MarketWatch  Apr 23  Comment 
Electricity and natural gas distributor CenterPoint Energy Inc. will acquire Vectren Corp. for $72 a share in cash, the companies said in a statement Monday. The price per share is 9.8% higher than Vectren's closing price of $65.55 on Friday....


Vectren is a utilities holding company operating in Indiana and Ohio. It sells gas at retail prices to 998,000 primarily residential customers in Ohio and Indiana. It it also provides 141,000 customers, mostly in Indiana, with electricity from its coal power plants.

VVC's gas and electric businesses are regulated utilities: the states of Ohio and Indiana set the rates that Vectren can charge its customers, approve the company's expansion projects, and dictate what customers are in Vectren´s territory. Government regulation guarantees steady, assured earnings at the cost of low growth potential because of capped returns. By lobbying for changes in its rates structure, Vectren has managed to shield itself from the impact that changing commodities prices and weather patterns would have on its gas revenues; in 2006 and 2007 Ohio and Indiana implemented new rate plans for VVC that let the company increase rates at its gas utilities if declining consumption patterns lead to decreased net income. In Indiana Vectren can also increase rates at its gas utilities if adverse weather conditions cause decreases in gas consumption and decreased revenue. This legislation does not affect the company´s electric utilities, which still see revenue seasonality as usage increases in the hot summer months and decreases in the cold winter months, and commodities risk as rising coal prices cause margins to shrink.

Business Financials

Vectren´s owns and operates regulated utilities in Indiana and Ohio.[1] Its utilities businesses are generally broken into two segments, described below.

  • Gas Utilities: The gas utility group buys natural gas at wholesale and sells it at retail to 998,000 customers in Indiana and Ohio.[2] The vast majority of Vectren´s gas customers are residential households; in 2007 it had 911,000 residential customers, 85,000 commercial and 2,000 industrial.[3] In 2007 gas utilities accounted for 1,269.4M, or 56%, of the company´s revenues.[4]
  • Electric Utilities: The electric utility group operates coal and natural gas power plants in Indiana. [5] The power plants supply electricity to 141,000 Indianan customers, of which 122,000 are residential 18,800 are commercial and 200 are industrial.[6] Vectren operates coal generators with the capacity to produce 1000MW of electricity and gas generators with the ability to produce 295MW of electricity. Historically, however, the company has only operated their coal generators, saving their gas generators for emergencies or periods of peak use.[7] For example, in 2007 VVC produced 98% of their electricity with coal and only 2% with natural gas. [8] In 2007 electric utilities accounted for 448.1M or 20% of VVC’s revenues.[9]

Vectren also operates various other businesses that provided support their utility businesses. For example, it operates an energy and marketing services segment which buys the gas sold by the gas utilities segment and enters into derivative contracts to hedge against increases in gas prices.[10] It also operate two coal mines that provide 92% of the coal used in their power plants, and an energy infrastructure segment that repairs pipelines and electrical lines for the company's utility customers.[11][12]

Below is a chart of the company´s net income and revenue broken out by business segments. While Vectren´s gas utilities provide the majority of the company's revenues, because the gas utilities segment purchases the natural gas it sells to consumers the segment only accounted for 32% of revenues. Gas purchased by the gas utilities segment accounted for over 70% of the segment's expenses.[13] To contrast, VVC's electric segment, though producing the least revenue of any business, had the highest net income. VVC's electric generators use coal, which is cheaper to purchase than natural gas, and the segment had low operating expenses. In other operations, 85% of net income came from VVC's gas marketing and energy infrastructure businesses; segments which support the company's utility groups.[14]

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VVC's utilities are regulated industries. The state governments of Ohio and Indiana regulate what rates VVC can charge its utility customers. State agencies also regulate what customers VVC can provide with utilities and which expansion projects VVC can undertake. Regulation was enacted because, due to high infrastructure costs, the utilties VVC operates are natural monopolies. The protect consumers from gas and electric companies from charging unreasonable rates for what is essentially a necessary good. Regulation also helps to protect Vectren. It provides the company with insulation from competition and, to a certain extent, from changes in commodity prices and consumption patterns. However, the cost of that security is growth potential. Regulated utilities like VVC generally provide steady income but have little opportunity to produce above average returns. In 2007, income and revenues steadily increased from 2007. Increases were due to rate increases in the company's gas delivery business in Southern Indiana, increased consumption caused by higher favorable weather conditions, and increased revenues at the companies energy infrastructure business.[16]

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Trends and Forces

Government Regulation of Gas Distribution Gives VVC less Control over its Margins

Utilities tend to be highly regulated business in the U.S. and VVC is no exception. The states of Indiana and Ohio set prices VVC can charge consumers for its utilities and regulate their expansion, production level and even customers.[18] For 2007, those rates were a 10.4% return on equity for VVC´s electric segments and a 10.15-10.2% return on equity for Vectren´s gas segments. These rules are designed to ensure both profitability for the company and accessibility for the consumer. Since the high cost of infrastructure installation makes most utilities natural monopolies, government regulation is in place to prevent utilities companies from hiking up rates for a good which can be considered a necessity (especially in the winter). Unfortunately for utilities, these regulations often hold them back from achieving potential revenues and profitability by preventing them from charging delivery rates that the level of demand would allow. The only way for VVC to increase its rates is to petition the regulatory agencies in Ohio or Indiana. Even then, the agencies will usually only agree to a rate increase if VVC can show that its margins have shrunk.

VVC is Insulated Against Changes in Consumption Patterns For Natural Gas, But Not Electricity

The price of natural gas has seen wide fluctuations in the past five years. The price has declined slightly in the past two years, down 5% since highs in 2005.[19] However, the price is still up 43% since 2002.[20] Rising prices have led revenues at many utility companies to fluctuate as consumers try to reduce consumption to reduce bills. In 2006 and 2007 VVC effectively insulated itself from these changes in demand.[21] Ohio and Indiana regulators reached agreements with VVC that let VVC increase rates on gas delivered to make up for net income lost due to changes in customer consumption patterns, setting 2006 as the base year.[22] This legislation was passed to incentivize natural gas companies to help consumers conserve gas. Though it will likely result in higher rates on natural gas sold to consumers, it is expected to lower bills for consumers by decreasing their overall consumption of natural gas. Like natural gas, the price of Coal Power has been increasing. The average price of coal at electric generating plants rose 35% between 2002 and 2006.[23] These rising rates affect consumers' demand for electricity. Indiana and Ohio regulations let VVC to pass along the increased fuel cost to consumers in the form of rate increases. However, rate increases incentive consumers to conserve energy. Unlike VVC's natural gas operations, state regulations do not insulate VVC from changes in demand for electricity.[24] As customers conserve electricity VVC's volumes delivered fall, decreasing revenue and net income.

The United States is Switching Towards Eco-Friendly Energy Sources, Which Lowers Demand For Coal Power Plants

Ninety eight percent of VVC's electric power is generated from coal generators.[25] Coal combustion produces Carbon Dioxide, Carbon Monoxide, Nitrogen Oxides, Sulfur Dioxide, Ash and Mercury, all pollutants and contributors to global warming. Coal Power produces more of every one of the previous listed pollutants than the combustion of either oil or natural gas, measured per billion BTU's of energy produced.[26] Though government regulations prevent Indiana consumers from choosing their electricity producer, increasing consumer consciousness about the effects of coal will likely lead many consumers to conserve electricity and lobby for more environmental regulations.[27] In 2007 Governor Ted Strickland announced a plan for Ohio to participate in the Renewable Portfolio Standards plan. Under this plan 25% of electricity sold in Ohio must be from renewable sources by 2025, though clean coal is included in the list of renewable sources.[28] Indiana has not yet passed a plan under the Renewable Portfolio Standards Plan, but is facing increasing political pressure to do so.[29] Increasing legislation has already started to increase expenses for VVC. In 2005 the EPA finalized the Clean Air Interstate Rule and Clean Air Mercury Rule which tightened emission regulations for power plants.[30] To comply with these rules VVC has already planned to invest $307M in emission reducing equipment.[31]

VVC Has Some Exposure To Weather Pattern Changes

Demand for natural gas distribution is highest during the coldest months of winter when it is used to heat homes.[32] Demand for VVC's electricity is highest during the summer months, when people use larger amounts of electricity to cool their homes.[33] During the temperate Fall and Spring seasons demand for natural gas and electricity balances between the valleys/peaks of summer/winter.[34] These factors work to create seasonality in VVC's revenues, with higher revenues in the winter and summer and lower revenues in the fall and spring. For example, Vectren´s revenues for the three month period of January-March in 2007 and 2008 were $902.1M and $834.0M.[35] For the three month period of July, August and September, revenues were only $381.4M.[36] [37] The weather can also impact annual revenues. If a winter or summer is longer and more severe than usual customers will demand more gas and electricity, increasing VVC's revenues. The opposite is also true: customers will demand less energy if the winter and summer seasons are short and temperate, decreasing VVC's revenues. The effect of the weather on annual revenues can be decreased through Normal Temperature Adjustment (NTA) mechanisms. NTA's let utility companies to raise rates during years with adverse weather conditions to normalize net income. As of December 31st, 2007 VVC's gas utilities in Indiana, representing approximately 60% of the company's total natural gas operations, were the company's only segments with NTAs.[38] In 2007 favorable weather conditions increased net income at the company's electrical utilities by $11.8M and net income at its Ohio natural gas utilities by $5.5M.[39][40]


VVC is a regulated utility. Due to state regulation, customers often don't have the ability to choose another electric or gas provider. In districts where customers can choose another gas or electric provider, VVC is allowed to charge margins for transporting gas or electricity on its distribution network equal to the margin it would have earned had it sold them the commodity.

VVC is differentiated from its competitors by an increased insulation from changes in demand. Ohio and Indiana have regulations which effectively shield VVC from changes in customers’ gas usage patterns, and Indiana has regulations that shield VVC's gas business from changes in weather. These regulations decrease VVC's risk relative to its competitors.

Though VVC has little direct competition with other utilities, it does compete with alternative fuels. The increasing consumer demand for alternative sources of energy has led both companies and consumers to invest in renewable energy sources such as nuclear, solar, and wind power to heat homes and generate electricity. As the demand for these renewable sources of energy increases, the demand for VVC's natural gas and coal powered electric utilities will fall.

Company Revenues (12/31/2007, $ in Millions) Market Cap($ in Billions, 05/15/08) Natural Gas Customers "'Electric Customers"' "'Operating States"'
"'Vectren (VVC) $2,281.90[41] $2.16[42] 998,000[43] 122,000[44] 2[45]
NiSource, Inc (NI) $7,939.80[46] $4.96[47] 3,300,000[48] 457,000[49] 10[50]
Atmos Energy (ATO) $1,361.41[51] $2.56[52] 3,200,000[53] N/A[54] 12[55]
Puget Sound Energy (PSD) $3,220.15[56] $3.61[57] 730,000[58] 1,100,000[59] 1[60]


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  12. 2007 Form 10K page 8
  13. 2007 Annual Report page 22
  14. 2007 Annual Report page 22
  15. 2007 Annual Report page 90
  16. 2007 Annual Report page 20
  17. Google Finance: Company Profile
  18. VVC 2007 Form 10-K Page 28
  19. Energy Information Association, Natural Gas Price Summary
  20. Energy Information Association, Natural Gas Price Summary
  21. VVC 2007 Form 10-K Page 28
  22. VVC 2007 Form 10-K Page 30
  23. National Coal Mining Association
  24. VVC 2007 Form 10-K Page 30
  25. VVC 2007 Form 10-K Page 9
  26. NaturalGas.Org: Natural Gas and the Environment
  27. VVC 2007 Form 10-K Page 9
  28. Renewable Energy World.Com: Ohio Considers Renewable Portfolio Standard, August 30th, 2007
  29. Energy Information Administration:Renewable Portfolio Standards and State Madnates By State
  30. VVC 2007 Form 10-K Page 30
  31. VVC 2007 Form 10-K Page 30
  32. Natural Gas.Org: Factors Affecting Demand For Natural Gas
  33. EP 2007 Form 10-K Page 11
  34. Natural Gas.Org: Factors Affecting Demand For Natural Gas
  35. Google Finance: Income Statements: Vectren
  36. Google Finance: Income Statements: Vectren
  37. Natural Gas.Org: Factors Affecting Demand For Natural Gas
  38. VVC 2007 Form 10-K Page 31
  39. VVC 2007 Form 10K Page 24
  40. VVC 2007 Form 10K Page 30
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  46. Google Finance: Company Profile
  47. Google Finance: Company Profile
  48. Reuters:Full Description:NI
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  50. Reuters:Full Description:NI
  51. Google Finance: Company Profile
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  53. Reuters:Full Description:ATO
  54. Reuters:Full Description:ATO
  55. Reuters:Full Description:ATO
  56. Google Finance: Company Profile
  57. Google Finance: Company Profile
  58. Reuters:Full Description:PSD
  59. Reuters:Full Description:PSD
  60. Reuters:Full Description:PSD
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