Financial Management: Briefing on Federal Electricity Activities--TVA

Published by the Government Accountability Office on 1997-11-19.

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

United States
General Accounting Offke
Washington, D.C. 20548

Accounting and Information
Management Division


November 19, 1997

The Honorable Zach Wamp
House of Representatives

Subject: Financial Management: Briefing on Federal Eleetricitv Activities-TVA

Dear Mr. Wamp:

On October 20, 1997, we briefed Ms. Helen Hardin, Mr. Bob Castro, and
Mr. Dick Kopper of your office on the results of our recently completed review
of federal electricity activities. This work was done at the request of the House
Committee on the Budget and the Subcommittee on Water and Power
Resources, House Committee on Resources, and resulted in our September 19,
1997, report entitled, Federal Eleticitv Activities: The Federal Government’s
Net Cost and Potential for Future Losses (GAO/Al&ID-97-110 and 97-1lOA). The
enclosed briefing slides highlight the findings in that report. The review
responded to congressional concerns about (I) any ongoing expenses incurred
by the federal government to support the electricity-related activities of the
Power Marketing Administrations (PMAs),’ the Department of Agriculture’s
Rural Utilities Service (RUS), and the Tennessee Valley Authority (TVA) and
(2) potential future losses &om these activities given the move toward
deregulation and increased competition in the electricity industry.

The federal government incurred net costs of over a billion dollars annually for
fiscal years 1992 through 1996to support the electricity-related activities of RUS
and the PM& We estimated that the net costs to the federal government for
fiscal year 1996 totaled about $2.5 billion-$0.4 billion for BPA, $0.2 billion for
the three PMAs, and about $1.9 billion for RUS, including about $982 milhon in
RUS loan write-offs. Cumulatively, for fiscal years 1992 through 1996, we
estimated that the net costs were about $8.6 billion in constant 1996 dollars,

‘We reviewed four of the five PEAS: the Bonneville Power Administration
(BPA) and the Southeastern, Southwestern, and Western Area Power
Administrations (which we refer to as the three PMAs). The fifth PMA, the
Alaska Power Administration, was excluded from our review because legislation
has been enacted to sell it to nonfederal entities.
                             GAO/m-9836R       Federal Electricity Activities-TVA
including over $1 billion in RUS loan write-offs. The net costs associated with
TVA were minimal. Under current policies and law, the federal government will
likely continue to incur many of the same types of costs; however, future ‘RUS
loan write-offs cannot be accurately predicted.

We also reported that there is risk to the federal government of future losses
from each of these entities because of financial difficulties faced by RUS
borrowers, TVA, BPA, and one or a few projects at each of the other three
PMAs. As of September 30, 1996, the federal government was exposed in
varying degrees to the risk of future losses because of its more than $84 billion
in direct and indirect financial involvement in the electricity-related activities of
RUS, the PMAs, and TVA. The risk of future losses relates to the possibility
that RUS borrowers, the PhIAs, or TVA would be unable to repay the full
$53 billion in debt owed to the federal government or that the federal
 government would incur unreimbursed costs as a result of actions it took to
prevent default or breach of contract on the $31 billion in nonfederal debt owed
 by these entities.

We are sending copies of this letter to interested congressional committees, and
copies will also be made available to others upon request.

We appreciated the opportunity to share the results of our work. If you have
questions or desire additional assistance on any of these matters, please contact
me at (202) 512-8341.

Sincerely yours,

 Linda M. Calbom
 Director, Civil Audits



 2                           GAO/AI&ID-98-36R Federal Electricity Activities-TVA
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m       Background

0 Requesters raised concerns about:
 l   The significant ongoing expenses incurred by
     the federal government to support the
     electricity-related activities of the PMAs and
     RUS and
 l   Potential future losses from the PMAs, RUS,
     and TVA given the move toward d.eregu1atio.n
     and increased competition in the electricity’ ’

GA0 Overall Objectives

l       For the federal government’s electricity-
        related activities, we designed our work to
    l    Estimate the fiscal year 1996 net recurring
         cost and, where possible, fiscal years 1992
         through 1996 cumulative net recurring cost
    l   Assess the likelihood of future losses
        beyond the net recurring costs

    l   Rural Utilities Service
    l   4 Power Marketing Administrations

         0 Southeastern
        l   Southwestern
        l   Western
        0 Bonneville
l       Tennessee Valley Authority

GAo Scope Limitations

l   GAO did not:
    l   Estimate the’forgone revenue for federal,
        state, or local governments resulting from the
        tax-exempt status of the RlJS borrowers, the
        PMAs, and TVA
    e Assess the’reasonableness of the
      methodologies used by the operating       i’ j,
      agencies to allocate power-related costs to
      the PMAs for recovery

w       Net Costs

l   For fiscal year 1996, the federal government
    incurred net costs of about $2.5 billion for
    BPA, the 3 PMAs, and RUS
l   For fiscal years 1992 through 1996, the
    federal government’s net cost of operating
    these entities was about $8.6 billion, in
    constant 1996 dollars
l   The net costs incurred by the federal
    government to operate TVA for fiscal years
    1992 through 1996 were minimal
w           Net Costs

    l       Criteria used to determine net cost
        l    Federal accounting
        l    OMB Circular A-25                cost

        l    Industry Practice        /

       GAO Net Costs

                            Estimated Net Costs to the Federal Government

(Dollars in millions)
                                                                                                  .:.,:                 .:;          I:‘:’        .,.          .,,::.:,                                  :..,         :.::.           :.:             .,:,,:.     t.:     :.      :.:.:.:.              ‘:
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                                                                                                     ;&                           ;:: 1.1.        : :‘yjjjlj                      .“‘l:rdt~,:,:.:,,i::                             :j;l,,.j,Giliii’Uj~t,~e,~                                        : j.
                                                                                                    :::j; :,,:,,,:, :: :          ‘.. :::      .::r      ........                  ..:: :,.g.:; :, :: “.                                        ..: .:::.::. :::::,::::::..:‘:.                    ::‘,I
                                                                                                  : . . . . .._....               ,:: ..,... :.:: ,.__.. :..:.:::               :.::,:..:.::.:‘.::.:..::~i:i.:’                    ::._::,:. . . . ::::. . .‘: :::‘::‘.‘.‘-’
                                                                                                                                                                                                                                                                  . . . .:.:.::.:             ::     .:::
                                                                                                                                                                                                                                                              .. ..
                                                                                                           ..,         :.I        .j,,    ,,I     :          .:.:..:..               :         j::j      .,::::,,:.:    ‘::.                         . . . . . . :::           ,..::..:.     :L::‘:“’
                                                                                                    : :::..
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                                                                                                                                                                                                       .        . .. .             c:::.:::         ::::::.:::::::::::::::::::::::::::
 Fina-&g           “”
                                      $874           $3,812                                                                                                                                     $1,459                                                                       $6,941
                                                                                                                              I                                           II                                    I
 Loan write-offs                       982              1,049                                                                                                                                               982 1                                                                  1,049
                            I                  I                                                                    II                                                    III                                                  I
 Benefits                   I             1 1                     3         16    82   21   110                  $1 1                                      $4 11                                                39 1                                                                         199
Construction                                                                30   138          1                                                                                                                 30                                                                           139
Other                                   21                  ll?                                                                                                                                            (48)                                        ::                                    269
                            I                  I

           Total                 $1,878              $4,976             f                                       $1                                         $4                                   $2,462                                                                       $8,597
GAs3 Federal Financial Involvement

  Dollars in billions

        Entity          Direct          Indirect             Total

   RUS                      $32.3                                $32.3

   Three PMAs                     7.0           $0.2                  7.2


   BPA                           10.1              7.1               17.2

  ITVA                             .
                                  381           24 . 1 1

   Total                    $53.2              $31.4             $84.6


MO, Federal Financial Involvement

l       The federal government would incur a future
    * Direct involvement - to the extent the RUS
      borrowers, the PMAs, or TVA fail to make
      payments on federal debt
    l    Indirect involvement - to the extent it,incurs
        unreimbursed costs as a result of .actions iti
        took to prevent default or breach of contract’
        on nonfederal debt

GAO Federal Financial Involvement --TVA

                               Treasury (FFB)
                               bonds (Direct)
                                 3.2 billion)

                                  debt (Direct)
                                  ($0.6 billion)
                                               ;I 1   4,
   Public ’
   debt (Indirect)
   ($24.1 billion)

MII          Risk of Loss

l       Criteria for assessing risk
    l    Statement of Federal Financial Accounting
         Standards (SFFAS) No. 5, Accounting for
         Liabilities of the Federal Government
        a Probable, reasonably possible, or remote
    0 Consistent with criteria used by bond
      rating services to assess credit risk for
      nonfederal utilities

MCI Risk of Loss

l   For RUS, we reviewed the loan portfolio,
    assessed the production costs of key
    borrowers relative to their respective markets,
    and considered state regulatory actions
l   For the PMAs and TVA, we considered the
    cost of electricity production and rates, key
    financial ratios, generating mix, competitive
    environment, management actions, and            ”   ’’
    legislative and other factors

G&I Risk of Loss - RUS

         $10.5 billion owed by 13 financially
         stressed G&Ts
     0 4 borrowers owing $7 billion are in
     l    9 borrowers have invested in
          uneconomical plants and/or have
          formally requested debt forgiveness   ,,
          from ‘RUS

GACJ Risk of Loss - RUS

  l       Some currently viable borrowers are likely
          to face future financial difficulty due to
      l    High production costs (27 of 33 G&Ts
           had average revenues per kilowatt hour
           higher than neighboring IOUs)
      0 Competitive and/or regulatory pressures ; i

GAO Risk of Loss -- RUS

 l       Despite certain mitigating factors, it is
         probable that
     l    the federal government will continue to
          incur losses on loans to financially
          stressed borrowers
     l   additional losses will be incurred on
         borrowers that are not currentlyStroubled,, i   ,,
         but will likely become troubled in the


w          Risk of Loss - Three PMAs

a Three PMAs competitively sound overal
    l    Production costs average more than 40
         perce.nt below IOUs and POGs in the
         primary NERC regions in which they
l       If required to recover all power-related
        costs, ability to remain competitive might
        be impaired

MO     Risk of Loss - Three PMAs           ’

 l   All three PMAs have at least one project
     or rate-setting system with problems that,
     taken as a whole, make risk of some loss
     to the federal government probable
 l   In aggregate, these problem projects or
     rate-setting systems represent 19 percent
     (about $1.4 billion) of the federal
     government’s involvement in the’ three

GAo Risk of Loss - BPA

  l       Risk of loss through fiscal year 2001 is
      l    Contracts through FY2001 with
           preference and industrial customers
           provide for stable revenues
      l    Fish cost funding responsibility capped
           through FY2001
      l    Current substantial financial reserve
           balance provides flexibility

cAs3 Risk of Loss - BPA

   l       Risk’of loss after fiscal year 2001 is
           reasonably possible
       l    Expiration of customer contracts
       l    Risks from market uncertainties
       l    High fixed   costs

       l   Substantial upward pressure on
           operating expenses

MI          Risk of Loss - TVA

l       GAO report issued in 1995 concluded that
    l   TVA has far more financing costs and
         deferred assets than its likely competitors
        .which limits its flexibility to meet competitive
    0 To the extent that TVA cannot compete
         effectively and improve its financial condition, , ,
         the federal government is at risk for some
         portion of TVA’s debt..

GAD Risk of Loss -- TVA

l   Under current monoDolv-twe
                          .    I . structure, risk
    of loss to the federal government from its
    involvement in TVA is remote
    0   Long-term contracts provide stability and
        ensured cash flow
    a   Exemption from the “wheeling” provisions
        of the Energy Policy Act of 1992 protects; , (
        against outside competition
        TVA can set rates with minimum oversight

MO     Risk of Loss -- TVA

0 Risk of loss is reasonablv possible absent
  protection from competition
  l   TVA has chosen to defer costs related to its
      substantial nuclear investment to future years
      rather than including them in current or prior
      year costs being recovered from ratepayers
  l   This cost deferral has resulted in a high level,
                                                  ! ‘  1I
        r r’
      OT Taxedcosts and deferred assets which
      Ieaves’TVA vulnerable to future competition

‘~0        Risk of Loss -- TVA

l   To assess TVA’s financial condition relative
    to its likely competitors, we compared the
    following ratios for TVA and 11 neighboring
    investor-owned utilities:
    l   Financing costs to revenue
    l   Fixed financing costs to revenue
    l   Accumulated depreciation to gross PP&E,
    l   Deferred assets to gross PP&E

CSQ Risk of Loss -- TVA

                             Financing costs to revenue
The financing costs   40

to revenue ratio                   35.3

indicates the         30 -

percentage of
operating revenues    20 -

needed to cover
the financing costs   IO -

of the entity ’

w    Risk of Loss -- TVA

                            Fixed financing costs to revenue
The fixed financina        Percent

costs to revenue rUati0              35.3

indicates the              30   -.
percentage of
operating revenues         20‘-
needed to cover the          -
fixed portion of the       10.-
financing costs

QUID Risk of Loss -- TVA

                           Ace. depreciation to gross PP&E
Accumulated               40
depreciation to
gross PP&E ratio          30 -

shows how much
PP&E had been             20 -      1

recovered through
                          10 -
rates at September
30,1996                    0

GM) Risk of Loss -- TVA

                                Deferred assets to gross PP&E
 Deferred assets t6        25

gross PP&E ratio
                           20 -         19.5
shows how much of
total PP&E has not         15 -

yet begun to be
                           IO -
depreciated and
taken into rates            5-


GAO         Risk of Loss -- TVA

 l       Other factors could negatively affect TVA
     l    Five municipal distributors that account for
          over 34 percent of TVA’s total sales to
          distributors want to renegotiate their
          contracts with TVA to obtain more
          favorable terms            I
     l    Twelve of TVA’s distributors are
          interconnected with other utilities

CKJ Risk of Loss -- TVA

 l       TVA’s vulnerability to wholesale competition
         without protections was recently
         demonstrated when the Bristol Virginia
         Utilities Board announced that it is going to
         leave the TVA system for Cinergy, Inc
     l    Cinergy offered firm wholesale power at
          2.59 cents per kWh for 7 years,-40 percent
          lower than TVA’s.comparable wholesale f :      ’I
          rate of 4.3 cents per kWh

MI         Mitigating Factors -- TVA

l       Mitigating factors reduc’e risk of loss
    l    Inherent cost advantages
    l    Management actions to increase
         revenues, cut operating expenses, and
         reduce debt
    l    Extensive transmission system


              Mitigating Factors -- TVA

l       TVA recently released a IO-year business
        plan that calls for:
    l   Increasing power rates enough to increase annual
        revenues by about 5.5 percent ($325 million)
    l   Limiting annual capital expenditures to $595 million
    l   Reducing debt by about 50 percent from $27.9 billion
        as of g/30/96, to $13.8 billion by FY 2007
    l   Reducing its total cost of power by about 16 percent   ’’
        by FY 2007

                                                                    :’   ‘\P
G&D Mitigating Factors - TVA

      While the. mitigating factors reduce
      the risk of loss, we believe the risk
      of loss is still reasonably possible.

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