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Remarks of Thos. E. Capps
Chairman & CEO - Dominion
at the
Deloitte Energy Conference

May 24, 2004

"Why We Need A National Energy Policy"

Good morning.

It's a pleasure to be here… and a privilege to join Chairman Wood for a discussion about national energy policy.

Just a few weeks ago, I would have asked, "What national energy policy?"

I was firmly—and uncharacteristically—in the gloom and doom camp.

Legislation was stalled in Congress. Prospects for forward progress appeared slim to none. Bickering over side issues torpedoed every effort to pass a comprehensive energy bill. Election-year politics made lawmakers shy away from doing anything decisive. All this, despite the urgent—and all-too-apparent—need for action.

About 50 million people were blacked out by the power failure last summer, and they didn't see fit to pass a comprehensive energy bill? I asked myself, what would it take?

I figured the blackout—and the reliability concerns it raised—had become repressed memories.

It looked like legislators had somehow forgotten the need to improve the energy infrastructure…and that "energy security" had been relegated to a convenient campaign slogan. It also seemed that our unhealthy dependence on foreign sources of energy—made riskier by the violent path of recent events—would never change.

I was tempted to dust off a speech I gave three years ago to a group of economists here in Washington. The topic was none other than national energy policy—or the lack of it.

I complained loud and hard about the inability of Congress to pass anything. I compared the energy infrastructure to a critically ill patient, suffering from clogged arteries, cardiac insufficiency…and self-inflicted wounds.

I'm afraid the patient is still sick.

But this morning, I'm happy to report, there may yet be a pulse—and even a few glimmers of hope.

We're still a long way from a remedy—namely, a comprehensive strategy for meeting the energy needs of the American people in a secure and reliable way.

But the blockage may be breaking up. Contrary to my fears, the magnitude of the problem may be too big for even the most timid legislators to ignore any more. I think high gasoline prices may have their attention right now.

On May 11, the Senate took the tax portion of the old comprehensive energy bill, hooked it to another piece of corporate tax legislation, and passed the package by a decisive 92-5 margin.

Finally, some legislative creativity!

As you might imagine, those of us in the energy industry strongly supported this move.

The tax bill does good things:

Here's another glimmer of hope. Before passing the tax bill, the senators approved an amendment that should give a boost to that much needed infrastructure improvement—the construction of new transmission lines. The amendment reduced the depreciation life of transmission assets by one-fourth—from 20 years to 15 years.

Unfortunately, the amendment was modified to apply only to new facilities entering service before June 30, 2006. That time limitation should be removed, either in the House or in conference committee. Lawmakers need to restore the open-ended tax break for transmission that was in last year's House version of the energy bill.

Overloaded transmission lines are like clogged arteries. They threaten transmission integrity. Without decisive action, the situation will deteriorate. With no new incentives, spending on transmission construction is expected to increase by only six percent over the next decade—less than one-third the rate of the growth of demand.

I congratulate the Senate for taking action. I also realize the bill is a long way from becoming law. It's late in the legislative season, and Congress probably can't resist the urge to get out of town early in an election year.

We can only hope the House will recognize the wisdom of the Senate's action and pass the tax bill promptly so it can be on the President's desk soon.

In case you were starting to worry, that's the extent of the good news. Let's sink back into gloom and doom for a few minutes.

Truth is, comprehensive energy policy still lies in legislative limbo. The tax bill wasn't even half a loaf…maybe an eighth, maybe a fourth, if you're an optimist.

Sure, tax breaks are important—but we still need a comprehensive energy policy. And after years of trying, we're not there yet.

So in the words of the Nike ad I say to Congress, "Just do it!" Finish the job! Stop bickering! You've been studying this for years. How hard can it be?

With a comprehensive energy blueprint, our industry—and our nation—will be better armed to mix it up with the same old opponents to energy security and reliability: spineless politicos, NIMBY activists, radical environmentalists, turf-conscious regulators (present company excluded), and anti-American regimes sitting on billions of barrels of crude oil.

The various bills considered—and shelved—by Congress in recent years contain the key elements of a successful energy policy.

The first one's easy: We need to improve the reliability of our transmission systems.

After the blackout last August, I sent a letter to members of Congress. I suggested four measures for bolstering the transmission system and ensuring the lights don't go off over a big chunk of the continent. Some of these steps are in one or more of the discarded bills. I'd like to see all of them in the final product.

First, the time for voluntary compliance with reliability rules has passed. We need binding federal standards for grid operation and a national organization such as FERC to enforce them. To my way of thinking, this falls in the category of "no brainer." It's been part of every so-called "comprehensive" bill to come down the pike.

Second, the federal government should have a hand in making sure vital electric transmission facilities get built…in a timely manner. Regulatory oversight of the transmission system is currently shared by FERC and state regulatory bodies. This arrangement is a holdover from the days when there was little or no interstate commerce in electricity.

The problem is, the game has changed. The transmission system is now being used to buy and sell power in larger, regional wholesale markets that don't respect state boundaries. Yet the responsibility for siting power lines still rests with the states. And their rules for approving new lines vary widely. That means individual states have the ability to "just say no" and kill or seriously delay a multi-state project.

As Dominion's utility neighbor to the west, American Electric Power found out, years—even decades—can go by when a proposed line crosses multiple jurisdictions and each one has to bless the project. Eleven years later, the line still hasn't been built.

Imagine a state telling the federal government, "Sorry, you can't build that interstate highway. We don't want people driving through here to get to the West Coast." That's the situation companies face when trying to site new power lines across multiple jurisdictions.

It's time for the FERC to have the same role in siting electric transmission lines as it has in siting gas transmission lines. High-voltage lines are part of interstate commerce. Moving electricity from place to place is a national business. Large, multi-state transmission projects should be subject to federal eminent domain powers.

State commission foot dragging, or worse yet, local opposition from those with the "Not on Planet Earth" approach too often prove fatal to desperately needed infrastructure projects.

Third, we need more financial incentives to build transmission projects. The profits currently allowed for owning and operating transmission networks are tightly regulated by FERC—and less than allowed returns on other types of infrastructure investments. The risk of devoting years of time, capital and sweat equity to propose, site and build a giant, multi-state power line is not offset by the potential financial reward.

The Edison Electric Institute, an industry trade group, estimates that investment in new transmission has dropped by more than $100 million a year for the past 25 years. That should come as no surprise when it takes more than 20 years on average to get your money back.

Bottom line: Power line expansion and construction is a risky, complicated business. Those who assume the risks should be compensated proportionately. Until higher returns on investment are allowed, adequate capital simply won't flow to these projects.

The accelerated depreciation is a good start…but just a start. An effective package would include new rate structures to promote much needed capital investment.

Finally on the reliability front, Congress should mandate regional transmission organizations. Down south, where I come from, RTOs tend to be viewed as something akin to the second coming of General Sherman. They're a federal threat to the states' rights.

Call me a federalist or a traitor to my roots, but I'm a firm believer in RTOs. They do the planning needed to ensure we have adequate transmission and generation facilities over broad, multi-state areas. They're vital to the success of a competitive marketplace, both wholesale and retail. I wish more of our state commissions shared that view.

A clear signal from Congress that if states don't act within a finite amount of time, sole jurisdiction moves to FERC. That might produce a helpful adjustment in attitude. Many southern states have never accepted the fact that we lost the Civil War and are still fighting it—but on a different front.

President Eisenhower never could have gotten our interstate highway system built if every village, Middlesex or farm could have halted construction. Our transmission system should resemble the interstate highway system, where electrons can move easily from place to place.

The press talks about a "national grid." There is no national grid like they have in the UK—but there damn well should be. Our problem has its roots in the provincial mindset that governed our original build out.

Under cost-of-service regulation, utilities built their transmission systems to serve only their own customers. There may have been a point or two where there was an interconnect with a neighboring utility so a few hundred megawatts of power could be bought or sold to protect against unplanned generating unit outages. Individual systems were not—and still aren't in many cases—designed to move large blocks of power over long distances.

That's my prescription for fixing the ailing veins and arteries of our patient.

But that alone won't restore complete health. There's still what I termed "cardiac insufficiency." We have to boost energy production.

Congress can and must make this happen.

First, let's put the nuclear and coal options back on the table. Three years ago I said the nation faced a dangerous fuel imbalance in power generation. New gas-fired plants were popping up like mushrooms all over the country. Virtually no new coal units—and absolutely no new nuclear units—were even being contemplated.

Not much has changed. There are some modest tax incentives for coal in the Senate's tax bill. And a few companies—including Dominion—are taking a very preliminary look at nuclear construction to see if it might be feasible down the road. But on both fronts, development remains virtually comatose.

Here's my wish list for kick-starting both sectors.

We've got to recognize that nuclear energy has a place in the mix. It supplies one-fifth of the nation's electricity and produces zero—yes zero—emissions. The industry has a sterling safety record and continues to excel in performance.

Last year, Senator Domenici, chairman of the Energy and Natural Resources Committee, repeatedly emphasized that strong nuclear incentives belonged in a comprehensive bill. Somewhere along the way, most of these provisions were dropped. Let's put them back in.

For example, at one point the Senate version of the bill used financial incentives, such as loan guarantees, to support construction of new nuclear stations. A good first step, but much more will be needed.

To build a new nuclear plant today would take a minimum of six-and-a-half years and more than $2.5 billion, financed on a 50/50 equity basis.

That means over the six-and-a-half-year construction period, the company would have to borrow and pay interest on $1.25 billion and issue $1.25 billion of new common equity. Until the plant was up and running, it would produce no income to service the debt or earnings for the common equity.

If you announced you were going to build a new nuclear plant, Moody's and Standard & Poor's would assuredly drop your bonds to junk status. Hedge funds would be bumping into each other trying to short your stock.

In my opinion, no company in our industry is large enough to take on this risk. Several companies, including my own, have banded together to look at it. While I believe in trying to keep all options available, Dominion has absolutely no plans to build a nuclear plant at this time. The intentions of these consortia are commendable. Their ambitions are, in my opinion, unrealistic.

I'm all for nuclear power—as long as Dominion doesn't have to take the risk of building a new nuclear unit. Before new plants are built, I think the federal government or some large company such as GE will have to build them and take on the construction and financial risks.

Even then, a nuclear unit financed with 50 percent debt and 50 percent equity with a 15 percent return on equity would have a buss bar cost of around $51.17 per megawatt-hour. Last year, a plant with that cost of production in the PJM Interconnection would have run only 700 hours. The numbers just don't work.

Still on the nuclear front, we should re-authorize the Price-Anderson Act. It shields nuclear generators from catastrophic damage claims. Without Price-Anderson, it would be damn tough to operate nuclear stations. Last year's House and Senate bills—as well as the conference report—also re-authorized the Act.

The cost of constructing nuclear plants—even if the government would build and finance them during construction—will have to come down before we see new nuclear plants.

And it's time to come to grips with the high-level waste issue. My message to Congress and the regulators on Yucca Mountain is simple: Get off your rear ends! Federal law should require the Department of Energy to fulfill its obligations by a date certain.

Dominion, for example, has paid the federal government $633 million for storage—and gotten nothing in return. I'd like to tell DOE, at least give us our cost of capital on that money—or give it back if all we can expect is more foot dragging.

As for coal, it supplies more than half of the power consumed in the U.S. Unfortunately, a lot of politicians, environmental activists and much of the press delight in bad-mouthing it. The power industry hasn't helped by failing to counter the jabbering with the sound science we know exists.

With today's technology, we can build coal plants that are clean and protect the environment. Congress has to figure out a way to promote construction of modern, environmentally friendly coal-powered units.

One helpful measure would be a required cost-benefit analysis of environmental regulations—before they go on the books. That would improve the chances of federal energy officials and the EPA following the same play book and not going off in different directions.

A comprehensive bill could require all states to create a one-stop siting board—or lose funds if they fail to comply.

We should be promoting market-based approaches to compliance, such as expanded emissions trading. Some environmentalists turn up their noses, but trading programs produce dramatic emissions reductions. What can I say—some bureaucrats are threatened by things they can't control—like the free market.

And let's not forget zero-emissions hydro power. It takes seven years or better to license or re-license these facilities. We need to streamline this process so hydropower remains a significant part of domestic energy supply. I have a lot of respect for our friends at FERC, but in the past, on occasion, they've been slow as molasses.

Americans also have a right to energy legislation that promotes domestic oil and gas production—and helps free us from dependence on unstable supplies from volatile parts of the globe.

About the only power plants that can be built today are fired by natural gas, but this country is running out of gas.

Last year, we consumed about 20 trillion cubic feet of natural gas. Gas wells in the Gulf of Mexico are declining at an annual rate of 37 percent, and across the country at a 27 percent annual clip.

In other words, our decline rate is 5.5 TCF per year. Add that to an annual demand growth of .6 TCF, and we're going to need 6.1 TCF in new gas production per year. Over the last 5 years, average incremental production amounted to 4.5 TCF. That leaves us with an annual shortfall of about 1.6 TCF. Drilling rig count remains high, but the average rig is finding 25 percent less gas than a year ago. In Canada, it's even worse.

Congress must force the Bureau of Land Management to open up more acreage for drilling in the West. According to the National Petroleum Council, access to these supplies could save consumers hundreds of billions of dollars during the next 20 years.

My company is lucky. We have well over one million acres of drillable land. For the past two years, we have drilled more wells than anyone, including the majors. This year, we will drill more than 1,000 wells.

Incentives in the tax bill for production in "non-conventional" settings represent a valuable step forward, but they're not the only ones needed.

We need steps to facilitate construction of long-distance gas and oil pipelines to haul both raw materials and refined products.

We also need a strong dose of realism. We will never wean ourselves from foreign supplies—especially with the demand for natural gas outstripping our ability to produce it domestically.

So let's accept that fact and not run out of natural gas. We need to develop more liquefied natural gas import facilities.

Right now, LNG supplies about 2 percent of the gas consumed in this country. By 2015, that figure will have to approach 20 percent to meet demand. To get there, four new LNG terminals will have to be built. That's in addition to planned expansions at three of the nation's four existing terminals, including Dominion's Cove Point facility on the Chesapeake Bay. The other three import terminals are located in Massachusetts, Georgia and Louisiana.

If you read either The Wall Street Journal or The New York Times a week ago Friday, you can understand the problems with siting new LNG facilities. Of the 30 or so that have been mentioned, we'll be lucky to get three or four built, in my opinion.

And let's also clear up any lingering doubts that FERC—not the states or the localities—should have siting power over LNG terminals.

LNG could go a long way to satisfying our country's growing appetite for natural gas—but only if we can expand our LNG infrastructure. Lawmakers must show their support for natural gas imports. Regulators must streamline the permitting process. Investors need assurance they can expect a reasonable return on invested capital. And public concerns about safety and security must be thoroughly addressed.

Finally, a federal energy bill should let the markets do their job. I know that concept threatens many folks in government. But that's fortunately not the case with our distinguished guest, Mr. Wood. He's well aware of the role markets play in promoting robust supplies and economical prices.

Others haven't caught up with his thinking. Too many regulators still believe markets and the public good are incompatible. I suggest they take another look at "cost of service" regulation—and the huge inefficiencies this outmoded model promotes.

This won't be easy. There are tough state-federal turf issues in play here. Again, I'll put on my federalist hat. Most people think an adequate supply of electricity is a God-given birth right. When you flick a switch, the lights should come on. As we know from the blackout last summer, this is not a local or state problem—it's a national one.

A federal energy bill should take steps to ensure that rates provide incentives for investment…that ratemaking serves to balance supply and demand and promote efficiency—not the "if you build it, they will pay for it" thinking embedded in the cost-of-service mentality.

Congress can also free our industry from some of the illogical and outdated regulations hobbling our ability to make sound business decisions—on behalf of our customers and our shareholders.

PUHCA, the Public Utility Holding Company Act, is a perfect example. This Depression-era law undermines competition, stifles innovation and hurts our sector's efficiency.

When PUHCA was enacted in 1935, the state of our Republic was dire. We were still in the grips of the Great Depression. No other legal framework existed to oversee the holding company structure. The law served a legitimate purpose back then. But to paraphrase W.C. Fields, it made the mistake of living too long.

Today, other regulatory and statutory authorities protect consumer and investor interests. The FERC and state agencies regulate utilities. The SEC oversees securities functions. The FTC and the Justice Department have plenty of muscle to monitor the market. And abundant market information is available to anybody who wants it.

Moody's and Standard & Poor's were asleep at the wheel when Enron and others were plying their trade. Now they have awakened with a terrible resolve. In my opinion, they are more involved in trying to atone for past mistakes and playing the "C-Y-A" game than they are serving the bond markets as they're paid to do.

Tougher accounting standards and disclosure requirements are in place. Eager prosecutors stand ready to punish the wicked. In my view, the free market does a much better job of punishing offenders and misdeeds than regulation does.

For 20 years, the SEC itself has been calling for PUHCA repeal. Agency Commissioners have told Congress repeatedly it's the most burdensome regulation they have to administer.

SEC Commissioner Isaac Hunt told the Senate Energy Committee two years ago—quoting here— "Repeal of the Act would… eliminate any impediments that exist to other regulators' attempts to modernize regulation of the utility industry."

No credible industry observer disagrees.

Let me share some real-world statistics from my own company.

In our accounting department, for starters, 19 professionals spend about 4,000 hours each year making sure we don't run afoul of the Act's endless do's and don'ts. About the same number of otherwise productive people in our legal, treasury, corporate secretary and external affairs groups burn another 1,500 hours on the same task. Beyond that, we can routinely count on adding about two percent of additional time for outside and inside legal work on each financing and acquisition we undertake. That's big money in a world of multibillion-dollar transactions.

As Milton Friedman at the University of Chicago taught us a long time ago, heavy-handed regulation equals heavy-handed taxation. Both are bad for the economy.

In my view, our industry stands to benefit by having smaller numbers of large market cap companies with deep pockets and strong liquidity as business conditions become more challenging.

With PUHCA blocking the way, our industry can't evolve into a sector where a handful of big market-cap players will confront and master those challenges. Our industry has a total market capitalization approaching $1 trillion—yet we are the only industry that size without large players.

Big players—the WalMarts, the CitiCorps, the ExxonMobils—with better access to capital and better operating efficiencies can manufacture and sell their products cheaper than less efficient entities. Big players also can afford R & D budgets aimed at future consumer well-being. Our industry's expenditures on R & D are somewhere between lousy and non-existent.

If there was ever an industry that could benefit from R&D, it's ours. Neither generation nor transmission technology has developed much since the late 1940s. Imagine the environmental breakthroughs we might achieve in emissions controls… or by bringing solar and wind power along to more rapid commercial development.

As it stand today, our top three market-cap players—Dominion, Exelon, Southern—hang in the neighborhood of $20-plus billion—peanuts compared to leaders in other industries.

Along with PUHCA repeal, we desperately need PURPA reform. The Public Utilities Regulatory Polices Act is a relic from the Carter era. It was a dumb Act then, and it's an even dumber Act now. It has been an albatross around the neck of the electric power industry since its inception. The "must buy" provisions have forced utilities to sign contracts with above-market, inefficient and uneconomical independent generators and have put the screws to the purchasing utilities' ratepayers.

We're doing our best to get out from under these contracts. Congress could make the future a lot brighter by repealing the "must buy" provisions and freeing utilities from the burden of buying power from such units in the future.

Will any of this come to pass? The gloom and doom side of me doesn't hold out much hope. It's an election year, after all.

But as I said earlier, there are glimmers of hope. The passage of the tax bill would be a good start. It makes many vitally needed reforms. It shows the gridlock can be broken.

We have a great opportunity before us to take decisive steps to promote a reliable and secure energy future for our nation. In today's world, which is often unreliable and insecure, it's an opportunity we shouldn't pass up.

If we don't get the job done, things will not get better, energy prices will continue to rise, and we will suffer the various adverse effects that rising energy prices have on our economy and our way of life.

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