Federal Power: The Role of the Power Marketing Administrations in a Restructured Electricity Industry

Published by the Government Accountability Office on 1999-06-24.

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

                         United States General Accounting Office

GAO                      Testimony
                         Before the Subcommittee on Water and Power, Committee
                         on Resources, House of Representatives

For Release
on Delivery
Expected at
                         FEDERAL POWER
2 p.m. EDT
June 24, 1999
                         The Role of the Power
                         Marketing Administrations
                         in a Restructured Electricity
                         Statement of Victor S. Rezendes, Director,
                         Energy, Resources, and Science Issues,
                         Resources, Community, and Economic
                         Development Division

    Mr. Chairman and Members of the Subcommittee:

    We are here today to discuss the role of the federal power marketing
    administrations (PMAs) in a restructured electricity industry. As we near
    the close of the first electrified century, vast opportunities face the
    electricity industry as we proceed into restructured, more competitive
    markets. Over the last 20 years, competition has been replacing regulation
    in major sectors of the U.S. economy, including transportation, natural
    gas, and telecommunications. As we enter the next millennium, new
    emerging opportunities of a competitive marketplace challenge the
    electricity industry. As this restructuring proceeds, we must consider how
    the existing federal system of generating, transmitting, and marketing
    electricity is managed.

    Our statement today is primarily based on the body of PMA work that we
    have completed for this Subcommittee over the last 4 years. We also
    discuss our reports concerning the Tennessee Valley Authority (TVA)
    because they relate closely to the PMA reports. On the basis of our review
    of the issues, we have identified several broad goals of the effort to
    restructure the electricity industry—goals that apply to both the private
    sector and government, including the PMAs. We will also discuss the role of
    the PMAs in this changing electricity industry.

    In summary, Mr. Chairman, our principal observations are the following:

•   We have identified several broad goals of the electric industry’s
    restructuring based on the various policymakers’ and industry experts’
    opinions. Today, we will discuss five of these goals that we believe
    particularly affect the PMAs: (1) encouraging competition for retail
    consumers, (2) protecting the environment, (3) balancing equity among
    stakeholders, (4) maintaining the reliability of the transmission grid, and
    (5) promoting deregulation by redefining federal roles. We will now
    summarize each goal and discuss its applicability to the PMAs.
•   One major goal of deregulating the retail electricity market is encouraging
    retail price competition. Removing practices that treat potential
    competitors inconsistently and providing customers with lower electricity
    prices are two major considerations. The PMAs are generally able to sell
    power more cheaply than other providers in part because they sell
    electricity generated almost exclusively by hydropower and because some
    of the government’s costs are not recovered through the PMAs’ rates. We
    estimated net financing costs attributable to the PMAs to be about
    $585 million in fiscal year 1996. In addition, unlike the investor-owned

    Page 1                                               GAO/T-RCED/AIMD-99-229
    utilities, the PMAs are not required to earn a profit. The PMAs and TVA also
    have competitive advantages in financing, taxes, and regulatory oversight.
•   Protecting the environment is the second broad goal. Because the
    electricity industry is a major source of air pollution, the debate over
    restructuring includes the question of how changes in how electricity is
    generated could affect the environment. Concern exists that competitive
    markets may result in increased emissions of pollutants from the burning
    of fossil fuels, such as coal. Although the mix of sources generating
    electricity may change, currently, over 50 percent of TVA’s power is
    generated from coal, whereas less than 2 percent of the PMAs’ power is
    generated from coal. The PMAs’ hydropower, which is about 93 percent of
    the PMAs’ total power, may offer potential environmental advantages over
    other electricity sources because it is a clean, domestic, and renewable
    source of energy. However, hydropower facilities can have significant
    impacts on fish and wildlife habitats.
•   Balancing equity among stakeholders is the third broad goal. Legislation
    has been proposed to require the PMAs and TVA to sell their power at
    market rates. As we discussed in recent reports, the Congress has the
    option of requiring the PMAs to sell their power at market rates. This would
    better ensure the full recovery of the appropriated and other debt of about
    $22 billion through the PMAs’ power sales. This would also lead to more
    efficient management of the taxpayers’ assets. This debt includes the costs
    of building and operating the federal electric power network as well as
    billions of dollars in irrigation–related debt. Such proposals would benefit
    federal taxpayers by better ensuring the full recovery of debt through the
    PMAs’ rates. One aspect that will require careful consideration is balancing
    the competing interests of various groups of stakeholders—ratepayers,
    customers, investors, and taxpayers. Yet, the PMAs are faced with the risk
    that the federal investment in hydropower will not be recovered if power
    generated by federal plants ultimately proves to be too unreliable or costly
    to be competitive.
•   The fourth broad goal of restructuring is maintaining the reliability of the
    interstate transmission grid. An issue that directly relates to the PMAs is the
    maintenance of reserves that can be called upon to meet planned or
    unforeseen outages by power providers. As we recently reported,
    hydropower’s inherent flexibility in meeting different levels of demand
    creates an opportunity for hydropower to play a significant role in meeting
    demand during peak periods.
•   Finally, the last broad goal is promoting deregulation by redefining federal
    roles, such as those of federal regulatory agencies. While restructuring has
    focused largely on deregulating the retail market, some segments of the
    electricity industry may face new or increased regulations to address

    Page 2                                                  GAO/T-RCED/AIMD-99-229
             market power and consumer protection issues. Recent transmission
             policies have dealt with the concerns of market power in the ownership
             and control of transmission facilities. For example, the PMAs’ transmission
             rates and facilities may come under new federal regulation.

             In 1997, residential, commercial, and industrial consumers spent about
Background   $215 billion on electricity, making the market for electricity larger than the
             markets for telecommunications, trucking, or airline transportation
             services. Over the last 20 years, competition has been replacing regulation
             in major sectors of the U.S. economy, including transportation, natural
             gas, and telecommunications. New legislation and technological changes
             have created a climate for change in traditional electricity markets at both
             the wholesale and retail levels. Through the Energy Policy Act of 1992 and
             subsequent rulings by the Federal Energy Regulatory Commission (FERC),
             the federal government has encouraged competition in the wholesale
             electricity market. At the retail level, the administration estimates that
             competition will result in annual savings of $20 billion for consumers and
             $2 billion for the government. Whereas transmission and distribution will
             remain largely regulated and noncompetitive, the retail market offers great
             potential for competition. Since 1992, 22 states—representing about
             60 percent of the U.S. population—have issued comprehensive
             deregulation orders or enacted restructuring legislation. Most of the
             remaining states have the matter under active consideration. The extent to
             which the federal government should participate in fostering retail
             competition has yet to be decided.

             The federal government—the nation’s largest single producer of electric
             power—generated nearly 10 percent of the nation’s electricity in 1998.
             Since the New Deal, the federal government has established water projects
             that—in addition to promoting agriculture, flood control, navigation, and
             other activities—produce electric power. The federal government has
             played an important role by selling electricity to rural America. The
             Department of the Interior’s Bureau of Reclamation (Bureau) and the
             Department of the Army’s Corps of Engineers (Corps) generate electricity
             at hydropower plants located at major federal water projects. The
             Department of Energy’s (DOE) four PMAs,1 along with TVA, generally sell this
             electricity in wholesale markets mostly to publicly and cooperatively
             owned utilities that, in turn, sell the electricity to retail consumers.
             Although not a PMA, TVA is a federal corporation and the nation’s largest

              DOE’s PMAs are the Bonneville Power Administration, Southeastern Power Administration,
             Southwestern Power Administration, and Western Area Power Administration.

             Page 3                                                              GAO/T-RCED/AIMD-99-229
                            single producer of power. As restructuring moves forward, the Congress,
                            states, and the industry are considering how the existing federal power
                            system fits into the new environment and how it is managed. Against the
                            backdrop of restructuring, the Congress is compelled to reconsider the
                            policies used to maintain and manage the federal hydropower system.

                            Mr. Chairman, we have identified several broad goals of electric industry
                            restructuring. We will now discuss the five goals that particularly affect
                            the PMAs, including their relationship to the PMAs in this changing

                            One major goal of deregulating the retail electricity market is encouraging
Encouraging Retail          retail price competition. Several objectives support the achievement of
Competition                 this goal. These include removing practices that treat potential
                            competitors inconsistently and providing customers with lower electricity
                            prices. Each of these objectives apply to both the private sector and
                            government, including the PMAs. We will now discuss these objectives.

The PMAs and TVA Have       As the market moves from a regulated to a more deregulated retail
Competitive Advantages in   environment, it may be necessary to determine whether more consistent
Financing, Taxes, and       treatment of power providers is warranted. Favorable financing for
                            power-related facilities gives some federally assisted potential competitors
Regulatory Oversight        advantages in the marketplace. For example, we have reported that
                            although the PMAs are generally required to recover all costs, favorable
                            financing terms2 and the lack of specific requirements to recover certain
                            costs have resulted in net costs to the federal government each year.3 Net
                            costs include net financing costs, pension and post retirement health
                            benefits, and certain construction costs. We estimated net financing costs
                            attributable to the PMAs to be about $585 million in fiscal year 1996. In part
                            because the PMAs sell power generated almost exclusively from
                            hydropower, are not required to earn a profit, and do not fully recover the

                             “Favorable financing” includes a requirement to repay the highest interest-bearing appropriated debt
                            first and interest rates on appropriated debt that, before 1983, were below market rates. We use the
                            term “appropriated debt” throughout this testimony because the PMAs are required to set their
                            electricity rates at levels that will recover appropriations used for capital improvements by the Bureau
                            and the Corps. These reimbursable appropriations are not considered to be lending by the Treasury.
                            Pursuant to legislation passed in 1996, Bonneville’s appropriated debt was refinanced to approximate
                            Treasury’s current borrowing costs.
                             See Power Marketing Administrations: Cost Recovery, Financing, and Comparison to Nonfederal
                            Utilities (GAO/AIMD-96-145, Sept. 19, 1996), Federal Electricity Activities: The Federal Government’s
                            Net Cost and Potential for Future Losses (GAO/AIMD-97-110 and 110A, Sept. 19, 1997), and Federal
                            Power: Options for Selected Power Marketing Administrations’ Role in a Changing Electricity Industry
                            (GAO/RCED-98-43, Mar. 6, 1998).

                            Page 4                                                                    GAO/T-RCED/AIMD-99-229
government’s costs in their rates, they are generally able to sell power
more cheaply than other providers. We reported in January that DOE’s
Southeastern Power Administration (Southeastern), Southwestern Power
Administration (Southwestern), and the Western Area Power
Administration (Western) sold wholesale electricity to their preference
customers,4 from 1990 through 1995, at average rates from 40 to 50 percent
below the rates that nonfederal utilities charged.5 In the recent past, the
rates of the Bonneville Power Administration (Bonneville) were at or
above market rates. We also reported that many rural electric
cooperatives—many of which are PMA preference customers—have had
access to favorable financing (either direct loans or guarantees) through
the U.S. Department of Agriculture’s Rural Utilities Service (RUS). Such
financing did not fully reflect the government’s net financing costs. These
costs were about $874 million in fiscal year 1996. Such financing would
give these cooperatives a competitive advantage if they were to compete
outside their traditional service areas against private competitors that do
not have access to such favorable interest rates.

Another example of favorable financing concerns federal entities’ bond
sales as compared with the criteria applied to other borrowers.
Bond-rating services give the higher rating to bonds issued by Bonneville
and TVA because they are federal entities. For example, Standard & Poors’
credit rating agency’s “AAA” rating for TVA bonds is not based on a
default, risk-based analysis. Instead, the bonds are generally viewed as
government-sponsored debt. The resulting lower bond interest rate gives
these entities a competitive advantage.

Also, some electricity suppliers, such as investor-owned utilities, are
required to pay federal, state, and local taxes, but the PMAs and TVA
generally are not subject to them.6 Municipalities and other public power
suppliers may also have favorable tax treatment that would give them a
competitive advantage if they were to compete outside their traditional
service areas. To address this possibility, legislation has been proposed,
for example, that would preclude government-owned utilities from using
tax-exempt financing to fund facilities if they choose to compete outside
their traditional service areas.

 Preference customers include cooperatives and public bodies, such as municipal utilities, irrigation
districts, and military installations.
 See Federal Power: PMA Rate Impacts, by Service Area (GAO/RCED-99-55, Jan. 28, 1999).
 TVA was expected to pay about $264 million in payments in lieu of taxes in fiscal year 1998.

Page 5                                                                   GAO/T-RCED/AIMD-99-229
                         Several inconsistencies also exist in the area of regulatory oversight. First,
                         investor-owned utilities are subject to full review and approval processes
                         by FERC, while TVA is exempt from regulation by FERC. TVA’s rates are
                         reviewed only by its board of directors. All rates established by the PMAs
                         are subject to a limited review by FERC. Second, by law, the transmission
                         facilities of Bonneville, Southwestern, and Western, as well as TVA and
                         some other smaller utilities, are exempt from FERC’s jurisdiction of
                         transmission rates and open access.7 And third, as a federal
                         instrumentality, TVA is not subject to antitrust legislation as are
                         private-sector firms. Some TVA critics assert that this exemption, together
                         with the agency’s total discretion in rate setting, allows TVA to control the
                         market by engaging in predatory pricing and other anticompetitive

                         Because the electricity industry is a major source of air pollution, the
Protecting the           debate over restructuring includes how changes in how the industry
Environment              generates electricity could affect the environment. A relevant question is
                         whether the existing body of environmental law and regulation can
                         accommodate future changes in electricity generation and transmission or
                         whether restructuring legislation should have an environmental
                         component to help ensure that further developments in the electricity
                         industry will be compatible with environmental values.

Fossil-Fuel Generation   The combustion of fossil fuels, which account for about two-thirds of the
                         nation’s electricity generation, results in airborne emissions. These
                         emissions include pollutants that directly pose risks to human health and
                         welfare, such as sulfur oxides, nitrogen oxides, particulate matter, carbon
                         monoxide, and certain heavy metals. Other emissions may pose indirect
                         risks; for example, carbon dioxide may contribute to global warming. Of
                         the fossil fuel-fired steam generators, coal-fired facilities contribute a large
                         share of these gases. The Environmental Protection Agency currently
                         regulates these emissions, except carbon dioxide. Any increase in fossil
                         fuel-fired generation may increase carbon dioxide emissions. Some are
                         concerned that competitive markets may result in increased generation
                         and emissions of pollutants because (1) lower prices resulting from
                         restructuring would increase electricity purchases and, as a result,

                          FERC Order 888 requires utilities under FERC’s jurisdiction to file nondiscriminatory open access
                         transmission tariffs and offer comparable transmission services to eligible third parties. Order 889
                         requires utilities to develop same-time information systems to make simultaneous transmission
                         information available to those entities that are selling power. Bonneville, Southwestern, and Western
                         have voluntarily filed open-access transmission service tariffs with FERC.

                         Page 6                                                                   GAO/T-RCED/AIMD-99-229
(2) older, more polluting coal-fired generating facilities, which are
generally exempt from the Clean Air Act’s new source emissions
standards, will be used more extensively.8 Although the generation mix
may change, currently, less than 2 percent of the PMAs’ power and over
50 percent of TVA’s power are generated from coal.

To address these concerns, some have suggested various measures, in
addition to the continued enforcement of environmental standards under
the Clean Air Act, to counteract the anticipated increase in the emissions
of air pollutants after deregulation. These include (1) requiring a
renewable portfolio standard, which directs utilities to have a specific
percentage of their generation power originating from a renewable
(non-air-polluting) source of energy; (2) implementing pollution output
controls, which focus on limiting emissions without encouraging any
particular kind of generation-type; and (3) ratifying the Kyoto Protocol,
which sets targets for greenhouse gas emissions for developed nations.

Yet, disagreements exist on how to control pollution. It is argued that a
mandate for a renewable portfolio standard, for example, is contradictory
to the spirit of deregulation. Instead, some industry representatives have
testified before the Congress that the federal government should establish
emissions standards for all generation facilities. These standards would be
output-based, not favor a particular fuel source, and allow market forces
to determine the most efficient means to develop cleaner coal plants and
other technologies, including renewable generation. Any environmental
component of restructuring legislation, it is argued, should be market
based and incentive driven because in the long run, competition will favor
cleaner and more efficient facilities and accelerate the turnover and
upgrading of existing power plants.

At least nine states have already adopted renewable portfolio standards
that require that specific percentages of the electricity sold in their state
be generated from renewable sources. Such sources include geothermal,
hydro, solar, and wind energy. The administration’s proposed renewable
portfolio standard would require electricity suppliers to eventually provide
7.5 percent of their electricity sales from nonhydroelectric renewable
technologies. The Congress is considering whether to promote fuel
diversity by adopting such a federal renewable portfolio standard. A
related issue is whether to prescribe specific technologies or fuel sources
as renewable energy. Including hydropower in a renewable portfolio

 While plants constructed before August 1971 are exempt, facilities that are modified are subject to the

Page 7                                                                   GAO/T-RCED/AIMD-99-229
                  standard would make achieving the proposed standard easier and less
                  costly for electricity suppliers. It would also increase the importance of
                  the nation’s federal hydropower assets if they could be tapped to meet any
                  new requirements.

Non-Fossil-Fuel   The PMAs may offer potential advantages in the generation of electricity
Generation        from non-fossil fuels. PMA hydropower, comprising about 93 percent of the
                  PMAs’ generation, is a clean, domestic, renewable source of electricity.
                  Hydropower plants provide inexpensive electricity and produce no
                  pollution. However, hydropower facilities can have significant impacts on
                  the surrounding area—especially fish migration patterns and wildlife
                  habitats. To mitigate adverse impacts, dams should maintain a steady
                  stream flow and be designed or retrofitted with fish ladders and fishways
                  to help fish migrate. As we reported in September 1997, Bonneville spends
                  hundreds of millions of dollars annually to mitigate damage to fish and
                  wildlife caused by the federal government’s hydropower operations. This
                  sum could increase considerably in the future, according to Bonneville.
                  Such costs may compromise Bonneville’s ability to compete in a
                  restructured environment. Conversely, TVA relies heavily on coal

                  Restructuring also has environmental implications for nuclear energy. As
                  we reported in May, industry experts expect that the deregulation and
                  restructuring of the electricity industry could result in the early retirement
                  of from 9 to 40 percent of the nation’s nuclear power plants. Such plants
                  may not be competitive with other sources of electricity, in part, because
                  of the high construction costs resulting in part from changes in the
                  Nuclear Regulatory Commission’s health and safety regulations issued
                  after the Three Mile Island accident. Additionally, the cost of
                  decommissioning—the disposal of radioactive and other wastes so that
                  the sites comply with environmental standards—is negatively affecting the
                  competitiveness of some nuclear power plants. As we reported in May,
                  competition could result in economic pressures that will affect the
                  availability of adequate funds for decommissioning and affect how utilities
                  address maintenance and safety in nuclear power plants.9 Because of
                  restructuring, owners may retire some of the nuclear plants before
                  sufficient decommissioning funds have been accumulated. In fact, 19 of 26
                  nuclear plants identified as likely to be retired early are owned, in whole
                  or in part, by licensees that have not accumulated sufficient

                  See Nuclear Regulation: Better Oversight Needed to Ensure Accumulation of Funds to Decommission
                  Nuclear Power Plants (GAO/RCED-99-75, May 3, 1999).

                  Page 8                                                             GAO/T-RCED/AIMD-99-229
                       decommissioning funds. More broadly, we also found that nearly half of all
                       the utilities with nuclear plant licenses were not accumulating sufficient
                       reserves through 1997 to pay for decommissioning costs. For example, we
                       reported that TVA had seriously underfunded its decommissioning reserves
                       under certain scenarios. Whereas nearly 20 percent of TVA’s power is
                       nuclear, less than 4 percent of the PMAs’ power is nuclear.

                       One aspect of restructuring that will require careful consideration is
Balancing Equity       balancing the competing interests of various groups of stakeholders that
Among Stakeholders     will be affected by the restructuring process. Stakeholders include
                       ratepayers of investor-owned utilities, preference customers of the PMAs,
                       investors who own stock issued by investor-owned utilities or bonds
                       issued by Bonneville and TVA, and federal taxpayers. We will mention these
                       stakeholders as we discuss the recovery of stranded costs for generation
                       assets and the relationship of the PMAs’ rates to market rates.

Recovery of Stranded   As the industry moves to a restructured environment, some costs that
Costs for Generation   were incurred under the traditional regulated structure may not be
Assets                 recoverable under competitive power rates. These are generally referred
                       to as stranded costs, and estimates of their total value have ranged from
                       $10 billion to $500 billion. State legislatures and others have defined the
                       specific components of stranded costs differently. Stranded costs may
                       include power plants that are rendered uneconomical by restructuring.
                       Nuclear plants with high fixed costs, such as decommissioning costs, may
                       be particularly vulnerable. Stranded costs may also include long-term,
                       high-cost power supply contracts mandated by federal legislation.10 To
                       date, states have been responsible for deciding the extent to which utilities
                       can attempt to recover stranded costs for generation. To the extent that
                       stranded costs are not fully recovered, investors and possibly federal
                       taxpayers must make up the difference and suffer the financial
                       consequences. To the extent that customers are not allowed to benefit
                       immediately and fully from reduced retail rates while stranded costs are
                       being recovered, ratepayers suffer from higher rates. Using their
                       discretion, individual states have allowed for varying degrees of stranded
                       cost recovery. The administration’s restructuring proposal provides
                       general support for utilities’ recovery of stranded costs. Also, the proposal
                       provides for imposing mandatory transmission fees to ensure the recovery

                        The Public Utility Regulatory Policies Act of 1978 requires utilities to buy power offered to them by
                       certain suppliers at rates equal to a utility’s cost of providing its own generating capacity. In many
                       cases, such rates are now well above current market costs.

                       Page 9                                                                    GAO/T-RCED/AIMD-99-229
                          of the power and any other costs assigned for recovery through the PMAs’
                          and TVA’s power rates.

                          A second issue regarding stranded costs that involves federal taxpayers as
                          stakeholders is the recovery of loans or the cost of loan guarantees made
                          by the Rural Utilities Service. These were provided for rural electric
                          cooperatives, many of which are PMA preference customers. To the extent
                          that retail competition may be allowed in electric cooperatives’ service
                          areas, the repayment by the cooperatives of over $32 billion in federal
                          direct or guaranteed loans is increasingly placed at risk. In March 1998, we
                          testified that RUS had written off about $1.5 billion in loans and that RUS
                          questioned the prospects of full repayment of another $10.5 billion in
                          loans.11 We also reported that outstanding loans to borrowers that were
                          currently considered viable by RUS may become stressed in the future
                          because of high costs and competitive or regulatory pressures. We
                          concluded that the federal government will probably incur losses on some
                          of these loans in the future.

                          A third issue concerning stranded costs—the adequacy of accumulating
                          decommissioning reserves—has already been mentioned. From an equity
                          viewpoint, arguments can be made that reserves, when inadequate, should
                          be funded by current ratepayers, future ratepayers, investors, or possibly
                          federal taxpayers.

Market Rates Exceed PMA   On a national scale, the administration estimates that, on average, a typical
Rates                     family of four would save $232 annually on electricity purchases and the
                          reduced costs of other goods and services if the administration’s
                          restructuring plan were implemented. The federal government would also
                          benefit from retail competition. Using various scenarios, we estimated that
                          the federal government could expect cumulative savings in its electricity
                          bills of from $600 million to $6.5 billion from 1998 through 2015 because of
                          retail competition.12 However, although several states have already
                          mandated varying rate reductions in their restructuring plans, not all
                          customers in all states would see price reductions from nationwide retail
                          competition. Residential customers in some states that currently have
                          electricity rates below the national average may see their rates rise,
                          according to several studies. For example, DOE estimates that electricity

                           See Rural Utilities Service: Risk Assessment for the Electric Loan Portfolio (GAO/T-AIMD-98-123,
                          Mar. 30, 1998).
                           See Federal Electricity: Retail Competition Could Create Government Savings (GAO/RCED-97-244,
                          Sept. 30, 1997).

                          Page 10                                                                GAO/T-RCED/AIMD-99-229
rates averaged across all customer classes would actually increase
somewhat in Montana, Oregon, and Washington State under the
administration’s restructuring proposal.

The PMAs are currently required to set their power rates at the lowest
possible level consistent with sound business principles. They generally
follow applicable laws and regulations regarding the recovery of costs. We
have reported that the PMAs’ rates have generally been lower than the
market rates. If the PMAs were authorized to charge market rates for power
in conjunction with federal restructuring legislation, some preference
customers who now purchase power from the PMAs at rates that are less
than those available from other sources would see their rates increase. As
we recently reported, slightly more than two-thirds of the preference
customers, which are located in varying portions of 29 states, that
purchased power directly from Southeastern, Southwestern, and Western
would experience relatively small or no rate increases—increases of
one-half cent per kilowatthour or less—if those PMAs charged market
rates.13 As we reported, the Congress has the option of requiring the PMAs
to sell their power at market rates to better ensure full recovery of the
appropriated and other debt14 that is recoverable through the PMAs’ power
sales.15 This debt totaled about $22 billion at the end of fiscal year 1997
and included nearly $2.5 billion in irrigation costs that are to be recovered
through the PMA’s power sales.16 This option would likely also lead to more
efficient management of the taxpayers’ assets.

Another issue affecting the future price of PMA power is the reliability of
federal generating assets. In March, we reported that the Bureau’s and the
Corps’ hydropower plants are generally less reliable in generating
electricity than nonfederal hydropower plants. We concluded that these
agencies were unable to obtain funding for maintenance and repairs as
needed and therefore delayed repairs. These delays caused frequent,
extended outages and inconsistent plant performance. For example, at the
Bureau’s Shasta plant in California, the need to repair the generating units

  See GAO/RCED-99-55 and Federal Power: Regional Effects of Changes in PMAs’ Rates
(GAO/RCED-99-15, Nov.16, 1998). To estimate potential rate changes, we calculated how much, in
cents per kilowatthour, each customer paid, on average, for power purchased from (1) all sources,
including the PMAs, and (2) sources other than the PMAs, including the wholesale market, in 1995.
Then, we took the difference between the two, considering the latter to be the market rate.
  “Other debt” is primarily debt for certain irrigation facilities and nonfederal nuclear power plants.
  See GAO/AIMD-97-110 and 110A and GAO/RCED-98-43.
 This total does not include any portion of TVA’s debt. TVA’s outstanding debt totaled nearly
$26 billion, as of March 31, 1999.

Page 11                                                                     GAO/T-RCED/AIMD-99-229
                    was identified in 1983. However, funding did not become available until
                    1995, when the customers provided advanced funding, and, according to a
                    Bureau official, repairs will not be completed until 2003. The uncertainty
                    of the federal planning and budget processes to provide timely and
                    predictable funding for maintaining and repairing the federal power assets
                    may be seen as evidence that the Bureau and the Corps cannot provide
                    electricity as efficiently as the nonfederal sector. Although PMA power has
                    been generally priced less than other electricity, as wholesale markets
                    become more competitive, the PMAs’ customers will have more suppliers
                    from which to buy electricity. As nonfederal electricity rates decline in
                    competitive markets, a portion of the PMAs’ debt of about $22 billion may
                    be at risk of nonrecovery if the market for PMA power is diminished.

                    The reliability of the high-voltage transmission system has been the
Maintaining the     responsibility of the North American Electric Reliability Council (NERC), a
Interstate Grid’s   not-for-profit entity with voluntary membership from all segments of the
Reliability         electricity industry. NERC reports that the existing system for setting and
                    encouraging compliance with the industry’s reliability standards is not
                    sustainable in a new environment where power flows on the grid are
                    changing, the number of transactions is increasing dramatically, and new
                    types of business entities are using the transmission system in ways that
                    have not previously been used. NERC believes that mandatory reliability
                    standards are needed. It also believes that the Congress should authorize a
                    new, independent self-regulating reliability organization with oversight by
                    FERC, a position largely supported by the administration.

                    Another aspect of reliability that is changing under restructuring is the
                    control or dispatching of power over the transmission lines. An emerging
                    patchwork of regional electric transmission grids, often working at cross
                    purposes, threatens the system’s reliability and it is time for federal
                    regulators to address the problem, according to a survey of state
                    regulators completed in March 1999.17 The survey also reported that
                    uncertainty over the future of transmission management is harming the
                    competitive position of utilities in regions where the issue is unresolved.
                    The problem arose with the implementation of FERC Order 888. Since that
                    time, FERC has encouraged the creation of new, regional transmission
                    groups, such as integrated system operators that would be responsible for
                    ensuring that loads match resources available to the system. These
                    operators are not to be controlled by the power generators. Currently,
                    FERC is strongly encouraging, but not requiring, owners of transmission

                      Crossed Wires, Neil Palmer & Associates and The Terra Group.

                    Page 12                                                          GAO/T-RCED/AIMD-99-229
facilities to participate in geographically broad transmission organizations.
According to FERC, these organizations are expected to improve the
efficiencies of transmission grid management by adopting better pricing
and congestion management, improving the grid’s reliability, removing
remaining opportunities for discriminatory transmission practices,
improving market performance, and facilitating lighter-handed regulation.
In May, FERC issued a notice of proposed rulemaking that seeks comments
on proposed minimum characteristics and functions for the regional
transmission organizations. Its impact on the PMAs is unclear. As an
example, Bonneville has explored participating in a regional transmission
group in the Northwest but may need clear legal authority to join. The
administration’s proposal would provide such clarity.

FERC  currently has authority over most of the nation’s interstate power
grid. But about one-third of the integrated grid is not under FERC’s
jurisdiction with regard to mandatory open transmission access. For
example, over 30,000 miles of transmission lines owned by Bonneville,
Southwestern, and Western, as well as 17,000 miles owned by TVA, are not
under FERC’s jurisdiction. To maximize the economic benefits of
restructuring, some proposals would extend FERC’s authority to include all
of the nation’s transmission facilities in the lower 48 states.

The restructured environment also creates uncertainty regarding access to
investment capital for new or upgraded transmission capacity. The
building of high-voltage transmission facilities is being delayed at a time
when the need for additional capacity grows in some areas, according to
an April 1999 report on transmission restructuring.18 For-profit entities
may be needed to provide capital if other entities are unwilling or unable
to provide enough capital for new or upgraded facilities. On the other
hand, a restructured market may reduce the need for new transmission
lines by using, for example, distributed generation and cogeneration19 that
would reduce the need to transmit power and that are supported under the
administration’s restructuring plan.

On a more technical note, reliability encompasses the maintenance of
reserves that can be called upon to meet planned and unforeseen outages
by power providers. The decisions on how to provide for standby reserves
in a restructured environment have not been finalized. Of particular

  Credit Implications of the ISO-Transco Debate, Duff & Phelps Credit Rating Co. (April 1999).
  Distributed generation systems include fuel cells, solar cells, and small turbines, which supply power
closer to consumers than a central generation station. Cogeneration systems produce electricity and
another form of energy, such as heat or steam, using the same fuel source.

Page 13                                                                   GAO/T-RCED/AIMD-99-229
                     relevance for today’s hearing is what role the federal government’s
                     hydroelectric facilities could play in providing reserves in the restructured
                     market. As we noted in a March 1999 report on the maintenance and repair
                     of federal hydropower plants, hydropower’s inherent flexibility in meeting
                     different levels of demand translates into the significant role that
                     hydropower may play in meeting demand during peak periods and
                     providing such services as maintaining reserves.20 Depending on the
                     actions taken by federal and state regulators in the near future, a separate
                     market for such services as maintaining reserves is beginning to develop,
                     and utilities with hydropower could capture a market niche and take the
                     opportunity to earn additional revenues.

                     While restructuring has focused largely on the generation sector of the
Promoting            electricity industry, some segments of the industry may face new or
Deregulation by      increased regulations to address market power and consumer protection
Redefining Federal   issues. For example, the PMAs’ transmission rates and facilities may come
                     under new federal regulations. We will now briefly discuss the possible
Roles                new roles of some federal agencies in a restructured electricity industry.

Transmission         FERC recently testified to the Congress that legislation on transmission
                     issues is needed to ensure the full development of competition. The
                     agency recommends (1) bringing all transmission facilities in the lower 48
                     states within its open access transmission rules, (2) clarifying its authority
                     to promote regional management of the transmission grid through regional
                     transmission organizations, and (3) establishing a fair and effective
                     program to protect the reliability of bulk power.

                     FERC’s open access transmission policies address the concern of market
                     power related to the ownership and control of transmission facilities. Fair
                     and open access to reliable transmission service is essential to
                     competition in power markets. In 1992, the Congress broadened FERC’s
                     authority to direct transmission service on a case-by-case basis.
                     Subsequently, FERC has prohibited, through regulatory orders, vertically
                     integrated utilities from discriminating against their competitors by
                     limiting or denying access to their transmission facilities. The
                     administration’s restructuring plan would place Bonneville, Southwestern,
                     and Western under FERC’s authority to review proposed transmission rates
                     under its “just and reasonable” and “not unduly discriminatory”

                       See GAO/RCED-99-63.

                     Page 14                                                GAO/T-RCED/AIMD-99-229
                           FERC  has suggested that regional transmission organizations, such as
                           independent system operators and independent for-profit companies,
                           would address barriers to competition by eliminating bias in transmission
                           operations and allowing the efficient and reliable operation and planning
                           of the transmission grid. The administration’s bill would authorize FERC to
                           require transmitting utilities to transfer operational control of transmission
                           facilities to a regional system operator to facilitate competition.
                           Bonneville, Southwestern, and Western would be required to participate in
                           the regional transmission organizations, if required by FERC.

Mergers and Acquisitions   FERC  believes that it should continue to consider market power issues in
                           reviewing applications for mergers or other asset acquisitions. Last month,
                           FERC testified that that the Congress should expand its jurisdiction over the
                           transfers of generation facilities. Currently, FERC can review a transaction
                           involving a public utility only when it involves other facilities over which it
                           has jurisdiction, such as transmission facilities or contracts for wholesale
                           sales. However, transactions involving only generation assets do not
                           necessarily fall under FERC’s jurisdiction even though the concentration of
                           generation assets may directly affect wholesale competition. FERC also
                           testified that the Congress should give it explicit, direct jurisdiction over
                           mergers of public utility holding companies—a role historically held by the
                           Securities and Exchange Commission (SEC).

                           The Public Utility Holding Company Act was enacted in 1935 to break up
                           the large trusts that controlled the nation’s electric and gas distribution
                           networks. An important feature of the 1935 Act was that it authorized SEC
                           to break up the massive interstate holding companies, which it regulates,
                           and require them to divest their holdings until each became a single
                           consolidated system serving a specific geographic area. The 1935 Act also
                           permitted holding companies to engage only in business that was essential
                           and appropriate for the operation of a single integrated utility. This latter
                           restriction eliminated the participation of nonutilities in wholesale electric
                           power sales. The law contained a provision that all holding companies had
                           to register with SEC, which was authorized to supervise and regulate the
                           holding company system.

                           Last month, SEC testified that the Congress should repeal the 1935 Act
                           conditionally. According to SEC, although portions of the 1935 Act largely
                           duplicate other existing regulation and controls imposed by the market, a
                           need to protect consumers continues. Specifically, SEC called for added

                           Page 15                                                GAO/T-RCED/AIMD-99-229
                 flexibility and authority for FERC to engage in more extensive regulation
                 and oversee transactions among affiliates in holding company systems.

                 The mandatory purchase provision of the Public Utility Regulatory
                 Policies Act of 1978 was partly intended to foster the commercialization of
                 renewable energy by requiring utilities to purchase power from
                 cogenerators and renewable energy facilities. However, the 1978 Act, in
                 some cases, resulted in high prices to consumers because some of the
                 mandatory contracts were based on forecasts of high fuel prices,
                 according to the Congressional Budget Office21 and others. These factors
                 rendered the contracts uneconomical for utilities in a competitive market.
                 Legislative proposals, including the administration’s, call for the
                 prospective repeal of this provision. The mandatory purchase provision
                 may be replaced with other regulatory requirements to ensure that these
                 sources of energy continue to enjoy market access through, for instance, a
                 renewable portfolio standard and a public benefit program.

                 This concludes our formal statement. We look forward to working with
                 this Subcommittee in the coming months in discussing options for
                 addressing the PMAs’ role in a changing electricity industry. If you or other
                 Members of the Subcommittee have any questions, we will be pleased to
                 answer them.

                 For future contacts regarding this testimony, please contact Vic Rezendes
Contact and      at (202) 512-3841. Individuals making key contributions to this testimony
Acknowledgment   were Peg Reese, Charles Hessler, and Daniel Garcia-Diaz.

                   See Electric Utilities: Deregulation and Stranded Costs, Congressional Budget Office (Oct. 1998).

(141350)         Page 16                                                                  GAO/T-RCED/AIMD-99-229
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