Tennessee Valley Authority: Response to Questions From September 22, 1999, Hearing

Published by the Government Accountability Office on 1999-11-19.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

         Accountability * Integrity *Relability

United States General Accounting Office                                    Accounting and Information
Washington, DC 20548                                                             Management Division


           November 19, 1999

           The Honorable Sherwood L. Boehlert
           Chairman, Subcommittee on Water Resources
             and Environment
           Committee on Transportation and Infrastructure
           House of Representatives

           Subject:          Tennessee ValleyAuthority: Response to Questions From
                             September22, 1999, Hearing

           Dear Mr. Chairman:

           Enclosed are responses to the questions that you provided subsequent to our
           testimony during your September 22, 1999, oversight hearing: TVA: Electricity
           Restructuring and General Oversight.

           I hope that this information is helpful. If you have further questions, or would like to
           discuss any of the issues in more detail, please contact me at (202) 512-9508 or
           Robert Martin, Assistant Director, at (202) 512-4063.

           Sincerely yours,

           Linda M. Calbom
           Director, Resources, Community, and Economic Development
             Accounting and Financial Management Issues


                                                  GAO/AIMD-00-47R Tennessee Valley Authority Qs&As

            Response to Questions From September 22, 1999, Hearing

Question 1: Describe the linkages between TVA reducing its debt and its preparation
to better position itself for a competitive electricity market.

GAO Response: To be competitive in a deregulated environment, TVA must have the
financial flexibility to offer competitively priced power. As we reported in 1996 and
 1997,2 because of TVA's high fixed interest charges, we concluded that TVA lacked
the financial flexibility it would need to compete in a deregulated environment. In
July 1997, TVA issued a 10-year business plan that recognized the need to reduce the
cost of delivered power to a level consistent with the industry's forecast of the future
market price of power in the areas surrounding TVA's service territory. The plan also
recognized the need to alter TVA's cost structure from a "...high fixed-to-variable cost
relationship to a structure that is more flexible and better able to adjust to a volatile

Interest expense on outstanding debt has been about one-third of TVA's total
expenses in recent years. Therefore, reducing debt and the corresponding interest
expense are key to TVA's ability to increase its financial flexibility to respond to
competitive pressures. TVA's 10-year plan recognized this and established a goal of
reducing debt by one-half to about $14 billion by 2007. The year 2007 was key in
TVA's plan because that was when TVA expected to face greater competitive
pressures and when many of its long-term contracts with customers could expire.

Question 2: What comprises TVA's high fixed financing costs and deferred assets?
How do TVA's fixed costs and deferred assets compare to other utilities with which it
may have to compete? How would these affect TVA's ability to compete?

GAO Response: TVA's high fixed financing costs consist of interest expense on TVA's
outstanding debt, which totaled about $26 billion as of September 30, 1999. Deferred
assets totaled $9.1 billion as of September 30, 1999, $6.3 billion of which represented
the cost of nonproductive nuclear plants that have not yet been included in TVA's
rate base. The remaining deferred assets of about $2.8 billion include unamortized
debt issuance and reacquisition costs, postemployment benefits, decommissioning
costs, and capitalized interest on nuclear fuel.

Compared to other utilities with which it may have to compete, TVA's fixed financing
costs and deferred assets are high. In our 1997 report,we assessed TVA's financial
condition relative to its likely competitors. We calculated the financing costs to
revenue ratio, which indicates the percentage of operating revenues needed to cover
the financing costs of the entity. We also compared the magnitude of TVA's deferred

'Tennessee Valley Authority: FinancialProblems Raise QuestionsAbout Long-term Viability
(GAO/AIMD/RCED-95-134, August 17, 1995).

-FederalElectricityActivities: The FederalGovernment's Net Cost and Potentialfor FutureLosses
(GAO/AIMD-97-110 and llOA, September 19, 1997).

Page 2-                            GAO/AIMD-OO-47R Tennessee Valley Authority Qs&As

assets to its most likely competitors by calculating the ratio of deferred assets to
gross property, plant, and equipment (PP&E), which shows how much of total PP&E
has not yet begun to be depreciated and taken into rates.

We found that for fiscal year 1996, TVA's ratio of financing costs to revenue was more
than twice as high as the ratio for the utilities that border on TVA's service territory.
In addition, we found that as of September 30, 1996, TVA's deferred assets
represented 20 percent of its gross PP&E while the ratio for the investor-owned
utilities (IOU) that border on TVA's service territory averaged just 3 percent. Given
these financial factors, if current legislative protections were removed and TVA was
required to compete at a time when wholesale prices are falling, its high fixed costs
and deferred assets compared to neighboring utilities would be a significant

In April 1999, 3 we reported that TVA's 10-year plan is moving TVA in the right
direction by seeking to reduce its high fixed financing costs and large investment in
nonproducing and other deferred assets that have not been recovered through rates.
Making progress in these areas prior to the full advent of competition is key to its
chances of being competitive without legislative protections.

Question 3: Even though TVA is behind in meeting some of its 10-year plan goals and
must incorporate significant costs previously unaccounted for, do you believe TVA
can achieve its ultimate objective of offering competitively priced power by 2007?
What would need to happen for TVA to be able to achieve this goal by then? For
example, would it have to maintain or increase its customer base? Would the
demand for power have to increase, and if so, by how much?

GAO Response: Because it is not possible to accurately predict what the market
price of power will be in 2007 or how the competitive environment might change, it
cannot be determined with certainty whether TVA will be able to compete
successfully in a competitive environment. TVA could achieve its objective of
offering competitively priced power even if it does not fully achieve the plan's other
goals and objectives. Conversely, depending on the market price of power, TVA
could fully achieve all of the goals and objectives outlined in the plan and still not be
positioned to offer competitively priced power in 2007 and beyond.

It is important to note that any progress. TVA makes toward achieving the goals and
objectives in its 10-year plan will put TVA in a better competitive position. TVA plans
to use the cash flow generated from higher power rates, lower expenses, and reduced
capital expenditures to reduce debt and corresponding fixed interest costs, which
should enable TVA to reduce its overall cost of producing power and begin to recover
its deferred assets. However, any decisions to spend additional money on increased
generating capacity and environmental compliance efforts would use cash that would
otherwise have been available to reduce debt. As pointed out in our April 1999
report, we do not think TVA will fully meet the debt reduction goals in its 10-year plan

 Tennessee Valley Authority: Assessment of the 10-Year Business Plan (GAO/AIMD-99-142,
April 30, 1999).

Page 3-                             GAO/AIMD-00-47R Tennessee Valley Authority Qs&As

because of expenditures on environmental compliance and its subsequent decision to
spend more money than originally planned on new generating assets.

The revenue projections contained in TVA's 10-year plan are predicated on its
maintaining its current customer base. Achieving the revenue projections is
important to TVA as it seeks to prepare for a competitive environment by reducing
debt and corresponding fixed interest costs and deferred assets. Doing these things
will increase the likelihood that TVA will be able to successfully compete. Increased
demand could benefit TVA if the costs of meeting the demand are lower than the
associated revenues. Conversely, increased demand could be detrimental to TVA if
the costs of meeting the demand are higher than the associated revenues.

Question 4: What would happen to TVA's debt reduction efforts if competition in the
region occurred prior to 2007?

GAO Response: The impact of competition prior to 2007 on TVA's debt reduction
efforts would depend on how TVA's rates and costs compared to the competition at
that time. If TVA is forced to compete before 2007 and competition forced it to sell
power at reduced rates, TVA's ability to reduce debt and recover the cost of deferred
assets would be impaired. Conversely, if competition before 2007 did not force TVA
to reduce rates from its planned levels, it would not have a negative impact on TVA's
ability to reduce debt and deferred assets.

Question 5: What is your reaction to TVA's statement that expected returns on
increased investment in generating capacity, and upward pressure on market prices
from the prospect of higher environmental spending allow TVA to remain on its path
to provide competitive prices by 2007, even though it won't meet its debt reduction

GAO Response: As indicated in our April 1999 report, TVA's predictions about the
future market price of wholesale power are not out of line with predictions made by
other knowledgeable parties. Based on TVA's current predictions about the future
price of power in its service region, it is not unrealistic for TVA to project that it
could increase spending on generating capacity and environmental compliance and
remain on a path to offer competitively priced power by 2007 without fully meeting
its debt reduction goals. However, TVA's plan for preparing for competition has not
been formally updated to show the impact that changes in certain goals and
assumptions will have on TVA's ability to offer competitively priced power. While
TVA has acknowledged several changes related to the goals and assumptions
contained in the plan-including that it will not achieve its debt reduction goal by
2007-the plan has not been formally updated to assess and demonstrate the impact
of those changes. Any delay in meeting its debt reduction goals increases the risk
that TVA will not be able to offer competitive prices in 2007.

Question 6: Does GAO believe that TVA bonds are implicitly backed by the federal
government (as stated by major bond-rating agencies), which is essential for TVA to
obtain AAA bond ratings? If so, does GAO believe such backing constitutes a federal

Page 4                         IGAO/AIMD-00-47R Tennessee Valley Authority Qs&As

subsidy? How so? What would happen if TVA lost its implicit federal backing of its
bonds, and would it affect TVA's debt reduction plans?

GAO Response: The federal government does not guarantee TVA's bonds, and the
bonds explicitly state that they are not backed by the federal government.
Nevertheless, the investment community, including major bond rating agencies,
believe that TVA's bonds are implicitly backed by the federal government. For
example, Moody's Investors Service's October 1999 analysis of TVA states that "the
Aaa rating on TVA power bonds derives from its status as a wholly-owned corporate
agency of the US Government. Although TVA's bonds are not guaranteed by the US
Government, Moody's believes that the US would not allow a default on TVA's debt
because of the impact a default would have on the funding costs of other
government-sponsored agency debt." Moody's further states that the implicit
government backing is a fundamental underpinning of the Aaa rating it assigned to
TVA's debt.4

This perception by the investment community is an advantage to TVA in that its
interest expense is lower than it otherwise would be. If the perception did not exist,
TVA's interest expense would likely be higher and less money would be available for
debt reduction. While these lower interest costs do not constitute a federal subsidy
to TVA, they do represent a competitive advantage.


4Moody's   Investors Service Global Credit Research Report on the Tennessee ValleyAuthority (Report
number 50006, October 1999).

Page 5                                GAO/AIMD-00-47R Tennessee Valley Authority Qs&As