Executive Speech

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Remarks of T.F. Farrell II
Before
House Commerce and Labor Committee

February 3, 2004

Good afternoon, Mr. Chairman and members of the committee.

My name is Tom Farrell, and I am the president of Dominion. Thank you for allowing me to give my company's perspective on the restructuring legislation facing you today.

Virginia's Restructuring Act has repeatedly been hailed as one of the best in the United States. Its gradual, evolutionary approach set an example for the nation. Thanks to this approach, we have not suffered like California. We have not seen the utility bankruptcies that some other states have experienced. Virginia's electric customers have seen a long period of rate stability.

The assertion that the retail competitive market has not developed as quickly as many expected is no reason to overturn the Act and make such a dramatic policy change. We are still in the middle of the Act's carefully thought-out, lengthy transition period. Change takes time - and the Act never envisioned an overnight transformation, with competitive markets quickly replacing a regulatory system in effect for almost a century. Only now are utilities and energy companies coming back from California's ill-advised law and from the bankruptcies of Enron and other companies.

• Suspension of retail choice and the re-bundling of rates would send a clear and unmistakable signal that Virginia has reversed course on restructuring. Competitive suppliers would have no reason to do business in the Commonwealth, preferring to concentrate on states that remain committed to retail choice.
  
  
• HB 264 would quickly bring an end to Dominion's retail choice pilot programs - programs for which more than 85,000 customers have so far volunteered. With retail choice suspended, no suppliers could participate in the pilots.
  
  The measure is a thinly disguised method designed to make the pilots fail.
  
  
• All of these measures will end retail choice in Virginia just as it is beginning to pick up momentum in other states. Chairman Morgan's op-ed piece this morning stated that retail choice has not worked anywhere.
  
  Here are the actual numbers:
  
  
  • Texas - almost 900,000 have switched - 15% of customers
  • Pennsylvania - just under 500,000 - 10% of customers
  • Ohio - just under 1,000,000 - 19% of customers
    
    

  Significant switching has also occurred in New York, New Jersey—and even in D.C. where over 10% have shopped.

• A recent study by the KEMA consulting group found that a third more people switched in 2003 than the year before. Now 7% of the nation is served by competitive suppliers.
  
  
• Interestingly, in Ohio 90% of those who have switched have done so through municipal aggregation, where the locality helps its citizens switch. Opt-out municipal aggregation is not presently allowed in Virginia, but SB 651, the Omnibus Bill endorsed by the Commission on Electric Utility Restructuring would open up that key market later this year.
  Why Stop Now?

We also urge you to defeat House Bills 1268 and 1437. Both bills would immediately take us back to the days of cost-of-service rate making. They would open the door to a stream of annual base rate cases and rate increases for every utility in the state. Under this system, Dominion Virginia Power's average residential base rate rose by more than 40 percent from 1980 to 1994 as customers paid for ever-increasing investments such as new power stations to meet Virginia's growth.

If you repeal or suspend the Restructuring Act, you will shift risk from shareholders - where the 1999 law mandated it to be - back to customers. For example, during the capped rate period, Dominion must cover almost $2.5 billion in new costs and investments without the opportunity to increase customer base rates. Dominion's largely urban service territory is experiencing very high growth. Therefore, our costs are rising rapidly. Our new costs and investments during the capped rate period include:

• $600 million for new generation projects;
• $700 million for advanced environmental controls;
• $780 million for new transmission and distribution projects;
• $200 million for projects to ensure the safe operation of our nuclear units; and
• $200 million for Hurricane Isabel.

These are staggering numbers. But under the Restructuring Act, they will not lead to higher base rates. Unfortunately, that won't be true if the Act is repealed or suspended - and the risk shifted back to consumers.

Thanks to the Restructuring Act and its capped rate provisions, Virginia's industrial rates are among the lowest in the nation, according to the Edison Electric Institute. The average industrial rate of 3.9 cents per kilowatt-hour is a cent below North Carolina's average - and a half-cent below South Carolina's. Dominion's base rates are capped essentially at 1993 levels -- and the average household served by the company has seen the monthly cost of electricity drop by 25 percent, adjusted for inflation, over the last decade.

Similar numbers are true for commercial customers:

I would also like to note that all three of the proposals before you (House Bills 264, 1268 and 1437) would continue the present system of annual fuel factor cases for all Virginia utilities, with customers continuing to bear the risk of highly volatile fuel prices. Last year fuel prices increased about five percent. This year they have already increased 25 percent. It is very hard to see how these bills can be viewed as "pro-consumer" when the offices of the Governor and the Attorney General have proposed a measure - recently endorsed by the Senate - that would impose new limits on Dominion's fuel rates from now through 2010.

So-called "Over-Earnings"

Before concluding, I would like to address briefly the so-called "over-earnings" allegations being thrown very carelessly at Dominion by critics of the Restructuring Act.

Dominion has exceeded its old target rate of return of 11.4 percent only once since 1998, taking into account the write-off of some assets required by the restructuring process. The target was set back in 1992, as part of a rate case under the old regulatory system that has been superseded by the Act. In fact, our return on equity in 2001 fell almost two percentage points below the old target.

The only exception to this pattern has been 2002, a year marked by unusual factors such as an extremely hot summer and a bitterly cold winter. The adjusted return on equity that year was 13.94 percent. Almost certainly, that combination of factors will not happen again. It did not in 2003. Virginia Power actually earned more than $200 million less in 2003 than in 2002 - and less than it did in 2000.

Opponents of the Act are seizing on this one instance of so-called "over-earnings" to launch an all-out assault on the Act. It's almost as though they're playing a game of legislative "gotcha."

One Final Point:

Some of those accusing Dominion of "over-earning" are deliberately misinterpreting a State Corporation Commission staff report filed last fall. In that report, the staff benchmarked our earnings against a 9.47 percent return on equity. Let's be clear: This figure was not determined by the Commission during a full-fledged rate case, with opportunities for all parties to present evidence. That was the only way target returns on equity were set under the old regulatory system. Instead, the figure was part of a staff accounting exercise referred to as an "earnings test" - and the staff itself noted that "an earnings test is never used to determine utility rates."

The use of the 9.47 percent benchmark is also very low, compared with rates of return in adjacent states that have maintained traditional regulation. Returns on equity for electric companies in these states range as high as 13 to 16 percent. For example, in North Carolina, Duke's return on equity is set at 12.5 percent, Carolina Power and Light's at 12.75 percent.

Act Gives Incumbents Chance to Prepare for Competition

Back in 1999, when the Act was passed, there was a broad consensus among the stakeholders that incumbent utilities would use any so-called "over-earnings" to lower their generation costs, bring them in line with the market, and prepare for competition.

That's precisely what we've been doing. In fact, the staff's report was aimed at showing what was available for stranded cost recovery.

We've spent just under 400 million dollars to lower our long-term costs by retiring high-priced contracts with independent power stations. We also have been required to write off of our shareholders books $562 million as a result of the Restructuring Act. Certain stakeholders have forgotten this part of the 1999 consensus. In doing so, they've put those of us who have faithfully followed the law's intent in financial jeopardy if the rules are changed midway through the transition.

A Clear Choice for the Assembly

These bills are extremely premature. We still must give the Act a chance to work. As one of Virginia's largest employers, we have completely turned our company upside down and inside out to become ready to survive in a nationally competitive market.

We believe a reversal of course - either through suspension or repeal of the Act - would be a very damaging public policy decision, harming the interests of more than five million Virginians served by Dominion. Our company, our ability to compete, and our financial strength would all be harmed, putting our employees and our customers in jeopardy.

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

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