by Peter Galuszka and Garry Kranz

Outside the large picture windows, rain is falling in torrents. Inside Dominion Energy Clearinghouse Inc.’s trading unit in suburban Richmond, dozens of traders constantly shift their gaze from computer monitors to a big, gaily-covered trading board showing energy prices around the eastern half of the U.S. On occasion, they glance at several, ceiling-high television screens permanently tuned to The Weather Channel. The time is 10:15 on a late spring morning. Traders are brokering electricity for the 11 a.m. to noon slot.

The big downpours are dampening demand for electricity in Dominion’s service area that includes most of Virginia. The Richmond-based utility’s big nuclear and coal-fired generation plants don’t have to work very hard. A cold front blowing from the west has also cut demand from utilities in West Virginia, Ohio and Kentucky. Ever-attentive traders are tapping away, locking in discounts. Plenty of good deals can be had in electricity. "This morning traders are buying the standard 50-megawatt blocks to balance out their books," says Richard T. Thatcher, vice president of Dominion Energy’s market services.

Dominion Energy’s 200-person trading unit is the clearest image yet of how the Brave New World of electricity deregulation will look. Such trading will eventually transform stodgy, reactive power companies, who relied on state regulators to set their prices, into voracious free marketers. Virginia consumers will start making their choices for power suppliers this January. Prices will remain capped until 2007 when full-fledged deregulation takes hold.

As Virginia and other states move toward that day, the $200 billion electricity market in the U.S. will be turned on its head. Homeowners and heads of companies will have to shop for the best power rates. Firms whose brand names aren’t known yet will become essential suppliers of power. Established utilities will have to become nimble, scrappy opportunists to survive. To accomplish this, many firms, including Dominion Resources Inc., plan to split themselves into separate generation and distribution companies although Dominion’s plans have been controversial (stories Page 13 and 16). Meanwhile, Dominion plans to use various corporate arms, including a major gas company based in Ohio, to market its power far beyond its traditional borders. "We have 1.8 million gas customers who have never had the advantage of using Dominion’s morally-superior electrons. But they will," vows Thomas E. Capps, Dominion Resources’ CEO and chairman.

As ploys such as Capps’ take hold, Virginia will emerge as an increasingly important exporter of electrical power. Strategically located near high-demand markets in the Northeast and Midwest, and criss-crossed with natural gas pipelines and critical high voltage lines, Virginia could become a miniature Saudi Arabia of electrons, at least for power markets east of the Mississippi River. Dominion Virginia Power is expanding its current generating capacity of 18,590 megawatts in the state by 8,500 megawatts. Non-Virginia utilities plan to take advantage of Virginia’s location and easy regulatory climate to build more than 20 natural gas-fired generating plants worth more than $3 billion. Most of their 6,000 or more megawatts of power, enough to light up more than 5 million households, will be shipped across state lines.

Proponents of deregulation expect the magic of supply and demand to bring cheaper and more efficient power. If it fails, as it has so far in California, the economy will face enormous and painful disruptions. Something as commonplace as switching on a light bulb could become a rare luxury. It seems possible that high-cost power in the Northeast will become cheaper while now-affordable power in the South and Midwest, including Virginia, will overall become more expensive. Virginia utility leaders insist, however, that pricing will be efficient and advantageous here. Says Capps: "We’ve got generation assets. In the case of California, the only word that comes to mind is dumb ... The free market is superior to regulation in any way."

Dominion's Capps got his utility ready for deregulation. Photo courtesy Richmond Times-Dispatch

As deregulation looms, utilities are busy in other ways as well. For them to succeed, distributing electrons will be as important as generating them. Utilities are busy negotiating distribution cartels called Regional Transmission Organizations (RTOs) that could become as important in the pricing of power as generation. For years, utilities have been wheeling power from region to region, especially during emergencies. As they did so, they incurred extra transmission charges as their power traversed other companies’ empires.

Hence, aligning with the right RTO is a critical step. Dominion considered joining an RTO base known as the PJM Pool, which includes much of Pennsylvania, all of Delaware and New Jersey and parts of Maryland and Washington, D.C. The heavily populated and highly industrial area is a natural market for great gobs of power. But Dominion executives dropped the plan because the PJM group wanted too many rules and required generation reserves that Dominion didn’t think were needed.

Instead, Dominion has opted to join the still-forming Alliance RTO, which includes utilities from Illinois, including metropolitan Chicago, east through Michigan, Ohio and West Virginia. The core utility is Columbus, Ohio-based American Electric Power. With its massive coal-fired units, it offers some of the cheapest electricity in the country along with extensive transmission facilities. By joining Alliance, Capps says Dominion will pay a single "postal rate" for transmission and make it cheaper for members to sell power. Dominion can still sell power wherever it wants, including to the PJM pool, but it will enjoy special benefits, such as Alliance’s strategic high-voltage line connections across the Appalachians. RTO electricity prices will be regulated by the Federal Energy Regulatory Commission, which has approved wholesale power rates for inter-state transmission for decades.

Such fundamental upheaval is changing the role of state regulators. For years state regulatory agencies, such as Virginia’s State Corporation Commission, decided retail prices for electrons. Regulators were empowered by logic that electricity is a necessity, and consumers are shareholders in a utility’s assets. State regulators, therefore, acted on behalf of the public to control how much money monopolistic utilities could charge.

Yet that logic is fast being tossed out the window. If all goes as hoped, there will be enough competition to protect the public from price gouging and inadequate service. Customers who feel short-changed simply can switch to another power company. Sounds simple enough, except that in the process regulators such as the SCC must undergo change themselves. At risk could be a level of protection that consumers often take for granted.

Energy traders must keep a constant watch on weather as they buy and sell power. Their work will become more important with deregulation. Photo by Doug Miller

Nationally, it seems that the high-cost Northeast, which has been quick to deregulate, will enjoy cheaper-than-normal prices. New York consumers, for example, have been paying energy prices double that of consumers in Kentucky. The low-cost South and Midwest will likely see their prices rise. A national study conducted by The Energy Modeling Forum at Stanford University in Palo Alto, Calif., predicts that deregulation will cause prices to fluctuate wildly from region to region. The study concludes that electricity exported to high-cost states triggers rate drops for customers there. It does so, however, at the expense of customers in the states exporting the power, who may see their monthly electric bills soar.

Deregulation theoretically spurs growth in rural underdeveloped areas, bringing jobs and newfound wealth to impoverished regions. New plants add to the local tax digest and give under-served areas more leverage through market competition, not regulated price caps. Yet, Hillard Huntington, a Stanford professor who oversees the energy forum, notes that low-cost energy states like Virginia may not be good test models for deregulation. If rates already are lower than the national average, what incentive is there to deregulate? "In that case you might be better off with a regulated environment," says Huntington.

Already, businesses in the Old Dominion are getting antsy about potentially volatile pricing. "Most feel comfortable about the next five years because of the capped rates. ... But there is an uneasiness about the future when full deregulation of electricity generation occurs in 2007," says Steve Walker, president and CEO of the Virginia Manufacturers Association.

For now, the betting is that consumers and businesses in the Dominion Resources service area of Virginia will avoid service disruptions since it has adequate generation capacity although prices are likely to rise when the caps come off. Dominion has invested heavily in added capacity, such as paying $1.3 billion for the troubled Millstone nuclear power station in Connecticut that sells to the wholesale market mostly in New England. The utility also plans a new $600-million coal-fired plant at the mouth of a coal mine in Upshur County, W.Va. The 450-megawatt unit is designed to provide power, not to Dominion’s traditional service area, but northward to customers in the Mid-Atlantic. Dominion is expanding into non-electrical energy as well. Meanwhile, Dominion is seeking relicensing for its two nuclear power plants at Surry and North Anna.

Yet, there are serious questions about generation capacity in the western part of the state. American Electric Power, Virginia’s second largest utility serving an area from Roanoke west to Kentucky and West Virginia, does not have Dominion Virginia Power’s assets. AEP has only 1,700 megawatts of generation capacity in the Old Dominion, says Dan Carson, AEP president for Virginia and Tennessee. Peak demand is 3,600 megawatts, more than double local generating capacity. Depending on what happens after price caps are removed, this dearth of capacity could cause rates in southwest Virginia to skyrocket. John B. Williamson III, head of RGC Resources Inc., a Roanoke-based gas company, says the exceptionally cheap electricity that Southwest Virginia now enjoys could be lost. "That would make us (RGS Resources) more attractive," he says, "but if it depresses the local economy, that’s bad for all of us."

Sister Clare McBrien of Wytheville worries that Duke Energy's gas-fired plant, along with an AEP power line, will hurt her area including the New River (background), the second-oldest in the world. Photo by Peter Galuszka

Others have deep worries, not just about AEP’s capacity, but about what will happen if Virginia customers are stuck with skyrocketing prices as utilities ride regional market upswings and sell their power at a premium outside of the state. Up in Winchester at the state’s northern tip, A. J. Ottinger Jr. has strong reservations about deregulation and forecasts an end to Virginia’s relatively low electricity prices. The vice president of operations for Henkel Harris, a furniture company, Ottinger wrote to the SCC: "If you are a relatively low-cost energy state, why would you want to get into deregulation (of) your energy?" He adds: "The only party to benefit from deregulation in Virginia will be the power companies."

These concerns are exacerbated by an accident of geography. Due to its location, Virginia is bound to become an important exporter of electric energy. Several major natural gas pipelines cross the state from southwest to northeast. They intersect a number of key high-voltage lines that can carry electrons to markets far from the Old Dominion. A major impediment to transporting power to and from the Midwest, however, is the Appalachian Mountain range. The New World of deregulated electricity means the craggy Appalachians are taking on geographic importance for the first time since railroads rumbled through in the early 1800s to open western markets.

AEP insists the region needs more connections to handle the flood of electrons deregulation will bring. "Our system in Virginia is transmission-dependent," says Carson. "We have the capability to serve those needs, but if there were an outage on another line, it could have a cascading failure because other lines won’t be able to absorb the capacity." Yet, environmentalists have blasted AEP’s plans for new high-voltage lines, saying they will ruin mountain views and could damage humans, animals and plants. They have already forced the company to alter the route of one proposed AEP high voltage line though the Jefferson National Forest. Also targeted is a 765-kilovolt line from West Virginia to a critical substation near Jackson Ferry in Wythe County. So far, however, AEP has cleared all necessary permits for the line.

While AEP officials say the disputed line would enhance southwest Virginia’s access to supplies of power, activists see it differently. Instead of aiding Virginians, they claim, the line will help non-Virginia utilities take advantage of the state’s lax regulatory climate to build "merchant" gas-fired generating plants. The purpose: to kick in during times of peak demand and generate electricity for sale out of state on the wholesale market. "Power companies like AEP are exacerbating an already bad situation to produce energy that might not even be needed here," says Dan Holmes, president of the Piedmont Environmental Council.

While Dominion Resources has or wants to build six gas-fired merchant plants mostly in the northern part of the state, a slew of non-Virginia utilities plan to build power plants in other regions of Virginia. Included on the list are Ohio’s Cinergy, Florida Power & Light and North Carolina’s Duke Energy. These gas-fired plants are essentially jet turbines that turn generators. While far less polluting than coal-fired power stations, and less potentially devastating than nuclear plants, these gas units still have drawbacks.

One spot where all the tensions seem to come together – the wish of a non-Virginia utility to generate and export power and the multi-faceted worries of the environmentalists and consumer groups – is at Jackson Ferry in Wythe County. Not only is it the terminus of the disputed 765-kilvolt AEP transmission line, it is the locus of a new, 620-megawatt gas turbine merchant plant that Duke Energy North America intends to build. Charlotte, N.C.-based Duke, which is erecting gas plants across the country, wants to put a $250 million plant on the New River. Duke does not need permission from state regulators to build its plant — only local zoning approval and the okay of the state Department of Environmental Quality. The Jackson Ferry site offers a lot for Duke, such as easy electrical transmission to Midwest markets, ample water and relatively easy environmental regulation.

Indeed, the project is so important for Duke Energy that another one of its units, Houston-based Duke Energy Gas Transmission, is extending a gas pipeline to the site to provide fuel for it. The 95-mile line will transport up to 200 million cubic feet of gas per day from Tennessee to southwest Virginia. While the merchant plant appears to be the motivation for the gas pipeline, Duke officials say it will also serve Virginia.

Environmentalists complain Duke’s merchant gas plant will have an adverse affect on the New River and its plant and animal life. "One of the things that bothers me is that this plant isn’t going to serve this area," says Sister Clare McBrien, a Roman Catholic nun who operates Appalachian Office of Justice and Peace, a social activist group associated with the Diocese of Richmond, in nearby Wytheville. Sister McBrien notes that while the plant will hire several hundred people in the construction phase and help the poor region, it will be operated only by a handful of permanent workers and won’t contribute much to the local labor force.

Yet, as they plan for the unknowns of the deregulated world, utilities are being forced to move ahead with matters even more critical to their survival. There are huge risks involved as they remake themselves from top to bottom. For big, capital-intensive ones such as Dominion and AEP, the invisible hand of the market could be very unforgiving. For them to stay profitable, they must produce power cheaply and find easy ways to transport it efficiently. If their power stations are poorly run, market forces will punish them quickly and painfully. Under regulation, poor managers could skimp by. The new risks for utilities are underlined boldly in California. There, Pacific Gas & Electric, a major utility, has filed for bankruptcy. It took a financial drubbing because it had to buy enormous amounts of high-priced power out of-state but wasn’t able to recoup those expenses in its billings.

Motivated by fear, and by opportunities for healthy profits, utilities such as Dominion are moving forward. Dominion geared up for trading by opening its trading floor in 1995 and now puts so much importance on it that it plans to move it into even flashier digs at the company’s headquarters in downtown Richmond near the famed site of the Tredegar Iron Works. Dominion’s trading operation even today is the fifth largest in the country and last year, it made a hefty $100 million before taxes, says Capps.

Wall Street is taking special notice of those utilities it deems are the better prepared for deregulation. It is dividing them into lists of those ready and those not. Wall Street analysts from Credit Suisse First Boston, for example, have dubbed Dominion and American Electric Power, "New Economy" utilities that are becoming "knowledge-based, dynamic competitors" which have grown beyond being "regulated monopolistic-based." These utilities are moving swiftly to dump their old-style hierarchical corporate structures in favor of decentralized, market-based ones. "They have prepared themselves for dereg by hiring top-notch brokers, wired them with the latest information technology hardware and software," says an analyst who helped draft the report.

If done correctly, deregulation could indeed prove an enormous windfall for utilities and their shareholders. Yet, there are tremendous risks and public policy issues that still must be addressed. Virginia appears to be making a wise choice in going about deregulation in a measured, gradual way. But the power industry is the biggest yet to undergo deregulation and the stakes are huge. Too many stumbles could mean brownouts everywhere.

Return to Virginia Business - August 2001