oversight

Bonneville Power Administration: Long-Term Fiscal Challenges

Published by the Government Accountability Office on 2003-07-01.

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

United States General Accounting Office
Washington, DC 20548




          July 1, 2003

          The Honorable David L. Hobson
          Chairman
          The Honorable Peter J. Visclosky
          Ranking Minority Member
          Subcommittee on Energy and Water Development
          Committee on Appropriations
          House of Representatives

          Subject: Bonneville Power Administration: Long-Term Fiscal Challenges

          The Bonneville Power Administration (BPA) provides about 45 percent of all electric
          power consumed in the Pacific Northwest—Idaho, Montana, Oregon, and
          Washington. The power that BPA markets and distributes is generated in large part
          at hydroelectric projects including dams in the Federal Columbia River Power System
          (federal power system). BPA also owns and operates about 75 percent of the region’s
          transmission lines. BPA charges for the power it sells and for its transmission
          services. Under the Pacific Northwest Electric Power Planning and Conservation Act
          of 1980, BPA is responsible for ensuring an adequate, efficient, economical, and
          reliable power supply for the Pacific Northwest. To do so, BPA balances the needs of
          its customers against the highly variable water resources available for generating
          electricity. In maintaining this balance, BPA sometimes exchanges power through
          purchases, sales, or otherwise with utilities and other entities within and outside the
          Pacific Northwest. In addition to providing power, BPA is required under the 1980
          act, various other statutes, treaties and court cases, to “protect, mitigate, and
          enhance” fish and wildlife resources affected by the federal power system.

          Recently, BPA has witnessed a substantial deterioration in its financial condition.
          For example, BPA’s cash reserves of $811 million at the end of fiscal year 2000 had
          fallen to $188 million by the end of fiscal year 2002. To cope with its financial
          difficulties BPA has increased the rates that it charges its customers for power by
          over 40 percent since 2001. In 2002, BPA asked Congress to increase its ceiling on
          Department of the Treasury (Treasury) debt by about $1.4 billion to fund capital
          spending and, in 2003, Congress approved a smaller increase of $700 million dollars.
          In February 2003, BPA announced that it estimated a 74 percent chance that it would
          miss a Treasury payment this year.

          In light of BPA’s deteriorating financial condition, request for increased borrowing
          authority, and increased risk of missing a Treasury payment, you asked us to (1)
          identify cost advantages, disadvantages, and challenges BPA may face in providing


                                                         GAO-03-918R Bonneville Power Administration
power and meeting its debt and other obligations; (2) identify the causes of BPA’s
recent financial difficulties; (3) determine how BPA plans to use its additional
borrowing authority; and (4) evaluate how the risk of default to Treasury has changed
over the past 5 years. This report presents the preliminary findings of our review of
BPA’s financial situation and the risk to Treasury. As agreed with subcommittee
staff, we will continue to work on these objectives as well as others, including an
assessment of options that would enable BPA to reduce the likelihood of future
financial difficulties and accompanying risk to Treasury. To perform our work we
reviewed BPA budget documents and investment plans, as well as numerous studies
and position papers by stakeholders and experts, and we collected views from BPA’s
customers, stakeholders, and oversight bodies.

Results in Brief

•   BPA has some inherent advantages that have generally enabled it to provide low-
    cost power to its customers in the Pacific Northwest and meet debt and other
    obligations. However, BPA also faces inherent challenges related to meeting its
    obligations to provide economical power while protecting fish and wildlife. These
    challenges are made greater by the changing demands on its power and its fish
    and wildlife protection resources.

•   BPA’s current financial difficulties are largely the result of decisions that caused
    rising costs and lower-than-projected revenues. BPA signed long-term contracts
    to buy power to serve demand that exceeds the supply of the federal power
    system. Of the additional demand BPA agreed to serve, a significant proportion
    was for industrial customers that BPA was not required to serve during the fiscal
    year 2002-2006 rate period. The prices BPA agreed to in these contracts turned
    out to be significantly higher than recent market prices and were higher than the
    rates BPA initially set for selling its own power. BPA also projected revenues
    from its own sale of surplus power that did not materialize when market prices
    turned out to be lower than BPA had projected.

•   BPA plans to use its expanded borrowing authority to upgrade and improve the
    transmission system and dams in the federal power system. These capital
    expenditures are expected to increase the reliability and efficiency of the system
    and may also increase generating capacity to some degree. BPA staff told us that
    these capital expenditures are, for the most part, not expected to solve BPA’s
    current financial problems.

•   We found that BPA’s long-term risk of default is greater than in the previous 5-
    year rate period because of BPA’s higher costs and because of uncertainty
    surrounding both its role as electricity provider and its obligations to protect fish
    and wildlife. While BPA has taken steps to improve its financial condition and
    deal with its long-term challenges, in the past such efforts have not entirely
    succeeded.




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Background

BPA was formed in 1937 to market electric power produced by the Bonneville Dam to
the Pacific Northwest. BPA’s role in the region has since evolved. BPA’s marketing
responsibilities were broadened to include power from 31 federally owned
hydroelectric projects, most located in the Columbia River Basin. BPA also markets
power from one nonfederal nuclear plant and power purchased from other sources.
In addition, under the Pacific Northwest Electric Power Planning and Conservation
Act of 1980 (Northwest Power Act), BPA is charged with providing the Pacific
Northwest with an adequate, efficient, economical, and reliable power supply. In this
role, BPA serves its customers’ electricity demand at rates that BPA sets to cover its
costs, including debt payments and operations-and-maintenance costs.1 BPA’s rates
are fixed in the sense that they do not typically vary to reflect changes in the prices of
power in the market on an hourly or even daily basis, but rather are set periodically
to cover BPA’s costs on average over a long period of time. At times when the
electricity generation of the federal power system is insufficient to meet the demand
of all BPA’s customers, BPA has purchased or otherwise acquired power from other
sources, including utilities and other suppliers in the Northwest, California, and other
western states, to make up the difference. In addition, BPA generates surplus power
when demand from its firm customers is low or when water levels are high, and has
traditionally exchanged this power under various terms with utilities and other
entities in the Northwest and other western states.

The recent restructuring of the nation’s wholesale electricity markets has affected
how BPA allocates and distributes its surplus power. The electricity industry is in the
process of restructuring from one in which monopoly utilities generated and provided
electricity to consumers at regulated prices to one in which numerous private
companies compete to sell electricity at prices determined by supply and demand
conditions. BPA’s response to this change has included developing a power trading
                                                                                     2
operation, in part, to sell surplus power as opposed to making exchanges of power.

BPA has additional obligations beyond providing power. For example, the Northwest
Power Act also requires that BPA protect, mitigate, and enhance fish and wildlife
resources affected by the operation of the federal power system. In addition,
significant declines in the historical returns of salmon and steelhead to the Columbia

1
 BPA’s customers include public and investor owned utilities. BPA serves the net needs of these
customers—the difference between what these customers produce themselves and what they sell to
their retail customers. In addition, BPA sells power to some industrial customers. BPA’s rates include
charges for the electricity BPA generates and for the use of transmission lines that BPA owns.
2
 For example, prior to this change, BPA frequently provided power to California utilities during the
spring when BPA had surplus electricity and, in return, the California utilities provided electricity to
BPA during the fall and winter when BPA was typically short of electricity. This sort of trading also
sometimes took place in a single day; BPA would send power to California utilities during the peak air
conditioning hours of the day and receive power back during the night. Now, BPA more commonly
sells its surplus power to utilities or power marketers.


Page 3                                              GAO-03-918R Bonneville Power Administration
River Basin have resulted in the listing of 12 populations of these fish as endangered
or threatened under the Endangered Species Act. With these listings, BPA became
responsible for ensuring that the operation of the federal power system does not
jeopardize the continued existence of these 12 populations. BPA also has a trust
responsibility with the 13 federally recognized American Indian tribes in the
Columbia River Basin, some of whose fishing rights are guaranteed by treaties,
executive order, and court cases. BPA currently provides the bulk of funding for fish
and wildlife programs in the Columbia River Basin.

BPA Has Inherent Cost Advantages and Some Disadvantages and Faces
Challenges in Meeting Competing Demands on Its Resources3

BPA has inherent cost advantages that have generally allowed it to keep its electricity
rates below those of nonfederal utilities in the Pacific Northwest. For example, BPA
predominantly relies upon electricity produced at hydroelectric dams in the federal
power system, which generally have low capital and operating costs. Many of these
projects were built decades ago and had relatively low construction costs compared
with newer generating facilities constructed by nonfederal utilities. BPA tends to
have lower operating costs in part because, unlike some competing generating units,
hydropower projects do not burn fossil fuels.4 Further, as a federal agency, BPA is
not required to pay income taxes. In contrast, according to the Energy Information
Administration, investor owned utilities paid taxes averaging between 8.1 and 13.5
                                                         5
percent of operating revenues from 1995 through 2001. In addition, BPA does not
include a profit margin in its power rates. In contrast, public utility commissions
typically approve a profit margin, in the form of a return to investment, to be included
in and thus increase the power rates of investor owned utilities. Moreover, BPA has
had access to more favorable financing conditions than investor owned utilities;
interest income to bondholders from BPA’s nonfederal debt is exempt from federal
personal income tax and some state income taxes. In addition, BPA has in the past
received favorable loan terms from the Treasury. Finally, these cost advantages have
historically benefited the region’s electricity consumers and enabled BPA to repay its
debt to Treasury and cover other costs, obligations, and debt.

However, BPA also has disadvantages compared with some nonfederal utilities. For
example, BPA operates under a different financial structure than investor owned
utilities with which it competes. Investor owned utilities can use equity (sale of stock

3
 This section is not intended as a complete enumeration of BPA’s advantages, disadvantages, and
challenges. Nor have we tried to assess the relative weight or importance of the examples provided in
this section.
4
 Many of the newer built generating facilities burn fossil fuels to generate electricity. While the
efficiency of fossil fuel burning power plants has generally increased over time, hydroelectric power
plants still tend to have cost advantages because of the length of life of dams and the cost of fossil
fuels.
5
 While publicly owned utilities typically do not pay income taxes, many do make payments in lieu of
taxes to local governments.



Page 4                                              GAO-03-918R Bonneville Power Administration
or retained earnings) to finance some capital spending. BPA cannot issue stock and
generally operates without a profit and, therefore, cannot generally use equity to
finance its capital investments. As a result, BPA generally relies on debt for financing
capital investments. Carrying higher levels of debt translates into greater average
fixed costs that ultimately must be recovered in BPA’s power rates. In addition,
BPA’s obligation to protect, mitigate, and enhance fish and wildlife resources adds to
its total costs, thereby increasing its power rates.6 For example, from fiscal years
1997 through 2001, BPA spent over $1.1 billion in support of fish and wildlife—
primarily to benefit salmon and steelhead. These expenditures have funded fish and
wildlife efforts, including those undertaken by BPA, other federal agencies, American
Indian tribes, and the four northwest states (Idaho, Montana, Oregon, and
Washington) and have funded operations-and-maintenance and capital costs for the
U. S. Army Corps of Engineers, Bureau of Reclamation, and the Fish and Wildlife
Service for projects such as fish bypass facilities at dams and fish hatcheries. BPA
also estimates that from fiscal years 1997 through 2001, spilling water from dams and
augmenting river flows to enhance fish survival resulted in over $2.2 billion in
forgone revenues or increased power purchases.7

BPA’s dual roles—as supplier of economical and reliable power and as protector of
fish and wildlife—present a challenge. BPA’s stakeholders include both consumers
of electricity and proponents of fish and wildlife protection, and both groups pressure
BPA to deliver more of what they want. However, providing more support for fish
and wildlife comes at the cost of less electricity and higher electricity rates.
Similarly, serving ever-increasing demand for economical electricity can put greater
stress on fish and wildlife, either through more intensive use of hydroelectric
generating facilities at the expense of spilling water to support fish migration, or
through rising costs and the resulting pressure from rate-payers to reduce funding for
fish and wildlife programs, as has occurred during the current financial crisis.

BPA, like its competitors, operates in an unstable environment with regard to
demand for its electricity and also with regard to its costs for fish and wildlife
protection. For example, while the regional demand for BPA’s electric power has
generally grown throughout BPA’s existence, demand for BPA’s power fell in the mid-
1990s as some of its customers found lower prices in the market. Demand for BPA’s
power increased dramatically after market prices rose during the western electricity
crisis of 2000 and 2001. While other utilities face similarly uncertain demand and
market conditions, BPA appears to have greater competing pressure from its various
stakeholders. For example, in an April 18, 2003 open letter to its customers and
Northwest citizens, BPA stated that it had been influenced by arguments and
demands from its stakeholders on such issues as how much power it would provide
and how it would structure its power rates. In addition, over the past two decades,
BPA’s spending and actions in support of fish and wildlife have grown considerably
with the enactment of various environmental laws and with increased regulations put

6
 BPA has pointed out that it has other obligations, including providing benefits to customers of
investor owned utilities and providing some irrigation assistance.
7
    We have not audited BPA’s estimates of foregone revenues or increased power purchases.


Page 5                                              GAO-03-918R Bonneville Power Administration
in place to protect the environment. BPA provides the majority of fish and wildlife
program money in the region, which increases its challenges relative to its
competitors.

BPA’s Financial Difficulties Caused by Rising Costs, Lower Than Expected
Revenues

BPA’s current financial difficulties have been largely caused by decisions resulting in
rising costs and lower than projected revenues. In April 2003, BPA estimated that its
costs over the current 5-year rate period, covering fiscal years 2002 through 2006,
would be $5.3 billion dollars greater than over the previous 5 years. This increase in
costs is quite substantial given that BPA’s total operating revenues—funds available
to cover its costs—were about $13.7 billion over the previous 5-year period from
            8
1997–2001. A large part of the increase in costs is related to serving demand at levels
above the estimated average power production of the federal power system during a
“critical water year.”9 BPA agreed to serve this additional demand and, to do so, BPA
                                                                     10
signed long-term contracts to purchase power from other sources. Of the additional
demand BPA agreed to serve, a significant proportion was for industrial customers
that BPA was not required to serve during the fiscal year 2002-2006 rate period. The
prices that BPA paid for the additional power were significantly higher on average
than the rates BPA initially set for the current rate period and are also higher than
recent market prices. More generally, BPA’s costs attributed to both its sale of
electric power (power business line) and sale of transmission services (transmission
business line) have risen in almost every cost category since 1997. Further, BPA’s
fish and wildlife expenditures increased from about $80.5 million in fiscal year 1997
to $109.6 million in 2001 in constant 2001 dollars—an increase of about 36 percent—
and are projected to be even higher over the next few years. Finally, staffing levels
have also increased, from a recent low of 2,738 full-time-equivalent positions (FTEs)
in 1999 to an estimated 3,206 in 2003—an increase of about 17 percent.

In April 2003, BPA also projected lower revenues than it had planned for in the
original rates set for the current rate period. A large part of this expected revenue
shortfall comes from lower than expected market prices. For example, because
market prices since the beginning of fiscal year 2002 have been lower than BPA
projected, BPA recently estimated that revenues from surplus sales of power would
be about $700 million lower than BPA had assumed when setting its initial rates for
                 11
the rate period. BPA’s projected revenues are also lower because of lingering


8
     Neither the $5.3 billion nor the $14.6 billion figure has been adjusted for inflation.
9
 BPA estimates its available power based on water conditions in a “critical water year.” In a critical
water year less than normal amounts of water are available to generate hydroelectricity.
10
 These contracts were for periods of up to 5 years. Many of the contracts were signed before and
during BPA’s formal rate-setting process for the fiscal year 2002–2006 period.
11
  As discussed previously in this report, BPA sometimes has surplus power to sell, even in years when
its capacity is insufficient to serve its entire demand.


Page 6                                                    GAO-03-918R Bonneville Power Administration
impacts of the drought of 2000 and 2001, which have reduced the amount of water
available to generate surplus electricity.


BPA Plans to Use Borrowing Authority to Upgrade Transmission and
Generation Systems

BPA plans to use the bulk of its borrowing authority to upgrade its transmission
system and make other investments to increase system reliability. Specifically, about
62 percent of BPA’s planned capital spending is directed at the transmission system.
Another about 5 percent of capital spending is for corporate uses, such as
information technology investments and projects. The remaining 33 percent is
directed toward reliability and efficiency improvements at federally owned dams.
Some of these dam improvements will also slightly increase the capacity of the
federal power system to produce electricity. Overall, BPA staff told us that while
these investments are needed to improve reliability and efficiency, most planned
capital investments are largely unrelated to BPA’s current financial difficulties and
are unlikely to resolve them.


Risk of Failure to Meet Debt Obligations to Treasury Has Likely Increased
As a Result of High Costs and Market Uncertainty

Several factors appear to have increased the risk over the past 5 years that BPA may
                                                                                   12
be unable to meet its full future debt obligations to Treasury. In a 1997 report, we
noted that BPA would likely face a higher risk of default on its debt to Treasury after
                                                     13
fiscal year 2001 as a result of (1) high fixed costs, which BPA must cover regardless
of how much electricity it sells; (2) high operating costs, including internal costs and
fish and wildlife protection costs; (3) greater market uncertainty, in part because of
the impacts of electricity restructuring on market prices and demand; and (4) an
increased likelihood that BPA will lose part of its customer base as its costs increase
relative to costs of alternative supplies of electricity. This likelihood of greater risk to
Treasury seems to be coming to pass. We found in our current review that BPA’s
fixed costs are expected to rise over the next few years, that its operating costs are
much higher than when the 1997 report was published, that market and other
uncertainty affecting BPA’s costs and revenues has increased, and that there is
significant risk that BPA will lose some of its customer base in the future.
Specifically:

•    With regard to fixed costs, the 1997 GAO report stated that as of 1996, BPA’s high
     fixed costs inhibited its flexibility to lower its rates and meet competitive

12
 U.S. General Accounting Office, Federal Electricity Activities: The Federal Government’s Net Cost
and Potential for Future Losses, GAO/AIMD-97-110 (Washington, D.C.: Sept. 19, 1997).
13
  Fixed costs are costs that must be paid regardless of how much electricity BPA sells. These fixed
costs include meeting long-term debt obligations incurred to build hydro projects, nuclear plants, and
the transmission system.


Page 7                                             GAO-03-918R Bonneville Power Administration
    pressures. For example, financing costs for BPA’s long-term debt ate up 32
    percent of BPA’s revenues—compared to a nationwide average of 14 percent for
    investor owned utilities. Currently, BPA expects its total debt to rise over the
    next few years as BPA undertakes its planned capital investments on transmission
    and generation upgrades. This additional debt will increase BPA’s fixed costs
    above current levels. Further, because the bulk of these planned investments are
    focused on reliability of the transmission system, the investments will have little
    positive impact on BPA’s revenues, while paying off the additional debt
    obligations will require higher total rates, including electricity and transmission
    charges.

•   With regard to high operating costs, BPA’s condition is worse than it was 5 years
    ago. The 1997 report stated that after 2001 BPA faced potential upward pressure
    on its operating costs, including fish and wildlife costs. For example, a
    memorandum of agreement that limited BPA’s fish and wildlife protection costs
    was set to expire in 2001, opening the door to possibly higher costs. Costs have
    indeed risen since 1997. For example, as discussed previously in this report, costs
    associated with fish and wildlife protection have increased significantly since
    1997, as have most other categories of operating costs.

•   BPA also faces greater uncertainty than it did 5 years ago. The 1997 report stated
    that BPA may face greater market uncertainty in the future, and our current
    review indicates that market uncertainty has indeed been an increased problem
    for BPA. For example, as discussed previously, BPA had difficulty making
    accurate projections of market prices for its surplus power sales and this
    difficulty led BPA to sign long-term contracts to purchase power at high prices
    and resulted in a downward revision in BPA’s expected revenues from surplus
    electricity sales. BPA also experienced an unanticipated increase in demand for
    its power following the 2000–2001 western electricity crisis. Further, BPA faces
    uncertainty with regard to future fish and wildlife costs with the recent federal
    court decision that rejected the National Oceanographic and Atmospheric
    Administration’s National Marine Fisheries Service (NOAA Fisheries) 2000
    biological opinion—a document setting out how NOAA plans to avoid
    jeopardizing the existence of certain listed species. Any changes to the operations
    of these projects resulting from the federal court decision may diminish BPA’s
    ability to control costs and/or earn revenue. For example, physical alterations to
    dams, changes in how the dams are operated, and changes to river flows or
    reservoir levels to improve fish survival may increase capital and operations costs
    for the projects and reduce the flexibility to generate power.

•   Finally, there is a significant long-term risk that customers will leave BPA in light
    of BPA’s current financial condition. The 1997 report noted that customers may
    opt to leave BPA if they can find cheaper power than BPA is offering. The
    availability of cheaper power depends in part on the cost of generating power by
    alternative means, such as generation plants fired by natural gas or coal. With
    regard to natural gas generators, the costs of operating these plants for any
    constant level of natural gas prices, has decreased significantly in recent years



Page 8                                       GAO-03-918R Bonneville Power Administration
                                                              14
     because of improvements in operating efficiency. In contrast, BPA’s current
     costs, as reflected in its power rates, are at historical highs and are currently
     higher than regional market prices for wholesale electricity have been in most
     weeks from January 1, 2002, through March 17, 2003.15 If demand for BPA’s power
     falls, BPA’s revenue may be subject to greater volatility because BPA will have to
     sell more of the power generated by the federal power system in the market
     where prices have been quite volatile. Greater revenue volatility increases the
     risk to Treasury, especially as BPA’s debt increases over the next few years.

BPA is currently taking steps to address its financial problems and improve its
outlook over the next few years, but the outcome of these efforts is in doubt. For
example, BPA is planning to reduce its internal costs. However, past efforts by BPA
to reduce internal costs have produced mixed results. For example, in 1996, BPA
planned to reduce its staffing level to 2,755 FTEs, down from its staffing level at the
time of 3,160 FTEs. While BPA met this goal, achieving an FTE level of 2,738 in 1999,
staffing has increased since then and is currently well above 1996 levels.

BPA expects a number of other factors to lead to more favorable financial conditions
in the future. For example, BPA hopes that improved water conditions and higher
market prices will boost revenues. BPA officials have recently told us that a wet late
winter and early spring and somewhat higher market prices for surplus power sales
have indeed improved BPA’s financial outlook in 2003 and reduced significantly the
risk that BPA will miss a Treasury payment this year. However, water and market
conditions remain subject to volatility, an ongoing revenue and cost risk for BPA.
Further, BPA expects its power acquisition costs to fall as its long-term contracts
expire between now and fiscal year 2006. Whether or not this cost reduction occurs
depends on market conditions in the future and on how much power BPA buys after
2006.

Another factor that BPA believes mitigates risk to Treasury is that many of BPA’s
customers have signed contracts requiring them to pay BPA for power, whether or
not they take the power. These contracts, referred to as “take-or-pay” contracts, may
shield BPA from the risk in the short run that customers will leave if BPA’s rates
remain high or rise further. Further, the take-or-pay obligation may make it easier for
BPA to recover its costs as long as the contracts are in force. However, BPA’s high
rates may increase the likelihood that it will alienate its customers or drive them to
lower cost suppliers in the long term or even out of business in some cases. For
14
  As of January 2003, average natural gas prices for the entire nation at the wellhead were over 50
percent higher than the average in 2002. However, the Energy Information Administration forecasts
that natural gas prices will fall in the future from recent levels.
15
  These market prices in the Northwest were obtained from the Energy Information Administration.
In addition, we reviewed average monthly prices in the Northwest from January 1997 through
December 2001, published by Dow Jones. This review indicated that in 41 out of 60 of these months
(about 68 percent), average prices were below BPA’s current rates of around $32 per megawatt-hour.
These prices are for wholesale electricity sold at the Mid-Columbia hub in the Northwest. Because
these prices have not been adjusted for inflation, the number of months that average prices have been
lower than BPA’s current rates may be less than 41 when measured in constant dollars.



Page 9                                             GAO-03-918R Bonneville Power Administration
example, a number of BPA’s utility and industrial customers filed suit this spring to
attempt to stop BPA from imposing further rate increases. In addition, some
industrial customers have claimed that they are unable to operate at BPA’s current
rates and may be forced to close down completely if BPA’s rates do not fall. If
customers do leave BPA in the long term as their take-or-pay contracts end, this may
increase future Treasury risk to the extent that BPA ends up selling a greater
proportion of its power in the volatile market.

Finally, BPA is engaged in a regional dialogue with its stakeholders to try to resolve
issues regarding how much power BPA will provide and under what terms, as well as
how best to assess the risks and distribute the benefits of the federal power system.
While the current regional dialogue to deal with BPA’s financial problems is a positive
step, in the recent past BPA did not adopt key recommendations of a previous
regional effort to resolve similar issues. Specifically, in 1996 a comprehensive review
of the Northwest energy system, undertaken at the request of the governors of Idaho,
Montana, Oregon, and Washington, advocated that BPA limit its role as power
supplier by not serving future demand increases beyond the expected generation of
the federal power system in a critical water year. However, as discussed previously
in this report, BPA did not follow this recommendation when it agreed to serve
additional demand during the current rate period. BPA has stated that its decision to
depart from the recommendations of the comprehensive review resulted from
pressure from its customers.

Agency Comments and Our Evaluation

We provided the Administrator and CEO of BPA with a draft of this report for
comment. In a June 20, 2003 letter (see enclosure), the Vice President for National
Relations of BPA provided overall comments on the report. These overall comments
relate to BPA’s potential to lose customers and to its costs—factors we identified that
affect BPA’s risk of defaulting on Treasury debt.

Regarding BPA’s risk of losing customers, BPA’s overall comments state that the risk
is no greater and is probably lower than in 1997 because while BPA’s rates have risen
since 1997, the market price for electricity has risen even faster and because many of
BPA’s customers have signed long-term contracts requiring them to pay for power
whether or not they actually take the power.

We believe that the risk is greater than projected in BPA’s comments. We agree that
the fundamental advantages of the federal power system—most notably the relative
low cost of hydroelectric generation—continue to create an opportunity for BPA to
provide economical power to its customers. However, we also believe BPA’s large
rate increases make alternative supplies of electricity more attractive. Moreover,
BPA’s power rates are currently over 40 percent higher than they were in the mid-
1990s when some BPA customers left to find cheaper power, while the costs of new
electricity generation have generally fallen in recent years. While some of these
customers returned to BPA during and after experiencing extremely high electricity
prices during the western electricity crisis of 2000 and 2001, prices in many months
since the crisis have returned to levels much closer to prices in the mid-1990s.


Page 10                                    GAO-03-918R Bonneville Power Administration
Moreover, we disagree with BPA’s statement that market prices rose faster than
BPA’s rates. While market prices for wholesale electricity were very high by
historical standards from about May 2000 through July 2001, for most months
between January 1997 and February 2003 market prices of wholesale electricity in the
Northwest have been lower than BPA’s current power rates of over $32 per MWh,
even before BPA’s recently announced additional 5 percent rate increase.

With regard to the long-term take-or-pay contracts that many of BPA’s customers
have signed, we agree that these contracts provide BPA with somewhat of a
guarantee that their customers will not leave BPA. However, in our discussions with
BPA officials we were told that, in the event of a prolonged period of high water and
low electricity market prices, it is likely that BPA will be under pressure from its
customers to lower its rates or change the terms of the take-or-pay contracts.

With regard to costs, BPA said in its overall comments that the risk that BPA will
default on Treasury debt is mitigated because, among other things, the take-or-pay
contracts in conjunction with cost-recovery clauses built into BPA’s rate case for
fiscal years 2001-2006 protect BPA’s ability repay its Treasury debt, and because
BPA’s Transmission services face virtually no competition and so can recover BPA’s
costs associated with these services, including its investments in electricity
infrastructure funded using Treasury debt.

We do not agree. While take-or-pay contracts in conjunction with cost recovery
clauses, in principle, allow BPA to raise its rates unilaterally and prohibit customers
from leaving BPA for lower priced power elsewhere, in practice, this is not
guaranteed. For example, in spring 2003, a number of BPA’s customers, including
public utilities and industrial customers filed suits to prevent BPA from implementing
additional rate increases. The outcome of these suits has not yet been decided, but if
the ruling goes against BPA, then BPA’s ability to raise its rates to fully cover its costs
and debt obligations may be in question.

We also do not agree that the absence of competition for transmission services in the
Northwest mitigates Treasury risk. As stated in this report, higher costs, whether in
the transmission or power business lines of BPA, all must be recovered in its rates.
Further, as stated in our 1997 report, higher debt—incurred to expand or improve the
transmission system—also decreases BPA’s flexibility to compete with market prices.
Therefore, higher debt on the transmission side potentially makes BPA less
competitive.

BPA also made a number of detailed technical comments that addressed, among
other things, its roles and responsibilities, the causes of its financial difficulties,
additional advantages and disadvantages BPA has compared with its competitors,
and actions that BPA has taken to improve its financial condition. We have
incorporated these comments as appropriate in our draft.




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Scope and Methodology

In conducting our work, we reviewed BPA budget documents and investment plans,
numerous studies and position papers by stakeholders and experts, our past reports.
We also met with BPA officials and stakeholders, including public utilities, direct
service industrial customers, investor owned utilities, representatives of American
Indian tribes, and industry experts. We also met with BPA’s oversight bodies,
including staff of the Department of Energy and staff of the Northwest Electric Power
and Conservation Planning Council. We conducted our review from April through
May 2003 in accordance with generally accepted government auditing standards.

                                         -------

As agreed with your offices, unless you publicly announce the contents of this report
earlier, we plan no further distribution of it until 14 days from the report date. At that
time, we will send copies of this report to interested Members of Congress and make
copies available to others upon request. In addition, the report will be available at no
charge on the GAO Web site at http://www.gao.gov.

If you have any questions about this report or need additional information, please call
me at (202) 512-3841. Major contributors to this report include Frank Rusco, Jill
Berman, Jonathan Dent, Samantha Gross, Jon Ludwigson, Cynthia Norris, and
Barbara Timmerman.




Jim Wells
Director, Natural Resources
 and Environment

Enclosure




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Enclosure




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