Vectren signs new coal deal, defends purchase of its own coal for Indiana plants

Vectren Corp. (NYSE: VVC) not only has signed a new contract with Foresight Coal Sales LLC for Illinois coal moving to the Brown power plant in Indiana, it also granted a Foresight affiliate the land rights to build a new rail-to-barge terminal next to Brown that will serve the broader Ohio River market.

Southern Indiana Gas and Electric Co., a Vectren unit also known as Vectren South, is before the Indiana Utility Regulatory Commission in a fuel rate case. On Nov. 9, the utility filed rebuttal testimony from Vice-President Power Supply Wayne Games that responded to earlier comments made by the state Office of Utility Consumer Counselor. An OUCC witness criticized the utility for buying much of its coal from a sister Vectren Corp. subsidiary, Vectren Fuels Inc., possibly driving up the prices it pays for its coal over the past few years and discouraging competitive bids from outside coal suppliers.

Games testified in August that Vectren had issued a coal request for proposals in April, called the 2011 RFP, and that the company planned to award out of that RFP a contract to coal operator Chris Cline’s Foresight Coal Sales for Illinois coal. The contract would be for 250,000 tons in the last half of 2012, then 500,000 tons per year for the 2013-2017 period. Games offered the company’s plan to sign the Foresight contract as an example of how the utility, which normally burns mostly Indiana coal, will buy outside coal from other suppliers, even coal from Illinois, when that coal is cost competitive.

The 2011 RFP requested pricing for up to 500,000 tons delivered to any of Vectren South’s units for a four-year period commencing July 1, 2012. The RFP was sent to 26 Illinois Basin producers and/or traders. Games said in the August testimony that Vectren Fuels was the second lowest bidder in the 2011 RFP and that Vectren South used the RFP offers to negotiate down prices charged by Vectren Fuels for existing coal supply.

In his Nov. 9 testimony, Games was asked if the Foresight contract had been signed and he said it has been. “Significant time was devoted to negotiation of the baseball arbitration provisions in the Foresight contract,” he added. “We believe we have reached agreement on reasonable language to guide the arbitrator. At the request of Foresight, the test burn is now planned for early 2012.”

Games said the 2011 RFP was well publicized in trade publications and bids were solicited from all “viable” coal producers. He noted that Vectren South used Emily Medine of consulting firm Energy Ventures Analysis to help with the RFP process because the industry knows and respects her and EVA.

The commission has already recognized that beginning in 2009, Vectren South took proactive steps to reduce coal deliveries from affiliate Vectren Fuels in reaction to slack power demand due to the recession, Games said. “Apart from exercising our option to take only 85% of the contract volumes, we cancelled delivery of 1 million tons of coal from Vectren Fuels to Brown in 2011, and over 2 million tons of coal from Vectren Fuels under the Brown and Culley contracts in 2012,” Games pointed out. “Thus, we have greatly reduced purchases from our affiliate.”

In the 2011 RFP process the company has addressed the commission’s desire to ensure continuing opportunities exist to allow it to periodically reprice coal by retaining ongoing staggering of contract terms and price reopeners. “We have also contracted for less than forecasted requirements, thereby providing Vectren South with flexibility to buy either spot or contract coal as needed,” Games said. “Unmentioned by the OUCC, in conjunction with this 2011 RFP process we obtained additional monetary concessions and reduced the future volume commitments under the existing contracts with Vectren Fuels.”

Asked if Vectren South would continue to try to buy Indiana coal, Games responded: “’Buy Indiana’ has been an emphasis of the current administration. Vectren Corporation’s investment over time in ‘home grown energy’ through its mines is consistent with this initiative, and it will continue to be Vectren South’s strong preference to purchase Indiana coal.”

Vectren Fuels has two existing deep mines in Indiana and a third in development. The newest of the operating mines is Oaktown No. 1 in Knox County, which got a production start in the fourth quarter of 2009 and turned out 1 million tons in 2010 and 2 million tons in the first three quarters of this year, according to U.S. Mine Safety and Health Administration data. Oaktown No. 1 is listed with MSHA under contract operator Black Panther Mining LLC, which would also operate the nearby Oaktown No. 2 deep job when it gets a production start as soon as mid 2012. The other operating mine is the Prosperity job in Pike County, which is listed with MSHA under contract operator Five Star Mining Inc. Prosperity turned out 1.9 million tons in the first three quarters of this year and 2.7 million tons in all of 2010.

Games pointed out that Vectren enhanced competition in the Illinois Basin coal market by agreeing to provide land rights on the Ohio River adjacent to the Brown plant and granted rail rights to access this property, allowing Foresight to establish a major new terminal for its coal. This terminal provides Foresight with the ability to move its Illinois coal to the rest of the region and beyond. “This is not an act that favors our affiliate,” Games pointed out.

Cline’s SITran LLC is building the rail-to-river dock, called the West Franklin Coal Transfer Facility, as an outlet for coal out of several new mines in Illinois moving into the Ohio River market. The dock is in Posey County, Ind., just across the state line from Illinois.

“Vectren Fuels is currently in negotiation with a number of customers regarding sales in 2012 and beyond,” said Vectren Corp. about the coal situation in its Nov. 4 quarterly earnings statement. “Vectren Fuels and Vectren South have adjusted both the price and quantity of coal through the remaining terms of contracts that had price reopener clauses. Pursuant to the supply contracts, Vectren Fuels expects to supply Vectren South, including its plant jointly owned with ALCOA, approximately 1.5 million tons in 2012. Sales to Vectren South are expected to be at least 2.3 million tons in both 2013 and 2014. At this time, approximately 70 percent of Vectren Fuel’s planned 2012 production has been subscribed.”

Alcoa Inc. (NYSE:AA), the aluminum company, owns most of the Warrick coal plant, while Vectren owns part of one unit. Alcoa procures coal for its own portion of Warrick’s capacity, much of it from its own Friendsville mine in Illinois.

In testimony attached to the Games filing, Medine said that the OUCC suggestion that Vectren South erred by not pre-qualifying coal bidders before the April 2011 coal solicitation. “In my experience, an RFP can draw attractive bids from unanticipated sources,” Medine noted. “Suppliers can respond based on their own knowledge of their production capability and contract commitments which is dynamic in nature. Moreover, the bid evaluation process is not burdensome as the in-depth reviews are only conducted on the most competitive offers.”

The Vectren Fuels bid was received simultaneously with the bids from third parties in that April RFP, Medine noted. “Together with Mr. Games, we negotiated with Vectren Fuels based on our own bid evaluation,” she added. “We did not reveal any third party bid information to Vectren Fuels during this negotiation process.”

Medine also responded to the OUCC recommendations for future RFPs, including the possibility that Vectren could use a regional coal-price benchmark to evaluate its coal bids. “First, I am unsure what additional improvements need to be made to the highly competitive RFP conducted this year,” she said. “The 2011 procurement process was fair, followed best practices, and yielded good results. That being said, there are specific problems with respect to each potential recommendation. For example, the use of an Indiana utility coal benchmark to determine the price of coal sold by Vectren Fuels to Vectren South may have some curb appeal, but it would be very difficult to construct such an index because of the different characteristics and locations of the various utility plants. Notably, some plants burn lower sulfur coal including coal from the Powder River Basin.”