Speech by Thomas F. Farrell II
President & CEO - Dominion
NARUC Roundtable Discussion
Washington, D.C.
February 19, 2007
Good morning. I am delighted to join you today. The timing of today’s
discussion is felicitous.
“Felicitous” is a term often associated with Thomas Jefferson.
It was once used to describe his writing style – although more in the
sense of his remarks being “well said” than my reference to today’s
topic as being “well suited” or “apt” to what is going
on in our industry.
I should tell you that we have a rule in Virginia that any speech with at
least one reference to Jefferson is, by definition, a good speech. And given
that I am an alumnus of Mr. Jefferson’s university, it has become a running
joke at my company that I never make a speech without at least one reference
to him.
So there it is. I have now fulfilled the requirement.
But the word “felicitous” really is appropriate in the
present instance. Last fall, I gave a speech in which I described the
potential for an “energy train wreck” looming ahead for our country
if we do not grapple with some serious challenges. I cited four key issues:
First, a growing imbalance between energy supplies and consumer demands;
Second, our congested and inadequate energy transportation network;
Third, rising environmental costs and uncertainties;
And, fourth, the nation’s aging fleet of electric generating stations.
Today, I want to expand on that theme.
Unfortunately, all of those challenges are still there. If we do not rise
to meet these challenges – and do it soon – our country’s
economy could derail. No 21st-century economy can move forward unless it is
running along a strong, dynamic and reliable energy infrastructure. When the
power stops flowing, both the knowledge economy and the information superhighway
shut down.
This means that those of us in the electric industry have quite a bit of “track” to
lay in the next few decades in the form of new transmission lines. We also
have many “engines” to build in terms of new power stations. And
we need to determine how to make those engines run cleaner and more efficiently
to meet ever-tightening environmental requirements.
Most of all, the people in this room – that includes regulators, staff
members and industry representatives – will have to work together wisely
and innovatively to ensure the capital resources are there to get the job done.
I am confident we can do it. We have done it before. But if we do not work
together, the challenges may not be met. And then, I am afraid, the energy
train wreck could be inevitable.
So just how big is the problem? Let me try to quantify it. Nationally, projected
demand for energy is expected to jump about 50 percent over the next 25 years. That
means our nation will need 245 gigawatts of new electric generating capacity
by 2030, according to the Energy Information Administration. A gigawatt
is, of course, a thousand megawatts, or enough to power almost 800,000 homes.
In the Dominion service area in Virginia, we expect to see demand increase
by 4,000 megawatts over just the next 10 years.
Conservation and demand-side management programs must and will be a part of
this equation, both nationally and in Virginia. But there has been no indication
so far that even the best such policies will be able to put much of a dent
in the nation’s growing appetite for electricity.
Add it all up nationwide, translate it into dollars, and the industry estimates
that it could cost more than $275 billion in new generation to meet this growth.
Additional tens of billions will be required for transmission and distribution – big
wires, small wires, transformers, cross arms, poles, you name it.
And there is more: Environmentally, the emissions limits continue to tighten. The
industry projects about $50 billion in compliance costs for NOx, SO2 and mercury
from now through 2025.
We should expect federal regulation of greenhouse gases in the not-too-distant
future, a view reinforced by policy statements from the leadership of both
major political parties. Controlling carbon dioxide emissions from fossil fuels
will be very expensive. The bottom-line impact on power generation in
the United States for carbon limitations may range anywhere from $70 billion
to $300 billion.
Now total up all of those dollars – new generation, improvements to
transmission and distribution, emissions controls and now carbon – and
the number is staggering. Total investment required by our nation’s electric
industry could be somewhere between 400 and 650 billion dollars over the next
25 years.
CERA last week issued its own estimate for capital expenditure requirements
for the power industry across all of North America. It is just as daunting,
maybe more so. CERA estimates that the CAPEX spending in the U.S., Canada,
Mexico and elsewhere on the continent could top $800 billion in just the next
15 years.
Let me put our own nation’s predicament in perspective another way:
The market capitalization of all of the investor-owned electric utilities in
the United States is about $550 billion, give or take a few billion. That is
the total value investors place on the shares of all of the publicly owned
electric utility companies – and this number includes some like Dominion
that have natural gas distribution companies, oil and gas exploration and production
units, and other assets.
So the investment that electric utilities will need to make over the next
25 years is about equal to their entire worth on the stock market in 2007,
maybe substantially more. That is an astounding challenge.
If we are given the tools, I am convinced we can get the job done. Our industry
has always been good at designing, engineering and constructing the infrastructure
to meet the needs of our customers. But we have to get the money to buy the
tools so we can lay the track and build the locomotives.
What we are facing – potentially – is a crisis in capital. As
I said, it will take a huge investment to meet the energy needs of our country … 400
to 650 billion dollars. Some of it will be debt; some of it will be equity.
Yes, the spending will be strung out over 25 years, but it is still a substantial
sum of money – even for a country the size of the United States.
Remember, too, that we will not be alone in looking to the capital markets
for new funding. Electric utilities compete every day with airlines and computer
makers and home builders and every other sort of business to get investors
and lenders to look our way. At the end of the day, investors and lenders want
only the best risk-based return for their dollars. They cut us no slack just
because we provide a basic public necessity.
To ensure that a crisis in capital does not ultimately lead to that energy
train wreck, I believe the key is a partnership among the people in this room.
It will require us to work together. We must put in place the kind of innovative
and dependable regulation that will continue to protect and provide for our
customers and – at the same time – allow the industry to attract
the billions of dollars it needs to add the necessary infrastructure.
To borrow a phrase, the electric industry needs regulation that is not focused
on the “Tyranny of the Immediate.” It is a phrase that has been
used numerous times over the years to describe many situations. In this case,
I mean it to say our industry needs regulation that is not focused on just
the current rate case. We need regulation that is as much an energy policy
designed to avoid the energy train wreck as it is to make sure that each utility’s
authorized return on equity is calculated properly down to the right decimal.
I am not proposing a radical shift to some completely new regulatory model.
I think the framework of the traditional cost-of-service model that is more
than a century old works well – but could work better with some important
modifications. I offer three suggestions.
First, the regulatory model employed by any state should recognize that ROEs
should be set at levels that are not only fair to customers but also allow
electric utilities to compete with every other industry in the market for debt
and equity capital – certainly at least as well as similarly situated
utilities. This includes providing incentives for efficiency and innovation
on the part of the utility by allowing returns above the authorized level.
We are a capital-intensive industry that is facing dramatic increases in planned
capital expenditures. Money flows freely across industries
and across promising new global markets, as each of us is keenly aware. And
the smart money will flow to the smartly regulated.
Incentives for efficiency and innovation will benefit the customer in the
long term. Utilities that know they can keep at least part of the benefits
from efficiencies and innovations will strive to create them.
Second, the regulatory model should also recognize that utilities cannot be
held hostage to years-long regulatory lag in recovering the cost of their projects.
In the case of a new nuclear unit, we are talking about billions of dollars.
No matter how large a utility is, it cannot afford to provide a loan of that
size to its customers and not see any cash for four or five years or more.
Coverage of construction work in progress in current rates not only reduces
the stress on a utility’s capital structure; it also reduces the rate
shock experienced by customers.
Finally, the regulation should provide some sense of certainty as to what
has been or will be determined. Advance approval for a specific project,
its regulatory treatment during its construction and its regulatory treatment
during commercial operation goes a long way toward providing this certainty.
In the current issue of Edison Electric Institute’s “Electric
Perspectives” magazine, there is an article about a panel discussion
among utility finance experts. The lead sentence states: “The one thing
everyone can agree on is the need for certainty.” Later in the article,
one participant says he hears debt and equity investors both say over and over
that the one thing they want is certainty.
There are several examples I can cite of some innovative regulatory solutions
that are allowing utilities to move forward to meet the demands of their customers.
One is in Florida. The Florida Public Service Commission last week approved
a rule involving utilities planning new nuclear units. The utilities may request
that they begin recovering some of the costs incurred in developing new nuclear
projects before the stations enter commercial operation. The commission had
very sound reasoning for this decision. First, it said that this will encourage
Florida utilities to invest in much-needed baseload generation, ultimately
benefiting customers. Second, the commission said easing the cost of a new
nuclear unit into rate base would minimize rate shock.
This is an example of looking out beyond just the current rate case, beyond
the tyranny of the immediate. It recognizes that long-term rate stability and
long-term reliability are not always best served by holding down the current
rate case to the lowest penny possible while leaving tomorrow to fend for itself.
Moving from the Sunshine State to Wisconsin, where just seeing the sun this
time of year is cause for celebration, there is another example. Wisconsin
Power and Light’s Alliant Energy subsidiary filed an application this
month with the PSC to build a 300-megawatt coal unit.
Under the 2005 Wisconsin Act 7, Wisconsin utilities may request that the PSC
establish – in advance – the principal financial terms and conditions
that will apply irrevocably to a new electric generating facility. Similar
laws exist in Iowa and Nebraska. Virginia also has one under consideration.
This kind of rate-making provides the certainty that the capital markets are
demanding and a rate of return that can justify a long-term investment. Please
keep in mind that when we build a new baseload power station – be it
coal, nuclear or whatever – we are asking investors to tie up money for
a very long time. They have no crystal ball to predict what interest rates
and inflation levels will be in 10, 20 or 30 years.
A third example comes from outside the electric industry – natural gas
storage.
As you may know, along with being an electric utility and
power generator, Dominion’s businesses also include a major natural gas
pipeline and North America’s largest gas storage operation. Our
Cove Point LNG import facility is about 50 miles southeast of here, along the
Chesapeake Bay in Maryland.
Because of an innovation by FERC, Cove Point is the first facility to have
both cost-of-service and market-based rates. An expansion of the LNG facility
now under way is covered by market-based rates, while the existing Cove Point
facilities are under cost-of-service rates.
FERC finalized the rules last spring. They are intended to mitigate natural
gas price volatility by encouraging development of new natural gas storage
capacity as part of the Energy Policy Act of 2005. The so-called “Hackberry
rates” – named after a storage facility in Louisiana where the
rates were first proposed – provide incentives for the development of
much-needed storage capacity while ensuring just and reasonable rates.
So, here are three examples – two from the states and one from FERC – where
traditional cost-of-service regulation has been modified to provide the three
things the traditional model does not always provide:
ROEs that encourage development of necessary infrastructure and make the
financial markets comfortable with long-term commitments,
Reduced regulatory lag, and
Certainty that once a decision is made by the utility and the regulators,
it will not be reviewed at some future date, possibly altering everyone’s
expectations..
In all three cases regulators still have a great deal of latitude and power
to act in the public’s best interest. But working in concert with the
industry, they have guidelines that ultimately benefit everyone.
It can be done. It is being done.
In closing, I will give you another piece of Virginia lore that is apropos
to my presentation.
The first recorded song to ever sell a million copies was called the “Wreck
of Ol’ 97.” The ballad was based on a train wreck that occurred
more than 100 years ago in Danville, Virginia. It killed 11 people and
received a great deal of national publicity.
The Ol’ 97 was running behind, much like the electric utility industry
is starting to feel in terms of meeting future demand. The engineer
tried a little too hard, too late to make up for lost time.
As a favor to all, I will not sing the lyrics – just recite them:
“He was comin’ round the bend doing’ 90 miles an hour” … so
goes the lyric … “and he was found in the wreck with his hand
on the throttle.”
I have no interest in duplicating the events of the Ol’ 97 in our industry. But
I fear it. I fear it because we may once more fall prey to the tyranny
of the immediate and the possibility of an energy train wreck. Now is
the time to start laying “track” and getting our “engine” up
to speed. We need innovative regulation and legislation to do just that.
