Dominion Power 2006 Annual Report Download - page 56

Commission is authorized to defer upto40% of anyfuel factor
increaseapproved for thefirst twelve-month period, with recovery
of the deferred amount over the two andone-half year period
beginning July 1, 2008. There willalso be an adjustmentforone
six-month period beginning July 1, 2010. Beginning July 1, 2007,
ourrisk ofunder-recoveringprudently incurred expenses until July
1, 2010 is greatly diminished. Because there will be no adjustment
to account for differences between projections and actualrecovery
of fuel costs at the end ofthesix-month period beginning July 1,
2010, we will be exposed to fuel price and other risks during that
period. Further, after December31, 2010 (or upon the earlier
termination of capped rates), fuel cost recovery provisions will
ceaseandwe will be exposed tothefuel price andotherrelated
risks as described above.
The foregoingrisks are subject tochange upon the adoption, if
any, of the proposed 2007 legislative amendments. The proposed
legislation would end capped rates on December 31, 2008. The
proposed legislation also calls forannual fuel cost recovery pro-
ceedings, beginning July 1, 2007 and continuing thereafter.The
first annual increase as of July 1, 2007 would be limitedtoan
amount that resultsinresidential customers not receiving an
increase of more than 4% of total rates as of that date, and the
remainder would be deferred and collected in the years 2008
through 2010, as described under Status ofElectric Restructuring
in Virginia.TheGovernor of Virginia has until March 26, 2007
to sign, propose amendments to, or veto the proposedlegislation.
We cannot predict the outcome of the legislation at this time.
Our merchant power business is operating in achallenging mar-
ket, which could adversely affect our results of operations and future
growth. The success of our merchant power business depends
upon favorablemarket conditions as well as our ability to find
buyers willing to enter into power purchase agreements at prices
sufficient tocoveroperating costs. We attempt tomanage these
risks by entering into both short-term and long-term fixed price
sales and purchase contracts and locating our assetsin 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 facili-
ties. We operate nuclear facilities that are subject torisks, includ-
ing the threatof terrorist attack and ability to dispose of spent
nuclear fuel, the disposal of which is subject tocomplex federal
and state regulatoryconstraints. These risks also include the cost
of and our ability to maintain adequate reservesfor
decommissioning, costs of replacement power, costs of plant
maintenance and exposure to potential liabilities arising outof 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 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,forwards, financial transmission rights, options and
swaps, to manage our commodity and financial market risks. In
addition, we purchaseand sell commodity-based contracts in the
natural gas, electricity and oil markets fortrading purposes. We
could recognize financial losses on these contracts as aresult of
volatilityin the marketvalues of the underlying commodities or if
acounterparty failsto perform underacontract. In the absence of
actively-quoted market prices and pricing information from
external sources, the valuation of these contracts involves manage-
ment’s judgment or use of estimates. As aresult, changes in the
underlying assumptionsor use of alternative valuation methods
could affect the reported fair value of these contracts.
In addition,weuse derivatives to hedge future salesof our
merchant generation andgasandoilproduction, which maylimit
the benefit we would otherwise receive from increases in
commodity prices. These hedge arrangements generally include
collateral requirements that require us to deposit fundsor post
letters of credit withcounterparties to cover the fair value of cov-
ered contracts in excess of agreed upon credit limits. When
commodity prices rise to levels substantially higherthan the levels
where we have hedged future sales, we mayberequired to use a
material portionof our available liquidity and obtain additional
liquidity to cover these collateral requirements. In some circum-
stances, this could have acompounding 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 marketrisks including market liquidity, counterparty
credit strength and price volatility. These market risks are beyond
our control andcould adversely affect our results of operations
and future growth.
For additional information concerning derivatives and
commodity-based tradingcontracts, see Market RiskSensitive
Instruments andRisk Management and Notes 2and8toour
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 mayaffect our
financial results include, but are not limited to: damagetoor
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 crudeoilprices, resultsof future drilling and
well completion activities, our ability to acquire additional land
positions in competitive lease areas, operational risks that could
disrupt production andgeological and other uncertainties
inherent in the estimate of gas and oil reserves.
Short-term market declines in the prices of natural gasand oil
could adversely affect our financial results by causing apermanent
write-down of our natural gasand oil properties as required by
the full cost method of accounting. Under the full cost method,
all direct costsof property acquisition, explorationanddevelop-
ment activities are capitalized. If net capitalized costs exceed the
present value of estimated future netrevenues based on hedge-
adjusted period-end prices from the production of proved gas and
oil reserves (the ceiling test)at the end of any quarterly period,
then a permanentwrite-down of the assets mustberecognized in
that period.
In the past, we have maintainedbusiness interruption, prop-
erty damage andother insurance for our E&P operations. How-
ever, the increased level of hurricane activity in the Gulf of
Mexico led our insurers to terminate certain coverages forour
E&P operations; specifically, our Operator’s Extra Expense
(OEE), offshore property damage and offshore business
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