oversight

Federal Electric Power: Views on the Sale of Alaska Power Administration Hydropower Assets

Published by the Government Accountability Office on 1990-02-22.

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

FEDERAL ELECTRIC
POWER
Views on the Sale of
Alaska Power
Administration
Hydropower Assets


                 140936
                   United States
                   General Accounting Office
GAO                Washington, D.C. 20548
      1            Resources, Community, and
      /            Economic Development Division

                   B-238296

      I            February 22,199O

                   The Honorable Mike Synar
                   Chairman, Environment, Energy
                     and Natural Resources Subcommittee
                   Committee on Government Operations
                   House of Representatives

                   The Honorable George Miller
                   Chairman, Subcommittee on
                     Water, Power and Offshore
                     Energy Resources
                   Committee on Interior and
                     Insular Affairs
                   House of Representatives

                   As requested by your offices in January 1989, we updated our earlier
                   work that examined the federal government’s efforts to sell the assets of
                   the Alaska Power Administration (APA). Specifically, we evaluated the
                   prospective sale to determine the extent to which concerns raised in our
                   March 1987 letter to the Secretary of Energy (see app. I) were consid-
                   ered by the Department of Energy (DOE) in arriving at its current sale
                   proposal. Our primary concern at that time was that APA'S planned
                   divestiture approach would likely lead to a proposed sale at a price that
                   would not (1) provide for full cost recovery for the government or (2)
                   reflect the full potential value of the assets to a purchaser. We, there-
                   fore, believed such a sale would benefit APA ratepayers at the expense of
                   taxpayers.


                           current sale proposal does not address our earlier concerns, Sales
Results in Brief   APA'S
                   agreements have been reached between APA and potential purchasers of
                   APA'S assets-the     Eklutna and the Snettisham hydroelectric power
                   projects. The sales agreements provide for selling prices that approxi-
                   mate APA'S previously established minimum acceptable bid of the pre-
                   sent value of the principal and interest due the Treasury over the life of
                   the loan. The sales agreements also provide that the federal government
                   (1) ensure that existing rights-of-way for the projects’ transmission
                   facilities be transferred to the purchasers and (2) bear any construction
                   cost over-runs related to the nearly completed Crater Lake portion of
                   the Snettisham project.




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                    R-238296




                    In our 1987 letter, we expressed our concern that APA’S approach to the
Stiles Agreements   sale would likely lead to a limited number of offers to purchase the
Have Been Reached   assets and that potential purchasers would likely offer a purchase price
                    representing APA’S announced minimum acceptable bid. This has proven
                    to be an accurate assessment of the situation.

                    APA  proceeded with its planned divestiture approach and solicited bids
                    as it had originally proposed at the time of our earlier work. Bids were
                    solicited for Snettisham on April 1, 1987, and for Eklutna on May 20,
                     1987. In the solicitations, APA limited eligible bidders to (1) electric utili-
                    ties who are currently purchasing power from APA, (2) local municipali-
                    ties, (3) the state of Alaska, or (4) a combination of these entities. We
                    were told by the APA Administrator that other parties expressed interest
                    in bidding for the projects but were told they were not eligible bidders.
                    As a result of the limitation on bidders, it is unlikely that bids actually
                    received represent the fair market value of APA assets.

                    APA received only one bid for each project. It then negotiated with each
                    potential purchaser to arrive at a final sales agreement for each project.
                    These agreements provide for selling prices approximating the minimum
                    acceptable bid criteria specified in APA’S request for proposals. These
                    criteria provided that the sale price be not less than the present value]
                    of future principal and interest payments that the Treasury would have
                    received under continued federal ownership (present value pricing
                    method). The sales agreements will be finalized with congressional
                    approval.

                    A brief discussion of the two sales agreements follows. A description of
                    the projects and background information on APA’S efforts to sell the fed-
                    eral power marketing administrations is contained in appendix II.
                    Details of each sales agreement are contained in appendix III.


Eklutna Project     The Eklutna project provides about 5 percent of the power for the
                    Anchorage-Matanuska Valley area. Its single power plant, which began
                    operation in 1955, produces 30,000 kilowatts of power.

                    A sales agreement for the project has been reached between the APA
                    Administrator and three publicly owned utilities that currently buy

                    ‘Present value is today’s value of a sum payable at a later date or of a stream of income receivable at
                    a future date. Because a dollar in hand today can be invested to earn interest, it is worth more than a
                    dollar at some time in the future.



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                       Eklutna’s power. These three utilities -the Chugach Electric Associa-
                       tion, Inc.; the Mantanuska Electric Association, Inc.; and the Anchorage
                       Municipal Light and Power Company-had         submitted a joint offer to
                       purchase the project. The agreed-upon selling price will be the present
                       value of the remaining federal investment and interest payments dis-
                       counted at a g-percent rate, plus an additional $1 million. An October 1,
                       1989, sale transaction date would have resulted in a sale price of about
                       $10,435,000. The Eklutna agreement further provides that APA will be
                       responsible for transferring project transmission line rights-of-way to
                       the purchasers.

            -.--____
&ett$sham Project      The Snettisham project serves the Juneau, Alaska, area. It currently
                       provides 70 to 80 percent of Juneau’s power from the Long Lake unit of
                       the project. Long Lake began full commercial operation in 1975 and pro-
                       duces 47,160 kilowatts of power. The second portion of the Snettisham
                       project, Crater Lake, is currently under construction. This unit should be
                       fully operational in 1991, adding 31,000 kilowatts of power. It is antici-
                       pated that the additional power will supply the projected increasing
                       power needs of the area.

                       A sales agreement has been reached through the APA Administrator’s
                       negotiations with the Alaska Energy Authority, an Alaska state agency.
                       The agreement provides that the selling price will be determined by the
                       present value of the remaining federal investment and interest pay-
                       ments due when the sale is finalized. Unlike the Eklutna agreement,
                       however, the Snettisham agreement contains two alternative methods of
                       computing the discount rate (and ultimately, the price). The agreement
                       specifies that the method providing the higher sales price be used.

                       The first method sets the price at the present value of remaining princi-
                       pal and interest using a discount rate equal to 2 percent above the
                       state’s bond rate (that is, its financing costs). The second formula, which
                       will guarantee some protection for the federal government by setting a
                       “floor” in the pricing method, sets the sales price at 85 percent of the
                       present value of principal and interest payments using the long-term
                       Treasury rate to discount the future payments. Even though the exact
                       purchase price for Snettisham cannot be determined in advance, the APA
                       Administrator believes that the price will fall between 85 percent and 90
                       percent of the present value of the remaining principal and interest pay-
                       ments discounted at the 30-year Treasury rate.




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                          Finally, according to the Snettisham agreement, the federal government
                          will be responsible for all costs associated with completing construction
                          on the Crater Lake portion of the project that exceed APA'S April 1988
                          estimate of total costs.


                          In our March 1987 letter, we said that APA'S present value method for
APA’s Selling Price       determining its minimum acceptable bid provided only minimal protec-
Minimizes Potential       tion for taxpayers. The currently agreed-upon formula for determining
Rate Impact on            the selling price for APA'S projects closely approximate or may, in the
                          case of Snettisham, be less than APA'S previously established minimal
Ratepayers but Limits     acceptable bids. While the selling prices will, in the APA Administrator’s
Taxpayers’ Recovery       view, facilitate accomplishing the sale and should have minimal impact
                          on current APA ratepayers, the selling prices, in our view, are unlikely to
                          reflect the fair market value of the projects and will not recover all fed-
                          eral costs associated with the projects.


Market Approach for       In March 30 and April 10, 1987, letters, DOE and the Administrator, APA,
Valuing Assets Not Used   respectively, responded to our March letter. DOE stated that it was essen-
                          tial that the sale be structured to avoid significant rate increases and
                          that approximating the discounted present value of future payments for
                          the repayment of the federal investment was necessary to avoid large
                          rate increases. The APA Administrator reiterated DOE'S view and stated
                          that the alternative pricing methods suggested by our March letter
                          would involve higher returns to the government than available under
                          existing law. In light of these views, the Administrator proceeded with
                          the sale process.

                          We believe that the federal government should receive fair market value
                          when selling government assets. Receiving fair market value is impor-
                          tant both to protect the government’s fiscal interests and to promote
                          economic efficiency. We recognize, however, that in particular cases
                          there could be other issues that make a market valuation approach for
                          an asset sale less compelling. A key issue in this case is whether receiv-
                          ing a fair market value for APA assets would lead to significant rate
                          impacts on Alaskan consumers and on the local economies, particularly
                          in the Juneau area.

                          Since a market valuation of APA assets has not been performed, it is
                          unclear what a sale price representing market value would be and thus
                          how it would impact on Alaskan ratepayers. We would expect, however,



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 B.238296




that power rates in Juneau would be sensitive to the price for Snet-
tisham because power produced by Snettisham represents the majority
of power sold in the Juneau area. On the other hand, we would not
expect power rates in Anchorage to be as sensitive to the price for
Eklutna because its contribution to the Anchorage area’s power supply
is rather small. In fact, according to the APA Administrator, a selling
price for Eklutna at double or more the currently agreed-upon selling
price would not be expected to have a significant impact on power rates.

According to the Administrator, APA, a market valuation of APA assets
was not done because such an evaluation, in the Administrator’s view,
was precluded by Sec. 506 of Public Law 98-360 (Energy and Water
Development Appropriation Act, 1985). Under Sec. 506, the administra-
tion was prohibited from conducting any studies related or leading to
the possibility of changing from a cost-based to a market-based rate for
the pricing of hydroelectric power marketed by the power marketing
administrations or the Tennessee Valley Authority (TVA).

Sec. 506 prohibits the administration from examining alternative, non-
cost based methods for pricing power marketed by the power marketing
administrations and TVA. We do not concur with the APA Administrator’s
view that this provision prohibits examining market values for federal
assets that are being considered for sale. Thus, in our view, this provi-
sion would not prohibit a market-based valuation of APA hydroelectric
power assets even though such an analysis requires an evaluation of
power rates that are not cost based.

Although a market valuation of APA assets was not performed, in 1986 a
study prepared by APA consultants, Coopers and Lybrand, estimated APA
assets using various alternative valuation methods, including replace-
ment costs.2 Their valuation estimates ranged from $81.8 million (repre-
senting the present value of future principle and interest payments) to
$319.5 million (replacement cost new less depreciation) and offer, in our
view, some perspective on other values, which could be associated with
AI)A assets. Replacement cost normally represents an upper limit of the
market value of an asset.




%placement cost is the cost of replacing the undepreciated portion of an asset with another asset
that will provide a similar function but with the most economic current technology.



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APA’s Sale Price Limits    In our 1987 letter, we said that APA'S present value pricing method pro-
Ta%payers’ Cost Recovery   vided only minimal protection for taxpayers. We noted, in particular,
                           that this value (1) assumed no residual value3 for the assets even though
                           the hydropower projects would have a continued service life for many
                           years following the federally scheduled repayment period and (2) did
                           not consider that actual federal costs would not be completely recovered
                           under current repayment practices by power marketing administrations.
                           Since federal power project interest rates are often below the Treasury’s
                           actual borrowing rates, interest paid to the Treasury under current
                           repayment practices generally does not fully recover the Treasury’s
                           actual interest costs.

                           The present value pricing method, as applied by APA in determining pro
                           ject selling prices, does not recognize that Treasury interest costs would
                           not fully be recovered in future years through current repayment prac-
                           tices. To illustrate this in regard to the Long Lake and Crater Lake por-
                           tions of the Snettisham project, we calculated the present value of
                           future payments that would be owed to the Treasury if project interest
                           rates reflected long-term Treasury borrowing rates at the time the
                           projects were placed in operation. Our calculations showed that, for
                           Snettisham, the present value of the principle and interest if interest
                           were accrued at nonsubsidized rates (equal to long-term Treasury rates
                           when the projects were placed online) would be approximately $73.6
                           million greater than the present value of the scheduled repayment
                           stream. Our assumptions and methodology are discussed in greater
                           detail in app. IV.


                           Uncertainty over the cost associated with two issues may reduce the
Unresolved Sale Issues     proceeds the federal government will receive from selling APA'S assets.
May ReduceNet              First, as discussed previously, APA has the responsibility under the
Proceeds                   Eklutna sales agreement to ensure the purchaser rights-of-way for
                           Eklutna’s transmission lines that cross nongovernment land. Second,
                           some uncertainty exists about the final cost of constructing the Crater
                           Lake unit of Snettisham. According to the Snettisham sales agreement,
                           APA will bear all Crater Lake construction costs that exceed APA'S April
                           1988 project cost estimate. While APA took, in our view, reasonable steps
                           to estimate the final Crater Lake costs, an October 1989 cost estimate
                           shows that Crater Lake will cost about $5.8 million more than was pro-
                           vided for in the April 1988 Snettisham sales agreement.

                           %esidual value is the remaining market value that assets will have at the end of the repayment
                           period.



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Rights-Of-Way for          The Eklutna project contains about 45 miles of transmission lines from
Trarbmission Lines         the powerhouse to customers in the Anchorage-Matanuska Valley area
                           (see app. V). These lines cross federal and state lands, as well as land
                           owned by private parties and by Eklutna, Inc., a corporation of Alaskan
                           Native Americans. As part of the Eklutna sales agreement, APA has
                           agreed to assume responsibility for ensuring that the purchaser obtains
                           all rights-of-way for these lines at no cost. While APA plans to transfer
                           its rights-of-way across federal land at no cost to the purchasers, it can-
                           not transfer its existing rights-of-way across private and Native Ameri-
                           can lands to the purchaser. Thus, assuring the purchaser such rights-of-
                           way may involve additional-and        as yet unknown-costs.

                           The APA Administrator believes that reaching agreement with land own-
                           ers on rights-of-way is manageable and can be accomplished at minimal
                           or no cost. The Administrator told us that the private landowners and
                           Eklutna, Inc. will find it in their best interests to assign the rights-of-
                           way to the purchasers. APA has made no estimate of any costs that might
                           be involved if this does not occur.

                           We believe obtaining transmission line rights-of-way for the Eklutna
                           purchasers could potentially result in costs being borne by APA in com-
                           pleting the sale. Given that rights-of-way agreements had not been
                           reached as of late September 1989, we believe it’s uncertain whether the
                           Administrator will be able to resolve the rights-of-way issue at no fur-
                           ther cost to the government. Should the rights-of-way issue be
                           unresolved at the time APA submits the sale agreements for congres-
                           sional approval, we expect, based on conversations with DOE officials,
                           that APA will include in its sales agreement package a detailed descrip-
                           tion of this issue including the administration’s plans for resolving it.


Costs to Complete Crater   The Snettisham purchase agreement states that all costs associated with
                           preparing the Snettisham assets for conveyance to the Alaska Energy
Lake                       Authority, including any costs that exceed APA'S April 1988 construction
                           cost estimate, shall be the responsibility of the federal government. The
                           agreement includes APA'S April 1988 estimate of projected final costs.

                           As of November 1989, construction was still underway at the Crater
                           Lake unit. In October 1989, the APA Administrator was provided with a
                           revised construction estimate. The revised estimate indicated that the
                           cost to construct Crater Lake would be about $5.8 million more than
                           provided for in the sales agreement and thus would not be recovered in
                           the project sales price. As with right-of-way matters, we anticipate that


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                E238296




                any additional cost stemming from this situation will be identified by
                APA at the time the sales agreements are provided to the Congress for its
                approval.


                Establishing a selling price for APA assets necessarily involves a tradeoff
Cchclusions     between ratepayers’ and taxpayers’ interests. Based on our current
                review of the proposed sale of APA'S hydropower projects, we continue
                to believe that the sales agreements that have been reached benefit APA
                ratepayers at the expense of taxpayers and thus do not balance the
                interests of both groups. Current APA ratepayers are expected to experi-
                ence a minimal initial rate impact from the proposed sale and, according
                to APA, will likely experience a decrease in rates below what would have
                occurred under continued federal ownership after about 10 years. On
  /             the other hand, while the agreed-upon selling prices generally provide
                an amount of revenue to the Treasury equivalent to that which would
                have been received under continued federal ownership and under APA
                scheduled repayment of the federal investment with interest, these
                prices do not include the recovery of all federal costs associated with
                the projects. In addition, they do not reflect the fair market value of
                these assets. In a sense, the proposed selling price represents a situation
                similar to a homeowner selling a house for the present value of the
                future scheduled mortgage payments while foregoing the value of the
                owner’s equity.

                Beyond our concern about how the selling prices have been determined,
                our recent review also found that some additional costs will be incurred
                by the federal government in accomplishing the sale. Based on the
                recent construction cost estimate for Snettisham project’s Crater Lake
                unit, the federal government will not recover about $5.8 million of the
                unit’s cost in the agreed-upon selling price. In addition, some costs to the
                federal government in transferring the transmission line rights-of-way
                for the Eklutna project may be incurred.


                If the Congress wishes to pursue the divestiture of APA assets and
Matter for      believes the sale of APA assets should be accomplished through a balanc-
Congressional   ing of ratepayers’ and taxpayers’ interests, it should reject the adminis-
Consideration   tration’s proposal and direct DOE to identify sales proposals that better
                balance ratepayers’ and taxpayers’ interests.
         Y




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R-238296




In completing this review, we held discussions with APA officials and
reviewed various documents and reports related to the proposed sale,
including the negotiated purchase agreements. We also interviewed rep-
resentatives of various utilities and governmental entities in the state of
Alaska. We performed our field work from March to September 1989 in
accordance with generally accepted government auditing standards.
Appendix VI provides our objectives, scope, and methodology.

As you requested, we did not obtain official agency comments on a draft
of this report. As arranged with your offices, we will make no further
distribution of this report until 30 days from the date of this letter,
unless you release its contents earlier. At that time, we will send copies
to the Secretary of Energy; the Director, Office of Management and
Budget; and other interested parties. Copies will also be provided to
others upon request.

This work was performed under the direction of Victor S. Rezendes,
Director, Energy Issues (202) 275-1441. Other major contributors are
listed in appendix VII.




                                 /
J. Dextek Peach
Assistant Comptroller General




Page 9                               GAO/RCED-90-93 Sale of APA Hydropower Assets
Cbntents


Letter
Appendix I
GAO’s March 1987
Letter to the
Secretary, Department
of iEnergy
Appendix II                                                                                 21
Project Description     Project Description
                        Background
                                                                                            21
                                                                                            23
and Background
Appendix III                                                                                25
Details of APA Sale
Agreements
Appendix IV                                                                                29
Calculation of
Alternate Interest
Costs for APA’s
Snettisham Project
Appendix V                                                                                 32
Map of Eklutna Lands
Under Private or
Native American
Corporation
Ownership
Appendix VI                                                                                34
Objectives,Scope, and
Methodology

                        Page 10                   GAO/RCED-90-93 Sale of APA Hydropower Assets




                                              4
Aphendix VII                                                                                           34
Major Contributors to
This Report
Tables                  Table II. 1: Size of Federal Power Marketing                                   23
                            Administrations, Fiscal Year 1988
                        Table III. 1: Projected Selling Price for Selected Dates                       26
                        Table IV. 1: Impact of Alternate Interest Rates on Long                        30
                            Lake Repayment
                        Table IV.2: Impact of Alternate Interest Rates on Crater                       31
                            Lake Repayment
                        Table IV.3: Impact of Alternate Interest Rates on                              31
                            Repayment of Total Snettisham Project

Figure                  Figure II. 1: Location of APA Facilities                                       21




                        Abbreviations

                        AI’A      Alaska Power Administration
                        DOE       Department of Energy
                        GAO       General Accounting Office
                        I’MA      power marketing administration
                        HCED      Resources, Community, and Economic Development Division
                        TVA       Tennessee Valley Authority


                        Page 11                              GAO/RCED-90-93 Sale of APA Hydropower Assets




                                                             I
                                                                 :!’ 1)   * a*’
                                                                                   ,
Appendix I

G$iO’sMarch 1987 Letter to the Secretary,
IJepartment of Energy


                     Ualted States
             GAO     General Accounting Ofllce
                     Washington, D.C. 20548




                       March       23,     1987

                       The     Honorable          John  S. Herrington,
                       The     Secretary          of Energy

                       Dear     Mr.      Secretary:

                       At the       request         of the Chairman                    of the        Subcommittee            on
                       Environment,             Energy,          and Natural               Resources,           House
                       Committee           on Government               Operations,               we are       reviewing          the
                      Department’s              efforts          to sell           the Alaska           Power
                      Administration’s                   (APA’s)         assets.             Because        the    proposed
                       sale     of APA assets                may set          important            precedents          for
                      divesting           the     other        four      power        marketing           administrations
                       (PMAs),        a goal        of the         current           Administration,               our     review
                      is focusing             on several             factors          which       may be important                 to
                      Congressional               approval           of the          proposed         sale.        These
                      factors         include          (1)     the     justification                and timing           of the
                      sale;       (2)     information              made available                 to and involvement
                      opportunities               for      the     affected            parties,         especially           the
                      Congress          and Alaskan              ratepayers;               (3)    protection           of the
                      economic          interests            of U.S.          taxpayers;            and (4)        APA’s
                      assessment            of the         economic,            social,          and environmental
                      impacts         of the        sale       on the Alaskan                  communities           served        by
                      APA.

                      On April          1, 1987,          the APA Administrator               plans     to issue      a
                      request         for     proposals         (RFP)      for   purchase       of APA’s     assets.
                      Although          we have         not   completed        our    review,       we would     like
                      to share          with      you some concerns             we have       about     the  sale
                      process         so that         you can consider             them before        an RFP is
                      issued.           These       concerns       involve      matters       which,      if not
                      clarified,            could      hinder      the APA sale           as well     as the
                      overall         Administration             goal      of divesting         all   PMAs.

                      Our primary            concern          is that         APA’s       planned         divestiture
                      approach         appears          to give          greater        emphasis          to protecting
                      current        APA ratepayers                  rather       than      balancing           ratepayera’
                      and taxpayers’                interests.              Specifically,               the     current        plan
                      to initially             limit        eligible          bidders         to several            entities
                      within       Alaska         could       result        in few bids             being       received         and
                      a low      sale      price.           Further,          APA’s       approach          for
                      establishing             a minimum             acceptable           bid,      in our        view,      does
                      not     appear       to consider               the    full     potential            value       of APA
                      assets       to a purchaser,                   nor does        it     reflect         all     costs
                      incurred        by the          government            in constructing                 APA facilities.
                      In addition,             we noted            several       other        matters         which       we
                      believe        merit       your       consideration               before        an RFP is issued.




                   Page 12                                                    GAO/RCED-90-93 Sale of APA Hydropower Assets
     Appendix I
     GAO’s Mnrch 1987 Letter to the Secretary,
     Department of Energy




In our work            to date,         we have     held     discussions        with       APA
officials           and with       representatives             of various       utilities
and governmental               entitles          In the    State      of Alaska.           We have
also      reviewed       various         APA documents           and reports          leading    up
to the        reviaed     work        plan     of January        14,    1987,   which
reflects          APA’s    current         strategy      for     pursuing     the
diveetiture.

BACKGROUND

APA produces                and markets            electric             power       generated           by two
widely         separated            hydroelectric               facilities              in the        State         of
Alaska.             Its     Eklutna        project          was completed                 In 1955 and
provides            the Anchorage-Palmer                     area        with       about       5 percent              of
ite      electrical              needs.        The Snettisham                   project         serve8         the
Juneau         area       and Is presently                  being         expanded.             The
facilities              constructed            in the        initial            phase        (Long      Lake)
began        operations             in 1973        and provide               about        70 percent             of
Juneau’s            electrical           needs.          A second            construction               phase
(Crater          Lake)         is under        way and should                   be completed              in
1988.          This       will      add 59 percent                more       firm       energy        to the
Snettlsham              powerplant’s              annual       production,                although           demand
for      that       added        power     ia unlikely               to develop             for     several
years,         according            to APA.

APA is required                by law,        as are      all    PMAs,   to recoup            through
its      power     rates       sufficient          revenues       to pay all          operation
and maintenance                costs      as well       as to repay,         with       interest,
the      federal       investment           required        to construct         its
facilities.              After       considering          estimated      costs        to complete
the      second      phaae       of Snettisham,             APA estimates           that      as of
October          1, 1988,        about      $162 million          in federal          investment
will        remain     to be paid           to the Treasury            on APA’s         two
projects.

The Administration                    originally           proposed         the    divestiture              of
APA in its            fiscal        year      1986 budget.               Since     that      time,
several         studles         have      been      completed          on the      proposed           sale,
including           a joint         study        by the      State       of Alaska         and APA on
potential           divestiture             issues,        and two studies               by the         firm
of Coopers            & Lybrand           on the       value       of APA assets             and on
alternative             ways      to structure             the     sale.        According          to
APA’s       revised          work     plan,       APA will         issue      an RPP on April                  1,
1987.         After       completing             a bid     selection/negotiation
process,          APA plans           to submit          a sale        proposal        to the
Congress          by February             1988.

APA’s       work     plan      specifies            that     the    primary       goal       of the
divestiture            is to close                out    all   federal       responsibilities
of APA.          As key objectives,                      the work       plan    states         that     the
sale      should       (1)     achieve            a fair     return       to the U.S.            taxpayer
and (2)        avoid       llnacceptable              impacts       on the      economy          of the




    Page 13                                                           GAO/RCED-90-93 Sale of APA Hydropower Assets
          Appendix I
          GAO’s March 1987 Letter to the Secretary,
          Department of Energy




    region.           As a guideline              for      carrying        out     the    divestiture
    process,          the work         plan     specifies           that     the     sale     will       be
    pureued         in an open,           competitive             manner       involving           all
    interested            and affected            parties.            As noted         by APA,         the
    diveatiture            objectives           involve          a balancing           of Interests,
    particularly             between         Alaskan         ratepayers          In seeking            to
    avoid        power     rate      increases          and the         government          in trying                     to
    obtain         a fair      price       for    its     assets.

    COMPETITION   IN BIDDING
    IS BEING LIMITED

    APA’s        current         divestiture               work        plan       states        that
    competition              in bidding              may be Important                     to help           assure
    that       the     federal           government            receives             a fair        price.
    Although           the     concept           of a competitive                     bidding         process           has
    been       retained          as a sale             guideline,              the work           plan        concludes
    that       a fair        price         can be achieved                   without          having          a fully
    competitive              bidding           process.             The work            plan      calls         for
    limiting          the      initial           bidders          to (1)         electric           utilities             now
    served         by the        projects,             (2)     municipalities                   in the
    projects’            service           areas,        (3)      the      State        of Alaska,              or (4)
    some combination                     of these          entities.                According             to the        APA
    Administrator,                  the decision               to limit             bidding         was made,             in
    part,        to help         assure         Alaskan           support           for     the     proposed
    sale.          Comments            from      Alaskan          entities            on an earlier                 APA
    work       plan      had opposed               divestiture               to non-Alaskan                   interests
    or to purchasers                     other       than      the       existing           customer
    utilities,            municipalities,                    and/or          the      state.

    Although          there      is interest           by Alaskan            entities           in
    purchaeing            APA’s      assets,       factors          such     as the         lack     of
    potential           bidders       with     adequate          financial            resources         and
    experience            in hydroelectric               operations,             as well          as
    weakness          in the       local     economy,         could        limit        the number          of
    bids      actually         received        to a very            few.       In the
    administrator’s                view,     there       is likely           to be one bid              for
    the     Snettisham           project       and one or two bids                      for     the Eklutna
    project.

    We are       concerned            that       the    initial           limitation             on those
    eligible         to bid         and the expected                    results          may work         against
    taxpayer         interests.               In our         view,        limiting            competition           to
    Alaskan        entities           Increases           the      likelihood               that     actual       bids
    received         may approximate                  APA’s        minimum           acceptable           bid
    since      there        would       be little            incentive             for      a bidder          to
    offer     more.           APA plans            to broaden             the      competition            only      if
    initial        bidders         are unsuccessful                     in meeting              APA’s
    acceptable            bid    criteria.              Furthermore,                 limiting          qualified
    bidders        to Alaskan             entities           would        preclude            an opportunity
    to consider             potentially              beneficial             proposals            from     non-
    Alaskan        entities.              For example,                Coopers          & Lybrand

”




         Page 14                                                           GAO/RCED-90-93 Sale of APA Hydropower Assets
       Appendix I
       GAO’@ March 1987 Letter to the Secretary,
       Department of Energy




    concluded            that      the APA projects                  offer    some interesting
    investment              opportunities              for     investor-owned            utilities
     (IOUs);         however,          they     stated         that      an IOU purchase               would
    increase           power       rates.         While        we recognize           that       support          for
    the     sale       from     Alaskan         entities           is important,           we note           that
    APA’s       criteria           for    selecting            among proposals              received
    contain          many elements              designed           to assure        that      Alaskan
    interests            are     protected.              We therefore           question           whether          it
    is appropriate                 under      these        circumstances            to preclude,               in
    the initial              RFP,      an opportunity                for   any interested                party
    to submit            a purchase           proposal           which     could,       potentially,
    best      meet       the     sale     objectives.                In addition,           the      limited
    bidding          approach          seems      to us to be inconsistent                         with      APA’s
    commitment             to provide           for      an “open,         competitive             process
    involving            all    interested            and affected            parties.”

    APA’S MINIMUM                   ACCEPTABLE  BID MAY
    ONLY MINIMALLY                   PROTECT TAXPAYERS

    APA has proposed                  that    a minimum          acceptable          bid      for    APA
    facilities            would       be the     present         value      of the        future
    principal           and interest            payments         APA would         make to the
    Treasury         if     the     projects       remained          under      federal         ownership
     (present-value               method).         This,     valuation          method        was one of
    several        used       by Coopers         & Lybrand           to estimate            the    value    of
    APA’s      assets.            Applying       the     present-value             method,         Coopers
    & Lybrand           calculated           a value       of $89.3        million          for   APA
    assets       when using             a discount         rate      of 7.6       percent.           As
    shown      in the         table      below,      other       valuation         methods         resulted
    in estimated              values       up to a high            of $319.5         million.

    Table         1:          Summary       of    APA Asset        Values    and Methods
                              Developed          By Coopers        & Lybrand     (In Millions)a

    Valuation         Method                                                  Snettisham                     Total
    Replacement          Cost                                                  S221.5                       $319.5
    Reproduction           Costb                       97.9                      184.7                        282.6
    Unpaid       Debt    Balance                       14.7                      146.9                        161.6
    Net Book Value                                     23.1                      120.6                        143.7
    Present       Value     of
       Principal         and
       Interest        Payments                        12 .o                       77.3                         89.3

      Notes:           a Estimates               projected        for      October        1, 1988.
                       b Estimates               are net of depreciation.                      Replacement
                       cost        refers        to the      cost       to construct         comparable
                       facilities.                 Reproduction            cost    refers      to the    cost
                       to reconstruct                 APA’s     facilities           exactly      as they
                       now exist.

    We note            that       the   discount          rate     is a key component                  in
    calculating                 the   value      of      APA’s     assets  using  the               present-

Y




      Page 15                                                         GAO/RCED-90-93 Sale of APA Hydropower Assets




                                                                                                                         /,
     Appendix I
     GAO’s March 1987 Letter to the Secretary,
     Department of Energy




value     method.        While     the     Coopers       & Lybrand          asset      valuation
study     used     a discount          rate     of 7.6       percent,        APA has not
diacloeed        in its       work     plan     the    discount         rate      it   will,u’se
or how the         rate     will     be determined             when computing               the
actual     value       of its      minimum        acceptable          bid.       Because
changes      in the       rate     can produce           large     differences              in the
minimum      acceptable          bid     computation,           we believe           this       matter
should     be clarified            prior      to issuing          a final        RFP.

APA’s     work     plan      provides       for    using       the    present,-value
method     for     establishing            a minimum         acceptable          bid     because
it   would     (1)    enable        the    purchaser         to maintain           rates     at the
same relative            level      as under       federal         ownership         and (2)
keep    the Treasury            “whole”       In the       sense      that     the     proceeds
would     be equivalent             to those       that     would       be realized          under
continued        federal        ownership.

Establishing               APA’s       minimum          acceptable             bid     based       on the
 present-value               method        could         set     an important              precedent             for
other       planned          PMA sales.               Although           we take         no position               on
whether         this       method        should         be used,           we believe            that
policymakers               need      to carefully                consider          the     implications
of using          this       method.            In our         view,       setting         a minimum
acceptable             bid     for     APA based             on the present-value                      method
provides          only       minimal          protection             for     U.S.      taxpayers            since
this      method         (1)     assumes          that       the     hydropower            projects            would
have      no residual              value        at the         point       in time         the     federal
investment            would        have       been      repaid         by APA even             though          both
projects          are      projected            to have          a continued             service         life,
 (2)   does       not      consider           the     increase           in the        value       of APA
assets       which         would       result         from       the     administration’s
proposed          PMA repayment                 reforms,           (3)     does      not     consider            the
leas-than-full                 recovery           of federal             costs       which       results
from      current          PMA repayment                practices,             and (4)         produces            the
lowest        value        for     APA’s        assets.

Minimum       acceptable                  bid     assumes
no
-    residual        value           in         APA assets

APA’s       present-value                approach        will       assign      a value         only        to
the     remaining          principal            and interest              payments       APA would
make to the            Treasury,            thus      assuming          the   projects          have        no
residual         value         when the         federal         investment          has been
repaid.          Applying           this      valuation           method      to a project                that
was completely                 paid     for    would       produce          an asset       value         of
zero      regardless            of the        project’s           remaining         useful        life.
It   is reasonable,                 in our view,              to assume         that     APA’s
hydropower           projects           have      residual          value     to a purchaser                  so
long      as the       facilities             have      a remaining           useful       life         beyond
the     period       required           to repay         the      federal       investment.




    Page 16                                                         GAO/RCED-90-93 Sale of APA Hydropower Assets
.                                       I



              Appendix I
              GAO%March1967Letterto theSecretary,
              Departmentof Energy




        According           to Coopers          6 Lybrand’e             asset      valuation             report,
        the Eklutna             and Snettisham              (Long       Lake)      facilities              have
        useful        service        lives      of 87 years             and 75 years,
        respectively.                Because        these       service        lives         are
        considerably             longer       than      the     periods        in which           the      federal
        investment            is to be repaid               (50 years          and 60 years,
        respectively),               it    appears        that      the    projects            could       have
        considerable             residual         value       to a purchaser.                    APA’s       work
        plan     does       not    explain        why the         remaining          service          lives        of
        these      projects          are    assumed         to have        no value.

        Increased          value      from        repayment           reforms
        has not         been     considered

        The approach             APA will         use to establish                  a minimum
        acceptable           bid     does     not     consider          the     impact       of the
        administration’s                 PMA repayment              reform        proposal         discussed
        in Its        fiscal       year      1988 budget.               This      repayment          reform       is
        expected          to be presented               for     congressional              consideration
        later       this     year      and is planned               for     implementation               in 1989.
        As we understand                 the    proposal,           the     repayment          reform        would
        require         PMAs to make equal                  annual        principal          payments          on
        the     federal        investment           for     each      of their         projects          rather
        than      simply       requiring          the     principal           be repaid          by the        end
        of the        repayment          period       as is currently                the     practice.
        Implementing             the     proposal         would       generally          have      the     effect
        of accelerating                retirement           of the        federal        investment.

        In our view,              the     impacts        of the        repayment          reform         proposal
        should        be given          consideration             when       establishing              the
        minimum         acceptable           bid     for    APA assets            because         this       minimum
        is to reflect               payments         the     government           would       have       received
        under       continued           federal        ownership.             Applying          the      repayment
        reform        to the        federal        investment            in APA would             increase            the
        present         value       of that        investment.               According          to
        calculations              made for         us by Coopers              & Lybrand,             the      $89.3
        million         estimate          of present          value        of the       remaining             federal
        investment            would       be increased            by $4.3         million         if     this
        repayment           reform        was considered--only                    the     Snettisham
        project         would       be affected            by this         repayment          reform.             From
        the taxpayers’                perspective,            it    can be argued               that       the
        mlnimum         acceptable           bid     should       reflect         consideration                 for
        this      increased           value.

        The    full     federal     cost           for     APA
        may    not     be recovered

        APA’s        minimum         acceptable       bid  calculation          approach        may not
        reflect         the     full      amount    of the     federal      investment          in APA
        facilities            because        costs    to the     government        are     generally
        not      fully      accounted           for in determining          the    federal
        investment            in PMA projects.             In the      case     of APA

    Y




           Page 17                                                       GAO/RCED-9083            Sale of APA Hydropower    Assets
         Appendix I
         GAO’s March 1987 Letter to the Secretary,
         Department of Energy




    facilities,           for     example,         Coopers        & Lybrand            estimeted         that
    the Treasury’s              long-term          borrowing          rate       was 7.6        percent       in
    October         1986.      APA’s       administrator              told       us,    however,         that
    interest         charged        during       the    current          construction             of the
    Crater        Lake    phase      of the        Snettisham            project         and the
    interest         to be charged            on this        investment              over     the     50-year
    life        of this     project        would      be based           on the        3 percent
    interest         rate     applicable           to the       original           1962     authorizing
    legislation           for     Snettisham.

    In a September                1986 report,             we examined              alternatives               for
    PMA pricing             of power          produced         at federal             water        projects.’
    Our work          showed        that     while       PMAs’        methods         of determining
    the     cost      of federal            power     were       generally            consistent             with
    existing          laws      and policies,              the      federal         investment             on many
    projects          may not         be fully         recovered.               More      specifically,
    (1)     practices           for     computing          interest           expense          for     PMA
    projects          during        construction             have       resulted          in
    understatement                of project           costs        (the      federal          investment)
    and (2)         interest          costs      associated            with       borrowing            from      the
    Treasury          have      been     based       on interest              rates       below        the
    Treasury’s            borrowing          rates.          Overall,           these        practices           have
    the     effect        of understating                the     full       cost      of the
    government’s              investment           in federal             hydropower             projects.

    As discussed           above,     we believe       our      past     findings       on
    undervaluation            and underrecovery            of federal           investments          in
    PMAs are       applicable         to APA.       According          to the       APA
    Administrator,            APA has no plans           to determine             the   full      cost
    of the      federal       investment       in APA’s         projects        or the       extent
    its    minimum       acceptable      bid     would     fail      to recover         these
    costs.

    Present-value                method      results         in
    the    lowest        value        for    APA

    As shown        in Table       1, the         present-value             approach        results         in
    a significantly             lower       value      for     APA’s      assets       than     do the
    other     valuation        methods          used     by Coopers           & Lybrand.            For
    example,        the   $89.3       million        present        value       of APA’s        future
    debt     payments       to the Treasury                is   about       (1)    38 percent           or
    $54.4     million       below      the      net    book     value,        (2)    45 percent           or
    $72.3     million       below      the      actual        amount      of the       remaining
    debt,     and (3)       72 percent            or $230.2         million        below      the     net
    replacement         value.

    In congressional                  hearings         last  year,          concerns    were
    expressed     by         some      members         of Congress            that   PMA sale             prices


    lPricing         Alternatives             for  Power    Marketed                by the
    Department           of Energy,           GAO/RCED-86-186BR,                    September           1986.

Y




        Page 18                                                       GAO/RCED-99-93 Sale of APA Hydropower Assets
        Appendix I
        GAO’slbiarch 1987I&tertotheSecretary,
        Department of Energy




     based      on the      unpaid     debt   balances          would      indicate        a “fire
     sale”      approach       to PMA divestiture.                  In light        of these
     expressed        concerns       and APA’s        plans       to establish          a minimum
     acceptable         bid    which    may be substantially                   below    the unpaid
     debt    balance,        we believe       additional            information         is needed
     to explain         how APA’s       proposed        pricing         approach      will      meet
     the    sale objective           of protecting            the     taxpayers’        interest.

    OTHER       MATTERS

    In addition           to the      concerns        discussed          above,      our uork
    disclosed         several       other     matters        which       suggest       that
    additional          information         on the        APA sale,         before       an RPP is
    issued,       may enhance           the   overall        divestiture           process.
    These      matters        are   discussed         below.

    Justification               for Sale--APA               has not        yet     fully       evaluated
     several         key aspects             of the       appropriateness                of the        proposed
    sale       in its        basic       sale      documents         and studies.                For
    example,           these       documents          do not       include         (1)     an analysis              of
    the      pros      and cons          of selling          or (2)        a discussion              of the
    details         of why APA is no longer                        needed        to carry          out      its
    basic        missions.             Also,       APA has not           fully       evaluated            the
    likely         benefits          and costs          from    the      sale      and compared                these
    to other          alternatives,                such    as not        selling         at all        or
    selling         based       on valuation              methods        other       than      the     proposed
    present-value               approach.             For example,             APA has not
    estimated            the    likely         effect      on retail           power       rates       from       the
    proposed          or alternative                 methods       for     pricing         and selling
    APA’s        assets.

    The APA administrator                       told       us that      the     purchase           proposal
     to be submitted                to the        Congress         in the       future        will      include
    the     basic     rationale             for      selling       APA and an analysis                    of the
    costs      and benefits               of the         proposed       sale.         This      proposal,
    however,        will        not     be prepared            until      after       bidding         and
    evaluation           are      completed.               We believe         that      the     divestiture
    process        may be better                served        by providing            this      information
    for     public       and congressional                    debate      before        an RFP is
    issued.         Not      only       should         these     assessments            and debate
    provide        meaningful             information            on the merits              of proceeding
    into     the    RPP phase            of divestiture,                but     they      could       also
    increase        the      likelihood             that      an eventual           sale      proposal
    would      be supportable                 by Alaskan,            congressional,                and other
    interested           parties.

    Timing      of Sale --The          timing       of the      proposed         sale    may not      be
    consistent        with     protecting           taxpayers’         interests         or in
    closing       out    APA’s    responsibilities.                  According         to Coopers
    h Lybrand,         the   Alaskan        economy        is in an unsettled               state
    due to the        upheaval         in the       oil    industry        and reductions           in
    state      government        spending.            Although       these       problems       are

Y




       Page 19                                                       GAO/RCED-90-93 Sale of APA Hydropower Assets
                                                                                                                             I
r
        Appendix I
        GAO’S March 1987 Letter to the Secretary,
        Department of Energy




    not     expected           to adversely             impact         the Eklutna            sale,        both
    Coopers          61 Lybrand         and the         APA Administrator                   believe          they
    could        significantly              affect         the     sale     of Snettisham.
    Coopers          6 Lybrand          stated        that       the     excess       capacity          of
    Snettisham,              when coupled             with       the     poor     economy,          may result
    in potential               buyers       heavily          discounting            the value           of this
    project.             They      said     that      from       the     Treasury         viewpoint,             the
    value        of Snettisham              may be increased                  by delaying             the      sale.
    Similarly,             the APA Administrator                       said     the    current          economic
    uncertainties                will     tend      to lower           the offering             price       from
    purchasers,              and he expressed                  concern        that      these       conditions
    may result             in not       being       able       to sell        Snettisham,
    particularly               in the near-term.
    Public          Involverent--             APA’s        efforts          to involve                all
     interested              and affected              parties          in the sale                 process         may
     warrant           strengthening              at the         community             level.             As we
     understand             APA’s       approach           to public            involvement,                  most
     informational                outreach          efforts           (eg.      meetings              and the
    distribution                of work         plans        and other            documents               for
     comment)            have     been      focused          on potential                purchasers               and
     other       important            interest          groups,           such       as electric                power
     associations               and congressional                    committees.                   According            to
     the     administrator,                 APA has not              distributed                 to general
     ratepayers             documents           designed           to acquaint                 the      public       with
    sale       issues         and how the             sale       might        affect           them.
    Additionally,                 he said         that       APA has no specific                          plans       for
     public        meetings/workshops                     in Juneau             and Anchorage                   to
     secure        comments           from      local        ratepayers             on the            proposed
    sale.          While        the APA Administrator                         believes             that       his
    dealings            with      the     local       municipalities,                    utilities,               and
    other        interest           groups        are     sufficient              to reach              the
    ratepaying              public,         additional             efforts          to inform               and
    involve           local       ratepayers            may enhance               the overall
    divestiture               process.



    We are     sending       copies        of this      letter     today       to the
    Chairman,         Subcommittee           on Environment,           Energy,      and Natural
    Resources,         House    Government           Operations        Committee;        and to
    the   chairmen        of the      various        congressional          committees      which
    have    oversight        responsibility             for    PMA activities.            We will
    be available          to discuss           these    matters      in more      detail    at
    your    convenience.

    Sincerely            yours,



    Keith     0.      Fultz     ”
    Associate          Director




       Page 20                                                           GAO/RCED-90-93 gale of APA Hydropower Assets
Appendix II

Project Description and Background


                                          The Alaska Power Administration (APA), one of the five federal power
Puject Description                        marketing administrations within the U.S. Department of Energy, is
                                          responsible for marketing electric power from two federal hydroelectric
                                          projects in Alaska-the Eklutna and Snettisham projects. (See fig. II. 1.)

Flourie 11.1:Location of APA Facllltier




          Eklutne Project

                                                                                            Alaska
                                                                                                        1




                                          ProJect
                                                                                     Long                   I
                                                                                     Lake
                                                                                                           :
                                                                                                     sower Tunnel




                                          Source: GAO analysis of APA data




                                          Page 21                            GAO/RCEDQO-93 Sale of APA Hydropower Assets



                                                                                                                    -1---
                         Appendix II
                         Project Description and Background




                                                                      .



                         The Eklutna project, which provides power to the Anchorage-Mata-
                         nuska Valley area, has been in service since 1955. The project’s facilities
                         consist primarily of a dam at Eklutna Lake, a powerhouse several miles
                         away, a tunnel for water to pass from the lake to the powerhouse, and
                         approximately 45 miles of high-voltage transmission lines. The 30,000
                         kilowatts] produced by the project provide about 5 percent of the area’s
                         power.

                         The existing 47,160-kilowatt Snettisham project is Juneau’s main power
                         source, supplying 70 to 80 percent of its power. The project was autho-
                         rized to be built in two stages. The first stage, the Long Lake unit, has
                         been in commercial operation since 1973. The Corps of Engineers, which
                         has construction responsibility for Snettisham, is now building the
                         Crater Lake unit, the second stage of the project. The Crater Lake unit
                         will add 31,000 kilowatts of capacity to the existing powerhouse. The
                         Snettisham project has about 45 miles of transmission lines.

                         APA  sells the power produced at these two projects at wholesale prices.
                         Eklutna’s power is marketed to three public utilities in the Anchorage
                         area-the Chugach Electric Association, Anchorage Municipal Light &
                         Power, and the Matanuska Electric Association. Snettisham’s power is
                         marketed to the state of Alaska and to Alaska Electric Light & Power,
                         an investor-owned utility serving Juneau. Combined, the Eklutna and
                         Snettisham projects provide about 8 percent of Alaska’s power.


Federal Investment and   At the end of fiscal year 1988, the cumulative federal investment made
                          in these projects, excluding the Crater Lake unit of the Snettisham pro-
APA Repayment            ject, was $128.8 million. According to APA records, about $23.4 million of
                         this investment had been returned to the Treasury, leaving a net invest-
                         ment of $105.4 million ($91.8 million for Snettisham’s Long Lake Unit
                          and $13.6 million for Eklutna). The October 1989 estimate for the total
                          federal investment in constructing the Crater Lake unit was $67.5
                         million.

                         In addition to repaying a portion of the investment, APA has also paid
                         $34.0 million in interest on the two projects to the Treasury through
                         fiscal year 1988. According to APA'S projection of future Treasury pay-
                         ments, the remaining outstanding investment and an additional $147.6
                         million in interest, including interest on the Crater Lake investment,


                         ’ A kilowatt is defined as a unit of power equal to 1,000 watts or about 1.34 horsepower.



                         Page 22                                          GAO/RCED-90-93 Sale of APA Hydropower Assets
                                         Appendix11
                                         Project Description and Background




                                         would be paid to the Treasury if the projects remain under federal
                                         ownership.


                                         The Department of Energy’s five federal power marketing administra-
Background                               tions (PMA) market about 6 percent of the electricity generated in the
                                         United States. Table II.1 shows the relative size of each of the PMAS in
                                         terms of installed generating capacity and power sales revenues.

Table 11.1:Sire of Federal Power
Marketing Administrations, fiscal Year   Dollars in millions
1988                                     _________
                                                                                   Installed
                                                                                 capacity in               Power                    Unpaid
                                         Power marketing administration          megawatts              revenues       -.      investment
                                                                                                                              ----    .-~-.
                                         APA (excluding      Crater      Lake)            77                     $95                  $104
                                         ----
                                         Bonneville            -                     21,507                21,360                      9,059
                                         --~.-      __-.--.___
                                         Southeastern         -..-___.                 3,092                   1,575                    1,121
                                         Southwestern
                                         ~~-__~~      ._ __--~.                        2,150                   1,550                       724
                                                                                               ______~.~~___                ~-~. ~. _....~~
                                         Western                                      10,385                   8,231                     2,719
                                         Total                                       37,211       --~    $32,811                   $13,727


                                         The administration has expressed its view that the federal government
                                         should not be involved in the sale and distribution of electrical power.
                                         Beginning in fiscal year 1986, it has proposed the divestiture of the
                                         PMAS. In a 1987 letter to the Speaker of the House of Representatives,
                                         the Director, Office of Management and Budget, stated that the five
                                         PMAS are “commercial activities which in most areas of the country are
                                         performed by private and other nonfederal enterprises.” He further
                                         stated that because the need for federal power development had long
                                         since been filled, the government should divest itself of those activities.

                                         In its fiscal year 1986 budget, the Reagan Administration proposed to
                                         transfer APA to state or other nonfederal ownership within Alaska. The
                                         Administration’s fiscal year 1987 budget contained a broader proposal
                                         to sell all five PMAS. At that time APA stated that the process of divesti-
                                         ture was to be open and competitive, and was to result in a fair return
                                         on investment for federal taxpayers while recognizing the benefits now
                                         enjoyed by present customers. However, no specific terms for the sales
                                         were proposed, In acting on the fiscal year 1987 budget, the Congress
                                         prohibited any further study of divestiture of the PMAS, except for APA,




                                         Page 23                                 GAO/RCED-90-93 Sale of APA Hydropower Assets
Appendix II
Project Description and Background




The former and current presidential administrations have proceeded
with efforts to sell APA. In August 1989, APA signed a purchase agree-
ment with the Chugach Electric Association, Anchorage Municipal Light
& Power, and the Matanuska Electric Association to sell APA'S Eklutna
project. In February 1989 APA and the Alaska Energy Authority, a pub-
lic corporation of the state of Alaska, also signed a purchase agreement
for the Snettisham facility.

In addition to its efforts to sell APA, the Bush Administration has contin-
ued to support the divestiture of the other PMAS. In its fiscal year 1988
budget, the Reagan Administration proposed legislation to study possi-
ble divestiture of the Southeastern Power Administration. In its fiscal
year 1990 budget, the Bush Administration proposed selling certain
assets of the Southeastern Power Administration in 1991 and to offer
selected assets of other PMAS for sale in future years.




Page 24                              GAO/RCED-90-93 Sale of APA Hydropower Assets
Appendix III

Qtails of AF?ASaleAgreements


                    Sales agreements for APA'S Snettisham and Eklutna projects were
                    reached in February and August 1989, respectively. The agreements
                    provide for how the final sales prices will be calculated, discuss the pro-
                    cess for how the assets will be transferred, and address various respon-
                    sibilities of the government and purchasers.

                    The pricing method for both projects will generally approximate a value
                    representing the present value of future principal and interest payments
                    that the Treasury would have received under continued federal owner-
                    ship. Since, under continued federal ownership, these payments would
                    be received by the Treasury over many years rather than immediately
                    in a lump sum, future payments were discounted to derive today’s value
                    of payments expected in future years. Discounting is a standard finan-
                    cial analysis method used to derive the present value of future expendi-
                    tures or payments. The method is based on the premise that a dollar in
                    hand today is worth more than a dollar sometime in the future, since
                    money currently available can be invested and grow at the rate of
                    interest.

                    The following sections discuss the agreements for each project as well as
                    provisions of the sales agreements that generally apply to both projects.


Eklutna Agreement   The Eklutna sales agreement includes the proposed sale dates of October
                     1 of 1989, 1990, or 1991.’ The sales price in each case is calculated as
                    the present value of all remaining principal and interest payments at the
                    sale date, using a Q-percent discount rate plus an additional $1 million
                    negotiated with the purchasers. Table III. 1 shows the approximate price
                    to be paid for the Eklutna project, depending on the date of sale. The
                    sales agreement provides that payment is required within 5 years of
                    enactment of federal legislation authorizing the sale.




                    ‘The agrcvtment also describes how the selling price is to be determined if the transaction is finalized
                    on a date other than these three.



                    Page 26                                           GAO/RCED-90-93 Sale of APA Hydropower Assets
     +
--                                        Appendix III
                                          Details of APA Sale Agreements




Table 111.1:Projected Selling Price for
Selected Dates                            Dollars    in thousands
                                                                                                 Remaining      Present value
                                                                                              principal and      of remainin
                                          Transaction date                                         interest’       payments II   Selling pric&
                                          10/01/89                                                   $16,583    -      $9,435          $10,435
                                          I o/o l/90                                                   15,544           8,580                9,580
                                          ----__-~
                                          lO/Ol I91                                                    13.912            7.631               8.631

                                          aThis is the amount that over time would be received by the federal Treasury under continued APA
                                          ownership.

                                          bDiscount rate of 9.0 percent; payments assumed at mid-year

                                          %cludes      the $1 million negotiated addition to the sales price.


                                           The three utilities that have reached an agreement to purchase Eklutna
                                          jointly submitted the only bid to purchase the project. The group’s initial
                                           purchase price offer was exactly the same as the minimum acceptable
                                           bid; however, APA negotiated an additional $1 million in selling price. An
                                           additional feature of the Eklutna agreement concerns rights-of-way for
                                           Eklutna’s transmission lines. According to the agreement, APA is respon-
                                          sible for ensuring that the purchaser has rights-of-way for use of the
                                          project’s transmission lines.


Snettisham Agreement                      The method for computing the sales price for the Snettisham project, as
                                          provided for in the sales agreement is more complex than that agreed to
                                          for the Eklutna project. Unlike Eklutna’s pricing formula, the Snet-
                                          tisham sales agreement has alternative pricing formulas. The first com-
                                          putation for the Snettisham selling price is the present value of future
                                          scheduled Treasury payments using a discount rate 2 percentage points
                                          above the interest rate associated with the state’s revenue bonds. These
                                          bonds are those that the state of Alaska will sell to obtain funds for the
                                          purchase. For example, if the purchaser’s revenue bonds sold for 8.5
                                          percent, a 10.5-percent rate would be used to discount APA'S remaining
                                          payments.

                                          Under the Snettisham pricing formula, as the purchaser’s borrowing
                                          costs (and subsequently the discount rate) increase, the proceeds to the
                                          federal government decrease. The APA Administrator told us that if the
                                          state’s borrowing cost rose too high relative to Treasury’s borrowing
                                          costs, the federal government’s proceeds from the sale would shrink to
                                          an unacceptable level. Thus, to preclude an unacceptably low sale price,
                                          the sales agreement includes an alternative pricing method that pro-
                                          vides a floor to the price the government would receive. This alternative


                                          Page 26                                               GAO/RCED-90-93 Sale of APA Hydropower Assets
                              ArwendJx III
                              Detach of APA Sale Alfreements




                              pricing formula sets a floor in the pricing formula of 85 percent of the
                              present value of the remaining principal and interest payments, dis-
                              counted at a rate equal to the average yield rate on 30-year Treasury
                              bonds.

                              Even though the exact purchase price for Snettisham cannot be deter-
                              mined in advance, the APA Administrator believes that the price will fall
                              between 85 percent and 90 percent of the present value of the remaining
                              principal and interest payments discounted at the 30-year Treasury
                              rate. For example, according to the APA Administrator, if interest rates
                              are 9 percent, the price for Snettisham would be about $60 million, or if
                              current interest rates drop to 7 percent, the price would be about $71
                              million. According to the Snettisham sales agreement, the purchaser will
                              make full payment of the sales price to the Treasury by wire transfer on
                              the transaction date.

                              One feature of the Snettisham agreement involves the treatment of the
                              costs of constructing the Crater Lake unit, which had not been com-
                              pleted at the time the agreement was reached. When APA negotiated the
                              Snettisham purchase agreement, it included an estimated $3,500,000 as
                              an additional cost to account for the likely construction claims that con-
                              tractors might file after completing the Crater Lake unit. APA'S cost esti-
                              mate was based on the average of construction claims estimates
                              provided by the Army Corps of Engineers, the project constructor. The
                              APA Administrator    said that using the average provided a balance of the
                              risks involved in estimating these costs. The actual amount of the
                              claims, however, could be lower or higher than this amount. If the
                              claims are higher than the estimate, the additional costs would be borne
                              by the government. If the actual amount of the claims are less, the “sav-
                              ings” would accrue to the government.


Other Features of the Sales   The Eklutna and Snettisham sales agreements contain several other fea-
Agreements                    tures designed to provide for a smooth transfer of operations. Within 6
                              months after congressional approval of the sale, the purchasers and APA
                              are to adopt specific transition plans describing arrangements and a
                              timetable for completing the sale and transfer. Among other things,
                              these plans include the selection of a transaction date to transfer owner-
                              ship, a schedule of payments to the Treasury, and provisions for envi-
                              ronmental, engineering, and safety inspections of the facilities being
                              sold.




                              Page 27                             GAO/RCED-SO-93 Sale of APA Hydropower Assets
Appendix III
Details of APA Sale Agwements




 The sales agreements also contain provisions protecting existing water
 agreements between APA and various nonpower beneficiaries of the
 projects, such as fish hatcheries, cities, and government agencies. For
 example, the Eklutna agreement provides that the purchasers will
 assume all APA responsibilities and benefits in regard to APA'S agreement
 with the municipality of Anchorage concerning the Eklutna water pro-
ject. Both agreements state that the purchasers will also continue to
 make lands and water available to the public for recreational uses.




Page 28                            GAO/RCED-90-93 Sale of APA Hydropower Assets
      ,
Appendix IV

Cakulation of Alternate Interest Costs for
@A’s Snettisham Project

                In our March 1987 letter to the Secretary, Department of Energy, we
                discussed our concern about APA’S method for establishing a minimum
                acceptable price for the Snettisham and Eklutna projects. One aspect of
                our concern was that APA'S pricing method failed to provide for a full
                recovery of the government’s costs associated with these projects. A
                major reason for the lack of full cost recovery is that interest costs on
                the APA investment paid to Treasury is less than the interest payments
                would have been if the Treasury’s actual borrowing rates were used,
                thus resulting in an interest rate subsidy.

                In order to obtain an estimate of the interest rate subsidy for the two
                units of the Snettisham project, we calculated the present value of
                future payments to the Treasury according to the current repayment
                schedule and the existing project interest rate of 3 percent, and com-
                pared that to the present value of what those payments would have
                been if the APA project interest rate had reflected long-term Treasury
                borrowing costs at the time each of the projects became fully
                operational.

                To analyze an unsubsidized investment recovery by the federal govern-
                ment, we assumed that the interest rate for the project was equal to the
                long-term Treasury borrowing cost at the time the projects were placed
                in service.’ We used these rates to derive alternative streams of interest
                that would have been paid had the investment not been subsidized by
                low project interest rates.

                We then calculated the present value of the actual expected stream of
                future payments (derived from the project rate of 3 percent) and the
                alternative stream of interest payments (derived by using the long-term
                Treasury bond rate at the time each of the units was placed on-line). We
                used the data on long-term Treasury rates for 1989 that were available
                at the time we undertook our analysis to discount future payments. The
                rate we used was approximately 9 percent, which was based on the
                average of the Treasury rates during the first 7 months of fiscal year
                1989.

                Our calculations for the Long Lake and the Crater Lake units follow.

                ‘We used the long-term Treasury rate at the time the project was placed into service to derive our
                alternative interest stream representing a nonsubsidized investment by the federal government. We
                used this rate since it is common for nonfederal utilities to borrow money on short-term loans during
                the project’s construction and then to refinance these debts with new long-term debt at the market
                rate of interest when the project goes on-line. Thus, we are using the analogy of how such a project
                might be financed in the private sector to determine how a nonsubsidized investment by the federal
                government might be structured.



                Page 29                                         GAO/RCEDBO-93 Sale of APA Hydropower Assets
                                                                                                                                               ..*
-,
                                           Appendix IV
                                           Calculation of Alternate Interest Costs for
                                           APA’s Snettisham Project




Long Lake Unit                             The Long Lake unit, the first part of Snettisham to be completed,
                                           became operational in 1975, 13 years after the authorizing legislation
                                           was passed. In 1975, the long-term Treasury bond rate was 6.96 percent,
                                           more than double the 3-percent rate that was established at the time of
                                           authorizing legislation.

Table IV.1: Impact of Alternate Interest
Raites on Long Lake Repayment                                                             Total payments over life       1989 Present value
                                           Long Lake repayment                                            of loan        discounted at 9.1%
                                           Principal ---_____ .-                                    $90,886,974.00            $15,538,136.47
                                           -____--.---._
                                           Interest (at 3%)                                          74,492,238.51             25,859,113.61
                                           Total                                                 $165,379,212.51             $41,397,250.08
                                           Principal                                                $90,886,974.00            $15,538,136.47
                                           Interest    (at 6.96%)                                   172,821,993.34             59,993,143.57
                                           Total                                                 $263,708,967.34             $75,531,280.04
                                           Pr;en;,v”:“e          of interest   payments
                                                            Oo                                                       a        $59,993,143.57
                                           _.-         --
                                               at 3.00 %                                                             a       -25,859,113.61
                                           .-----~
                                           Difference                                                                0       $34,034,030.16
                                           aData not applicable




Crater Lake Unit                           The Crater Lake unit is scheduled to be completed in 1991. The project
                                           interest rate applied to this unit will be the original project rate of 3
                                           percent. Because we cannot predict the 1991 interest rate, we have used
                                           the long-term Treasury bond rate for 1989 that was available at the time
                                           that we undertook our analysis. That rate of approximately 9 percent
                                           was based on the average of the long term Treasury rates during the
                                           first 7 months of fiscal year 1989.




                   J




                                           Page 30                                            GAO/RCED-90-93 Sale of APA Hydropower Assets
  .
                                                                                                                                                           -
       ,                                   Appendix IV
                                           Calculation of Alternate Interest Costs for
                                           APA’s Snettisham Project




Table IV.2: Impact of Alternate Interest
Rates on Crater Lake Repayment                                                               Total payments o;;;Jlf;                1989 Present value
                                           Crater Lake repayment                                                                    discounted at 9.1%
                                           Principal                                                         $61,700,000.00                $5,309,282.72
                                           __.-- .._._..-__-..---.         .-.-                                                                 ___.
                                           interest (at 3%)                                                   66,693,760.80                19,354,909.70
                                           Total                                                           $128,393,760.80              $24,664,192.42
                                           Principal
                                           __..  - .._-._ --.---.---..--                                     $61,700,000.00                $5,309,282.72
                                                                                                                                                 --...
                                           Interest (at 9.13%)                                               202.971.345.37                58.903.441.86
                                           Total                                                           $264,671,345.37              $64,212,724.588
                                           Pr~~;;~lue            of interest      payments
                                                         Oo                                                                   b          $58,903,441.86
                                                 at 3.00%                                                                     b          -19,354,909.70
                                           ---
                                           Difference                                                                         b         $39,548,532.16
                                           aThe discounted present value at a 9.13 rate of discount of a stream of principal and interest payments
                                           where interest is accruing at a 9.13 rate should equal the original investment level, in this case,
                                           $61,700,000. Our method only approximates the original investment level due to the mid-year interest
                                           accrual used in this analysis.
                                           “Data not applicable




Total Snettisham Project                   The alternative interest rate repayment for the combined Long and
                                           Crater Lake units of the Snettisham are shown in Table IV.3.

Table IV.3: Impact of Alternate Interest
Rates on Repayment of Total Snettisham                                                             1989 present value of          1989 present value of
Project                                                                                           total principal and 3%             total principal and
                                                                                                  interest discounted at                current interest
                                           Snettisham Project                                                       9.1%            discounted at 9.1%
                                           Long Lake                 __...--~~ ~-            --                 $41,397,250                 $75,531,280
                                           Crater    Lake                                          .-           $24,664,192                 $64,212,725
                                           Total                                                               $66,061,442                $139,744,005




                                           Page 31                                                      GAO/RCED90-93 Sale of APA Hydropower Assets
Aljpendix V

Map of Eklutna Lands Under Private or Native”
American Corporation Ownership


                                                                                                                             Substation
                                                                    Problems wlth easements ------------                                   A
                                                                    could occur along thls
                                                                    part of the transmisslan   line
                                                                                       ___-.-_.-.---




                                                                                                                                       i    Eklutna
                                                                                                                                            Powerplant
                                                                                                                                       --- Power
                                                                                                                                  I        Tunnel
                                                   .. .. . :..      .
                                                              .. . ..L.... :. . .:. . . . . .                            .        I7
                                               .. .. :: .. .. . .. ... .. . .
                                                                           . .. .
                                         . .. . ...:.. .... . . . .. . .... ..                     Yf
                                . .. ... . .::. ........ .... .... . .. . . . .                 ,f .
                        .,. .:: . .: . .                 .. ..  .. .
                                                                                             :I .
                             .. . .... .. .. . .... ..:. .
                                 .. . . . ... .                                           /-                 Probloms wlth easemenls
                          ... . ... . .. :. . .                                          ---w _ ---_         could occur along this
                        ... . :’                                                      /                 -
                          ..... .                                                                            part of the transmlsslon line
                    . .  .
                  ;T’i/ . ..                                                        I



                                                         /
                                                   /’
                                        I
                                  A -.d -
                             Substation                                                           0               5               10
                                                                                                            Scale in Miles




              I                               Source: GAO analysis of APA data.




                                             Page 32                                                        GAO/RCED-90-93 Sale of APA Hydropower Assets
&p&$x   VI

Objectives, Scope,and Methodology


               The staffs of the Environment, Energy and Natural Resources Subcom-
               mittee, House Committee on Government Operations, and the Subcom-
               mittee on Water, Power and Offshore Energy Resources, House
               Committee on Interior and Insular Affairs, asked us to determine which
               concerns we raised in our March 1987 letter to the Secretary of Energy
               and which concerns raised during congressional hearings in 1986 had
               been addressed by DOE in reaching sales agreements for APA'S hydroelec-
               tric power projects. Our key concern was that the approach being taken
               by the Department in selling APA'S assets would likely lead to sales
               agreements that failed to recover all of the government’s costs in con-
               structing and operating the projects and would not reflect the market
               value of the assets.

               We addressed our objective by holding a series of discussions with APA
               officials and reviewing various documents and reports that they pro-
               vided. We reviewed the negotiated purchase agreements as well as the
               purchasers’ original proposals and APA'S analyses of these documents.
               We examined other documents, such as papers on tax exempt financing
               and the pricing of the Crater Lake unit for the Snettisham agreement,
               and various documents discussing personnel plans. We also analyzed
               alternative selling prices using market interest rates.

               We interviewed representatives of various utilities and governmental
               entities in the state of Alaska.

               We performed our field work from March to September 1989. We con-
               ducted this assignment in accordance with generally accepted govern-
               ment auditing standards.




              Page 33                            GAO/RCED-90-93 Sale of APA Hydropower Assets
&f)cndix   VII                                                                                         I
ll@ajorContributors to This Report


                           John W. Sprague, Associate Director
Resources,                 Paul 0. Grace, Assistant Director
Community, and             Rachel B. Hathcock, Assignment Manager
                           Charles W. Bausell, Jr., Senior Economist
Economic
Development Division,      Amy D. Abramowitz, Economist

Washington, D.C.
                           Benjamin S. Gross, Attorney
Office of the General
COunsel,Washington,
DC.
                           Raymond A. Larpenteur, Evaluator-in-Charge
Stiattle Regional Office




                           Page 34                          GAO/RCED-90-93 Sale of APA Hydropower Assets