Vectren 2008 Annual Report Download - page 101

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99
Synfuel Risk Management
As discussed in Note 5, the Company’s synfuel operations were exposed to commodity price risk associated with
oil. The Company executed derivative instruments designed to limit the effects of a phase out of synfuel tax credits
and other risks. During 2006 the Company purchased contracts with a notional amount of 0.5 million barrels to
mitigate 2006 risks. All contracts were settled in 2006 at a loss of $5.3 million, which is recorded in Other-net. In
2006, the Company also purchased contracts with a notional amount of 2.8 million barrels to mitigate 2007 phase
out risk and other risks. The mark to market loss associated with these contracts totaled $2.5 million in 2006 and
was also reflected in Other-net. In 2007, these contracts increased income $13.4 million, all of which was a
realized gain. The fair value of those contracts, which was recorded in Prepayments and other current assets,
totaled $22.8 million as of December 31, 2007 and was received in 2008. The pretax impact of an insurance
contract related to synfuels was a loss of $0.3 million in 2007 and earnings of $3.1 million in 2006. These results
are also recorded in Other- net.
SO2 Emission Allowance Risk Management
The Company’s wholesale power marketing operations are exposed to price risk associated with SO2 emission
allowances. To mitigate this risk, the Company executed call options to hedge wholesale emission allowance
utilization in future periods. The Company designated and documented these derivatives as cash flow hedges. At
December 31, 2008, a deferred gain of approximately $0.2 million remains in accumulated comprehensive income
related to these call options which will be recognized in earnings as emission allowances are utilized. Hedge
ineffectiveness totaled $0.2 million of expense in 2006. No SO2 emission allowance hedges are outstanding as of
December 31, 2008.
Natural Gas Procurement Activity
The Company’s regulated operations have limited exposure to commodity price risk for purchases and sales of
natural gas and electricity for retail customers due to current Indiana and Ohio regulations which, subject to
compliance with those regulations, allow for recovery of such purchases through natural gas and fuel cost
adjustment mechanisms. Although Vectren’s regulated operations are exposed to limited commodity price risk,
volatile natural gas prices can result in higher working capital requirements, increased expenses including interest
costs, uncollectible accounts expense, and unaccounted for gas, and some level of price-sensitive reduction in
volumes sold. The Company may mitigate these risks by using derivative contracts. These contracts are subject to
regulation which allows for reasonable and prudent hedging costs to be recovered through rates. When regulation
is involved, SFAS 71 controls when the offset to mark-to-market accounting is recognized in earnings.
The Company’s wholly owned gas retail operations also mitigate price risk associated with forecasted natural gas
purchases by using derivatives. These nonregulated gas retail operations may also from time-to-time execute
weather derivatives to mitigate extreme weather affecting unregulated gas retail sales.
At December 31, 2008 and 2007, the market values of these contracts and the book value of weather contracts were
not significant.
Interest Rate Management
The Company is exposed to interest rate risk associated with its borrowing arrangements. Its risk management
program seeks to reduce the potentially adverse effects that market volatility may have on interest expense. The
Company has used interest rate swaps and treasury locks to hedge forecasted debt issuances and other interest rate
swaps to manage interest rate exposure.
As of December 31, 2008, no interest rate swaps were outstanding. At December 31, 2007, the fair value liability
associated with interest rate swaps was $8.9 million. Related to derivative instruments associated with completed
debts issuances, an approximate $7.7 million net regulatory asset remains at December 31, 2008. In 2008, $0.3
million was reclassified as a decrease to interest expense, $0.6 million reduced interest expense in 2007, and $0.7
million reduced interest expense in 2006. The Company estimates a $0.3 million reduction to interest expense will
occur in 2009 related to the amortization of this net position.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines
fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP),
and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value