Frank Sharry occasionally plays the state lottery, but has yet to hit the winning numbers. So he was surprised when his employer, Lafarge Calcium Aluminates Inc., won a lottery last summer. The maker of specialty cements was one of four companies picked out of a pool of more than 100 large industrials in Virginia that jumped at the chance to try an electric choice pilot run by Dominion Virginia Power. After hearing the news, Sharry couldn’t resist teasing his wife that he’d won big. "We won the lottery," he announced. Show me the money, she responded, calling his bluff. In any event, "We were the first name out of the hat," recalls Sharry.

Sharry has good reason to be happy. As purchasing manager for electricity-gob-

bling Lafarge, he sees a jackpot in Virginia’s emerging market of deregulated electric supply. As part of the pilot, Lafarge buys electricity for the first time from a competitive supplier and at a lower rate than it pays Dominion Virginia Power. The result? A savings surge on its electric bill. Lafarge, which manufactures 100,000 tons a year of specialty cement powders at its Chesapeake plant, uses a whopping 1.5 million kilowatt hours of electricity per month. "The power bill is one of our highest costs. Our fuel bill in a year is $600,000 just for electricity. Under the new program, we should save $30,000 to $35,000."

Can the magic of the market provide cheaper electricity? That’s the hope behind a national shift to deregulate electric generation, a move backed strongly by large industrial and commercial users. Since 1996, 24 states and the District of Columbia have passed laws allowing retail competition while delivery remains under regulatory protection. In Virginia, where the General Assembly enacted electric restructuring 18 months ago, customer choices in power supply will phase in starting in January 2002. Legislators capped electricity rates until the middle of 2007, giving markets in Virginia five years to transition from a regulated to a retail market.

In theory, deregulation sounds great. It promises lower prices, innovation, new products and services from companies no longer constrained by regulatory ropes. Yet consumer groups wonder if residential customers will really benefit. Will competitive suppliers be interested in serving the little guy in rural areas or will marketing efforts be directed only toward heavy industrial users?

Indeed, deregulation got a black eye this past summer when electricity prices spiraled out of control in San Diego, the first place in the country where rates were subject to market prices following the removal of rate caps. Last month, California made headlines again when it ordered hundreds of companies to cut back on electricity due to low supplies. Two of the country’s most influential consumer advocacy organizations have come out with a report panning the effectiveness of restructured electricity markets. The Consumer Federation of America and Consumers Union, publisher of Consumer Reports magazine, claimed that supply and demand conditions make the industry too volatile to function effectively, thus destroying any promised consumer benefits. The groups’ advice to states regarding deregulation: Don’t do it.

Mindful of such concerns, Virginia’s General Assembly is expected to tweak the state’s electric restructuring law during the current legislative session. One of the most controversial issues involves default service, a key consumer protection. Currently, the State Corporation Commission is split on how to set rates after 2007 for Virginians who choose not to shop, are unable to get service from anyone other than their incumbent electric utility or who contract for service from a supplier who fails to perform. The restructuring law requires that these customers have access to reliable electric service, which incumbent electric utilities must provide during the transition phase.

After 2007, though, it isn’t clear who will provide default service and if rates will continue to be protected or set by the market. "Companies can ask for default rates to be discontinued as early as 2004. We could end up with no traditional rate protections for customers using default service," observes Jean Ann Fox, director of consumer protection for the Consumer Federation of America and one of Virginia’s most vocal consumer advocates. The debate is also crucial for utilities. How much generation they can sell in unregulated markets is directly affected by the amount of generation required for default customers.

While Virginia continues its debate, regulatory barriers continue to fall in other states. Indeed, this move to deregulate power has touched off the largest scramble ever by the usually stodgy, monopolistic industry. Across America, utilities are rewiring themselves. They’re building power plants, diversifying operations and boosting growth through mergers and acquisitions. All in all, the merger frenzy could see $210 billion change hands, or double the amount of money transferred when the telephone industry deregulated two decades ago.

Virginia is not being left out. Dominion Resources, parent company of Virginia’s largest electric utility, recently merged with Consolidated Natural Gas of Pittsburgh, forming a $25 billion energy powerhouse, serving 4 million customers, including 1.9 million in Virginia. The state’s second largest utility, American Electric Power Co., with 480,000 Virginia customers, closed a deal last summer with Central and South West Corp. of Dallas creating a $12.5 billion company with generation, trading and distribution assets.

As utilities boot up for a new game, deregulation is sparking interest from investors and analysts alike who are including utilities on lists of strong buys. Andrew Levi, a utility analyst with Credit Suisse First Boston in New York, puts Dominion in the company of Enron, Reliant Energy and other large, utilities he refers to as "new economy electrics." They’re expected to emerge as industry leaders with added products and services, growth rates of between 12 to 14 percent a year and above-average earnings. "One of the reasons we like Dominion is because of the legislative deal that was struck," he says, referring to Virginia’s restructuring legislation. "It leaves the company alone. There are no caps on their returns, so they can run it more like a business, instead of a utility."

Will the road to deregulation result in record high prices for Virginians? State officials say no. Ken Schrad, director of information resources for Virginia’s State Corpora-tion Commission, blames California’s spiraling prices on early removal of rate caps, a lack of generation to meet growing demand and California’s unique structure for buying and selling electricity—a state middleman known as the power exchange. "No one could enter into long-term contracts," Schrad says.

A similar predicament seems unlikely in Virginia, says Senior Assistant Attorney General John F. Dudley. Capped rates over five years, the absence of a state power exchange and plenty of new generation should ensure a smooth flow to retail competition. About a dozen new plants, capable of generating 7,000 megawatts or enough to power 4 million homes, are on the books. They’re proposed by in-state companies, including Old Dominion Electric Coopera-tive, and out-of-state companies.

With restructuring, however, companies aren’t required to follow through on building plans, nor, if plants are built, must they sell the generated electricity to Virginians. They can serve customers anywhere, provided there are lines to transmit the power. Educating consumers on how to shop for an electric supplier will be the main focus of a $30 million, tax-financed, state consumer education campaign. By 2002, the state will roll out advertising, a hotline and Web site.

Another way Virginia is trying to prevent static is through state-ordered, pilot choice programs that allow utilities to test-drive operations before the advent of statewide choice. Besides Dominion Virginia Power, AEP and Rappahannock Electric Cooperative offer pilots to a limited number of residential and business customers. Dominion reassigned 130 staff members to run its pilot which has enrolled 38,000 residential volunteers in the central part of the state and 30,680 in Northern Virginia.

Gearing up for deregulation means big changes in how utilities operate. David F. Koogler, manager for Dominion’s Project Current Choice, says it affects everything from daily business operations to consumer initiatives. He says his group keeps track of enrollment, billing, collection, even forecasting customer loads for competing suppliers.

While many residential customers enroll, not all switch. Greg Carr of Chesterfield County received two offers. One offered only short-term savings, much like a credit card introductory rate, so he signed off on a plan from Dominion Retail of Pittsburgh, a subsidiary of Richmond-based Dominion. It offers a rate of 4.5 cents per kilowatt-hour compared to the 5.7 cents he pays now. His new rate doesn’t kick in until this month, so Carr is reluctant to say how much he will save on monthly electric bills for his five-bedroom home "My philosophy generally is that competition is good. I look at the long-distance phone industry and what happened there. That has been good for me personally."

So far, ten suppliers have gained state licenses to sell electricity competitively in Virginia. Yet not one supplier has taken on AEP in the Southwest part of the state. With

easy access to low-cost, coal-fired plants, AEP’s rate to residential customers is 3.7 cents per kilowatt hour, far below the national average of 8.1 cents, and a tough rate to beat. So far, AEP hasn’t raided Dominion’s territory with low-price offers. However, a subsidiary sent out an offer in central Virginia for "green power," electricity produced from a renewable source, for a rate of 5.3 cents per kilowatt hour, slightly above Dominion’s average customer price of 5.1 cents.

If competitors don’t enter some markets, how can customers be assured of choice? And won’t consolidation of the electric industry through mergers and acquisitions lead to fewer competitors or domination by unregulated monopolies? John Shepelwich, AEP’s manager of state corporate communications, agrees that restructuring brings risk. "If you’re not in a good market and you’re not a good customer, you may not get a good offer."

Overall, Schrad says, "The risk is that you relax regulatory oversight, yet you don’t know if a market is going to develop that keeps rates at the traditional prices, below the national standard, that Virginians are used to. The good thing is the General Assembly will continue to monitor this situation and has six legislative sessions to do something else if the competitive environment doesn’t work out as anticipated."