Last week, electric and natural gas utility Dominion Resources (NYSE:D) reported a 13% decline in first-quarter net profits and a 17% decline in earnings per share versus the first quarter in 2003, on a generally accepted accounting principles (GAAP) basis.

The company prefers that investors judge it on its operating earnings, however, and ignore the onetime expenses that can affect GAAP numbers. Happy to oblige: Operating earnings were down 6% company-wide and 10% per share.

Even if investors focus on Dominion's operating earnings performance, a few months ago, Dominion was promising to increase operating earnings by 7% to 8% in 2004. Then it lowered the outlook to a 5% to 7% boost. And in its annual report, the guidance was toward "the low end of that range," i.e., the 5% to 7% range. Not an encouraging trend.

Meanwhile, the company put a brave face on what would ordinarily be considered a depressing development. Virginia, where the company does much of its business, had been moving toward electric power deregulation (called "Energy Choice") in recent years. The idea was that Dominion could continue delivering power to its customers, but would be required to compete with other electricity suppliers to see who can produce power at the best rates. Dominion's profits would remain capped, as they now are, through 2007 -- at which point it could throw its cap into the air, shout "Free at last!" and begin charging whatever the market would bear for its power.

Well, graduation was postponed a couple weeks ago when Virginia passed a law extending Dominion's rate cap through Dec. 31, 2010. (Actually, there will be a pre- and a post-2007 rate cap, with an adjustment in July 2007, when the cap was supposed to expire altogether.)

Granted, in its annual report to shareholders, Dominion implied that it would consider an extension of the rate cap, a boon for the company and its shareholders. But that claim rings false. Dominion's rationale was that, with rates fixed, any savings it makes in efficiencies will fall right to its bottom line. Granted, again. But savings from cost-cutting are "capped" themselves. You can only cut costs so far (theoretically, to zero), at which point you have run out of room for growing profits.

A company's real profit potential is in increasing its rates (theoretically, to infinity). And Virginia has just postponed that possibility for three more years.

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Fool contributor Rich Smith owns no shares in Dominion.