Dominion Power 2007 Annual Report Download - page 59

cost-recovery shortfalls, such as costs related to hurricanes or other
unanticipated events.
The rates of our Virginia electric utility are subject to regulatory
review. As a result of the Restructuring Act, commencing in 2009
the base rates of our electric utility company will be reviewed by
the Virginia Commission under a modified cost-of-service model.
Such rates will be set based on analyses of our electric utility’s
costs and capital structures, as reviewed and approved in regu-
latory proceedings. Under the Restructuring Act, the Virginia
Commission may, in a proceeding conducted in 2009, reduce
rates or order a credit to customers if our electric utility company
is deemed to have earnings during a 2008 test period which are
more than 50 basis points above a return on equity level to be
established by the Virginia Commission in that proceeding. After
the initial rate case, the Virginia Commission will review the rates
of our electric utility company biennially and may order a credit
to customers if it is deemed to have earned more than 50 basis
points above a return on equity level established by the Virginia
Commission and may reduce rates if our electric utility company
is found to have had earnings in excess of the established return
on equity level during two consecutive biennial review periods.
Energy conservation could negatively impact our financial results.
A number of regulatory and legislative bodies have introduced
requirements and/or incentives to reduce energy consumption by
certain dates. Conservation programs could impact our financial
results in different ways. To the extent conservation resulted in
reduced energy demand or significantly slowed the growth in
demand, the value of our merchant generation, E&P assets and
other unregulated business activities could be adversely impacted.
In our regulated operations, conservation could negatively impact
Dominion depending on the regulatory treatment of the asso-
ciated impacts. Should we be required to invest in conservation
measures that resulted in reduced sales from effective con-
servation, regulatory lag in adjusting rates for the impact of these
measures could have a negative financial impact. We are unable to
determine what impact, if any, conservation will have on our
financial condition or results of operations.
Our merchant power business is operating in a challenging market,
which could adversely affect our results of operations and future growth.
The success of our merchant power business depends upon favor-
able market conditions as well as our ability to find buyers willing
to enter into power purchase agreements at prices sufficient to
cover operating costs. We attempt to manage these risks by enter-
ing into both short-term and long-term fixed price sales and
purchase contracts and locating our assets in active wholesale
energy markets. However, high fuel and commodity costs and
excess capacity in the industry could adversely impact our results
of operations.
There are risks associated with the operation of nuclear facilities.
We operate nuclear facilities that are subject to risks, including
the threat of terrorist attack and our ability to dispose of spent
nuclear fuel, the disposal of which is subject to complex federal
and state regulatory constraints. These risks also include the cost
of and our ability to maintain adequate reserves for
decommissioning, costs of replacement power, costs of plant
maintenance and exposure to potential liabilities arising out of the
operation of these facilities. We maintain decommissioning trusts
and external insurance coverage to mitigate the financial exposure
to these risks. However, it is possible that decommissioning costs
could exceed the amount in our trusts or that costs arising from
claims could exceed the amount of any insurance coverage.
The use of derivative instruments could result in financial losses
and liquidity constraints. We use derivative instruments, including
futures, swaps, forwards, options and financial transmission rights
to manage our commodity and financial market risks. In addi-
tion, we purchase and sell commodity-based contracts primarily
in the natural gas market for trading purposes. We could recog-
nize financial losses on these contracts as a result of volatility in
the market values of the underlying commodities or if the
counterparty fails to perform under a contract. In the absence of
actively-quoted market prices and pricing information from
external sources, the valuation of these contracts involves
management’s judgment or use of estimates. As a result, changes
in the underlying assumptions or use of alternative valuation
methods could affect the reported fair value of these contracts.
In addition, we use derivatives to hedge future sales of our
merchant generation and gas production, which may limit the
benefit we would otherwise receive from increases in commodity
prices. These hedge arrangements generally include collateral
requirements that require us to deposit funds or post letters of
credit with counterparties to cover the fair value of covered con-
tracts in excess of agreed upon credit limits. When commodity
prices rise to levels substantially higher than the levels where we
have hedged future sales, we may be required to use a material
portion of our available liquidity and obtain additional liquidity
to cover these collateral requirements. In some circumstances, this
could have a compounding effect on our financial liquidity and
results of operations.
Derivatives designated under hedge accounting to the extent
not fully offset by the hedged transaction can result in
ineffectiveness losses. These losses primarily result from differ-
ences in the location and specifications of the derivative hedging
instrument and the hedged item and could adversely affect our
results of operations.
Our operations in regards to these transactions are subject to
multiple market risks including market liquidity, counterparty
credit strength and price volatility. These market risks are beyond
our control and could adversely affect our results of operations
and future growth.
For additional information concerning derivatives and
commodity-based trading contracts, see Market Risk Sensitive
Instruments and Risk Management and Notes 2 and 10 to our
Consolidated Financial Statements.
Our E&P business is affected by factors that cannot be predicted or
controlled and that could damage facilities, disrupt production or reduce
the book value of our assets. Factors that may affect our financial
results include, but are not limited to: damage to or suspension of
operations caused by weather, fire, explosion or other events at
our or third-party gas and oil facilities, fluctuations in natural gas
and crude oil prices, results of future drilling and well completion
activities, our ability to acquire additional land positions in
competitive lease areas, drilling cost pressures, operational risks
that could disrupt production, drilling rig availability and geo-
logical and other uncertainties inherent in the estimate of gas and
oil reserves.
Short-term market declines in the prices of natural gas and oil
could adversely affect our financial results by causing a permanent
write-down of our natural gas and oil properties as required by
Dominion 2007 Annual Report 57