Dominion Power 2000 Annual Report Download - page 42

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Interest Rate Risk
Dominion manages its interest rate risk exposure by maintaining a
mix of fixed and variable rate debt. In addition, Dominion enters
into interest rate sensitive derivatives. Examples of these deriva-
tives are swaps, forwards and futures contracts. In addition,
Dominion, through subsidiaries, retains ownership in mortgage
investments, including subordinated bonds and interest-only resid-
ual assets retained at securitization of mortgage loans originated
and purchased. For financial instruments outstanding at December
31, 2000, a hypothetical 10% increase in market interest rates
would decrease annual earnings by approximately $40 million. A
hypothetical 10% increase in market interest rates, as determined
at December 31, 1999, would have resulted in a decrease in annual
earnings of $31 million.
Commodity Price Risk
— Non-Trading Activities
Dominion manages the price risk associated with purchases and
sales of natural gas and oil by selecting derivative commodity
instruments including futures, forwards, options, swaps, and collars.
For sensitivity analysis purposes, the fair value of Dominion’s
oil and natural gas derivative financial contracts are determined
from models which take into account the market prices of oil and
natural gas in future periods, the volatility of the market prices in
each period, as well as the time value factors of the underlying
commitments. In most instances, market prices and volatility are
determined from quoted prices on the futures exchange.
Dominion has determined a hypothetical change in fair value for
its oil and natural gas derivative financial contracts assuming a 10%
unfavorable change in market prices. This hypothetical 10% change
in market prices would have resulted in a decrease in fair value of
approximately $56 million and $20 million as of December 31, 2000
and December 31, 1999, respectively.
The impact of a change in oil and natural gas commodity prices
on Dominion’s oil and natural gas derivative financial contracts at a
point in time is not necessarily representative of the results that
will be realized when such contracts are ultimately settled. Net
losses from oil and natural gas financial derivative contracts used
for hedging purposes, to the extent realized, should generally be
offset by recognition of the hedged transaction.
Commodity Price Risk — Trading Activities
As part of its strategy to market energy from its generation capacity
and to manage related risks, Dominion manages a portfolio of
derivative commodity contracts held for trading purposes. These
contracts are sensitive to changes in the prices of natural gas and
electricity. Dominion employs established policies and procedures
to manage the risks associated with these price fluctuations and
uses various commodity instruments, such as futures, swaps and
options, to reduce risk by creating offsetting market positions. In
addition, Dominion seeks to use its generation capacity, when not
needed to serve customers in its service territory, to satisfy commit-
ments to sell energy.
A hypothetical 10% change in commodity prices would have
resulted in a hypothetical loss of approximately $3 million and $5
million in the fair value of its commodity contracts, held for trading
purposes, as of December 31, 2000 and 1999, respectively.
Equity Price Risk
Dominion is subject to equity price risk due to marketable securities
held as investments and in trust funds. In accordance with current
accounting standards, the marketable securities are reported on
the balance sheet at fair value. The following table presents
descriptions of the equity securities held by Dominion at
December 31, 2000 and 1999.
2000 1999
Fair Fair
(millions) Cost Value Cost Value
Trading:
Short-term marketable
securities $275 $275 $1 $2
Other than trading:
Marketable securities 134 118 134 126
Nuclear decommissioning
trust investments 279 549 274 565
Risk Management Policies
Dominion has operating procedures in place that are administered
by experienced management to help ensure that proper internal
controls are maintained. In addition, Dominion has established an
independent function at the corporate level to monitor compliance
with the price risk management policies of all subsidiaries.
Dominion maintains credit policies that include the evaluation of
a prospective counterparty’s financial condition, collateral require-
ments where deemed necessary, and the use of standardized
agreements which facilitate the netting of cash flows associated
with a single counterparty. In addition, Dominion also monitors the
financial condition of existing counterparties on an ongoing basis.
Dominion believes it unlikely that a material adverse effect on its
financial position, results of operations or cash flows would occur
as a result of counterparty nonperformance.