UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

Commission file number 001-15565

SEMCO Energy, Inc.

248-702-6000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

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 [   ]

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. [   ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [   ]

The aggregate market value of the Registrant’s common stock held by non-affiliates as of June 30, 2003 was $102,700,535 based on 17,646,140 shares held by non-affiliates and the closing price of $5.82 on that day (New York Stock Exchange).

Number of outstanding shares of the Registrant’s common stock as of February 20, 2004: 28,139,218

Documents Incorporated by Reference:

Portions of Registrant’s definitive Proxy Statement (filed pursuant to Regulation 14A) with respect to Registrant’s May 24, 2004 Annual Meeting of Common Shareholders are incorporated by reference in Part III of this Form 10-K.

Table of Contents

TABLE OF CONTENTS

INFORMATION ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections of the registrant, SEMCO Energy, Inc. (the “Company”). Statements that are not historical facts, including without limitation, statements about the Company’s outlook, beliefs, plans, goals, and expectations, are forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue” or the negatives of these terms or variations of them or similar terminology. These statements are subject to potential risks and uncertainties and, therefore, actual results may differ materially. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, the Company cannot assure you that these expectations will prove to be correct. Important factors that could cause actual results to differ materially from the Company’s expectations include, but are not limited to, the following:

•

the effects of weather and other natural phenomena;

	•		the economic climate and growth in the geographical areas where the Company does business;
	•		the capital intensive nature of the Company’s business;
	•		increased competition within the energy industry as well as from alternative forms of energy;
	•		the timing and extent of changes in commodity prices for natural gas and propane;

•

the effects of changes in governmental and regulatory policies, including income taxes, environmental compliance and authorized rates;

	•		the Company’s ability to bid on and win construction contracts;
	•		the impact of energy prices on the amount of projects and business available to the Company’s construction services business;

•

the nature, availability and projected profitability of potential investments available to the Company;

•

the Company’s ability to remain in compliance with its debt covenants and accomplish its financing objectives in a timely and cost-effective manner in light of changing conditions in the capital markets;

•

the Company’s ability to consummate planned divestitures of certain of its businesses; and

•

the Company’s ability to effectively execute its strategic plan.

PART I

ITEM 1. BUSINESS

SEMCO ENERGY, INC.

SEMCO Energy, Inc. is a diversified energy and infrastructure services company headquartered in southeastern Michigan. It was founded in 1950 as Southeastern Michigan Gas Company. In 1977, Southeastern Michigan Gas Enterprises, Inc. was formed as a holding company, into which Southeastern Michigan Gas Company was transferred. On April 24, 1997, Southeastern Michigan Gas Enterprise’s name was changed to SEMCO Energy, Inc.

     SEMCO Energy, Inc. and its subsidiaries operate four reportable business segments: (1) gas distribution; (2) construction services; (3) information technology services; and (4) propane, pipelines and storage. The latter three segments are sometimes referred to together as the “diversified businesses.” Certain smaller subsidiaries or divisions of SEMCO Energy, Inc. are not part of the four previously mentioned business segments. Instead, they are included together in a category referred to as “Corporate and other.” For information on what constitutes a business segment, refer to Note 11 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. Reference to “the Company” in this document means SEMCO Energy, Inc. , SEMCO Energy, Inc. and its subsidiaries, individual subsidiaries or divisions of SEMCO Energy, Inc. or the business segments discussed above as appropriate in the context of the disclosure.

     During 2003, the Company entered into a definitive agreement to sell its wholly-owned subsidiary, Alaska Pipeline Company (“APC”). APC is part of the Company’s gas distribution business segment. Also, during the fourth quarter of 2003, the Company announced that its Board of Directors decided to pursue the sale of the Company’s construction services business. The Company began to actively market that business for sale during the first quarter of 2004. For further information regarding these items, refer to Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

GAS DISTRIBUTION

The Company’s gas distribution business segment consists of operations in Michigan and Alaska. The Michigan operation is sometimes referred to as “SEMCO Gas” and the Alaska operation is sometimes referred to as “ENSTAR.” These operations are referred to together as the “Gas Distribution Business.”

     SEMCO Gas operates as a division of SEMCO Energy, Inc. The ENSTAR operation includes ENSTAR Natural Gas Company, APC and Norstar Pipeline Company (“Norstar”). ENSTAR Natural Gas Company operates as a division of SEMCO Energy, Inc., while APC operates as a subsidiary of SEMCO Energy, Inc. and Norstar operates as a subsidiary of APC. As discussed previously, the Company has entered into a definitive agreement to sell APC. Norstar is not part of the pending sale of APC. Norstar began operations in 2002 and provides pipeline management and pipeline construction management services to non-affiliate customers in Alaska.

     The Gas Distribution Business distributes and transports natural gas to residential, commercial and industrial customers and is the Company’s largest business segment. The Company’s strategy for the Gas Distribution Business is to expand its distribution system in an economical manner through attachment of on-main and near-main potential customers within our existing service territories. The Company will also seek ways to capitalize on other market opportunities, including pipelines related to new power generation projects that may become available.

     Set forth in the table below is various financial and operating information for the Gas Distribution Business:

(a)

Degree days are a measure of coldness determined daily as the number of degrees the average temperature during the day in question is below 65 degrees Fahrenheit. Degree days for a particular period are determined by adding the degree days incurred during each day of that period. The Company determines the percent (%) that weather is warmer or colder than normal for a particular period by computing the deviation of actual degree days for that period from the average of degree days during the same periods in the prior fifteen years and dividing the deviation by such fifteen year average.

     All revenue generated by the Gas Distribution Business for the years ended December 31, 2003, 2002 and 2001 is from non-affiliate customers. Refer to Note 11 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K, for the operating revenues, operating income, assets and other financial information of the Gas Distribution Business for the past three years.

Rates and Regulation. The Gas Distribution Business is subject to regulation. The regulatory matters associated with gas distribution customers located in the City of Battle Creek, Michigan and surrounding communities are subject to the jurisdiction of the City Commission of Battle Creek (“CCBC”). The Michigan Public Service Commission (“MPSC”) has jurisdiction over the regulatory matters related to the Company’s remaining Michigan customers. Regulatory matters for gas distribution customers in Alaska are subject to the jurisdiction of the Regulatory Commission of Alaska (“RCA”). These regulatory bodies have jurisdiction over, among other things, rates, accounting procedures, and standards of service.

     For information on regulatory matters including recent regulatory orders, filings and rate cases, refer to Note 2 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

Gas Sales. Gas sales revenue is generated primarily through the sale and delivery of natural gas to residential and commercial customers. These customers use natural gas mainly for space heating purposes. Consequently, weather has a significant impact on sales. Given the impact of weather on this business segment, most of its gas sales revenue is earned in the first and fourth quarters of the calendar year. Revenues from gas sales accounted for 78%, 70% and 66% of consolidated operating revenues in 2003, 2002 and 2001, respectively.

     The Company’s aggregated transportation service (“ATS”) program, which was effective for all classes of Michigan gas sales customers from April 1, 1999 through March 31, 2002, provided gas sales customers the opportunity to purchase their gas from a third-party supplier, while allowing the Gas Distribution Business to continue charging the existing distribution fees and customer fees plus a gas load balancing fee. In an MPSC order issued in August 2002 the ATS program was replaced by the Gas Customer Choice Program and expanded over the years 2002, 2003 and 2004 such that by April of 2004 it will be available to all gas sale customers in the Company’s service area regulated by the MPSC. There were no customers taking service under the Gas Customer Choice Program at December 31, 2003. Refer to the Gas Distribution section in Item 7 of this Form 10-K, under the captions “Gas Sales Margin” and “Gas Transportation Revenue,” for further information regarding the impact of these programs on gas sales and transportation revenue.

Transportation. The Gas Distribution Business provides transportation services to its large-volume commercial and industrial customers. This service offers those customers the option of purchasing natural gas directly from producers or marketing companies while utilizing the Company’s gas distribution network to transport the gas to their facilities.

     APC owns and operates the only natural gas transmission lines in its service area that are operated for utility purposes. APC’s transmission system delivers natural gas from producing fields in southcentral Alaska to ENSTAR’s Anchorage-based gas distribution system. APC’s only customer is ENSTAR Natural Gas Company. The anticipated sale of APC will not impact the transportation revenue of the Gas Distribution Business. See Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information.

Customer Base. At December 31, 2003, SEMCO Gas had approximately 276,000 customers. The largest concentration of customers, approximately 115,000, is located in southeastern Michigan. The remaining Michigan customers are located in and around the following communities: Battle Creek, Albion, Holland, Three Rivers, Niles, Marquette and Houghton. The Michigan customer base is diverse and includes residential, commercial and industrial customers. The largest customers include power plants, food production facilities, paper processing plants, furniture manufacturers and others in a variety of other industries. The average number of customers in Michigan has increased by an average of approximately 1.9% annually during the past three years. By comparison, the most recent survey issued by the American Gas Association indicated that the customer growth rate for the U. S. gas distribution industry has averaged approximately 1.3% annually during the most recent three years included in the survey (1999-2001). However, average annual gas usage per customer has been decreasing slightly because new homes and appliances are much more energy efficient.

     At December 31, 2003, ENSTAR had approximately 115,000 customers in and around the Anchorage, Alaska area including the communities of Big Lake, Bird Creek, Butte, Chugiak, Eagle River, Eklutna, Girdwood, Houston, Indian, Kenai, Knik, Nikiski, Palmer, Peters Creek, Portage, Sterling, Soldotna, Wasilla and Whittier. ENSTAR is the sole distributor of natural gas to the greater Anchorage metropolitan area, and its service area encompasses over 50% of the population of Alaska. ENSTAR has two types of customers: gas sales and transportation. Gas sales customers are primarily residential and commercial. ENSTAR provides transportation service, on behalf of gas producers and gas marketers, to power plant sites, a liquified natural gas plant, an ammonia plant, and approximately 1,300 commercial locations. The average number of customers at ENSTAR has increased by an average of approximately 3.1% annually during the past three years.

Competition. Competition in the gas sales market arises from alternative energy sources such as electricity, propane and oil. However, this competition is generally inhibited because of the time, inconvenience and investment for residential and commercial customers to convert to an alternate energy source when the price of natural gas fluctuates. ENSTAR supplies natural gas in its service territory at prices that currently preclude substitution of alternative energy sources. At present, the residential energy cost of natural gas in Alaska is less than half the cost of fuel oil, the next most economical energy choice.

ENSTAR’s additional supply requirements through 2007. Unocal’s estimated delivery requirements are 6.7 Bcf in 2004, 9.6 Bcf in 2005, 12.8 Bcf in 2006 and 15.8 Bcf in 2007. In any year after 2007, Unocal’s minimum supply commitment to ENSTAR is 3 Bcf less than the prior year’s commitment. Under the terms of the agreement, Unocal must advise ENSTAR each October of Unocal’s commitments for the subsequent five years. Gas supplied under the contract is priced annually according to a 36-month daily average price of certain traded natural gas futures contracts, subject to a floor price provision that is similar to the price of the Moquawkie contract. The contract also provides for reimbursement to the producer of severance taxes and certain transportation costs. The contract received final approval by the RCA in January 2002.

     As noted above, Unocal has committed to supply ENSTAR’s additional supply requirements, above the delivery obligations specified in the Marathon, Beluga and Moquawkie Contracts, through 2007. After that time supplies will still be available under these contracts in accordance with their terms, but at least a portion of ENSTAR’s requirements are expected to be satisfied outside the terms of these contracts, as currently in effect.

     ENSTAR’s gas supply source, primarily though the Marathon, Beluga, Moquawkie and Unocal Contracts, is confined to the Cook Inlet area with no direct access to other natural gas pipelines. However, the Cook Inlet area is home to major gas producing fields. As of January 1, 2003, the Cook Inlet had approximately 2.0 trillion cubic feet (“Tcf”) of total proved gas reserves according to the Alaska Department of Natural Resources Division of Oil and Gas 2003 Annual Report. Based on the Department’s reported 2002 net production of 210 Bcf, there is a reserve life of approximately 10 years. There is ongoing exploration for gas in the Cook Inlet and a new natural gas discovery of an estimated 75 to 100 Bcf of recoverable reserves was announced in November 2003. An additional 2.3 Tcf of undiscovered gas in the Cook Inlet area has been estimated by the United States Geological Survey and Minerals Management Service.

Environmental Matters. The Gas Distribution Business currently owns seven Michigan sites which formerly housed manufactured gas plants. In the earlier part of the 20th century, gas was manufactured from processes using coal, coke or oil. By-products of this process have left some contamination at these sites. The Gas Distribution Business is in compliance with State of Michigan rules which require companies to take “due care” steps to insure that the sites are safe. The Gas Distribution Business has closed a related site with the approval of the appropriate regulatory authority in the State of Michigan and has developed plans and conducted preliminary field investigations at two other sites. For further information, refer to Note 13 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

DIVERSIFIED BUSINESSES

The Company’s diversified business operations are organized as subsidiaries of SEMCO Energy, Inc. The diversified businesses are complementary to the Company’s core gas distribution operations. Specifically the Company’s information technology services business uses existing technical infrastructure and services required to support the Gas Distribution Business for external customers, whereby the Company realizes additional revenue and income. The following table shows operating revenues for each of the diversified businesses, including intercompany revenues, for 2001 through 2003:

     Refer to Note 11 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K, for each of the diversified business’ operating revenues, operating income, assets and other financial information for the past three years. As previously discussed, in the fourth quarter of 2003, the Company announced that its Board of Directors decided to pursue the sale of the Company’s construction services business. The Company began to actively market that business for sale during the first quarter of 2004. For further information regarding the intended sale, refer to Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

CONSTRUCTION SERVICES

The Company’s construction services segment (“Construction Services”) operates in the mid-western, southern and southeastern areas of the United States and has offices in Georgia, Iowa, Michigan and Texas. Its primary service is the installation and replacement of underground natural gas main and service lines and the installation and upgrade of compressor stations.

     Construction Services had operating revenues, excluding intercompany transactions, of $72.4 million, $107.4 million and $117.2 million in 2003, 2002 and 2001, respectively. These operating revenues accounted for 13%, 22% and 26% of consolidated operating revenues in 2003, 2002 and 2001, respectively. Construction Services’ business is seasonal in nature. Most of the profits from this segment are made during the summer and fall months. Construction Services generally incurs losses during the winter months when underground construction is inhibited by weather. General economic conditions also have an impact on the amount and type of work

available for Construction Services. During economic downturns, new housing starts often decline, which leads to a decrease in new gas service line installations. Customers may also reduce amounts typically spent for non-essential construction projects, which also leads to a decrease in work available to Construction Services. Construction Services competes with a variety of other underground construction contractors ranging in size from small local contractors to large national companies. The basis of the competition is generally price and service.

INFORMATION TECHNOLOGY SERVICES

The information technology (“IT”) services business, under the Aretech Information Services name (“Aretech”), began operations in April 2000 and provides IT infrastructure outsourcing services, and other IT services with a focus on mid-range computers, particularly the IBM I–Series (or AS-400) platform. The Company’s other business segments accounted for approximately 74% of Aretech’s revenues during 2003. However, the Company believes there is a growing trend by small to mid-sized companies to outsource certain information technology functions. The Company also believes the trend towards outsourcing large mainframe computers is now moving to include mid-range computers. The Company’s goal is to capitalize on its internal expertise in this area and position itself to take advantage of these trends. Aretech’s business strategy is focused on IT infrastructure outsourcing services.

     Aretech competes with businesses that range from small local firms to large international companies, as well as the in-house IT departments of potential customers. Aretech is an early provider in the mid-range computer outsourcing market and, as the market expands, it is likely that new competition will arise from other firms that possess the necessary technical skills.

PROPANE, PIPELINES AND STORAGE

The Company’s pipelines and storage business consists of three pipelines and a gas storage facility, all of which are located in Michigan. The Company has a partial ownership interest in one of the pipelines and an equity interest in the gas storage facility. Refer to Item 2 of this Form 10-K for additional information on each pipeline and storage facility such as its location and customers. Management believes that the gas pipeline and storage operations could experience opportunities for growth with the increasing demand for natural gas. As gas markets expand, management believes that the quantity of gas moving through the Great Lakes Region will increase, which could create additional pipeline and storage opportunities.

     The Company also owns a propane distribution business known as “Hotflame.” Hotflame supplies more than 4 million gallons of propane annually to retail customers in Michigan’s upper peninsula and northeast Wisconsin. Because propane is used principally for heating, most of the operating income for the propane business is generated in the first and fourth quarters of the calendar year. Propane is transported easily in pressurized containers and is generally the fuel used in rural areas where natural gas pipelines and distribution systems do not exist or are not economical to build. The Company has access to a variety of propane suppliers including Inergy Propane LLC, NGL Supply, Inc., and BP Canada Energy Marketing Corp. The propane operation competes with other energy sources such as natural gas, fuel oil, electricity and other regional and national propane providers. The basis of the competition is generally price and service.

MISCELLANEOUS INFORMATION

The Company had approximately 1,436 full-time employees at December 31, 2003. Approximately 697 of the employees were part of collective bargaining units and approximately 859 of the employees were employed by Construction Services. As discussed previously, the Company’s Board of Directors has decided to pursue the sale of Construction Services.

     The Company maintains a website on the Internet at address http://www.semcoenergy.com. The Company makes available free of charge on or through its website, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (“SEC”). This reference to the Company’s Internet address shall not, under any circumstances, be deemed to incorporate the information available at such Internet address into this Form 10-K. The information available at the Company’s Internet address is not part of this Form 10-K or any other report filed by the Company with the SEC. The information the Company files with the SEC can also be obtained on the SEC’s website on the Internet at address http://www.sec.gov.

ITEM 2.	PROPERTIES

GAS DISTRIBUTION

The gas delivery system of SEMCO Gas included approximately 160 miles of gas transmission pipelines and 5,489 miles of gas distribution pipelines at December 31, 2003. The pipelines are located throughout the southern half of Michigan’s lower peninsula (centered in and around the cities of Port Huron, Albion, Battle Creek, Three Rivers, Niles and Holland) and also in the central and western areas of Michigan’s upper peninsula. At December 31, 2003, ENSTAR’s gas delivery system included approximately 396 miles of gas transmission pipelines and 2,460 miles of gas distribution pipelines. ENSTAR’s pipelines are located in Anchorage and other communities around the Cook Inlet area of Alaska.

     The distribution system and service lines of the Gas Distribution Business are, for the most part, located on or under public streets, alleys, highways and other public places, or on private property not owned by the Company with permission or consent, except to an inconsequential extent, of the individual owners. The distribution systems and service lines located on or under public streets, alleys, highways and other public places were all installed under valid rights and consents granted by appropriate local authorities.

     The Gas Distribution Business owns underground gas storage facilities in eight depleted salt caverns and three depleted gas fields, together with measuring, compressor and transmission facilities. The storage facilities are all located in Michigan. The aggregate working capacity of the storage system is approximately 5.1 Bcf.

     The Gas Distribution Business also owns meters and service lines, gas regulating and metering stations, garages, warehouses and other buildings necessary and useful in conducting its business. In addition, it leases a significant portion of its transportation equipment and certain buildings.

CONSTRUCTION SERVICES

The tangible properties of Construction Services include equipment required for the installation, repair or replacement of compressor stations and underground natural gas main and service lines. This includes primarily equipment necessary for excavation such as backhoes, trenchers, directional drills and dump trucks. This equipment can be driven or carried on trailers from one worksite to another. The largest concentrations of Construction Services’ equipment at December 31, 2003 were located in Georgia, Iowa, Michigan and Texas.

INFORMATION TECHNOLOGY SERVICES

The properties of Aretech consist of a building, leasehold improvements, office equipment, telecommunications equipment and computer equipment. The building is located in Marysville, Michigan and the remaining property is located in that building and in leased office space in Port Huron, Michigan.

PROPANE, PIPELINES AND STORAGE

The principal properties of this business segment include interests and operations in propane distribution, natural gas transmission and an underground gas storage system.

     The Company owns a 50% equity interest in the Eaton Rapids Gas Storage System (“ERGSS”). The Company’s equity investment in the ERGSS totaled approximately $5.3 million at December 31, 2003. This system, located near Eaton Rapids, Michigan, became operational in March 1990 and consists of approximately 12.8 Bcf of underground storage capacity. The Gas Distribution Business leases 6.5 Bcf of the capacity.

     The property of the propane distribution operation consists primarily of pressurized propane storage tanks used by customers to store propane purchased from the Company and trucks for transporting propane. The Company also owns large propane storage tanks that allow the Company to store up to 258,000 gallons of propane inventory. The propane distribution property is all located in Michigan’s upper peninsula and northeast Wisconsin.

     The following table sets forth the pipeline operations wholly or partially owned by the Company, the total net property of each system, and the Company’s ownership percentage and net property in each system at December 31, 2003:

     The Litchfield Lateral is a 31-mile pipeline located in southwest Michigan. The line, which is leased entirely to ANR Pipeline Company, links the ERGSS with interstate pipeline supplies. The Litchfield Lateral began operations in July 1992.

     The Greenwood Pipeline, an 18.5-mile pipeline constructed in 1991, connects an interstate pipeline with the DTE Energy Greenwood Power Plant located near Port Huron, Michigan. The pipeline provides transportation services to the Greenwood Power Plant and to the Gas Distribution Business’ service area north of Port Huron. In 1999, the pipeline received upgrades, which allowed the Company to serve additional peak load generation units at the Greenwood site. The Greenwood Pipeline has a capacity of 271 million cubic feet (MMcf”) per day. There is an agreement between the Company and DTE Energy whereby DTE Energy has contracted for 259 MMcf per day, of this capacity. The Company also has an agreement with its Gas Distribution Business for the remainder (12 MMcf per day) of the pipeline capacity.

     The Eaton Rapids Pipeline is a 37-mile pipeline that provides direct delivery of gas from the ERGSS to the Gas Distribution Business’ systems in Battle Creek and Albion, Michigan. The original 30-mile line was purchased in 1986. The seven-mile extension to the ERGSS was completed in 1990.

CORPORATE AND OTHER

The properties of the Corporate and other segment include leasehold improvements, office furniture, office equipment, computers and computer systems. These properties are located in a leased office building located in Port Huron and leased office space located in Farmington Hills, Michigan.

ITEM 3.  LEGAL PROCEEDINGS

In the normal course of business, the Company may be a party to certain lawsuits and administrative proceedings before various courts and government agencies. These lawsuits and proceedings may involve personal injury, property damage, contractual issues and other matters. Management cannot predict the ultimate outcome of any pending or threatening litigation or of actual or possible claims. However, management believes resulting liabilities, if any, will not have a material adverse impact upon the Company’s financial position or results of operations. Notwithstanding the above statement, in late March 2003 the Company was served a complaint in a putative class-action lawsuit alleging that the approximately 30 defendants, including SEMCO Energy and SEMCO Energy Ventures, Inc., engaged in practices that violated the Sherman Anti-Trust Act and tortuously interfered with the business of the plaintiffs. In October 2003, the plaintiff voluntarily dismissed this action in the jurisdiction in which the action was originally filed and gave the Company notice that it would refile the complaint in a different jurisdiction. In November 2003, the plaintiff filed a separate but similar lawsuit against SEMCO Energy Services, Inc. The Company is considering potential legal and factual defenses to these claims and intends to vigorously defend itself in this action. Although the Company cannot make assurances, management currently believes that this suit will not have a material adverse effect on its business or results of operations.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of 2003.

PART II

ITEM 5.	MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

SEMCO Energy, Inc. common stock began trading on the New York Stock Exchange on January 6, 2000 with the trading symbol “SEN.” Prior to this date the Company was traded on the Nasdaq Stock Market with the trading symbol “SMGS.” The table below shows the reported high and low sales prices of the Company’s common stock during 2003 and 2002, as reported on the New York Stock Exchange.

     At February 20, 2004, the closing price of the Company’s common stock was $5.50 per share and the Company had 28,139,218 shares of common stock outstanding and had 8,866 registered common shareholders.

DIVIDENDS

For information regarding dividends, see Notes 4 and 15 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K and Selected Financial Data in Item 6 of this Form 10-K.

UNREGISTERED SECURITIES

During the fourth quarter of 2003, the Company issued an aggregate of 2,441 shares of unregistered common stock, valued at approximately $12,000, to members of the Company’s Board of Directors pursuant to three equity compensation plans for Board members, which are described in the Company’s definitive Proxy Statement (filed pursuant to Regulation 14A), incorporated by reference in Item 12 of this 10-K Report. The transactions were exempt from registration under Section 4(2) of the Securities Act of 1933. Information about the issuance of unregistered common stock is included in the Company’s quarterly reports on Form 10-Q.

ITEM 6.  SELECTED FINANCIAL DATA

(a)		At year end
(b)		Includes current maturities of long-term debt
(c)		Includes debt exchange and extinguishment expenses of $24,030,000.
(d)		Includes a special one-time dividend of $0.05 per share.

ITEM 7.	MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company had a net loss of $30.0 million for 2003, net income of $8.9 million for 2002 and a net loss of $6.4 million for 2001. The most significant items contributing to the loss for 2003 were a $17.6 million charge ($15.6 million, net of income taxes) for impairment of goodwill at Construction Services, a $2.8 million charge ($1.8 million, net of income taxes) for the impairment of equipment at Construction Services and an expense of $24.0 million ($15.6 million, net of income taxes) for debt exchange and extinguishment costs. The charges for impairment of goodwill and equipment are reflected in operating expenses in the Company’s 2003 Consolidated Statement of Operations, while the debt exchange and extinguishment costs are reflected in non- operating expenses. Refer to Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information on the impairment charges. For further information on debt exchange and extinguishment costs, refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. The other primary factors contributing to the decrease in earnings were an increase in operating losses from Construction Services (exclusive of the impairment charges discussed above) and an increase in interest expense, both of which are discussed in greater detail on the following pages.

     The results for 2001 also include several unusual items, including losses associated with the Company’s discontinued engineering operations, restructuring charges and asset impairments. These items are discussed in more detail below. Income (loss) from continuing operations was $(30.0) million, $8.9 million and $(0.2) million for 2003, 2002, and 2001, respectively. Earnings (loss) per share from continuing operations was $(1.34), $0.48 and $(0.01) for 2003, 2002 and 2001, respectively. All references to earnings or loss per share (“EPS”) in Management’s Discussion and Analysis are on a diluted basis. For information related to the calculation of diluted EPS, refer to Note 10 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

     As discussed above, operating results for 2001 include unusual items, including losses associated with discontinued operations, restructuring charges and asset impairments. During the fourth quarter of 2001, the Company began plans to restructure and redirect its business strategy. The divestiture of the Company’s engineering services business was part of the 2001 restructuring plan and has been accounted for as a discontinued operation. The operating loss, net of income taxes, from the discontinued operations was $1.1 million for 2001. In the fourth quarter of 2001, the Company also recorded a loss of $5.0 million, net of income taxes, for the estimated loss the Company expected to incur on the disposal of its engineering business segment, including estimated losses from operations during the phase-out period. In November 2002, the Company sold its engineering services business.

     In addition to the losses from discontinued operations, the Company’s results for 2001 include restructuring charges, asset impairments and certain other unusual items that reduced net income by $5.1 million, or $0.28 per share. The restructuring charges and asset impairments account for $4.0 million of the charges, net of income taxes, and include severance expense, costs associated with terminating leases, write-downs of certain construction operations and other related expenses associated with the redirection of the Company’s business strategy. The other unusual items account for $1.1 million of the charges, net of income taxes, and include the write-off of certain assets and an increase in reserves for certain contingencies.

     The 2001 restructuring charges and asset impairments ($6.1 million before income taxes) are reflected in operating expenses in the Company’s 2001 Consolidated Statement of Operations. The other unusual items are reflected in both operating expenses ($0.9 million before income taxes) and non-operating expenses ($0.6 million before income taxes). For 2001 business segment reporting, the operating income of the Gas Distribution Business includes $1.1 million of the charges; the operating loss of Construction Services includes $3.3 million of the charges; and $2.6 million is reflected in the operating loss of the Corporate and other business segment.

     The business segment analysis and other discussions on the next several pages provide additional information regarding the differences in operating results when comparing 2003, 2002 and 2001. The following table shows the Company’s consolidated operating results for the past three years.

THE IMPACT OF WEATHER

The Company’s largest business segment is natural gas distribution and, as a result, temperature fluctuations have a significant impact on operating results. The Company believes that information about normal temperatures is useful for fully understanding the Gas Distribution Business. The Company’s budgets, forecasts and business plans are prepared by management using expected gas consumption under normal weather conditions as a central assumption. The regulatory bodies which have jurisdiction over the rates charged by the Gas Distribution Business use weather-normalized data to set customer rates and to establish authorized rates of return. Therefore, information about the estimated impact of warmer or colder than normal weather is helpful in understanding the expected earnings of the Company.

     The Company estimates the impact of weather on its operating results by comparing actual gas consumption per customer during a period to the average of weather-normalized customer gas consumption during previous periods. The difference is multiplied by the average number of customers during the period to arrive at the total estimated increase or decrease in consumption associated with weather. The total increase or decrease in consumption is multiplied by the actual margin per unit of consumption during the period to arrive at the estimated impact of weather on operating results for the period. The weather-normalized customer consumption used in this calculation is determined by multiplying actual customer gas consumption during a particular period by a ratio, the numerator of which is an average of degree days during the same periods in the prior fifteen years, and the denominator of which is the actual degree days for that period.

     The Company determines the percent (%) that weather is warmer or colder than normal for a particular period by computing the deviation of actual degree days for that period from the average of degree days during the same periods in the prior fifteen years and dividing the deviation by such fifteen year average. Degree days are a measure of coldness determined daily as the number of degrees the average temperature during the day in question is below 65 degrees Fahrenheit. Degree days for a particular period are determined by adding the degree days incurred during each day of that period.

     Weather was approximately 8.0%, 7.8% and 3.0% warmer than normal in ENSTAR’s customer service area during 2003, 2002 and 2001, respectively. In SEMCO Gas’s customer service area, weather was approximately 4.7% colder than normal during 2003 and approximately 0.9% and 11.5% warmer than normal during 2002 and 2001, respectively. The Company has estimated that the combined impact of warmer or colder than normal temperatures in Alaska and Michigan reduced the gas sales margin of the Gas Distribution Business by approximately $2.7 million, $5.9 million and $8.4 million in 2003, 2002 and 2001 respectively. Adjusted for income taxes, the estimated impact would have been approximately $1.5 million, $3.6 million and $5.3 million, respectively.

SUMMARY OF BUSINESS SEGMENTS

As discussed previously, the Company operates four reportable business segments: (1) gas distribution; (2) construction services; (3) information technology services; and (4) propane, pipelines and storage. Each business segment is discussed separately on the following pages. The Company evaluates the performance of its business segments based on operating income. Operating income does not include income taxes, interest expense, discontinued operations, or other non-operating income and expense items. A review of the non-operating items follows the business segment discussions. The business segment discussions should be read in conjunction with Item 1 of this Form 10-K, which provides information regarding competition and other business matters. Refer to Note 11 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information regarding each business segment and a summary of financial information by business segment.

GAS DISTRIBUTION

Gas Sales Revenue. The Company’s gas sales revenue was $427.9 million, $335.7 million and $295.4 million for 2003, 2002 and 2001, respectively. The primary factor causing the large change in gas sales revenue from year-to-year is the change in the cost of gas sold. Since April 1, 2002, a significant portion of the Company’s cost of gas sold was accounted for under regulator-approved GCR mechanisms, which allow for the adjustment of rates charged to customers for increases and decreases in the cost of gas purchased. Under the GCR mechanisms, customers are charged rates that allow the company to recoup its cost of gas purchased. As a result, for any increase or decrease in cost of gas sold, there is a corresponding increase or decrease in gas sales revenue. Refer to the caption “Cost of Gas” in Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information on cost of gas and the GCR mechanism. Management generally evaluates changes in gas sales margin rather than gas sales revenue due to the large fluctuations caused by changes in cost of gas sold. Please refer to the gas sales margin section below for a detailed variance analysis.

Gas Sales Margin. During 2003, gas sales margin increased by $3.8 million (or 3.3%) when compared to 2002. The increase was due in part to the addition of new customers, which increased gas sales margin by approximately $2.2 million, and an increase in customer gas consumption, which increased gas sales margin by approximately $0.6 million. Approximately $0.4 million of the gas sales margin increase was due to the impact of all remaining customers in the Company’s aggregated transportation service (“ATS”) program switching back to gas sales service (discussed in more detail below) when the ATS program ended in March 2002. Changes in customer rates and gas cost savings increased gas sales margin by approximately $0.1 million and a decrease in unaccounted-for gas (discussed in more detail below) also increased gas sales margin by approximately $0.3 million. The remainder of the change in gas sales margin between 2003 and 2002 was due to other miscellaneous factors.

     During 2002, gas sales margin increased by $4.8 million (or 4.4%) when compared to 2001. The increase was due primarily to the addition of new customers, which increased gas sales margin by approximately $2.6 million, customers switching from the ATS program back to general gas sales service, which increased gas sales margin by approximately $0.9 million, and changes in customer rates and gas cost savings, which increased gas sales margin by approximately $0.7 million. A decrease of $1.0 million in unaccounted-for gas also contributed to the increase in gas sales margin. These factors were offset partially by a decrease in customer consumption, which decreased gas sales margin by approximately $0.4 million. The remainder of the change in gas sales margin between 2002 and 2001 was due to other miscellaneous factors.

     Changes in customer rates and gas cost savings directly impact gas sales margin. A reduction in customer rates at ENSTAR was required by an order issued by the RCA based on an RCA rate review. The rate reduction took effect in September 2002 and generally reduces annual gas sales margins at ENSTAR by approximately 3.6%. There was an increase in customer rates effective in May 2003, for customers located in the Company’s service areas regulated by the MPSC (“MPSC customers”). The rate increase for MPSC customers was the result of a settlement agreement reached with the MPSC. The settlement took effect May 3, 2003 and generally increases annual gas sales margins generated from MPSC customers by approximately 4.8%.

     Under the terms of a third-party natural gas supply and management agreement for SEMCO Gas, certain gas cost savings were passed through to the Company. On March 31, 2002 this agreement expired and a new agreement covering our customers located in jurisdictions regulated by the MPSC was executed. This new agreement does not contain similar provisions for gas cost savings. As a result, 65% of the gas cost savings realized during the first three months of 2002 was non-recurring. A new agreement covering our customers located in the jurisdictions regulated by the CCBC includes similar provisions for gas costs savings and is effective from April 1, 2002 through March 31, 2005. For further information regarding the Company’s natural gas supply and management agreements, gas cost savings and the GCR pricing mechanism, refer to the caption “Cost of Gas” in Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

     The ATS program was effective for all classes of gas sales customers from April 1, 1999 through March 31, 2002. A program similar to the ATS program, referred to as the Gas Customer Choice program, was opened to customers on October 1, 2002. These programs provide Michigan gas sales customers the opportunity to purchase their gas from a third-party supplier, while allowing the Gas Distribution Business to continue charging the existing distribution fees and customer fees. Distribution and customer fees associated with customers who switched to third-party gas suppliers were recorded in gas transportation revenue rather than gas sales revenue because the Company acted as a transporter for those customers. During 2001 and 2002, certain ATS customers switched back to the Company’s general gas sales service because the third-party suppliers they were utilizing stopped participating in the ATS program primarily due to significant fluctuations in the market price of natural gas. When the ATS program ended on March 31, 2002, all remaining ATS customers became gas sales customers because they were turned back to the Company by their third-party gas suppliers. Currently, there are no third-party gas suppliers providing service under this program in our customer service territories. If any third-party gas supplier in our service territories were to begin participating in the Gas Customer Choice program, we would record the distribution and customer fees associated with such customers as gas transportation revenue rather than gas sales revenue.

     Unaccounted-for gas is a term used in the natural gas distribution industry which refers to the difference between the gas that is measured and injected into the Company’s gas distribution system and the amount of gas measured at customer meters. Typically there is more gas injected into a gas utility’s distribution system than is actually measured as sold or transported through customer meters. There are a number of reasons for this lost gas including, but not limited to, gas used by compressor stations along the system, measurement errors, and small leaks. The annual unaccounted-for gas volumes of the Gas Distribution Business typically range from 0.5% to 1.4% of total gas volumes sold and transported.

     During 2003, the Company’s average number of gas sales customers increased by 8,462. However, 970 of the 2003 increase was caused by customers switching from the ATS program back to general gas sales service. The remaining increase of approximately 7,500 represents the average number of new gas sales customers added to the Company’s distribution system in 2003. During 2002, the Company’s average number of gas sales customers increased by 11,558. However, 3,200 of the 2002 increase was caused by customers switching from the ATS program back to general gas sales service. The remaining increase of approximately 8,400 represents the average number of new gas sales customers added to the Company’s distribution system in 2002.

     Changes in customer gas consumption from one period to the same period of a prior year is attributable primarily to the impact of changes in temperatures between the periods. However, other factors including energy conservation by customers, the increasing use of more energy efficient gas furnaces and appliances, the addition of new energy efficient homes to the Company’s gas distribution system and the price of natural gas also contribute to changes in customer gas consumption. However, the impact on gas margin of these additional factors is believed to be fairly small from one period to the next.

Gas Transportation Revenue. In 2003, gas transportation revenue increased by $2.0 million when compared to 2002. The primary causes of the increase were an increase in standard transportation volumes at ENSTAR partially offset by the impact of the rate reduction at ENSTAR and ATS customers switching from the ATS program back to gas sales service in Michigan in the first quarter of 2002. Standard transportation volumes and revenues relate to large volumetric customers that are billed using standard transportation tariffs instead of the monthly service fees used for the ATS program. As discussed previously, under the ATS program, the Company charged ATS customers the same distribution fees and customer fees that were charged to gas sales service customers.

     In 2002, gas transportation revenue decreased by $0.2 million when compared to 2001. The primary factors contributing to this decrease were a decrease in transportation volumes for power companies in Alaska and the impact of ATS customers switching from the ATS program back to gas sales service in Michigan. These items were partially offset by an increase in industrial and commercial transportation volume when compared to 2001.

Other Operating Revenue. During 2003, other operating revenue increased by $3.3 million when compared to 2002. The increase was due in part to a $2.5 million increase in revenues from Norstar, the Company’s pipeline management subsidiary. The remainder of the increase was due primarily to an increase in miscellaneous services fee revenues and late payment fee revenues, offset partially by a reduction in ATS balancing fees as a result of remaining ATS customers switching back to gas sales service in the first quarter of 2002. During 2002, other operating revenue increased by $0.8 million, when compared to 2001. The increase was due primarily to revenues from Norstar’s first year of operation and fees on new transmission pipelines in service in Michigan, offset partially by a reduction in ATS balancing fees as a result of ATS customers switching back to gas sales service. Balancing fees are those fees associated with our cost for maintaining transportation and storage assets used for the daily balancing of supply on our Michigan distribution system. Balancing fees were charged to ATS customers at a rate of $0.25 per Mcf.

Operating Expenses. During 2003, operating expenses increased by $9.1 million (or 10.6%) when compared to 2002. The increase is comprised of a $8.6 million increase in operation and maintenance expense, a $0.2 million increase in depreciation expense and a $0.3 million increase in general business taxes. The increase in operation and maintenance expense is due primarily to a $2.1 million increase in expenses at Norstar, approximately $3.5 million in higher employee benefit costs, including pension expense, health care costs and retiree medical costs, a $1.5 million increase in commercial insurance costs and a $1.5 million increase in uncollectible customer accounts. The increase in depreciation expense was due primarily to additional property, plant and equipment placed in service, offset partially by lower depreciation rates approved in the recent MPSC rate case. The increase in general business tax expense is due primarily to property taxes on additional property, plant and equipment placed in service.

     During 2002, operating expenses of the Gas Distribution Business decreased by $3.4 million (or 3.8%) when compared to 2001. A restructuring charge recorded in December 2001, most of which was made up of employee severance expense associated with workforce reductions, accounted for $1.1 million of the decrease for 2002. The remainder of the decrease was due to a number of offsetting factors. Amortization expense decreased by $3.6 million when compared to 2001. The decrease was due to the elimination of goodwill amortization as a result of the adoption of SFAS 142. For further information on SFAS 142 and its impact on goodwill, see Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. Operation and maintenance expense decreased by $0.8 million due primarily to general cost cutting measures and the impact of a reduction in workforce and other cost reductions related to the Company’s redirected business strategy, offset partially by expenses from Norstar’s first year of operation, higher employee benefit costs, including pension expense, health care costs and retiree medical costs and increased maintenance costs. Property and other taxes increased by $0.3 million, due primarily to property taxes on additional property, plant and equipment placed in service. Depreciation expense increased by $1.7 million, also due to additional property, plant and equipment placed in service.

Regulatory, Environmental and Other Matters. For further information regarding regulatory matters and the application of the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) 71, “Accounting for the Effects of Certain Types of Regulation,” refer to Notes 2 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K and the “Critical Accounting Policies” section near the end of Management’s Discussion and Analysis. For information regarding environmental matters and property tax litigation, refer to Note 13 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. Refer to the section titled “Gas Distribution” in Item 1 of this Form 10-K for information on competition in this business segment. As discussed previously, the Company has entered into a definitive agreement to sell Alaska Pipeline Company, which is a component of ENSTAR, for $95 million. For further information regarding the definitive agreement, refer to Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

CONSTRUCTION SERVICES

Operating Revenues. Construction Services’ revenues decreased to $83.5 million during 2003, a $35.8 million (or 30%) decrease from 2002. The decrease was due primarily to a significant reduction in work levels when compared to last year. During the last half of 2002, several high margin customers of the southern division of Construction Services delayed projects. These delays continued throughout 2003 and significantly reduced revenues. In addition, the cessation of construction operations in certain unprofitable regions of the mid-western division also contributed to the decrease in revenues. Construction Services bid on numerous projects in 2003 but did not experience the expected level of success in being awarded these projects due to the increased competition for the supply of work in the industry.

     Construction Services’ revenues decreased to $119.3 million during 2002, a $7.0 million (or 6%) decrease from 2001. The decease during 2002 was due in part to customers in the northern regions of the country delaying or canceling projects in 2002 in light of the generally depressed economy. Operating revenues in the southern region of the country were up significantly during the first half of 2002, due to large projects in that region. However, as discussed above, during the second half of 2002, several customers in the southern region of the country also began delaying projects.

Operating Income. Construction Services had an operating loss of $28.5 million for 2003, compared to operating losses of $2.4 million for 2002 and $1.4 million in 2001. The results for 2003 include the $17.6 million goodwill impairment charge and the $2.8 million equipment impairment charge discussed previously. Exclusive of these charges, the operating loss increased in 2003 when compared to 2002, by approximately $5.6 million. This increase in operating loss was due primarily to the same items discussed above which caused the decrease in operating revenues during 2003. Customers have delayed or cancelled projects. This decrease in market demand increased competition for the supply of available work, which also caused a decrease in margins during 2003. The southern division of Construction Services also experienced unprecedented rainfall during the second quarter of 2003, which contributed to the decrease in operating results by interrupting work execution for extended periods of time and lowering productivity. In addition, colder than normal temperatures in the mid-western regions of the United States kept frost levels deep during the entire first quarter of 2003, which inhibited construction activity and lowered productivity levels during that period. These items were offset slightly by gains on equipment sales in 2003 compared to losses on sales in 2002.

     Construction Services had an operating loss of $2.4 million for 2002, compared to an operating loss of $1.4 million for 2001. Excluding restructuring charges, asset impairments and other unusual charges of $3.3 million, Construction Services had operating income of $1.9 million in 2001. The restructuring and impairment charges and other unusual items include the write-down of goodwill and fixed assets of certain construction operations, severance expense and other related charges.

     The operating loss of $2.4 million for 2002 represents a decline of $4.3 million from the $1.9 million of operating income, excluding unusual charges, reported for 2001. The decrease is due primarily to reduced construction activity during all of 2002 in the northern region of the country and during the last half of 2002 in the southern region of the country. In addition, the Company experienced lower than expected margins on some of the work performed and higher than anticipated costs on some projects. As discussed above, the Company believes that the softening economy caused many customers to delay or cancel certain construction projects, which changed the mix of work available to Construction Services. The mix of work included more lower-margin work at certain business units because of the competition for the limited supply of available work. The reduced construction activity also eroded margins because of the time lag required to reduce the staffing levels and other fixed costs, which were required for the previously higher level of revenues. Losses on the sale of equipment also contributed to the decrease in operating results in 2002. These factors were offset partially by operating income generated from the increase in construction projects in the southern regions of the United States during the first half of 2002.

Other Matters. As discussed previously, during the fourth quarter of 2003, the Company’s Board of Directors instructed management to pursue the sale of Construction Services. Refer to Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information. Refer the section titled “Construction Services” in Item 1 of this Form 10-K for information on competition and the impact of the U.S. economy on this business segment.

INFORMATION TECHNOLOGY SERVICES

Operating Revenues. Operating revenues for Aretech, the Company’s IT business, were $9.0 million, $9.6 million, and $10.3 million in 2003, 2002 and 2001, respectively. Of these amounts $6.7 million, $7.6 million and $9.3 million for 2003, 2002 and 2001, respectively, represent sales to SEMCO affiliates. The decrease in revenues in 2003, when compared to 2002, was due primarily to fewer special projects with affiliate customers and lower pass-through costs, offset partially by an increase in business with non-affiliates. These were also the primary factors contributing to the decrease in revenues in 2002, when compared to 2001. The Company refers to projects that are in addition to a base service contract between Aretech and other SEMCO affiliates as special projects.

Operating Income. Operating income for Aretech was $0.5 million for 2003, $0.6 million for 2002 and $0.4 million for 2001. The decrease in 2003, when compared to 2002, was due to an increase in depreciation expense and a loss on the sale of equipment, offset partially by decreases in administrative costs and business taxes. The increase in 2002, when compared to 2001, was due primarily to an increase in business with non-affiliate customers and a decrease in indirect operating expenses, particularly marketing costs, partially offset by an increase in depreciation expense.

PROPANE, PIPELINES AND STORAGE

Operating Revenues. Operating revenues were $7.9 million in 2003, compared to $7.1 million in 2002 and $7.4 million in 2001. The increase in revenues in 2003, when compared to 2002, was due primarily to higher propane distribution revenues resulting from colder weather in the Company’s propane distribution service area and an increase in the market price for propane. The decrease in revenues in 2002, when compared to 2001, was due primarily to lower propane distribution revenues resulting from a reduction in the market price for propane.

Amounts in the above table do not include the equity income from a 50% investment in a gas storage partnership which amounted to $1,482,000, $1,374,000 and $1,190,000 in 2003, 2002 and 2001, respectively. The equity income is reflected in other income and deductions.

Operating Income. The operating income of the Company’s propane, pipelines and storage segment was $2.1 million for 2003, compared to $1.9 million for both 2002 and 2001. The increase during 2003, when compared to 2002, was due primarily to lower operating expenses and lower business taxes, offset partially by an increase in depreciation expense. Weather in Hotflame’s market area was also colder than normal in 2003 and warmer than normal in 2002 and 2001.

OTHER INCOME AND DEDUCTIONS

Interest Expense. Interest expense increased by $9.7 million in 2003 when compared to 2002. Contributing to this increase is approximately $3.2 million of dividends on company-obligated mandatorily redeemable trust preferred securities (“trust preferred securities”) recorded in the second half of 2003. In compliance with SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, dividends incurred on these securities during the period from July 1, 2003 through December 31, 2003 are reflected in the Company’s Consolidated Statement of Operations as interest expense. For further information on SFAS 150 and other new accounting standards that impact the trust preferred securities, refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. The remainder of the increase in interest expense was primarily due to higher levels of long-term debt, an increase in financing fees related to the Company’s short-term bank credit facility and an increase in amortization of debt issuance costs due to the issuance of additional long-term debt in 2003, partially offset by lower levels of short-term bank borrowings in 2003. A larger portion of the Company’s outstanding debt during 2003 was long-term, which has a higher rate of interest than the Company’s short-term bank credit facility.

     Interest expense decreased by $0.5 million in 2002 when compared to 2001. The decrease was primarily due to lower short-term interest rates and a reduction in interest expense as a result of an interest rate swap agreement, which was entered into in August 2001 and terminated in August 2002. However, these items contributing to the decrease in interest expense were offset partially by incremental interest on additional debt issued in 2001. The interest rate swap referred to above was entered into in order to hedge the Company’s $55 million 8% Notes due in June of 2004. During the period prior to terminating the swap, the floating interest rate under the terms of the swap agreement steadily declined, which reduced the Company’s interest expense. The Company received $2.2 million in proceeds when the interest rate swap was terminated in August 2002, which was being recognized pro-rata, as a reduction to interest expense, over the remaining term of the 8% Notes due in June of 2004. In May 2003, the underlying 8% Notes were retired and the unrecognized balance of the swap proceeds was recognized as part of debt exchange and extinguishment costs, which are discussed below.

     Refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for information regarding the issuance and retirement of debt and trust-preferred securities during the past three years.

Debt Exchange and Extinguishment Costs. For 2003, the Company’s Consolidated Statements of Operations reflect $24 million of debt exchange and extinguishment costs. In May 2003, the Company completed a refinancing of certain of its long-term debt through the issuance of new senior unsecured notes and the exchange and repurchase of existing notes. In connection with the repurchase of existing notes, the Company paid approximately $24 million for make-whole premiums or similar items. For further information regarding the refinancing and the debt exchange and extinguishment costs refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

Other Income. During 2003, 2002 and 2001, other income was $2.2 million, $2.5 million and $2.3 million, respectively. The $0.3 million decrease in 2003, when compared to 2002, was primarily due to the non-recurrence in 2003 of income from an engineering project completed by SEMCO Gas for a third-party in 2002, offset partially by higher equity earnings from an investment in a gas storage partnership. In 2002, other income increased by $0.2 million when compared to 2001. The increase was due, in part, to the write-off of certain of the Company’s assets in 2001 as a result of the Company’s redirected business strategy discussed previously and losses incurred in 2001 by SEMCO Gas’s “Heating, Ventilation and Air Conditioning” department, which did not recur in 2002 because the Company closed that business. In addition, during 2002 SEMCO Gas earned income from an engineering project and there was an increase in equity earnings from the investment in a gas storage partnership. These items were partially offset by decreases in allowance for funds used during construction (“AFUDC”) and interest income.

INCOME TAXES

Income tax expense (benefit) for 2003, 2002 and 2001 was $(7.4) million, $10.1 million and $6.6 million, respectively. The change in income taxes, when comparing one year to another, is due primarily to changes in income before income taxes and minority interest. Refer to Note 3 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for information on current and deferred income tax expense, deferred tax assets and liabilities, and recent net operating losses for tax purposes.

MINORITY INTEREST – DIVIDENDS ON TRUST

Dividends on trust preferred securities, net of income tax benefit, were $4.3 million for 2003 and $8.6 million for both 2002 and 2001. The $4.3 million decrease in dividends in 2003 when compared to 2002 was the result of reflecting dividends on trust preferred securities incurred after July 1, 2003 in interest expense, as previously discussed in the “Interest Expense” section. In addition, the retirement of approximately $101 million of trust preferred securities in August 2003 also decreased dividends on trust preferred securities when compared to 2002. For further information on the retirement of the trust preferred securities, see Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

DISCONTINUED OPERATIONS

In December 2001, the Company’s Board of Directors approved a plan to redirect the Company’s business strategy, which, as discussed previously, included the divestiture of its engineering services business. The divestiture has been accounted for as a discontinued operation and, accordingly, the operating results and the loss on the disposal of this business have been segregated and reported as discontinued operations in the Consolidated Statements of Operations. The Company completed the sale of its engineering services business effective November 1, 2002. For additional information, including a component breakdown of operating results reflected in discontinued operations, refer to Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows Used For Investing. One of the Company’s largest uses of cash is capital investments in property, plant and equipment. The following table identifies capital investments for the past three years:

     Property additions for the Gas Distribution Business represent primarily gas service lines for new customers and, to a lesser extent, gas main and service line replacements. In 2004, the Company plans to spend approximately $35 million on property additions. During 2002, the Company received $4.5 million in proceeds from property sales, net of costs. This was a significant increase over prior years. The primary reason for the increase was the sale of two buildings and vacant land. The two buildings housed a large portion of the operations and administrative personnel of SEMCO Gas. These two facilities are now being leased by the Company.

Cash Flows Provided by Operations. The Company’s net cash provided by (used for) operating activities totaled $(12.5) million in 2003, $26.2 million in 2002 and $36.7 million in 2001. The change in operating cash flows is influenced significantly by changes in the level and cost of gas in underground storage, changes in accounts receivable and accounts payable and other working capital changes. The changes in these accounts are largely the result of the timing of cash receipts and payments. The change in cash provided by operating activities is also impacted by changes in the operating results of the Company’s businesses. As discussed in previous sections, the operating results of Construction Services have decreased significantly over the past few years, which has contributed to the decrease in cash provided by operating activities. However, this has been mitigated somewhat by a decrease in capital expenditures for equipment at Construction Services, which has caused a decrease in cash flows used for investing activities by this segment.

     The Company uses significant amounts of short-term borrowings to finance natural gas purchases for storage during the non-heating season. Generally, gas is injected into storage during the months of April through October and withdrawn for sale from November through March. The Company’s credit ratings were lowered over the past year by both Moody’s Investors Service and Standard & Poor’s. As a result of these events and other circumstances, two of the pipelines SEMCO Gas utilizes have required prepayment for their services. One gas supplier has required SEMCO Gas to pay multiple times in the month of delivery and other gas suppliers for SEMCO Gas have requested prepayment or letters of credit. This has shortened the Company’s accounts payable cycle significantly compared to prior years and is one of the primary causes of the decrease in cash flows from operations during 2003. The other primary cause of the decrease in cash flows from operations was an increase in the market price of natural gas purchased. As a result, the value of the Company’s gas in underground storage at December 31, 2003 was approximately $23.8 million higher than it was at December 31, 2002.

Cash Flows Provided by Financing. The Company received net cash provided by financing activities of $40.9 million, $5.6 million and $19.3 million in 2003, 2002 and 2001, respectively.

     The Company’s net funds borrowed (paid) on notes payable were $(39.8) million, $13.9 million and ($26.2) million in 2003, 2002 and 2001, respectively. In December of 2003, the Company issued an aggregate of $50 million of senior unsecured notes with a premium of $2.1 million. The proceeds from this issuance were used to repay indebtedness under the Company’s bank credit facility.

     In May of 2003, the Company completed an offering of an aggregate of $300 million of senior unsecured notes. The Company used approximately $92.3 million of the new notes in an exchange for other outstanding debt of the Company. For further information regarding the use of the remaining proceeds from the $300 million offering, which included the retirement of other debt of the Company and payment of debt extinguishment costs, see Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

     During 2002 the Company issued $30 million of long-term debt and used the proceeds to repay $30 million of debt, which matured in October 2002. During 2001, the Company issued $60 million of long-term debt and used the proceeds to repay a portion of its short-term bank credit facility.

     Cash dividends paid per share for common shareholders were $0.40, $0.59 and $0.84 in 2003, 2002 and 2001, respectively.

Non-Cash Financing Activities. In August 2003, the Company issued approximately 8.74 million shares of common stock for $101 million through the mandatory purchase obligation specified under the terms of stock purchase contracts, which were a component of the Company’s FELINE PRIDES. The Company also retired approximately $101 million of 9% trust preferred securities, which were also a component of the FELINE PRIDES. These transactions were non-cash financing activities and, therefore, both the issuance of the $101 million of common stock and the retirement of the $101 million of trust preferred securities are not reflected in cash flows provided by financing activities. Refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information.

     As discussed above, in May of 2003, the Company completed an offering of an aggregate of $300 million of senior unsecured notes. The Company used approximately $92.3 million of the new notes in an exchange for other outstanding debt of the Company. The debt exchange was a non-cash financing activity and therefore is not reflected in cash flows provided by financing activities. Refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information regarding the debt exchange.

Off-Balance Sheet Arrangements. The Company does not have any off-balance sheet financing arrangements as defined in Item 303 (a)(4) of Regulation S-K.

Guarantees. The Company does not have any material guarantees that are required to be disclosed under the provisions of Financial Accounting Standards Board Interpretation No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”

Contractual Obligations and Commercial Commitments. Summarized below are the contractual obligations and commercial commitments of the Company as of December 31, 2003.

Other Commitments and Contingencies. For information about other commitments and contingencies, refer to Note 13 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

Future Financing. In general, the Company funds its capital expenditure program and dividend payments with operating cash flows and the utilization of short-term bank credit facilities. When appropriate, the Company will refinance its short-term debt with long-term debt, common stock or other long-term financing instruments. During, 2002, the Company entered into a credit agreement with a group of banks, replacing four lines of credit which were due to expire. During 2003, the Company amended its bank credit agreement on several occasions. Refer to Note 5 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information regarding the bank credit agreement and amendments thereto. At December 31, 2003, the Company had $125 million of aggregate commitment under the bank credit facility, of which $38.3 was unused.

     Covenants contained in the Company’s bank credit agreement require maintenance at the end of each calendar quarter of a minimum net worth of $215.0 million adjusted annually by 10% of annual net income and certain issuances of common stock. In addition, the Company must maintain a fixed-charges coverage ratio of at least at least 1.33 through March 31, 2004 and 1.50 at the end of each calendar quarter thereafter, and a debt-to-capitalization ratio of less than 0.72 through the earlier of March 31, 2004 or the sale of Alaska Pipeline Company and less than 0.65 at the end of each calendar quarter thereafter. As of December 31, 2003, the Company was in compliance with all debt covenants. Failure to comply with such covenants may result in a default with respect to the related debt and could lead to the acceleration of such debt or any instruments evidencing indebtedness that contain cross-acceleration or cross-default provisions. In such a case, there can be no assurance that the Company would be able to refinance or otherwise repay such indebtedness.

     Net worth, as defined in the Company’s bank credit agreement, includes the Company’s common shareholders’ equity and the trust preferred securities issued by the capital trusts discussed in Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. Any non-cash goodwill and asset impairment charges that may be taken by Construction Services are excluded from common shareholders’ equity.

     The fixed-charges coverage ratio, as defined in the Company’s bank credit agreement, represents a ratio of earnings to fixed charges. Under the agreement, “earnings” represents income (loss) before income taxes, interest expense, dividends on trust preferred securities, discontinued operations and certain other items. Also excluded from earnings are the debt exchange and extinguishment costs incurred in connection with the May 2003 issuance of $300 million of senior unsecurred notes and all non-cash goodwill and asset impairment charges that may be taken by Construction Services. “Fixed charges,” as defined in the agreement, represents interest expense, excluding dividends on trust preferred securities of the capital trusts or interest expense on the Company’s debt held by the capital trusts.

     The debt-to-capitalization ratio requires the Company to maintain on the last day of each fiscal quarter a ratio of funded debt, defined as all debt having a final maturity of more than one year from the date of origin of such debt, all rentals due under all capitalized leases under which we are the lessee and off-balance sheet liabilities as defined in the bank credit agreement, plus an amount equal to the lowest 30-day average of short-term debt less $10 million, to a measure of total capitalization that is the sum of the aggregate principal amount of such debt then outstanding and consolidated net worth. The Company’s debt-to-capitalization ratio was 0.696 at December 31, 2003.

     In March 2000, a registration statement on Form S-3 (“registration statement”) filed by the Company and SEMCO Capital Trust I, SEMCO Capital Trust II and SEMCO Capital Trust III with the Securities and Exchange Commission became effective. The Company and

the capital trusts registered up to $500 million of securities under the registration statement, of which $467 million has been utilized to issue securities during 2003 and prior years. The remaining balance of $33 million under the registration statement is available for any future issuances of common stock, preferred stock, trust preferred securities and long-term debt, as needed. At the present time, the Company does not meet the requirements under its indentures to issue additional senior notes. Long-term debt of the Company scheduled to mature during the next five years includes $0.1 million of 3.77% notes due in 2005, $15 million of 6.50% notes due in 2005, $150 million of 7.125% notes due in 2008 and $5 million of 6.40% notes due in 2008.

     The Company’s ratio of earnings to fixed charges, as defined under Item 503 of SEC regulation S-K, was less than a one-to-one coverage for 2003, 1.32 for 2002 and 1.04 for 2001. The deficient amount of earnings that would be required to attain a ratio of one-to-one for 2003 is approximately $39.7 million. This ratio is more strictly defined than the fixed charges coverage ratio used to determine compliance with the previously discussed debt covenants contained in the Company’s bank credit agreement. “Earnings,” as defined by Item 503, represents income (loss) before income taxes, interest expense and minority interest. “Fixed charges,” as defined by Item 503, represents interest expense and preferred securities dividend requirements of consolidated subsidiaries. We have such dividend requirements under our Trust Preferred Securities and include them in the calculation of fixed charges for purposes of calculating the ratio required under Item 503.

Other Matters. In September 2003, the Company entered into a definitive agreement to sell its wholly-owned subsidiary, Alaska Pipeline Company to Atlas Pipeline Partners, L.P. for $95 million. Proceeds of the sale will be used to reduce the Company’s outstanding debt obligations. In November 2003, the Company announced that its Board of Directors instructed management to pursue the sale of Construction Services. The Company anticipates that the proceeds of a sale will be used to strengthen the financial position of the Company by supporting the growth of the Gas Distribution Business through the funding of capital expenditures, or by paying down indebtedness. Refer to Note 14 of the Notes to the Consolidated Financial Statements in Item 8 of this form 10-K for further information.

MARKET RISK INFORMATION

The Company’s primary market risk arises from fluctuations in commodity prices and interest rates. The Company’s exposure to commodity price risk arises from changes in natural gas and propane prices throughout the United States and in eastern Canada, where the Company conducts sales and purchase transactions. The Company does not currently use financial derivative instruments (such as swaps, collars or futures) to manage its exposure to commodity price risk. A significant portion of the natural gas requirements of the Company’s Michigan gas distribution operations are covered under third-party supply arrangements and the MPSC-approved GCR mechanism that passes commodity costs through to its customers. ENSTAR’s natural gas requirements are primarily covered by a number of long-term supply arrangements and the RCA-approved GCA mechanism that passes commodity costs through to its customers. For further information on how these agreements reduce the Company’s exposure to commodity price risk, see the caption “Cost of Gas” in Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

     The Company is also subject to interest rate risk in connection with the issuance of variable and fixed-rate debt. In order to maintain its desired mix of fixed-rate and variable-rate debt, the Company may use interest rate swap agreements and exchange fixed and variable-rate interest payment obligations over the life of the agreements, without exchange of the underlying principal amounts. See Note 7 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for additional information on interest rate swap agreements and how the Company accounts for its risk management activities.

     For information regarding the fair value of the Company’s financial instruments, refer to Note 6 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. The following table provides information about the Company’s financial instruments that are sensitive to interest rate changes as of December 31, 2003:

IMPACT OF INFLATION

The cost of gas sold in Alaska is recovered from natural gas distribution customers on a current basis through the GCA mechanism. The cost of gas sold in the geographic areas of Michigan subject to the jurisdiction of the MPSC is recovered from natural gas distribution customers on a current basis through the GCR mechanism. The GCA and GCR mechanisms allow for the adjustment of rates charged to customers in response to increases and decreases in the cost of gas purchased. The Company applied for and received approval from the CCBC to extend the fixed gas charge program until March 31, 2005 for customers located in the City of Battle Creek, Michigan and surrounding communities. See the caption “Cost of Gas” in Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for more information.

     Increases in other utility operating costs are recovered through the regulatory process of a rate case and, therefore, may adversely affect the results of operations in inflationary periods due to the time lag involved in this process. The Company attempts to minimize the impact of inflation by controlling costs, increasing productivity and filing rate cases on a timely basis.

CRITICAL ACCOUNTING POLICIES

The Company has prepared its Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. The following is a summary of the Company’s most critical accounting policies, which are defined as those policies whereby judgments or uncertainties could affect the application of those policies and materially different amounts could be reported under different conditions or using different assumptions. For a complete discussion of the Company’s significant accounting policies, refer to Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

Rate Regulation. The Gas Distribution Business is subject to regulation. The regulatory matters associated with gas distribution customers located in the City of Battle Creek, Michigan, and surrounding communities are subject to the jurisdiction of the CCBC. The MPSC has jurisdiction over the regulatory matters related to the Company’s remaining Michigan customers. Regulatory matters for gas distribution customers in Alaska are subject to the jurisdiction of the RCA. These regulatory bodies have jurisdiction over, among other things, rates, accounting procedures, and standards of service.

     The Gas Distribution Business has accounting policies, which conform to SFAS 71, “Accounting for the Effect of Certain Types of Regulation” and which are in accordance with the accounting requirements and ratemaking practices of the regulatory authorities. The application of these accounting policies allows the Company to defer expenses and income as regulatory assets and liabilities in the Consolidated Statements of Financial Position when it is probable that those expenses and income will be allowed in the rate setting process in a period different from the period in which they would have been reflected in the Consolidated Statements of Operations by an unregulated company. These deferred regulatory assets and liabilities are then included in the Consolidated Statements of Operations in the periods in which the same amounts are reflected in rates. Management’s assessment of the probability of recovery or pass-through of regulatory assets and liabilities requires judgment and interpretation of laws and regulatory commission orders. If, for any reason, the Company ceases to meet the criteria for application of regulatory accounting treatment for all or part of its operations, the regulatory assets and liabilities related to those portions ceasing to meet such criteria would be eliminated from the Consolidated Statements of Financial Position and included in the Consolidated Statements of Operations for the period in which the discontinuance of regulatory accounting treatment occurs. Such amounts would be classified as an extraordinary item.

Goodwill. The Company evaluates its goodwill for impairment in accordance with SFAS 142, “Goodwill and Other Intangible Assets.” SFAS 142 requires that the Company perform impairment tests on its goodwill balance annually or at any time when events occur which could impact the value of the Company’s business segments. The Company’s determination of whether an impairment has occurred is based on an estimate of discounted cash flows attributable to the Company’s reporting units that have goodwill, as compared to the carrying value of those reporting units’ net assets. The Company must make long-term forecasts of future revenues, expenses and capital expenditures related to the reporting unit in order to make the estimate of discounted cash flows. These forecasts require assumptions about future demand, future market conditions, regulatory developments and other factors. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. If an impairment test of goodwill shows that the carrying amount of the goodwill is in excess of the fair value, a corresponding impairment loss would be recorded in the Consolidated Statements of Operations. The 2003 annual impairment tests were performed for the Company’s business segments and indicated that there was an impairment of goodwill at Construction Services. For further information on this impairment, see Note 1 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

Pensions and Other Postretirement Benefits. The Company accounts for pension costs and other postretirement benefit costs in accordance with the SFAS 87, “Employers’ Accounting for Pensions” and SFAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” respectively. These Statements require liabilities to be recorded in the Consolidated Statements of Financial Position at the present value of these future obligations to employees net of any plan assets. The calculation of these liabilities and associated expenses require the expertise of actuaries and are subject to many assumptions including life expectancies, present value discount rates, expected long-term rate of return on plan assets, rate of compensation increase and anticipated health care costs. Any change in these assumptions can significantly change the liability and associated expenses recognized in any given year. For example, a one percentage point increase in anticipated health care costs each year would increase the accumulated retiree medical obligation as of December 31, 2003 by $5.8 million and the aggregate of the service and interest cost components of net periodic retiree medical costs for 2003 by $0.5 million. For further sensitivity analyses, refer to Note 8 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

NEW ACCOUNTING STANDARDS

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). In October 2003, the FASB issued FASB Staff Position 46-e, “Effective Date of Interpretation 46.” In December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”). In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” For information regarding these new accounting standards, refer to Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.

     In December 2003, President Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003. This Act expanded Medicare to include, for the first time, coverage for prescription drugs. Refer to Note 8 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further information.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For the information required pursuant to this item, refer to the section titled “Market Risk Information” in Item 7 of this Form 10-K.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reports of Independent Auditors, page 25 and 26

Consolidated Statements of Operations, page 27

Consolidated Statements of Financial Position, page 28

Consolidated Statements of Cash Flows, page 29

Consolidated Statements of Capitalization, page 30

Consolidated Statements of Changes in Common Shareholders’ Equity, page 31

Notes to the Consolidated Financial Statements, pages 32 through 55

Reports of Independent Auditors on Financial Statement Schedules, pages 56 and 57

Financial Statement Schedule II – Consolidated Valuation and Qualifying Accounts, page 58

All other financial statement schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and
Shareholders of SEMCO Energy, Inc.:

In our opinion, the accompanying consolidated statements of financial position and capitalization and the related consolidated statements of operations, changes in common shareholders’ equity and cash flows present fairly, in all material respects, the financial position of SEMCO Energy, Inc. and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the two years ended December 31, 2003 and 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The financial statements of the Company for the year ended December 31, 2001, prior to the inclusion of the goodwill transitional disclosures in Note 1, were audited by other independent accountants who have ceased operations. Those independent accountants expressed an unqualified opinion on those financial statements in their report dated February 7, 2002.

     As explained in Note 1 to the financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill in accordance with the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” As explained in Note 4 to the financial statements, effective July 1, 2003, the Company changed its method of accounting for its trust preferred securities and associated minority interest dividends on trust preferred securities, in accordance with SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” As explained in Note 4 to the financial statements, effective December 31, 2003, the Company changed its method of accounting for its capital trust subsidiaries in accordance with Financial Accounting Standards Board Interpretation No. 46R, “ Consolidation of Variable Interest Entities an Interpretation of ARB No. 51.”

     As discussed above, the financial statements of SEMCO Energy, Inc. for the year ended December 31, 2001 were audited by other independent accountants who have ceased operations. As described in Note 1, these financial statements have been revised to include the transitional disclosures required by SFAS No. 142. We audited the transitional disclosures in Note 1. In our opinion, the transitional disclosures for 2001 in Note 1 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole.

PricewaterhouseCoopers LLP
Detroit, Michigan
February 16, 2004

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen, and Andersen did not consent to the incorporation by reference of this report (as included in this Form 10-K) into any of the company’s registration statements.

     As discussed in Note 1, the Company has revised its Financial Statements for the year ended December 31, 2001 to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Intangible Assets. The Andersen report does not extend to these changes. The revisions to the 2001 Financial Statements related to these transitional disclosures were reported on by PricewaterhouseCoopers LLP, as stated in their report appearing herein. The footnote shown below was not part of the Andersen report.

To SEMCO Energy, Inc.

We have audited the accompanying consolidated statements of financial position and capitalization of SEMCO Energy, Inc. (a Michigan corporation) and subsidiaries as of December 31, 2001 and 2000*, and the related consolidated statements of income, changes in common shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2001*. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

     We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SEMCO Energy, Inc. and subsidiaries as of December 31, 2001 and 2000*, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001*, in conformity with accounting principles generally accepted in the United States.

ARTHUR ANDERSEN LLP
Detroit, Michigan
February 7, 2002

*

The Company’s consolidated statements of financial position and capitalization as of December 31, 2001 and 2000 and the consolidated statements of income, changes in common shareholders’ equity and cash flows for the years ended December 31, 1999 and 2000 are not included in this Form 10-K.

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes to the consolidated financial statements are an integral part of these statements.

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION