Dominion Power 2003 Annual Report Download - page 29

27.Dominion 2003
damage caused by Hurricane Isabel. For gas distribution opera-
tions, Dominion is permitted to seek recovery of the cost of gas
sold to customers.
Dominion Exploration & Production includes Dominion’s gas
and oil exploration, development and production operations.
These operations are located in several major producing basins
in the lower 48 states, including the outer continental shelf and
deepwater areas of the Gulf of Mexico, and Western Canada.
Dominion Exploration & Production operates a drilling
program focused on low risk development drilling in several
proven onshore regions of the United States and Western
Canada, while also maintaining some exposure to higher risk
exploration opportunities. Significant development drilling pro-
grams are currently underway in West Texas, the Appalachians
and the Rocky Mountains where Dominion Exploration & Produc-
tion holds sizable acreage positions and operational experience.
While each region provides Dominion Exploration & Production
with exploration opportunities, most exploratory drilling takes
place in the Gulf Coast region, including the deepwater Gulf of
Mexico. Dominion Exploration & Production maintains an active
and ongoing drilling program, participating in 922 net wells
during 2003, and replacing approximately 160 percent of its
2003 production.
Revenue and cash flow provided by exploration and produc-
tion operations are based primarily on the production and sale of
company-owned natural gas and oil reserves. Variability in
Dominion Exploration & Production’s revenue and cash flow
relates primarily to changes in commodity prices, which are mar-
ket based, and volumes, which are impacted by numerous factors
including drilling success, timing of development projects, as well
as external factors such as severe weather. Dominion manages
commodity price volatility by hedging a substantial portion of its
near term expected production.
Variability in Dominion Exploration & Production’s expenses
relates primarily to changes in operating costs and production
taxes, which tend to increase and decrease with changes in gas
and oil prices and the prevailing cost environment. Commodity
price changes place upward or downward pressure on related
E&P service industry costs, while severance and property taxes
move with changes in revenue. A changing price environment
impacts both operating costs and the cost of acquiring, finding
and developing natural gas and oil reserves.
Corporate and Other includes:
• The operations of Dominion Capital, Inc., a financial services
subsidiary (DCI), which are being divested in accordance with
an SEC order;
• Dominion Fiber Ventures, LLC (DFV) and its subsidiary,
Dominion Telecom, Inc. (DTI), a telecommunications business that
is being discontinued;
• Dominion’s corporate and other operations, including its ser-
vices company and
• Specific items attributable to Dominion’s operating segments
that are reported in Corporate and Other.
Accounting Matters
Critical Accounting Policies and Estimates
Dominion has identified the following accounting policies, includ-
ing certain inherent estimates, that as a result of the judgments,
uncertainties, uniqueness and complexities of the underlying
accounting standards and operations involved, could result in
material changes to its financial condition or results of operations
under different conditions or using different assumptions.
Accounting for derivative contracts at fair value
Dominion uses derivative instruments to manage its commodity
and financial market risks. In addition, Dominion purchases and
sells commodity-based contracts in the natural gas, electricity
and oil markets for trading purposes. Accounting requirements for
derivatives and hedging activities are complex; interpretation of
these requirements by standard-setting bodies is ongoing.
Generally, derivatives are reported on the Consolidated Bal-
ance Sheets at fair value. In addition, in 2002 and prior years,
all energy trading contracts were reported at fair value. As a
result of new accounting requirements beginning in 2003, non-
derivative trading contracts are no longer reported at fair value.
Prior period financial statements were not restated for this
change. Changes in the fair value of derivatives that are not
designated as accounting hedges are recorded in earnings.
The measurement of fair value is based on actively quoted
market prices, if available. Otherwise, Dominion seeks indicative
price information from external sources, including broker quotes
and industry publications. If pricing information from external
sources is not available, measurement involves judgment and
estimates. These estimates are based on valuation methodologies
considered appropriate by Dominion management.
For individual contracts, the use of different assumptions
could have a material effect on the contract’s estimated fair
value. In addition, for hedges of forecasted transactions,
Dominion must estimate the expected future cash flows of the
forecasted transactions, as well as evaluate the probability of
the occurrence and timing of such transactions. Changes in con-
ditions or the occurrence of unforeseen events could affect the
timing of recognition in earnings for changes in fair value of
certain hedging derivatives.
Use of estimates in goodwill impairment testing
Dominion is required to test its goodwill for potential impairment
on an annual basis, or more frequently if impairment indicators
are present. In performing the test, Dominion estimates the fair
value of its reporting units by using discounted cash flow analy-
ses and other valuation techniques based on multiples of earn-
ings for peer group companies, as well as analyses of recent
business combinations involving peer group companies. These
calculations are dependent on many subjective factors, including
management’s estimate of future cash flows, the selection of
appropriate discount and growth rates, and the selection of peer
group companies and recent transactions. The cash flow esti-