TABLE OF CONTENTS

PART I

ITEMS 1 AND 2.   BUSINESS AND PROPERTIES

Website Access to Reports

Through our Internet website, www.blackhillscorp.com, we make available free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

General

We are a diversified energy holding company operating principally in the United States. Our regulated and unregulated businesses have expanded their asset bases significantly in recent years. Our integrated energy group produces and markets power and fuel and transports crude oil. We produce and sell electricity in a number of markets, with a strong emphasis on the western United States. We also produce coal, natural gas and crude oil primarily in the Rocky Mountain region and market fuel products primarily in the Rocky Mountain, western and mid-continent regions of the United States and in Western Canada. Our electric utility serves approximately 60,000 customers in South Dakota, Wyoming and Montana. Our communications group offers state-of-the-art broadband communication services to residential and business customers in Rapid City and the northern Black Hills region of South Dakota. Our predecessor company was incorporated and began providing electric utility service in 1941 and began selling and marketing various forms of energy on an unregulated basis in 1956.

As the following table illustrates, we have experienced significant change over the last five years, primarily as a result of the expansion of our integrated energy business and increases in wholesale electric sales at our electric utility. Unusual conditions in the western energy markets during the first half of 2001 and the last part of 2000 accounted for approximately $1.40 per share and $0.40 per share of our earnings in 2001 and 2000, respectively.

For additional information on our business segments see – ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK and Note 16 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

Industry Overview

The energy and telecommunications industries can be expected to become increasingly competitive due to a variety of regulatory, economic and technological changes.

In the last decade, many U.S. regulatory bodies took steps to transform the energy sectors which they regulate to encourage competition, introduce customer choice and, in some cases, to improve the operational performance of strategic energy assets. As a result of regulatory initiatives at the federal and state levels, the electric power industry has experienced and is undergoing substantial change. As early as the mid-1990‘s, new regulatory initiatives to increase competition in the domestic power generation industry were adopted or were being considered. The primary focus of such efforts was to increase competition through the disaggregation of the traditional utility functions of generation, transmission, distribution and marketing of electricity. These changes created new investment opportunities for competitive or partially regulated businesses to enter previously non-competitive or closed markets.

The electric power industry also witnessed growing consumer demand and frequent regional shortages of electricity over the past several years. The summers of 1998, 1999 and 2000 and the winter of 2000-2001 were characterized by very high peak prices for electricity in a number of recently deregulated wholesale electricity markets. In a number of these markets, government agencies and other interested parties made proposals to delay market restructuring or even re-regulate certain areas of the markets that had been previously deregulated. The Federal Energy Regulatory Commission (FERC) instituted a series of price controls designed to mitigate (or cap) prices in the western United States and initiated numerous investigations into the western markets as a result of the California energy crisis. These price controls contributed to the lowering of spot and forward energy prices in the western markets. Other proposals to re-regulate the energy industry or to institute price controls may be made, and legislative or other actions may cause the electric power restructuring process to be delayed, discontinued or reversed in states that have already deregulated. Mild weather patterns in the summer of 2001 and winter of 2001-2002 and the current recession mitigated most regional energy shortages.

The energy industry recently faced a financial crisis stemming from the loss of billions of dollars in market capitalization reflecting broad market conditions and investor attitudes. Investors and consumers have lost confidence in the financial health of many energy providers as a result of numerous events following the collapse of Enron. Accordingly, energy companies have been subject to much greater scrutiny and significantly tighter credit standards. Companies are moving aggressively to improve liquidity and to restructure their balance sheets. They are selling non-core assets, downsizing, issuing new equity, canceling acquisitions, postponing or canceling construction projects, reducing significant levels of capital expenditures, accelerating debt repayment and realigning trading around their own generation assets.

The oil and gas industry has experienced volatile changes in commodity prices in recent years. Price increases were driven in part by several years of modest drilling activity combined with strong growth in demand for energy commodities and the threat of war in the Middle East. Price decreases were driven by weather patterns, the recession and actions by OPEC. Natural gas is expected to remain the fuel of choice. Demand for natural gas is expected to be strong in the future as an increasing number of gas-fired power plants are brought into service.

The telecommunications industry underwent widespread changes brought about by, among other things, the Telecommunications Act of 1996, the decisions of federal and state regulators to open the monopolistic local telephone and cable television markets to competition, the increased consumer demand for higher speed and higher capacity networks and for expanded telecommunications services, including broader video choices and high speed data and Internet services. The convergence of these trends allowed many new entrants into the telecommunication market. More recently the telecommunication industry suffered the effects of an economic slowdown, increased competition and financial stress.

Our Business Strategy

Our long-term growth strategy is to add and augment revenue streams from our diverse integrated energy operations. We have implemented a balanced, integrated approach to fuel production, energy marketing and power generation, supported by disciplined risk management practices. Building on the strength of our electric utility, we enhanced our local operations by providing broadband communications to our customers in South Dakota. Our diverse operations avoid reliance on any single business to achieve our growth objectives. This diversity provides a measure of stability to our business and financial performance in volatile or cyclical periods.

Our strategy includes the following key elements:

• grow our power generation segment by developing and acquiring power generating assets in targeted western markets and, in particular, by expanding generating capacity of our existing sites through a strategy known as “brownfield development;"
  
  
• sell a large percentage of our production from new independent power projects through long-term contracts in order to secure a stable revenue stream and attractive returns;
  
  
• preserve our electric utility’s low-cost rate structure for our retail customers while retaining the flexibility to allocate excess generating capacity to maximize returns in changing market environments;
  
  
• increase our reserves of natural gas and crude oil and expand our fuel production;
  
  
• manage the risks inherent in energy marketing by maintaining position limits that minimize price risk exposure;
  
  
• conduct business with a diversified group of creditworthy counterparties;
  
  
• exploit our fuel cost advantages and our operating and marketing expertise to remain a low-cost power producer;
  
  
• increase margins from our coal production through an expansion of mine-mouth generation and increased coal sales;
  
  
• build and maintain strong relationships with wholesale energy customers;
  
  
• create a strong “super local” service company by capitalizing on our utility’s established market presence, relationships and customer loyalty to expand our local communications business, integrating our electric and telecommunications products around the same customer base; and
  
  
• organize our lines of business into retail and wholesale energy components. The retail component will consist of electric and telecommunications products in the same footprint as our electric utility exists today. The wholesale component will consist of fuel production, marketing, mid-stream assets and power production facilities.
  

Grow our Power Generation Segment by Developing and Acquiring Power Generating Assets in Targeted Western Markets, and in Particular, by Expanding Generating Capacity of our Existing Sites Through a Strategy Known as “Brownfield Development.” We aim to develop power plants in regional markets based on prevailing supply and demand fundamentals in a manner that complements our existing fuel assets and fuel and energy marketing capabilities. This approach seeks to capitalize on market growth while managing our fuel procurement needs. Over the next few years, we intend to grow through a combination of disciplined acquisitions and development of new power generation facilities primarily in the western region where we believe we have the detailed knowledge of market fundamentals and competitive advantage to achieve attractive returns. We believe the following trends will provide us with growth opportunities in the future:

• Demand for electricity in the western regions is expected to grow and new generation capacity will be required over the next several years.
  
• New electric generation construction will be predominantly gas-fired, which may create further competitive cost advantages for new and existing coal-fired generation assets.
  
• Transmission construction will significantly lag new generation development, favoring new development located near load centers or existing, unconstrained transmission locations.
  
• Disaggregation of the electric utility industry from traditionally vertically integrated utilities into separate generation, transmission, distribution and marketing entities will continue, thereby creating opportunities for acquisitions and joint ventures.

We believe that existing sites with opportunities for brownfield expansion generally offer the potential for greater returns than development of new sites through a “greenfield” strategy. Brownfield sites typically offer several competitive advantages over greenfield development, including:

• proximity to existing transmission systems;
  
• operating cost advantages related to ownership of shared facilities;
  
• a less costly and time consuming permitting process; and
  
• potential ability to share infrastructure with existing facilities at the same site.

We recently expanded our capacity with brownfield development at our Arapahoe and Las Vegas sites and are currently expanding our Wyodak site. We believe that our Fountain Valley, Wyodak and Las Vegas sites in particular provide further opportunities for significant expansion of our gas- and coal-fired generating capacity over the next several years.

Sell a Large Percentage of our Production From New Independent Power Projects Through Long-Term Contracts in Order to Secure a Stable Revenue Stream and Attractive Returns. By selling the majority of our energy and capacity under mid- and long-term contracts, we believe that we can satisfy the requirements of our customers while earning more stable revenues and greater returns over the long term than we could by selling our energy into the more volatile spot markets. Approximately 90 percent of our unregulated power generation assets are under long-term contracts.

Preserve our Electric Utility’s Low-Cost Rate Structure for our Retail Customers While Retaining the Flexibility to Allocate Excess Generating Capacity to Maximize Returns in Changing Market Environments. In 1999, the South Dakota Public Utilities Commission extended our previous retail rate freeze until January 1, 2005. The rate freeze preserves our low-cost rate structure at levels below the national average for our retail customers while allowing us to retain the benefits from cost savings and wholesale “off-system” sales. This provides us with flexibility in allocating our generating capacity to maximize returns in changing market environments. We have historically optimized the utilization of our power supply resources by selling wholesale power to other utilities and to power marketers in the spot market and through short-term sales contracts.

Increase our Reserves of Natural Gas and Crude Oil and Expand our Fuel Production. We aim to support the fuel requirements of our growing portfolio of power plants as well as power plants owned by others by emphasizing natural gas. Our strategy is to expand our natural gas reserves through a combination of acquisitions and drilling programs. We aim to maintain sufficient natural gas production either to directly serve or indirectly hedge the fuel cost exposure of our gas-fired generation plants. Specifically, we plan to:

• substantially increase our natural gas reserves while minimizing exploration risk by focusing on lower-risk exploration and development drilling as well as acquisitions of proven reserves;
  
• exploit opportunities based on our belief that the long-term demand for natural gas will remain strong by emphasizing natural gas in our acquisition and drilling activities; and
  
• add natural gas reserves and increase production by focusing on various shallow gas plays in the Rocky Mountain region, where the added production can be integrated with our fuel marketing and/or power generation activities.

Manage the Risks Inherent in Energy Marketing by Maintaining Position Limits That Minimize Price Risk Exposure. Our energy marketing 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 have implemented risk management policies and procedures for each of our marketing companies that establish price risk exposure levels. We formed oversight committees to monitor compliance with our policies. We also limit exposure to energy marketing risks by maintaining separate credit facilities for each of our marketing companies.

Conduct Business With a Diversified Group of Creditworthy Counterparties. Our operations require effective management of counterparty credit risk. We mitigate this risk by conducting business with a diversified group of creditworthy counterparties. We accomplish this by establishment of counterparty credit limits, continuous credit monitoring, and regular review of credit compliance with our policy by our Executive Credit Committee that reports to our board of directors.

Exploit our Fuel Cost Advantages and our Operating and Marketing Expertise to Remain a Low-Cost Power Producer. We expect to expand our portfolio of power plants having relatively low marginal costs of producing energy and related products and services. As an increasing number of gas-fired power plants are brought into operation, we intend to utilize a low-cost power production strategy, together with access to coal and natural gas reserves, to protect our revenue stream. Low marginal 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 aggressively manage each of these factors to achieve very low production costs, especially at our coal-fired and hydroelectric generating facilities.

Our primary competitive advantage is our coal mine, which is located in close proximity to our retail service territory. We are exploiting the competitive advantage of this native fuel source by building additional mine-mouth coal-fired generating capacity. This strengthens our position as a low-cost producer since transportation costs often represent the largest component of the delivered cost of coal.

Increase Margins From our Coal Production Through an Expansion of Mine-Mouth Generation and Increased Coal Sales. Our strategy is to expand our coal production through the construction of mine-mouth coal-fired generation plants at our Wyodak mine location. Our objective is to maintain coal reserves to serve our mine-mouth coal-fired generation plants directly. Specifically, we plan to:

• increase coal production and sales from our Wyodak mine by continuing to develop additional mine-mouth generating facilities at the site, such as the Wygen plant, which went into service in the first quarter 2003; and
  
• pursue future sales of coal from the Wyodak mine to rail-served customers.

Build and Maintain Strong Relationships With Wholesale Energy Customers. We strive to build strong relationships with utilities, municipalities and other wholesale customers, who we believe will continue to be the primary providers of electricity to retail customers in a deregulated environment. We further believe that these entities will need products, such as capacity, in order to serve their customers reliably. By providing these products under long-term contracts, we are able to meet our customers’ 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 the more volatile spot markets.

Create a Strong “Super Local” Service Company by Capitalizing on our Utility’s Established Market Presence, Relationships and Customer Loyalty to Expand our Local Communications Business, Integrating our Electric and Telecommunications Products Around the Same Customer Base. As a result of its firmly established market presence, our electric utility has built solid brand recognition and customer loyalty in the Black Hills region. By ensuring a reliable supply of power to retail customers in our South Dakota and Wyoming service territory at rates below the national average, we have developed a strong, supportive relationship with our utility regulators. Our utility provides a solid foundation of support for the expansion of our communications businesses. In addition, technical and market expertise from our utility and our strong brand recognition promotes rapid customer acceptance of our bundled communications services in our Black Hills service territory.

Integrated Energy

Our integrated energy group engages in the production of electric power through ownership of a diversified portfolio of generating plants and the sale of electric power primarily under long-term contracts, the production of coal, natural gas and crude oil primarily in the Rocky Mountain region, and the marketing of energy products. The integrated energy group consists of four segments: power generation, natural gas and crude oil production, coal mining and energy marketing and transportation.

Power Generation

Our power generation segment acquires, develops and expands unregulated power plants. We hold varying interests in independent power plants in California, New York, Massachusetts, Wyoming, Nevada and Colorado with a total net ownership of 950 megawatts in operation, including minority interests in several power-related funds with a net ownership interest of 24 megawatts.

Project Development Program. At December 31, 2002, we were in the final stages of construction of the 90 megawatt coal-fired Wygen power plant at our Wyodak site located near Gillette, Wyoming. The Wygen plant became operational in the first quarter of 2003 and is accounted for as an operating lease.

Through our active acquisition and development program we are pursuing a number of additional generation projects in the early stages of development, including a coal-fired mine-mouth power plant with generating capacity of up to 500 megawatts, to be located at our Wyodak site near Gillette, Wyoming. We cannot assure you that we will be successful in completing any or all of the projects currently under consideration.

How We Manage Our Portfolio. We strive to maintain diversity and balance in our portfolio of regulated and unregulated power plants. Our unregulated portfolio (including plants currently operating and those under construction) is diversified in terms of fuel mix and geographic location, with 87 percent of net unregulated capacity being gas-fired, 9 percent coal-fired, and the remainder hydroelectric. Our independent power plants are located in California, Wyoming, Colorado, Nevada, New York and Massachusetts. By comparison, our electric utility capacity is approximately 50 percent coal-fired, 39 percent oil or gas-fired and 11 percent under purchased power contracts, with plants located in South Dakota and Wyoming.

We sell our output under contracts of varying length, thereby allowing us to mitigate the impact of a potential downturn in prices in the future. We sell energy and capacity under a combination of short- and long-term contracts as well as direct sales into the energy markets. Currently, we sell approximately 90 percent of our unregulated generating capacity in operation under contracts greater than one year in duration. We sell the remainder of this capacity under short-term contracts or directly into the power markets. Substantially all of the energy and capacity generated by our Wygen plant is also under long-term contracts.

How We Develop and Acquire Power Plants. We plan to actively pursue power plant acquisitions and development opportunities in areas we view as attractive throughout North America. Our primary focus has been, and is likely to remain, in the North American Electric Reliability Council region known as the Western Electricity Coordinating Council, or “WECC.” Among the factors we consider critical in evaluating the relative attractiveness of new generation opportunities are the following:

• potential electric demand growth in the targeted region;
  
• regional generation capacity characteristics;
  
• permitting and siting requirements;
  
• proximity of the proposed site to high transmission capacity corridors;
  
• fuel supply reliability and pricing;
  
• the local regulatory environment; and
  
• the potential to exploit market expertise and operating efficiencies relating to geographic concentration of new generation with our existing power plant portfolio.

Our goal is to sell approximately 80-90 percent of the independent power generation portfolio under long-term contracts to counterparties with investment grade credit, while reserving the remainder for merchant or “spot” sales. We aim to secure long-term power sales contracts in conjunction with project financing. This structure limits our liability and establishes a debt repayment schedule to closely match the term of the power sales contracts so that at the end of the contract term, the project debt will largely be repaid.

Rocky Mountain and West Coast Facilities. We own approximately 845 megawatts of generating capacity in the WECC states of California, Colorado, Nevada and Wyoming, and at December 31, 2002, we were in the final stages of constructing another 90 megawatts in the region which became operational in the first quarter of 2003. All the facilities currently in operation are gas-fired, and the majority are operating under long-term power purchase or tolling agreements whereby the purchaser assumes the fuel price risk. The 90 megawatt plant under construction is coal-fired.