Dominion Power 2004 Annual Report Download - page 48

D 2004/Page 46
Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued
electric transmission and distribution assets, purchases of nuclear fuel and
expenditures to explore for and develop natural gas and oil properties.
Dominion expects to fund its capital expenditures with cash from operations
and a combination of sales of securities and short-term borrowings.
Dominion may choose to postpone or cancel certain planned capital
expenditures in order to mitigate the need for future debt financings.
Use of Off-Balance Sheet Arrangements
Leasing Arrangements
Dominion has an agreement with a voting interest entity (lessor) to lease
the Fairless power station in Pennsylvania, which began commercial opera-
tions in June 2004. During construction, Dominion acted as the construc-
tion agent for the lessor, controlled the design and construction of the
facility and has since been reimbursed for all project costs advanced to the
lessor. Project costs totaled $898 million at December 31, 2004. Dominion
will make annual lease payments of $53 million. The lease expires in 2013
and at that time, Dominion may renew the lease at negotiated amounts
based on original project costs and current market conditions, subject to
lessor approval; purchase Fairless at its original construction cost; or sell
Fairless, on behalf of the lessor, to an independent third party. If Fairless is
sold and the proceeds from the sale are less than its original construction
cost, Dominion would be required to make a payment to the lessor in an
amount up to 70.75% of original project costs adjusted for certain other
costs as specified in the lease. The lease agreement does not contain any
provisions that involve credit rating or stock price trigger events.
Benefits of this arrangement include:
•Certain tax benefits as Dominion is considered the owner of the leased
property for tax purposes. As a result, it is entitled to tax deductions for
depreciation not recognized for financial accounting purposes; and
•As an operating lease for financial accounting purposes, the asset and
related borrowings used to finance the construction of the asset are not
included on Dominion’s Consolidated Balance Sheets. Although this
improves measures of leverage calculated using amounts reported in
Dominion’s Consolidated Financial Statements, credit rating agencies
view lease obligations as debt equivalents in evaluating Dominion’s
credit profile.
Securitizations of Mortgages and Loans
As of December 31, 2004, Dominion held $335 million of retained interests
from securitizations of mortgage and commercial loans completed in prior
years. Dominion did not securitize or originate any loans in 2004. Investors
in the securitization trusts have no recourse to Dominion’s other assets for
failure of debtors to repay principal and interest on the underlying loans
when due. Therefore, Dominion’s exposure to any future losses from this
activity is limited to its investment in retained interests.
Forward Equity Transaction
As described in
Financing Cash Flows and Liquidity — Forward Equity Trans-
action
, in September 2004, Dominion entered into a forward equity sale
agreement relating to 10 million shares of Dominion’s common stock. The
use of a forward agreement allows Dominion to avoid equity market uncer-
tainty by pricing a stock offering under then current market conditions,
while mitigating share dilution by postponing the issuance of stock until
funds are needed. If Dominion decides it does not need any or all of the
proceeds, it has the option to cash settle or net share settle the forward
sale agreement in whole, or in part.
Future Issues and Other Matters
Status of Electric Deregulation in Virginia
The Virginia Electric Utility Restructuring Act (Virginia Restructuring Act)
was enacted in 1999 and established a plan to restructure the electric util-
ity industry in Virginia. The Virginia Restructuring Act addressed among
other things: capped base rates, regional transmission organization (RTO)
participation, retail choice, the recovery of stranded costs and the func-
tional separation of a utility’s electric generation from its electric transmis-
sion and distribution operations.
Retail choice has been available to all of Dominion’s Virginia regulated
electric customers since January 1, 2003. Dominion has also separated its
generation, distribution and transmission functions through the creation of
divisions. Virginia codes of conduct ensure that Dominion’s generation and
other divisions operate independently and prevent cross-subsidies
between the generation and other divisions.
Since the passage of the Virginia Restructuring Act, the competitive
environment has not developed in Virginia as anticipated. In April 2004, the
Governor of Virginia signed into law amendments to the Virginia Restruc-
turing Act and the Virginia fuel factor statute. The amendments extend
capped base rates by three and one-half years, to December 31, 2010,
unless modified or terminated earlier under the Virginia Restructuring Act.
In addition to extending capped rates, the amendments:
•Lock in Dominion’s fuel factor provisions until the earlier of July 1, 2007
or the termination of capped rates;
•Provide for a one-time adjustment of Dominion’s fuel factor, effective
July 1, 2007 through December 31, 2010 (unless capped rates are termi-
nated earlier under the Virginia Restructuring Act), with no adjustment
for previously incurred over-recovery or under-recovery, thus eliminat-
ing deferred fuel accounting for the Virginia jurisdiction; and
•End wires charges on the earlier of July 1, 2007 or the termination of
capped rates, consistent with the Virginia Restructuring Act’s original
timetable.
The risk of fuel factor-related cost recovery shortfalls may adversely
impact Dominion’s cost structure during the transition period, and
Dominion could realize the negative economic impact of any such adverse
event. Conversely, Dominion may experience a positive economic impact to
the extent that it can reduce its fuel factor-related costs for its electric util-
ity generation-related operations.
Dominion anticipates that its unhedged natural gas and oil production
will act as a natural internal hedge for electric generation. If gas and oil
prices rise, it is expected that Dominion’s exploration and production opera-
tions will earn greater profits that will help offset higher fuel costs and
lower profits in Dominion’s electric generation operations. Conversely, if
gas and oil prices fall, it is expected that Dominion’s electric generation
operations will incur lower fuel costs and earn higher profits that will off-
set lower profits in Dominion’s exploration and production operations.
Dominion also anticipates that the fixed fuel rate will lessen the impact of
seasonally mild weather on its electric generation operations. During peri-
ods of mild weather it is expected that electric generation operations will
burn less high-cost fuel because customers will use less electricity,
thereby offsetting decreased revenues. Alternatively, in periods of
extreme weather, Dominion’s higher fuel costs from running costlier
plants are expected to be mitigated by additional revenue as customers
use more electricity.