Vectren 2008 Annual Report Download - page 62

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60
The Company purchases and sells commodities, including electricity, natural gas, and coal to meet customer
demands and operational needs. The Company executes forward contracts and occasionally option contracts that
commit the Company to purchase and sell commodities in the future. Price risk from forward positions obligating
the Company to deliver commodities is mitigated using stored inventory, generating capability, and offsetting
forward purchase contracts. Price risk also results from forward contracts obligating the Company to purchase
commodities to fulfill forecasted nonregulated sales of natural gas and coal that may or may not occur. With the
exception of a small portion of contracts that are derivatives that qualify as hedges of forecasted transactions under
SFAS 133, these contracts are expected to be settled by physical receipt or delivery of the commodity.
Unconsolidated Affiliate
ProLiance, a nonregulated energy marketing affiliate, engages in energy hedging activities to manage pricing
decisions, minimize the risk of price volatility, and minimize price risk exposure in the energy markets.
ProLiance's market exposure arises from storage inventory, imbalances, and fixed-price forward purchase and sale
contracts, which are entered into to support its operating activities. Currently, ProLiance buys and sells physical
commodities and utilizes financial instruments to hedge its market exposure. However, net open positions in terms
of price, volume and specified delivery point do occur. ProLiance manages open positions with policies which
limit its exposure to market risk and require reporting potential financial exposure to its management and its
members.
Interest Rate Risk
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 manages this risk by allowing an annual average of 20 percent and 30 percent of its total debt to be
exposed to variable rate volatility. However, this targeted range may be exceeded during the seasonal increases in
short-term borrowing. To manage this exposure, the Company may use derivative financial instruments.
Market risk is estimated as the potential impact resulting from fluctuations in interest rates on adjustable rate
borrowing arrangements exposed to short-term interest rate volatility. During 2008 and 2007, the weighted average
combined borrowings under these arrangements approximated $412 million and $495 million, respectively. At
December 31, 2008 and 2007, combined borrowings under these arrangements were $519 million and $660 million,
respectively. Based upon average borrowing rates under these facilities during the years ended December 31, 2008
and 2007, an increase of 100 basis points (one percentage point) in the rates would have increased interest expense
by $4.1 million and $4.9 million, respectively.
Other Risks
By using financial instruments to manage risk, the Company, as well as ProLiance, exposes itself to counter-party
credit risk and market risk. The Company manages exposure to counter-party credit risk by entering into contracts
with companies that can be reasonably expected to fully perform under the terms of the contract. Counter-party
credit risk is monitored regularly and positions are adjusted appropriately to manage risk. Further, tools such as
netting arrangements and requests for collateral are also used to manage credit risk. Market risk is the adverse
effect on the value of a financial instrument that results from a change in commodity prices or interest rates. The
Company attempts to manage exposure to market risk associated with commodity contracts and interest rates by
establishing parameters and monitoring those parameters that limit the types and degree of market risk that may be
undertaken.
The Company’s customer receivables from gas and electric sales and gas transportation services are primarily
derived from residential, commercial, and industrial customers located in Indiana and west central Ohio. The
Company manages credit risk associated with its receivables by continually reviewing creditworthiness and
requests cash deposits or refunds cash deposits based on that review. Credit risk associated with certain
investments is also managed by a review of creditworthiness and receipt of collateral. In addition, credit risk is
mitigated by regulatory orders that allow recovery of all bad debt expense in Ohio and the gas cost portion of bad
debt expense in Indiana based on historical experience.