Foresight Energy and Vectren South were due to conduct a coal test burn in May that is designed to assure that Vectren South’s coal-fired units can burn the coal and that the fly ash that is produced has a chemical makeup that allows it to be shipped to Holcim, the concrete manufacturer, for beneficial reuse.
Assuming the test burn is successful, Foresight contract deliveries will commence later this summer. The contract volume increases from 250,000 tons this year to 500,000 tons in 2013, said Wayne Games. He is Vice President-Power Supply at Southern Indiana Gas and Electric Co. d/b/a Vectren Energy Delivery of Indiana Inc., also known as Vectren South. Testimony by several Vectren South officials, including Games, was filed on May 21 at the Indiana Utility Regulatory Commission as part of the company’s latest fuel adjustment clause case.
For 2013, Vectren South currently has coal priced under four separate contracts. As a result of negotiations related to a 2011 request for proposals for coal supply, Vectren Fuels‘ Brown 1 contract was reduced from 1 million tons to 600,000 tons (with 15% volume flexibility). Vectren Fuels is another subsidiary of Vectren Corp. (NYSE: VVC) that supplies Vectren South with coal. The current 2013 portfolio, which covers 2.58 million tons, includes the following supply:
- Foresight, Brown plant, 500,000 tons, contract ends 2017;
- Vectren Fuels, Brown 1 contract, 600,000 tons, ends 2014;
- Vectren Fuels, Culley plant, 1,000,000 tons, ends 2015; and
- Vectren Fuels, Warrick plant, 480,000 tons, ends 2014.
Because the three contracts with Vectren Fuels provide 15% delivery flexibility, Vectren South can reduce the contract volumes (other than Foresight) by 312,000 tons, therefore leaving a firm commitment for 2013 of 2.268 million tons versus a projected burn of 2.7 million-2.9 million tons. This leaves opportunity to procure incremental coal for 2013, Games noted.
Two contracts up for price re-openers
Vectren South has two existing supply contracts that entered a price re-opener phase on April 1. The Alliance Coal contract for 250,000 tons has another two years remaining through 2014. Similarly, the second Vectren Fuels contract to provide coal to Brown (Brown 2) under which Vectren South is receiving 349,000 tons this year (85% of 410,000 tons) also entered a re-opener on April 1. Under each contract, if the parties cannot agree on a price for the remaining contract years, the contract expires. Because Vectren South wants to monitor changing market conditions and supply needs before deciding what to do with these contracts, it has proposed to both suppliers that the re-openers be deferred until the fall of 2012.
In 2012, firm contract supplies under the Foresight, Alliance and Vectren Fuels contracts total 1.456 million tons. As part of the 2011 RFP, in exchange for various price and volume concessions from Vectren Fuels, including price discounts and a waiver of off-site coal handling charges, Vectren South agreed that its incremental needs in 2012 would be bought from Vectren Fuels at $43/ton FOB mine.
Asked if Vectren Fuels recently offered to sell Vectren South additional coal at a price below the negotiated $43/ton contract price, Games said it has. He was then asked why Vectren Fuels made this offer given it already has a contract to sell Vectren South its incremental needs in 2012.
“Vectren Fuels realizes that Vectren South, like many coal generators, had experienced reduced demand in 2012,” Games replied. “Thus, Vectren Fuels’ sales have declined at the same time it is poised to open the Oaktown 2 mine. Vectren Fuels is also aware that Vectren South can use its off-site coal pile in 2012 to meet part of our supply needs.”
Games added: “In an effort to support its sales and thereby avoid layoffs of some of its workforce, on April 21 Vectren Fuels offered to sell Vectren South 200,000 tons of coal in 2012 at a below market price if Vectren South would take this coal instead of using its off-site stored inventory. Vectren Fuels reiterated that it would continue to maintain that pile at its cost. The offered price, for coal meeting Vectren South’s contract specifications, was $40/ton FOB mine.”
Vectren Fuels provided an analysis of recent market prices for Illinois Basin coal and then offered a price below the published market average. Under this proposed arrangement, after purchasing this 200,000 tons of coal and deferring use of the off-site inventory until 2013, Vectren South would still decide how much of the inventory and its plants to use this year, and would buy its incremental needs in 2012 at $43/ton FOB mine.
“The offer would have allowed us to procure coal at $3/ton below the contract price for incremental volumes in 2012,” said Games. “However, before responding, we further evaluated reported market prices and determined they had dropped slightly since the offer. We also looked at several recently reported comparable sales of coal to Kentucky utilities to further verify the attractiveness of the offer. Based on this data, on May 1 we informed Vectren Fuels we would agree to take 200,000 tons of coal in 2012 at a price of $38/ton FOB mine in lieu of using off-site storage. Vectren Fuels accepted this offer.”
Recent coal slump makes 2011 bargain price look pretty costly
When Vectren South locked in 2012 pricing last year, it had indications that market prices were rising, Games said. So the $43/ton price was a very good price at the time. “The current depressed market conditions that arose as a result of the extremely mild winter weather have created this opportunity to buy what is essentially spot coal at a price that is $5/ton lower than our RFP based contract price,” he pointed out. “Because of their offer, we can enter into this purchase without breaching our 2012 contract obligation to Vectren Fuels to buy incremental needs at $43/ton. This allows us to reduce costs to our customers’ benefit and helps Vectren Fuels keep local miners employed. Leaving the off-site coal for 2013 has no negative impact from a cost perspective. In these circumstances, it makes sense to seize the opportunity to buy more low cost coal.”
As of Feb. 29, coal inventory at Vectren South’s coal-fired generating plants stood at about 786,000 tons, with additional off-site storage of 259,000 tons.
Vectren South’s generating units are offered into the Midwest ISO Day Ahead (DA) and Real Time (RT) markets and are dispatched by the Midwest ISO on an economic basis. Vectren South has contracted through competitive bidding to purchase its coal requirements from nearby mines at reasonable market prices, Games told the commission. Purchasing from mines in close proximity to Vectren South’s generating stations helps minimize transportation costs while providing a reliable, reasonably priced fuel supply.
To date, in 2012 coal generation throughout MISO has experienced significant reductions due to extremely mild winter conditions which reduced demand well below normal levels, and low gas prices which have continued to make gas generation more competitive, Games noted. “As a result, some utilities have experienced large increases in inventory levels,” he added.
Vectren South originally projected that its burn would exceed 2.7 million tons of coal this year. That level will likely fall, although summer demand could cause a rebound in demand. However, Vectren South entered the year with significant supply flexibility. While it is required to take 250,000 tons under the Alliance contract, it flexed down to 85% on the Vectren Fuels Brown and Warrick contracts (349,000 and 408,000 tons respectively), and had 199,000 tons of contract coal deferred from 2010, for a total under these contracts of 1.206 million tons.
Vectren South also planned to use offsite inventory of 301,000 tons, and on-site inventory of approximately 240,000 tons. As a result of the 2011 RFP process, Vectren South has the new Foresight contract for 250,000 tons beginning in July 2012, and a commitment to buy incremental requirements in 2012 from Vectren Fuels under a new Culley contract at $43/ton FOB mine. In total, firm contract obligations exist of 1.456 million tons. The remaining supply can be provided by a mix of inventory and purchases, as needed, from Vectren Fuels under the Culley contract at $43/ton FOB mine.