Vectren 2010 Annual Report Download - page 63

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61
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 state 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 on working capital requirements, interest costs, and some level of price-
sensitivity in volumes sold or delivered.
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 future periods. 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. 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, 2010 and 2009.
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 as needed and occasionally from
other third parties in advance of usage. In the past, the Company also used derivative financial instruments to hedge this risk,
but no such derivative instruments were outstanding at December 31, 2010 or 2009.
Other Operations
Other commodity-related operations are exposed to commodity price risk associated with natural gas and coal. Other
commodity-related operations include Vectren Source, a nonutility retail gas marketer, coal mining operations, and the
operations at ProLiance. Open positions in terms of price, volume, and specified delivery points may occur and are managed
using methods described below with frequent management reporting.
These subsidiaries, as well as ProLiance, purchase and sell natural gas and coal to meet customer demands. Forward
contracts, and occasionally option contracts, commit them to purchase and sell commodities in the future. Price risk from
forward positions is mitigated using stored inventory and offsetting forward purchase contracts. Price risk also results from
forward contracts to purchase commodities to fulfill forecasted non-regulated sales of natural gas and coal that may or may not