Vectren 2008 Annual Report Download - page 100

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The Company is typically in a net sales position with MISO as generation capacity is in excess of that needed to
serve native load and is only occasionally in a net purchase position. When the Company is a net seller such net
revenues are included in Electric Utility revenues and when the Company is a net purchaser such net purchases are
included in Cost of fuel and purchased power. Net positions are determined on an hourly basis. Since the
Company became an active MISO member, its generation optimization strategies primarily involve the sale of
excess generation into the MISO day ahead and real-time markets. Net revenues from wholesale activities included
in Electric Utility revenues totaled $57.6 million in 2008, $39.8 million in 2007 and $29.8 million in 2006.
The Company also receives transmission revenue that results from other members’ use of the Company’s
transmission system. These revenues are also included in Electric Utility revenues. Generally, these transmission
revenues along with costs charged by the MISO are considered components of base rates and any variance from
that included in base rates is recovered/refunded through tracking mechanisms.
As a result of MISO’s operational control over much of the Midwestern electric transmission grid, including
SIGECO’s transmission facilities, SIGECO’s continued ability to import power, when necessary, and export power
to the wholesale market has been, and may continue to be, impacted. Given the nature of MISO’s policies
regarding use of transmission facilities, as well as ongoing FERC initiatives, and a Day 3 ancillary services market
(ASM), where MISO began providing a bid-based regulation and contingency operating reserve markets on January
6, 2009, it is difficult to predict near term operational impacts. The IURC has approved the Company’s
participation in the ASM and has granted authority to defer costs associated with ASM
The need to expend capital for improvements to the regional transmission system, both to SIGECO’s facilities as
well as to those facilities of adjacent utilities, over the next several years is expected to be significant. The
Company timely recovers its investment in certain new electric transmission projects that benefit the MISO
infrastructure at a FERC approved rate of return.
17. Derivatives & Other Financial Instruments
Accounting Policy for Derivatives
The Company executes derivative contracts in the normal course of operations while buying and selling
commodities to be used in operations, optimizing its generation assets, and managing risk. The Company accounts
for its derivative contracts in accordance with SFAS 133, “Accounting for Derivatives” and its related amendments
and interpretations. In most cases, SFAS 133 requires a derivative to be recorded on the balance sheet as an asset
or liability measured at its market value and that a change in the derivative's market value be recognized currently
in earnings unless specific hedge criteria are met.
When an energy contract that is a derivative is designated and documented as a normal purchase or normal sale, it
is exempted from mark-to-market accounting. Otherwise, energy contracts and financial contracts that are
derivatives are recorded at market value as current or noncurrent assets or liabilities depending on their value and
on when the contracts are expected to be settled. Contracts and any associated collateral with counter-parties
subject to master netting arrangements are presented net in the Consolidated Balance Sheets. The offset resulting
from carrying the derivative at fair value on the balance sheet is charged to earnings unless it qualifies as a hedge or
is subject to SFAS 71. When hedge accounting is appropriate, the Company assesses and documents hedging
relationships between the derivative contract and underlying risks as well as its risk management objectives and
anticipated effectiveness. When the hedging relationship is highly effective, derivatives are designated as hedges.
The market value of the effective portion of the hedge is marked to market in accumulated other comprehensive
income for cash flow hedges. Ineffective portions of hedging arrangements are marked-to-market through
earnings. For fair value hedges, both the derivative and the underlying hedged item are marked to market through
earnings. The offset to contracts affected by SFAS 71 are marked-to-market as a regulatory asset or liability.
Market value for derivative contracts is determined using quoted market prices from independent sources.
Following is a more detailed discussion of the Company’s use of mark-to-market accounting in four primary areas:
synfuels risk management, SO2 emission allowance risk management, natural gas procurement, and interest rate
risk management.