| VECTREN CORP ITEM 1A RISK FACTORS Investors should consider carefully the following factors that could cause the Company’s operating results and financial condition to be materially adversely affected |
| New risks may emerge at any time, and the Company cannot predict those risks or estimate the extent to which they may affect the Company’s businesses or financial performance |
| Vectren Corporation is a holding company, and its assets consist primarily of investments in its subsidiaries |
| Dividends on the Companyapstas common stock depend on the earnings, financial condition, and capital requirements of itapstas subsidiaries, principally Vectren Utility Holdings, Inc |
| and Vectren Enterprises, Inc |
| and the distribution or other payment of earnings from those subsidiaries to the Company |
| Should the earnings, financial condition, or capital requirements of, or legal requirements applicable to, the Company’s subsidiaries restrict the ability of these subsidiaries to pay dividends or make other payments to Vectren, Vectren’s ability to pay dividends on its common stock could be limited, and its stock price adversely affected |
| 10 _________________________________________________________________ [51]Table of Contents The Company operates in an increasingly competitive industry, which may affect its future earnings |
| The utility industry has been undergoing dramatic structural change for several years, resulting in increasing competitive pressure faced by electric and gas utility companies |
| Increased competition may create greater risks to the stability of Vectren’s earnings generally and may in the future reduce its earnings from retail electric and gas sales |
| Currently, several states, including Ohio, have passed legislation that allows customers to choose their electricity supplier in a competitive market |
| Indiana has not enacted such legislation |
| Ohio regulation also provides for choice of commodity providers for all gas customers |
| In 2003, the Company implemented this choice for its gas customers in Ohio |
| Indiana has not adopted any regulation requiring gas choice except for large-volume customers |
| The Company cannot provide any assurance that increased competition or other changes in legislation, regulation or policies will not have a material adverse effect on its business, financial condition or results of operations |
| A significant portion of the Company’s gas and electric utility sales are space heating and cooling |
| Accordingly, its operating results may fluctuate with variability of weather |
| The Company’s gas and electric utility sales are sensitive to variations in weather conditions |
| Vectren forecasts utility sales on the basis of normal weather, which represents a long-term historical average |
| Since the Company does not have a weather-normalization mechanism for its electric operations or its Ohio natural gas operations, significant variations from normal weather could have a material impact on its earnings |
| However, the impact of weather on the gas operations in its Indiana territories has been significantly mitigated through the implementation on October 15, 2005, of a normal temperature adjustment mechanism |
| The Company’s gas and electric utility sales are concentrated in the Midwest |
| The operations of the Company’s regulated utilities are concentrated in central and southern Indiana and west central Ohio and are therefore impacted by changes in the Midwest economy in general and changes in particular industries concentrated in the Midwest |
| These industries include automotive assembly, parts and accessories, feed, flour and grain processing, metal castings, aluminum products, appliance manufacturing, polycarbonate resin (Lexan®) and plastic products, gypsum products, electrical equipment, metal specialties, glass, steel finishing, pharmaceutical and nutritional products, gasoline and oil products, and coal mining |
| Risks related to the regulation of the Company’s businesses, including environmental regulation, could affect the rates charged, its costs and its profitability |
| Vectren’s businesses are subject to regulation by federal, state and local regulatory authorities |
| In particular, the Company is subject to regulation by the Federal Energy Regulatory Commission (FERC), the IURC and the PUCO These authorities regulate many aspects of its transmission and distribution operations, including construction and maintenance of facilities, operations, safety, and the rates that it can charge customers and the rate of return that it is allowed to realize |
| The Company’s ability to obtain rate increases to maintain its current authorized rate of return depends upon regulatory discretion, and there can be no assurance that Vectren will be able to obtain rate increases or rate supplements or earn its current authorized rate of return |
| In addition, its operations and properties are subject to extensive environmental regulation pursuant to a variety of federal, state and municipal laws and regulations |
| These environmental regulations impose, among other things, restrictions, liabilities and obligations in connection with storage, transportation, treatment and disposal of hazardous substances and waste and in connection with spills, releases and emissions of various substances in the environment |
| Such emissions from electric generating facilities include particulate matter, sulfur dioxide (SO[2]), and nitrogen oxide (NOx), among others |
| Environmental legislation also requires that facilities, sites and other properties associated with the Company’s operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities |
| Vectren’s current costs to comply with these laws and regulations are significant to its results of operations and financial condition |
| In addition, claims against the Company under environmental laws and regulations could result in material costs and liabilities |
| With the trend toward stricter standards, greater regulation, more extensive permit requirements and an increase in the number and types of assets operated by the Company subject to environmental regulation, its investment in environmentally compliant equipment has increased and is expected to increase in the future |
| 11 _________________________________________________________________ [52]Table of Contents From time to time, the Company is subject to material litigation and regulatory proceedings |
| The Company may be subject to material litigation and regulatory proceedings from time to time |
| There can be no assurance that the outcome of these matters will not have a material adverse effect on its business, results of operations or financial condition |
| The Company’s electric operations are subject to various risks |
| The Company’s electric generating facilities are subject to operational risks that could result in unscheduled plant outages, unanticipated operation and maintenance expenses and increased purchased power costs |
| Such operational risks can arise from circumstances such as facility shutdowns due to equipment failure or operator error; interruption of fuel supply or increased prices of fuel as contracts expire; disruptions in the delivery of electricity; inability to comply with regulatory or permit requirements; labor disputes; and natural disasters |
| The Company may experience significantly increased gas costs |
| Recently, commodity prices for natural gas purchases have increased and have become more volatile |
| Subject to regulatory approval, the Company’s subsidiaries are allowed recovery of gas costs from their retail customers through commission-approved gas cost adjustment mechanisms |
| Nevertheless, it is possible regulators may disallow recovery of a portion of gas costs for various reasons, including but limited to, a finding by the regulator that natural gas was not prudently procured, as an example |
| In addition, it is possible that as a result of this near term change in natural gas commodity prices, Vectren’s subsidiaries may experience increased interest expense due to higher working capital requirements, increased uncollectible accounts expense and unaccounted for gas and some level of price sensitive reduction in volumes sold or delivered |
| The impact of MISO participation is uncertain |
| Since February, 2002 and with the IURC’s approval, the Company has been a member of the Midwest Independent System Operator, Inc |
| (MISO), a FERC approved regional transmission organization |
| The MISO serves the electrical transmission needs of much of the Midwest and maintains operational control over the Company’s electric transmission facilities as well as that of other Midwest utilities |
| On April 1, 2005, the MISO energy market commenced operation (the Day 2 energy market) |
| As a result of being a market participant, the Company now bids its owned generation into the Day Ahead and Real Time markets and procures power for its retail customers at Locational Marginal Pricing (LMP) as determined by the MISO market |
| As a result of MISO’s operational control over much of the Midwestern electric transmission grid, including SIGECO’s transmission facilities, SIGECO’s continued ability to import power, when necessary, and export power to the wholesale market has been, and may continue to be, impacted |
| Given the nature of MISO’s policies regarding use of transmission facilities, as well as ongoing FERC initiatives and uncertainties around Day 2 energy market operations, it is difficult to predict near term operational impacts |
| However, it is believed that MISO’s regional operation of the transmission system will ultimately lead to reliability improvements |
| The potential need to expend capital for improvements to the transmission system, both to SIGECO’s facilities as well as to those facilities of adjacent utilities, over the next several years will become more predictable as MISO completes studies related to regional transmission planning and improvements |
| Such expenditures may be significant |
| Wholesale power marketing activities may add volatility to earnings |
| The Company’s regulated electric utility engages in wholesale power marketing activities that primarily involve asset optimization strategies |
| These optimization strategies manage the utilization of available electric generating capacity and include the execution of energy contracts that are integrated with portfolio requirements around power supply and delivery |
| As part of these strategies, the Company will execute forward contracts and option contracts that may not result in the physical flow of electricity, but hedge, other commitments |
| While most physical forward positions to sell electricity are hedged with these contracts or with planned unutilized generation capability, the Company does not hedge its entire portfolio from market price volatility |
| To the extent the Company has unhedged positions or its hedging procedures do not work as planned, fluctuating prices for electricity are likely to cause its net income to be volatile and may lower its net income |
| Beginning in April 2005, substantially all physically delivered off-system sales occur into the MISO day-ahead market |
| 12 _________________________________________________________________ [53]Table of Contents If the Company does not accurately forecast future commodities prices or if its hedging procedures do not operate as planned in certain nonregulated businesses, the Company could experience losses or lower net income |
| The Company’s gas marketing, coal mining, and nonregulated retail gas supply business execute forward and option contracts that commit it to purchase and sell natural gas and coal in the future, including forward contracts to purchase commodities to fulfill forecasted sales transactions that may or may not occur |
| If the value of these contracts changes in a direction or manner that Vectren does not anticipate, or if the forecasted sales transactions do not occur, the Company may experience losses |
| To lower the financial exposure related to commodity price fluctuations, these nonregulated businesses may execute contracts that hedge commodity price risk |
| As part of this strategy, fixed-price forward physical purchase and sales contracts, and/or financial forwards, futures, swaps and option contracts traded in the over-the-counter markets or on exchanges may be utilized |
| However, although almost all natural gas and coal positions are hedged, with either these contracts or with company-owned coal inventory and known reserves, the Company does not hedge its entire exposure or its positions to market price volatility |
| To the extent the Company has unhedged positions, its hedging procedures do not work as planned, or coal reserves cannot be accessed, fluctuating commodity prices are likely to cause its net income to be volatile and may lower its net income |
| The performance of the Company’s nonregulated businesses are also subject to certain risks |
| Execution of the Company’s synfuel, coal mining, gas marketing, performance contracting, utility infrastructure, and broadband strategies and the success of its efforts to invest in and develop new opportunities in the nonregulated business area is subject to a number of risks |
| These risks include, but are not limited to, the effects of weather; failure of installed performance contracting products to operate as planned; storage field and mining property development; increased coal mining industry regulation; creditworthiness of customers and joint venture partners; factors associated with physical energy trading activities, including price, basis, credit, liquidity, volatility, capacity, and interest rate risks; and changing market conditions; |
| The Company’s nonregulated businesses support its regulated utilities pursuant to service contracts by providing natural gas supply services, coal, utility infrastructure services, and other services |
| In most instances, the Company’s ability to maintain these service contracts depends upon regulatory discretion and negotiation with interveners, and there can be no assurance that Vectren will be able to obtain future service contracts, or that existing arrangements will not be revisited |
| The Company’s coal mining operations may be adversely affected if Section 29 credits are limited or disallowed |
| The Company’s coal mining operations are comprised of Vectren Fuels, which includes the Company’s coal mines, and Vectren Synfuels, which holds an investment in Pace Carbon |
| Pace Carbon produces and sells coal-based synthetic fuel, and based on current US tax law, receives a tax credit for every ton of coal-based synthetic fuel sold |
| However, the Permanent Subcommittee on Investigations of the US Senate’s Committee on Governmental Affairs has an ongoing investigation relating to Section 29 tax credits |
| Further, Section 29 tax credits are only available when the price of oil is less than a base price specified by the tax code, as adjusted for inflation |
| Credits realized in 2005 or in prior years are not affected by the limitation |
| However, an average NYMEX price of approximately dlra60 per barrel in 2006, could begin to limit Section 29 tax credits, with a total phase out occurring at approximately dlra74 per barrel |
| Oil prices currently exceed the threshold where Section 29 tax credits would begin to be phased out |
| While Congress is considering legislation that would positively impact or entirely negate this potential limitation on tax credits related to oil prices in 2006, there can be no assurance Section 29 tax credits will be available in future periods |
| 13 _________________________________________________________________ [54]Table of Contents Absent the effect of Section 29 tax credits, the Company’s investment in Pace Carbon has operated, and is expected to continue to operate, at a net loss |
| Due to the potential limitation of Section 29 tax credits, Pace Carbon investors must assess at what level to operate the synfuel plants |
| If the investors continue to operate the plants, and tax credits are phased out, the Company could potentially incur additional losses |
| In addition, the Company would be required to assess the potential impairment of its investment in Pace Carbon |
| If a phase out of tax credits were to occur in 2006 approximately, one third of that phase out risk is proportionately protected by an insurance arrangement that was executed in January 2005 |
| Vectren’s nonregulated group competes with larger, full-service energy providers, which may limit its ability to grow its business |
| Competitors for the Company’s nonregulated businesses include regional, national and global companies |
| Many of Vectren’s competitors are well-established and have larger and more developed networks and systems, greater name recognition, longer operating histories and significantly greater financial, technical and marketing resources |
| This competition, and the addition of any new competitors, could negatively impact the Company’s nonregulated group and its ability to grow its businesses |
| Catastrophic events could adversely affect the Company’s facilities and operations |
| Catastrophic events such as fires, explosions, floods, terrorist acts or other similar occurrences could adversely affect the Company’s facilities and operations |
| A downgrade in the Company’s credit rating could negatively affect its ability to access capital |
| The following table shows the current ratings assigned to certain outstanding debt by Moody’s and Standard & Poor’s: Current Rating Standard Moody’s & Poor’s Utility Holdings, Indiana Gas and SIGECO senior unsecured debt Baa1 A- Utility Holdings commercial paper program P-2 A-2 The current outlook of both Moody’s and Standard and Poor’s is stable and are categorized as investment grade |
| A security rating is not a recommendation to buy, sell, or hold securities |
| The rating is subject to revision or withdrawal at any time, and each rating should be evaluated independently of any other rating |
| Standard and Poor’s and Moody’s lowest level investment grade rating is BBB- and Baa3, respectively |
| The Company may be required to obtain additional permanent financing (1) to fund its capital expenditures, investments and debt security redemptions and maturities and (2) to further strengthen its capital structure and the capital structures of its subsidiaries |
| If the rating agencies downgrade the Company’s credit ratings, particularly below investment grade, or withdraw its ratings, it may significantly limit the Company’s access to the debt capital markets and the commercial paper market, and the Company’s borrowing costs would increase |
| In addition, Vectren would likely be required to pay a higher interest rate in future financings, and its potential pool of investors and funding sources would likely decrease |
| Finally, there is no assurance that the Company will have access to the equity capital markets to obtain financing when necessary or desirable |