Virginia’s biggest power company could benefit from the freeze in electric rates but it also could take a big hit to earnings from power-plant shutdowns.
by James A. Bacon
One of the biggest stories of the 2015 General Assembly session was lawmakers’ efforts to prepare the state for the oncoming Environmental Protection Agency regulations that will compel Virginia utilities to reduce carbon dioxide emissions 38% from 2005 levels by 2030. Virginia political reporters, as is their wont, covered the debate as a political story, with an emphasis on Dominion Virginia Power’s role in shaping the final legislation. That coverage left me deeply dissatisfied, as I wrote last month in “Does Anyone Really Understand This Dominion Deal?” The argument I advanced then was that no one understood the deal. Legislators were buying a pig in a poke.
The overriding question was, and still is: Who will pay for the restructuring of Virginia’s electric power industry in order to meet EPA mandates? Dominion and the State Corporation Commission contend that write-offs on four coal-fired power plants could go as high as $2.1 billion while ratepayers could be stuck with $5.5 billion to $6 billion to replace the lost capacity with new electric generating facilities — as much as $8 billion all told. Environmental groups argue that energy-efficiency measures could reduce the impact on customers significantly. Still, that’s a lot of pain to spread around. Who will get stuck with the bill — Virginia’s electric utilities, ratepayers or someone else?
I have spent the better part of the past week reading documents, conducting interviews and checking facts. I don’t pretend to have definitive answers. Indeed, there may be no definitive answers. Every time I peeled away one layer of the onion, I reached another layer that raised more questions. But I do think I can clarify the issues and get us closer to the answers. In this blog post I will address how General Assembly legislation impacts Dominion, which supplies 80% of the electric power consumed in Virginia. In the next I will explain how the law affects rate payers.
First, some background…
Last year the EPA issued rules designed to reduce carbon-dioxide emissions implicated in global warming. Given the way the rules were formulated, Virginia will be required to make especially onerous cuts. In October 2014 the State Corporation Commission (SCC) staff weighed in with a letter contending that the proposed regulation would raise electric rates and jeopardize the reliability of Virginia’s electric grid. In November the McAuliffe administration, which supports the CO2-reduction initiative in principle, followed with a letter suggesting how the proposed guidelines could be made more equitable to Virginia.
Last fall legislators, too, were concerned what impact the EPA regulations would have on Virginia rate payers. The SCC estimated that shuttering four of Dominion’s five coal plants would result in a 22% increase to electric rates. In response, Sen. Frank Wagner, R-Virginia Beach filed Senate Bill 1349, which he characterized as a “place holding bill” to jump-start discussion of how to deal with the challenge.
An early version of the bill was “very hostile” to the EPA’s Clean Power Plan, says Cale Jaffe, attorney with the Southern Environmental Law Center. By the time the bill reached the governor’s desk, however, language that would have made it difficult to shut down the coal plants was stripped out and provisions were inserted to encourage investments in solar energy and energy efficiency. The capital press corps interpreted the legislative drama as a display of Dominion’s political muscle, making frequent mention of its outsized political contributions to legislators and its veritable army of lobbyists and PR staff.
Was the final legislative package, in fact, a giveaway to Dominion? Let’s start with a summary of the main features of the legislation. The new law:
- Freezes base rates and exempts Dominion from biennial rate reviews for five years. The next rate review will be in 2022.
- Requires the utility, not customers, to bear the risk of power plant closures due to federal carbon regulations over the next five years.
- Requires the utility to forgo collecting $85 million in fuel costs from 2014.
- Accelerates a reduction in fuel-cost cuts by 30 days.
- Requires the utility, not customers, to bear the risk of all weather events and natural disasters over the next five years.
- Establishes a pilot energy assistance program for low-income, elderly, and disabled customers.
- Declares up to 500 MW of utility-scale solar capacity to be in the public interest.
- Affirms the SCC’s ability to audit Dominion’s books at any time and requires SCC approval before any power plant can be permanently retired.
Now the gory details…
Base-rate freeze. Legislators and Dominion justify the five-year freeze on base rates, which comprise roughly half of the total electric bill, as a way to provide a measure of certainty to both Dominion and consumers as the EPA regs work their way through the system. According to the Virginia Committee for Fair Utility Rates, a group of large industrial customers, this measure would fix Dominion’s base rates at a level deemed by the SCC in the last biennial review as likely to be excessive by $280 million a year. The freeze, critics say, allows Dominion to continue pocketing those excess earnings.
Dominion takes issue with the $280 million excess-earnings figure. That number does not include one-time costs like employee severance, unplanned environmental costs, storm costs and power plant impairments, which added up to $600 million in 2011 and 2012, according to David Botkins, Dominion media relations director. The excess-earnings forecast is meaningless, he says: There are always one-time expenses that must get factored in. Natural disasters like hurricanes, tornadoes and ice storms are recurring events. Dominion will continue to be affected by new rules emanating from the EPA. The $280 million number, says Tom Wohlfarth, senior vice president of regulation for Dominion Resources, “is a “picture-perfect” forecast of earnings that does not take into account “stuff that happens.”
It’s important to remember that base rates reflect only ongoing operational costs. The freeze will not affect fuel cost adjustments, which will continue to nudge electric bills up and down as the cost of purchasing fuel fluctuates, and it will not affect rate adjustment clauses (also called riders), which pass through the cost of building new power facilities and other capital expenditures such as hardening the grid to rate payers. The estimated $5.5 billion to $6 billion capital cost of replacing coal-fired power plants with renewables, nuclear or gas under the Clean Power Plan will be borne by consumers, not Dominion.
Bearing the risk of plant closures. Dominion will assume the risk of plant closures for five years, a huge potential liability that would be passed onto ratepayers in the absence of this legislation. On paper this could be a significant sum — the company would have to write off about $2.1 billion if the plants were forced to shut down tomorrow. This would be a direct hit to Dominion’s bottom line. But there are offsetting factors.
Coal-fired power plant assets (excluding the Virginia City Hybrid Energy Center) will depreciate at the rate of $80 million to $100 million yearly, according to Wohlfarth. If the shutdown of the power plants can be delayed until the expiration of the five-year rate freeze, the liability to Dominion will decline to $1.6 billion. “The longer you can delay having to shut down the coal plants, the more value you get out of those plants,” he says. If the shutdowns were delayed beyond the five-year freeze, the liability would be shifted back to the ratepayers. That doesn’t mean Dominion would suddenly give up the fight to keep the plants open, he hastens to add. The utility would gain nothing from losing the capacity; conversely, if rates go up, it would risk losing large industrial customers to competition.
What are the odds that Dominion can delay the coal plant closings? The EPA regulations are not set in stone. Strong pushback from the McAuliffe administration and the SCC might persuade the environmental agency to reduce the CO2 reductions imposed on Virginia, which might mean closing fewer coal plants. And there is always the prospect of litigation — from other states, if not Virginia. Says Sen. Wagner: “The Supreme Court will ultimately decide what the states have to comply with.”
Says Wohlfarth: “It’s not a foregone conclusion that [the four coal-fired power plants] will be shut down. It’s a very real risk, but not a foregone conclusion.”
Foregone fuel costs. Before Gov. Terry McAuliffe signed the bill into law, Dominion was entitled to collect some $85 million in past fuel costs. In 2014 the SCC had deferred passing on those costs with the thought that spreading out payments would ease the impact on customers. The utility has agreed to eat them instead.
Immediate rate cuts. Dominion residential customers will receive a 5.5% cut to their overall electric bills to reflect lower fuel costs; industrial customers will get a 10% cut . Before the bill was signed, the new tariff was scheduled to go into effect July 1. The law accelerates that date to April 1. Changes in fuel costs are automatically passed through to rate payers, so this measure has minimal impact on Dominion earnings.
Weather events. Dominion will assume the risk for extra expenses incurred during natural disasters such as hurricanes, earthquakes or snow storms. This is a crap shoot. Dominion may or may not experience a hurricane during the five-year rate freeze. Hurricane Isabel, a major hurricane that struck in 2003, cost the utility roughly $200 million. A more moderate hurricane would cost in the realm of $100 million.
Hurricanes are inherently unpredictable. Dominion lists the following hurricanes in the past 15 years as affecting a significant number of customers and generating storm-related expenses: Hurricane Isabel (2003), Tropical Storm Ernesto (2006), Tropical Storm Ida (2009), Hurricane Irene (2011) and Hurricane Sandy (2012). Demos, a liberal public policy think tank, published a 2012 paper, “Economic and Environmental Impacts of Climate Change in Virginia,” arguing that hurricane incidence will increase in the years ahead, although only marginally in the near future. The paper assigns the following probability, based on National Hurricane Center data, to major storm events in Virginia:
Thus, in 2020, the actuarial odds are that Virginia will experience a tropical storm every five years, a Category 1 hurricane every 15.6 years, and so on. On average (according to my calculations, very rough numbers) Virginia has a roughly 30% chance of experiencing some kind of tropical storm or hurricane event in any given year. That produces roughly $150 million in potential exposure for Dominion over five years, although the actual number could vary widely.
Additionally, Dominion incurs maintenance costs for frequent weather events such as snow and ice storms. The company lists the following significant events since 2000: Super Bowl ice storm (2000); February wind storm, March Daylight Savings wind storm and tornadoes/lightning storm (2008); snow/wind storm (2009); February blizzard (2010); and the June 29th Derecho (2012). Weather-related events cost the utility $140 million in 2011 and 2012, an average of $70 million each year.
Energy assistance. Dominion operates an energy assistance program (Energy Share) as well as a weatherization program for the poor and elderly. EnergyShare, funded by voluntary contributions from Dominion customers and employees, varies year to year but runs roughly $1 million annually, says Katharine Bond, Dominion’s director of policy. A previous weatherization program, which expired in 2014, spent $4 million to $6 million annually. No budget has been set for an expanded successor program, which will be operated in conjunction with EnergyShare as a coordinated assistance program. Dominion shareholders will fund the weatherization program. If the new, expanded weatherization plan operates on the same scale as the old one — an assumption that Dominion officials are not willing to make — it could cost Dominion $25 million over the next five years.
Solar capacity. The bill declares the building of 500 megawatts of industrial-scale solar energy to be in the public interest, allowing Dominion to accelerate construction of solar capacity. The cost, already identified in the utility’s long-term Integrated Resource Plan, will be passed on to customers.
Let’s boil all this down: What does Dominion win and what does it lose from this deal?
It is difficult to assign a value to Dominion of the five-year rate freeze. Using the SCC figure of $280 million a year and extrapolating it over five years, this measure would be worth $1.4 billion to the utility. But the figure is incomplete, failing to take into account one-time expense charges that would be included in a biennial rate review. In the 2011-2012 period, for example, these charges averaged about $600 million, or roughly $300 million per year. Wohlfarth, the Dominion regulatory executive, says there likely will be more one-time write-offs relating to weather, new EPA rules and preparations for the restructuring of the utility’s fuel mix. Also offsetting the windfall, Dominion is giving up $85 million in fuel-cost increases, and it will fund a weatherization program, which, if it equals the previous program, would amount to roughly $25 million over five years. Wohlfarth contends that the benefit of the freeze to Dominion will be minimal.
In exchange, Dominion takes on the liability for the possible shutdown of four coal plants — a figure that, if it occurs within the next five years, would exceed $1.6 billion. There are tremendous uncertainties. Will EPA modify its methodology for calculating Virginia’s CO2 emission targets? What are the odds that a lawsuit filed by 13 states will overturn the EPA regulations? What are the prospects of the next president reversing the Obama administration’s interpretation of the Clean Air Act that led to the CO2 regulations? Any reduction or abolition of EPA emission targets could wipe out some or all of Dominion’s liability.
Bottom line: It is impossible to say whether Dominion will come out ahead or behind in this deal. The rate freeze could benefit the utility, but by far less than the $280 million-a-year in benefits repeated in the media. At the same time, Dominion takes on massive risk. If efforts fail to reverse or modify the EPA regulations, its losses could be massive. In the end, any appraisal of what kind of deal Dominion negotiated depends largely upon one’s analysis of the odds that the EPA regulations will go into effect as they now stand. And that is an analysis that will have to await another blog post.
Author’s note: I have made my best effort to include all relevant data points, obtain accurate information and make reasonable assumptions. If anyone can suggest additions or changes to what I have written, please let me know at jabacon[@]baconsrebellion.com, and I will consider amending this analysis.
This version differs in important details from a version I posted last night. In particular, it deletes mention of $600 million expenses with which Dominion will be credited in relation to preparatory work for a third nuclear unit at North Anna. That credit will be applied to the 2013-2104 biennial review not subject to the freeze — even though the review is being conducted in 2015.
Also, this story corrects an under-count of one-time expenses included in the calculation of Dominion’s excess earnings. I had assumed, based on the experience of 2011-2012, that such one-time expenses would average $150 million a year. In fact, the average would be $300 million a year.
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