**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC  20549**

**Form 10-K**

                

| x      | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934     |
|--------|------------------------------------------------------------------------------------------|
|   |                                                                                     |
|        | For the fiscal year ended December 31, 2006                                              |
|   |                                                                                     |
| o      | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|   |                                                                                     |
|        | For the transition period from ___________________ to __________________                 |
|   |                                                                                     |
|        | Commission File Number 1-7978                                                            |

 

**BLACK HILLS POWER, INC.**

 

| Incorporated in South Dakota                                                                                          |   | IRS Identification Number 46-0111677 |
|-----------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|
| 625 Ninth Street, Rapid City, South Dakota  57701                                                                     |
|                                                                                                                  |   |                                 |
| Registrant’s telephone number, including area code: (605) 721-1700                                               |
|                                                                                                                  |   |                                 |
| Securities registered pursuant to Section 12(b) of the Act:         None |
|                                                                                                                  |   |                                 |
| Securities registered pursuant to Section 12(g) of the Act:         None |

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

|   | Yes | o | No | x |
|--------|-----|---|----|---|

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

|   | Yes | x | No | o |
|--------|-----|---|----|---|

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

|   | Yes | x | No | o |
|--------|-----|---|----|---|

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

 

|   | This paragraph is not applicable to the Registrant. | x |
|--------|-----------------------------------------------------|---|

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

|   | Large accelerated filer | o | Accelerated filer | o | Non-accelerated filer | x |
|--------|-------------------------|---|-------------------|---|-----------------------|---|

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

|   | Yes | o | No | x |
|--------|-----|---|----|---|

 

State the aggregate market value of the voting stock held by non-affiliates of the Registrant.

 

All outstanding shares are held by the Registrant’s parent company, Black Hills Corporation.  Accordingly, the aggregate market value of the voting common stock of the Registrant held by non-affiliates is $0.

 

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.

 

| Class                         | Outstanding at February 28, 2007 |
|-------------------------------|----------------------------------|
| Common stock, $1.00 par value | 23,416,396 shares                |

 

**Reduced Disclosure**

The Registrant meets the conditions set forth in General Instruction I (1) (a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format.

 

| **TABLE OF CONTENTS** |
|-----------------------|
|                  |   |   |
|                  |   | Page |
|                  |   |   |
| ITEMS 1. and 2.       | BUSINESS AND PROPERTIES | 3 |
|                  | Safe Harbor for Forward Looking Information | 3 |
|                  | General | 4 |
|                  | Rate Regulation | 7 |
|                  |   |   |
| ITEM 1A.              | RISK FACTORS | 8 |
|                  |   |   |
| ITEM 1B.              | UNRESOLVED STAFF COMMENTS | 10 |
|                  |   |   |
| ITEM 3.               | LEGAL PROCEEDINGS | 10 |
|                  |   |   |
| ITEM 5.               | MARKET FOR REGISTRANT’S COMMON EQUITY AND |   |
|                  | RELATED STOCKHOLDER MATTERS | 11 |
|                  |   |   |
| ITEM 7.               | MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS |   |
|                  | OF OPERATIONS | 11 |
|                  |   |   |
| ITEM 8.               | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 15 |
|                  |   |   |
| ITEM 9.               | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS |   |
|                  | ON ACCOUNTING AND FINANCIAL DISCLOSURE | 44 |
|                  |   |   |
| ITEM 9A.              | CONTROLS AND PROCEDURES | 44 |
|                  |   |   |
| ITEM 9B.              | OTHER INFORMATION | 45 |
|                  |   |   |
| ITEM 15.              | EXHIBITS, FINANCIAL STATEMENT SCHEDULES | 46 |
|                  |   |   |
|                  | SIGNATURES | 48 |
|                  |   |   |
|                  | INDEX TO EXHIBITS | 49 |

 

 

2

**PART I**

 

**ITEMS 1**

| **and 2.** | **BUSINESS AND PROPERTIES** |
|------------|-----------------------------|

 

**Safe Harbor for Forward Looking Information**

 

This Annual Report on Form 10-K includes “forward-looking statements” as defined by the Securities and Exchange Commission, or SEC. We make these forward-looking statements in reliance on the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this Form 10-K that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements. These forward-looking statements are based on assumptions which we believe are reasonable based on current expectations and projections about future events and industry conditions and trends affecting our business. However, whether actual results and developments will conform to our expectations and predictions is subject to a number of risks and uncertainties that, among other things,could cause actual results to differ materially from those contained in the forward-looking statements, including, without limitation, the Risk Factors set forth in Item 1A. of this Form 10-K and the following:

 

| **•**     Our ability to obtain adequate cost recovery for our retail utility operations through regulatory proceedings and receive favorable rulings in periodic applications to recover costs for fuel and purchased power;                                                                                                                   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     The amount and timing of capital deployment in new investment opportunities or for the repurchase of debt or stock;                                                                                                                                                                                                                   |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     Our ability to successfully maintain or improve our corporate credit rating;                                                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     The timing and extent of scheduled and unscheduled outages of power generation facilities;                                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     The possibility that we may be required to take impairment charges to reduce the carrying value of some of our long-lived assets when indicators of impairment emerge;                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     Changes in business and financial reporting practices arising from the enactment of the Energy Policy Act of 2005;                                                                                                                                                                                                                    |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     Our ability to remedy any deficiencies that may be identified in the review of our internal controls;                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     The timing, volatility and extent of changes in energy-related and commodity prices, interest rates, energy and commodity supply or volume, the cost and availability of transportation of commodities, and demand for our services, all of which can affect our earnings, liquidity position and the underlying value of our assets; |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     Our ability to effectively use derivative financial instruments to hedge commodity risks;                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     Our ability to minimize defaults on amounts due from counterparty transactions;                                                                                                                                                                                                                                                       |
|                                                                                                                                                                                                                                                                                                                                                                          |
| **•**     Changes in or compliance with laws and regulations, particularly those relating to taxation, safety and protection of the environment;                                                                                                                                                                                                |

 

 

3

 

|                                                                                                                                                                        |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **•**     Weather and other natural phenomena;                                                                                                |
|                                                                                                                                                                        |
| **•**     Industry and market changes, including the impact of consolidations and changes in competition;                                     |
|                                                                                                                                                                        |
| **•**     The effect of accounting policies issued periodically by accounting standard-setting bodies;                                        |
|                                                                                                                                                                        |
| **•**     The cost and effects on our business, including insurance, resulting from terrorist actions or responses to such actions or events; |
|                                                                                                                                                                        |
| **•**     The outcome of any ongoing or future litigation or similar disputes and the impact on any such outcome or related settlements;      |
|                                                                                                                                                                        |
| **•**     Capital market conditions, which may affect our ability to raise capital on favorable terms;                                        |
|                                                                                                                                                                        |
| **•**     Price risk due to marketable securities held as investments in benefit plans;                                                       |
|                                                                                                                                                                        |
| **•**     General economic and political conditions, including tax rates or policies and inflation rates; and                                 |
|                                                                                                                                                                        |
| **•**     Other factors discussed from time to time in our other filings with the SEC.                                                        |

 

New factors that could cause actual results to differ materially from those described in forward-looking statements emerge from time to time, and it is not possible for us to predict all such factors, or the extent to which any such factor or combination of factors may cause actual results to differ from those contained in any forward-looking statement.  We assume no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events, or otherwise.

 

**General**

 

We are a regulated electric utility serving customers in South Dakota, Wyoming and Montana.  We are incorporated in South Dakota and began providing electric utility service in 1941.  We are a wholly-owned subsidiary of the publicly traded Black Hills Corporation.  

 

Unless the context otherwise requires, references in this Form 10-K to “the Company,” “we,” “us” and “our” refer to Black Hills Power, Inc.

 

We engage in the generation, transmission and distribution of electricity.  We have a solid foundation of revenues, earnings and cash flow that support our capital expenditures, dividends, and overall performance and growth. 

 

4

***Distribution and Transmission***

 

***Distribution and Transmission.***Our distribution and transmission businesses serve approximately 64,200 electric customers, with an electric transmission system of 447 miles of high voltage lines (greater than 69 KV) and 420 miles of lower voltage lines.  In addition, we jointly own 47 miles of high voltage lines with Basin Electric Cooperative.  Our service territory covers a 9,300 square mile area of western South Dakota, northeastern Wyoming and southeastern Montana with a strong and stable economic base.  Approximately 91 percent of our retail electric revenues in 2006 were generated in South Dakota.

 

The following are characteristics of our distribution and transmission businesses:

 

| **•**     We have a diverse customer and revenue base.  Our revenue mix for the year ended December 31, 2006 was comprised of 26 percent commercial, 21 percent residential, 13 percent contract wholesale, 22 percent wholesale off-system, 11 percent industrial and 7 percent municipal sales and other revenue.  Approximately 84 percent of our large commercial and industrial customers are provided service under long-term contracts.  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 primarily in the Western Electricity Coordinating Council (WECC) and Mid-Continent Area Power Pool (MAPP)regions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **•**     We are subject to regulation by the South Dakota Public Utility Commission (SDPUC), the Wyoming Public Service Commission (WPSC) and the Montana Public Service Commission (MTPSC).  We operated under two consecutive retail rate freezes in South Dakota that were imposed in 1995 and expired on January 1, 2005.  The rate freezes preserved a low-cost rate structure for our retail customers at levels below the national average and insulated them from changes in fuel and purchased power costs but allowed us to retain the benefits from cost savings and from wholesale “off-system” sales, which were not covered by the rate freezes.  On June 30, 2006, we filed a rate case with the SDPUC to increase retail rates for South Dakotacustomers and to add tariff provisions for automatic adjustment of rates for changes in energy, fuel and transmission costs.  The cost adjustments would require us to absorb a portion of power cost increases, depending in part on earnings on certain short-term wholesale sales of electricity.  On December 28, 2006, we received an order from the SDPUC approving a 7.8 percent increase in retail rates and the addition of tariff provisions for automatic adjustments, effective January 1, 2007.  Absent certain conditions, the order also restricts us from requesting an increase in base rates that would go into effect prior to January 1, 2010. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **•**     We own 35 percent and Basin Electric owns 65 percent of a transmission tie that provides an interconnection between the Western and Eastern transmission grids, enabling access to both the WECC region in the West, and the MAPP region in the East.  Our system is located in the WECC region.  The total transfer capacity of the tie is 400 megawatts - 200 megawatts from West to East and 200 megawatts from East to West.  This transmission tie allows us to buy and sell energy in the Eastern interconnection without having to isolate and physically reconnect load or generation between the two electrical transmission grids.  The transmission tie accommodates scheduling transactions in both directions simultaneously.  This transfer capabilityprovides additional opportunity to sell our excess generation or to make economic purchases to serve our native load and our contract obligations, and to take advantage of the power price differentials between the two electric grids.  Additionally, our system is capable of directly interconnecting up to 80 megawatts of generation or load to the Eastern transmission grid.  Transmission constraints within the MAPP transmission system may limit the amount of capacity that may be directly interconnected to the Eastern system at any given time.                                                                                              |

 

 

5

 

|                                                                                                                                                                                                                                                                                                                                   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **•**     We have firm point-to-point transmission access to deliver up to 50 megawatts of power on PacifiCorp’s transmission system to wholesale customers in the Western region from 2007 through 2023.                                                                                           |
|                                                                                                                                                                                                                                                                                                                                   |
| **•**     We have firm network transmission access to deliver power on PacifiCorp’s system to Sheridan, Wyoming to serve our power sales contract with Montana-Dakota Utilities Company (MDU) through 2016, with the right to renew pursuant to the terms of PacifiCorp’s transmission tariff. |

 

***Power Sales Agreements.***  We sell a portion of our current load under long-term contracts.  Our key contracts include:

 

| **•**     an agreement with MDU, which expired on December 31, 2006, for the sale of up to 55 megawatts of capacity and energy to serve the Sheridan, Wyoming electric service territory.  Our new power purchase agreement with MDU, effective January 1, 2007 through the end of 2016, will supply up to 74 megawatts of capacity and energy for Sheridan, Wyoming; and |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                    |
| **•**     an agreement with the City of Gillette, Wyoming, expiring in 2013, to provide the city’s first 23 megawatts of capacity and energy.  The agreement renews automatically and requires a seven year notice of termination.                                                                                                                                   |

 

These consumers are integrated into our control area and considered part of our firm native load.  We also provide 20 megawatts of energy and capacity to Municipal Energy Agency of Nebraska (MEAN) under a contract that expires in 2013.  This contract is unit-contingent based on the availability of our Neil Simpson II plant.

 

***Regulated Power Plants and Purchased Power.***  Our electric load is primarily served by our generating facilities in South Dakota and Wyoming, which provide 435 megawatts of generating capacity, with the balance supplied under purchased power and capacity contracts.  Approximately 50 percent of our capacity is coal-fired, 39 percent is oil- or gas-fired, and 11 percent is supplied under the following purchased power contracts with PacifiCorp:

 

| **•**     a power purchase agreement expiring in 2023, involving the purchase by us of 50 megawatts of coal-fired baseload power; and                                                                             |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                            |
| **•**     a reserve capacity integration agreement expiring in 2012, which makes available to us 100 megawatts of reserve capacity in connection with the utilization of the Ben French Combustion Turbine units. |

 

Since 1995, we have been a net producer of energy.  We reached our peak system load of 415 megawatts in July 2006 with an average system load of 249 megawatts for the year ended December 31, 2006.  None of our generation is restricted by hours of operation, thereby providing us the ability to generate power to meet demand whenever necessary and economically feasible.

 

6

**Rate Regulation**

 

***Rate Regulation***

 

Rates for our retail electric service are subject to regulation by the SDPUC for customers in South Dakota, the WPSC for customers in Wyoming and the MTPSC for customers in Montana.  Any changes in retail rates are subject to approval by the respective regulatory body.  Two consecutive rate freezes granted by the SDPUC, which were in effect for us since 1995, expired on January 1, 2005.  During this ten-year term, we were prohibited, subject to certain limited exceptions, from filing for any increase in our rates or invoking any fuel and purchased power adjustment tariff which would take effect during the freeze period.  On June 30, 2006, we filed an application with the SDPUC for an increase in electric rates for our South Dakota customers and to provide automatic adjustment of rates for changes in energy, fuel and transmission costs.  On December 28, 2006, the SDPUC approved a rate increase of 7.8 percentalong with the addition of tariff provisions which provide for the automatic adjustment of rates.  The rates and new tariff provisions were effective beginning January 1, 2007.  Terms of the settlement agreement with the SDPUC include the following:

 

| **•**     Annual cost adjustments reflecting changes in the costs of both electric transmission and fuel delivered to coal-fired power generation will be allowed, with adjustments reflected in monthly customer billings commencing in March following the year on which the calculation was made;                                                                                                          |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **•**     Annual cost adjustments reflecting changes in the cost of natural gas used in power generation and purchased power, with adjustments, if any, reflected in monthly customer billings commencing in March following the year on which the calculation was made.  We also agreed to share in such cost increases, under certain circumstances while retaining the benefits from off-system sales; and |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **•**     No additional base rate increases, with certain exceptions, for a period of three years ending December 31, 2009.                                                                                                                                                                                                                                                                                   |

 

***Regulatory Accounting***

 

As it pertains to the accounting for our utility operations, we follow Statement of Financial Accounting Standards (SFAS) No. 71, “Accounting for the Effects of Certain Types of Regulation” (SFAS 71), and our financial statements reflect the effects of the different ratemaking principles followed by the various jurisdictions in which we operate.  If rate recovery becomes unlikely or uncertain, due to competition or regulatory action, these accounting standards may no longer apply to our generation operations.  In the event we determine that we no longer meet the criteria for following SFAS 71, the accounting impact to us could be an extraordinary non-cash charge to operations of an amount that could be material.

 

**New Accounting Pronouncements**

 

See Note 1 of our Notes to Financial Statements in this Annual Report on Form 10-K for information on new accounting standards adopted in 2006 or pending adoption.

 

7

**ITEM 1A.**      **RISK FACTORS**

 

The following specific risk factors and other risk factors that we discuss in our periodic reports from time to time should be considered for a better understanding of our Company.  These factors and other matters discussed herein are important factors that could cause our actual results or outcomes to differ materially from those discussed in the forward looking statements included elsewhere in this document.

 

**We may not raise our retail rates without prior approval of the SDPUC, WPSC or the MTPSC.  If we seek rate relief, we could experience delays, reduced or partial rate recovery, or disallowances in rate proceedings.**

 

Because we are generally unable to increase our base rates without prior approval from the SDPUC, the WPSC, and the MTPSC, our returns could be threatened by plant outages, machinery failure, increased purchased power costs, acts of nature, acts of terrorism or other unexpected events over which we have no control that could cause operating costs to increase and operating margins to decline.  While we have cost pass-through mechanisms in place that allow recovery of increased costs related to fuel, purchased power, transmission and natural gas, there is no guarantee that all increases in these costs will be recovered.  Additionally, our general operating costs and investments are subject to the review of the SDPUC or the WPSC.  These commissions could find certain costs or investments are not prudent and not recoverable in our rates, thus negatively affecting our revenues.

 

**Our credit ratings could be lowered in the future.  If this were to occur, our access to capital and our cost of capital and other costs would be negatively affected.**

 

Our credit rating on our First Mortgage Bonds is “Baa1” by Moody’s Investors Services, Inc. (Moody’s) and “BBB” by Standard & Poor’s Rating Services (S&P).  Any reduction in our ratings by Moody’s or S&P could adversely affect our ability to refinance or repay our existing debt and to complete new financings.  In addition, a downgrade in our credit rating would increase our costs of borrowing under some of our existing debt obligations.  A downgrade could also result in our business counterparties requiring us to provide additional amounts of collateral under new transactions.

 

**Construction, expansion, refurbishment and operation of power generating and transmission facilities involve significant risks which could lead to lost revenues or increased expenses.**

 

The construction, expansion, refurbishment and operation of power generating and transmission facilities involve many risks, including:

 

| **•**     the inability to obtain required governmental permits and approvals; |
|--------------------------------------------------------------------------------------------------------------|
| **•**     contract restrictions upon the timing of scheduled outages;          |
| **•**     cost of supplying or securing replacement power;                     |
| **•**     the unavailability of equipment and labor supply;                    |
| **•**     supply interruptions;                                                |
| **•**     work stoppages;                                                      |
| **•**     labor disputes;                                                      |
| **•**     social unrest;                                                       |
| **•**     weather interferences;                                               |
| **•**     unforeseen engineering, environmental and geological problems; and   |
| **•**     unanticipated cost overruns.                                         |

 

 

8

The ongoing operation of our facilities involves all of the risks described above, in addition to risks relating to the breakdown or failure of equipment or processes and performance below expected levels of output or efficiency.  New plants may employ recently developed and technologically complex equipment, especially in the case of newer environmental emission control technology.  Any of these risks could cause us to operate below expected capacity levels, which in turn could reduce revenues, increase expenses, or cause us to incur higher maintenance costs and penalties.  While we maintain insurance, obtain warranties from vendors and obligate contractors to meet certain performance levels, the proceeds of such insurance and our rights under warranties or performance guarantees may not be timely or adequate to cover lost revenues, increased expenses or liquidated damage payments.

 

**Because prices in the wholesale power markets are volatile, our revenues and expenses may fluctuate.**

 

A portion of the variability of our net income in recent years has been attributable to wholesale electricity sales.  The related power prices are influenced by many factors outside our control, including:

 

| **•**     fuel prices;                                                                 |
|----------------------------------------------------------------------------------------------------------------------|
| **•**     transmission constraints;                                                    |
| **•**     supply and demand;                                                           |
| **•**     weather;                                                                     |
| **•**     economic conditions; and                                                     |
| **•**     the rules, regulations and actions of the system operators in those markets. |

 

Moreover, unlike most other commodities, electricity cannot be stored and therefore must be produced concurrently with its use.  As a result, wholesale power markets are subject to significant, unpredictable price fluctuations over relatively short periods of time.

 

**Our business is subject to substantial governmental regulation and permitting requirements as well as on-site environmental liabilities we assumed when we acquired some of our facilities.  We may be adversely affected by any future inability to comply with existing or future regulations or requirements or the potentially high cost of complying with such requirements.**

 

Our business is subject to extensive energy, environmental and other laws and regulations of federal, state and local authorities.  We generally must obtain and comply with a variety of licenses, permits and other approvals in order to operate.  In the course of complying with these requirements, we may incur significant additional costs.  If we fail to comply with these requirements, we could be subject to civil or criminal liability and the imposition of liens or fines.  In addition, existing regulations may be revised or reinterpreted, new laws and regulations may be adopted or become applicable to us or our facilities which could have a detrimental effect on our business.

 

We strive to comply with all applicable environmental laws and regulations.  Future steps to bring our facilities into compliance, if necessary, could be expensive, and could adversely affect our results of operation and financial condition.  We expect our environmental expenditures to be substantial in the future due to the continuing trends toward stricter standards, greater regulation, more extensive permitting requirements and an increase in the assets we operate.

 

9

**Ongoing changes in the United States utility industry, including state and federal regulatory changes, a potential increase in the number or geographic scale of our competitors or the imposition of price limitations to address market volatility, could adversely affect our profitability.**

 

The United States electric utility industry is currently experiencing increasing competitive pressures as a result of:

 

| **•**     the Energy Policy Act of 2005 and the repeal of the Public Utility Holding Company Act of 1935; |
|-----------------------------------------------------------------------------------------------------------------------------------------|
| **•**     industry consolidation;                                                                         |
| **•**     consumer demands;                                                                               |
| **•**     transmission constraints;                                                                       |
| **•**     renewable resource supply requirements;                                                         |
| **•**     technological advances; and                                                                     |
| **•**     greater availability of natural gas-fired power generation, and other factors.                  |

 

The Federal Energy Regulatory Commission (FERC) has implemented and continues to propose regulatory changes to increase access to the nationwide transmission grid by utility and non-utility purchasers and sellers of electricity.  In addition, a number of states have implemented or are considering or currently implementing methods to introduce and promote retail competition.  Industry deregulation in some states has led to the disaggregation of some vertically integrated utilities into separate generation, transmission and distribution businesses.  Deregulation initiatives in a number of states may encourage further disaggregation.  As a result, significant additional competitors could become active in the generation, transmission and distribution segments of our industry, which could negatively affect our ability to expand our asset base.

 

In addition, the independent system operators who oversee many of the wholesale power markets have in the past imposed, and may in the future continue to impose price limitations and other mechanisms to address some of the volatility in these markets.  These types of price limitations and other mechanisms may adversely affect the profitability of generating facilities that sell energy into the wholesale power markets.  Given the extreme volatility and lack of meaningful long-term price history in some of these markets and the imposition of price limitations by independent system operators, we may not be able to operate profitably in all wholesale power markets.

 

| **ITEM 1B.** | **UNRESOLVED STAFF COMMENTS** |
|--------------|-------------------------------|

 

None.

 

| **ITEM 3.** | **LEGAL PROCEEDINGS** |
|-------------|-----------------------|

 

Information regarding our legal proceedings is incorporated herein by reference to the “Legal Proceedings” subcaption within Item 8, Note 11, “Commitments and Contingencies”, of our Notes to Financial Statements in this Annual Report on Form 10-K.

 

10

**PART II**

 

| **ITEM 5.** | **MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED** |
|-------------|------------------------------------------------------------|