Vectren 2008 Annual Report Download - page 61

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59
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various business risks associated with commodity prices, interest rates, and counter-
party credit. These financial exposures are monitored and managed by the Company as an integral part of its
overall risk management program. The Company’s risk management program includes, among other things, the
use of derivatives. The Company may also execute derivative contracts in the normal course of operations while
buying and selling commodities to be used in operations and optimizing its generation assets.
The Company has in place a risk management committee that consists of senior management as well as financial
and operational management. The committee is actively involved in identifying risks as well as reviewing and
authorizing risk mitigation strategies.
Commodity Price Risk
Regulated Operations
The Company’s regulated operations have limited exposure to commodity price risk for transactions involving
purchases and sales of natural gas, coal and purchased power for the benefit of retail customers due to current
Indiana and Ohio regulations, which subject to compliance with those regulations, allow for recovery of the cost of
such purchases through natural gas and fuel cost adjustment mechanisms. Constructive regulatory orders, such as
those authorizing lost margin recovery, other innovative rate designs, and recovery of unaccounted for gas and
other gas related expenses, also mitigate the effect volatile gas costs may have on the Company’s financial
condition.
Although Vectren’s regulated operations are exposed to limited commodity price risk, volatile natural gas prices
have other effects such as higher working capital requirements, higher interest costs, and some level of price-
sensitivity in volumes sold or delivered. The Company manages these risks by executing derivative contracts that
hedge the price of forecasted natural gas purchases. These contracts are subject to regulation which allows for
reasonable and prudent hedging costs to be recovered through rates. Therefore, SFAS 71 controls when the offset
to mark-to-market accounting is recognized in earnings.
Wholesale Power Marketing
The Company’s wholesale power marketing activities undertake strategies to optimize electric generating capacity
beyond that needed for native load. In recent years, the primary strategy involves the sale of excess generation into
the MISO Day Ahead and Real-time markets. As part of these strategies, the Company may also from time to time
execute energy contracts that commit the Company to purchase and sell electricity in the future. Commodity price
risk results from forward positions that commit the Company to deliver electricity. The Company mitigates price
risk exposure with planned unutilized generation capability and occasionally offsetting forward purchase contracts.
The Company accounts for any energy contracts that are derivatives at fair value with the offset marked to market
through earnings. No market sensitive derivative positions were outstanding on December 31, 2008 and 2007.
For retail sales of electricity, the Company receives the majority of its NOx and SO2 allowances at zero cost
through an allocation process. Based on arrangements with regulators, wholesale operations can purchase
allowances from retail operations at current market values, the value of which is distributed back to retail customers
through a MISO cost recovery tracking mechanism. Wholesale operations are therefore at risk for the cost of
allowances, which for the recent past have been volatile. The Company manages this risk by purchasing
allowances from retail operations and other third parties in advance of usage creating an intangible asset. In the
past, the Company has also used derivative financial instruments to hedge this risk, but no such derivative
instruments were outstanding at December 31, 2008 or 2007.
Other Operations
Other commodity-related operations are exposed to commodity price risk associated with fluctuating commodity
prices including natural gas and coal. Other commodity-related operations include nonutility retail gas marketing,
and coal mining operations. Open positions in terms of price, volume, and specified delivery points may occur and
are managed using methods described below with frequent management reporting.