by Paula C. Squires

Early this summer, Dominion Virginia Power took a controversial step. Until that point, the state’s largest utility company had chosen public forums to push its unwavering support for electricity deregulation that starts in January. Dominion’s public relations strategy had been to play public advocate so it could gain vast new business opportunities with consumers’ approval. Before it can position itself for those benefits in a new competitive market, however, it must separate its $6.7 billion in power plant assets from regulated distribution and transmission units.

Yet Dominion wants to go a step further than just a simple business separation. Following the lead of utilities in other states who are scrambling to get ready for deregulation, Dominion wants to transfer its power plants to a new, legally separate subsidiary of its parent company. Doing so would mean that power sales from its generating plants would switch from state to federal oversight. Taking such a step would gain Wall Street favor and save millions by streamlining Dominion’s electricity trading operations.

But the utility’s plans hit a snag. It needs support from industry and consumer groups in its bid to win formal approval from the State Corporation Commission. After negotiating with the groups for months, no consensus emerged. So, the utility asked the SCC for a closed-door meeting with all the parties to help move the stalled discussions along — a bold maneuver that jolted consumer groups and the media. Media General Inc., which publishes this magazine and the Richmond Times-Dispatch, formally petitioned the SCC to keep the meeting open. "This is a remarkably important issue," said John W. Montgomery Jr., a lawyer for the Virginia Citizens Consumer Council. "Once legal separation occurs, you can’t unring the bell. There’s a lot at stake, and that’s all the more reason for it to be open and above reproach."

Under such strong pressure, on July 16, Dominion withdrew its request for a closed-door meeting, although it remains hopeful that an open meeting with commissioners might still be held if needed. The brouhaha underscores the anxiety that’s building as Virginians prepare for deregulation on Jan.1. If Dominion’s plan for a legal separation is approved, the Federal Energy Regulatory Commission, rather than the SCC, would regulate a contract between the new entity, Dominion Generation, and Dominion Virginia Power to supply 2 million Virginia customers with power. Opponents wonder if the SCC will be able to enforce such important consumer protections as default pricing — making sure that consumers can go back to their original utility if they have a bad experience — and capped rates in effect until 2007. Urchie B. Ellis, a civic activist and retired corporate lawyer, wrote the SCC, saying, "How will the general public be protected against increases in rates? There is an acute need to preserve the maximum SCC authority ..."

Utility officials counter that their plan will make Dominion’s operations more efficient. Arranging power plants under a legally separate entity will allow better management, thus preventing much of what consumer groups fear. "We’ll be able to consolidate all of our assets into one entity and to trade as one entity which will put us in a much stronger position to meet these requirements," explains E. Paul Hilton, a senior vice president for Dominion Virginia Power.

Meanwhile, to operate in a deregulated world, Dominion will need to constantly buy and sell great amounts of electricity from wholesale markets. The most efficient way to do that would be to operate one massive trading operation that represents all Dominion Resources Inc.’s generation assets. But that’s not an option unless Dominion Virginia Power’s generation assets are moved into the new entity. Otherwise, FERC would require two trading floors, one for Dominion Virginia Power and another for its parent company causing a loss of $6.4 million a year in cost savings from operating one floor.

If its plan goes through, Dominion has much to gain. On Wall Street, financial markets react positively to power companies with integrated power assets, according to Jonathan E. Baliff, a vice president with Credit Suisse First Boston in New York, who testified to the SCC on behalf of Dominion Virginia Power’s plan. "Legal separation is becoming the standard process investor-owned utility companies use to realign their liabilities as choice is phased in," he said. It provides a framework for what can be better credit ratings, because companies no longer have to overcome the financial and operational disadvantages inherent in operating two separate generation businesses.

There could be other benefits down the road, as well. "Some people are taking it to the next step of having two different publicly traded stocks," says Mike Beall, an energy analyst for Davenport & Co. in Richmond. "A generation company can be attractive to a different group of investors than a distribution company." Southern Co. in Alabama and Constellation Energy, parent company of Baltimore Gas and Electric, took this route following legal separation, he adds.

But as utilities scramble to protect their economic viability, states are wary about giving up control over the power sales of their plants. California required divestiture of its plants, a move that critics say contributed to the state’s energy crunch which brought brownouts and huge price spikes. "It’s one of the issues states are wrestling with. You’ve got a real tension there," says Charles Gray, executive director of the National Association of Regulatory Utility Commissioners. (Map of deregulation status across the U.S.)

Of particular concern to the Virginia Attorney General’s office is the effect the plan might have on so-called default service. It will be offered to people who choose not to shop for an alternative supplier, can’t get service from anyone other than their incumbent utility or who contract for service from a supplier who fails to perform. "This provides protection against California-type runaway pricing in the event there are not enough generators in the market to effectively regulate the price for energy," says Randy Davis, director of communications for the Attorney General’s office.

The SCC is charged with attempting to identify default service providers through competitive bidding. However, if bids don’t produce suitable providers, Dominion Virginia Power and the state’s second largest utility, AEP-Virginia, must be prepared to serve as the default service provider in their service territories through 2007 or longer if competitive markets don’t develop. Rates remain capped through the transition period for those who remain with the incumbent utility and after that will be based on competitive regional electricity markets.

For lawyers at Dominion Virginia Power, who are busy negotiating with 17 interested parties, mapping out the utility’s future presents nettlesome contradictions. They have to prepare Dominion so it can operate in a competitive market while also meeting requirements in Virginia’s restructuring law to protect the public interest. Under the utility’s proposed legal separation, Dominion Generation would sell Dominion Virginia Power electricity through a power

purchase agreement. "We need to show them that when we transfer the assets and put the power purchase agreement in place that customers in Virginia will have the equivalent of what they would have had before the transfer (of the assets)," says Dominion lawyer Edward L. Flippen.

To reassure consumer and industry groups that they are playing above board, Dominion is willing to file the agreement with FERC to gain its approval before the SCC’s public hearing on functional separation in October. The company doesn’t anticipate problems with federal regulators altering the contract. "We can’t give a 100 percent guarantee that FERC won’t change the contract at some point in the future," Flippen says, "and that’s what the Attorney General’s office and others have been concerned about." Even if FERC approves the contract, the SCC still has the final say on the separation. Another safeguard: Dominion Generation can’t sell any of its power plants without SCC approval while price caps are in effect or as long as Dominion Virginia Power is a default provider.

Yet some on the SCC staff find Dominion’s ploy nerve-wracking. They worry that Virginia’s consumer protections would rest solely on a contract between the utility and Dominion Generation. Legal contracts are broken all the time. Ken Schrad, the agency’s director of information resources, says the staff is also concerned about dwindling reserve margins. In Dominion Virginia Power’s application for the separation, it says a target reserve margin of 12.5 percent — down from around 20 percent in the 1980s — will probably diminish as regional generation supply markets mature. "The focus of the SCC is to keep the lights on," says Schrad. That won’t be a problem according to Thomas E. Capps, president and CEO of Dominion Resources. "The first rule is don’t run out of power. No blackouts. We’re going to have enough power," he says.

The SCC could opt to approve only a divisional, rather than a legal separation of the company’s power assets. That would keep state regulators in charge of consumer pricing protections, because without the new legal entity, there would be no need for a purchase agreement, since the utility then would only be selling power back to its distribution unit, which is not a wholesale power transaction requiring federal oversight.

Dominion remains confident about moving the discussion beyond the current bottleneck. What is clear under the law is that the SCC must decide on separating the company’s business functions by Jan. 1, 2002. If things aren’t worked out, the decision could go down to the count and some of Dominion’s plans would be derailed.

Return to Virginia Business - August 2001