What a Tangled Analysis We Weave

Dominion Energy Virginia does not want state regulators to require a formal cost-benefit analysis of its plan to spend $3 billion on grid modernization over the next decade, reports the Richmond Times-Dispatch.

“I do not believe it would be appropriate to impose such a requirement for its approval,” said Edward H. Baine, senior vice president of distribution for Dominion Energy’s power delivery group. In testimony filed with the State Corporation Commission. He urged the commission to consider “the many qualitative or otherwise unquantifiable benefits” of the plan.

At first blush Baine’s remarks sound like Dominion is asking for a blank check –“Give us permission to spend a bunch of money, but don’t look too closely at how we spend it.” Predictably, Dominion’s critics of all stripes have been quick with criticisms. Some say the grid modernization sacrifices the interests of rate payers with unnecessary spending, others that the plan is insufficiently transformative of the electric grid. In today’s political environment, Dominion makes an easy target. In the T-D article, even the utility’s friends had qualms about the company’s wish to avoid a traditional cost benefit-analysis.

My intention in this post is not to defend the plan, the details of which I have yet to see. As a general rule, I am a huge proponent of conducting cost-benefit analyses for any public expenditures (or in Dominion’s case, expenditures that require public approval). Indeed, some criticism may be justified. As Steve Haner has pointed out, some of the tap-lines in the proposed undergrounding project sound absurdly expensive. And as Walton Shepherd with the National Resources Defense Council has blogged, the strategic thrust of the $3 billion spending plan, a grab bag of initiatives, could use sharpening.

So, by all means, let’s have a vigorous public debate over Dominion’s grid modernization plan. But let’s have a better debate than the one that seems to be shaping up. To start, let’s admit that some benefits to Dominion’s plan are, in fact, difficult or impossible to quantify. Then, permit me to introduce two critical concepts — (1) risk and (2) the time value of money — without which we cannot have an intelligent discussion.

Writing in the Commentary section of the Times-Dispatch today, Robert M. Blue, CEO of the Dominion Energy Power Delivery Group, discusses the benefits of the plan’s priorities — investment in renewable energy and energy-efficiency; resilience in the face of sabotage, cyber threats and natural disasters; more assistance to lower-income Virginians — without offering a cost-benefit justification.

In his SCC testimony, Baine has said the plan will save the company more than $2 billion over 20 years. In other words, $3 billion invested over 10 years will save only $2 billion over 20 years. On its face, that seems like an indefensible assault on the rate payers. But, as he made clear, the numbers exclude “unquantifiable benefits.”

Let’s take the undergrounding program as an example. In March Dominion filed to recover $284 million to bury 660 miles of its most outage-prone tap lines. Those lines accounted for 9,368 outages over the past 10 years. Dominion should be able to quantify the estimated cost of continuing to repair these tap lines over the next 10 years. I don’t know what the cost is, but it’s certainly in the tens of millions of dollars, perhaps in the hundreds of millions of dollars. What Dominion cannot quantify is the value to customers of having their electric service restore more quickly. When your power goes out, how much is it worth to get it back on? The loss of an hour or two is a minimal hardship. But the loss of electricity for three, four, or five days — I’ve had mine go out for 10 days — spikes as food spoils, working at home is impossible, or as extreme cold or heat makes houses uninhabitable.

Alternatively, let us consider investments in hardening infrastructure against the sabotage of physical facilities or corruption of IT systems. These may be investments for which we never see a benefit. Dominion can spend tens of millions of dollars upgrading its IT computers and communications and never come under cyber attack. Without making the investment, however, there is an increased risk of system-wide collapse. How much will Dominion decrease the risk of catastrophe by making those investments? That’s impossible to measure. What would the cost be if the grid experienced an extended blackout? Also impossible to measure.

While the risk of sabotage on an electric sub-station, a cyber-attack on grid IT systems, or a Category 3 hurricane overwhelming coastal infrastructure may be remote, it would be irresponsible not to guard against them. How much should Dominion spend to protect against them? There is no measure. The decision requires a judgment call.

Next, let’s address the time value of money.

In his T-D article Michael Martz makes the following statement:

The company plans to spend $2 billion on the Strategic Undergrounding Project, which the SCC estimates will cost $6 billion over the life of the buried lines, including the financing expense and utility profit.

I am seeing this total-cost number — initial cost + profit + financing costs — quite often. The purpose, of course, is to make the cost to rate payers look as large and frightening as possible. We never see this with other types of infrastructure expenditure, as in, to make up an example, “The Virginia Department of Transportation plans to spend $2 billion to build Superhighway X, which will cost $6 billion after operations, maintenance and interest expense on bonds are taken into account.”

When a private-sector company examines its capital-expenditure alternatives, it looks not only at the up-front cost, it looks at the time value of money. The basic principle is that a dollar spent today has greater economic value than a dollar spent twenty years from now. Why? Because a dollar put to work today will have twenty years of compounded returns compared to a dollar invested two decades from now. In simplified terms, a dollar spent today is worth two dollars spent twenty years from now.

To compare the value of projects with long expected finance costs and financial payback, financial people calculate what they call net present value. To include the financing expense of the Strategic Undergrounding Project (or any other project) without taking into account the time value of money is highly deceptive.

Do these qualifiers mean that Dominion’s proposed $3 billion grid-modernization investment is totally justified? Not at all. The SCC needs to give each component a good, hard look. But it is fair to say that any analysis of costs and benefits is meaningless without taking into account unquantifiable benefits, risk and the time value of money.

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14 responses to “What a Tangled Analysis We Weave”

  1. LarrytheG Avatar

    If Dominion was proposing some alternative ways to provide transparency and be held accountable – certainly worth a listen – but a proposal to have none is just another example of how Dominion wants to conduct itself with minimal oversight….

    but if net present value is the gold standard for evaluating then why haven’t Dominion or the SCC been doing that all along for other projects?

    It’s sorta like – every time a new issues appears these days – that we have to either re-invent the wheel rather than use long-established practices or – just don’t do any of them – just let Dominion do it’s thing as it sees fit.

    I think this proves more than ever than Dominion just wants the money to spend as it pleases.. without any “interference”.

    At the 5000 foot level – this smells to high heaven – but then again – it’s got some company of other issues also – like how much it will REALLY cost to move coal ash to lined facilities… Sorry, I don’t trust Dominions numbers on that than the man in the moon… and would be happy to see that analysis done by a taxpayer-hired 3rd party , independent expert.

    “Reports” and “studies” done by Dominion or done by folks hired by Dominion are solidly in the category of “Trust but Verify”.

    If I had ONE WORD to describe Dominion these days , it would be CHUTZPAH!

    1. djrippert Avatar

      Gotta agree with Larry here. Chutzpah occasioned by having outright purchased the General Assembly which, in turn, de-fanged the SCC.

      We don’t need no stinkin’ cost/benefit analysis!

      Virginia … America’s most corrupt state.

  2. djrippert Avatar

    “Dominion Energy Virginia does not want state regulators to require a formal cost-benefit analysis of its plan to spend $3 billion on grid modernization over the next ten decades, …”

    Ten decades? Bookbinder’s might not be in business in 100 years. Where would the overpaid and underworked Dominion executives spend their ill-gotten gains once Bookbinders is gone? Something tells me they’ll want the money sometime sooner.

    1. Ouch. I’ve fixed the mistake. Thanks for pointing it out.

      Thanks goodness I have readers to be my proof readers!

  3. LarrytheG Avatar

    Here’s a map of Virginia showing the electricity service areas:


    Makes me wonder why Dominion alone is involved.

    Was it ONLY Dominion customers that overpaid

    Even if so – are we only talking about customers in the areas served by Dominion and no where else?

    Does it mean that only the Dominion service areas will be affected by “Grid Modernization”?

    See – it’s questions like this that point out that Virginia is not Dominion and things like Grid Modernization – ought to affect all of Virginia not just those who get their electricity directly from Dominion as evidenced by quite a few of the 3rd party solar proposals are not even in Dominion’s service area… at all… and so would not be affected by any of this … and yet – shouldn’t we want these things addressed on a Virginia-wide basis? For instance, what good does it do for Dominion to upgrade it’s grid to better accommodate wind and solar if many of the proposals are in the non-Dominion service areas?

    Doesn’t this whole thing demonstrate that Dominion alone should not be driving this issue and we need all electricity providers involved in policy and implementation?

  4. Jane Twitmyer Avatar
    Jane Twitmyer

    This question about whether or not a cost benefit analysis should be made is a complete distraction. The real question isn’t whether or not Dominion’s plans are justified. The real question is … in a variation of the NRDC argument … do you spend money maintaining the old house when a complete modernization is needed to make that old house livable?

    An engineer could do a lot better than I at this but, as a long ago IBM Systems Engineer I understand enough to throw out a few things the argument should be about. The future is not only centrally generated and wire distributed electricity. The future is using less and generating differently. Combining distributed energy resources like on-site and community solar, with the way our current system operates requires ‘stuff’ made up of software to collect, analyze and then choose actions.

    As Schneider Electric puts it … ”new technologies are required that ”enable optimal cooperation among distributed energy resources” … technologies that can “optimally operate and manage the interconnected system, or relieve design constraints regarding bidirectional power systems.” So if we want to encourage more onsite and community solar we can’t just hook up to the old system. We will have to do a big deal renovation… and if we must do a big deal renovation, then why are we spending extra money keeping the old house running, or as the NRDC said … “on an expensive grab bag of routine maintenance?”

    Here is Schneider’s short list of real upgrades … “low short circuit capacity, bi-directional energy flow … Harmonics … frequency variations … transients …voltage sags and swells.” Updating the grid means making the grid able to manage lots of data and it means lots of new software to do things a bit differently when integrating DERs. New England is installing microgrids to increase their hurricane reliability, a lot different than the proposed ‘old house maintenance’ of buried lines.

    All that said, Dominion should be at least trying out the new modes of operating, make those smart meters do some work that helps the grid. Thing is they can’t unless they do the grid work … which takes us back to Tom’s basic argument about our monopoly regulation. Dominion, a private company, will not propose anything that will reduce their profits and create the ‘death spiral’ of declining monopoly utility sales and rising rates, a spiral exacerbated by all those distributed energy measures. We must change the rules and allow them to succeed in a different way.

    1. djrippert Avatar

      Greetings from another Big Blue alum. I see the cost/benefit analysis as a means to force Dominion to clearly articulate their plans. As you write …

      “Dominion, a private company, will not propose anything that will reduce their profits and create the ‘death spiral’ of declining monopoly utility sales and rising rates, a spiral exacerbated by all those distributed energy measures. We must change the rules and allow them to succeed in a different way.”

      In my opinion, that will not happen in Virginia by allowing Dominion to do what it thinks best in a fact vacuum. They had 30 years to deal with the obvious coal ash problem but only acted when forced to do so by legislation. Needless to say, they wanted not only the cleanup costs but the added costs of the cleanup caused by their failure to address the issue for decades paid by the ratepayers rather than the shareholders. You write about “changing the rules”. Part of that rule changing has to be much more transparency from Dominion as they rake billions upon billions of dollars out of the ratepayers for vague programs like “modernization”.

      I also think its foolhardy to believe that our legislature will represent the people of Virginia instead of the Dominion shareholders and executives. Virginia is one of only four states that allow unlimited campaign contributions (even from a regulated monopoly the legislature is supposed to regulate). The General Assembly has been “bought and paid for” and they have no interest in changing the rules. The best alternative is the one recently used in Prince William County regarding the Haymarket power line for Amazon. Force public disclosure by Dominion and then engage in a battle of delaying tactics through the courts until Dominion is forced to do something different than usual. A cost / benefit analysis forces Dominion to disclose its plans and expected benefits. The people and the courts can take it from there. This approach is sad but it cuts out our totally compromised General Assembly. Dominion will only be brought to heel by the people and the courts and the people need disclosure from Dominion to get into court.

      1. Jane Twitmyer Avatar
        Jane Twitmyer

        I am not looking for, or expecting Dominion to “articulate their plans.” They are hanging on to the old way of doing things and will continue to hang on with their fingernails even while the rest of the country addresses the actual future, a networked grid with the software to connect and manage it.

        I certainly do agree that allowing Dominion to do what it thinks best in a fact vacuum is not good either, but cost benefit isn’t the issue. The rules are the issue; rules that require Dominion to ‘sell more/build more’ in order to make profits. Dominion won’t make any change unless they are required to. Who will do the requiring? Not the legislature for sure. But I don’t think your plan will do it either. The extra costs for the ACP have been totaled up and broadcast but that hasn’t mattered. Gas and the ACP don’t win a cost benefit analysis. The opposition keeps fighting for ‘peanuts’, and Dominion just hangs on, finding ways to work around anything that might threaten their plans.

        I have promoted PACE loans to give commercial property owners a cash positive way to build the network without the utilities. I think following the money is the only way to create a pivot until a new legislature wakes up.

    2. Yes but Big Blue had to compete as a private company. Dominion is a monoply and has partners in crime, our elected officials who see utilities structure as an industry they can control as way to make dollars flow and create jobs yadda yadda. I would be in total war by now, but coal-fired power plants finally fell off their “must-do” project list, so I am satisfied they can not destroy the planet anymore. I never expected to see that change in my lifetime.

  5. “In his SCC testimony, Baine has said the plan will save the company more than $2 billion over 20 years.”

    We should pay careful attention to the language that Dominion uses. They are saying Project A will save THE COMPANY X billion over the next so many years. They do not say the project will save CUSTOMERS any money, because in many instances it will not save them any money.

    For example, costs for tree trimming and storm damage are included in the base rates which collect money to cover those charges from ratepayers based on what happened in 2007 or whenever the assumptions were built into the rates. If Dominion can reduce the cost of tree trimming and storm recovery by undergrounding lines, the shareholders get the savings not the ratepayers. At least until the rates are finally reviewed in 2022 (or perhaps as late as 2028).

    The Company wins twice. First, by receiving a 40-year stream of profits equal to about twice what the project costs (depending on the approved rate of return). They also win by avoiding an expense they are being reimbursed for.

    The ratepayers pay a bundle for a project that they might not benefit from. It is relatively inexpensive to loop distribution lines so that they get service from multiple locations so that it is only the homes around the downed lines are affected not a whole section of town.

  6. “What Dominion cannot quantify is the value to customers of having their electric service restore more quickly.”

    Yes they can. There are a number of studies that have quantified the cost of an outage for a residential customer, a commercial customer, and an industrial one. It is easy to use these values (or a range of values from different studies) to calculate the value of the amount of time that an outage is reduced by these undergrounding projects for the types of customers that would be affected by the improvements. Just a note, the monetary benefit to residential customers from reducing an outage by a few hours, or even a day, is not very much. Certainly not in the billions of dollars that it will cost ratepayers for this project.

    It would be far cheaper for the utility to acquire a wider right-of-way and cut the trees down in those situations where the project costs multiples of the value of the property.

    It is well known by utilities and their regulators that at some point investing in reducing an outage by the next unit of time is no longer cost-effective. The cost curve rises pretty steeply from here (the point of diminishing returns). I suspect this is what the SCC is looking at in many of the cases that Dominion has proposed.

  7. “Let us consider investments in hardening infrastructure against the sabotage of physical facilities or corruption of IT systems. These may be investments for which we never see a benefit.”

    This is a legitimate issue, given the world we live in. However, we have a choice about how we respond to it.

    Hardening structures might have some value, but as the old saying goes “Fences only keep the honest people out.” It would be a good idea for PJM to have its utilities standardize on the most vulnerable or longest replacement time pieces of equipment and keep backups of those scattered around the region in secure locations.

    Moving to more digital control of the grid exposes it more to cyber-attack. But most intrusions have come through the unprotected systems of trusted contractors or lower protected systems such as co-op utilities. If a big utility just paid attention to its own system, it would still be vulnerable.

    We are still approaching the grid as if it were a mainframe system: a huge, complex, and brittle system. If we changed our mindset and moved to a network model, our grid would be more resilient and reliable. Networks chop our e-mails into packets and send the pieces via a wide variety of routes to be re-assembled and verified at its destination. The network is less vulnerable to being entirely disrupted in the way a few properly targeted attacks can do to our electrical grid.

    Imagine if Virginia developed its modern grid as nested micro-grids. Our emergency responders, hospitals, government offices, commercial and retail complexes, schools and universities, military bases and industrial sites could still function (at least at a moderate level) using local generation and storage, isolated from the surrounding grid that has gone down. We would have multiple locations that could shelter and care for people without service.

    We learned from Superstorm Sandy and other severe weather events that relying primarily on diesel-fired generators for our emergency facilities left us vulnerable, as lack of electricity to pump the fuel kept it from being replenished.

    With each community having some basic service, we are more able to help each other and provide some blackstart capability to get the larger grid back on line.

    Developing such a nested grid would involve the utilities, third parties, and public-private cooperation. It would be a new way of dealing with our energy issues, but that’s what we need.

  8. “(1) risk and (2) the time value of money”

    Risk – is not the same for a utility as it is for a typical corporation. There does not need to be a risk premium because once a RAC is awarded, the utility is guaranteed to recover its costs for a project.

    “I am seeing this total-cost number — initial cost + profit + financing costs — quite often.”

    “To include the financing expense of the Strategic Undergrounding Project (or any other project) without taking into account the time value of money is fundamentally deceptive, if not outright dishonest.”

    You are seeing an undiscounted cash flow totals in our discussions because members of the general public are not privy to the internal discount rates the utility uses for its project accounting.

    However, the undiscounted numbers are useful. They do represent the money that families and businesses will have to pay back to the utility over the financial life of these projects. It is valuable for a family to understand how much more it will pay in interest than the cost of the house for a 30-year mortgage, even though the costs don’t involve equal value dollars. They might choose a shorter term mortgage as a result.

    You don’t see this type of presentation for highway projects, because the politicians don’t want you to see how much people will really end up paying for the project. Discount rates, like statistics, can often help an organization put their proposal in the best light.

    Energy companies are notorious for using high discount rates to make public presentations about the cost of their projects. High discount rates (an assumption of high inflation rates or high opportunity costs) greatly diminish the value of money in the future and make project cost estimates rely on money spent mostly in the near-term. Long-term environmental costs or long-term losses from customers’ pocketbooks tend to be reduced by this technique.

    High discount rates are even less valid in this era of low interest and low inflation rates (at least according to government figures).

    It is curious to hear Dominion argue about the time value of money when they totally ignore that concept when using the customers’ money. They have told us that letting the utility keep the customers money (without compensation for its time value) will somehow provide a cost savings to customers. It is not clear to me how this is so.

    Let’s assume that using the old rate assumptions over-recovers $200 million from customers each year. Dominion wants to use this $200 million at no charge. Imagine they are building a $400 million project. Dominion uses the ratepayers’ money as its equity contribution (avoiding the 4% return it would pay shareholders for the same amount). The other $200 million would be financed. At the 6.8% interest rate that Dominion assumed for financing the ACP, the ratepayers would have to repay about $400 million for the finance charges. The utility would receive a 40-year stream of payments for its profit from the project. This would total about $800 million (undiscounted) assuming a rate of return of 9.6% (Greensville) to 10% (base rates).

    In this scenario, the utility has built a $400 million project, earned $800 million in profit and saved $320 million in dividends (by using the customers’ money instead of shareholders’); without using a penny of its own money and not offering the customers any payment for the use of their money. These are not discounted values, but they illustrate the principle of what is going on. If the project was one of many in the new energy bill where the savings accrue only to the shareholders, the project is even more unfair to the customers. Virginia families and businesses pay and pay and seldom get anything in return from Virginia’s current energy policies.

    Eventually this will drive customers away from using as much electricity provided by the utility. Those who least can afford it will be left to pay higher amounts. This is the death spiral that I see our utilities helping to create in search of higher near-term profits. I believe that this outcome that can be avoided with more sensible policies.

    If someone is willing to take the time to discount these values, I would suggest using a 4% discount rate that was recommended by leading economists to calculate the social cost of carbon. Energy companies wanted to use a 7% discount rate, which reduced the number considerably. Dominion should identify what discount rate they used to make their calculations.

  9. Good discussion TH, to be continued I hope.

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