Dominion Power 2002 Annual Report Download - page 40

Management’s Discussion and Analysis of Financial Condition
and Results of Operations, Continued
decommissioning trusts. In addition, the decrease included a
$12 million decline in equity income from Elwood Energy, an
equity method investment, reflecting higher interest expense
due to the issuance of additional debt by that company in 2002.
Operating Results— 2001
Dominion Energy contributed $2.86 per diluted share on
net income of $723 million for 2001, an increase of $234
million and $0.79 per diluted share over 2000 results. The
increase in net income reflected a full year of CNG operations
in 2001, the acquisition of Millstone and reductions in certain
operating expenses.
Operating revenue increased $1.3 billion to $6.1 billion in
2001, as compared to 2000 reflecting the acquisition of Mill-
stone and a full year of CNG operations for 2001. Regulated
electric sales for 2001 reflected customer growth and compara-
tively higher fuel rates; however, these increases were largely off-
set by comparatively mild weather. Millstone operations largely
contributed to the increase in non-regulated electric sales. Non-
regulated gas sales and gas transportation and storage revenue
increased, reflecting a full year of CNG operations and
increased transportation rates. The results of Dominion’s trad-
ing and marketing operations contributed to the overall increase
in operating revenue.
Operating expenses increased $810 million to $4.7 billion
for 2001, as compared to 2000. Higher commodity prices con-
tributed to increased electric fuel and energy purchases and pur-
chased gas. In addition, purchased gas increased, reflecting
CNG operations for the entirety of 2001. Depreciation
increased overall due to the inclusion of Millstone. This increase
was partially offset by an extension of the estimated useful lives
of Dominion’s nuclear plants in connection with the expected
relicensing of those plants. This change in estimate resulted in a
$78 million decrease in depreciation expense. Purchased capac-
ity decreased as Dominion terminated certain contracts in early
2001. Other operations and maintenance increased due to the
inclusion of Millstone operations and scheduled outages at both
nuclear and fossil plants.
Selected Information— Energy Trading Activities
As previously described, Dominion Energy manages Dominion’s
energy trading, hedging and arbitrage activities through the
Clearinghouse. Dominion believes these operations comple-
ment its integrated energy businesses and facilitate its risk
management activities. As part of these operations, the Clear-
inghouse enters into contracts for purchases and sales of energy-
related commodities, including natural gas, electricity and oil.
Settlement of a contract may require physical delivery of the
underlying commodity or, in some cases, an exchange of cash.
These contracts are classified as energy trading contracts for
financial accounting purposes. The contracts are included in
the Consolidated Balance Sheets as components of current and
non-current derivative and energy trading assets and liabilities.
Gains and losses from energy trading contracts, including
both realized and unrealized amounts, are reported net in the
Consolidated Statements of Income as revenue.
In accordance with generally accepted accounting princi-
ples, Dominion reports energy trading contracts in its financial
statements at fair value. A discussion of how Dominion deter-
mines fair value for its energy trading contracts, can be found in
Critical Accounting Policies presented earlier in MD&A.
The Clearinghouse enters into contracts with the objective
of benefiting from changes in the prices of energy commodities.
Clearinghouse management continually monitors its contract
positions, considering location and timing of delivery or settle-
ment for each energy commodity in relation to market price
activity, seeking arbitrage opportunities. For example, after
entering into a contract to purchase a commodity, the Clearing-
house typically enters into a sales contract, or a combination of
sales contracts, with quantities and delivery or settlement terms
that are identical or very similar to those of the purchase con-
tract. When the purchase and sales contracts are settled either
by physical delivery of the underlying commodity or by net
cash settlement, the Clearinghouse may receive a net cash mar-
gin (a realized gain), or sometimes will pay a net cash margin
(a realized loss).
Until the contracts are settled, however, Dominion must
record the changes in the fair value of both contracts. These
changes in fair value represent unrealized gains and losses. To
the extent purchase and sales contracts with identical or similar
terms are held by the Clearinghouse, the changes in their fair
values will generally offset one another. Although the Clearing-
house may hold purchase or sales contracts for delivery of com-
modities at particular locations and times that have not been
offset, such exposures are monitored and actively managed
on a daily basis. Dominion’s risk management policies and
procedures are designed to limit its exposure to commodity
price changes.
Additional discussion can be found in Market Rate Sensitive
Instruments and Risk Management and Notes 2, 15 and 29 to
the Consolidated Financial Statements. Also, see Note 4 to the
Consolidated Financial Statements for a discussion of Domin-
ion’s implementation of new accounting requirements effective
January 1, 2003 to reflect the decision of the Emerging Issues
Task Force (EITF) in Issue No. 02-3, Issues Involved in Account-
ing for Contracts under Issue No. 98-10. As a result, some energy-
related contracts are no longer subject to fair value accounting.
During 2002, the Clearinghouse also held derivative finan-
cial contracts to manage the price risk of certain anticipated
sales of Dominion Exploration & Production’s 2002 and 2003
natural gas production (economic hedges). Dominion did not
designate these derivatives as hedges for accounting purposes
and, as a result, any change in the fair value of these derivatives
38 Dominion ’02 Annual Report