as a vertically-integrated electric utility. This business model remains a core strength and strategy today, as we invest in and operate efficient power generation resources to cost effectively transmit and distribute electricity to our customers. We provide power at reasonable rates to our customers, and earn competitive returns for our investors.

We have a competitive power production strategy. Our access to coal and natural gas reserves allows us to be competitive as a power generator. Low production costs can result from a variety of factors, including low fuel costs, efficiency in converting fuel into energy, and low per unit operation and maintenance costs. We leverage our mine-mouth coal-fired generating capacity which strengthens our position as a low-cost producer by eliminating fuel transportation costs which often represent the largest component of the delivered cost of coal for many other utilities. In addition, we typically operate our plants with high levels of availability, compared to industry benchmarks. We aggressively manage each of these factors with the goal of achieving low production costs.

Rate-base generation assets offer several advantages including:

Customers - since the generating assets are included in the utility rate base and reviewed and approved by government authorities, customer rates are more stable than if the power was purchased from the open market through wholesale contracts that are renegotiated over time;

Regulators - regulators participate in a planning process where long-term investments are designed to match long-term energy demand;

Investors - investors are poised that a long-term, reasonable, stable rate of return may be earned on their investment;

All - a lower risk profile may improve credit ratings which, in turn, can benefit both consumers and investors by lowering our cost of capital.

Our actions to provide power at reasonable rates to our customers are exemplified in our successful request to secure the construction financing riders in Wyoming and South Dakota during the construction of Cheyenne Prairie. These riders will reduce the total cost of the plant ultimately passed along to our customers while we construct this plant to accommodate growth and replace plants that were closed prematurely due to environmental regulations.

Expand utility operations through selective acquisitions of electric and gas utilities consistent with our regional focus and strategic advantages. For more than 130 years we have provided reliable utility services, delivering quality and value to our customers. Our tradition of accomplishment supports efforts to expand our utility operations into other markets, most likely in areas that permit us to take advantage of our intrinsic competitive advantages, such as baseload power generation, system reliability, superior customer service, community involvement and a relationship-based approach to regulatory matters. Utility operations also enhance other important business development opportunities, including gas transmission pipelines and storage infrastructure, which could promote other non-regulated energy operations. Utility operations can contribute substantially to the stability of our long-term cash flows, earnings and dividend policy.

We have and will continue to pursue the purchase of small, private or municipal natural gas distribution systems, which can be easily integrated into our operations. We purchased several small systems in Kansas and Iowa in the past three years, and recently announced the acquisition of another in Wyoming. We have a scalable platform of systems and processes, which simplifies the integration of potential future utility acquisitions. Merger and acquisition activity has continued in the utility industry. We believe that impacts of the recent recession may produce opportunities for healthy utility companies to acquire utility assets and operations of other companies on reasonable terms and conditions. We expect to consider such opportunities if they advance our long-term strategy and maximize shareholder value.

Build and maintain strong relationships with wholesale power customers of both our utilities and non-regulated power generation business. We strive to build strong relationships with other utilities, municipalities and wholesale customers. We believe we will continue to be a primary provider of electricity to wholesale utility customers, which will continue to need products, such as capacity, in order to reliably serve their customers. By providing these products under long-term contracts, we help our customers meet their energy needs. Through this approach, we also believe we can earn more stable revenues and greater returns over the long term than we could by selling energy into more volatile spot markets. In addition, relationships that we have established with wholesale power customers have developed into other opportunities. MEAN, MDU and the City of Gillette, Wyo. were wholesale power customers that are now joint owners in two of our power plants, Wygen I and Wygen III.

Proactively integrate alternative and renewable energy into our utility energy supply while mitigating and remaining mindful of customer rate impacts. The energy and utility industries face tremendous uncertainty related to the potential impact of legislation and regulation intended to reduce GHG emissions and increase the use of renewable and other alternative energy sources. To date, many states have enacted and others are considering some form of mandatory renewable energy standard, requiring utilities to meet certain thresholds of renewable energy use. Additionally, many states have either enacted or are considering legislation setting GHG emissions reduction targets. Federal legislation for both renewable energy standards and GHG emission reductions is also under consideration.

Mandates for the use of renewable energy or the reduction of GHG emissions will likely produce substantial increases in the prices for electricity and natural gas. At the same time, as a regulated utility we are responsible for providing safe, reasonably priced, reliable sources of energy to our customers. As a result, we employ a customer-centered strategy for complying with renewable energy standards and GHG emission reductions that balances our customers' rate concerns with environmental considerations and administrative and legislative mandates. We attempt to strike this balance by prudently and proactively incorporating renewable energy into our resource supply, while seeking to minimize the magnitude and frequency of rate increases for our utility customers.

Colorado legislative mandates apply to our electric utility segment regarding the use of renewable energy. Therefore, we pursue cost-effective initiatives with the regulators that will allow us to meet our renewable energy requirements. Where permitted, we will seek to construct renewable generation resources as rate base assets, which will help mitigate the long-term customer rate impact of adding renewable energy supplies. For example, the Busch Ranch Wind site, a 29 megawatt wind turbine project, was completed in the fourth quarter of 2012, as part of our plan to meet Colorado's Renewable Energy Standard. This site also has significant expansion potential;

In states such as South Dakota and Wyoming that currently have no legislative mandate on the use of renewable energy, we have proactively integrated cost-effective renewable energy into our generation supply based upon our expectation that there will be mandatory renewable energy standards in the future. For example, under two 20-year PPAs we purchase a total of 60 megawatts of wind energy from wind farms located near Cheyenne, Wyo. for use at Black Hills Power and Cheyenne Light; and

In all states in which we conduct electric utility operations, we are exploring other potential biomass, solar and wind energy projects, particularly wind generation sites located near our utility service territories.

Increase the value of our oil and gas properties by prudently growing our reserves and increasing our production of natural gas and crude oil. Our strategy is to cost-effectively grow our reserves and increase our production of natural gas and crude oil through both organic growth and acquisitions. While consistent growth remains our objective, we emphasize managing for value creation over managing for growth as follows:

Through detailed reservoir analysis, apply proven technologies to our existing assets to maximize value;

Participate in a limited number of selective and meaningful exploration prospects;

Primarily focus on the Rocky Mountain region, where we can more easily integrate new opportunities with our existing crude oil and natural gas operations as well as our power generation activities. Specifically, we intend to focus our near term efforts on fully developing the substantial shale gas potential of our San Juan and Piceance Basin properties, and participating in select oil exploration prospects with substantial upside opportunities;

Support the future capital requirements of our drilling program by stabilizing cash flows with a hedging program that mitigates commodity price risk for a portion of our established production for up to three years in the future; and

Enhance our crude oil and natural gas production activities with the construction or acquisition of mid-stream gathering, compression and treating facilities in a manner that maximizes the economic value of our operations.

Selectively grow our non-regulated power generation business in targeted regional markets by developing assets and selling most of the capacity and energy production through mid- and long-term contracts primarily to load-serving utilities. While much of our recent power plant development has been for our regulated utilities, we intend to continue to expand our non-regulated power generation business by developing and operating power plants in regional markets based on prevailing supply and demand fundamentals, in a manner that complements our existing fuel assets and marketing capabilities. We intend to grow this business through the development of new power generation facilities and disciplined acquisitions primarily in the western region, where we believe our detailed knowledge of market and electric transmission fundamentals provides us a competitive advantage and, consequently, increases our ability to earn attractive returns. We expect to prioritize small-scale facilities that serve incremental growth or provide critical back up to renewable resources, and are typically easier to permit and construct than large-scale generation projects.

Most of the energy and capacity from our non-regulated power facilities is sold under mid- and long-term contracts. When possible, we structure long-term contracts as tolling arrangements, whereby the contract counterparty assumes the fuel risk. Going forward, we will continue to focus on selling a majority of our non-regulated capacity and energy primarily to load-serving utilities under long-term agreements that have been reviewed or approved by state utility commissions. An example of this strategy is the 200 megawatts of combined-cycle gas-fired generation constructed by our non-regulated power generation subsidiary to serve our Colorado Electric utility subsidiary. The plant commenced operations on Jan. 1, 2012, under a 20-year tolling agreement.

Diligently manage the credit, price and operational risks inherent in buying and selling energy commodities. All of our operations require effective management of counterparty credit risk. We mitigate this risk by conducting business with a diverse group of creditworthy counterparties. In certain cases where creditworthiness merits security, we require prepayment, secured letters of credit or other forms of financial collateral. We establish counterparty credit limits and employ continuous credit monitoring, with regular review of compliance under our credit policy by our Executive Risk Committee. Our oil and gas and power generation operations require effective management of price and operational risks related to adverse changes in commodity prices and the volatility and liquidity of the commodity markets. To mitigate these risks, we implemented risk management policies and procedures. Our oversight committees monitor compliance with these policies.

Maintain an investment grade credit rating and ready access to debt and equity capital markets. Access to capital has been and will continue to be critical to our success. We have demonstrated our ability to access the debt and equity markets, resulting in sufficient liquidity and solid cash flows. We will require access to the capital markets to fund our planned capital investments or, when possible, to make strategic acquisitions that prudently grow our businesses. Our access to adequate and cost-effective financing depends upon our ability to maintain our investment-grade issuer credit rating.

Moody's, S&P and Fitch each upgraded our corporate credit rating during 2013, which helped us obtain financing for $525 million in debt at favorable terms.

Prospective Information

We expect to generate long-term growth through the expansion of integrated and diverse energy operations. Sustained growth requires continued capital deployment. Our diversified energy portfolio with an emphasis on regulated utilities provides growth opportunities, yet avoids concentrating business risk. We expect much of our growth in the next few years will come from major capital investments at our existing business segments. During 2013, we refinanced much of our highest cost debt on favorable terms. Although dependent on market conditions, we are confident in our ability to obtain additional financing, as necessary, to continue our growth plans. We remain focused on prudently managing our operations and maintaining our overall liquidity to meet our operating, capital and financing needs, as well as executing our long-term strategic plan.

Utilities Group

Electric Utilities

During 2013, Black Hills Power and Cheyenne Light commenced construction on the new 132 megawatt Cheyenne Prairie generating facility located in Cheyenne, Wyo. and construction is on schedule for commercial operations in the fourth quarter of 2014. Black Hills Power also received approval for increased rates effective June 16, 2013. Preparation continued for the retirement of Ben French, Osage and Neil Simpson I on March 21, 2014, while Colorado Electric retired W.N. Clark and Pueblo Units 5 and 6 on Dec. 31, 2013.

Pursuant to prior approved resource plans and pending electric rate increase requests, the Electric Utilities engaged in the following regulatory requests related to construction activities:

Similar to the construction financing rider approved by the WPSC effective Nov. 1, 2012, for Cheyenne Light and Black Hills Power to earn and collect a rate of return during the construction period on the portion of the financing costs related to serving Wyoming customers, the SDPUC approved a construction financing rider for Black Hills Power's South Dakota customers effective April 1, 2013. On Dec. 2, 2013, Cheyenne Light filed a rate case with the WPSC requesting electric and natural gas revenue increases of $13 million and $1.3 million, respectively, to recover the construction of Cheyenne Prairie and an increase in operating costs. Black Hills Power filed a rate case on Jan. 17, 2014, with the WPSC requesting an electric revenue increase of $2.8 million to recover investment in Cheyenne Prairie, existing infrastructure and increasing operating costs. During the first quarter of 2014, Black Hills Power also intends to file a rate case in South Dakota to recover its investment in Cheyenne Prairie.

On April 30, 2013, Colorado Electric filed a revised Electric Resource Plan with the CPUC addressing its projected resource requirements through 2019 and seeking to develop and own replacement capacity for the retirement of the coal-fired W.N. Clark power plant to comply with Colorado Clean Air - Clean Jobs Act. On Jan. 6, 2014, the CPUC issued its initial written decision approving a settlement with Colorado Electric on this resource plan, which included the approval to construct a 40 megawatt gas-fired combustion turbine to replace the retirement of the W.N. Clark power plant and to retire the aging natural gas-fired steam turbines, Pueblo Units #5 and #6. A final written order from the CPUC is expected in the first quarter of 2014.

On Oct. 16, 2013, the CPUC denied Colorado Electric's application for approval of a wind solicitation for the acquisition of up to 30 megawatts of wind energy for its electric system. This solicitation and related requests for proposal were reviewed by an independent evaluator who verified that our Power Generation segment's bid was the lowest cost to customers. The CPUC found that the calculated customer benefits over the 20 year evaluation period were insufficient for all of the bids and stated its preference to consider renewable energy needs in Colorado Electric's Electric Resource Plan hearings held in November 2013. The settlement approved by the CPUC on Jan. 6, 2014, denied any additional wind generation at this time, but indicated that the acquisition of eligible energy resources would be considered in the 2015 to 2017 renewable energy plan to be filed in May 2014.

In October 2013, the City of Rapid City, S.D., experienced the second most severe blizzard in history which left most Black Hills Power customers experiencing power outages. Repairing the substantial and widespread damage far exceeded average annual storm-related costs and in December 2013, Black Hills Power submitted an application to the SDPUC for approval to defer the incremental costs of approximately $2.5 million, including labor, materials and supplies, equipment and outside contractors that were incurred in the efforts to restore power to its customers. In January 2014, approval was received and these costs are included in Regulatory assets until the next rate case filing.

Similar to the Gas Utilities discussed below, Cheyenne Light's gas utility will look for opportunities to purchase local gas distribution systems and infrastructure. In January 2014, Cheyenne Light announced the pending acquisition of assets serving approximately 400 customers.

Gas Utilities

Weather returned to more normal patterns in the beginning of 2013 but ended colder than normal. Our Gas Utilities continued their focus on investment in our gas distribution network and related technology such as advanced metering infrastructure and mobile data terminals. We continually monitor our investments and costs of operations in all states to determine when additional rate cases or other rate filings will be necessary. As part of our growth strategy, we continue to look for opportunities to purchase municipal and privately-owned gas infrastructure and distribution systems. We acquired five small gas systems during 2013 with a total of approximately 900 customers.

Non-regulated Energy Group

Power Generation

In 2013, Black Hills Wyoming completed the early redemption of high cost project financing along with the settlement of the related interest rate swaps, which . . .

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