Black Hills Corp (BKH) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Black Hills quarterly earnings conference call. At this time all participants are in a listen-only mode, later we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Mr. Dale Jahr, Director of Investor Relations, please, go ahead.

Thank you for joining us, and welcome to our conference call. I remind the audience that this conference call may include forward-looking statements as defined by the SEC, these statements concern our plans, expectations and objectives for future operations. Such statements are based on what we believe are reasonable assumptions, and based on current expectations of industry and economic conditions and other factors. However, risks and uncertainties could cause results to differ materially from those in forward-looking statements. I refer you to the cautionary language published in our press release, and other public disclosures.

Our decision of recent results will be led by Mr. Mark Thies, our Executive Vice President and CFO. Mark would like to start off with a review of recent results before we open the call to your questions. Mark?

Thank you, Dale. Good morning everyone, and thank you for joining Black Hills Corporation's third quarter earnings call. In the third quarter, we did report net income of $17.1 million or 52 cents a share, compared to $22.4 million or 69-cent a share last year. From continuing operations, we reported $17.3 million or 53 cents per share, compared to $17.7 million or 54-cent per share in the prior year. This does represent a return to historical levels of earnings, which, we haven't been at for the past several quarters.

Our third quarter was impacted by a few items, unusual items, not unusual, weather in the electric utility was down. Degree days were down 37% from the prior year, and our utility was down approximately 3 cents per share. Our energy marketing operations also recorded a slight decline from last year, primarily due to mark-to-market losses. It's an accounting for mark-to-market transactions of $1.9 million this year, compared to a slight positive in the year before, which resulted in approximately a 3 cent per share decline.

Our going down by segments. Just a brief review of our segments. Our energy operations, energy marketing operations, were down slightly, .7 million or 2 cents a share, and again, primarily due to the mark-to-market. We did have an increase in our volumes marketed, and coincident with that, margins from that business, but the mark-to-market pulled us down. Our oil and gas operations were flat for the year as average prices were slightly higher, but we had a slight decline in our overall production, as well as a slight increase, or increase, in our lease operating expenses at our oil and gas unit. Our coal mine did increase slightly. Over the year, we did have a benefit from a settlement with Pacific Corp., one of our -- our largest coal customer, and that resulted in about a $.6 million benefit to Black Hills. And power generation earnings from continuing operations were flat with the prior years.

From, a statistics perspective, we had a slight decline year-over-year in our tons of coal sold, 4% at 1.2 million, and we're about flat with last year on year-to-date basis. Our oil and gas production was slightly down at 1%. We do expect that to improve as we have a very aggressive and ongoing drilling and completion program throughout our oil and gas company, primarily at our Black Hills Gas Resources, that is formerly Mallon Resources field in New Mexico. In addition, as I mentioned, our energy marketing volumes were up sharply, albeit at low margins, but we did, we are able to deliver gas to customers, and we continue to be able to demonstrate our ability to do that.

In our electric utility, again, our earnings were down $.9 million or 3 cents a share. Really, that represents our ability through wholesale off system sales which increased significantly 64% in the third quarter, because of our ability to arbitrage a system, buy power in the east or the west and sell to the other, we were able to offset some of the loss, or some of the decline, relative to the milder weather in our electric utility. As you see, we had a 6% decline in fern(ph) sales, and those are generally our higher margin customers, our local retail sales, and that declined 6%, but we were able to partially offset that with wholesale off-system sales. Our communications business was relatively flat with the prior year, we had a slight decline in residential customers, but we did have an increase in business customers, and we had a relatively flat year, or quarter, versus last year's quarter in our communications business.

A few items relative to the balance sheet. We have increased our natural gas storage volumes, that is one area where we are able to make margins, and we have increased that to approximately $100 million. We expect that cash to return in the fourth quarter of this year, as well as the first and second quarter, primarily the first quarter, but into the second quarter of next year, as we've hedged summer gas over and selling that gas out forward in the winter.

We do have approximately $80 million of cash on our balance sheet, and our debt to capitalization is 51% of total capitalization. Now, that does include, as reported in our 10-Q which was filed yesterday, $45 million of utility bonds, that call was affective on October 21. So, in the fourth quarter, you will see that that number is where we are at. That is reported in our current maturities, the $45 million of utility bonds, that was a 8.3% coupon. So, we do expect a slight savings on interest in the fourth quarter and then going forward.

We would like to now open up the call to any questions.

(Operator instructions) One moment please for your first question. First question today is from the line of Michael Worms with Harris Nesbitt. Please, go ahead.

Good morning, Mark and Dale. How are you doing?

Good.

Couple of questions. Maybe you can help us understand a little bit better the oil and gas business. It seems to me based on the numbers that production was essentially flat with last year. We expected higher production, I think, after the second quarter you were suggesting that production in the second and half of the year would actually double over the 6 million that was produced in the first half of the year. That doesn't seem to be in the numbers at this point. And, with prices up pretty sharply, oil up 16%, gas up 31%, and expenses only up 10%. I am just trying to understand why income is essentially flat, and why production isn't higher? Can you give us more color on all of this?

Yes. There is number of questions in there, Mike, and I will try to address all of them. I don't know if they'll be in any particular order, if I miss, please, please, you know reask. But, with respect to production, we didn't say double. We did say up to 50% increase. We continue to have a very active drilling and completion program. We have a number of wells drilled in there, and various stages of completion to get those wells on line. The reserves are still there, and our employees are working very hard to get the production on line. We did not see that in the third quarter. We do continue to expect to see increased production as we go forward. With respect to the prices received, again, we have hedged our production, and you see, generally, our hedges go from April to October and then November to March. And when we put those earlier hedges in, we had hedged, you know, the north end, we always take 25 to 50% of gas, and we hedge a significant amount of our oil. So, those prices were locked in. So, the current market prices, you don't necessarily see reflected in the third quarter results. We do expect improvement in prices as we move forward as, again, a seasonal hedging expectation in October, our summer hedges will fall off, and we will have our winter hedges on, which, given the forward, the current prices, we would expect to see some improvement in our prices received and the fourth and the first quarter of next year. With respect to our lease operating expenses, or our expenses from oil and gas, again, as we are doing a significant amount of work to get those reserves on, we do have an increase in the quarter, and once that production comes on line, we expect to return to normal levels of operating expenses, compared to our production levels.

Thank you. But, you bought Mallon, and, I guess, you closed on Mallon last year in March.

Correct.

And, giving you the benefit of the doubt that you weren't up and cranking production at the full extent in the third quarter of last year, but, now owning it for well over a year and a half, we would have expected to see better production in the third quarter of '04 versus the third quarter of '03 when you probably weren't doing very much at Mallon. I am still a little confused as to why we are not seeing better production?

Well, again, in the, as we mentioned in the first quarter and the second quarter of this year, we spent a tremendous amount of time on the pipeline and the compression issues, which we resolved by the end of the second quarter, or largely resolved by the end of the second quarter, and then the focus turned to drilling and continuing to expand production. So, really, all we replaced was our normal decline curve in the third quarter, so, we did, you know, those wells generally decline and we did replace the normal decline in the wells, but they are long life properties. Approximately nine to 10 years, on an average life. So, you would expect under that to have approximately, you know, a 10% decline, and we did cover it largely cover that on the gas side. As you notice in the queue our oil production was down, our gas was slightly up in our total production numbers, but on an overall bases we were down. So, the focus has been drilling, and we have been actively working in that field and working to hook those wells up. Once we get those wells hooked up, we believe we will see a typical increase in our production. And we continue to expect that, but we focused a lot of time in the first part of this year, as well as most of last year, working in that field to get it to our standards, and we spent a lot of time with that. Now we are focused this year, and really starting in the summer, spring and summer, on both the compression and the pipeline, as well as an active drilling program, that just continues.

Just moving on to earnings for a moment. The, based on your guidance, which hasn't changed for 2004, it is going to require a fairly strong fourth quarter to meet, even, the low ends of your range. Now, I know there is a positive swing factor in this year's fourth quarter, because you didn't have revenue coming in from the Las Vegas plant last year. But, can you remind us -- give us an idea of how much Las Vegas hurt fourth quarter earnings last year, and how much of that will, you know, I know it won't be all back because of the new contracts at a lower economic rate. But, still, can you give us some idea of what the negative impact of Las Vegas was in the fourth quarter last year?

Well, Mike, as opposed to trying to compare to the fourth quarter of last year, really, looking more towards, you know, what changes versus the third quarter. We just recorded 53 cents from continuing operations in the third quarter, and what changes from that in the fourth quarter can we expect that would help us increase, because, to get, your exactly correct, to get to our, the low end of our guidance we need approximately 58 cents a share in the fourth quarter, and we just reported 53 cents a share. And, a few items that we expect that will effect that is, again, you know, with our increase, we do expect increased production in the fourth quarter ,as well as higher prices received as our winter hedges for two months of the year, November and December, pick up. So, we do expect improvement in our oil and gas operations. Again, historically, energy marketing operations, they're just the seasonality of their earning stream is largely fourth and first quarters are the strongest quarters for energy marketing, and second and third are the weaker quarter for energy marketing, so, we would expect an improvement in the energy marketing business to move forward and assist us in attaining the lower end of the guidance. Our utility business had a, had a weaker third quarter than normal, but, third and fourth quarter and first quarter are historically our strongest quarters in our electric utility business, with the second quarter being the weakest quarter historically. So, we do expect, still, a reasonably strong quarter from our electric utility. A improved quarter from, versus the third quarter of this year from our oil and gas operations and our energy marketing operations, which we would expect would provide us the opportunity to get the 58 cents a share, and attain the low end of our guidance.

Thank you. That's helpful. One last question on '05. I think your guidance is conservative. You suggested in the past that you are taking a very conservative view on commodity prices going forward. But, that was several months ago. Now, commodity prices seem to be even higher, the forward gas curve is in the 7.5, 7.75 range. I am wondering if you might be relooking at that?

We continue to evaluate the expectations of our results, but our guidance is the $1.85 to $2. That was based on the July forward pricing in oil and gas, so to the extent there is improvement there. If it was significant, and as we report quarters, you know, we will report that as we move forward, but we don't want to just change our guidance every time the price moves in the commodity markets. You know, if we end up being slightly conservative then we'll report positive results, but prices are volatile and can change. So, yes, at this time, prices have improved, and the outlook relative to commodity prices appears to be beneficial. But, we don't expect to change our guidance at this point.

Thank you, Mark.

Thank you, Mike.

We have a question from the line of Mike Weinstein with Zimmer Lucas Partners.

I was wondering if you could just go into a little more detail about what's going on with Mallon, the progress being made, the drilling program? You know, at this point, are you on schedule, or are you a little bit behind schedule, in order to meet the 50% increase by the end of the year?

I would say we are behind schedule. I don't believe, I mean, that is going to be very challenging in what we said in the -- we said up to 50%. That would have been, had we shown, you know, strong improvement in the third quarter, as well as then continued improvement into the fourth quarter. We do believe we will be able to demonstrate improvement versus the first six months. Still, it just is not -- we don't believe that it will be at the higher end, because the third quarter, again, was relatively flat with the prior year. From that perspective, if you look at it from that perspective, we believe we are slightly behind schedule. But, we do have a number of wells that are in various stages, number of them drilled, and various stages of drilling, as well as having completion rigs to get those wells hooked up. The gas is still there, it's just a matter of getting it above -- out of the well and into the pipelines and for sales. So, yes, relative to that, on the high end, if we look toward the 50%, we believe we will be behind that. But, we do expect to show some improvement over the first six months still, with an improvement in the fourth quarter's production.

And what kinds of things are causing the behind schedule situation? Is that, is it physical problem with equipment, some of the compression problems that you had talked about last quarter, or is it more of a regulation problem? In other words, you know, tribal requirements that are being, you know, that are preventing you from hooking up at this point? What kind of problems are you facing?

I think it's normal operations, we are running a number of completion rigs, and a drilling rig, and we continue to work that field very, very ambitiously. It is not a delay, relative to regulatory issues, or tribal concerns, at all. In fact, we spent a lot of time, I failed to mention that earlier in my discussion, you know the other time was filling up the pipeline of drilling permits, as you have to start them, we have a number of permits in various stages of approval, and we believe that that has been resolved, and we continue to get permits coming out the back end, and ability to drill wells as putting in new requests for drilling permits in that process. But, it is just the operational impacts of getting all of the completion rigs to complete the wells and get them hooked up to pipeline. We have had some delay there, but we do expect -- those are normal operating delays. They happen to come on the heels of spending a lot of time with compression and a lot of time with the pipeline. But, we are continuing to actively work that field, and we believe that the results will improve in the fourth quarter as well as going forward.

This is Craig Lucas, I just wanted to ask an additional question about that. Are you getting the gas out of the ground, but you are having problems transporting it?

No, it is completing the wells to get it out of the ground.

It is not the hooking up and transporting, it is --

No. No. It's, you drilled the well, you are laying the pipe, and you're getting the well completed so you can hook it up. It is just taking some additional time. That is generally in the 30 to 40 day range of time to complete a well. They are not deep wells, 3,000 feet to 5,000 feet with multiple pay zones, but it is evaluating, once we get it drilled, get the completion rig in, and get that well hooked up. It's just taking time. There is not a pipeline issue or a compression issue. We believe we've resolved those largely in the second quarter and early into the third quarter of this year.

But, I apologize. Because my lack of knowledge about it. I am just trying, what is preventing the gas from coming out of the ground?

Well, it is getting the completion of the well. You drill it, and then you have to complete the well to get it hooked up to the pipeline, and that just takes time, and we have had some delays, not extraordinary delays, just some delays in getting that done.

Thank you, very much for explaining it to me.

The next line is Paul Patterson with (inaudible) Associates.

Just, get a little bit more clarity on this, what are you guys actually now expecting for production in 2005?

In 2005?

Yes.

Well, we would expect to, when we historically and going forward, we expect a 10 to 15% increase in production. Relative to oil and gas, I assume you are speaking?

That's right. I mean, so when --

When we post our year-end numbers, then for '05 we would expect a 10 to 15% increase in production.

That is off what kind of base, Mcfe base that you are expecting for '04?

Again, we had approximately 9 million Mcf equivalent, in the --

In the nine month.

year to date in the nine months, we do expect some improvement in the fourth quarter relative to that, relative to the 3 million we had in the third quarter, 3.1 million Mcf equivalent sales, we would expect some improvement in that, and then that would be our base in which we look forward.

Okay. Now, when you are looking at the, some hedges are rolling off and you are putting some on. What are we looking at in terms of the amount that is hedged for '05? What percentage? And, do you have a rough approximation of what the hedged price is now?

We began, and we do this based on actual, you know, current production. We don't hedge anticipated production. What we've historically said is 25 to 50% of our gas is hedged. We leave some of our gas open, primarily because we have a plant in Las Vegas, Las Vegas 1, a small 51 megawatt plant that has a gas sales, an open gas sales, that we use our internal production to hedge the plant as an internal hedge, but , generally we are in the 25 to 50% range of gas sales, and we continue to put those on. That's different, just looking at the forward strips last year to this year, you can estimate what the price is. We don't disclose our specific hedges and prices.

You don't? Okay. So, okay. Then, just, I noticed that your reserves are updated, and that year-to-date activity you guys had a 47 -- about $48 a barrel and at 517 Mcf. And, I guess what I am trying to figure out here, is that just the basis differential that you are encountering there? Or, because it seems like it's a little bit of a lower price there particularly for the gas. Is that causing it for the September period?

Yes. We take it back to the well head and the well head received price when we do our reserve study. So, that is an estimate at September 30, a point in time of what that price was. You can't look to today's price going forward. It an estimate of that price at the time, and we do take a basis differential back to the well head. Now, we do expect to have, again, as always, our independent engineers have a report at year-end. These are based on our internal estimates, and we will get that verified through our independent engineers at year-end.

Is that increase in reserves basically caused because of the higher price of the commodity, or is it because of the drilling activity? I would assume it's probably some combination there of.

Yes. It's a combination of both. You do have, not to go into tremendous detail for the callers, but, you do have an economic recoverability that, at higher prices certain wells may have economic recoverability, so, they are included in our reserve study. But, also due to our drilling program, and as we complete wells that allows for locations nearby that, or adjacent to that, to be included as reserves.

Sure.

Based on the engineering studies. And, I am not an engineer. But based on those studies we can do that. So, it's a combination of both.

Can you give me an idea about how much is a result of the drilling activity, versus or acquisition, what ever activity, versus how much is the result of prices have gone up?

I don't have that information.

Okay.

To say specifically what the different components are. We will have, again, in our 10K a very detailed disclosure of our reserves and the changes in our reserves. That will be verified by our independent engineer.

Then also, what is the impact of this Pacific Corp. Wyoming settlement going forward? Is there any impact that we should expect?

No, there is no impact going forward.

Okay. Thanks, a lot.

Thank you.

We have a question on the line of James Bellessa from D.A. Davidson & Company.

You have been asked several questions about production and I would like to continue on those questions. The statement at the end of the second quarter, when you had your conference call last time, you indicated that maybe second half production might be up as much as 50%. You have indicated that that is now unlikely. Would you be surprised that second half production would be up less than 25%?

I don't know that we are, that, you know, we do expect to have improvement in production, the specific, trying to put a specific amount out there, we do expect improved production, a lot of that is dependent on getting the completion rigs and getting our wells hooked up. So, at this point, you know, I would prefer not to really try to give another target out there. We do expect improvement in the fourth quarter over the third quarter in our production. To put a specific target out there, you know, again, when we had those wells, if you had that production in the third quarter, we would get it both third and fourth quarter. So, we've missed that. I don't know that it's particularly linear, in that, had we improved production in the third quarter, we would have had that production for all of the fourth quarter. So, it would be greater than 25% in third quarter, and 25% increase in fourth quarter.

If the fourth quarter is going to be the base line from which we anticipate the future, approximately, what level of Mcf equivalents might you be at? Will you be at 3.5? Will you be at 4? Will you be at 4.5 million? And then from that base, you are saying we are going to be able to see your company grow at 10% annualized?

Correct and that's a range, you know, again, the specific production is going to depend on the timing of the completion of those wells, but, yes, in the 3.5 to 4.5 range for the fourth quarter, we do expect some improvement in the fourth quarter. That is a broad range, I know. But, a lot of it depends on the timing of completion of our wells and getting them hooked up to the pipeline. And, then, that is the basis for which we would expect to grow our production going forward.

Changing subjects, Cheyenne Light Fuel and Power, you are going to be closing on that transaction you think by the end of the year, how much you financed that transaction?

Well, we would use internal resources to do that. You know, the transaction, yes, we do expect to, we do expect to close that by the end of the year, and we are assuming approximately $25 million of debt, that is on their books, and the rest we would expect to pay with internal resources. Either cash on the balance sheet, or possibly, a slight increase indebtedness that we would cover with cash flow as we move forward, depending on the timing of our acquisition and our cash flows.

Are you able to give us a range as to what the total transaction value will be?

Again, we've historically said we are buying it at book value. And, their assets were approximately 85 to $90 million. That's what their historical was. You know, we do have to look at what minor changes they may have made to capital deployment through the year to continue to maintain their distribution system. But, you know, we would expect it would be in that range on a total -- total dollars, and then, again, we are assuming some indebtedness, so our cash requirement would be less that.

Let's just suppose it is 85, and you assume 25 million in bonds, or debt that they have in their balance sheet. You would need $60 million.

Correct.

After you take out the $45 million that you just paid down some debts with, you are down to 30, $35 million of cash.

Well, we do generate cash flow every quarter, as well, from our normal operations. And that is, you know, that will assist us, as well as, we expect to, over the course of the fourth quarter, as well as the first quarter, turn some of our storage gas into cash, as we have those items forward sold, primarily. So, we would expect some cash to come in, relative to our storage gas that we have. Again, it is a timing issue, the timing of that turning into cash, you know, fourth quarter or first quarter, versus closing by the end of the year. So, there may be a short term increase in some short term borrowings, but we'd expect that storage gas to turn to cash, and have sufficient cash to pay for that transaction.

Did you say earlier that the storage gas position was roughly $100 million?

Correct.

Now back to Cheyenne transaction. You think you're able to finance it temporarily through internal resources and the assumption of debt? Longer term, what are your plans?

Well, again, we would have the cash, once we turn the storage numbers, and again, that is a timing issue. Any amount of short term debt we would need to do, we would expect to be able to pay off upon the storage gas, and then, again, we continue to generate operating cash flow that we wouldn't expect to have to finance that transaction other than through normal operating cash flow. No, we don't expect any additional long term indebtedness other than what we are assuming.

Thank you very much.

Thank you, Jim.

We have a question from the line from John Hanson with Imperial.

I have a few on oil and gas. I think that we've pretty well gone through most of those, but the one area I would like to explore a little bit is costs. What are you seeing in terms of the market for getting rigs in, and the cost of those things? Are you seeing some pressure on that because of the activity out that way?

Well, that is why we had our increase in our. -- I mean, we did, identify, we did have an increase in cost. It just wasn't offset by the reserves being produced, but we are seeing some additional cost relative to rigs and, drilling rigs and completion rigs, as well as all the work we are doing in that field to improve it. Again, it's a very ambitious program. Once we get that production to levels we expect, we believe our costs will be in line with market norms for producing gas out of that area. But, it's a timing issue. And, you do incur the costs as you're going through those processes.

Okay. Shifting over, as I look at the rest of the business, for '05, and try to kind of run through how we might build it up. There are a few things that I saw here. I want to get some information on. One is, you mentioned in the past, the outage on the big fossil unit. That's still in the plans for next year?

At this point, yes, it is.

What are the current components of, do you have anything on the cost of that outage in terms of, or an overall effect on the power business, the coal business, or anything along those lines that we can kind of factor in as we look at our numbers for next year.

That plant is our largest coal customer. It is on site, and it is our largest coal customer, I believe we've historically disclosed what we had in sales to the Wyodak Plant, or (inaudible) plant, so, you know, assume -- the timing is generally a six week outage, give or take a week or two, on the long end. You can't, generally, get it done shorter. So, it is six to eight weeks of total outage time. That would affect our coal sales, it also effects our utility from the availability of that power, and our fossil plants are some of our cheapest sources of power. That is dependent on what the market prices are to purchase power, to the extent we need it, and, historically, that is when you have strong hydro prices and were able to purchase power at a cheaper rate. That did not occur in 2003, as gas came on the margin, so we saw our costs at our utility go up to purchase power. But, we do expect to have normal pricing with a normal hydro year next year that we wouldn't see that.

Have you lined up replacement power for that outage yet?

We don't forward purchase, because, again, we have to make sure that we know it is going to occur.

Okay.

And we do expect it to occur, but if it didn't occur then we'd have a forward purchase that would be speculative, and also expect normal conditions in hydro. We continue to monitor that, and as we see go through the winter, we will have a better idea of where we expect the hydro market to be, and then the forward power market, and if we determine, as we get closer, that it makes some sense to buy some, to purchase some replacement power, we will evaluate that.

Okay. There were a couple of items that were in Q3 with regard to tax items in the coal business. Those are not recurring items, of what 400,000 and a 600,000 benefit?

Well the income tax reserve, it is an annual look at what we have, relative to our reserves for income taxes, and that can change annually up or down, relative to that. But the settlement is an one time, you know, that was a settlement of issues on coal taxes, so, that would be one time. The other one, you know, can occur, it can go either way.

Okay. And lastly, on the -- also some notes about the fact that the -- what the harbor facility and Gillette gas turbine, didn't have as much in the way of revenues here this quarter. Is that something that you see as kind of the norm going forward, or is that kind of an anomaly for this quarter?

Well the harbor facility it's really relative to last year. This year, we had a contract in 2003 with the California (indiscernible), I believe that had some incremental revenues that we were carrying into the California market in 2003. We did not have that contract in 2004. Everything else we would expect from 2004 to 2005 we would expect to be consistent. Our contracts go through on the Harbor Facility 2007, I believe. Or 2008. I believe it's 2007. So, we would expect that, going forward, and that would continue. The Gillette CT is really a determination of, it's contracted out so our capacity payment is tolled. Our capacity payment is an amount we would expect to continue to receive. That's a 10 year contract that we sell to Public Service Company of Colorado. That contract was assigned to Public Service Company of Colorado. We would expect that to continue. Incrementally, to the extent there is a strong weather in the third quarter going forward, we could pick up increment tall revenues. It just did not run very significantly, because it was a milder third quarter than normal with degree days in our own service territory down 37%. I don't know what the degree days were for Public Service Company of Colorado service territory, but I would assume they were down as well. We are not that far away from that area ,so they did not run that turbine. We did have our capacity payment. We didn't pick up incremental revenues, due to weather, you know, that can be used for peaking, it's a simple cycle LM6000 turbine that's used, primarily, for peaking resources.

Okay. Thank you.

We have a question from the line of Eric Beaumont with Copyia Capital.

Good morning, guys.

Good morning, Eric.

Quick question to follow, actually, on Paul's line of question. With gas pricing where it was, if I recall exactly, last year you ended up taking a charge for realizing some of what would have been uneconomic reserves previously, with gas prices going higher yet, is that something we should be aware of potentially for this year?

I am not exactly sure. I don't think we ever took a charge for uneconomic reserves. What we do is, we evaluate the total cost of our reserves, and that's included in our depletion calculation, and to the extent you have a significant amount of cost that you have to incur, to make those reserves economic, it could increase your cost pool slightly on a future development costs, and we would take a slight increase in depreciation -- or depletion expense, which is a non-cash expense. We don't expect, and we didn't have a significant change to our expectations there, and we will get a reserve, an annual reserve study, as I mentioned by the reserve analysis. But, the incremental increases, I don't believe will be significant. You know, the price is going from where we were to the $30 a barrel in last year was a significant jump for certain reserves. I don't believe that we would expect the difference between that and the $47 to have the same impact.

Okay. That's helpful. With respect to the plant outage again, you don't get to actually pick when that occurs if you don't operate, so, there is ambiguity as to when that outage might occur?

Yes. That's correct. We don't operate that plant. We do expect that, just given prudent utility practice, we would want to have that plant in the April, May time frame just because that's generally, again, when the hydro is strong and replacement power, for both, ourselves and Pacific Corp., the operator of that plant, because, they will have the same issue when they take that plant off line, as they will lose 80% of their resources as well. So, you know, we are aligned with our partner on the timing of that, but we do not control that timing.

Okay. For '05, the $1.85 to $2. Again, just refresh my memory, that does, it takes into account you will have that outage and it assumes normal hydro as far as the make up part you would be on the hook for?

Yes.

Okay. Thanks a lot, guys. Appreciate it.

Thank you, Eric.

We have a question on the line of Mike Weinstein with Zimmer Lucas Partners.

I wanted to make sure I have my production numbers correct. The increase of up to 50% by the end of this year -- up to 50%, what is the base that we are using '03, that 50%?

Well, it is the first six months.

First six months, right?

Yes. Again, we don't expect that because third quarter came in flat, we don't expect we are going to hit the high end of the range. We do expect improvement over the third quarter in the fourth quarter. And as Mr. Bellessa indicated, the 3.5 to 4.5 million Mcf equivalent is, albeit a broad range, that probably is a reasonable range because it is dependent on the timing of our improved -- you know, getting our completion rigs done.

The 3.4 to 4.5, is that an improvement over the first half, or is that an improvement over last year?

No. It's versus the quarter, versus the third quarter. We had 3.1 million in the third quarter.

All right. In terms of just looking at how it will move up versus '03. Let's say you did hit the 50%. Grant you it's not going to happen. But, if you did hit 50%, what would the production be for 2004?

Well, I can't make make that estimation, Mike. Because, we don't expect to do that. We expect to have a 10 to 15% improvement annually in our production. So, if there is some, you know, delay, you can't get those reserves back. You know, the production back, so, you are still working on those wells to get those wells hooked up. And then doing new wells on top of that, so, we expect 10 to 15% production increases annually, and we would expect that on the base of our actual production.

Okay. So, these delays aren't going to necessarily be made up for in 2005. 2005 is simply, you are just going to be going on the straight 10 to 15% improvement, after this year?

That's, again, our guidance and our expectation.

Okay. All right. Thank you very much, guys.

Thank you.

We go to the line of James Bellessa with D.A. Davidson & Company.

Following up, again, on the same point. Let's say you got to 4 million Mc equivalents in the fourth quarter. Would we expect that each quarter of next year would have an increase from that base line, or is that not the base line? Is the production of 13 million of this year --

No, we would expect to improve annually year-over-year. If we assumed, as you say, Jim, that we made 4 million, and we got to, roughly, 13 million equivalent for the year, and I am not doing the rounding for incremental amounts, if we got to 13 million of production for the year. Then we would expect that to grow by 10 to 15%. It is not just a quarterly growth expectation.

If the base line is 4 million, and you are able to produce at the rate of 4 million per quarter, that would be 16 million for the whole year of 2005.

Well, and you have 10% decline curve as well. Normally, if you look at it, our average well life is approximately 9 to 10 years. So, you have a normal decline in that production annually. And you are going to have a decline because of the wells as they deplete. There is a decline in the production of those wells. It is not just necessarily flat. So, to get back to zero, we have to improve production, and then we are going to grow on top of that is our expectation.

Thank you.

Thank you, Jim.

We have a question from Jeff (indiscernible) of Millennium Partners.

Just getting a little confused here. When I look at '05 guidance, and you put out $1.85 to $2, you were going off a base of production '04, 10 to 15%, and you said up to 50% increase in the seconds half. What was the lower end of that range that you were assuming in your guidance as far as production?

Well, just the base, I mean up to 50% increase over the first six months. The first six months was approximately 6 million Mcf equivalent. So, that was the basis.

No, but what was the low end of your expectations for the second half? You said up to --

Well, we did expect some improvement in the third quarter and didn't get it. We were flat. So, to the extent again, looking at the fourth quarter, I've tried to lay out a range of expectations for the production for the fourth quarter, and then we would expect, going forward to grow off of that.

And would that --

We are not expecting to change our guidance relative to the production differences, if that's what you're asking.

So, the lower production is consistent with the, your range for '05.

It's within the range, you know, recognizing that we also have an improvement in price relative to next year, with respect to our range of expectations.

Right. So price --

If we have an improvement in price, if we had a slight reduction of production, we believe that we are still in our guidance, and we are not changing that.

Okay. That's fine. So, the way we should think about it though, is price should offset, maybe any weakness in the production growth?

I don't know that the offset number, yes. We expect price improvements and a potential weakness in production relative to that, but we are not changing our expectations for next year.

Okay. But, just, I guess, up to 50%. 50% would amend you produce 9 Bcfe in the second half of '04, correct?

Correct.

What was the low end of your expectation?

Again, you know, we didn't, because, the low end would have been flat production. Or 6 Bcfe.

So, that's contemplated in your projections?

I don't know that I would say that, Jeff. You know, if you wanted to put a range on it, as you're trying to put a range on it, that would be the range. We would not have expected the decline over all because of the activity we had, but the earlier you get that production on, you get both quarters with it and you get to work on additional wells, and try to continue to improve it. We did not get that in the third quarter.

That's fine. All I am trying to figure out, if you just get 6 Bcfe's in the second half of '04, and grow 10 to 15% off that, we should be in your guidance range?

Yes, we expect to be in our guidance.

Okay. Thanks a lot.

Thank you.

Any additional questions, please press star and then one. We have a question from the line of Jim Harman from Lehman Brothers.

Quick question. Have you been able to test run your AC/DC intertie yet?

We have been running that since last year. You notice the significant increase in our off system sales at our utility, and part some of that is running power through that system, because we can move from the east to the west. It is buy directional, west to east, east to west. So, we had a significant increase in wholesale sales and that did help us get that increase.

That's what I was going to allude to. Okay. Great. Thank you very much.

Thank you, Jim.

At this time there are no further questions in queue, please continue.

Well, we thank everyone for their interest in Black Hills Corporation. Have a good day.

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