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1/7/2011
INVESTOR OWNED
ELECTRIC UTILITY
REGULATION IN VIRGINIA
Findings & Recommendations of the Electric Utility
Regulat...
1
Table of Contents
Introduction.............................................................................................
1
INTRODUCTION
The Virginia Electric Utility Regulatory Work Group was formed in May of 2010
to review the current electri...
2
WHY STUDY ELECTRIC UTILITY REGULATION IN VIRGINIA
Historically, Virginians have laid claim to some of the lowest electri...
2
Chart A: Schedule of Appalachian Power Company Rate Filings and Statutes Cited: January 2006-August 2010
Case # Case Typ...
3
THE STEEL DYNAMICS INC. EXPERIENCE
Steel Dynamics Inc., headquartered in Ft. Wayne, Indiana, is one of the largest steel...
4
THE VAUGHAN-BASSETT EXPERIENCE
Vaughan-Bassett Furniture Company is the largest wooden bedroom maker in
the United State...
5
Ω
THE RESIDENTIAL CUSTOMER EXPERIENCE
“Last winter I kept my heat at 66 degrees to conserve energy and keep my
electric ...
6
RECENT HISTORY OF VA ELECTRIC UTILITY REGULATION
In the mid to late 1990’s overall electric rates for Virginia’s investo...
7
from 6.53% to 13.96%15
and it
collected almost $59 million of excess
earnings according to the Attorney
General.16
In 20...
8
South Carolina and Florida.24
In the South, only Tennessee and West Virginia
had lower average industrial rates during t...
9
WHAT ARE THE PROBLEMS/SPECIFIC FAILINGS OF THE
CURRENT REGULATORY SYSTEM
When the General Assembly decided to “reregulat...
10
highest returns and the two with the lowest, and the cap is 300 basis
points above the average34
. This peer group rate...
11
on performance.36
Also, each utility’s return on equity may be increased by
50 basis points if it meets the renewable g...
12
Then, in addition, the company would receive an ”incentive” of 200 basis points
on its equity investment in its nuclear...
13
A regulatory commission, such as the Virginia State Corporation Commission,
can and does consider such factors in makin...
14
Markups and Excess Returns
In addition, the statute allows the utility a “margin,” or markup, on its operating
expenses...
15
fair combined rate of return on both generation and distribution services . . .,”
the SCC is required to credit to cust...
16
The reviewers were correct that the new law is the most favorable in the nation
for electric utilities. The reviewers, ...
17
Under the new law, for almost any project, the utility can create a RAC, defer
costs until the new clause is in place, ...
18
Rebundling
Electric utilities, as regulated monopolies, have a long history of being
“integrated” – as the functions of...
19
as investors focus on electric utilities as integrated entities, it makes more sense
for regulators to again focus on t...
20
from the 2007 legislation. The schedule requires multiple cases to proceed at
once and there is no break when the legis...
21
TRENDS IF ACTION IS NOT TAKEN
As detailed earlier in this report, the 2007 reregulation statutes reduce drastically
the...
22
KEY POLICY CHANGES
Any changes to Virginia’s investor-owned electric utility regulation will only be
effective if they ...
23
RECOMMENDATIONS OF THE WORK GROUP
Given the fundamental lack of balance and fairness in the 2007 reregulation
statutes,...
24
intentionally or specifically requires a cut that it knows will create a catastrophic
failure, there are numerous examp...
25
relocated to other chapters in Title 56. Existing rate adjustment clauses approved
by the SCC under the 2007 legislatio...
26
rate of return on new renewable energy generation facilities, in lieu of
the existing provision that grants participati...
27
able to count on all of the procedures and rules to which the Assembly agreed. It
will be explained that this increased...
28
Another driver of filed cases during Q1, and a frequent
driver of filed cases in general, was the attempt by utilities ...
29
Finally, when the need for more reform is reduced, the stability of the
Virginia system and the Commission will be seen...
30
CONCLUSION
A regulatory system that permits the dramatic and unnecessary increase
of electric bills in a two year perio...
31
is destined to join the group of states with the highest electric rates in the nation;
thereby placing our citizens and...
ii
APPENDIX A
ELECTRIC UTILITY WORK GROUP MEMBER BIOGRAPHIES
The Hon. John Chichester represented the 28th district in the...
iii
Lindback Award for Distinguished Teaching from Hampton University. She is also
a member of the Hampton-Newport News Se...
iv
Mr. Moore currently serves on the Board of Directors of Union First Market
Bankshares Corporation, a Virginia multi-ban...
v
His more than 25 years in telecommunications began with AT&T in New York in
1970 as a Staff Analyst in the Management Sc...
vi
Irene Leech is an Associate Professor at Virginia Tech and leading Consumer
Advocate with an emphasis on Electric Utili...
vii
Doug Bassett is the Executive Vice President and COO of Vaughan-Bassett
Furniture Company, which is based in Galax, VA...
viii
Southside Virginia on regulatory reform and has circulated a petition against
Appalachian Power’s rate increases, whi...
i
APPENDIX B
Extracted from Moody’s June 6, 2008 “Credit Opinion” on
Virginia Electric and Power Company
“The key drivers ...
ii
arrangement is viewed as a material credit positive, we
observe the dramatic changes associated with the 2007
Virginia ...
iii
“submission of legal memoranda that may address, among
other issues, the legal permissibility” of VEPCO’s offer to
def...
iv
perspective, we view investment additions into regulated
rate base positively. We observe that VEPCO has been
authorize...
A
ENDNOTES
1 EEI Average Overall Rates, 2007, 2008, 2009.
2 EEI Average Residential Rates, 2007, 2009. According to EEI Do...
B
actual cost of investment plus a reasonable return. Since competition and the market
never developed and the utilities s...
C
13 SCC Case No. PUE-2009-00019, Testimony of Kimberly B. Pate dated December 8,
2009, at 4-5 and 18.
14 SCC Case No. PUE...
D
25 EEI Average Industrial Rates, 2006, 2007. Tennessee was 3rd
least expensive in 2006
and ranked 1st
in 2007. West Virg...
E
44
§56-585.1A8(iii) and 9.
45 §56-585.1.
46 EEI Average Residential Rates, 2007, 2008, 2009.
47 EEI Average Commercial R...
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Investor Owned Electric Utility Regulation in Virginia

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Investor Owned Electric Utility Regulation in Virginia

  1. 1. 1/7/2011 INVESTOR OWNED ELECTRIC UTILITY REGULATION IN VIRGINIA Findings & Recommendations of the Electric Utility Regulatory Work Group
  2. 2. 1 Table of Contents Introduction.................................................................................................................................... 1 Why Study Electric Utility Regulation in Virginia...................................................................... 2 THE STEEL DYNAMICS INC. EXPERIENCE................................................................. 3 THE VAUGHAN-BASSETT EXPERIENCE....................................................................... 4 THE RESIDENTIAL CUSTOMER EXPERIENCE........................................................... 5 Recent History of VA Electric Utility Regulation ........................................................................ 6 What are the problems/specific failings of the current regulatory system ................................ 9 Peer Group Return on Equity (ROE) ........................................................................................ 9 Risk and Rate Adjustment Clauses......................................................................................... 12 Markups and Excess Returns.................................................................................................. 14 Rebundling................................................................................................................................ 18 Consumer Protections .............................................................................................................. 19 Trends if action is not taken........................................................................................................ 21 Key Policy Changes...................................................................................................................... 22 Risk............................................................................................................................................ 22 Consumer Protections .............................................................................................................. 22 Recommendations of the Work Group ........................................................................................ 23 Revert Back to Basic Chapter 10 Regulation ......................................................................... 24 Attempt to add Balance and Fairness to the Current System .............................................. 25 Reaction from Utilities............................................................................................................. 26 Conclusion .................................................................................................................................... 30 Appendix A..................................................................................................................................... ii Appendix B...................................................................................................................................... i Endnotes.........................................................................................................................................A
  3. 3. 1 INTRODUCTION The Virginia Electric Utility Regulatory Work Group was formed in May of 2010 to review the current electric utility regulatory scheme in Virginia, produce a report of its findings, and develop new legislation to address identifiable problems regarding lack of consumer protections and escalating energy costs to consumers. The bi-partisan work group included current and former legislators, former State Corporation Commission (SCC) commissioners, consumer advocates, certified rate of return analysts, former electric utility executives, residents and business leaders. The Work Group met throughout the summer to study the evolution of electric utility regulation in Virginia over the last decade, Virginia’s current regulatory law, and regulations in place in other states. The work group examined problems and shortcomings in Virginia’s current regulatory standards as they relate to the high cost of electric service and limited protections for consumers. The Work Group adopted the following Guiding Statement for its work: The goal of electric utility regulation in general, and ratemaking in particular, is to have financially strong, well-managed utilities that consistently, safely, and reliably produce and deliver electricity in an environmentally responsible manner at rates that are fair, just, and reasonable. The following report will present the findings and recommendations of the Work Group including: A history of contemporary electric utility regulation in Virginia. An analysis of the current regulatory scheme and how it affects both utilities and all three consumer classifications: residential, commercial, and industrial. Projected trends if action is not taken. Recommendations for improvement to ensure rates that are fair, just, and reasonable. Ω The goal of electric utility regulation in general, and ratemaking in particular, is to have financially strong, well-managed utilities that consistently, safely, and reliably produce and deliver electricity in an environmentally responsible manner at rates that are fair, just, and reasonable.
  4. 4. 2 WHY STUDY ELECTRIC UTILITY REGULATION IN VIRGINIA Historically, Virginians have laid claim to some of the lowest electric rates nationwide. According to the Edison Electric Institute (“EEI”), based on overall rates, Virginia had the 11th lowest electric rates in the country in 2007.1 Yet the last three years have seen dramatic increases in electric costs for all consumer classes: residential, commercial, and industrial. Residential customers of Dominion Virginia Power (VEPCo) have seen their rates go up more than 24% since 2007 according to EEI.2 And, Appalachian Power Company’s (APCo) residential rates soared by more than 33% during the same period.3 From 2007 to 2009, average commercial rates for APCo experienced a 34% increase and VEPCo’ commercial rates rose by 33%.4 APCo’s industrial rates increased almost 43% from 2007 to 2009,5 and Dominion Virginia Power’s industrial rates increased over 38%; and, for the first time in recent years, and perhaps ever, in 2009 Dominion Virginia Power’s industrial rates were above the national average.6 But nowhere has the increase in rates been more dramatic or deeply felt than in the APCo service area. The sharp and rapid increase in electric utility rates that Virginia’s APCo customers have faced over the past few years have resulted in public outcry from both residential and business customers. According to statistics provided by the State Corporation Commission (SCC), ten of the eleven rate increases requested by Appalachian Power and approved by the SCC since December of 2006 have been regulated under the 2004 or 2007 legislation as cited in the application and/or final order. [Chart A] The following customer experiences illustrate just a few examples of the troubles that residential, commercial, and industrial electric customers are facing as a result of rapidly increasing electricity prices. These statistics and the stories from electric customers across the Commonwealth point to a systemic problem in the way Virginia currently regulates utilities that must be addressed. Residential customers of Dominion Virginia Power have seen their rates go up more than 24% since 2007 according to EEI. And, Appalachian Power Company’s residential rates soared by more than 90% during the same period.
  5. 5. 2 Chart A: Schedule of Appalachian Power Company Rate Filings and Statutes Cited: January 2006-August 2010 Case # Case Type Date Filed Rates Effective Annual Revenue Change Requested Annual Revenue Change Granted Approx. Residential Bill Approx. Residential Increase % Statute Cited in Application and/or Final Order PUE-2005-00090 Fuel 10/21/05 1/1/06 $57,700,000 $57,700,000 $62 6.3% 1989 Legislation PUE-2006-00065 OSS Margin 5/4/06 10/2/06 $198,500,000 $24,018,526 $62 1.2% 2004 Legislation PUE-2005-00056 E&R Surcharge 7/1/05 12/1/06 $62,100,000 $21,337,000 $64 3.0% 2004 Legislation PUE-2006-00100 Fuel 11/9/06 1/1/2007 $38,700,000 $38,700,000 $67 3.8% 1989 Legislation PUE-2007-00067 OSS Margin Fuel 7/16/07 7/16/07 9/1/07 9/1/07 $100,600,000 -$67,200,000 $33,400,000 $100,600,000 -$96,700,000 $3,900,000 $68 1.6% 2007 Legislation PUE-2007-00069 E&R Surcharge 7/16/07 1/1/08 $38,163,000 $27,584,000 $70 3.3% 2004 Legislation PUE-2008-00067 Fuel 7/18/08 10/20/08 $132,500,000 $117,461,171 $77 10.6% §2007 Legislation PUE-2008-00046 Base 5/30/08 10/28/08 $207,900,000 $167,867,699 $90 17.0% 2004 Legislation PUE-2007-00068 IGCC Surcharge 7/16/07 1/1/09 $45,000,000 $0 $90 0.0% 2007 Legislation PUE-2008-00045 E&R Surcharge 5/30/08 1/109 $17,579,000 $11,700,000 $91 1.0% 2004 Legislation PUE-2009-00038 Fuel 5/15/09 8/10/09 $194,400,000 $111,000,000 $99 7.8% 2007 Legislation PUE-2009-00031 Transmission 7/15/09 12/12/09 $24,200,000 $21,686,058 $104 5.3% 2007 Legislation PUE-2009-00030 Base-Interim 7/15/09 12/12/09 $154,000,000 $154,000,000 $114 9.9% 2007 Legislation PUE-2009-00039 E&R Surcharge 5/15/09 1/1/10 $41,579,000 $28,900,000 $116 2.0% 2004 & 2007 Legislation PUE-2009-00030 Base-Interim 7/15/09 2/24/10 -$154,000,000 -$154,000,000 $106 -8.8% SB 680 & HB 1308 in 2010 PUE-2009-00030 Base 6/22/09 8/1/10 $154,000,000 $61,500,000 $110 4.0% 2007 Legislation Fuel 6/22/09 8/1/10 -$101,000,000 -$101,000,000 $103 -7.0% 2007 Legislation Source: State Corporation Commission
  6. 6. 3 THE STEEL DYNAMICS INC. EXPERIENCE Steel Dynamics Inc., headquartered in Ft. Wayne, Indiana, is one of the largest steel producers and metal recyclers in the United States. The Steel Division consists of five producing mills – three in Indiana, one in West Virginia and the Roanoke Bar Division, located in Roanoke, Virginia. The Roanoke Bar Division sells semi-finished “billets” and merchant steel products both domestically and in the world market. The Roanoke Bar Division, which operated from 1955 to 2006 as Roanoke Electric Steel Corporation, was acquired by Steel Dynamics in April 2006. This division currently has approximately 400 employees and annual sales of around $300 million. In 2006, when acquired by Steel Dynamics, the Roanoke Bar Division had the lowest power rates per kilowatt hour of any of the other four producing mills within Steel Dynamics, which was a contributing factor in Steel Dynamics’ acquisition of Roanoke. Since then and through 2009, our power rates increased over 80% to the highest level in all of Steel Dynamics. Effective August 2010, we realized a net reduction in rates of approximately 8%, as the base rate increased and the fuel factor decreased. In addition, effective January 1, 2011, we will save an additional 5% with the elimination of the Environmental & Reliability rider. These reductions still result in the overall rate increases experienced since 2006 being approximately 68%. Most importantly, these rate increases have occurred in the most difficult economy and steel industry downturn experienced in our Division’s 55-year history, contributing to poor results and an annual Corporate loss by Steel Dynamics in 2009. This also occurred in the same timeframe that American Electric Power reported earnings in the billions of dollars. --Joe Crawford, Vice President and General Manager, Roanoke Bar Division Photo Courtesy of Joe Crawford
  7. 7. 4 THE VAUGHAN-BASSETT EXPERIENCE Vaughan-Bassett Furniture Company is the largest wooden bedroom maker in the United States, with sales of over $85 million in 2009. Founded in 1919, we employ about 700 workers, over 90% of them working out of our main factory and headquarters in Galax, Virginia and the rest at our facilities in North Carolina. We are the largest employer within at least a 25-mile radius of our factory in Galax. In 2007, our utility bill with Appalachian Power was $833,000. By 2009, the bill had exploded to $1.3 million and we are on track to pay over $1.5 million in 2010. Over the last three years, our usage is up slightly – by about 20% -- but the vast majority of our increased utility bill is the result of the 48% increase in the kilowatt/hour rate charged by Appalachian. In contrast, Duke Power has increased its rate in North Carolina by less than 10% during the last three years. Three years ago, Appalachian Power in Virginia and Duke Power in North Carolina charged its industrial users like Vaughan-Bassett almost identical rates. Appalachian now charges industrial users like Vaughan-Bassett about 45% more than Duke Power charges industrial users our size in North Carolina. --Doug Bassett, Executive Vice President and COO Photo Courtesy of Doug Bassett
  8. 8. 5 Ω THE RESIDENTIAL CUSTOMER EXPERIENCE “Last winter I kept my heat at 66 degrees to conserve energy and keep my electric bill costs down. My highest bill prior was $218, my Dec bill was almost $500.00. Also I am a single person household living on a fixed income in a well insulated house and burn firewood.” “My electric bill has gone up again just this month we were paying $180 per month and now starting in august we will pay $212 per month. We are on the budget plan.” “The APCO bills are 3 to 4 times higher than the last time I received a raise over 5 years ago. My July bill was $500 and August bill was $389. I have had to turn the AC off.” --Residential Customers, submitted via website www.wardarmstrong.com Stock Photo
  9. 9. 6 RECENT HISTORY OF VA ELECTRIC UTILITY REGULATION In the mid to late 1990’s overall electric rates for Virginia’s investor-owned utilities were below the national average, with Appalachian Power Company’s (APCo) rates being lower than those in all but a handful of states. Commercial and industrial customers fared even better with Virginia being ranked in the lowest cost quartile.7 In 1999, the General Assembly opted for competition with the intense support and lobbying of the regulated electric utilities. To protect consumers while waiting for competition to become an effective regulator, the Assembly turned to “capped rates.” While the statues referred to capped rates, the effect of the Assembly’s action was not to cap electric rates, because rate reductions could not be required. Base rates were, in effect, frozen, and fuel costs were allowed to continue to flow through to ratepayers.8 The rationale was that the utilities “might” have some “stranded costs,”9 and any extra profits the utilities earned during the phase-in to competition would offset these costs.10 While some states awarded customers stranded benefits, it was decided that Virginia would not do this. In fact, unlike many states, Virginia did not even attempt to quantify these costs. This was a costly choice for Virginia and her citizens. There were no stranded costs, so excess earnings were simply excess profits for the monopoly utilities. From 2001 through 2004, Dominion Virginia Power’s Virginia jurisdictional return on average common equity on a regulatory basis ranged from 9.8% to 23.31% and averaged over 15.75%.11 According to the Attorney General’s report to the Commission on Electric Utility Restructuring, during this four-year period, Dominion Virginia Power received $1.06 billion in excess of the level of authorized earnings for the utility “if it were regulated under traditional methods used prior to the passage of the Virginia Electric Utility Restructuring Act . . . .”12 For 2008, Dominion Virginia Power calculated its average equity return at 17.26%; SCC Staff found the return to be 19.12%.13 According to the SCC Staff, Dominion Virginia Power had excess earnings in 2008 of over $525 million.14 APCo did not fare as well as Dominion Virginia Power, but it, too, over-earned during the same period. From 2001 through 2004, APCo’s equity returns ranged . . . the 2007 reregulation statutes reduce drastically the ability of the State Corporation Commission to set rates fairly and effectively, essentially guarantee recovery of all costs and returns, and encourage and provide for excessive returns for APCo and Dominion Virginia Power.
  10. 10. 7 from 6.53% to 13.96%15 and it collected almost $59 million of excess earnings according to the Attorney General.16 In 2007, after it became obvious that competition would not develop, the General Assembly “reregulated” electric utilities. As will be described in some detail later in this report, the 2007 reregulation statutes reduce drastically the ability of the State Corporation Commission to set rates fairly and effectively, essentially guarantee recovery of all costs and returns, and encourage and provide for excessive returns for APCo and Dominion Virginia Power. The new law is just beginning to impact rates and the results are startling and disturbing, especially compared to rates in other states. According to the Edison Electric Institute (“EEI”), based on overall rates, Virginia dropped from having the 11th lowest electric rates in 2007 to 17th lowest in 2008 and 25th in 2009.17 EEI reports that from 2008 to 2009, overall electric rates in the country increased about 0.6%; Virginia’s average rates increased 10.8%; Dominion Virginia Power’s increased 7.6%, and APCo’s average rates were up by 30%.18 For residential rates, Virginia fell from 13th least expensive in the nation in 2007 to 16th in 2008 and 28th in 2009.19 Specifically, residential customers of Dominion Virginia Power have seen their rates go up more than 24% since 2007 according to EEI.20 And, APCo’s residential rates soared by more than 90% during the same period.21 Commercial rates saw significant increases as well. From 2007 to 2009, according to EEI, average commercial rates for Virginia increased 33%, with APCo experiencing a 34% increase and Dominion Virginia Power’s commercial rates rising by 33%.22 For large businesses, the story is particularly troubling. EEI reports Virginia’s industrial rates were the 7th and 9th least expensive as recently as 2006 and 2007.23 Virginia’s average industrial electric rates in those years were below those of North Carolina, Alabama, Mississippi, Georgia, Louisiana, Kentucky, EEI reports that from 2008 to 2009, overall electric rates in the country increased about 0.6%; Virginia’s average rates increased 10.8%; Dominion Virginia Power’s increased 7.6%, and APCo’s average rates were up by 30%. Based on overall rates, Virginia dropped from having the 11th lowest electric rates in 2007 to 17th lowest in 2008 and 25th in 2009.
  11. 11. 8 South Carolina and Florida.24 In the South, only Tennessee and West Virginia had lower average industrial rates during this period.25 Virginia’s ranking fell to 11th in 2008 and 29th in 2009. 26 As of 2009, every state in the South except Florida has industrial electric rates that average less than those in the Commonwealth. 27 In 2005, APCo’s average industrial rates were the lowest in the nation.28 By 2008, APCo was about equal to the average industrial rate of the 7th least expensive state.29 From 2008 to 2009, APCo fell from about equal to the 7th, to more expensive than the 26th least expensive state.30 APCo’s industrial rates increased almost 43% from 2007 to 2009.31 The EEI report for Dominion Virginia Power is also telling. From 2007 to 2009, Dominion Virginia Power’s industrial rates increased over 38% and, for the first time in recent years, and perhaps ever, in 2009 Dominion Virginia Power’s industrial rates were above the national average.32 The dramatic increases in rates over the last several years in both absolute and relative terms make bringing new industry and jobs to the Commonwealth much more difficult. The sharp rate hikes, however, should come as no surprise. They are not the result of cost increases that bypassed the rest of the South and occurred only in Virginia. The increases are rather the result of the 2007 reregulation statutes that allow and encourage excess earnings for Virginia’s investor-owned electric utilities. Ω As of 2009, every state in the South except Florida has industrial electric rates that average less than those in the Commonwealth.
  12. 12. 9 WHAT ARE THE PROBLEMS/SPECIFIC FAILINGS OF THE CURRENT REGULATORY SYSTEM When the General Assembly decided to “reregulate” electric utilities in 2007, it did not return electric utilities to the rate base / rate of return regime that had been in place for decades, had served Virginia and her utilities and ratepayers well, and was relatively short and understandable. Instead, a complex, massive (§§56-585.1 and .2 alone contain almost 8,000 words) new regulatory scheme was developed. It was untested and even today, no other state has adopted it. The new law applies only to Appalachian Power Company (“APCo”) and Virginia Electric and Power Company (“VEPCo”); Kentucky Utilities was exempted, and Potomac Edison opted to transfer its service territory to two electric cooperatives. Electric cooperatives’ rates were essentially deregulated as long as rates for distribution service do not increase or decrease more than 5% in any three-year period. The lengthy, complex new law makes fundamental changes to electric utility ratemaking that reduce drastically the ability of the State Corporation Commission to set rates fairly and effectively, essentially guarantee recovery of all costs (unless found imprudent)33 and returns for these utilities, provide numerous opportunities for VEPCo and APCo to earn excessive returns, and generally tip the balance heavily in favor of utilities to the detriment of the businesses and citizens of the Commonwealth. Several of these major changes will be discussed below. Peer Group Return on Equity (ROE) Under the 2007 legislation new law, the SCC cannot set the authorized return on equity for an electric utility below a “floor” that is established based on the average rate of return of a strict, statutorily proscribed group of so-called “peer” companies. The floor rate of return is the average of a majority of these “peers” after removing the two companies with the The lengthy, complex new law makes fundamental changes to electric utility ratemaking that reduce drastically the ability of the State Corporation Commission to set rates fairly and effectively.
  13. 13. 10 highest returns and the two with the lowest, and the cap is 300 basis points above the average34 . This peer group rate of return on equity (ROE) is a different concept from the “cost of equity” that regulatory commissions traditionally set for utilities. To our knowledge, no other state uses this methodology. This artificial floor has resulted in SCC recommended rates that are higher than they would have been under previous regulation. During APCo’s most recent base rate increase in July of 2010, the SCC recommended a higher rate of return than they would have recommended were it not for the floor established by the 2007 legislation. Under previous regulation the SCC staff would have allowed APCo to earn a 10 percent profit for the coming year. However, due to the “floor” required by the 2007 legislation the SCC staff was required to recommend a profit of 10.53 percent. While that may not appear to be significant, it costs the rate payers $1.5 million.35 From an economic and financial perspective, the ROE for a company reflects a ratio of two accounting entries taken from the historic financial records of that company – the “net income” (from the income statement) and the “common equity” (from the balance sheet). The resulting ratio – rate of return on equity – is thus an accounting concept and is mechanical in nature. The cost of equity, in contrast, is a forward-looking concept that focuses not on accounting records but rather on financial market conditions. The cost of equity, unlike the rate of return, cannot be measured (from accounting records) but rather is estimated using financial models and capital market data. It is improper to restrict the cost of capital by reference to the ROE for a peer group. Such a restriction, in essence, equates the accounting concept of ROE with the economic/financial concept of cost of capital. These are different concepts that are only equal by chance. In addition, under the current 2007 law, every two years the SCC may increase or decrease the return on equity by up to 100 basis points based During APCo’s most recent base rate increase in July of 2010, the SCC recommended a higher rate of return than they would have recommended were it not for the floor established by the 2007 legislation-an increase of $1.5 million.
  14. 14. 11 on performance.36 Also, each utility’s return on equity may be increased by 50 basis points if it meets the renewable goals set in §56-585.2. Further, if the utility qualifies for the renewables’ 50 basis points and it has a negative performance adjustment, the positive 50 basis points replace the negative adjustment. If the performance adjustment is positive and higher than the 50 point renewable award, the higher award applies, but is not added to the renewable award. If a utility has a negative 100 basis point adjustment for performance and qualifies for the renewable 50 point adjustment, the 100 point decrease is eliminated and the base return increased by the 50 basis point renewable award. In that case, the renewable adjustment would, in reality, be 150 basis points, not 50. For VEPCo, the extra 100 basis points would cost ratepayers about $65 million per year. Section 56-585.1A6 provides long term “incentive” additions to the basic return on equity for investments in the construction of almost any kind of power plant other than a combustion turbine. These incentives may also be provided for “a project whose purpose is to reduce the need for construction of new generation facilities by enabling the continued operation of existing generation facilities.”37 These “incentives” range from 100 to 200 basis points and apply for 5 to 25 years. Electric utilities are monopolies that have their rates set to give the companies an opportunity to earn a fair profit. In return, the companies have an obligation to provide adequate, reliable, and safe service. As will be discussed in some detail in the next section of this report, return on equity for investments should be based on risk; a utility should not receive an ”incentive” simply to meet its public service obligations. If construction of a new power plant increases the risk to a utility, that fact will be reflected in the overall return on equity. Under the 2007 law, however, the risk would be reflected in the return on equity established by the SCC and, in addition, the company could earn up to 200 basis points on its equity in the particular facility. For example, if VEPCo were to construct a $10 billion nuclear power plant, the risk associated with that action would be reflected in its return set by the SCC. Return on equity for investments should be based on risk; a utility should not receive an “incentive” simply to meet its public service obligations.
  15. 15. 12 Then, in addition, the company would receive an ”incentive” of 200 basis points on its equity investment in its nuclear power plant. Just that “incentive,” after being grossed-up for taxes, would cost ratepayers over $125 million per year when the plant goes into service. Risk and Rate Adjustment Clauses It is a fundamental principal of economics and finance that risk and return are directly related – as the perceived risk of an entity or project increases, the expected or required return (i.e., cost of capital) increases. This basic concept carries forward into the regulation of electric utilities, as the costs of debt and common equity for a particular utility may vary from that of other utilities and unregulated firms that may be examined for comparative purposes. There are a number of measures of risk for all types of companies (e.g., bond ratings, “safety” rankings, betas) and these, as well as qualitative factors, are considered in estimating the cost of capital for individual utilities. The common financial models used in estimating the cost of equity for electric utilities – discounted cash flow (DCF), capital asset pricing model (CAPM), comparable earnings method (CEM) and risk premium method (RP) – all focus on both the concepts of risk/reward and financial market indicators. Rate Adjustment Clauses Permissible under the 2007 Regulation: Fuel Generation Transmission Lines Reliability/Environmental Peak Shaving Programs Energy Efficiency Programs Renewable Energy Portfolio Standards Environmental Programs
  16. 16. 13 A regulatory commission, such as the Virginia State Corporation Commission, can and does consider such factors in making determinations of the cost of equity for a utility which is then embedded in the rates the utility is allowed to charge its customers. One significant set of risk factors that is important in assessing the risk of a particular utility is the “regulatory mechanisms” prevalent in the jurisdiction. Examples of regulatory mechanisms include automatic adjustment mechanisms that allow utilities to change rates in an automatic or expedited manner. In Virginia, examples of this type of regulatory mechanisms include the Rate Adjustment Clauses (RACs) that have been authorized by the General Assembly. These RACs, in conjunction with other regulatory mechanisms in Virginia, clearly have the impact of reducing risk to Virginia utilities. Sections 56-585.1A4, 5, and 6 allow APCo and VEPCo to file an unlimited number of independent Rate Adjustment Clause (“RAC”) cases for any number of new projects, from transmission facilities, to modifications of current generation facilities, to compliance with environmental laws, to new power plants. It is difficult to think of many major expenses not covered by the RACs. Together APCo and VEPCo have already filed six RACs, and VEPCo recently filed an increase update request for one of its previously filed RACs. These RACs are based on estimated expenses, with all expenses and returns essentially guaranteed. For example, the companies are allowed to defer all expenses for a project until the RAC can begin to collect them. Also, over-earnings in other areas of the company cannot be considered to reduce the size of, or the necessity for, a RAC. Nor can any excess earnings of the RACs be considered when base rates are reviewed. By “silo-ing” or separating these filings, a system has been created where the SCC cannot look at the entire company's operation when determining rates, resulting in decreased risk and increased profits for the utility and increased costs to consumers. Rate Adjustment Clauses or RAC’s are based on estimated expenses, with all expenses and returns essentially guaranteed. Also, over-earnings in other areas of the company cannot be considered to reduce the size of, or the necessity for, a RAC. Nor can any excess earnings of the RACs be considered when base rates are reviewed.
  17. 17. 14 Markups and Excess Returns In addition, the statute allows the utility a “margin,” or markup, on its operating expenses for energy efficiency programs equal to the allowed return on equity.38 The return on the utility’s actual equity investment with the added “margins” could be extreme. Profits are considered to be after taxes for ratemaking and must be “grossed-up” for taxes. The tax gross-up would put the “margin” at over 17.5% if the allowed equity return is 10.53%, as APCo’s is. That means that, if the company has an energy efficiency program with operating expenses of $200 million, the operating expense would increase to over $235 million per year to provide the “margin” and APCo would still be guaranteed its equity return for its actual investment in the program. Depending on the size of the capital investment, the extra “margin” could greatly increase the actual return on equity. Base rates are reviewed every two years under the new law. The SCC is to determine “fair rates of return on common equity applicable separately to the generation and distribution services of such utility, and for the two services combined . . ....” 39 According to the statute, a rate increase will be allowed during a biennial review only if the utility “during the test period or periods under review, considered as a whole, earned more than 50 basis points below a fair combined rate of return on both its generation and distribution services . . ..”40 There does not, however, appear to be any prohibition to the utility filing for a base rate increase each year, independent of the biennial review and without the requirement that earnings be more than 50 basis points below the authorized return on equity.41 If the biennial review finds that the utility “during the test period or test periods under review, considered as a whole, earned more than 50 basis points above a Under the 2007 law, although the SCC is required to credit customers’ bills 60% of the excess above the 50 basis points above the authorized return, the Commission must leave in place the rates that produced the excess returns. Only if the utility over- earns in excess of 50 basis points above the authorized return for both generation and distribution services for two consecutive biennial reviews may the SCC consider reducing rates
  18. 18. 15 fair combined rate of return on both generation and distribution services . . .,” the SCC is required to credit to customers’ bills 60% of the excess above the 50 basis points above the authorized return, but the Commission must leave in place the rates that produced the excess returns.42 For example, for VEPCo, based on its current rate base and capital structure, if it over-earned $100 million per year, it would keep about $60 million43 of that amount and the excessive rates would stay in effect. Only if the utility over-earns in excess of 50 basis points above the authorized return for both generation and distribution services for two consecutive biennial reviews may the SCC consider reducing rates.44 Except for this situation, it does not appear that the SCC may consider reducing base rates. Also, remember that the RAC’s are not considered as part of this. Their rates of return are set and guaranteed outside of these reviews, While the security analysts and rating agencies did not discuss the details of the new law, it was clear from the beginning that the 2007 law was extraordinary. This was evident even with the conservative, staid language of the reviewers. For example, the December 10, 2007, Credit Suisse Equity Research review of Dominion Resources concluded: The Citigroup January 3, 2008, Global Markets Equity Research, Company Focus (apparently written in late 2007) said: With the passage of reregulation legislation earlier this year, VEPCO now appears to enjoy one of the more constructive regulatory frameworks in the country. VEPCO has negotiated one of the best regulatory deals in the industry, offering good returns . . . and project specific regulatory treatment through riders for new plants that should reduce lag.
  19. 19. 16 The reviewers were correct that the new law is the most favorable in the nation for electric utilities. The reviewers, however, failed to note, and perhaps were unaware of, the unfairness and overreaching nature of many aspects of the system adopted in 2007. The reduction in risk has been recognized by rating agencies, such as Moody’s Investors Service, in their description of Virginia regulation and related ratings of Virginia utilities. For an example, see Moody’s June 6, 2008 “Credit Opinion” on Virginia Electric and Power Company in Appendix B. In a traditional regulatory environment, the VA SCC could consider the risk- reducing regulatory mechanisms in determining the cost of capital for the electric utilities it regulates. In particular, to the extent that Virginia utilities are more “favored” by such mechanisms than are the “proxy” utilities which are used to estimate the cost of equity (via use of DCF, CAPM, etc.), an “adjustment” to the cost of equity for the proxy utilities could and under traditional regulation, would be made. However, the 2007 Legislation precludes the VA SCC from making such an adjustment. This is the case since the “peer group” earned return on equity (ROE) provides a “floor” to the cost of equity which the VA SCC can find as appropriate for the electric utilities it regulates. This peer group ROE floor clearly runs counter to the risk-return relationship that is fundamental to the economic and financial principles that normally impact both regulated and unregulated firms. To achieve the goal of fair and responsible electric utility ratemaking, the SCC must be able to look at each utility as a whole and determine its risks to establish a fair return on equity and determine if the company is over-earning or under-earning. . . . a utility could, for example, over- earn more than 50 basis points for generation every year, and over-earn above 50 basis points every other biennial period for distribution service, and the SCC could not even consider reducing rates even when the evidence clearly shows that the over-earning will continue in the future . . . This means the utilities may retain hundreds of millions of excess earnings over a period of just three or four years.
  20. 20. 17 Under the new law, for almost any project, the utility can create a RAC, defer costs until the new clause is in place, and have all expenses and returns guaranteed. As noted above, if the utility believes that base rates are too low, it may file a rate case, independent of the biennial review and the 50 basis point limit, and obtain a rate increase. On the other hand, a utility could, for example, over- earn more than 50 basis points for generation every year, and over-earn above 50 basis points every other biennial period for distribution service, and the SCC could not even consider reducing rates even when the evidence clearly shows that the over-earning will continue in the future. A utility can manage its expenses from year to year to greatly minimize the chance of over-earning by more than 50 basis points in a particular biennium, especially when such action will prevent the Commission from even considering reducing rates. Moreover, when one considers that refunds do not start until the excess earnings exceed 50 basis points above the authorized return on equity and include only 60% of the excess above that, the utilities may retain the majority of excess earnings. This means the utilities may retain hundreds of millions of excess earnings over a period of just three or four years. This does not make sense, nor is it fair. The SCC must be able to look at the entire utility and determine if it is over-earning or under-earning. If the company as a whole under-earns and it shows that the under-earning will continue, its rates should be increased. On the other hand, if the company is under-earning a small amount on its distribution service and this is more than offset by excess earnings from generation and that situation is to continue, no increase in rates is needed and a rate decrease should be considered. To achieve the goal of electric utility ratemaking, the SCC must be able to look at each utility as a whole and determine its risks to establish a fair return on equity and determine if the company is over-earning or under- earning.
  21. 21. 18 Rebundling Electric utilities, as regulated monopolies, have a long history of being “integrated” – as the functions of generation, transmission, and distribution are lumped into a single service and are provided by a single entity (i.e., the electric utility). This differs, for example, from the automobile industry where they are manufactured by one set of entities (i.e., auto manufacturers), are transported by a second set of entities (i.e., railroads) and are distributed by a third set of entities (i.e., dealerships). This corporate structure of electric utilities, in turn, carried over into the financial and ownership attributes of utilities. One cannot, for example, buy shares in the generation assets of a utility, as the utility is a single entity and ownership accrues to the entire integrated entity. Likewise, bond investors do not lend the utility money in a manner that is secured by specific assets, as even first mortgage bonds are secured by all of the assets of the utility. In a similar manner, rating agencies and security analysts focus on the combined entity in evaluating utilities – again because the investment in these entities focuses on the total company. The regulation of electric utilities has historically followed this same practice, and the utility was regarded as a provider of all three functions (i.e., generation, transmission and distribution). In this regard, utility services were “priced” as a single product – the provision of electric energy to the ultimate consumer. All aspects of utility pricing – revenue requirements, cost of capital, depreciation, and cost of service/rate design – were performed on a total company basis. This practice is now known as “coupling” – the antithesis of “decoupling” – and means that the three functions of electric utilities are provided for and priced on a total company basis. This is also known as “bundled” rates as opposed to “unbundled” rates. The concept of “decoupling” only came into being in the 1990s during the short- lived and failed concept of electric deregulation. Since the generation of electric power was then erroneously considered to be more optimal as a competitive function, deregulation focused on unbundling of the “wires” functions (i.e., transmission and distribution) from the generation function. This un-bundling was carried forward into the regulatory arena in the late 1990s-early 2000s and likewise found itself prevalent in the Virginia Statues governing the regulation of electric utilities.45 Now that “deregulation is dead” there is no longer any compelling reason to continue to focus on electric utilities in a decoupled/unbundled framework. Just
  22. 22. 19 as investors focus on electric utilities as integrated entities, it makes more sense for regulators to again focus on them as integrated entities Consumer Protections The 2007 legislation reduced Virginia’s already limited consumer protection, replacing it with utility guarantees and utility control. From the outset, the 2007 legislation was referred to as hybrid re-regulation. The utilities complained that traditional regulation gave the SCC too much flexibility and power and them too much uncertainty in costs and schedule and the outcomes desired by utilities were not sufficiently assured or timely. The 2007 law was designed by utilities to resolve those problems. It did not address consumer protection and in fact, reduced it. Neither the process that led to implementation of the 2007 law, nor the law itself, protect consumers. In fact, the playing field has been significantly tilted to favor utilities and disadvantage consumers. While most states that went through this process began with rate cases designed to assure that utilities were earning a fair return, Virginia skipped this step. Base rates were frozen and fuel costs were allowed to continue to flow through to consumers. The Assembly accepted the utilities’ proposal that they be allowed to keep any extra earnings to compensate them for stranded costs. Customers were deemed to have no stranded benefits. The Assembly’s action allowed utilities to over-earn by hundreds of millions of dollars as described earlier in this report. For example, when VEPCo's customers finished reimbursing the utility for the cost of the abandoned North Anna Nuclear Unit 3, because rates were, in effect, frozen rather than capped, the utility continued to collect the money. As a result of the 2007 legislation, consumer involvement in the decision making processes is reduced. Neither individual consumers nor consumer groups have the resources to participate in the number and frequency of cases that result This situation has been especially difficult for low income residential customers and those facing financial challenges since, unlike most other states; Virginia has no systematic and guaranteed safety net for residential customers who have difficulty paying their utility bills.
  23. 23. 20 from the 2007 legislation. The schedule requires multiple cases to proceed at once and there is no break when the legislature is in session, which reduces the consumer resources available for either cases or legislative involvement. Further limiting consumer protection is the fact that the Division of Consumer Counsel of the Attorney General’s office has a relatively small staff for a state the size of Virginia. This situation has been especially difficult for low income residential customers and those facing financial challenges since, unlike many other states, Virginia has no systematic and guaranteed safety net for residential customers who have difficulty paying their utility bills. Instead, utilities make voluntary and varied contributions to funds they also encourage customers to contribute to for the benefit of customers with financial problems. Families depend upon the federal LIHEAP funds, with occasional supplements of state tax funds made by Virginia governors, and privately funded local efforts to support citizens with low incomes and financial problems. Ω
  24. 24. 21 TRENDS IF ACTION IS NOT TAKEN As detailed earlier in this report, the 2007 reregulation statutes reduce drastically the ability of the State Corporation Commission to set rates fairly and effectively. The utilities are essentially guaranteed recovery of most costs and returns, and the statute encourages and provides for excessive returns for APCo and VEPCo. The new law has only just begun to impact rates with startling and disturbing results. Virginia’s current regulatory system has permitted dramatic increases of of electric bills in just a two year period. This is a problem that affects citizens and businesses all across the Commonwealth and will only continue to grow. Since 2007 Virginia’s investor-owned electric rates have risen dramatically across the board: Residential rates have fallen from the 13th least expensive in the nation to the 28th.46 Commercial rates have increased by an average of 33%.47 Industrial rates have fallen from the 9th least expensive in the nation to the 29th .48 As of 2009, every state in the South except Florida has industrial electric rates that average less than those in the Commonwealth.49 Overall, Virginia dropped from having the 11th lowest electric rates in 2007 to 25th in 2009.50 While overall electric rates in the country have increased about 0.6% from 2008 to 2009; Virginia’s average rates increased 10.8%.51 Unless the regulatory process for electric utilities is reformed, the current double digit utility inflation rate will only get worse. Investor owned electric utilities will undoubtedly take full advantage of the guarantees and profit margins provided to them under Virginia law. The electric utilities have, up to now, only filed a relatively small number of rate adjustment clause requests. With a number of large power plant and environmental projects on the drawing board, including nuclear plants, future RAC requests will require billions of dollars, all of which will essentially be guaranteed. Under such a scenario, Virginia's electric utility rates have the potential to quickly become among the highest in the nation. The dramatic increases in rates over the last several years in both absolute and relative terms has made bringing new industry and jobs to the Commonwealth much more difficult. If electric utility regulation in Virginia maintains its current form, these trends will continue to place the Commonwealth at an economic disadvantage. Ω
  25. 25. 22 KEY POLICY CHANGES Any changes to Virginia’s investor-owned electric utility regulation will only be effective if they solve key failings in current legislation and return to a regulatory system that both protects consumers and properly balances risk and reward for the utilities. Key policy changes that are needed include: Risk  Allowing the SCC to look at each utility as a whole and determine its risks to establish a fair return on equity and determine if the company is over- earning or under-earning. This ability to look at the utility as a whole must include the re-bundling of generation, transmission, and distribution as well as the elimination of silo-ing rate adjustment clauses.  Elimination of the arbitrary “floor and cap” rates of return as an average of the majority of a statutorily proscribed group of so-called “peer” companies. This peer group rate of return on equity (ROE) is a different concept from the “cost of equity” that regulatory commissions traditionally set for utilities.  Eliminate massive incentives for utilities to meet their standard public service duties. Consumer Protections  Requiring that all rate adjustment clauses and base rates occur in a single, annual proceeding in order to establish rate stability for the customer and decrease the number of rate increases.  Return overearnings that exceed a fair rate of return by more than 50 basis points to the customers.  Eliminate provisions that prevent the SCC from lowering rates if they determine that a utility is over earning. Ω
  26. 26. 23 RECOMMENDATIONS OF THE WORK GROUP Given the fundamental lack of balance and fairness in the 2007 reregulation statutes, changes are necessary. The initial question is whether to repeal the 2007 legislation to the extent possible and revert back to the basic Chapter 10 rate base / rate of return regulatory framework that had been in place for many decades in the Commonwealth or to try to add balance and fairness to the current system that basically guarantees the utilities full recovery of all expenses not found to be imprudent plus a guaranteed return on equity that may include adders for performance and other factors. There are several reasons why repealing the 2007 reregulation system is far better than simply trying to make the law more balanced and fair. The first reason relates to service quality and safety. Under the pre-competition framework, if a utility cut maintenance or other operating expenses, in the next rate case, the new, lower level of expenses would become the basis for rates in the future. The utility could keep the “savings” until the new rates went into effect, but, long term, reducing expenses would reduce rates. Under the new legislation, the utility is allowed to keep a very significant portion of excess earnings. For example, for VEPCo, based on its current rate base and capital structure, if it over-earned $100 million per year, it would keep about $60 million52 of that amount and the excessive rates would stay in effect. Thus, there is a much greater incentive for the utility to cut costs under the new statute; it gets to keep most of the savings almost indefinitely. Such cuts, of course, can reduce quality of service. It is difficult for regulators to see changes in quality of service until it has declined significantly and then service quality can be hard and often expensive, to improve. Also, if that happens, the ratepayers may lose in two ways. They will pay higher rates for poor service until the utility is required to improve, and then, perhaps, pay extra because catching up may cost more. As far as safety is concerned, cuts to maintenance and other items tend to build over time. While management never The primary differences between these proposals and the current law are that, with the revisions, the law will be more balanced and SCC will have the authority to apply basic regulatory principles fairly, without a heavy hand on the scales in favor of the utilities.
  27. 27. 24 intentionally or specifically requires a cut that it knows will create a catastrophic failure, there are numerous examples where, over time, the reductions did impact safety with drastic consequences. The 2007 legislation provides great incentive to cut costs. That incentive can lead to reduced service quality and reduced safety. And, the ratepayers would be providing excessive profits to the utility while quality of service and safety declined. While there is an increased incentive to cut operating costs, there is the opposite incentive with regard to capital investment. For example, for a base coal or combined-cycle power plant, a utility will receive a 100 basis point increase in its equity return for investment in the plant. VEPCo’s equity return for its next biennial review is set at 11.9%. The 100 point “incentive” combined with its high normal return provides a strong incentive (a 12.9% guaranteed return on equity) to over-invest in such a plant. The 12.9% return is after taxes and must be “grossed-up” for taxes so ratepayers actually pay, and the company actually receives, a pre-tax 21.5% return on the equity investment. While the company must pay taxes on this income, current taxes actually paid by the company will be far less than the amount provided by the gross-up. When a plant is going to cost $2 billion, gold-plating an extra $200 million would be hard to detect53 and would mean significant income for the utility. For VEPCo, as an example, the added revenue on equity alone for this would be over $21 million per year per $100 million of equity. When the 21.5% return per year is guaranteed for many years, there is little incentive to be frugal and a great incentive to over-invest. In the 2007 reregulation statutes, the General Assembly created a number of incentives. Some of these, such as incentives for excellent performance, can benefit the utility and its customers. Other incentives, such as the “margin” on operating expenses for energy efficiency programs, encourage excessive spending that can make a program less cost-effective and increase rates unnecessarily. Revert Back to Basic Chapter 10 Regulation The first option would be to reinstate much of the system under which investor- owned electric utilities were regulated prior to 1999. This measure would repeal the Virginia Electric Utility Regulation Act of 2007 and reenact provisions relating to State Corporation Commission (SCC) ratemaking, including provisions addressing the recovery of fuel and purchased power costs, that existed prior to the 2007 legislation that re-regulated most of Virginia's investor-owned electric utilities. Existing provisions of the Virginia Electric Utility Regulation Act pertaining to ratemaking for electric cooperatives, to net energy metering, to consumer education programs, and to interconnections by farms would be
  28. 28. 25 relocated to other chapters in Title 56. Existing rate adjustment clauses approved by the SCC under the 2007 legislation would remain in effect as set forth in an enactment clause. Attempt to add Balance and Fairness to the Current System The second option would attempt to add balance and farness to the current system which is in place as a result of the 2007 legislation. This option would rebundle charges for the transmission, distribution, and generation services into the base rates of investor-owned electric utilities and revise the system enacted in 2007 by which rates of investor-owned electric utilities are to be set. The measure would restore the State Corporation Commission's authority to set the utility's authorized rate of return on equity at a level that reflects the utility's risk, allows the utility to attract capital, and will be fair to ratepayers. Existing provisions of the Virginia Electric Utility Regulation Act that establish floors on a utility's rate of return based on returns reported by peer group utilities in other Southeastern states would be repealed. Other key provisions would do the following: (i) Require the Commission to consider all rate adjustment clause petitions in single annual proceedings in order to limit the number of rate increases; (ii) Provide that costs recoverable through rate adjustment clauses may be deferred; and if the utility has over earned on base rates, excess base rate earnings may be credited to under recovered RACs. (iii) Direct that a utility that has earned more than 50 basis points above its fair rate of return in a biennium, (after crediting any overage that has been used to offset under collections in a RAC ), shall credit the overage to customers; (iv) Excess earnings used to offset under recovered RAC’s may not reduce the earned rate of return below the fair rate of return established by the SCC; (v) Eliminate a provision that limits the Commission's authority to lower a utility's rates to cases where the utility has earned more than 50 basis points above a fair rate of return for two consecutive biennia; (vi) Eliminate the ability of a utility to earn a margin on operating expenses for energy efficiency programs; (vii) Limit the incentive for participation in the renewable energy portfolio program to an additional 50 basis points above the otherwise-available
  29. 29. 26 rate of return on new renewable energy generation facilities, in lieu of the existing provision that grants participating utilities a 50 basis point increase in its rate of return on all of its equity; (viii) Authorize the Commission to increase the allowed return on equity for certain investments by up to 200 basis points for a period between 5 and 25 years based on the risk of the project, not otherwise reflected in the return established by the Commission, in lieu of the existing provision that establishes incentives with specific ranges and durations based on the type of project; (ix) Permit the Commission to extend the period for its review in cases by up to nine months, provided that the utility may place its proposed rate increase in effect subject to refund at the end of the original period; (x) Delete provisions requiring stand-alone determinations of income tax costs in ratemaking proceedings. If the second option be selected, a future review of the performance of this legislation should be undertaken to ensure fairness and make adjustments as needed, as this is a much more complex undertaking. The Work Group proposes returning Virginia to the Chapter 10 regulation that was in effect prior to deregulation in 1999, but with the aforementioned updates. It is the belief of the Work Group that this proposal would give the State Corporation Commission the appropriate discretion in setting rates. Under this proposal, like the pre-1999 regulatory system, electric utilities would be allowed to make only base rate petitions as well as request fuel rate adjustments if their fuel costs went up or down. However, the Work Group also endorses as a “Plan B” the rewriting of the code to attempt to add balance and fairness to the current system, replacing and repairing the 2007 legislation. Reaction from Utilities The reaction by the utilities to the changes proposed by the Electric Utility Regulatory Work Group may be that the revisions are unnecessary, and that just making the proposals increases the risks for the companies. They may argue that the General Assembly determined several years ago how electric utilities would be treated for ratemaking and, even though the first biennial review has just been completed, the treatment may change such that the utilities will not be
  30. 30. 27 able to count on all of the procedures and rules to which the Assembly agreed. It will be explained that this increased risk can have a negative impact on the securities of the utilities. The utilities will be correct in that any change that is not favorable to the utilities will be viewed negatively by the investment community. Thus, there may, in fact, be a negative short-term reaction by the investment world. There are several responses to these assertions: First, and most importantly, the current law is grossly unfair to the businesses and citizens of Virginia and must be balanced. By overreaching so much in 2007, the utilities brought these changes on themselves. Second, under Plan B, the substantive essence of the advantages for utilities in the current law remains with the proposed changes. The ability to defer RAC expenses until collection begins would remain available and the opportunities for increased equity returns for RACs for risk (up to 200 basis points), for performance (up to 100 basis points), and for renewables (50 basis points) would stay in the statute. Also, the revisions would make clear what the current law only implies, the guaranteed recovery of all prudent costs and returns under the RACs. In addition, the utilities would still be able to retain a portion of excess earnings, though not as much as is allowed under the current statute. The primary differences between these proposals and the current law are that, with the revisions, the law will be more balanced and SCC will have the authority to apply basic regulatory principles fairly, without a heavy hand on the scales in favor of the utilities. The Edison Electric Institute’s EEI Q12010 Financial Update provided to the Work Group listed what amounts to a wish list of utilities during the first part of the year. Requests by utilities to implement tracking mechanisms, adjustment clauses and related rate structures also played a large role in the quarter’s filings. With regard to regulatory lag, the EEI Report said: Commissions can allow utilities to moderate regulatory lag in several ways, including adjustment clauses, interim rate increases, construction work-in-progress (allowing the utility to recover costs of construction before a project comes online) and the use of projected costs in rate cases. The EEI Report also noted:
  31. 31. 28 Another driver of filed cases during Q1, and a frequent driver of filed cases in general, was the attempt by utilities to implement adjustment clauses, riders, trackers and other interim rate mechanisms, with a number of companies eager to implement several trackers. Almost all of the items listed in the EEI Report would remain in the revised law. Even after the revisions, Virginia’s regulatory regime would be beyond the wildest dreams of almost every utility executive and retain the advantages sought by EEI members and cited by the security analysts and rating agencies: an unlimited number of RACs can be filed for almost any conceivable project or plant; deferral of expenses until collection begins so not a penny is left behind; guaranteed recovery of all expenses and the allowed equity return; an opportunity for a higher equity return based on performance that would also be guaranteed; an opportunity for a guaranteed higher equity return for a risky project; use of projected costs for establishing the RACs; allowance of a return on construction work-in- progress prior to the operation of the project or power plant; and allowance for the utility to keep the first 50 basis points of excess earnings. The investment community, like the utility executives, will see the tremendous advantages of the proposal. Third, revisions of regulations are not that unusual within the first few years of a major regulatory change as the regulator and others involved see how things will work in practice. This is particularly true here where the General Assembly essentially took over the role of regulator from the SCC in 2007 by including numerous requirements and limits in the statutes so the Commission cannot make adjustments as needed. An example of this is HB 1308 addressing interim rates that passed the House and Senate earlier this year without a negative vote; the perceived need for the change clearly flowed from the operation of the 2007 reregulation statutes. Obviously all agreed that a change was needed; the change, however, either has been, or probably will be, viewed negatively by investment commentators. Many changes and adjustments can be avoided by restoring to the SCC the responsibility to regulate again; if done correctly this can also remove, to a significant extent, politics from regulation. The Commission was established so that it would be insulated from politics, but that advantage is lost when the Assembly becomes the regulator.
  32. 32. 29 Finally, when the need for more reform is reduced, the stability of the Virginia system and the Commission will be seen as an advantage, as it was in the decades before the foray into competition in the late 1990s. Ω
  33. 33. 30 CONCLUSION A regulatory system that permits the dramatic and unnecessary increase of electric bills in a two year period is flawed. This is a problem that affects citizens and businesses all across the Commonwealth and will only continue to grow if we do not take action now. The last several years have been hard on Virginia; businesses are suffering and unemployment is up. State and local governments have seen revenues decline and services cut. The General Assembly has refrained from increasing taxes for fear of hurting taxpayers further. Citizens, businesses, and state and local governments have no guarantees upon which to rely to make ends meet. Only VEPCo and APCo have built-in guarantees. Only VEPCo and APCo can file for RACs with recovery of all expenses and profits guaranteed. The analysts agree these utilities have the best deal in the country. Those facts are hard to take in the current economic environment. In addition to the many guarantees, the current law also allows and encourages excess profits so the utilities earn more than their allowed returns. And, the utilities are allowed to keep much of the excess. Furthermore, under the law, the overcharging rates cannot be reduced for years. At least these excesses need not be tolerated. The General Assembly approved the current law and is responsible for its results. The excess charges provided for in the 2007 law are the equivalent of a tax on every home and business in the Commonwealth. The charges are, in essence, a utility tax; the only difference is the utilities keep the money. This tax does not pay a single teacher or policeman. Finally, remember that the United States Constitution protects utilities; rates set too low may be found to deprive the utility of its property without due process in violation of the fourteenth amendment. Consumers, however, have no such protection. They must rely on the General Assembly and, to the extent allowed, the State Corporation Commission to ensure that rates are not set unreasonably high. If the General Assembly does not make changes to Virginia’s electric utility regulatory laws to ensure rates are fair, just, and reasonable, the Commonwealth The excess charges provided for in the 2007 law are the equivalent of a tax on every home and business in the Commonwealth.
  34. 34. 31 is destined to join the group of states with the highest electric rates in the nation; thereby placing our citizens and businesses at a regrettable, and ultimately preventable, economic disadvantage. Ω
  35. 35. ii APPENDIX A ELECTRIC UTILITY WORK GROUP MEMBER BIOGRAPHIES The Hon. John Chichester represented the 28th district in the State Senate from 1978 to 2008. He also served as the Senate’s President pro tempore, a position he held from 2000 to 2008. Senator Chichester has received widespread recognition for his distinguished service to the Commonwealth and has been honored by organizations in Virginia and throughout the nation. Most notably, he was selected as one of Governing Magazine’s Public Officials of the Year in 2004. In 2005, he received the prestigious Excellence in State Legislative Leadership Award from the National Conference of State Legislatures and the State Legislative Leaders Foundation. Senator Chichester is past chairman of both the Southern Legislative Conference and the Council of State Governments. He served on the Board of Directors of the State Legislative Leaders Foundation and the Senate Presidents’ Forum. Sen. Chichester was also a gubernatorial appointee to the Southern Regional Education Board and a member of the National Conference of State Legislatures’ Blue Ribbon Commission on Higher Education. Outside of the Senate, Chichester has been active in business and his local community. He served on the Board of Directors of the Northern Neck Insurance Company, and he is a member and past president of the Fredericksburg Rotary Club. He was a member of the Board of Directors of the National Bank of Fredericksburg from 1984 to 2007, serving as the Board’s chairman from 2003 to 2007. Senator Chichester is a graduate of Virginia Tech. The Hon. Mary Christian represented the 92nd district in the Virginia General Assembly from 1986 to 2004, where she championed legislation on education, healthcare and prescription drugs. During her time in the General Assembly, she served as Chair of several subcommittees including a Labor & Commerce Subcommittee. For more than twenty five years, Christian was a professor at Hampton University in the School of Education, where she served as Director of the School of Education, rising to Dean of the School of Liberal Arts and Education. Delegate Christian is the recipient of numerous awards for her community and humanitarian service including the NAACP Merit Award for Community Services, the Outstanding Service Award from the, NAACP, Virginia State Conference, and the Outstanding Educators of America Award and Christian R. and Mary L.
  36. 36. iii Lindback Award for Distinguished Teaching from Hampton University. She is also a member of the Hampton-Newport News Service Boards Hall of Fame. Delegate Christian received an undergraduate degree in Elementary Education from Hampton Institute (now Hampton University), a graduate degree in Speech and Drama from Columbia University and her Ph.D. in Elementary Education from Michigan State University. The Hon. Theodore “Ted” Morrison Jr. retired as Chairman of the Virginia State Corporation Commission on January 1, 2008. During his 19 years of service he supervised the regulation of various industries including electric, gas and water utilities, insurance, securities and retail franchising, ship pilot rates, corporate and business entity formation and compliance. Judge Morrison also participated in the regulation of state chartered banks, credit unions, mortgage lender/brokers, and telecommunications companies. He served on the board of directors of NARUC. Prior to his State Corporation Commission service, Mr. Morrison maintained a general law practice in Newport News and represented that city in the Virginia House of Delegates (1968-1988). His General Assembly committee assignments included Finance (chairman), Courts of Justice (vice-chairman), Rules, Privileges and Elections, and Corporations, Insurance, and Banking. Having been a member of the Virginia Code Commission for 21 years, he served as its chairman four years. He was a member of the Joint Legislative Audit and Review Commission (vice-chairman), the State Crime Commission, and the Committee on District Courts. Mr. Morrison served in the United States Army. He was awarded B.A., LL.B, and LL.D degrees from Emory University and he holds active member status in the Virginia State Bar. The Hon. Hullihen Williams Moore served as a member of the State Corporation Commission of Virginia for twelve years, from 1992 through January of 2004. Prior to his first election to the Commission in February, 1992, Moore practiced law for 25 years in Richmond, Virginia, concentrating in administrative and public utility law. Mr. Moore also taught public utility law and economic regulation at the law schools of the College of William and Mary, Washington and Lee University, and the University of Virginia. Mr. Moore is a past President of the Mid-Atlantic Conference of Regulatory Utilities Commissioners (1997) and a past President of the Southeastern Association of Regulatory Utility Commissioners (1994-1995). In addition, Mr. Moore was a member of the Board of Directors and the Committee on Electricity of the National Association of Regulatory Utility Commissioners. He also served as a member of the Advisory Council of the Electric Power Research Institute.
  37. 37. iv Mr. Moore currently serves on the Board of Directors of Union First Market Bankshares Corporation, a Virginia multi-bank holding company. The company is the largest banking organization headquartered in Virginia. In addition, Mr. Moore serves as Chair of the Virginia State Air Pollution Control Board. Mr. Moore also is a member of the Board of Trustees of the Shenandoah National Park Trust. The Trust supports the preservation of the beauty, habitat, and cultural heritage of Shenandoah National Park. Mr. Moore is a graduate of Washington and Lee University with a major in philosophy. He received his law degree from the University of Virginia where he served on the Editorial Board of the Virginia Law Review. He also served as Editor of The Virginia Lawyer and authored numerous articles in the regulatory law area. Vincent D’Amelio retired from Consolidated Edison in New York City as Vice President Customer Service in September of 1999. He now resides at Smith Mountain Lake near Roanoke Virginia. Mr. D’Amelio joined Con Edison in February 1997 with full operations responsibility as Vice President, Staten Island Service and as special assistant to Con Ed’s president to provide advice and counsel on issues associated with deregulation of the electric industry in New York State. In October 1997 he was appointed to the position of Vice President, Service, responsible for Con Edison’s Northern Region, comprised of Westchester County and the Bronx. He has overall responsibility for the operation of the electric distribution system and customer service operation. He is on the Board of Directors of Con Edison’s telecommunication subsidiary, Con Edison Communications. At Sprint, he was Director-Service, Staff Operations beginning in 1993, where he reported to the Consumer ServicesGroup, Chief Operating Officer, managing the combined Customer Service and Accounts Receivable Corporate Staff. He joined Sprint in 1988 as Director of Staff Operations, charged with reorganizing their national Accounts Receivable and Customer Service operations. In 1985 he was appointed Assistant Treasurer of AT&T Communications, Managing their Accounts Receivable and cash flow. Prior to that, he had held the position of Division Manager-Financial Programs, in AT&T’s Business Marketing Organization, establishing the financial control’s architecture and implementation plans for AT&T’s newly formed, deregulated, equipment subsidiary. He had previously been responsible for AT&T’s Business market, sales forecast, revenue, expense and product planning results analysis. After completing assignments in Marketing, Product Development, Customer Service, Financial Analysis, Capital Budgeting, Tax Planning, Information Systems Design, and Corporate Planning, he was appointed to the position of Executive Assistant to the Business Marketing Development Vice President in 1979.
  38. 38. v His more than 25 years in telecommunications began with AT&T in New York in 1970 as a Staff Analyst in the Management Sciences Division of the Office of the Chairman before being promoted to District Manager, Financial and Economic Studies in AT&T’s Business Research Unit in 1974. Prior to joining AT&T, he held positions at General Electric’s Missile and Space Division in engineering and marketing capacities. Mr. D’Amelio completed his undergraduate work at the State University of New York at Buffalo, in Chemical Engineering and his Masters of Business Administration in Finance, at New York University. David Parcell is President of Richmond based Technical Associates Inc., and is an expert in Financial; Insurance; Transportation; Franchise, Merger & Anti-Trust; and Utility Economics. He has performed numerous financial studies of regulated public utilities and testified in over 450 cases before some fifty state and federal regulatory agencies including the Federal Energy Regulatory Commission and Federal Power Commission. Mr. Parcell has prepared numerous rate of return studies incorporating cost of equity determination based on DCF, CAPM, comparable earnings and other models. In addition he has developed procedures for identifying differential risk characteristics by nuclear construction and other factors. Mr. Parcell has conducted studies with respect to cost of service and indexing for determining utility rates, the development of annual review procedures for regulatory control of utilities, fuel and power plant cost recovery adjustment clauses, power supply agreements among affiliates, utility franchise fees, and use of short-term debt in capital structure. He has published articles in law reviews and other periodicals on the theory and purpose of regulation and other regulatory subjects. Mr. Parcell is a Certified Rate of Return Analyst and a member of the American Economic Association, Virginia Association of Economists, Richmond Society of Financial Analysts, and Financial Analysts Federation. In addition he served on the Board of Directors of the Society of Utility and Regulatory Financial Analysts from 1992-2000, during which time he served as Secretary/Treasurer from 1994-1998 and President from 1998-2000. He completed both his undergraduate and graduate work in economics at Virginia Tech and received an MBA from Virginia Commonwealth University.
  39. 39. vi Irene Leech is an Associate Professor at Virginia Tech and leading Consumer Advocate with an emphasis on Electric Utility Regulation. She has written regularly on electric utility regulation and deregulation in Virginia and testified frequently on the consumer perspective on electric deregulation in Virginia before Legislative and Regulatory bodies. Ms. Leech has served on the Governor’s Energy Policy Advisory Committee from 2007- 2010 and was appointed to the Post-Capped Rates Subcommittee of the Virginia General Assembly’s Commission on Electric Utility Restructuring in 2006. She served on the Task Force convened by the Virginia Attorney General’s Office to review Dominion’s proposed hybrid electric regulation legislation in 2007. Leech was a co-Primary Investigator on a National Science Foundation funded research project, A Holistic Approach to the Design and Management of a Secure and Efficient Distributed Generation Power System from 2003-2007 and presented the work of the Virginia Tech team at NSF project conference s in 2003, 2004, and 2005. Ms. Leech has held numerous professional memberships and leadership positions including with the American Association of Family and Consumer Sciences, American Council on Consumer Interests, Consumer Federation of America, National Consumers League, Take Back the Power, Virginia Citizens Consumer Council, Virginia Department of Agriculture and Consumer Services’ Consumer Advisory Committee, the Virginia State Corporation Commission’s Energy Choice Education Committee and Virginia Energy Sense Consumer Education Committee. She is a graduate of Virginia Tech where she received her bachelor’s, master’s and doctoral degrees. Donnette Leonard is a resident of Cana, VA and has been locally active on behalf of area residents affected by increases in electric utility costs. Ms. Leonard has been active in organizing local town halls on rising utility rates and circulating a petition against rate increases that amassed over 1800 signatures. Her opinion columns on the topic of increasing electric costs from the perspective of Virginia residents have been published in several newspapers including the Roanoke Times and The Carroll News. Ms. Leonard continues to work to keep residents engaged around the issue of electric utility regulation and to shine a spotlight on the personal and economic impacts that high rates have on both residents and businesses. Ms. Leonard is also active with veterans and military organizations where she has served as coordinator for Wake Forest University’s 2008 Welcome Home Warrior Program and the University’s Annual Military Family Reunion. She attended East Tennessee State University where she studied Psychology.
  40. 40. vii Doug Bassett is the Executive Vice President and COO of Vaughan-Bassett Furniture Company, which is based in Galax, VA. With sales of over $85 million and with over 700 employees, Vaughan-Bassett is the largest wooden adult bedroom manufacturer in the United States. Mr. Bassett graduated from the University of Virginia in 1988 and was the first legislative director for Congressman Richard Burr (R-N-C) in 1995 and 1996. Burr is now North Carolina’s senior senator. He was press secretary for Congressman Charles Taylor (R-N-C) in 1991 and 1992 and was campaign manager for Taylor’s 1992 re-election campaign. Mr. Bassett is a member of the Board of Directors and sits on the Executive Committee of the High Point Market Authority. He also sits on the Board of Directors of Webb Furniture Company. The Hon. Wm. Roscoe Reynolds currently represents the 20th Senate district, made up of four counties and parts of two others in southwestern Virginia, plus the cities of Galax and Martinsville. Previously Reynolds served in the Virginia House of Delegates from 1986–1997. Prior to his election to the House of Delegates, Reynolds served as Commonwealth's Attorney for Henry County. Senator Reynolds has been a long-time champion for consumers and outspoken advocate against increasing electric rates, testifying numerous times before the State Corporation Commission. In addition, he has sponsored legislation to return full regulatory discretion to the SCC and require that rates be set based on the entire operations of a company, not by individual costs. Senator Reynolds received his undergraduate degree from Duke University and his law degree from Washington and Lee University. The Hon. Ward Armstrong was elected to the House of Delegates in 1992 and currently serves as Minority Leader, a position he was elected to in 2007. Delegate Armstrong has sent numerous letters and contributed in person testimony at SCC hearings in opposition to Appalachian Power Company’s most recent rate requests of the past several years. In addition, Armstrong has worked to provide greater opportunities for citizens to show their opposition and attend rate hearings in person. During the 2010 General Assembly Session Armstrong submitted legislation to return Appalachian Power to the regulatory standards that were in place prior to deregulation. He has held town hall meetings throughout southwest and
  41. 41. viii Southside Virginia on regulatory reform and has circulated a petition against Appalachian Power’s rate increases, which to date has received over 8000 signatures. Delegate Armstrong received an undergraduate degree in business from Duke University and his law degree from the University of Richmond.
  42. 42. i APPENDIX B Extracted from Moody’s June 6, 2008 “Credit Opinion” on Virginia Electric and Power Company “The key drivers of VEPCO’s ratings are: - Regulatory and political supportiveness The vast majority of VEPCO’s revenues are regulated by the Virginia State Corporation Commission (VA SCC) and the North Carolina Public Service Commission (NCPSC). In general, Moody’s views the regulatory and political environments in both Virginia and North Carolina as a credit positive, given the region’s overall supportiveness to long-term credit quality and the established legislative framework to maintain a financially strong and healthy utility sector. The regulatory and political supportiveness represents a significant positive ratings driver for VEPCO. - VA SCC jurisdictional boundaries In Virginia, VEPCO’s primary service territory, it is our opinion that the legislature has been extremely supportive in maintaining a sound, financially health electric utility sector. As evidence, Moody’s observes that legislation has been passed on numerous occasions designed to tackle the changing fundamentals and market environment in the region, to address the recovery of rising costs and to provide financial incentives to make necessary infrastructure investments. In effect, Virginia has transitioned from being quasi-deregulated to fully re-regulated, a credit positive. More importantly, the VA SCC’s role, as a judicial branch of government tasked to enforce the laws enacted by the legislature, is well regarded, in our opinion, due to their deliberate and measured interpretation of the existing legislation. While this
  43. 43. ii arrangement is viewed as a material credit positive, we observe the dramatic changes associated with the 2007 Virginia Restructuring Act, which had an effect that eliminated historical legal precedents. As a result, there could be occasions in the future where the interpretation of the legislature’s intent behind the restructuring law could emerge potentially introducing lengthy legal or regulatory delays Moody’s notes that the first significant test under this new regulatory framework – the approval of the cost riders associated with the proposed construction of the Virginia City Hybrid Energy Center, a coal-fired generation facility located in southwestern Virginia – was completed without any of the interpretation risks we have highlighted in this section. From a credit perspective, we incorporate a view that the Virginia legislature will continue to remain supportive to the long term financial health of the utility sector and towards the utilities in the state that they indirectly regulate. - Fuel clause recoveries As expected, in early May 2008, VEPCO filed with the VA SCC a plan to revise its fuel factor pursuant to Virginia Code 56-249.6 (case number PUE-2008-000.39). VEPCO’s fuel factor is forward looking, as opposed to historical, which is neither positive nor negative to credit as long as adequate liquidity availability is maintained. In the filing, VEPCO proposes raising its fuel factor rate, which is a pass-through item, to 4.245 cents per kilowatt hour (kwh) from 2.232 cents per kwh, beginning on July 1, 2008, an increase of roughly $1.3 billion above its 2007-2008 fuel cost recovery level. As part of its filing, VEPCO also proposed to defer approximately $700 million of under- collected fuel expenses for the period July 1, 2007 through June 30, 2008, thereby moderating, to some degree, the impact of even higher rates on consumer bills. Moody’s observes that VEPCO reported approximately $2.5 billion of electric fuel and energy purchases for the year ended 2007. In addition, we note that in the order establishing the fuel factor proceeding the VA SCC is allowing the
  44. 44. iii “submission of legal memoranda that may address, among other issues, the legal permissibility” of VEPCO’s offer to defer the $700 million under-recovered balance. It is our understanding that the VA SCC will review the testimony from interested parties in mid-June and a hearing has been scheduled for June 24, 2008. In our opinion, the pass-through nature of VEPCO’s fuel factor is generally viewed as a credit positive. While the framework for fuel recoveries has changed over the past few years (from an annual adjustment, to a multi-year freeze and back to an annual adjustment – see regulatory supportiveness above), we believe the regulatory procedural process is relatively straightforward, and that VEPCO will be allowed to recover the vast majority of its increased fuel and purchased power expenses over a reasonably timely basis. In addition, we incorporate a view that most of the major industrial interveners recognize that the costs are directly related to rising commodity prices, and so any disputes will most likely revolve around the composition of the forward fuel price assumptions. - Significant capital investment plans VEPCO has a very significant capital expenditure plan, which includes both near term and longer term infrastructure investments. For the year ended 2007, VEPCO reported approximately $1.3 billion in capital expenditures, up from the approximately $1.0 billion spent in 2006 and the roughly $0.9 billion noted in 2005. These investments are expected to enjoy the attractive recovery incentives embodied in the 2007 Virginia Restructuring Act, and include investment sin incremental generation supplies, transmission and distribution upgrades, new connections and environmental enhancements. Over the longer-term horizon, VEPCO is planning a significant amount of investment into new base load generation supplies, including new coal and nuclear facilities. In addition, VEPCO is planning on investing a significant amount of capital (approximately $500 million per year over the next several years) into new transmission and distribution projects. From a credit
  45. 45. iv perspective, we view investment additions into regulated rate base positively. We observe that VEPCO has been authorized to commence collecting, through a rate rider (the framework of which was established in the 2007 Virginia Restructuring Act), the cost associated with its southwest Virginia Coal-fired project (Virginia City), beginning in January 2009. Moody’s anticipates that VEPCO will avail itself of similar rider-collection authority with respect to the mounting costs associated with a prospective new nuclear facility.”
  46. 46. A ENDNOTES 1 EEI Average Overall Rates, 2007, 2008, 2009. 2 EEI Average Residential Rates, 2007, 2009. According to EEI Dominion Virginia Power‟s average residential rate increased from $.0865 in 2007 to $.1075 in 2009, an increase of 24.3%. 3 EEI Average Residential Rates, 2007, 2009. According to EEI, APCo‟s average residential rate increased from $.0484 in 2007 to $.0923 in 2009, an increase of 90.7%. 4 EEI Average Commercial Rates, 2007, 2009. According to EEI, Virginia‟s average commercial rates increased from $.0620 in 2007 to $.0825 in 2009, or 33.1%. APCo‟s commercial rates increased from $.0572 in 2007 to $.0769 in 2009, or 34.4%. Dominion Virginia Power‟s commercial rates increased from $.0626 in 2007 to $.0833 in 2009, or 33.1%. 5 EEI Average Industrial Rates, 2007, 2009. According to EEI, APCo‟s average industrial rate increased from $.0435 in 2007 to $.0622 in 2009, an increase of 43%. 6 EEI Average Industrial Rates 2007, 2008, 2009. Dominion Virginia Power‟s industrial rates increased from $.0484 in 2007 to $.0672 in 2009, or 38.8%. The national average industrial rate in 2009 was $.0663. 7 State Corporation Commission Staff Response to August 2, 2010, Requests for Information from Delegate Ward L. Armstrong included average rate information from the “Edison Electric Institute‟s („EEI‟) Periodic Typical Bills and Average Rates Reports.” These data provide the following: EEI Average Rates, Overall Rates Ranked from Lowest to Highest State Annually for 1995-1997 and 2003-2009 (“EEI Average Overall Rates”); EEI Average Rates, Residential Rates Ranked from Lowest to Highest State Annually for 1995-1998 and 2003-2009 (“EEI Average Residential Rates”); EEI Average Rates, Commercial Rates Ranked from Lowest to Highest State Annually for 1995-1997 and 2003-2009 (“EEI Average Commercial Rates”); and EEI Average Rates, Industrial Rates Ranked from Lowest to Highest State Annually for 1995-1998 and 2003- 2009 (“EEI Average Industrial Rates”). For example, Virginia ranked 13th , 12th and 12th for lowest Average Commercial Rates in 1995, 1996, and 1997, and APCo‟s average residential rates were slightly higher than the 3rd and 4th ranked states during this period. 8 See §56-582. Note that while the headings refer to rate “caps,” there is no provision to reduce base rates. Also, Subsection B provides a number of ways rates could be increased. 9 “Stranded Cost” was the term coined to define the loss in value of generation assets caused when the market price of electricity is lower than that necessary to recover the
  47. 47. B actual cost of investment plus a reasonable return. Since competition and the market never developed and the utilities set rates based on costs, there are not, and have not been, any stranded costs. 10 See §56-584. 11 State Corporation Commission Report to the Commission on Electric Utility Restructuring of the Virginia General Assembly and the Governor of the Commonwealth of Virginia; Status Report: The Development of a Competitive Retail Market for Electric Generation within the Commonwealth of Virginia, September 1, 2007 (“2007 SCC Report”). At page 35, the report states the following with regard to earnings of Virginia‟s investor-owned electric utilities for the period 2001-2005: Each investor-owned utility operating in Virginia with annual revenues in excess of $1,000,000, is required to make an Annual Informational Filing (“AIF”) with the Commission. The purpose of these filings is to allow the Commission to, among other things, monitor the earnings generated by currently approved tariff rates. One section of the AIF, referred to as the Earnings Test Analysis, assesses current earnings on a regulatory basis by making limited adjustments to the utility‟s financial records. Staff conducts a review of each filing and prepares a report to the Commission stating its findings. The following chart shows the calendar year 2001, 2002, 2003, 2004 and 2005 earnings of each investor-owned electric utility based on Staff‟s review of the earnings test analysis included in each company‟s AIF. The earnings reflect the bundled (generation, transmission and distribution) Virginia jurisdictional return on average common equity adjusted to a regulatory basis. Dominion Virginia Power‟s 2005 return on equity was 6.88%. The return was lowered significantly by the fact that the Company voluntarily agreed to freeze its 2004 fuel factor for future years. Fuel costs increased and profits declined. The fuel clause was reinstated as of July 1, 2007 and excess earnings soared again. See note 8, supra. 12 Report on the Status of Stranded Cost Recoveries by Virginia Incumbent Electric Utilities, 2001-2005 for the Commission on Electric Utility Restructuring of the Virginia General Assembly by Division of Consumer Counsel, Virginia Office of the Attorney General, September 1, 2006, Revised 9/12/06, at 1-2. (“2006 Attorney General Report”).
  48. 48. C 13 SCC Case No. PUE-2009-00019, Testimony of Kimberly B. Pate dated December 8, 2009, at 4-5 and 18. 14 SCC Case No. PUE-2009-00019, Testimony of Kimberly B. Pate dated December 8, 2009, at 18. SCC Staff found that earnings were “approximately $527.7 million higher than necessary to achieve a 10.20% return on average equity, as supported by Staff witness Oliver.” The Commission ultimately found the appropriate equity return to be 11.3%. The SCC Staff advised the Work Group that 100 basis points increase in equity equates to about $40 million after taxes and $65 million of revenue requirement for Dominion Virginia Power. Accordingly, if the excess earnings were based on a return requirement of 11.3% rather than 10.20%, the excess would still be at least $450 million. 15 2007 SCC Report at 35. 16 2006 Attorney General Report at 1-2. 17 EEI Average Overall Rates, 2007, 2008, 2009. 18 EEI Average Overall Rates, 2008, 2009. USA overall average rates increased from $.0977 to $.0983 (0.6%); Virginia‟s overall average rates increased from $.0769 to $.0852 (10.8%); Dominion Virginia Power‟s overall average rates increased from $.0807 to $0868 (7.6%); APCo‟s overall average rates increased from $.0608 to $.0791 (30.1%). 19 EEI Average Residential Rates, 2007, 2008, 2009. 20 EEI Average Residential Rates, 2007, 2009. According to EEI Dominion Virginia Power‟s average residential rate increased from $.0865 in 2007 to $.1075 in 2009, an increase of 24.3%. 21 EEI Average Residential Rates, 2007, 2009. According to EEI, APCo‟s average residential rate increased from $.0484 in 2007 to $.0923 in 2009, an increase of 90.7%. 22 EEI Average Commercial Rates, 2007, 2009. According to EEI, Virginia‟s average commercial rates increased from $.0620 in 2007 to $.0825 in 2009, or 33.1%. APCo‟s commercial rates increased from $.0572 in 2007 to $.0769 in 2009, or 34.4%. Dominion Virginia Power‟s commercial rates increased from $.0626 in 2007 to $.0833 in 2009, or 33.1%. 23 EEI Average Industrial Rates, 2006, 2007. 24 EEI Average Industrial Rates, 2006, 2007. Virginia ranked 7th and 9th least expensive in 2006 and 2007 respectively. Other states ranked as follows for 2006 and 2007 respectively: North Carolina (17th and 16th ), Alabama (13th and 20th ), Mississippi (30th and 27th ), Georgia (22nd and 22nd ), Louisiana (33rd and 31st ), Kentucky (8th and 10th ), South Carolina (9th and 11th ), and Florida (36th and 35th ).
  49. 49. D 25 EEI Average Industrial Rates, 2006, 2007. Tennessee was 3rd least expensive in 2006 and ranked 1st in 2007. West Virginia ranked 2nd and 3rd respectively in 2006 and 2007. 26 EEI Average Industrial Rates, 2008, 2009. 27 EEI Average Industrial Rates, 2009. 28 EEI Average Industrial Rates, 2005. APCo‟s rate was $.0340. 29 EEI Average Industrial Rates, 2008. Wyoming‟s rate was $.0455 and APCo‟s was $.0460. 30 EEI Average Industrial Rates, 2009. Arkansas‟s rate was $.0617 and APCo‟s was $.0622. 31 EEI Average Industrial Rates, 2007, 2009. According to EEI, APCo‟s average industrial rate increased from $.0435 in 2007 to $.0622 in 2009, an increase of 43%. 32 EEI Average Industrial Rates 2007, 2008, 2009. Dominion Virginia Power‟s industrial rates increased from $.0484 in 2007 to $.0672 in 2009, or 38.8%. The national average industrial rate in 2009 was $.0663. 33 Generally, unless otherwise provided by statute, the utility is not required to prove affirmatively its utility expenses are prudent unless they involve affiliates; such non- affiliate expenses are presumed prudent unless there is a contrary showing. 34 §56-585.1A2. 35 SCC Case Number: PUE-2009-00030 , Final Order, p10. The News and Advance. “Lawmakers examine utility rate regulations.” April 21, 2010. 36 §56-585.1A2c. 37 §56-585.1A5e. 38 §56-585.1A5c. 39 §56-585.1A2. 40 §56-585.1A8(i). 41 §56-585.1B. 42 §56-585.1A8(ii). 43 The utility is allowed to keep the first 50 basis point excess, about $32.5 million for VEPCO, and credit 60% of the remainder to customers and retain the rest, about $27 million for VEPCo.
  50. 50. E 44 §56-585.1A8(iii) and 9. 45 §56-585.1. 46 EEI Average Residential Rates, 2007, 2008, 2009. 47 EEI Average Commercial Rates, 2007, 2009. According to EEI, Virginia‟s average commercial rates increased from $.0620 in 2007 to $.0825 in 2009, or 33.1%. APCo‟s commercial rates increased from $.0572 in 2007 to $.0769 in 2009, or 34.4%. Dominion Virginia Power‟s commercial rates increased from $.0626 in 2007 to $.0833 in 2009, or 33.1%. 48 EEI Average Industrial Rates, 2008, 2009. 49 EEI Average Industrial Rates, 2009. 50 EEI Average Overall Rates, 2007, 2008, 2009. 51 EEI Average Overall Rates, 2008, 2009. USA overall average rates increased from $.0977 to $.0983 (0.6%); Virginia‟s overall average rates increased from $.0769 to $.0852 (10.8%); Dominion Virginia Power‟s overall average rates increased from $.0807 to $0868 (7.6%); APCo‟s overall average rates increased from $.0608 to $.0791 (30.1%). 52 The utility is allowed to keep the first 50 basis point excess, about $32.5 million for VEPCO, and credit 60% of the remainder to customers and retain the rest, about $27 million for VEPCo 53 Unless the investments involve an affiliate or the statutes require otherwise, investments by utilities are generally presumed to be reasonably made unless the contrary is shown. Moreover, the issue probably will not be “prudence” but a matter of judgment, making the “incentive” more important.

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