Executive Speech

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Remarks of T.F. Farrell II
for Dominion Commission
on Electric Utility Restructuring

January 13, 2004

Good morning, Mr. Chairman and members of the Commission.

I am Tom Farrell, president and chief operating officer of Dominion. Thank you for giving me the opportunity to present my company's thoughts on Virginia's restructuring effort and the proposed changes to the Act.

The Virginia Electric Utility Restructuring Act: Producing Consumer Benefits

Dominion believes that the Virginia Electric Utility Restructuring Act is making substantial progress and producing major savings for Dominion Virginia Power customers.

We strongly oppose any and all efforts to suspend the Act, re-impose the old "cost of service" regulatory framework, or push retail choice into the indefinite future.

Such proposals—including several before you today—are purely and simply anti-consumer legislation that will eliminate the significant benefits our customers have enjoyed under the Act. These proposals could potentially bring about many new rate cases between now and the end of the decade.

We do support the proposal from the offices of the Governor and the Attorney General which would extend the capped rate period through 2010. The measure will give the competitive market more time to develop and mature, especially since wires charges will be removed. The proposal will also provide three additional years of the "safety net" which rate caps provide consumers.

The argument that the retail competitive market has not developed as quickly as many expected a few years ago is no reason to overturn the Restructuring Act. Change takes time—this is Virginia, after all—and the Act has always envisioned a lengthy, careful transition. Disrupting the Act now would be a great disservice to our customers and our company after the preparation and changes we have made to get ready for competition, not to say the enormous expenses already borne by our shareholders.

Virginia Electric Utility Restructuring Act: Major Strengths

In fact, the lengthy transition period—with careful regulatory and legislative oversight—is one of the major strengths that continue to distinguish Virginia's Act from every other state restructuring law in the nation. Here are some of the other strong points.

• The Act established capped base rates to provide a "safe harbor" and price stability for the Commonwealth's electric customers during the transition to a competitive market. The capped rate provisions prohibit us from raising base rates except under extraordinary circumstances. As a result of restructuring, the price of electricity for Dominion Virginia Power's residential customers has dropped by more than 25 percent—adjusted for inflation—in the past decade. The company has not had a base rate increase in almost a dozen years. What other commodities or businesses can say that? The chart you have before you clearly shows this price stability.
  
  
• The Act also provides for default service—under the broad authority delegated to the State Corporation Commission—to protect consumers from market disruptions once the rate caps come off.
  
  
• And the Act has forced utilities to become more efficient. With the rate caps in place, they can no longer continue to pass virtually every cost and expense imaginable along to customers through higher base rates. Under cost of service, there was no incentive for improved efficiency. Instead, there was a steady stream of rate cases—as utilities operated under the assumption that the more they spent, the more they earned. Capital projects added to the rate base remained there for as much as 40 years. Customers decades in the future were obligated to pay for them.

Shift of Risk

In fact, the Restructuring Act has produced a profound change in the assignment of risk in Virginia's electric industry.

The passage of the Act in 1999 shifted the financial burden from the customer to our shareholders. Utilities must work harder and smarter to meet their obligations, without asking for more money from their customers.

Dominion alone will have to cover more than $2 billion in additional costs and investments during the capped rate period…with no opportunity to pay for them through higher customer base rates.

These costs include:

• More than $600 million for generation projects to keep up with Virginia's growth.
  
  
• More than $700 million for advanced environmental controls, including new emissions control equipment for our coal-fired power stations.
  
  
• Approximately $780 million for transmission and distribution projects, and for connecting new customers, especially in high growth urban and suburban areas.
  
  
• Approximately $200 million for projects to ensure the continued safe and efficient operation of our nuclear units, which continue to supply much of Virginia's low-cost energy.

And we cannot ask for higher base rates to pay for the massive restoration effort we launched in the wake of Hurricane Isabel. We've estimated the after-tax cost of restoring power and rebuilding our system as at least $128 million. Without the tax adjustment, the cost is approaching $200 million. This is many times greater than our expenses for dealing with any other storm in our corporate history. But it will not lead to higher rates.

Chmura Study of Capped Rate Savings

This shift of risk has resulted in big savings for Dominion's customers. The savings were highlighted by a study prepared by the respected Richmond consulting firm of Chmura Economics and Analytics. The study, commissioned by us and released in November 2002, compared the capped rates to what base rates likely would have been if Virginia had failed to launch its restructuring program.

The results were impressive.

• Dominion residential customers will save as much as $871 million during the capped rate period of 1998 to 2007.
  
  
• The average residential customer will save between $45 and $50 each year of the capped rate period.
  
  
• This represents annual savings of four to five percent for the typical Dominion residential customer.

Further study by Chmura Economics and Analytics indicates that the extension of capped rates proposed by the Governor and the Attorney General would provide even more savings for Dominion customers.

• The new study shows that with the extension, the capped rates would produce total savings of $1.5 billion to $1.8 billion for Dominion residential customers during the period from 1998 through 2010. As much as $700 million of those savings would come during the three-year extension alone.
  
  
• The average household would save as much as $966 on electricity over the entire capped rate period of 1998 through 2010.
  
  
• And base rates for residential customers would likely have risen between 8 and 11 percent from 2001 to 2010 in the absence of capped rates.

These savings represent a huge contribution to Virginia's economy. They will help fuel the Commonwealth's continued growth and maintain a strong competitive advantage with other states.

Pilot Programs

Returning to the era of "cost-of-service" regulation also runs counter to customer interest in retail choice. Interest remains very high, as evidenced by the recent support for Dominion's pilot programs.

So far, Dominion has had over 80,000 volunteers—from all customers classes—for retail pilots approved by the SCC last year. Interest in the pilots is strong throughout our service area; northern, central and eastern Virginia have each contributed about one-third of the volunteers.

The number of volunteers is almost double the number of participants the programs can accommodate. Everyone who sees a place for competition in the future of the electricity business should be very pleased by this response. We believe the programs will do much to boost the development of the competitive market in Virginia.

A return to "cost-of-service" would make these programs meaningless—and bring them to an abrupt halt. Legislative provisions that would allow the pilots to continue for awhile without the certainty of retail competition are nonsensical. Who would participate? What competitive suppliers would invest their time or money? Such provisions are included only for appearances' sake. They are designed to ensure the pilots' failure.

Greater Efficiency at Dominion

I also believe the Act has made us a much better company. With the responsibility for rising costs shifted from the customer to the shareholder, we've become more efficient. We've developed a culture of working harder and smarter, to the benefit of both our customers and our shareholders. Overturning the Act and returning to the old regulatory system would eliminate the incentive for making these changes. We see absolutely no reason to return to the past.

No Valid Reasons for Turning Back

There appear to be several arguments driving the call for suspending the Act or re-imposing cost-of-service regulation. Absolutely none of them is valid.

• Let me first address the argument that the Act has somehow resulted in "over-earnings" for Dominion. This issue has arisen from claims that we have exceeded our old regulated rate of return of 11.4 percent, which was set under the cost-of-service system almost a dozen years ago.
  
  Taking into account the requirement that we write off regulatory assets, we have exceeded the old target rate of return only one year—2002—since the Act went into effect. The Return on Equity that year was the product of several extraordinary factors, including an extremely hot summer and an extremely cold winter. Almost certainly, they won't happen again. Indeed, they did not in 2003.
  
  We must also point out that we have spent hundreds of millions of dollars to lower our long-term costs and enable our generation to compete in the competitive market. These costs include measures such as the retirement of above-market contracts for non-utility generation. This is exactly what we are supposed to do with our "over-earnings" between now and 2007. The SCC Staff, however, has consistently and incorrectly—even under the outmoded cost-of-service theory—overlooked these measures in its calculation of our Return on Equity.
  
  It's almost as though the opponents of the Act are playing a game of legislative "gotcha," seizing on one year of alleged over-earnings—2002—as a reason for undermining the whole structure. I must point out that Dominion did not appear before you, hat in hand, appealing for relief through higher rates when we failed to meet our old target rate of return. With Isabel, moderate weather, and our investment of hundreds of millions of dollars in our nuclear units, I can assure you that 2003 will look more like 2000 or 2001 than 2002.
  
  
• Fear of future price increases also appears to be driving the movement to undermine the Act. Our forecasts indicate that customer prices will actually go down, not up, in 2007, when the rate caps are scheduled to expire. In addition, a recent cost-benefit study indicates that Dominion's membership in the PJM regional transmission organization—another integral part of the restructuring process—would produce savings of almost $500 million for Virginia consumers during the next 10 years. That points to lower prices—not higher ones.
  
  Concern about post-2007 price behavior also is not a valid reason for suspending or scrapping the restructuring movement.

Capped Rate Extension: The Preferable Path

But suppose we are wrong and market prices do go up?

The capped rate extension bill offered by the Governor and the Attorney General is a far more appropriate response to such concerns. The extension would give the consumer an additional three years of the safety net of capped rate protection while the market developed. If indeed the post-2007 electricity prices are lower, our customers can take advantage of them while still having the safe harbor of capped rates.

The bill is totally consistent with the spirit of the Restructuring Act, which has avoided the "one size fits all" approach to changing Virginia's utility industry.

This is reflected in the language in the bill that allows Virginia's electric cooperatives to make their own decisions and follow their own business needs. The bill gives the cooperatives as a group the right to opt-out of the Restructuring Act. They would also have the right to return to the Act later, also as a group. The Act already recognizes the special nature of the cooperatives and contains many provisions that specifically apply only to them.

Other proposals would require that we all be treated the same—an approach the Act has never taken in the past.

We recognize that bill's elimination of the wires charge in 2007 carries considerable risk for us. But we accept those risks.

We do have some concerns about the bill's proposal to freeze the fuel factor until 2007, followed by a one-time fuel rate adjustment to run through the end of the extended cap period. This represents significant risk for us, as fuel prices over the next six or seven years are uncertain, at best. However, we will work with the other stakeholders in the restructuring process to address this and other issues stemming from the bill - and to help keep the measure moving forward.

Allow the Act to Work

In short, we believe the Virginia Electric Utility Restructuring Act should be allowed to work. There's no need for suspension, re-bundling, re-imposition of cost-of-service rate making or other drastic measures. These measures would have very damaging implications for our customers and our company—and for the Commonwealth as a whole.

An extension of the capped rate period is a vastly preferable option. It harms no one. It would allow three more years for retail markets to develop and provide price protections that will bring even more savings for consumers.

Turning back the clock to some non-existent "good old days" would be a very damaging public policy decision. It would harm the interests of more than 2 million Dominion customers here in Virginia.

Thank you. I'd be happy to answer any questions you may have.

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Editor's Note: View a related news release.