Dominion Power 2006 Annual Report Download - page 54

ronmental AppealsBoard (EAB)andtheDivision of Admin-
istrative Law Appeals in Massachusetts, and both permits were
stayed. In February 2006, the EAB remandedaportion of the
EPA’s NPDES permit totheEPAforreconsideration. In
November 2006, EPA issued its determination on remandregard-
ing fourremaining issues appealed by Brayton Pointconcerning
its NPDES permit. In January 2007, Brayton Pointappealed
three of thoseissues to the EPA EAB. Both permits are stayed
pending the outcome of the EPA process. Until the remand proc-
ess and any resulting appeals are completed, the outcome of this
matter cannot be predicted.
FUTURE ENVIRONMENTAL REGULATIONS
From timetotime, the U.S. Congress considers various legislative
proposals that would require generating facilities to comply with
more stringent air emissions standards. Emission reduction
requirements under consideration would be phased in under
periods of up to ten to fifteen years. If these new proposals are
adopted, additional significant expenditures may be required.
In 1997, the U.S. signed an International Protocol (Protocol)
to limit man-made greenhouse emissions under the United
Nations Framework Convention on Climate Change. However,
the Protocol will not become binding unless approved by the U.S.
Senate. The Bush Administration has indicated that it will not
pursue ratification of the Protocol and has set a voluntary goal of
reducing the nation’s greenhousegasemission intensityby 18%
duringthe period 2002 through 2012. We expect continuing
legislative efforts in the U.S. Congress to include provisions seek-
ing to target the reductions of greenhouse gas emissions. In addi-
tion to possible federal action, some of the statesinwhich we
operate have already or mayadopt carbon reduction programs.
The cost of compliance with theProtocol or other greenhouse gas
reduction programscould be significant. Given the highly
uncertain outcome and timingoffuture action, if any, by the
U.S. federal government and states on this issue, we cannot pre-
dict the financial impact of future climate change actions on our
operations at this time.
MARKET RISK SENSITIVE INSTRUMENTS AND
RISK MANAGEMENT
Our financial instruments, commodity contracts and related finan-
cial derivative instruments are exposed to potential losses due to
adverse changes in commodity prices, foreign currency exchange
rates, interest rates and equity security prices as described below.
Commodity price risk is present in our electric operations, gas
and oil productionandprocurementoperations, and energy
marketing and tradingoperations due to the exposure to market
shifts in prices received and paid for natural gas, oil, electricity
and other commodities. We use commodity derivative contracts
to manage price risk exposures forthese operations. We are
exposed to foreign currency exchange rate risks related to our
purchases of fueland fuel services denominated in foreign curren-
cies. Interest rate risk is generally related to our outstanding debt.
In addition,weare exposed to equity price risk through various
portfolios of equity securities.
The following sensitivity analysis estimates the potentialloss of
future earnings or fair value from market risk sensitive instru-
ments over aselected time period due to a10%unfavorable
change in commodity prices, foreign currency exchange rates and
interest rates.
Commodity Price Risk
We manage price risk associated with purchases and sales of natu-
ral gas, oil, electricity and certain other commodities using
commodity-based financial derivative instruments held for
non-trading purposes. As part of our strategy to market energy
and to manage related risks, we also hold commodity-based
financial derivative instruments fortrading purposes.
The derivatives used tomanage risk are executed within estab-
lished policies and procedures andinclude instruments such as
futures,forwards, swaps and options that are sensitive to changes
in the related commodity prices. For sensitivity analysis purposes,
the fair value of commodity-based financial derivative instruments
is determined based on models that consider the market prices of
commodities in future periods, the volatilityof the marketprices
in each period, as well as the time value factors of the derivative
instruments. Prices and volatilityare principally determined based
on actively quoted market prices.
Ahypothetical 10% unfavorable change in market prices of
our non-trading commodity-based financial derivative instru-
ments would have resulted in adecrease in fair value of approx-
imately $597 million and$691 million as of December 31, 2006
and 2005, respectively. A hypothetical 10% unfavorable change
in commodity prices would have resulted in adecrease of approx-
imately $3 million in the fair value of our commodity-based
financial derivative instruments held fortradingpurposes as of
December 31, 2006 and 2005, respectively.
The impact of achange in energy commodity prices on our
non-trading commodity-based financial derivative instruments at
apoint in time is not necessarily representative of the results that
will be realized when such contracts are ultimately settled. Net
losses from commodity derivative instruments used forhedging
purposes, to the extent realized, will generally be offset by recog-
nition of the hedged transaction, such as revenue from sales.
Foreign Currency Exchange Risk
Our Canadian natural gasand oil E&P activities are relatively
self-contained within Canada. As aresult, our exposure to foreign
currency exchange risk for these activities is limited primarily to
the effects of translation adjustments that arise from including
that operation in our Consolidated Financial Statements. We
monitor this exposure and believe it is not material. In addition,
we manage our foreign exchange risk exposure associated with
anticipated future purchases of nuclear fuel processing services
denominated in foreign currencies by utilizing currency forward
contracts. As aresult of holding these contracts as hedges, our
exposure to foreign currency risk is minimal. Ahypothetical 10%
unfavorable change in relevantforeign exchange rateswould have
resulted in adecrease of approximately $3 million and $8 million
in the fair value of currency forward contracts held at
December 31, 2006 and 2005, respectively.
Interest Rate Risk
We manage our interest raterisk exposure predominantly by
maintaining a balance of fixed and variable rate debt.Wealso
enter into interest rate sensitive derivatives, including interest rate
swaps and interest rate lock agreements.For financial instruments
outstanding at December 31, 2006, a hypothetical 10% increase
in market interest rates would have resulted in adecrease in
annual earnings of approximately $25 million. Ahypothetical
10% increase in market interest rates, as determined at
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