Dominion Refinances Capital Structure, and What It Means to Virginia

by James A. Bacon

Dominion Energy Inc. will sell a 25% interest in its Cove Point  liquid natural gas-exporting facility to Brookfield Super-Core Infrastructure Partners, an infrastructure fund, for $2 billion, the company announced this morning. Said Dominion CEO Thomas F. Farrell II: “The agreement highlights the compelling intrinsic value of Cove Point and allows us to efficiently redeploy capital toward our robust regulated growth capital programs.”

That raises an interesting question: What does Farrell mean by “regulated growth capital”? Does this mean Dominion is redeploying capital from competitive, lightly regulated business enterprises such as natural gas exports toward heavily regulated enterprises such as electric utilities, as evidenced by its acquisition of SCANA in South Carolina?

In a word, the answer is, “yes.”

An article in S&P Global Marketing Intelligence sheds light on Dominion’s strategic thinking and capital spending plans. In March 2019 the company unveiled a $26 billion “growth capital plan” for 2019 through 2023. The first three years will be financed by $7 billion in operating cash flow, the issuance of debt, and the cobbling together of capital from other sources.

Dominion’s business structure now consists of Dominion Energy Virginia, Dominion Energy South Carolina, Dominion Energy Gas Transmission & Storage, Dominion Energy Gas Distribution, and Dominion Energy Contracted Generation. Of these, Dominion Energy Virginia remains by far the most important. The parent company will lavish $17 billion, about 64% of its capital spending, on its Virginia-North Carolina utility over the next few years.

Dominion Energy Virginia foresees investing about $4.3 billion in electric transmission from 2019 to 2023, with about $1.6 billion earmarked for grid transformation projects under the Grid Transportation and Security Act. Other spending includes $2.4 billion on regulated solar growth, $1.3 billion on contracted solar, $1.1 billion for offshore wind, and $1.2 billion for operating license extensions at its Surry nuclear units.

The investments are expected to grow the Virginia utility’s base rate from $23 billion in 201 to $32-$34 billion in 2023. The larger the capital base, the more money the State Corporation Commission allows the company to earn, and the more the company can charge rate payers.

The parent company plans to spend another $3.6 billion at its gas transmission & storage subsidiary. That business, says S&P Global, includes “regulated and regulated-like assets,” most notably the Cove Point export facility and Dominion’s partnership share in the Atlantic Coast Pipeline. Dominion expects to invest an additional $3.5 billion in its regulated gas distribution companies. All told, the company expects this plan to achieve a 6.7% compounded annual growth rate in earnings per share through 2020 and for EPS to grow by more than 5% annually from 2020 to 2023.

According to an article in Seeking Alpha, “From 2006 to 2019 (based on management’s estimate), Dominion Energy sees the rate regulated or “like-regulated” side of its business growing from ~40% to ~90% of total operating income generation. Roughly two-thirds of Dominion’s Energy’s total operating income now comes from rate-regulated utilities. Of Dominion’s major assets, the Cove Point LNG facility in Maryland is the most exposed to market pricing risk.

Bacon’s bottom line: A positive way to spin today’s announcement is that Dominion is selling a stake in its Cove Point LNG facility in order to finance continued capital investment in its Virginia utility. The parent company is funneling a big chunk of its own equity capital, $2 billion worth, into the Commonwealth of Virginia. That $2 billion will leverage another large sum — a roughly equal amount — in debt investment.

A negative way to spin the announcement is that it marks a huge step in Dominion’s ongoing reinvention of itself from a company with a strong exposure to the competitive energy marketplace to a company active primarily in regulated markets. Today’s transaction today moves $2 billion from a venture with significant market price risk to an enterprise with much lower market risk. One might argue that the company’s competitive advantage increasingly springs from achieving beneficial legislative and regulatory outcomes — what some might call rent seeking — and less from marketplace innovation.

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21 responses to “Dominion Refinances Capital Structure, and What It Means to Virginia

  1. Once the game of shifting risk off of stockholders and onto ratepayers was explained to me, it all became clear. It is the Rosetta Stone. Those who are studying the real estate deal in downtown Richmond should be focused on finding the same pattern.

    I wish the company would behave the same way (as with the LNG terminal) with the planned massive, and massively expensive, off shore wind project. But in that case, with captive ratepayers taking huge risk, it will not be seeking the partnerships and sharing the wealth.

    • When your State utility commission allows you to make your captive ratepayers pay you a guaranteed rate of return for the full actuarial life of the plant that’s higher than the profit any reasonably competitive electric utility business would yield, why take the risk of less in the short run (competition), or long run (obsolescence)?

  2. More later but cove point is not in baltimore. It is southeast of DC

  3. And Steve … What exactly is the Hugh Risk in offshore wind? Tom tells us Dominion would be better off buying the wind from a third party developer …cheaper that way, but it is a planet saver deemed secure by lots of studies etc.

  4. I have little to base this on, but I think you are right that Dominion wants to expand in more regulated markets, i.e. SCANA. I’ve visited Cove Point and even ridden the bicycle through the underwater tunnel to the shipping platform. The move to retask the facility to export LNG was done a few years back when fracked gas was all the rage. But fracking has its problems. For one thing, fracked wells are much more expensive than traditional gas wells. They have already fallen into a familiar boom-bust cycle. People frack and the extra supply drives down gas prices. That makes it harder to get the capital for more wells. Another problem is that fracked wells play out faster than traditional ones. One would assume Dominion has a reliable, long-term supply of gas, but it is relying upon mostly Marcellus product. I was surprised by the sell-off since one might assume Dominion has solid customers among Asian utilities. There’s a bigger story here and I don’t know what it is.

  5. I’d wonder how much the delay in the pipeline has affected planning?

  6. In other news today, I see Virginia is entering a contract with Dominion Energy to buy 420 MW of power from four solar projects and a onshore wind farm to help meet a mandate of using renewables for 30% of the state’s electricity needs by 2022. (Richmond Times-Dispatch, Roanoke Times).

    Same article says Facebook already is spending $250 million for renewable energy credits to offset the electricity demand at its new data center in eastern Henrico County.

    Don’t want to go off-topic, but why can’t big cloud companies that want to say they are using renewables, use these same approaches as Virginia and FaceBook?

    Of course regulated environment preferred. They can get elected official support for mega-projects and rate payers are captive.

  7. This is exactly what Steve Haner, Acbar and I, and others have been warning about over the past several years. Dominion Energy has made a strategic move over the past 20 years to exit the competitive energy market for the more certain environment of the regulated energy market. They even have a campaign underway to move most of that last 5% into the regulated or “regulated-like” category. This is contrary to the direction that most energy markets and many state regulators are moving in the U.S.

    From a return-to-shareholders perspective, Dominion has discovered that it is easier and cheaper to influence public opinion and the legislative/regulatory arena to provide higher profits than it is to compete on an equal footing with other energy providers. The results speak for themselves. They have obtained legislative approval of several major bills that diminish regulatory oversight and allow them to use ratepayers’ funds for free, and over-recover billions in additional revenues, as well as gain approval to invest in billions of dollars of new energy infrastructure that is either unnecessary or much more expensive provided by utility and put in the ratebase, compared to what it costs if provided at a fixed price by independent producers.

    Dominion Energy has been very creative in their financial activities. Financial analysts have been telling Dominion that they are overleveraged (too much debt compared to equity) for some time. Dominion sold some of their merchant generating stations (non-regulated) to reduce debt, gained a significant subsidy from Connecticut for the Millstone nuclear power plant, after threatening to close, what the Wall Street Journal called, the most profitable nuclear facility in the U.S.

    Dominion also sold off much of their portfolio of gas-leases and used those funds to pay down debt and buy back 55 million shares of outstanding stock. Reducing the number of outstanding shares increases the earnings per share with the same level of earnings, leads to higher stock prices and increases in executive bonuses. With continued low interest rates, more stock buy-backs could be on the horizon.

    Cove Point has been mischaracterized has having significant market risk. Dominion deftly negotiated a contract that had little exposure to increased costs. Cove Point provides only the service of liquefying the gas and providing a loading point for LNG tankers. The cost of gas and the price for transporting the LNG are the responsibility of the customers in Japan and India, who have agreed to 20-year take-or-pay contracts. I think a portion of project was sold because there was no room for more upside in the endeavor. Dominion could get the present value of the future stream of revenues from Cove Point and put that money to use in building regulated projects that yield a higher rate of return for a longer period.

    Remember, a $1 billion project requires ratepayers to pay back 3-4 times that amount over the 30-40 year life of the project. Perhaps 40%-50% of what the ratepayers repay is profit for the utility. The remainder repays the cost of the project and the cost of debt financing. Using ratepayers’ money that should have been returned to them does not save customers any money. They are still obligated to pay all of the same costs they would be required to pay if they had received an appropriate refund of over-recovered funds. But keeping that money saves Dominion money. They use it to pay for some of the equity portion of financing a new project. This allows them to issue less new stock and avoid paying dividends, and avoid paying any interest for using the customers’ money. This is a huge savings on the $1 billion or so that the SCC estimates has been over-recovered from ratepayers.

    This new strategy has broken the 100-year old utility compact. A monopoly was awarded to utilities in exchange for a fair price to ratepayers and a fair return for shareholders. Dominion’s program will create much higher prices for electricity than would result from a modern energy system that was designed to be cost-effective for customers instead of yielding the maximum return for shareholders.

    In a modern system, utilities would receive a fair return for shareholders. But they would not be allowed to build unnecessary and overly expensive projects in order to maximize profits.

    Dominion has proposed a huge addition to generating capacity during a period of stable load growth. A recent Bacon’s article repeated Dominion’s claim of a 2% annual increase in electricity use. This was not reported on a weather-normalized basis (Dominion never does). That is the only way to determine if usage actually increased, or if it was just due to more extreme weather. Dominion has claimed the total increase in data center use in its previous IRPs, even though half of the data centers are in co-ops’ territories. The data centers also told the SCC that as the number of data centers increase, the usage of electricity will remain about the same due to efficiency improvements.

    There are much better and less expensive ways of providing a reliable energy supply than what Dominion has proposed. Our businesses will be less competitive compared to neighboring states as our energy costs rise. Families, especially those with lower incomes, will be burdened with higher utility bills. We are not obligated to pay for projects that benefit only utility shareholders. There are a variety of ways to better serve the people of Virginia and still provide a fair return to utility shareholders.

    • “In a modern system, utilities would receive a fair return for shareholders. But they would not be allowed to build unnecessary and overly expensive projects in order to maximize profits.” — Well said, TomH!

  8. So Dominion is bailing on Cove Point. Does the Company need cash or as Steve is saying just shifting the risk to its ratepayers from its shareholders? Maybe their partner in the ACP, Duke Energy, has forwarded the letter from the Duke University Earth Science professor to the NC Governor. It was backed up by 2 dozen former EPA scientists and administrators.

    The letter was NC should place a “permanent moratorium” on natural gas infrastructure in the state including gas plants and the ACP. The letter warned … “In addition to causing possibly irreparable climate damage, such infrastructure is likely to saddle consumers with much greater costs than would a more rapid transition to 100% renewable energy, while also causing additional harm to already vulnerable communities.”

    Looks like energy realignment is a real possibility in NC., a realignment that is also backed up by market information on natural gas …. “Natural gas-fired power plants, which have crushed the economics of coal, are on the path to being undercut themselves by renewable power and big batteries, … By 2035, it will be more expensive to run 90% of gas plants being proposed in the U.S. than it will be to build new wind and solar farms equipped with storage systems. … As gas plants lose their edge in power markets, the economics of pipelines will suffer, too, RMI said in a separate study Monday.” (IEEFA)

    NY’s response to the future is to replace 16 natural gas ‘peaker’ plants with batteries. And in the Southeast under performance of coal plants presents a clear opening for solar-plus-storage plants, using solar during the day to charge storage units that can then be tapped during peak periods in the evening rather than using fossil generation, whether coal- or gas-fired. This future is not the natural gas future that the ACP planned on.

    Then there is the issue of the drillers themselves. Again from IEEFA …
    • “US fracking-focused oil and gas companies continued their decade-long losing streak through the first quarter of 2019.
    • A cross-section of small and mid-sized U.S. E&Ps (Exploration and Production companies) reported $2.5 billion in negative cash flows from January through March 2019.
    • Negative cash flows have soured investors on the sector, constraining the oil and gas industry’s ability to tap debt and equity markets.

    Investors are being told to wait 2 more years for a positive cash flow. … but “the report advises investors to view the fracking sector as a “speculative enterprise” with a weak outlook and an unproven business model.”

    “During the past 12 months, an equally weighted index of North American renewable power producers has risen by 35.3%, compared to a 53.6% drop in the S&P Oil & Gas Exploration and Production Select Industry Index. The outperformance of renewable energy stocks continues a years-long trend.” Investor interest in “clean tech” is at its highest since before the 2008 financial crisis, driven by a “potent combination” of technological and political tailwinds, Pavel Molchanov, an equity analyst at Raymond James & Associates, wrote in an Oct. 1 research report.”

    I am sure the 14% ‘reservation” fees for the ACP are keeping the project on the boards, but the future envisioned by Dominion and Duke in 2012 looks very different today. It’s time to do more than bail on Cove Point.

    • Jane,

      Dominion is not bailing on Cove Point. They are selling 25% of their interest in the project to free up $2 billion to invest in regulated projects that will provide returns that are higher and will last twice as long.

      • I stand corrected.
        I wrote that before I had read your post.
        AND I remain convinced that their ‘all in for natural gas’ is a strategy that has not worked out as they thought it would.

        • The public was hoodwinked by the “decades of cheap natural gas” campaign and its characterization as a “clean” fuel. It has worked thus far. Companies have made billions as a result of that subterfuge.

          However, the facts are slowly catching up. “Cheap” does not result from the nature of the gas resource, but from the fact that failing gas producers must overproduce to stay current with their loans, driving the price down. Sooner or later, a few oil majors will buyout most of the gas leases for dimes on the dollar and get production back in line with demand, raising gas prices.

          People are also seeing that the pipelines that were said to be “absolutely essential” to be in operation several years ago are not needed after all. However, the pipeline developers will still do everything they can to recover the billions they have invested in the projects even if it means continuing the disinformation campaign.

          I hope we can show them better ways of making money that are good for their customers.

          • Jane Twitmyer

            Tom, Yes, the hype made some investors a lot of money, not the drillers though. I would just like to add some info from Hughes in TX who did the original analysis on our shale resources, questioning the hype and detailing shale well analysis which questioned the EIA.

            The data from the EIA is the data that the majors evidently use. But looking at the Hughes analysis, I don’t think that the majors will buy up the leases resulting in a lineup of demand and production. The Hughes analysis “finds that EIA projections of production through 2050 at the play-level are highly to extremely optimistic, and are therefore very unlikely to be realized.”

            Hughes says, “The Marcellus is a very large play that accounts for 38% of current U.S. shale gas production and is projected by the EIA to account for 34% of cumulative shale gas production through 2050.” In fact, the EIA’s projection “assumes that production will exit 2050 at levels 41% above current rates.” For that to happen there would need to be vast additional resources remaining to be recovered over and above the EIA estimate of proven reserves and unproven resources.”

            The Utica case is worse … So yes, they need better ways to make money.

          • Jane Twitmyer

            I have just read about the major push by the American Petroleum Institute, the guys that gave us Climate Change Doubt, for GAS. I have seen the ads on TV for how great gas is …. so my conclusion above could be wrong, lost to another ‘campaign’. UGH!

      • In my view, Cove Point was (and still is) a good play from a competitive natural gas deliver and sales point of view, particularly given the long range potential for international (export) n.g. markets in Europe. Venezuelan competition for LNG sales is essentially gone: but Russian gas is cheaper delivered to Europe (to the extent it can get delivered there) and likely to stay that way. More importantly, Cove Point is a bet on possible future profits, whereas a regulated return on domestic electric investment is immediate and assured for the life of the plant regardless of obsolescence. Given DE’s turn away from competition toward regulated rates, is selling off part of Cove Point surprising?

        It will be instructive to see what DE does with the cash from this sale. As little as possible will be invested in regulated plant. My bet is on the purchase of another regulated utility (like SCANA), and/or another huge stock buyback.

  9. Larry the G, I doubt the pipeline timeline matters. In fact, stretching it out and adding costs just adds to the potential long term shareholder earnings. The key is the concept of making ratepayers absorb both risk and costs and allowing shareholders (and employees) to get the benefits. Dominion exists to earn money. It is not about social good (serving Virginians) or fair rates for rate payers.

    This isn’t just about Dominion. Currently our marketplace is dominated by companies that focus on just making as much money as possible. We depend upon government to make them provide some social good and ignore it when that does not happen because government is limited. With big companies getting bigger and bigger and controlling a larger and larger portion of the marketplace, the system will eventually break. In recent years we have largely undone the laws put into place to protect the marketplace from dominance by a few super large entities.

    Those who ignore history are doomed to repeat it.

  10. re: ” Dominion exists to earn money. It is not about social good (serving Virginians) or fair rates for rate payers.”

    yes… yes and yes…….

    but as you went on – it seemed like you pretty much generalized the behavior for most all for-profit business… which I would also agree.

    I don’t know about the pipeline but Dom has to have committed resources to do it and now they are on hold… AND at the same time they are shedding other assets. I’m not sure what it means but pretty sure it’s not to give back to consumers!

    😉

    in terms of the bigger “social good” issue – I also agree but at this point not clear on how we extract social good from big business other than by law and regulation and those companies are quick to adapt to such changes these days and in Dominions case – their strategy is to directly participate in the laws and regulations and even to neuter the regulators.

    Not sure how to fix that… short of fairly Draconian laws/regs that actually might hurt American companies trying to compete with foreign countries businesses. But I think Europe has gotten better than us at this… especially when it comes to healthcare, education and energy (with some caveats).

  11. It is now official. Thanks to your local environmentalists there, California now has descended into chronic Hell. Just last night, a wild fire flared out of nowhere to consume overnight another 10, 000 acres in California, so far. Instantly, then a half million people lost their electric power, casting those half million California citizens into the dark, and it is yet to be restored even now into the light.

    Meanwhile, working and fully employed citizens are leaving the state, streaming out in long caravans never to return, thought they can’t afford the gas, along with taxes and state fees imposed for the right to live there in Hotel California. Meanwhile too, more homeless people flood in daily by the hundreds into San Fransisco alone, to become huddled masses lost and alone in sight of Golden Gate Bridge. The Environmentalists’ Future is now in California to stay for good, their own version of global warming has turned out to be chronic hell on earth, all as predicted here for several years on Bacon’s Rebellion.

    • As goes California, so goes the nation….

      Unlike California, the other 49 states don’t have an economic juggernaut like Silicon Valley capable of surviving dystopia.

      Here in Virginia, Northern Virginia is the canary in the coal mine.

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