Dominion Power 2007 Annual Report Download - page 33

associated with volumetric production payment (VPP) agreements
as discussed in Note 13 to our Consolidated Financial Statements.
Variability in earnings relates to: changes in commodity prices,
which are largely market-based; production volumes, which are
impacted by numerous factors including drilling success and tim-
ing of development projects; and drilling costs which may be
impacted by drilling rig availability and other external factors. We
manage commodity price volatility by hedging a substantial por-
tion of our expected production. These hedging activities may
require cash deposits to satisfy collateral requirements.
Earnings from Dominion Energy’s other nonregulated busi-
ness, producer services, are subject to variability associated with
changes in commodity prices. Producer services uses physical and
financial arrangements to hedge this price risk.
Dominion Generation includes the generation operations of our
merchant fleet and our regulated electric utility, as well as energy
marketing and price risk management activities for our generation
assets. Our generation mix is diversified and includes coal,
nuclear, gas, oil, renewables and purchased power. The generation
facilities of our electric utility fleet are located in Virginia, West
Virginia and North Carolina. The generation facilities of our
merchant fleet are located in Connecticut, Illinois, Indiana,
Massachusetts, Pennsylvania, Rhode Island, West Virginia and
Wisconsin.
Dominion Generation’s earnings primarily result from the
generation and sale of electricity. Due to 1999 Virginia dereg-
ulation legislation, as amended in 2004 and 2007, revenues for
serving Virginia jurisdictional retail load are based on capped rates
through 2008. Additionally, fuel costs for the utility fleet, includ-
ing purchased power, were subject to fixed rate recovery provi-
sions until July 1, 2007. Pursuant to the 2007 amendments to the
fuel cost recovery statute, annual fuel rate adjustments, with
deferred fuel accounting for over- or under-recoveries of fuel
costs, were instituted beginning July 1, 2007 for our Virginia
jurisdictional customers. As discussed in Status of Electric
Regulation in Virginia under Future Issues and Other Matters, the
Virginia General Assembly enacted legislation in April 2007 that
returned the Virginia jurisdiction of our utility generation oper-
ations to a modified cost-of-service rate model, subject to rate
caps in effect through December 31, 2008. During the remainder
of the capped rate period, changes in our utility operating costs
relative to costs used to establish capped rates, will likely impact
our earnings.
Variability in earnings provided by the merchant fleet relates
to changes in market-based prices received for electricity and the
demand for electricity, which is primarily dependent upon
weather. We manage price volatility by hedging a substantial por-
tion of our expected sales. Variability also results from changes in
the cost of fuel consumed, labor and benefits and the timing,
duration and costs of scheduled and unscheduled outages.
Corporate and Other includes our corporate, service company
and other functions (including unallocated debt), corporate-wide
commodity risk management, the remaining assets of DCI, and
the net impact of certain operations disposed of or to be disposed
of, which are discussed in Note 6 to our Consolidated Financial
Statements. Operations disposed of during 2007 included all of
our non-Appalachian E&P operations, three natural gas-fired
merchant generation peaking facilities (Peaker facilities) and
certain DCI operations. Operations to be disposed of reflect two
regulated gas distribution subsidiaries, Peoples and Hope, which
we agreed to sell to Equitable Resources, Inc. (Equitable), in
March 2006. This sale was subject to regulatory approvals in the
states in which the companies operate as well as antitrust clear-
ance under the Hart-Scott-Rodino Act. However, in January
2008, Dominion and Equitable announced the termination of
the agreement for the sale of Peoples and Hope, primarily due to
the continued delay in achieving final regulatory approval. We are
seeking other offers for the purchase of these utilities.
In addition, Corporate and Other includes specific items
attributable to our operating segments that are not included in
profit measures evaluated by executive management in assessing
the segments’ performance or in allocating resources among the
segments.
A CCOUNTING M ATTERS
Critical Accounting Policies and Estimates
We have identified the following accounting policies, including
certain inherent estimates, that as a result of the judgments,
uncertainties, uniqueness and complexities of the underlying
accounting standards and operations involved, could result in
material changes to our financial condition or results of oper-
ations under different conditions or using different assumptions.
We have discussed the development, selection and disclosure of
each of these policies with the Audit Committee of our Board of
Directors.
A CCOUNTING F OR D ERIVATIVE C ONTRACTS
AT
F AIR V ALUE
We use derivative contracts such as futures, swaps, forwards,
options and financial transmission rights (FTRs) to manage the
commodity and financial markets risks of our business operations.
Derivative contracts, with certain exceptions, are subject to fair
value accounting and are reported in our Consolidated Balance
Sheets at fair value. Accounting requirements for derivatives and
related hedging activities are complex and may be subject to fur-
ther clarification by standard-setting bodies.
Fair value is based on actively-quoted market prices, if avail-
able. In the absence of actively-quoted market prices, we seek
indicative price information from external sources, including
broker quotes and industry publications. If pricing information
from external sources is not available, we must estimate prices
based on available historical and near-term future price
information and use of statistical methods, including regression
analysis. For options and contracts with option-like characteristics
where pricing information is not available from external sources,
we generally use a modified Black-Scholes Model that considers
time value, the volatility of the underlying commodities and other
relevant assumptions when estimating fair value. We use other
option models under special circumstances, including a Spread
Approximation Model, when contracts include different
commodities or commodity locations and a Swing Option Mod-
el, when contracts allow either the buyer or seller the ability to
exercise within a range of quantities. For contracts with unique
characteristics, we estimate fair value using a discounted cash flow
Dominion 2007 Annual Report 31