Vectren 2013 Annual Report Download - page 67

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65
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 generation into the MISO Day Ahead and Real-
time markets. The Company accounts for any energy contracts that are derivatives at fair value with the offset marked to
market through earnings. No derivative positions were outstanding on December 31, 2013 and 2012.
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.
Other Operations
Other commodity-related operations are exposed to commodity price risk associated with gasoline/diesel and coal through third
party suppliers. Open positions in terms of price, volume, and specified delivery points may occur and are managed using
methods described below with frequent management reporting.
The Company purchases and sells coal to meet customer demands. Forward contracts commit coal operations to purchase and
sell commodities in the future. Price risk from forward sell positions is mitigated using stored inventory and expected reserves.
Coal mining contracts are expected to be settled by physical receipt or delivery of the commodity. Occasionally, the Company
will hedge a portion of its gasoline requirements using financial instruments. However, during the years presented such
utilization has not been significant.
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 limits this risk by
allowing only an annual average of 15 percent to 25 percent of its total debt to be exposed to variable rate volatility. However,
this targeted range may not always be attained during the seasonal increases in short-term borrowings. To further manage this
exposure, the Company may also 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 2013 and 2012, the weighted average combined borrowings
under these arrangements approximated $421 million and $287 million, respectively. At December 31, 2013, combined
borrowings under these arrangements were $309 million. As of December 31, 2012 combined borrowings under these
arrangements were $420 million. Based upon average borrowing rates under these facilities during the years ended December
31, 2013 and 2012, an increase of 100 basis points (one percentage point) in the rates would have increased interest expense
by approximately $4.2 million in 2013 and $2.9 million in 2012.
Other Risks
By using financial instruments to manage risk, the Company creates exposure 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.