DIRECT TESTIMONY OF DAVID A. HEACOCK ON BEHALF OF VIRGINIA ELECTRIC AND POWER COMPANY BEFORE THE STATE CORPORATION COMMISSION OF VIRGINIA CASE NO. PUE-2009- 1 Q. Please state your name, position, business address and professional 2 background. 3 A. My name is David A. Heacock, and I am President of Dominion Virginia Power, 4 a functional operating division of Virginia Electric and Power Company. My 5 business address is 120 Tredegar Street, Richmond, Virginia 23219. My 6 background and qualifications are detailed in Appendix A to this testimony. 7 Q. What are your responsibilities as President of Dominion Virginia Power, and 8 in what previous capacities have you worked for Virginia Electric and Power 9 Company? 10 A. I manage the regulated transmission, distribution, and customer service operations 11 of Virginia Electric and Power Company ("Dominion Virginia Power" or the 12 "Company"), a public utility regulated by the State Corporation Commission (the 13 "Commission") providing electricity service to approximately 2.4 million homes 14 and businesses from northeastern North Carolina to Northern Virginia. The 15 Company's Virginia service territory comprises approximately 65% of the 16 Commonwealth's total land area and accounts for over 80% of its population. 17 Dominion Virginia Power's electric generation fleet consists of over 18,000 MW 18 of generating capacity, transmitted over approximately 6,000 miles of 19 transmission lines and 56,000 miles of distribution lines. I spent over 28 years 1 working on the generation side of the Company's business before assuming my 2 current position. 3 Q. What is the purpose of your testimony in this proceeding? 4 A. I am testifying in support of the Company's response to the Commission's orders 5 in Case No. PUE-2009-00002, initiating a review of the Company's rates, terms 6 and conditions as required by § 56-585.1 A of the Code of Virginia ("Va. Code") 7 (the Company's "2009 Rate Case Filing" or "Filing"). I provide an overview of 8 the Company's Filing and explain why it is essential for the Company to obtain 9 the rate relief it is requesting. 10 Our Filing demonstrates that because of the increased costs of providing our 11 services since our last general base rate increase in 1992, the Company's 12 combined rate of return on common equity ("ROE") on its generation and 13 distribution services, based on a 2008 test year adjusted as permitted by law, is 14 more than 50 basis points below a fair combined rate of return as determined 15 pursuant to § 56-585.1 A. The Company therefore requires an increase in its rates 16 that will provide it with the opportunity to recover its costs of providing safe and 17 reliable service to its customers. Specifically, based on an adjusted 2008 test year, 18 the Company has a total revenue requirement including fuel of approximately $6 19 billion, which represents an increase in its jurisdictional base rates of $298 million 20 over present total revenue of $5.7 billion, or a 5.2% increase in its total annual 21 operating revenue, including fuel. The annual revenue requirement calculation in 22 this case is supported principally by Company Witness M. Stuart BoIton, Jr. and 2 1 is shown on Company Exhibit No. _ , MSB, Schedule 3 attached to Mr. 2 Bolton's testimony. 3 Q. What Company witnesses are filing testimony in this case? 4 A. The Company is presenting the following witnesses: 5 I provide an overview of the Company's Filing and why it is crucial for the 6 Company to obtain the rate relief it is requesting. 7 Thomas N. Chewning, Executive Vice President and Chief Financial Officer, 8 explains why the Company must attract sufficient equity capital at a 9 reasonable cost to meet our customers' current and future demand for 10 electricity. He discusses why the Company's ROE serves that end. 11 Marc P. Zenner, Ph.D., Managing Director, Capital Structure Advisory and 12 Solutions group for J.P. Morgan Securities Inc., will present a capital markets 13 report on the dramatic changes in the global capital markets since the summer 14 of2007. 15 Robert S. Harris, Ph.D., the C. Stewart Sheppard Professor at the University 16 of Virginia's Darden School of Business and a consultant in the area of 17 finance, estimates the Company's cost of equity and provides a 18 recommendation on that rate for the Commission's consideration. 19 David A. Christian, President and Chief Nuclear Officer-Dominion Nuclear, 20 discusses the Company's development of new generation resources to support 21 its growing load obligations, along with the substantial capital needs 22 associated with these projects. He then presents the generating plant 23 performance criteria associated with the Company's requested performance 24 incentive and describes the relevant performance of the Company's generation 25 fleet. 26 Thomas R. Bean, Vice President of Financial Management, discusses the 27 infrastructure and associated capital requirements of our transmission and 28 distribution business areas over the coming years in order to meet the 29 Company's service obligations, and then presents the support, along with Mr. 30 Christian, for the Company's request for a performance incentive in this 31 proceeding. In particular, he focuses on the operating efficiency and customer 32 service criteria under Va. Code § 56-585.1 A related to retail distribution 33 activities and our performance over the relevant period, compared to 34 nationally recognized standards for such performance. 35 Shannon L. Venable, Vice President of Integrated Resource Planning, 36 explains Dominion Virginia Power's integrated resource planning process and 37 provides an overview of the Company's Demand-Side Management ("DSM") 3 1 programs and of the Company's use of Advanced Metering Infrastructure 2 ("AMI") technology. 3 Patrick L. Baryenbruch, President of Baryenbruch & Company, LLC, presents 4 the results of his study, which evaluated and confirmed the reasonableness of 5 costs for services provided by Dominion Resources Services and other 6 affiliates to Dominion Virginia Power during the 12 months ended December 7 31,2008. 8 Andrew J. Evans, Managing Director of Cost Allocation and Policy, presents 9 the various jurisdictional, functional and class cost of service studies included 10 in our Filing and explains the cost allocation methods by which they were 11 developed. 12 M. Stuart Bolton, Jr., Senior Vice President of Regulatory Accounting, 13 presents the calculation of the increase in the Company's revenues required in 14 this case to provide the Company with the opportunity to recover its costs of 15 providing service and to earn a fair combined ROE for its generation and 16 distribution services, based on an adjusted 2008 test year, the determination of 17 the Company's "peer group" of investor-owned electric utilities and the ROE 18 "peer range" as established from that peer group. 19 20 Julius M. Griles, Jr., Manager of Electric Distribution Design, presents the 21 Company's proposed line extension plan that will expand the utilization of 22 underground lines for new services and enhance the opportunity to convert 23 overhead service feeds to underground for existing residences. 24 David F. Koogler, Director of Rates and Load Research, describes the 25 Company's proposed changes to its Rate Schedules and Terms and Conditions 26 for the Provision of Electric Service, and also introduces new voluntary 27 dynamic pricing tariffs for residential, commercial and industrial customers. 28 Q. Do you have any preliminary comments regarding this Filing? 29 A. The Company faces a multitude of challenges in the years ahead to succeed in 30 meeting our customers' increasing demand for electricity and providing it in a 31 reliable, cost-effective and environmentally responsible manner. Specifically, the 32 Company must fund the enormous costs of additional infrastructure in all facets of 33 its operations - generation, transmission and distribution - to meet its anticipated 34 load growth and to protect customers from short and long-term pricing risks. 4 1 Virginia currently imports more power from the wholesale market than any state 2 in the country, except California. Continued, or increasing, reliance upon 3 imported power subjects our customers to risks of congestion on the transmission 4 system, substantial price increases, price volatility and reliability concerns. In 5 2007, the Virginia General Assembly enacted a regulatory construct for the 6 Commonwealth's electric utilities designed to reduce long-term reliance upon 7 imported electricity (the "2007 Act"). Our long-term planning will always have at 8 its core the goal of delivering to our customers excellent service at reasonable 9 costs. In contrast to the outcomes we have all witnessed in California, Illinois, 10 Maryland and elsewhere, where prices became uncontrollable, this new regulatory 11 structure largely protects our state from such effects as long as the Company is 12 able to build and operate our own units, which are diverse with respect to size, 13 location, fuel and dispatch factors. Simply put, we plan to continue to take 14 advantage of marginal cost opportunities in the wholesale market when they 15 benefit our customers, but being reliant upon those markets is a result we believe 16 the General Assembly sought to guard against in the 2007 Act. 17 Q. Please discuss key components of the Company's infrastructure needs. 18 A. The Company's service territory lies in one of the fastest growing regions in the 19 country. Virginia's economy has consistently out-paced the national economy 20 over the past 20 years. In 2009, Dominion Virginia Power projects connections to 21 more than 30,000 new customers, even with the current economic downturn. As 22 Company Witness Christian relates, the 2009 Load Forecast Report released by 23 PJM Interconnection, LLC ("PJM") on January 22,2009, provides strong 5 1 evidence that Virginia will continue to experience significant electric demand 2 growth well into the next decade. 3 Historically, peak demand grew more than 3,800 MW over the 10-year period 4 from 1998 to 2008, representing an annual average growth rate of2.3% in the 5 Dominion Zone ("DOM Zone"), representing the majority of electric load in 6 Virginia. The PJM 2009 Load Forecast Report, which Mr. Christian discusses, 7 forecasts an increased demand of approximately 4,600 additional MWs during the 8 next decade (2009 to 2019) in the DOM Zone, representing an annual average 9 growth rate of2.2%. As of the summer of2009, the Company will own or 10 control approximately 18,182 MW of generation dedicated to serving our Virginia 11 and North Carolina customers. Obviously, the Company has a responsibility not 12 only to serve these loads, but it must in addition maintain an adequate reserve 13 margin. That margin is now 15.0 % for this year, and it grows to 15.5% in 2010 14 for PJM' s Installed Reserve Margin. 15 The Company's provision of reliable electric service to operations that are central 16 to the nation's security should not be overlooked. In 2007, the Department of 17 Energy ("DOE") established two National Interest Transmission Corridors based 18 upon its assessment of risks to national defense and homeland security, national 19 energy independence and the economic vitality of the region. One of the 20 designated corridors, the Mid-Atlantic Area National Interest Electric 21 Transmission Corridor, is located in PJM and includes the Washington, DC and 22 Northern Virginia markets. In making this designation, the DOE explained: 6 1 The Mid-Atlantic Critical Congestion Area is home to 55 2 million people (19 percent of the Nation's 2005 population) 3 and is responsible for $2.3 trillion of gross state product (18 4 percent ofthe 2005 gross national product). Given the 5 large number of military and other facilities in the Mid- 6 Atlantic Critical Congestion Area that are extremely 7 important to the national defense and homeland security, as 8 well as the vital importance of this populous area to the 9 Nation as an economic center, any deterioration of the 10 electric reliability or economic health of this area would 11 constitute a serious risk to the well-being of the Nation. 12 72 Fed. Reg. 25,838, 25,896 (May 7, 2007) (internal footnote omitted). 13 The Company's responsibility to serve this particular region's growing need for 14 power (as well as vital needs in other areas of our service territory) places 15 tremendous importance on planning, construction, customer service and funding 16 in all major areas of our operations - generation, transmission and distribution. 17 Each of these components of an integrated system must necessarily adopt a long- 18 term perspective. Each regulatory proceeding should be viewed with an eye 19 toward achieving far-reaching goals and not solely with a view of the immediate 20 horizon. We believe it would be short-sighted to regard this pending rate review 21 as relating only to the Company's proper rate levels from now until the next 22 occasion for those rates to be reviewed. As Mr. Chewning will testify, decisions 23 made in, and resulting from, this case will set the tone and lay the groundwork for 24 how this Company will fund its operations for years to come. Based in large 25 measure upon the outcome of this proceeding, the capital markets, broadly 26 defined, will, by its actions, quickly declare how it intends to price the Company's 27 future capital funding requirements. 7 1 Q. What are the Company's plans for meeting its long-term infrastructure 2 demands? 3 A. The Company plans to construct a combination of baseload, intermediate and 4 peaking plants with carefully considered sizes, in-service dates, fuel types and 5 locations, as well as new DSM programs, and to commit significant capital on the 6 transmission and distribution side. Company Witnesses Christian and Bean 7 describe these extensive plans in more detail in their testimony and the billions of 8 dollars those plans will entail. Mr. Chewning testifies that the Company must 9 have access to capital at a reasonable cost in order to implement this plan, and 10 explains why we must attract new equity capital at the most opportune times and 11 in the amounts necessary if we are to maintain critical investment grade ratings. 12 In addition, Mr. Chewning testifies about the relationship between these 13 investment grade ratings and the costs borne ultimately by customers. He then 14 explains why the ROE Commission determines in this proceeding is the most 15 significant factor in the Company's preparation of its financial plans. 16 Significantly, and as Company Witnesses Christian and Bean explain, the 17 Company's planned capital expenditures for generation total approximately $1.8 18 billion, $1.4 billion and $1.6 billion in 2009, 2010 and 2011, respectively. That is 19 a three-year total of approximately $4.8 billion. For transmission and 20 distribution those numbers are approximately $0.9 billion in each of those same 21 three years, or approximately $2.7 billion in total for 2009-2011. Roughly $3.7 22 billion of these short-term capital expenditures are included in the Company's 23 base cost of service over the coming rate period. The Company's long-term 8 1 capital requirements for generation, transmission and distribution for the period 2 2012 to 2018 are expected to total an additional approximately [BEGIN 3 CONFIDENTIAL] .[END CONFIDENTIAL] Over the entire 10- 4 year period (2009-2018), capital needs are projected to approach [BEGIN 5 CONFIDENTIAL] _ [END CONFIDENTIAL]. 6 This long-term plan places an emphasis upon Company-built and Company- 7 owned generating plants. As noted, market purchases, generally to address short- 8 term needs, will be made when they are cost-effective. This focus on construction 9 and ownership of our own generation is fully consistent with the view of Virginia 10 utilities as vertically-integrated, regulated entities - a view endorsed by the 2007 11 Act. This approach will promote reliable and stable power supplies, from a 12 diversified portfolio of plants employing a proper mix of fuel sources, with long 13 service lives, along with the extra benefits of greater cost control and 14 predictability - all of which will result in less financial and operational risk for 15 our customers. Furthermore, this plan will greatly assist the Company in 16 mitigating the risks of transmission system congestion and price volatility that 17 comes with increased reliance on purchased power. 18 Moreover, this flexibility and diversity will be important in helping our Company 19 manage the inevitable future costs associated with climate change legislation. 20 That legislation will likely affect all types of generation plants, regardless of their 21 ownership status. We believe our customers' best hope relies upon our Company 22 managing and planning for this new responsibility. 9 1 Q. Mr. Heacock, with that general background, what are some of the specific 2 factors that drive the Company's need for rate relief for the rate period from 3 now until the first biennial rate review in 2011 ? 4 A. Prior to the rate adjustment clause ("RAC") that took effect on January 1, 2009 5 related to the Virginia City Hybrid Energy Center ("VCHEC"), our customers' 6 base rates had not increased since 1992. In fact, there was a refund of $150 7 million and a two-phased base rate reduction resulting from a Stipulation 8 approved by the Commission in Case No. PUE-1996-00296. The first reduction 9 was $100 million per annum beginning March 1, 1998, followed by an additional 10 $50 million per annum reduction beginning March 1, 1999. After the second 11 phase of the reduction took effect, rates were then frozen until March 1, 2002. 12 Subsequent to this rate freeze, rates were capped under action taken by the 13 General Assembly. 14 Quite obviously, costs in virtually all areas of our operations have increased 15 substantially from 1992 to 2008, as evidenced by the 48.15% increase in the 16 Consumer Price Index for All Urban Consumers ("CPI-U") in that time. Our 17 customers' base rates, though, have remained the same. On an inflation-adjusted 18 basis they are actually down 36.55%. At the same time, we have added 19 approximately 714,000 new customers to our system, and electricity usage per 20 residential customer has also increased by 12.05% (non-weather-normalized). 21 Our system has kept pace with this demand at significant expense. 22 During this time, the Company managed, among many other items, a 3.5-year 23 period of unrecovered increases in fuel expenses, damages from major storms, 10 1 environmental upgrades and settlements, reactor vessel head replacements at 2 Surry and North Anna Power Stations, other power station upgrades, and 3 substantial increases in expenses related to payroll, taxes, health care benefits and 4 other administrative costs. Yet, because of the capped rate provisions of prior 5 law, none of these events or expenditures resulted in base rate increases to our 6 customers until the VCHEC RAC. The enactment of the 2007 Act, which are the 7 impetus for this proceeding, was timely, because rate relief is needed if the 8 Company is to recover its reasonable costs of service. 9 It is plain that the costs of operating the Company for the benefit of our 10 customers, as explained in detail by Company Witnesses Bolton and others, are 11 higher now than our existing rate levels will support. Those costs will continue 12 that upward movement in the future. While it is true that recovery of some 13 significant categories of these costs can be sought through the new RAC 14 mechanisms of the law, there are still large amounts of capital costs (providing 15 not only for new growth, but also maintenance and uprates of our systems), as 16 well as expenses, that do not flow through the RACs and that must be covered 17 through base rate revisions. 18 This Filing will address our base cost of service through November 2011, a nearly 19 three-year planning horizon that will see a substantial need for increased capital 20 and operating funds, based on reasonably predictable cost levels during that time. 21 For example, Mr. Christian will describe projected expenditures included in base 22 cost of service for peaking and uprate projects that are expected to total $545 11 1 million between 2009 and 2011. These expenditures reflect the Company's 2 efforts to increase the capacity of its existing generating units over the past 3 several years, and through 2011 they will add over 1,000 MW of available 4 generation resources to our portfolio. Additional generation-related maintenance, 5 environmental and other capital expenditures included in base cost of service are 6 projected at $1.56 billion over the 2009-2011 period. These base rate capital 7 requirements are over and above specific projects, such as needed new baseload 8 and intermediate capacity power stations and DSM programs, which may be 9 eligible for RAC treatment. 10 For the same planning horizon, Mr. Bean will address the fact that, between now 11 and the end of2011, the Company expects to connect approximately 90,000 new 12 customers. This system growth will require continuing distribution infrastructure 13 growth and maintenance capital expenditures of an additional $1.6 billion that 14 must be covered by base rates. These capital requirements to meet customer 15 demand and service needs will be accompanied by increases in a large number of 16 other specific cost categories, discussed by Company Witness Bolton, such as 17 depreciation expense, employee salary and benefit increases, property taxes, debt 18 service costs, and other normal operating expense increases over this three-year 19 horizon. 20 Also, as discussed by Company Witnesses Evans and Bolton, the Company's 21 existing contract for supplemental sales with Old Dominion Electric Cooperative 22 will expire on December 31, 2009, resulting in a need to recalculate Virginia 23 jurisdictional allocation factors to reflect this loss ofload effective January 1, 12 1 2010. Another significant adjustment is related to investments and upgrades in 2 new distribution technology, including deployment of AMI discussed specifically 3 by Company Witness Shannon L. Venable, and the accelerated depreciation of 4 existing meters associated with this initiative, as discussed by Mr. Bolton. There 5 are also adjustments for increases in the nuclear refueling outage schedule for the 6 rate period compared to the test year. 7 In short, significant cost factors such as those above, and many others, are the 8 driving forces behind the revenue requirement in this case. Mr. Bolton and other 9 Company witnesses will discuss in detail the basis for these individual 10 adjustments, as well as the development of our cost of service statements in 11 general. 12 Q. After providing for sufficient revenues to cover these capital and operating 13 cost levels, what ROE does the Company propose in this case? 14 A. As Company Witnesses Harris and Chewning will testify, the Company's cost of 15 equity is 12.5%. The Company also proposes an additional 100 basis point 16 performance incentive in recognition of its high levels of performance, as 17 discussed by Company Witnesses Christian and Bean. 18 Q. Do you have any concluding remarks? 19 A. Yes. This Company is committed to meeting its public service obligation to 20 provide excellent, reliable and environmentally responsible electric utility service 21 to this Commonwealth at fair and reasonable rates, and we believe that we do it 22 better than anyone in the business. Fulfilling this obligation to our customers 13 1 requires expertise and experience in engineering, finance and a range of many 2 other disciplines. It also depends upon cooperative and supportive relationships 3 with regulators, investors, and creditors. In this regard, the Company respectfully 4 requests the assurance it vitally needs from this Commission that the spending and 5 capital investment program that Dominion Virginia Power proposes for the long- 6 term future will be appropriately supported through regulatory actions. In 7 particular, we urge the Commission's approval of the Company's proposed 8 revenue requirement in this proceeding, based on our cost of service statements, 9 as well as the adoption of a fair ROE. 10 Some participants in this case will undoubtedly advocate for a short-term 11 approach, always with an eye to paring returns to their lowest levels and denying 12 or paring cost recovery to their lowest conceivable levels. This approach, if 13 adopted, would deprive the Company of the support it needs to complete the 14 enormous tasks ahead of it. The interests of our customers and the 15 Commonwealth require that we plan for the long term to address the challenges of 16 improving our infrastructure by adding to our native generation resources and by 17 updating our transmission and distribution systems as part of modernizing the 18 nation's power grid. Of course, we will try to minimize the costs to our 19 customers while doing so. Our Company's plans entail only the spending that 20 which is necessary to "keep the lights on," and we will do this in a manner that 21 will provide greater reliability and price stability for our customers over many 22 years to come. But as Company Witness Chewning describes, in the near future, 23 we must ask investors and creditors to finance billions of dollars of construction 14 1 and upgrades to modernize our generation, transmission and distribution systems. 2 Those initiatives will take the Company well beyond the rate period to implement. 3 We will outline a plan in this proceeding to fortify and enhance our electric plant 4 with technologies made to serve our customers in the 21 st Century. This case will 5 determine how successfully we can proceed with these vital efforts. Its outcome 6 will affect this Company's, and this Commission's, vision for many years to 7 come. 8 The eventual economic recovery that we all look forward to will need to be 9 sustained by many essential components of the nation's infrastructure. There is 10 no more vital infrastructure than that which delivers safe and reliable electric 11 service at levels adequate to satisfy demand, with prices that are just and 12 reasonable. Dominion Virginia Power stands ready to meet its considerable 13 responsibilities to its many constituents in this arena, and we look forward to the 14 Commission's validation and support of our efforts. 15 Q. Does this conclude your direct testimony? 16 A. Yes, it does. 15 APPENDIX A Background and Qualifications of David A. Heacock I received a Bachelor's degree in Nuclear Engineering from the University of Virginia in 1979. I am a professional engineer registered in Virginia. I joined Virginia Electric and Power Company in 1979 as an assistant engineer at the North Anna Nuclear Power Station, and was promoted to associate engineer in 1980, and engineer in 1981. In March 1985, I was promoted to senior engineer, and in August of that year became Supervisor of Surveillance and Test Engineering. I received my Nuclear Regulatory Commission senior reactor operator license in 1985. In 1989, I was appointed Superintendent of Station Engineering, and in 1990 I became Superintendent of Technical Services. In June 1994, I was promoted to Assistant Station Manager, Nuclear Safety and Licensing at North Anna. I assumed the position of Manager, Nuclear Safety and Licensing in March 1998. In June 1998, I was appointed Manager, Station Operations and Maintenance. I was named Site Vice President at North Anna Power Station in May 2000. In December 2003, I was named Vice President, Fossil & Hydro System Operations, and became Senior Vice President, Fossil and Hydro in April 2005. I assumed my current position of President of Dominion Virginia Power on October 1,2007. I was appointed to the Governor's Commission on Climate Change by Virginia Governor Timothy Kaine in 2007.
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