Return to Virginia Business - August 2004

Electric Deregulation
Virginia stays the course, extending rate caps to give competitive market more time to mature. For businesses, keeping power affordable and reliable is key.

by Jim Strader and Paula C. Squires
Virginia Business
August 2004

Five years after Virginia joined other states in the shift to deregulate electricity, the effort had all but sputtered by early 2004. No competitive suppliers had come in with offers that would beat Virginia’s already low electricity prices. Fresh in many people’s mind was a massive blackout the previous summer, which highlighted weaknesses in the country’s transmission grid. While Virginia wasn’t affected, many residents here did get a taste of the challenges of being without juice when Hurricane Isabel rampaged through the state last September, knocking out power lines that took days and sometimes weeks to repair.

The blackout and hurricane reminded everyone how essential electricity is to modern life and business. By the time the General Assembly convened in January a continuing lack of competition had some former proponents of deregulation telling lawmakers to suspend parts of the law, including retail choice.

“The promised benefits of electricity deregulation have failed to materialize,” declared full-page ads taken out by the Consumer Coalition, a group backed by retailers, consumer groups, the state’s electric co-ops and some of Virginia’s largest industrial users of electricity. “…Capped rates have cost consumers hundreds of millions of dollars.”

Yet intense lobbying by Dominion Virginia Power to extend capped electricity rates carried the day. Despite the revolt by some businesses, the General Assembly amended the restructuring law, extending capped rates for three and a half more years—from mid-2007 through the end of 2010 — to give the competitive power market more time to develop. Without the extension, Virginians might have faced a daunting scenario: a market of unregulated monopolies, which is why the caps were proposed by the attorney general and governor’s offices and approved by wide margins.

The amendment brought other changes to stimulate competition. Chief among them: an end to charges for customers who switch suppliers and a freeze on the fuel rate charged by Richmond-based Dominion Virginia Power, the state’s largest utility. The rate will stay at its current level until 2007, after which it can be adjusted only once during the life of the rate caps. “This is a very significant part of advancing deregulation,” says Thomas F. Farrell II, president and COO of Dominion, the utility’s parent company. “It’s hard for suppliers to get a fix on what their price to beat is going to be” if fuel costs continue to be variable. Removing fluctuations helps level the competitive field.

The assembly’s action sets up the next few years as make-or-break time for Virginia’s experiment with electric deregulation. In a sense, the state is moving into a period much like the eye of a hurricane. There’s an uncertainty about how events will play out, but also an expectation that some big jolt might come. Will the latest legislative tweaking create enough of a surge to fulfill the promise of a free energy market? Or three years down the road will Virginia decide, as some states already have, to pull the plug on electric deregulation?
Virginia businesses are keeping a close watch on the next wave of activity. “The fighting’s done and now we have to work together,” says Brett Vassey, president and CEO of the Virginia Manufacturer’s Association, which represents some of the state’s largest commercial users of electricity. For manufacturers, affordability and reliability are key concerns. “Our survival depends on those variables being predictable,” says Vassey, particularly at a time when electricity costs are way up for some manufacturers due to increased automation. Last summer’s sudden blackout in Ohio, he adds, cost manufacturers there $1 billion.

Opinions vary within the association on whether capping base rates—the costs of power excluding fuel — will provide the lowest costs while the competitive market matures. Vassey says some manufacturers preferred a bill backed by the Consumer Coalition that would have restored authority to Virginia’s State Corporation Commission to set retail electric rates. “Some members just feel that they can’t predict the future with a market-based rate. They can with a cost-of-service [regulatory] rate.”

One attorney, who represents major industrial users of power, says that in the beginning customers of Dominion Virginia Power backed the development of competition. But some businesses are disappointed in restructuring so far, says Edward Petrini. ”Restructuring has failed to produce savings. Our clients remain concerned about the prospect of paying excessive rates in the future.”

Farrell, viewed as a possible successor to Dominion’s current CEO Thomas E. Capps, was one of the most visible proponents for capped rates, selling the measure to legislators as a way to protect customers and save them money. A study commissioned by Dominion Virginia Power claims that extending rate caps will save as much as $1.8 billion for residential customers during the capped rate period of 1998-2010, with $700 million coming during the three-year extension.
However, critics note that the extension also helps Dominion’s bottom line, with executives expecting increased profits of between 5 to 7 percent a year through 2010. One report by the Wall Street firm of Morgan Stanley says capped rates will add nearly $500 million to the value of Dominion. An SCC study pointed out that in 2002, the utility earned $680 million more under rate caps than it would have under the old system of cost-of-service regulation.

At Dominion, executives are encouraged by the assembly’s action. “I think we’re getting the pieces in place,” says Farrell. “The whole process was supposed to be deliberative. I think there will be more competition.” Company officials say capped rates — set at 1993 levels — are a good deal for customers. And as for Dominion profiting from the move to deregulation, executives point out that the company has already spent hundreds of millions preparing for a market-based system of supply. There’s the new $17.5 million energy clearinghouse on the banks of the James in downtown Richmond across from the company’s corporate headquarters not to mention the money Dominion spends annually lobbying the General Assembly. In 2003, Dominion’s political action group spent more than $200,000 lobbying on various issues including electric deregulation.

With capped rates shifting the risk to the company’s shareholders, Farrell says Dominion will have to cover more than $2 billion in additional costs and investments during the rate caps with no opportunity to recoup the money through higher customer rates. Even so, critics note that in December, the SCC granted Dominion Virginia Power a $386 million rate settlement to cover its fuel costs over the next three years. And to bring American Electric Power-Virginia on board with extended rate caps — the state’s second largest-utility had originally sided with the coalition in rolling back retail choice — the assembly is requiring the SCC to let AEP recover its environmental and reliability costs as it prepares for deregulation.

Deregulation has enjoyed some success in other states, and Dominion seems confident that its investments will pay off. “Consumers do benefit,” says David F. Koogler, director of regulation and competition at Dominion Virginia Power. “What they’ve seen in Ohio with natural gas is that instead of a fuel factor that changes every quarter, causing bills to jump up and down, a competitor will come in and offer them a two-year contract, and they love that certainty. We’ll see the same thing here, hopefully.”

Another possible area for growth, he adds, could come from the expanded ability of municipalities to form buying groups (aggregations) to purchase electricity for their residents and to make a profit from such aggregation, another development made possible with the new legislation. In Ohio, most of the 1 million customers who have switched are aggregation customers. A free market also would give retailers with multiple locations the opportunity to buy power from a single source at a possibly lower price.

While Dominion paints an optimistic picture for the future, other industry watchers are more skeptical. About a dozen competitive suppliers are licensed to market electricity to Virginia customers. But for now they are “sitting on their licenses,” says Ken Schrad, a spokesman for the SCC, and renewing them in case the market takes off. “No one is making any offers of any electricity in Virginia.” Still, there’s interest. Nearly 90,000 residential and small business customers have signed up to participate in a pilot program to shop from competitive suppliers. About 2,000 industrial customers recently vied for 200 slots in another pilot. Yet, Schrad asks, “Where’s the shopping? There wasn’t any a year ago; there isn’t any today. Deregulation was sold as better price, better price, better price. That isn’t what’s happening.”

As the state’s traditional utility regulator, the SCC is charged with overseeing the transition to deregulation. It issues an annual report to a General Assembly task force on the status of retail choice. The 2004 report is due out next month, but Schrad doesn’t expect any major changes since last year. “We’re still in sort of a holding pattern in Virginia, for a variety of reasons. The primary thing is that because of our rate caps, which are really rate freezes, the price of electricity is lower than the wholesale price. It’s almost impossible for anyone to come into Virginia and beat the frozen capped rate prices. … There’s just not any incentive for them to come in.” Until new companies come, the state’s customers will continue to be supplied by Dominion Virginia Power, which has about 2 million customers; AEP -Virginia, 500,000 customers; Allegheny Power, Conectiv and a dozen electric cooperatives.

In the 2003 report, the SCC recommended that the assembly suspend the act, rebundle retail electric rates and continue a moratorium on transfers of control of Virginia’s transmission systems to federally regulated RTOs (regional transmission organizations). Virginia isn’t alone in having doubts about the wisdom of deregulation. It is among only 17 states that have active utility restructuring programs under way. Five states have delayed their plans, and California suspended restructuring three years ago following a crisis that sparked brownouts and skyrocketing prices.

The SCC’s reticence over relinquishing control over the state’s power supply is sure to be the subject of debate as Dominion and Columbus-based AEP prepare to join an RTO this fall. This step is considered crucial in laying the groundwork for competition, because RTOs provide a larger pool of power with access granted to all competitive suppliers. They also allow customers to pay a single cost for power transmission, rather than accumulated fees as power moves across borders. Both utilities plan to join PJM Interconnection, a regional electric transmission system operator that serves a population of more than 35 million people in all or parts of Delaware, Illinois, Maryland, New Jersey, Ohio, Pennsylvania, Virginia, West Virginia and the District of Columbia.

Virginia’s restructuring law requires membership in an RTO, and it’s also a requirement of the Federal Energy Regulatory Commission (FERC). Originally, Virginia utilities were supposed to join an RTO by Jan. 1, 2001. However, fears over the state’s ability to ensure that consumers get reliable service at reasonable rates once control over its power supply is turned over to FERC-controlled RTOs prompted Virginia to delay the date to Jan. 1, 2005.

The delay, says Farrell, has impeded competition. “The biggest reason why we haven’t had progress is because we aren’t in PJM,” he says. Dominion has filed for PJM membership in applications with both the SCC and FERC. Action is expected this fall. Federal regulators approved AEP’s application for membership in June, clearing the way for the company to join the transmission group in October. AEP Virginia, which serves the Southwestern part of the state and offers rates as low as three cents per kilowatt hour —thanks to its relatively inexpensive coal-fired plants—initially sought to join a different RTO, known as Alliance, says Dan Carson, AEP-Virginia’s president. That effort was turned down by FERC, forcing the company to revise its plans and apply to PJM. “We had worked for a long period of time to meet the requirements of the law to join an RTO, only to have that process interrupted,” Carson says. With the approval of its PJM membership, “things have worked out relatively well.” Dominion had also originally planned to join Alliance.

FERC’S decision to allow AEP to join the PJM transmission organization came over objections raised by Virginia officials. In its ruling, FERC said utilities could be exempted from state laws and regulations that prevent them from taking steps to improve competitive conditions. Schrad questions whether the decision is a sign that Virginia is “slowly losing its authority to federal regulators,” putting at risk its long history of overseeing utilities for the good of Virginians. The FERC ruling, Schrad adds, indicates that the federal agency feels that the greater reach of a regional power group and the “broader good” of facilitating its competitive operation outweigh the interests of any individual state.

One issue with Dominion’s PJM application has already prompted public criticism. The utility has asked FERC for permission to begin tracking the costs of joining an RTO with the thought of recovering those costs later by passing them along to customers in the form of transmission tariffs. The costs are estimated to be about $280 million. “We certainly believe these costs were not part of the original language … of the legislation,” says Dominion spokesman Jim Norvelle. State lawmakers, regulators and customers have spoken out against the idea, saying it violates the intent of the 1999 electric restructuring law. Yet Dominion points out that the benefits of joining PJM would flow to customers in the form of reliability and lower bills. PJM coordinates a pooled generating capacity of more than 106,000 megawatts and operates the country’s largest wholesale electricity market.

Some people wonder if joining a regional RTO is a good deal. Why should Virginia send its low-cost electricity out of state and will such a move mean higher prices? Koogler says the opposite is true. The importing of cheap, coal-generated power would lower prices. “We’ll be able to bring in lower-cost power from the Midwest — buckets of it,” he says. In general the idea of RTOs appeals to large industrial customers, because they allow access to a wider electricity pool.
The importance of transmission reliability jumped to the front pages after the blackout last August left millions of people in the dark in eight states and two countries, including the U. S. and Canada. One concern raised at that time is that the country’s aging transmission grid isn’t equipped to handle the increased wholesale trade of electricity prompted by deregulation. PJM plans $700 million dollars worth of transmission upgrades.

With so many complex issues, the slowness in developing a robust power supply market comes as no surprise to Koogler. “We essentially were trying to open a retail market without a wholesale market to support it and that’s tough. That’s about impossible to do,” he says. Besides, there’s recognition that an industry that’s been heavily regulated for decades can’t be transformed overnight. “You can’t expect competition to come in over night in just a matter of a year or two. It’s going to take some time. We’ve got another three and a half years.”

Return to Virginia Business - August 2004