With the public outcry over rising power costs, Dominion Virginia Power believes the time is right for it to seek major changes to the regulatory structure of the power business in Virginia.

The utility company has come up with a reregulation plan that could make it unique among large investor-owned utility companies across the nation. Instead of having its rates set by state regulators, Dominion Virgina Power’s rates would be set by a formula established by the state General Assembly that would ensure a set profit margin for power sales, generation and power distribution.

The company is floating a proposal at the General Assembly’s Commission on Electric Utility Restructuring that would remove the rate cap on retail power sales two years early (Dec. 31, 2008) in the state, would abolish retail customer choice for small customers at the end of 2008 — customers with more than 5 MW of demand would still have choice — and would set the company’s rate of return (ROE) at 6% over the yield of long-term investment grade bonds in the Baa category, currently about 5.5%, which would mean an 11.5% ROE currently, said Dominion spokesman Jim Norvelle.

“What we are proposing would be a bill into the Virginia General Assembly in early January,” said Norvelle. The General Assembly convenes Jan. 10. “There are two reasons for the proposal. Obviously, we have seen what has happened in Maryland and in Illinois, and we do not believe that our customers, let alone our company, should be subjected to what is happening there.

“The proposal recognizes that retail competition likely will never be an efficient retail price regulator in Virginia, especially to small customers… It’s not working. It seems to be too tumultuous. It swings too wildly, be it because of fuel costs, be it because of capped prices. It is not something that is working as we all thought it would…back as the mid 1990s.”

Norvelle said the other reason for Dominion’s proposal is the need for rate stability, not only for its customers, but also for its own investment in infrastructure. “We need to earn an appropriate return on equity that would allow us to secure capital financing for the projects that we know are in our future,” he said. “The competitive marketplace has not allowed for that to occur.”

Under the plan, the SCC would still have the authority to examine Dominion’s books and records every two years to assure that its ROE was appropriate. Regulators would be able to increase or reduce Dominion’s ROE by 0.5% based on performance. And as long as the company did not earn an ROE more than 1% above the formula, its rates would be determined to be just and reasonable. If its returns exceed the set ROE by more than 1%, then the profits would be shared equally with customers.

“A lot of this is not that unusual,” said Norvelle. “We’re not going back to the historical cost-of-service model. The legislation would set the return, not the SCC. The 12% ROE would not be unlike what other utilities earn in our peer group. It would put us on equal footing with our peer group so that we are not at a disadvantage.”

He could not say whether the SCC would retain any real ratemaking authority over the company’s operations. The plan apparently does not anticipate any changes to its power transmission operations, which are now part of the PJM interconnection and are regulated by the Federal Energy Regulatory Commission.

Norvelle said he doesn’t know of any other utility in the country that is under a similar form of regulation to the plan that Dominion is proposing.

In a research note to clients on Thursday Merrill Lynch analyst Jonathan Arnold said the plan actually may not lead to higher profits from Dominion Virginia Power’s regulated business. The utility company’s ROE in 2005 was about 6.6% but it was “depressed by some $400 million for under-recovery of fuel costs…

“If we add this back and adjust equity accordingly, adjusted 2005 ROE” would have been “more like 15.9%.” He said the new plan would mean Dominion’s utility would give up about 165 basis points of ROE or potentially 20 cents per share of earnings, if a full fuel cost recovery can be expected.

“This could overstate the impact as the actual ROE will likely have declined by the 2008 test year with three years of cost pressures. On the other hand, once Dominion sells its E&P business and buys back stock, future share count would be lower.”

Arnold also noted that the structural change would give Dominion the opportunity to open a “new growth avenue in the form of regulated generation additions” at a time when the Mid Atlantic region is rapidly headed toward a short supply situation.

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