1/7/2011

INVESTOR OWNED

ELECTRIC UTILITY

REGULATION IN VIRGINIA

Findings & Recommendations of the Electric Utility

Regulatory Work Group

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

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.

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.

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

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

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

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

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.

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.

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.

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.

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.

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.

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

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.

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

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.

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.

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.

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

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.

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

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

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

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.

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

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

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

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:

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.

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

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.

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

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.

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.

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.

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.

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.

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

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.

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

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

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

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.”

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

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”).

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 7

th and 9

th 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 (8

th and 10

th),

South Carolina (9th

and 11th

), and Florida (36th

and 35th

).

D

25 EEI Average Industrial Rates, 2006, 2007. Tennessee was 3

rd least expensive in 2006

and ranked 1st in 2007. West Virginia ranked 2

nd and 3

rd 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.

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.