Virginia Power appreciates the opportunity to provide its views on "best model" for the transition to competition in Virginia. SB 688 provides a basic framework for future comprehensive legislation to bring competition to Virginia.

It is extremely important that this legislation provides the appropriate degree of specificity for each component that it addresses. The challenge is to provide enough detail to effectively guide the process, yet reserving sufficient flexibility where needed.

Our comments follow the outline format as of SB 688 provided by the staff of the Legislative Services Division in their memorandum dated May 29, 1998.

§ 56-578. Applicability; municipalities

Basic Issue: The treatment of municipally-owned and operated electric utilities under a comprehensive restructuring act.

Municipally owned or operated electric utilities should, at the discretion of their local governing bodies, have the opportunity to participate in a competitive retail market. If a municipally owned or operated electric utility opts to market its electric energy to retail customers outside of its distribution service territory, other suppliers of electric energy should be permitted to market electric generation to the municipal's retail customers.

• Determination of whether all sales must be made through RPX.

Virginia Power believes that wholesale transactions by municipalities may be made through the RPX(s) or via bilateral contracts, subject to the rules and procedures adopted by the ISO(s).

§ 56-579. Schedule for transition to retail competition; Commission authority.

Basic Issue: The timeline and structure of transition to retail competition, including timelines, SCC oversight, rate cases, linkages to ISO/RPX formation

• Commencement of competition; phase-in (e.g., PA), or concurrent commencement for all customer classes (e.g., CA).

Virginia Power believes that a phase-in of competition, by approximate customer class stages, is the most effective method of implementing competition. Initially, the industrial class of customers could be open to competition on January 1, 2002, followed by the commercial customers on January 1, 2003, and the residential customers on January 1, 2004. While there are other possible methods to phase in competition, this one has certain advantages. Each class of customer has unique characteristics for which allowances will need to be made. Bringing competition to each class on an individual basis allows the suppliers, incumbent utility and local distribution company the opportunity to focus on and address these unique characteristics. In addition, this sequence starts with the smallest group, which requires the lowest infrastructure investment, rather than incurring the greatest information technology costs at the front-end, which would be the case if residential customers went into competition first. It also begins competition with the group that can best manage any risks associated with the transition. This helps preserve reliability for all as the transition proceeds.

• Relationship between commencement of retail competition and completion of ISOs and RPXs.

House Bill 1172 provides in § 1 that the ISO(s) and RPX(s) that will serve the Commonwealth will be in place by January 1, 2001. This bill also states in § 2 that the transition to retail competition will commence on January 1, 2002. This relationship between retail competition and the completion of the ISO(s) and RPX(s) is appropriate and allows a margin of time throughout 2001 to get the ISO/RPX(s) fully operational and approved by FERC.

• Relationship between commencement of retail competition in Virginia and similar commencement in other states served by the ISO(s) serving Virginia.

There should be no real tie between the commencement of retail competition in Virginia and other states served by the ISO(s) and RPX(s). The type and timetable of implementation by each state may vary significantly, especially with regard to customer phase-in and transition periods. ISO/RPX governance will address these interstate variations. The Commonwealth, however, should continue to encourage regional participation in ISO/RPX activities.

• Authority, if any, of Virginia State Corporation Commission to vary time schedule.

HB 1172 sets appropriate dates for transition to retail competition, and future legislation should define and determine the details of this process. The SCC should have authority to vary the date of implementation of retail competition for industrial and commercial customers due to FERC action or inaction and any proceeding pending before the Supreme Court of Virginia.

In addition, the SCC should have the authority/ability to vary the schedule or withhold customer choice for residential consumers, if it is found to be in the public interest to do so, which may include consideration of any unresolved market power issues.

• "Baseline" rate cases.
• Rate freezes in mitigation of stranded costs.

Each utility may utilize existing statutes in filing rate cases for the period prior to the transition to competition. In Virginia Power's case, the SCC staff, the Attorney General's office, and other stakeholders have agreed to a proposed settlement in Virginia Power's rate case. With this proposed settlement, customer rates would be essentially set into the transition period (rate freeze until March 1, 2002). On January 1, 2002 transition to retail competition, per HB 1172, is scheduled to commence. This settlement is pending approval by the Commission.

The above-mentioned proposed settlement also provides for the accelerated amortization of regulatory assets. Specifically, any earnings above a benchmark will be allocated 1/3 to shareholders and 2/3 to the accelerated amortization. It is important that future legislation be consistent with the outcomes of action which has occurred.

Transition plans, as called for in SB 688 should be required to provide for rates during the transition period.

• Preliminary wholesale competition.

In accordance with HB 1172, in 2002, when the transition to competition commences, deregulation of generation will take place. When deregulated generation is bid into the competitive market, it will effectively implement wholesale competition for the supply of electricity to all retail customers in the Commonwealth. This will bring the benefits of competition even to those customers for which choice has not been implemented.

• Unbundling

The unbundling of rates should take place with the initial implementation of retail competition in 2002 as provided for in House Bill 1172. With the advent of retail competition, delineation of generation and distribution charges will be necessary. The generation charges would be subject to market conditions while the distribution charges would continue to be regulated. Further, the provider of these items may or may not be separate entities.

• Pilot Programs

SB 688 does not need to address pilot programs. The SCC has issued an order in case no. PUE980138 that requires Virginia Power and AEP to implement retail access pilot programs. Both utilities are developing their proposed programs for consideration by the SCC.

§ 56-580. Nondiscriminatory access to transmission and distribution systems.

Basic Issue: Access by electricity suppliers to transmission and distribution systems currently owned and operated by incumbent utilities.

• Delineation of jurisdictional limitation of both SCC and FERC.

The Federal Power Act of 1935 established FERC's jurisdiction over interstate transmission, while reserving to the states jurisdiction over facilities used in local distribution. SB 688 should reiterate this principle and specify that any matters relating to transmission and distribution access, not expressly under federal jurisdiction should come under the regulation of the SCC.

In addition, HB1172 envisions SCC involvement in the process of ISO/RPX formation.

• Transmission import constraints, and impact on market power.

The development of the electric utility industry in the regulated monopoly environment required that utilities prudently plan and construct facilities that most efficiently served their "native" load (i.e., the load in their prescribed service territory). Transmission interconnections were primarily constructed for grid reliability purposes. The prospect of using transmission for true interstate commerce is a relatively recent development. Thus, occasional import/export constraints on the interfaces should be expected. The import/export capacity for Virginia is comparable to that for most states and regions across the nation.

It must be reiterated that any potential import/export constraints on the transmission system are physical in nature and that the financial transactions associated with potential market power are not necessarily bound by just these physical limitations. Before market power for a particular utility can be determined, the operational market for that utility must first be defined.

The ISO(s) and RPX(s) that are established to serve the Commonwealth will transcend state boundaries. Because of this the market for generation will be expanded. Also, because of FERC's Open Access Transmission Tariff (OATT) and the principle that the ISO(s) will not give preferential treatment to any party while administering the transmission system, the opportunity to exert market power will be eliminated. To the extent that transmission constraints contribute to market power issues, the SCC should be able to consider this in determining the timing of residential customer choice.

• Regulation of transmission rates where transmission constrained until constraint relieved.

FERC has regulatory jurisdiction (OATT) over the interstate transmission system. The ISO will neutrally administer the system and the SCC has oversight on the siting and determining need for new transmission lines provides the framework for the regulation of transmission rates and mitigating, in the long-term, transmission constraints for import/export. FERC will regulate transmission rates, regardless of whether constraint exists. The transmission rates are likely to be based upon historic cost plus a return.

Generators will not be allowed to extract monopoly profits. FERC will not approve market-based rates until the constraint is relieved.

§ 56-581. Independent system operator.

Basic Issue: The role of regional independent system operators (ISOs) in furnishing generation dispatch coordination.

The purpose of an ISO is to coordinate the operation of the transmission system to ensure its reliability. The ISO will coordinate the commitment and dispatch of generation only to the extent necessary to fulfill that role.

While the following representative issues are important to the development of ISOs, many of them are not directly related to the basic issue as defined above.

• ISO governance; board membership composition.

ISO governance structures should support the consistent delivery of fair, non-discriminatory and comparable access to all users of the transmission system. Such governance structure is likely to take the form of an independent board, with an appropriate mechanism to ensure stakeholder input and/or representation. The governance structure should not be so rigid as to preclude the evolution of the ISO as changes in the industry occur over time. Both the operating policies and ISO governance structure are subject to FERC approval prior to initiation of the ISO. Because the FERC approval process provides a forum to address governance issues, they should not be addressed in legislation.

• Conformity of ISO(s) to a Virginia "public interest" standard, or to any other Virginia-specific standards.
• Extent of Virginia oversight of ISO following formation and approval of electricity dispatch in Virginia through ISO; ceding oversight to FERC.

Prior to formation of the ISO(s), the state, through the SCC staff, will have the opportunity to provide significant input into the development of these entities. The SCC staff is today involved in informal talks with the Midwest ISO, the PJM ISO and the Alliance ISO and has indicated it intends to remain active as these ISOs move forward. The SCC has also ordered the Virginia utilities to report monthly about ISO developments so that it might stay apprised.

Subsequent to the formation of ISO(s) any new transmission facilities will still be subject to state certification and routing approvals by the SCC.

The SCC will have intervention before the FERC and investigative opportunities after the establishment of the ISO(s).

• Determining ISO responsibility for coordinating with load serving entities, voltage stability, generation reserves and overall generation and transmission upgrades and reliability.
• Identification and obligations of must-run units
• Dispatch of must-run units

The FERC Order No. 888 sets forth eleven principles addressing ISOs. Specifically, Principle No. 4 addresses grid reliability, Principle No. 6 requires the ISO(s) to identify constraints on the system and take operational action to relieve those constraints and Principle No. 11 calls for the ISO(s) to develop mechanisms to coordinate with neighboring control areas.

The ISO(s) must also identify and appropriately dispatch must-run units. Currently, utilities have self-defined must-run units which are based upon the configuration of their own system and generation technology. Formation of the ISO(s) may have no immediate impact on the dispatch of these units. However, the ISO(s) will have boundaries greater than any one utility's service territory. This, accompanied by competition, will result in a more efficient utilization of the transmission system, which in turn may result in a different definition of must-run units for each utility. This enhances overall generation efficiency.

• Minimum size requirements.

There is no specific minimum size requirement for the ISO(s). As the ISO(s) develop, they will also evolve. It is appropriate that in this section of SB 688 an ISO is allowed to merge with, join or cede its authority to a similar entity. The optimum size(s) for the ISO(s) that include the Commonwealth will naturally develop with the passage of time.

• Eminent domain and rights of condemnation.

Eminent domain and the rights of condemnation will remain with the state and utility. While the ISO(s) may work closely with both the state and utility in determining the needs and routes for additional transmission facilities, the state should, through the SCC, approve siting and the utility should exercise eminent domain.

§ 56-582. Regional power exchange.

Basic Issue: The role of regional power exchanges in providing electricity pricing mechanisms.

• Conformity of RPXs to a Virginia "public interest" standard.

HB 1172 calls only for the formation of the RPX(s). It is important that the legislation for the RPX(s) not be overly prescriptive. Once the RPX(s) is established, many of the policies and procedures will evolve and be modified based upon input and intervention by stakeholders and the applicable state commissions.

• Opportunities for bilateral contracts between suppliers and customers.
• Determination of whether all sales must be made through RPX.

Bilateral contracts are not prohibited in HB 1172. Legislation should be flexible enough to allow ISO/RPX systems and policies to evolve as needed.

• Relationship to electric cooperatives and municipal power suppliers.

Just as in the case of the ISO(s), all cooperatives and municipalities should be allowed to participate (i.e., bid into; purchase from; participate in governance) in the RPX(s). The participation of the cooperatives and municipalities may proceed on a different timeline than that of the IOUs and may be subject to other local or state regulation, but as not expressly prohibited by law, they should be allowed to participate.

• Pricing of generation from must-run units.

Rules of ISOs already in operation can provide guidance on appropriate control of must-run units (units required for voltage stability, system reliability, or other unique situations). FERC and ISO rules will prohibit must-run units from establishing market prices or exercising market power. Provision for control of must-run units must be part of the ISO filing submitted to FERC for approval. FERC will establish, for must-run units, rates based on costs, which include a reasonable return. Therefore, pricing of must-run units need not be addressed by state regulation.

§ 56-583. Transmission and distribution of electric energy.

Basic Issue: The regulatory and structural framework for electricity's transmission and distribution.

• Equality of treatment between incumbent utilities and new market entrants.

As stated in the Joint Memorandum in reference to supplier issues: "it must be undertaken to ensure that all elements are applied equally to any entities that supply or propose to supply electric energy to retail customers in the Commonwealth, regardless of whether such suppliers own or operate generation facilities or are located within or outside of Virginia." Virginia Power still endorses this philosophy. The playing field should truly be level for all participants with regard to the structure of the competitive environment.

• Continuation of eminent domain authority under SCC oversight.

The comments of the SCC staff to the FERC on 6/8/98 indicates that the SCC believes it will still have authority over new transmission facilities subsequent to the formation of ISOs and the advent of competition. Virginia Power concurs with that assessment.

• Siting of merchant plants and any other new generation; role for SCC.

Under the longstanding, regulated industry structure, any entity proposing to construct a plant for the sole purpose of generating electricity was required to obtain a certificate of convenience and necessity from the SCC before a plant could be constructed. In the competitive generation market, this should not be the case. Economics will be the driver of the "necessity" of a merchant plant. This does not mean that the state will lose authority over the siting of power plants or compliance with environmental regulations. The state and localities will still have significant authority in determining whether a particular location is appropriate for a merchant plant. In addition, any merchant plant must comply with applicable federal, state and local environmental requirements.

• Preservation of current IOU, cooperative and municipal power supply systems' distribution service territories.

As indicated in the Joint Memorandum, the distribution of electric energy by IOUs will continue to be regulated by the SCC, and exclusive distribution territories should be preserved.

§ 56-584. Regulation of rates subject to the Commission's jurisdiction

Basic Issue: Transitional and ultimate rate regulation for bundled and unbundled electric service.

• Determination of services subject to rate regulation, and those subject to competition.

Supply and generation of electricity should be the only areas of competition during the transition period. Transmission and distribution of electricity will remain regulated.

§ 56-585. Licensure of suppliers of retail electric energy; license suspension or revocation; penalties

Basic Issue: Licensing, financial responsibility and customer service requirements imposed on all suppliers of electricity within the Commonwealth.

The ability of a supplier to provide reliable electric service to their customer(s) is of paramount importance. To that end, it is the duty of the Commonwealth to ensure that all potential suppliers are duly licensed and able to perform the services for which they contract. Virginia Power believes that this regulatory duty is most effectively lodged with the SCC.

The type of oversight that would be required is not unlike that the SCC currently has with respect to banks, insurance companies, electric utilities and other entities.

§ 56-586. Suppliers of last resort [and default suppliers].

Basic Issue: Determining the generation suppliers of electricity customers who (I) are unable to obtain generation supply services, or (ii) do not affirmatively choose generation suppliers.

• Backstop providers where contract suppliers fail to deliver generation supply.

In Virginia Power's June 10, 1998 comments to the SJR 91 Task Force on Structure and Transition, the company stated that the incumbent utility should be the supplier of last resort and also serve as the default supplier. It is also Virginia Power's position that the incumbent utility should also be the "backstop provider" for those customers of suppliers that fail to deliver. Having the incumbent utility as the supplier of last resort, default supplier and the backstop provider ensures continuity of reliable electric service and provides a needed level of certainty during the transition to competition.

§ 56-587. Voluntary aggregation permitted.

Basic Issue: The framework within which individual electricity customers may aggregate demand in negotiating for generation supply.

Virginia Power believes aggregation should be allowed because it will allow smaller consumers to join together to gain leverage or "buying power" equivalent to that of larger customers.

§ 56-588. Metering, billing and other related distribution services.

Basic Issue: How billing, metering and related services will be handled and regulated.

• Determining whether any of these or any other distribution services should be provide on a competitive basis.

It is the position of Virginia Power that at the outset of electric competition, only the supply and generation functions should be competitive. This does not preclude other related services being subject to competition in the future. Initially introducing metering, billing and related services to competitive situations would add an unnecessary level of complexity to an already complicated process.

In addition, as stated in our comments to the SJR 91 Subcommittee Task Force on Structure and Transition on June 10, 1998, we agree with the 1997 SCC staff report (pages 42-43) that it is premature to determine which of these other services should be subject to competition.

It is important for any legislation passed be flexible in determining which services are or may be competitive and which are to remain regulated.

§ 56-589. Consumer protections and customer services; penalties.

Basic Issue: Maintenance of customer service functions during and after transition to retail competition, plus consumer information and disclosures during transition.

• Antitrust consideration.
• Runaway prices

[No response requested at this time; issue is before the Consumer and Environmental Education and Protection Task Force.]

§ 56-590. Public purpose programs.

Basic Issue: The establishment or continuation of public benefit programs, including universal service, energy efficiency and conservation, etc.

[No response requested at this time; issue is before the Consumer and Environmental Education and Protection Task Force.]

§ 56-591. Transition costs and benefits.

Basic Issue: Allowance for an calculation of stranded costs and benefits - an issue currently before the task force assigned this topic.

[No response requested at this time since the issue is currently pending before the Stranded Costs Task Force]

§ 56-592. Nonbypassable wires charges.

Basic Issue: The extent to which and the methods by which retail customers could be assessed pro rata surcharges for stranded cost recovery, the cost of establishing ISOs and RPXs, the cost to public purpose programs, etc.

Nonbypassable wires charges are an appropriate competitively neutral mechanism for the collection of stranded costs and other transition charges in a competitive environment.

Until recovery of stranded costs and transition costs are addressed by the appropriate task forces, Virginia Power believes that it is inappropriate to comment on the methodology for determining nonbypassable wires charges.

§ 56-593. Divestiture not required; functional separation [and other corporate relationships].

Basic Issue: Treatment of incumbent utilities' current vertically integrated structure.

• Divestiture to sufficient numbers of entities to create a competitive market.

As the Attorney General's office pointed out to the SJR 91 Subcommittee, requiring divestiture of generation will not necessarily result in mitigation of market power. It may just move the market power from one entity to another.

Virginia Power's stance on this issue is that any requirement for or prohibition of divestiture is inappropriate. In a sufficiently broad ISO/RPX market environment, this will not be an issue. In the Joint Memorandum of May 20, 1998 the major utilities in Virginia, representatives of the Cooperatives, and the Independent Power Producers all agreed that divestiture of generation should not be mandated.

• Separation of generation and distribution.

The functional separation of generation and distribution is an appropriate measure for legislation to address. It is our belief that this functional separation process will occur naturally with the establishment of the ISO(s) and RPX(s) and the deregulation of generation.

• Relationships between suppliers or distributors and their affiliates.

Related to the functional separation of generation and distribution is the issue of the relationship between affiliates. In the May 20 Joint Memorandum, the affiliate relationship is agreed to be a complex issue, but functional separation should adequately address the problem.

• Mergers and acquisitions.

Mergers and acquisitions in this evolving environment have taken place. Each of these has been viewed with close regulatory scrutiny (e.g., PEPCO and BG&E). Some of these mergers and acquisitions will be successful, others will not be completed. The regulatory bodies responsible for overseeing these mergers (i.e., SCC, FERC, NRC, Attorney General, Justice Department) are all paying close attention to activity in this area. Virginia Power believes that with this attention and existing anti-trust laws, mergers and acquisitions will only be consummated if they can successfully clear the many existing regulatory and legal hurdles and, is found to be in the public interest.

§ 56-594. Legislative transition task force established.

Basic Issue: The role of the General Assembly during phase-in to retail competition.

Virginia Power supports the establishment of a transition task force during this transition to a competitive industry. This proposed task force will be extremely valuable in working with the industry and regulators in guaranteeing that the development of a competitive electric industry is successfully completed consistent with the legislative direction established by the General Assembly. In addition, the task force will serve as an important liaison to the General Assembly during the transition.

Basic Issue: Striking a competitive balance between incumbent utilities and new market entrants.

• Mitigating market power associated with existing generation.

As the competitive market unfolds, utilities should be able to sell generation at competitive wholesale prices. Before a utility is able to sell at competitive wholesale prices within its own service territory, the FERC must approve market-based rates. In order to receive approval for this, the utility must be able to demonstrate a lack of market power. In order to do this, it must show that it:

1. does not dominate the generation of power in the relevant market

1. lacks the ability to block buyers from reaching other sellers using transmission facilities which it owns or controls; and

1. cannot erect or control any other barrier to market entry.

The emergence of additional privately owned generation will contribute greatly to robust competition. As demonstrated in New England (where merchant plants being proposed or built represent a 40% increase in the region's capacity), Virginia Power anticipates an influx of merchant plants with the advent of a competitive marketplace and the deregulation of generation in 2002.

The IOUs cannot block entry by merchant plants through exercise of vertical control of the industry. They do not own or control any of the generation equipment suppliers. They do not control the fuel suppliers or the transportation systems for bringing the fuel to the plants. In order to erect barriers, the IOUs would need to have the ability to do so.

The measures outlined above should prevent any instances of market dominance. However, the SCC should have the authority to delay residential customer choice if market power has not been sufficiently mitigated.

• Market power impact of existing generation sites as candidates for new incremental generation.

Although Virginia Power and the other IOUs own sites that are suitable for new generation, these utilities do not own all possible sites for generation. Non-Utility generators have existing sites, which may be utilized for additional generation. As generation technology advances, many sites that have been, in the past, considered unsuitable for generation may have great potential as generation sites. These sites may provide great opportunity for merchant plants.

• Competitive advantages associated with ownership of SO₂ allowances and the ability to generate NO_x offsets necessary to build generation in non-attainment areas.

Virginia Power has "scrubbed" and is planning to "scrub" flue gases from several of its older coal units in order to comply with acid rain regulations regarding SO₂ emissions. Many of the allowances gained from the scrubbing of these units are used to displace the emissions on other coal units. There is also a ready market in SO₂ allowances from which any potential new entrant can purchase allowances. Thus, Virginia Power gains no competitive advantage via SO₂ allowances, the price and availability of allowances is determined by the nationwide allowance trading market.

With the development of combined cycle generation plants and technological advancements in scrubber technology new market entrants may actually have a slight competitive advantage from an environmental compliance standpoint. Combined cycle generators allow for the use of multiple fuels and also produce cleaner emissions than older pulverized coal units. In addition, advancement in the scrubber technology has resulted in lower cost of new SO₂ reduction facilities in existing plants, which in turn helps to lower the cost of allowances in the marketplace.

• Competition for default service.

In comments presented to the Structure and Transition Task Force on June 10, 1998, Virginia Power indicated that during the transition to competition the default provider should be the incumbent utility. As was stated in those comments, having the incumbent utility function as the default provider provides a needed level of certainty and minimizes the customer's risk.

• Implication of long-term contracts between incumbent utilities and existing customers prior to commencement of retail competition.

Virginia Power's long-term contracts consist primarily of wholesale contracts to the cooperatives and retail contracts to the counties and municipalities. These contracts are actually somewhat short-term (e.g., county & municipal agreement is renegotiated every three years).

There are also long-term contracts for the recovery of excess distribution facilities. These contracts should remain in effect with the advent of retail competition, since they are not an obligation to purchase generation service beyond the implementation of retail competition.