With the recent sale of most of its independent generating plants and the acquisition of utility power systems in four western states, Rapid City, SD-based Black Hills Corp. is placing increased emphasis on holding rate-based assets as its riskier plays in the oil/gas exploration and production (E&P) sector lose emphasis. This was the gist of remarks by Black Hills CEO Dave Emery Tuesday during a second quarter earnings conference call with financial analysts.

“We continue to believe that utility-owned, rate-based generation provides the best long-term rates for customers,” he said. “The ownership of the utility plant in rate base is a benefit for customers; they gain the value of the plants as the plants depreciate over time and add rate stability for them. We believe firmly in the vertically integrated utility model.”

Nevertheless, Emery also said the company’s strategy will continue to seek a “balance” between utility and merchant operating units. Following the closing of the merchant plants sale and the purchase of the utility units, Black Hills will hold another conference call in mid-September to outline its revised earnings guidance for the rest of this year and 2009.

While reporting earnings overall that were down for both the second quarter and six-month periods compared to last year, profits were up for its utilities and for its E&P operations. However, for the third straight quarter production continued to decline, the company said. For the second quarter net income was $22.2 million (58 cents/share) compared to $25.1 million (66 cents) for the same period in 2007.

The utilities delivered a “strong performance,” Emery said. Oil and gas earnings increased 64%, but production was 9% lower, and E&P capital expenditures for the year were reduced by $30 million to about $65 million, he said.

While noting that the integration of the Aquila utilities in four states (Colorado, Montana, South Dakota and Montana) was going very well, Emery made it clear that Black Hills is betting its future on growing its utility business and that includes needing to expand utility rate-based holdings in Colorado where its assets acquired from Aquila depend mostly on power purchase deals that expire the end of 2011. Emery outlined what Black Hills has filed with Colorado regulators as its integrated resource plan.

“The Colorado electric utility has a very unusual situation in that its power purchases [with Xcel Energy] expire at the end of 2011, and literally it will be faced with replacing about 75% of its energy supply on one day beginning Jan. 1, 2012,” said Emery, noting that the Colorado Public Utilities Commission (PUC) is aware of the situation and is reviewing Black Hills’ plan to provide replacement resources.

Black Hills no longer is looking at adding baseload coal-fired generation, Emery said. Instead it is focused on developing 350 MW of natural gas-fired generation, but not necessarily in one facility; it could develop as many as three separate facilities, collectively adding up to 350 MW. It also is committed to developing about 60 MW of wind-generated power and another four or five MW of solar power.

“Under the rules in Colorado on renewable portfolio standards and the governor’s executive orders on greenhouse gas reduction targets, coal is not currently a viable option,” Emery said. “The situation could possibly change in the future, but for now, to meet the immediate needs of our customers [in 2012] we are pursuing gas-fired and renewable generation, adding that to the existing gas- and coal-fired generation that the utility holds today.

“We must go through the planning and the regulatory process at the PUC in Colorado to demonstrate that our plan is in the best interests of our customers. We intend to do just that.”

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