The SCC says Dominion generated up to $395 million in excess revenue in 2016 under the electric rate freeze. Dominion says the SCC is inflating the numbers.
Depending on how you crunch the numbers, Dominion Energy Virginia (DEV) is earning between $221 million and $252 million in excess profits. Had the company not expensed nearly $174 million in coal ash clean-up costs, excess earnings would have amounted to $395 million. That’s the analysis of the State Corporation Commission in a report released last week.
The report supports the narrative that Dominion and its counterpart in western Virginia, Appalachian Power Co., negotiated a lopsided deal for themselves when they pushed for a base-rate freeze in 2015. Invoking the uncertainty created by the Obama administration’s Clean Power Plan, which would have compelled a major re-engineering of the electric power industry, power companies persuaded the General Assembly that a rate freeze would provide stability for the companies and their customers.
Now that the Clean Power Plan appears to be a dead letter under the Trump administration, critics argue, it’s time to roll back the freeze. Sen. J. Chapman Petersen, D-Fairfax, who had sought in the 2017 General Assembly session to overturn the freeze, said the SCC report confirms his claims. “It simply proves what we suspected all along,” he told the Richmond Times-Dispatch. “Everything I filed last year that was even mildly controversial will be coming back.”
I wanted perspective on the SCC numbers, so I reached out to Dominion as well as Edward L. Petrini at Christian Barton LLP, who represents large industrial and commercial electricity customers in Virginia, and to Michael Kelly, director of communications for the Virginia Attorney General’s Office. Only Dominion responded to my interview request.
I spoke with Thomas P. Wohlfarth, senior vice president of regulatory affairs. Not surprisingly, he says there is a lot less to the SCC excess-earnings numbers than meets the eye.
Accounting for coal ash expenditures. It is “ridiculous,” Wohlfarth says, to remove expenses tied to coal ash removal from the excess-earnings estimates. Dominion incurred a large liability when the Environmental Protection Agency ordered it to develop a permanent storage solution for millions of tons of coal combustion revenue accumulated over the decades. While about half the coal ash expenses qualify for recovery under a “rider” request not included in the base rate, about half of it does, he says.
“There are no circumstances under which it would be appropriate other than to record those expenses when the liability occurred,” Wohlfarth says. Referring to the SCC presentation of the excess-earnings data, he adds, “That’s the game they kind of play, trying to inflate the numbers worse than they are.”
Accounting for Return on Equity. Other accounting issues are more complicated to explain. First some background…. The key determinant in how much money electric utilities are allowed to earn before returning the surplus to ratepayers is Return on Equity (ROE), a ratio expressing earnings as a percentage of shareholder equity. The goal is to set the ROE at a level high enough to encourage power companies to invest in their utility operations — but no higher. Dominion Energy, DEV’s parent company, typically earns a corporation-wide ROE of about 14% to 15%. That includes the return on non-regulated business operations. Because regulated utilities are perceived as less risky, the SCC sets DEV’s ROE significantly lower.
The SCC calculates separate ROEs for Dominion’s generation business and its distribution business, which have different risk profiles. Here are the results based on SCC accounting:
“The combined generation and distribution earned ROE of 11.94% is above the 9.60% ROE approved by the Commission for DEV’s RACs (Rate Adjustment Clauses) during 2016 by 2.34 percentage points, or $358.2 million in revenues,” states the SCC report, “and is above the 10.0% ROE approved by the Commission in DEV’s last biennial review by 1.94 percentage points, or $297 million in revenues.”
Wohlfarth says that the SCC inflated the appearance of excess earnings by using the 9.6% ROE as the basis for its calculations. The SCC allows the company to earn a 10.7% ROE for the base rate, which applies to ongoing operations and are subject to the freeze. Why would the SCC pick the high ROE used for rate adjustment clauses rather than the low ROE used for the base rate when the freeze applies to the base rate?
An exceptional year. Another thing to consider, says Wohlfarth, is that “2016 was an anomalously good year for us.” Dominion benefited from a spike in revenue relating to the way PJM Interconnection, the regional transmission organization of which Virginia is a part, calculated its “capacity” payments. (PJM pays power companies separately for making generating capacity available, whether it is used or not, and for the electricity they actually generated.) That non-recurring revenue added $150 million in revenue.
“If you normalize for capacity revenue, we were down around 11% ROE, which doesn’t give us much of a buffer at all,” says Wohlfarth.
That leaves Dominion somewhat ahead of the game in 2016, concedes Wohlfarth, but that’s only one year. The company is still exposed to considerable downside risk in future years.
Future risks. Coal ash remains a potential liability. While Dominion has endeavored to pursue a “cap in place” strategy, environmental groups have pushed hard for Dominion to remove the coal ash and place it in synthetically lined landfills, which could be significantly more expensive. Dominion is expected to issue a report on the economics of coal ash disposal to the General Assembly later this fall.
Also, Dominion remains at risk for major weather events. In 2016, the company experienced only one hurricane remnant, but it was not an expensive one. A superstorm like Hurricane Harvey or Hurricane Irma could incur hundreds of millions of dollars in repair costs.
Yet another risk Dominion faces is plant “impairment.” The company still operates a handful of coal-burning power plants, but in an era of increased electric generation by wind, solar and gas, they are increasingly relegated to the sidelines. When natural gas is cheap and gas plants are more economical to run, coal plants are dispatched less frequently, which means they produce less revenue.
“We’ve got units that are not being dispatched very much at all,” says Wohlfarth. “It becomes difficult to keep them on the books at value. We’re not at that point right now. But it’s something we’re always reviewing.”
Impairment resulting from changing economic or regulatory conditions could result in write-downs of hundreds of millions of dollars, he says. That was one of the concerns about the Clean Power Plan, which, if implemented would have put some of Dominion’s remaining coal-generating assets in jeopardy. While the Clean Power Plan is on the back burner under the Trump administration, it is not dead. The initiative is tied up in the courts. Meanwhile, the McAuliffe administration is pursuing its own restrictions on carbon-dioxide emissions.
All things considered, says Wohlfarth, and Dominion’s ROE is about where it ought to be. Revenues might be a little high in 2016, but they could well be lower in the years ahead. “It’s part of the balanced equation. … Look under the hood, and you’ll see that our rates are adequate to deal with the risks we take.”