:report/of the Comptroller General of the United States. United States.General Accounting Office. [Washington, D.C.:U.S. General Accounting Office,1976] Public utilities United States Design and construction Costs. Public utilities United States Rate of return. United States. Federal Power Commission. REPORT OF THE COMPTROLLER GENERAL OF THE UNITED STATES COASTAL ZONE INFORMATION CENTER An Evaluation Of The Federal Power Commission's Rulemaking On Utilities' Construction Work In Progress GAO has asked to review a propsed Federal Power Commission rule to allow natural gas and electric utility companies to include con- struction work in progress in their basics for computing rates. The rulemaking order does not appear to serve adequately either of the purposes the Commission originally envisioned. The im- mediate financial impact appears to me mini- mal, and little change will result in the utili- ties' allowances for funds used during con- struciton accounts. Of more importance, the rulemaking sets a precedent for the Commission to depart from its historic "used and useful" policy and pro- vides an opening for utiltities to submit future rate increases filings with cost of construction work in progress in the rate base. CZIC COLLECTION END 77-7 DEC. 2.1976 COASTAL ZONE INFORMATION CENTER TO THE READER: SEVERAL PAGES OF THE FOLLOWING MATERIAL MAY BE ILLEGIBLE BECAUSE OF THE POOR QUALITY OF THE COPY SUBMITTED FOR MICROFILMING CZIC COLLECTION COMPTROLLER GENERAL OF THE UNITED STATES WASHINGTON, D.C. 20 B-180228 The Honorable John E. Moss Chairman, Subcommittee on Oversight and Investigations Committee on Interstate and Foreign Commerce House of Representatives Dear Mr. Chairman: In a March 29, 1976, letter, you requested us to review the Federal Power Commission's proposed rulemaking, RM75-13, which would allow natural gas and electric utility companies to include construction work in progress in their rate bases. Because of your concern about the impact on consumers if the Commission ordered the rulemaking, you wanted us to determine (1) the propriety of the proposed rulemaking from the stand- points of procedure and necessity, (2) the benefits that will accrue to the utility industry if the proposed rulemaking goes into effect, and (3) the impact of the rulemaking on the rates currently being paid by utility customers. On November 8, 1976, the Commission issued a modified version of the original rulemaking proposal which would be- come effective 30 days fromt he date of issuance unless the Commission granted a rehearing on the order. The rulemaking, Order No. 555, as approved by the Commission, contains three major provisions. 1. Natural gas pipeline companies are excluded from the Commission order. 2. The Commission will permit rate base treatment for pollution control and fuel conversion costs incurred by electric utilities in accordance with the terms outlined in the rulemaking. 3. An in extremis provision whereby under specified cir- cumstances the Commission will pe t, in individual proceedings, including construction work in progress int he rate base when the utility is in severe finan- cial stress. The Commission's actions in formulating, processing, and approving the proposed rulemaking, RH75-13, followed the legal requirements for rulemaking contained in the Administrative Procedures Act (5 U.S.C. 553) but some of the Commission's normal actions for ially proposing and processing a rulemaking B-180228 proposal were bypassed. For example, at the time RM75-13 was initiated, no analysis or study was prepared supporting the need for the rulemaking and no proposal was made as to how it would be implemented. Also, in contrast to normal proce- dures, the Commission office responsible for initiating the rulemaking proposal did not prepare a recommendation for Commission consideration following the staff analysis of the respondents' written comments. However, later Commission memoranda and proposals did address the question ofimplementation, and recommendations for Commission consideration were prepared before the final order on the rulemaking. Therefore, except for no detailed analysis demonstrating the need for the rulemaking, the only ap parent effect of the Commiss ion not followin g normal proce- dures was the long period of uncertainty for the utility in- dustry as to the actual resolutionn of the proposal. The Commission did not maintain a complete central file con taining all pertinent documentation on the proposed rule- making. This lack of documentation made it difficult to follow the steps taken by the Commission in processing the rulemaking. We believe that, although the Commission, has broad discretion in a rulemaking procedure, its public responsibil- ity dictates a recordkeeping system that not only provides sufficient informaton for staff use but also makes avail- able to the public as much information as possible. We have recommended that the Chairman require a complete central file to be maintained f or each rulemaking. The Commission initiated the rulemaking to provide cur rent financial relief to the utility industry. The Commis- ion's assessment of the industry indicated that the utili- ties were suffering from an acute cash shortage and that utilities with large construction programs I were having dif- ficulty borrowing funds at favorable interest rates. The proposal to allow construction work in progress in the utili- ties' rate bases was expected to help overcome these finan- cial problems. As the Commissioners delayed taking final action on the proposed rulemaking, the financial condition of the utility industry as a whole began to improve and the current finan- cial need of the utilities was not the focal point for the approved rulemaking order. Instead, the Commissioners 2 B180228 decided to only allow certain pollution control and conversion facilty costs in the rate base because of the present gener- ation's commitment to pollution control or the controlled con- sumption of existing stocks of natural resources. However, the Commissioners did not exclude the possibility that cer- tain utilities might need financial help and included a pro- vision in the final order that allows them to expand the rule- making by authorizing other construction costs in the rate bases for utilities demonstrating financial hardship. The Commission has excluded the natural gas companies from the effects of the rulemaking. It determiend that the relatively small amount of the gas industries' construction work in progress account, the different method of financing large projects, and the uncertainty of the identity of fu- ture gas users justified the exclusion. The Commission has consistently refused to allow con- struction work in progress in a utility company's rate base and failed toa ct even though many of the utilities were in poor financial condition in 1974 and 1975. Now that finan- cial indicators show the utility industry to be much improved and able to compete in the market for funds, the Commission has elected to move ahead--on different grounds than origi- nally envisioned--and allow at least some constructionw ork in progress in the rate base. The financial impact of allow- ing certain environmental costs in rate base is not yet clear, but it does not appear to represent a large increase in either industry benefits or consumer costs. This is due in part to the fact that nearly one-half of the State com- missions currently allow their jurisdictional utilities to include some or all construction work in progress costs in their rate bases. On the basis of the Commission's juris- dictional share of the utility industry, we estimated that, if the $1.558 billion in pollution control costs recorded as construction work in progress on December 31, 1975, were allowed in the utilities' rate bases, wholesale revenues would increase only by about $12 million, or 0.2 percent. In our o inion, the rulemaking does little to achieve the purpose o the original proposal to provide substantial financial relief to the industry. However, it does estab- lish a precedent for future Commission actions by removing 3 B-180228 the "used and useful" 1/ restrictions that governed prior Commission construction work in progress policy. The potential impact of the in extremis provisions to permit construction work in progress in the rate base of a utility demonstrating a severe financial situation appears to be much more important. Utilities with large construction programs and in a poor financial condition could submit a rate increase filing with construction work in progress in in the rate base. Commission approval of the requested in- crease could considerably raise wholesale rates to customers, particularly if the Commission had jurisdiction over much of the utility's operations. Although the provision allows The Commission to take prompt action to provide relief to utilities in financial trouble, the incentive for a utility company to operate in an efficient and prudent manner would appear to be reduced. Commission approval of the rulemaking raises the pros- pect that the administrative workload of the staff will in- crease as a result of more complex rate increase filings. The Commission staff will now have to accept all rate filings that include construction work in progress costs in the rate base. Through staff analysis and possibly the full hearing process, the reasonableness of the filing, including a deter- mination of financial need, will have to be decided, and allowing construction work in progress in the filing might require additional time to resolve differences between the utility and any intervenors contesting the rate filing. A more detailed discussion of these matters is presented in appendix I. Although your staff requested that the report not be submitted for formal agency comments, we did discuss it informally with the Commission Chairman and his assistant. Their comments have been included in our report as consid- ered appropriate. This report contains a recommendation to the Commission which is set forth on page 10. As you know, section 236 of the Legislative Reorganization Act of 1970 requires the head of a Federal agency to submit a written statement on actions 1/It has been Commission policy not to allow construction work in progress int he rate base until such time as the facility is completed and put into service. 4 B-180228 taken on our recommendations to the House and Senate Commit- tees on Government Operations not later than 60 days after the date of the report and to the House and Senate Committees on Appropriations with the agency's first request for appro- tions made more than 60 days after the date of the report. We will be in touch with your office in the near future to arrange for the release of the report to meet the require- ments of section 236. Sincerely yours Comptroller General of the United States 5 Contents Page RULEMAKING--LEGAL AUTHORITY AND REQUIREMENTS 1 ASSESSMENT OF PROCEDURES FOLLOWED IN PROPOSED RULEMAKING 2 Internal procedures generally followed by FPC 2 Procedures for RM75-13 deviated from normal pattern 4 Later actions taken on the proposed rulemaking 6 Conclusions 9 Recommendation to the Chairman, FPC 10 Agency comments and our evaluation 10 NECESSITY FOR IMPLEMENTING THE PROPOSED RULEMAKING 10 Studies in 1974 disclosed utilities' financial problems 11 Current assessment of utilities' financial con- ditions 13 Conclusions 15 POTENTIAL IMPACT OF THE PROPOSED RULEMAKING Current method of accounting for construciton costs 16 Financial impact of the rulemaking order 17 Additional administrative burden should be considered 18 Conclusions 19 APPENDIX I APPENDIX I THE COMPTROLLER GENERAL'S REPORT ON AN EVALUATION OF THE FEDERAL POWER COMMISSION'S RULEMAKING ON UTILITIES' CONSTRUCTI0N WORK IN PROGRESS APPENDIX I APPENDIX I REVIEW OF FPC'S PROPOSED RULEMAKING TO ALLOW CONSTRUCTION WORK IN PROGRESS IN UTILTIES' RATE BASES The Federal Power Commission (FPC), as one of the major independent regulatory agencies in the Federal Government, regulates the interstate aspects of the electric power and natural gas industries. Its regulatory policies and deci- sions directly or indirectly affect the great majority of U.S. consumers of electricity or natural gas. In addition to using its adjudicative procedures, FPC establishes or amends its policies through the rulemaking process, an accepted method backed by abundant legal author- ity. One example of this procedure is a policy change con- cerning the treatment of utilities' construction work in progress account. FPC has approved a modified version of the proposed rulemaking, Docket No. RM75-13, Amendments to Uni- form System of Accounts for public utilities and licensees and for natural gas comapnies (classes A, B, C and D) and regulations under the Federal Power Act and the Natural Gas Act, to include construction work in progress in rate base. FPC first released the rulemaking proposal for public com- ment on November 14, 1974. Final approval of the modified version was given at an FPC meeting held November 2, 1976, and Order No. 555 was issued on November 8, 1976. At the request of Chairman John E. Moss, we reviewed the entire rulemaking process in terms of FPC compliance with legal or established procedures, necessity for the rulemaking, and the impact of the rulemaking on utility companies and their customers. RULEMAKING--LEGAL AUTHORITY AND REQUIREMENTS A rule (or a regulation--a term used interchangeably with rule) is the product of rulemaking, and rulemaking is part of the administrative process resembling a legislature's enactment of a statute. Rules established pursuant to a grant of power to make law through this procedure have the same force as statutes if they are valid. The three tests of validity are constitutionality, statutory authority, and proper procedure. Federal agencies are required to follow the rule- making procedures contained in the Administrative APPENDIX I APPENDIX I Procedures Act, (5 U.S.C. 553). General notice of a proposed rulemaking is to be published in the Federal Register, unless persons subject thereto are named and either personally served or otherwise notified. After the notice has been published, the agency gives interested persons an opportunity to comment on the rulemaking through submission of written data, views, or arguments, with or without opportunity for oral presenta- tion. After considering the relevant matter presented, the agency incorporates in the rules adopted a concise general statement of their basis and purpose. A new rule generally cannot become effective until 30 days after publication and each agency gives an interested person the right to petition for the issuance, amendment, or repeal of a rule. Procedurally, no requirements are placed on Federal agencies before the time the notice of proposed rulemaking is published in the Federal Register. In other words, agen- cies are not required to maintain any documentation support- ing or justifying a decision to propose a rule. ASSESSMENT OF PROCEDURES FOLLOWED IN PROPOSED RULEMAKING The procedures FPC followed in RM75-13 were legally in conformance with the requirements of the Administrative Pro- cedures Act, but the initial steps in proposing and process- ing the rulemaking deviated somewhat from the procedures generally followed in other FPC rulemaking proceedings. Since FPC actions before the final approval of the rulemaking pro- posal addressed the issues not previously covered, the only apparent effect of the deviation from normal procedures was the long period of uncertainty for the utility industry as to FPC's eventual resolution of the rulemaking. We found that the FPC's central files which should contain complete records of all data pertaining to the rule- making were of little use in determining the rationale for and later processing procedures of the rulemaking proposal. We recognize that FPC has broad discretion in a rulemaking proceeding but believe that its public responsibility dictates a better recordkeeping system. Therefore, we believe that action should be taken to improve the central file system. Internal procedures generally followed by FPC FPC has few formal procedures other than those contained in the Administrative Procedures Act. 2 APPENDIX I APPENDIX I However, we found that its practices in rulemaking cases generally follow a consistent pattern. According to FPC officials, a rulemaking is generally initiated with a memorandum to the Commissioners from one or more of the departments within FPC. They told us that the department that submits a recommendation for a rulemaking proposal usually makes some type of analysis or study sup- porting the need for the rulemaking. In the event of a pro- posed change in the Commission's Uniform System of Accounts-- as RM75-13 was initially considered to be--the proposal may even be discussed with utility industry and State utility commission representatives and their views considered in mak- ing the proposal. However, the FPC's only formal justifi- cation supplied to the public is contained in the notice of proposed rulemaking. According to FPC's General Counsel, the Commissioners consider the initiating memorandum and, if the recommenda- tions are approved, the memorandum is referred to the Office of General Counsel or back to the department initiating the rulemaking. An attorney from the Office of the General Counsel or a member of the department initiating the rule- making is then assigned to review the proposal, all pertinent statutory provisions, and prior FPC decisions which would be affected by, or have some bearing on, the proceeding. The person assigned then prepares a notice of proposed rulemaking for final action. The proposal is reviewed by the appro- priate person within the Office of General Counsel with re- view respnsibilities--an assistant to the General Counsel or some other senior lawyer having responsibility over the subject-matter of the proceeding. The followup review is conducted by the head of the department initiating the rule- making, the General Counsel, and finally, the Commissioners. After Commissioner approval, the proposed rule is published in the Federal Register as indicated. We were told that normally the bureau or office that makes the original recommendation for the rulemaking is also given the responsibility for analyzing the written comments submitted by respondents to the rulemaking and recommending the action to be taken by the Commissioners. In addition to receiving written comments on a proposed rulemaking, the Commissioners can order a formal hearing or hold oral argu- ments. In such cases the secretary issues a public notice and fixes the date by which outside parties may request permission to participate. These hearings are open to the public. 3 APPENDIX I APPENDIX I The written comments and oral arguments are then considered by FPC staff and and order promulgating the rule is prepared by the responsible party and reviewed by the Office of General Counsel. The order incorporates the basis and purpose of the adopted rule and is subject to the same approval noted above in connection with the issuance of a notice. Following Commissioner approval, the order is then issued. According to FPC's General Counsel, the time that elapses between the first overt act towards drawing up a rule and the date of publication of the notice in the Federal Reg- ister varies from rule to rule and depends on the degree of complexity and urgency of the proposal. FPC maintains a central file of all cases accepted for processing. These docket files are separated into public and nonpublic categories with specific data records kept in each file. However, all data that pertains to a specific docket is to be in either one or the other file. Procedures for RM75-13 deviated from normal pattern As indicated previously, a rulemaking proceeding is generally initiated with a memorandum from one or more of the departments within FPC. In the case of RM75-13, the directive to prepare the proposed rulemaking originated with the Commissioners. However, the timing and sequence of events surrounding the proposal was not clear because FPC did not have a complete record of rulemaking proceedings in one cen- tral file location. Individual Commissioners or FPC staff that participated in preparing rulemaking documentation gen- erally kept copies of their own contribution, but even these were not always readily available. The only written record available was an FPC staff memorandum, dated August 29, 1974, which stated that the Commissioners had directed the Office of Accounting and Finance (OAF) to prepare a rulemaking on construction work in progress for their consideration. FPC's General COunsel said that the proposal was made by the former FPC Chairman during a Commissioners' meeting in August 1974. The former Chairman concurred in this statement but emphasized that he had spoken for all Commissioners in making the request to OAF and it was not a unilateral decision on his part. This method of originating a rulemaking is somewhat unusual, because a rulemaking is generally initiated by a memorandum to the Commissioners with the need for the 4 APPENDIX I APPENDIX I rulemaking supported by some type of analysis or study. No analysis or study supporting the propose rulemaking was available to the Commissioners before r uesting the pro- posal nor were they prepared by the OAF staff given the responsibility for drafting the proposal. However, an FPC official stated that two studies con- cerned with the financial condition of the electric utility industry were publicly released in Spetember 1974. One study, prepared by FPC's Office of Economics, analyzed the financial requiremetns of the electric utility industry for the period 19 79 and identified means of meeting them. The study also analyzed the relative impacts of a number of policy alterna- tives of these financial requirements. The second study was prepared by OAF staff who were not involved in preparing the rulemaking proposal. This study was similar to the Office of Economics study and examined the present and prospective financing problems of the electric utility industry. It offered eight policy options that FPC and State regulatory commissions could consider to enable the industry to meet the challenges of the future. The FPC official could not identify a direct relationship between these studies issued in September 1974 and the preparation of the proposed rule- making a month earlier. He did say that the Commissioners were no doubt aware of these studies as they deliberated the proposed rulemaking in the fall of 1974. The notice of proposed rulemaking, as published in the Federal Register, contained no plan for implementing the rul if adopted. OAF's Chief Accountant said this was unusual, although FPC's General Counsel said that an implementaion plan was to be determined after comments had been received on the propsed rulemaking. We noted that one of the major difficulties FPC faced in agreeing on an acceptable rulemak- ing was the resolution of the implementation question. FPC received 160 written comments on the proposed rule- making. The comments displayed a sharp division of opinion on the FPC proposal. Virtually all regulatory private elec- tric utilities and gas pipelines supported the proposal; consumer groups, electric cooperatives, and publicly owned systems were strongly opposed. The comments also disclosed various administrative problems, incentive effects, and po- tentially discriminatory results. FPC action taken after receipt of written comments on RM75-13 seemed to deviate from their normal procedure of analyzing the written comments and forwarding them with a recommended rulemaking to the Commissioners for consideration. 5 APPENDIX I APPENDIX I The Commission Chairman requested that OAF prepare a prelimi nary assessment of the 160 written comments. Th is was com- pleted and sent to the Commissioners on June 30,1975. The item was put on their agenda for July 11, and July 30, but the matter was not discussed either time. Following the preliminary assessment,the OAF staff made their detailed analysis of the comments and prepared a draft proposal of the rulemaking (this step followed normal proce- dures). This August 18, 1975, draft was circulated for com- ment among cognizant FPC offices. On the basis of the com- ments received, a final draft proposal was prepared recom- mending that the rulemaking be implemented on an ad hoc basis. However, the OAF chief accountant, as final reviewing officer, did not agree with the staff recom -mendation. He felt the rulemaking was a policy not an accounting matter and that OAF should not make a recommendation on the proposal. Conse- quently, on December 8, 1975 he forwar ded to the Commis- sioners only the staff analysis of the written comments. Later actions taken on the proposed rulemaking OAF's analysis of the comments was placed on the agenda for discussion on December 10, 1975. The discussion was postponed until December 17 and again until December 31. Our review of these agendas and discussion with responsible FPC staff indicated that the rulemaking issue did not appear on the December 31 agenda and was not formall y discussed until July 14,1976. Although RM75-13 wa s not discussed in a Commissioners' meeting until the July date, they apparently accepted OAF's assessment that the rulemaking was not an accounting prob- lem. Memoranda covering various aspects of the rulemaking submitted after December 8,1975, were prepared by FPC offices other than OAF. On December 17, 1975, staff members from FPC' s Office of Economics submitted a memorandum discussing the extent to which treatment of construction work in progress (CWIP) may affect management decisions concerning types of electric- generating plants to be built (no conclusion was reached). On December 18, 1975,the Assistant General Counsel for- warded a memorandum supporting his opinion that no legal bar exists to including CWIP in utilities' rate bases. The Chief, Office of Economics, submitted a second memorandum, dated December 22, 1975, in which he reviewed certain respondents' written comments and offered the con- clusion 6 APPENDIX I APPENDIX I "* * * that it would be inadvisable for the Com- mission to adopt a general policy of rate base treatment for CWIP. Instead, I would recommend requiring a utility desiring CWIP in rate base to demonstrate special circumstances (e.g., major obstacles to new financing, compatability with state regulation, exceptionally heavy CWIP fi- nancing)." Following the receipt of the above memorandums, FPC announced on January 23, 1976, that it would hold oral arguments on the proposed rulemaking in New York City on March 8, 1976. The oral argument was held as scheduled with 50 respondents participating. On March 3, 1976, just before the oral arguments were held, the Chief, Division of Economic Studies, Office of Economics, submitted a memorandum to FPC at the Chairman's request. He presented a brief analysis of the financial effects of putting CWIP in the rate base, generally repeat- ing points that had been covered in respondents' replies to the initial proposal. Following the completion of the oral arguments on March 8, 1976, the FPC Chairman gave his assistant and the Chief, Division of Economic Studies, Office of Economics, the responsibility for analyzing the oral arguments and pre- paring a draft order on the proposed rulemaking for Commis- sioners' consideration. Two memorandums for Commissioners' information were prepared on March 18 and 26, 1976, which set forth Office of Economics thought. These memorandums served as the basis for a draft proposal that was offered for considreation at a July 14, 1976, Commissioner meeting. Basically, the proposal excluded gas pipeline companies from the rulemaking, allowed in the rate base all costs incurred by utilities for pollution control devices and for converting facilities from gas to oil or coal and oil to coal, and stated FPC would consider including other CWIP costs in the rate base if 50 percent or more of the sales of the affected company ar subject to FPC jurisdiction or to the jurisdic- tion of States that allow CWIP in rate bases. However, the CWIP costs that would be considered were limited to that amount necessary to bring the company's pretax interest cover- age ratio to 2.5 using the following computation: Operating income + Federal taxes Interest expense 7 APPENDIX I APPENDIX I in tl,e rulemaking Natural gas companies"were excluded fro 'becIause' FPC dete@,:rined. that tne relatively sman' amount of -s the different.-. method of the gas industries' CWIP account ts and the uncertainty o,,- the identity fi:nancing large projecl of f users justified the exclusion. .. Cc;sts,f,or pollu uture gas, trol devices and conversion facilities were justified tion con neration on the basis of FPC's assessment that the present ge quiring the controls'and,it has recog- caused the.po.1lution re the pollution. nized the-need for containing The C ommissioners considered the draft proposal on July 14, 1976, and again on July 16, 1976,. The Commissioners all agreed that pol .lution control and conversion costs sho uld, be a I llowed in the rate base. The majority agreed there.-should 9 be some test for allowing other CWIP costs in the rate ba se but they had@qbestions concerning the test criteria as stated in therulemaking proposal. Therefore, no finalwte was taken and the Chairman referred thedraft proposal back..to, the staff.for additional work., On September 15, 19760 the Commission discussed two staff memorandums.concerned. with the proposed rulemaking. Both the Bureau of Power and Office,of Economics staff that prepared the memorandums favored allowing pollution control and.conversion costs in the rate base but did not pr opo,s.e retaining the test criter,ia as given in the July proposal. The Commissioners present agreed with the staff position but again delayed making a final decision. On September 29, 1976, the Commissioners, discussed a revised draft proposal that reflected FPC's concern over t* ity companies to include.CWIP in their.rate allowing u il bases if they met certain prescribed tests. This test re- auirement.was deleted,in,its entirety, and it,was proposed. ihat only pollution control orconversion costs would be allowed in.rate bases. Gas pipeline companies were still excluded and an.open-end clause.was added by which the Com- Missioners reserved the rightto make future decisions on allowing other CWIP costs in rate bases. The proposal was. generally acceptable to.the Commissioners, but,they wanted some estimate of the potentialimpact and a better.de,fini- tion of exactly'what items would be included in rate bases.. Consequently, the Commissioners again delayed taking a final vote. The proposed rulemaking.was next-discussed-on October 6, .1976. General agreement was re ached with the exception of one objection to the open-end clause giving the Commissioners the. right to add other,CWIP costs. in, the f uture. Discuss.-Lon 8 APPENDIX I APPENDIX I of that issue was postponed until the meeting 'scheduled for. October 13, 1576. The rulemaking proposal was not discussed at the Octo- ber...13, 1976, meeting as scheduled@ On October 20, 1976, the Commissioners discussed (1) the revisions made to the ..September 24, 1976, draft (2) a new propqsal@that limited rate base treatment of CWIP to pollution control and,conver sion retrofitting costs and excluded@the open-end clause, and (3) an in extremis clause to the new proposal'tha.t au-, t.horized the Commissionersto permit, in 'individual proceed- ings,@including CWIP in a rate base when the utility was in severe financial stress. Faced with.the choice:of making a se.lection from the three options, the Commissioners agreed. to delay the decision for 1 additional week,.' On November 201* 1976,. after acknowledging: the fact that there would be-a rehearing on the order, a..majority of the Commissioners voted to accept the. rulemaking proposal that limited rate base treatment.to pollution control and conver- sion costs aslamended by the in extremis provision. The rulemaking order was issued @oH November, 8, 19.76. Conclusions lie recognize. that FPC has broad discretion in how -it a proceeds in the rulemaking process:and that relitively few steps are legally required. In our opinionP however,.the deviations from normally:followed FPC.prDcedures in initially- proposing and- processing-the draft CWIP rulemaking order did ..@not provide the Commissioners, with sufficient information to act -expeditiously on the rulemaking.pr-pposal,.,.,, This had the effect of lengthening the time required for FPC to act on the'proposal and extended the period of uncertainty for-the, utilityindustry as to the final'resolution of the rulemak- ing proposal. Also, in view of FPC's responsibility to.-Keep the public informed of its activities and to, act in an. efficient manner, we believe, that good management practices thatgo beyond the legal.requitements should be followed when using r ulemaking procedures. 'These practices should include not only preparing pertinent documentation charting'FPC actions, but also main-, @taining a complete.centralfile accessible to both the public and FPC staff. 9 APPENDIX I APPENDIX I Recommendation to the Chairman, FPC We recommend that the Chairman, FPC, require that a com- plete central file be maintained for each rulemaking. In our opinion, this file should contain all memoranda, studies, analysis, or other documentation pertaining to the rulemaking and should be readily available to all interested parties. The present distinction between data filed in the nonpublic versus the public file should be reexamined with as much data as possible made available to the public. Agency comments and our evaluation In commenting informally on our recommendation the FPC Chairman recognized the need to improve the administrative organization, including the central files, at FPC. He said that on September 23, 1976, he approved Administrative Order No. 161 which established the Office of Regulatory Support Services. This office will be responsible for providing skilled professional records management services for FPC, including processing and controlling the official FPC dockets and central files. We found that under Order No. 161 the FPC staff made preliminary plans to improve the records management services, although the implementation method is still uncertain. One part of the plan relates directly to our concern about cen- tral file content and if properly implemented should re- solve the central file issue. NECESSITY FOR IMPLEMENTING THE PROPOSED RULEMAKING The Federal Power Commission's initial and primary pur- pose for allowing CWIP in a utility's rate base was "to help alleviate the current financing problems being experienced by utility companies." The extremely unfavorable money market conditions of 1974 prompted FPC to propose including CWIP in the rate base to lessen utilities' cash flow problems. As the Commissioners delayed taking final action on the proposed rulemaking, the financial condition of the util- ity industry as a whole began to improve. Our analysis of current financial data provided by FPC and obtained from pub- lications of various financial services indicates that the problems faced by the electric utility industry in 1974 have diminished. This view was supported by an OAF study com- pleted in July 1976. The improved financial condition of the industry, therefore, raises questions as to whether the rule- making was really needed. 10 APPENDIX I APPENDIX I Studies in 1974 disclosed utilities' financial problems Before publishing the Notice of Proposed Rulemaking in November 1974,FPC issued two studies analyzing the current and prospective conditions of the electric utility industry. FPC focused on the electric utility industry because it felt that the financial problems of the electric utilities were more severe than those of the natural gas companies. Con- sequently, there were no studies of the financial condition of natural gas companies. The studies discussed the effect on the electric util- ity industry of inflation,high interest rates, and other factors with reference to their impact on future financial requ irements. The studies also contained assessments of various policy alternatives which, if implemented, woul d affect utilities' financial conditions. One study prepared by OAF analyzed 116 electric companies from an operational, financial, and ma r k et view- point. The study also used FPC data on class A 1/ and B 2/ electric utilities as an aggregate group.0AF examined the trends of the following financial indicators, for the period 1969-73, which it believed best measured the financial capability of each company: Fin anci al risk --Pretaxinterest coverage (the number of times interest costs ate covered by pretax earnings). --Common equity ratio (the percentage of total pe r- manent capital that is contributed by common stock- holders). Operating efficiency --Gross plant turnovers (the number of times gross revenues exceed gross plant valuation). l/Class A utilities are those with operating revenues of $2.5 million or more. 2/Class B utilities are those with annual revenues of l mil- lion or more but less than $2.5 million. 11 APPENDIX I APENDIX I Quality of earnings --Allowance for funds used during construction (AFUDC) (interest on funds used for construction projects that has been capitalized and credited to current income--expressed as a percent of income). Profitability ratios --Earnings per share (the net amount from earnings that is available to common stockholders). --Return on common equity (the earnings available to common stockholders after preferred dividends have been paid--expressed as a percent of common equity). --Return on total capital (gross income as a percent of total permanent capital). Market assessment of risk --Price-earnings ratio (the earnings per share divided into the market price of the stock). --Market-to-book ratio (the market price of common stock divided by its book value). The study concluded that (1) financial risks of electric utilities had increased significantly, (2) rating agencies had acknowledged the increased risk by dropping utilities' bond ratings, and (3) electric utilities were in a poor posi- tion to attract additional capital. The FPC staff also noted that, among the many problems which emerged during the rapidly changing economic and finan- cial environment of the last few years, two problems demanded immediate attention. The first problem concerned the utili- ties' liquidity positions--they were suffering from an acute cash shortage. The second problem involved the utilities' rates of return on investment--either the utilities could not earn the rate of return authorized by the regulatory authori- ties or the rate of return authorized was inadequate. To help alleviate the problems identified, either di- rectly or indirectly, the OAF staff suggested eight policy options, one of which was to allow the CWIP cost to be in- cluded in a utility's rate base. Among the other options were provisions to (1) increase investment tax credits, (2), base allowable rates of return on future costs instead of historical test periods, (3) use tax exempt bonds for 12 APPENDIX I APPENDIX I pollution-control facilities, (4) expand the use of automa- tic adjustment clauses, and (5) allow utilities to account for the difference between taxes collected and taxes paid over a longer period of time. While preparing the study, OAF identified 27 electric utilities and 5 electric utility holding companies that ap- peared to be in a relatively weak financial condition in relation to the other companies studied. The 5 holding companies represented 25 electric utilities; therefore, as many as 52 utilities were in questionable financial condi- tion in September 1974. The OAF staff did not identify the specific problems causing the utilities' financial difficul- ties. An OAF official said that in many cases FPC had limited jurisdiction over the companies and could offer little help other than to increase the utilities' rates of return on whole- sale sales and to limit suspensions on rate increase filings to 1 day. Although it considered assistance through the regu- latory process to be a State prerogative, FPC had not made any efforts to work with State commisisons in solving these financing problems. Current assessment of utilities' financial conditions There is little question that the utility industry has rebounded financially from the circumstances it found itself in during 1974 and early 1975. FPC staff studies and memoran- dums indicate that, with some exceptions, the overall finan- cial conditions of the utilities have improved and that much of the rationale for allowing CWIP in the rate base no longer applies. This assessment confirmed our analysis of the current situation in which we used essentially the same utilities as were used in FPC's 1974 study. We used eight of the nine financial indiacators (previously defined) included in FPC's 1974 study and added data for 1974 and 1975 as shown below. Year 1971 1972 1973 1974 1975 Pretax interest coverage 3.57 3.59 3.36 2.96 3.07 Common equity ratio 35.82% 35.70 35.74 35.20 34.88 Allowance for funds used during construction 20.54% 23.42 30.03 34.50 29.22 Return on average total capital 7.81% 8.12 8.02 7.90 8.51 Earnings per share $2.18 2.36 2.28 2.17 2.37 Return on common equity 11.77% 12.30 11.56 10.73 11.58 Price- earnings ratio 12.22 10.68 9.78 7.88 7.00 Market-to- book ratio 1.47 1.36 1.15 0.85 0.84 13 APPENDIX I APPENDIX I Using 1971 statistics as the base year, the a na1 y s is shows a gradual decline in the utilities financial condi- tions through 1974, with a general recovery starting in 1975. The two major exceptions to the improvement were the price- earning ratio and the market-to-book ratio, both indicative of the market's uncertainty as to the utility industry's future financial stability. This questionable investment potential is also shown in the continued decline in the percentage of common equity used to finance the industry. The remaining five indicators showed measured improvement from 1974 to 1975, with earnings per share exceeding the 1971 level. Various analyses completed by respected financial serv- ices indicate that the improving trends should continue in 1976. Two such analyses by the Argus Research Corporation and the Value Line Investment Survey demonstrate this opti- mism. The Argus analysis predicts many com panies will u nd ergo upward price-earnings ratio evaluations and the quality of utility earnings will improve. The Value Line Survey predicts that the "electric-utility industry has recovered from its worst slump in decades" and also indicates that the qua l i ty of utility earnings will improve. Therefore, it appears the utilities' financing problems are being allevi- ated, at least to some extent, by improved market conditions. FPC did little to assess the CWIP issue and the necessity f or the rulemaking unti1 nearly 16 months after the initial proposal was publicly announced. On March 18, 1976, a memorandum from the Office of Economics to the Office of the Commissioners suggested that FPC consider rate filings, on a case-by-case basis and only allow CWIP in the rate base when a company meets the following criteria: --The company needs the plant expansion or improvement to supply energy with reasonable reliability in con- junction with environmental and public policy objec- tives. --External capital markets are either too costly or totally unavailable to meet the capital needs of such expansion and improvement. This memorandum also highlights several reasons for in- cluding CWIP in the rate base. However, the information in the memorandum that provides support for including CWI P is based on 1974 data. 14 APPENDIX I APPENDIX I In July 1976 OAF prepared "A Study of the Capital Needs and Capital Attraction Ability of the Electric Utility In- dustry." This study indicated that a general concensus seems to be that the financial condition of the industry is much improved over the conditions that existed 2 years ago. Util- ity companies' customer growth, sales, revenues, and income available for common stockholders have generally increased, and business and financial risk has been reduced. The Office of Economics submitted another memorandum to the Commissioners on August 23, 1976. This memorandum recommended (1) FPC permit pollution control and conversion costs in the rate base if the costs could be defined to avoid adjudication and (2) FPC leave open the possibility of per- mitting additional CWIP in the rate base if certain condi- tions were met. However, using financial data available through March 1976, the staff pointed out that the 1974 rationale for including CWIP is no longer applicable and that prompt regulatory action by FPC and State commissions is more valuable than FPC allowing CWIP in the rate base. Conclusions We believe that, in view of the improving financial condi- tion of the electric utility industry, a more definitive anal- ysis of the immediate need for the rulemaking should have been made before the final decision. This analysis should have included as a minimum (1) an assessment of the current finan- cial condition of the utility industry, particularly for op- tions available for financing environmental facility costs and utilities in a precarious fianncial position and (2) a critical evaluation of the policy options proposed in 1974, their implementation status, and their potential for providing the financial assistance required by the utility industry or by individual utility companies in today's environment. POTENTIAL IMPACT OF THE PROPOSED RULEMAKING FPC intended that the immediate impact of the proposed rulemaking would be to improve the cash flow of the utility companies. A secondary purpose of the rulemaking was to mini- mize the impact of the AFUDC account and improve the utili- ties' "quality of earnings" by reducing the percentage of noncash income credited to the earnings account. The rulemaking Order No. 555, issued on November 8, 1976, appears to achieve neither of these objectives. The - term dollar impact of the rulemaking on utility earnings is expected to be relatively small. The extent of any future 15 APPENDIX I APPENDIX I effects will depend on FPC's acceptance of a utility company's claim of financial hardship and approval of its petition to include CWIP costs in the rate base to alleviate the hard- ships. A more important impact of the rulemaking order may be on FPC's ability to adequately regulate the industry. The FPC staff is already burdened with a backlog of rate filing cases that continues to grow. Increased numbers of rate filing cases are not anticipated. However, the present limi- tations in the order as to the environmental costs that will be considered and the uncertain definitions of these costs could require more detailed analysis of the cases by the staff and might result in extended hearings for each case. In addition, the in extremis provision of the order makes it mandatory that the staff accept for filing each rate in- crease case and analyze every case submitted with CWIP in the rate base. Current method of accounting for construction costs FPC has consistently refused to allow a utility to include CWIP costs in its rate base until such facilities become "used and useful." Until such time as the facility is completed and put into service, construction costs are accumu- lated in a CWIP account. As construction is completed, the associated costs are transferred from CWIP to the utility's plant-in-service ac- count. When FPC approves, the costs are considered as part of the rate base for ratemaking purposes and the utility is allowed to begin depreciating the asset and earning a rate of return. For many years, prescribed systems of accounts for regu- lated companies have considered the actual and imputed inter- est costs for externally and internally generated construc- tion funds to be legitimate construction costs. Under FPC's Uniform System of Accounts, utilities use an AFUDC account to record actual interest cost for externally generated construc- tion funds and an imputed interest cost for the use of funds internally generated. These interrest costs accumulate during the construction period, and when the plant under cosntruction is placed in service, the related AFUDC expense becomes part of the rate base along with direct construction costs. The interest costs are recovered in utility rates through the depreciation expense allowance the same as for physical 16 7 APPENDIX I APPENDIX.I lso include a return,on the ..assets. The allowed rates a unrecovered.AFUDC amounts -in. the same manner as any other ed plant costs. unrecover 'Although both the AFUD and CWIP accountsrepresent cap italized costs that are recovered over the life of the asset., there is one major differencp.: TheAFUDC amounts capit6lited'each year in the accounting.records are accounted, for as income inthe annual.financial,stat.ements even though, there'is no matching cash flow.to the utility until the con- struction work is completed. As the amount of interest cap- italized each year has grown.larger, 1inancial analysts have tended to.,view.,this increasing proportion of..utility noncash, income as "poor quality" earnin s. This market assessment of 9 earnings-h6areportedly made it diffict@lt for util;ty compan- ies.with.large construction,programs to@b.orrow funds at favot- able interest rates and has been a, matter@of FPC concerm,-@ Financial imoact of the rulemaking7order The financial impact of the rulemaking can be determined with some degree of certainty only for the FPC regulated wholesale electric power market. Even if.the provisions of the.-order were to be incorporated into all.State'regulatory guidelines, the total effect would be greatly reduced'because. nearly one-half,of,the.State commissions currently allow their Jurisdiction al utilities to include some or,all CWIP cost in their rate bases. FPC has estimated that, if.the $1.558 billion'in ton-. structioncosts for pollution control equipment reported 'In. 1975 by.jurisdictional utilities had been.'allowed in rate, bases, and wholesale rate schedules had::been adjusted, rates-. would.have increased by less than 1 percent. On the basis of our own analysis, which included a factor for CWIP allowed by:. State commissions, we estimated the increase could have been ..as little as $11.8 million dollars, or 0.2.percent of total wholesale revenues reported. FPC is projecting, however, that.the wholesale rates could.initially increase'to between 1 and 2 pet.6ent@and become a.larger percent of total CWIP over,-the next 5 years. This change, includes the need for more utilities to retrofit air pollution control equipment in existing coal:plants, in plants converting to coal, and the expected large proportion of coal plants in hew construction with their need for con.-. 17 APPENDIX I APPENDIX I The impact of the in extremis provision appears to be important but is more difficult to estimate. A sudden down- turn in the financial viability of the utility industry could result in a number of rate filings with CWIP in the rate base by utilities with large construction program and financial difficulties. FPC approval of these rate filings could cause large increases in wholesale rates for some customers of utilities that are largely FPC jurisdictional, but the extent of these increases cannot be determined. The in extremis provision allows FPC to provide prompt assistance to utilities in financial trouble. However, it also appears to reduce the incentive for a utility company to operate in an efficient and prudent manner. The rulemaking order does not appear to have much im- pact on improving the utilities' "quality of earnings" by reducing the amount of AFUDC-generated noncash income. However, there is some question that even this FPC concern may not be justified. The OAF study of July 1976 reported that electric power companies floated $1,365 billion in bonds (16 percent of all corporate bond offerings) during the first quarter of 1976. The study stated there were no known instances where an electric utility was unable to raise debt capital during that period. The study concluded that debt capital at prevailing interest rates could probably be raised by the utility industry at competitive costs; i.e., the costs incurred by other sectors of industry. The rulemaking order as approved will not affect much of the current CWIP and AFUDC accounts. As of December 31, 1975, the amount of CWIP affected by the order represented only about 6 percent of total CWIP and the capitalized in- terrest costs would be only a fraction of that amount. How- ever, if a utility in financial distres filed to have its CWIP included in rate base and FPC approved the filing, the AFUDC account for that utility could be reduced and more cash income would be generated. Additional administrative burden should be considered In addition to the impact already discussed, we believe that the Commissioners have not given sufficient recognition to the additional administrative load the rulemaking will place on its already overburdened regulatory staff. The FPC staff is currently facing a large backlog of rate increase cases which continues to mount. FPC recognizes the regula- tory lag problem and is taking steps to alleviate the 18 APPENDIX I APPENDIX I situation. Despite its efforts, FPC expects the existing backlog which existed on June 30, 1975 to increase by 50 percent by the end of fiscal year 1977 without considering the additional impact that would be caused be caused by allowing CWIP inthe rate base. We discussed this problem and FPC's re- sponse in our report on "Management Improvements Needed in the Federal Power Commission's Processing of Electric Rate- Increase Cases," (EMD-76-9, Sept. 7,1976). Although the Commission is not necessarily expecting an increase in the number of rate increase filings by utili- ties, the complexity of the filings will undoubtedly increase the analytic requirements by the FPC staff. It does not ap- pear that the definition of the environmental costs to be included in the rulemaking is sufficiently clear to avoid an additional burden in terms of workload, suspension period, and refund provisions. The addition of the in extremis pro- vision requires that each rate increase filing submitted with CWIP as a rate base element must be analyzed by the staff and included as an item to be considered in the regulatory process to determine the justification for adding CWIP,to the rate base. This could also add to the complexity of the hearing process and to the staff workload. Conclusions The rulemaking order does not appear to adequately serve either of the purposes FPC initially envisioned in November 1974. The immediate financial impact appears to be minimal. and little change will result in the utilities' AFUDC-ac- counts. Mor e importantly, however, the rulemaking sets a prece- dent for FPC to depart from its historic " us ed and useful" policy and provides an opening for utilities to submit future rate increase filings with CWIP in the rate bases. The greatest impact of the rulemaking will probably be to increase the administrative workload of the FPC staff, thereby intensifying the regulatory lag problem. This situa- tion is likely to result because of the more detailed analysis of rate filings required by the FPC staff in assessing (1) the propriety of environmental costs incurred and (2)the f inan- cial need of the utility submitting the rate filing. 19 community level. Among these were inadequate ERR analvsis and documei-.tation, failure to consider alternatives and moz!ifications, and difficulties in the historic preservation review,?@-ocess. Actions needed to improve the quality of necessary,environmental reviews HUD's participation in the environmental review process has generally been iimited to (1) providing training and other guidance to communities, (2) monitoring community performance, and (3) approving the release of grant funds based on community certificatioLi of compliance with HUD and NFPA requirements. However, to improve the quality of their ERRs, communi- t4es need incrPased train:ng and better gu-,Jance and HUD n;eds to,do more effective' monitoring. HUD sould assume ar. expanded role in re@:ponding t o these needs. Training and guidance needed The need for increased training and better guidance is supporr--d not only by the questionable quality of communir-y environmental reviews but also by the number of communities citing problems. For example: --Of the 26 communities we visited, 22 had problems with their envirormental reviews, incl.-iding 10 communities which had difficulty determinirg the scope of the review or designing an acceptable ERR format. --A study performed.by the HUD Central Offi-ce in SeptembEr 1976 showed that communities were having problems (1):identifying environmental conditions. and impacts and determining their significance, (2) identifying and obtaining required data, and (3) decidIng vnether to consider project modificat ions.. and alternatives.. A number of communities also believed a problerp had been caused by HUD's,con-, tradictory or inadeadate advice. The study indicated that communityproblem .s have diminished 'since fiscal year 1975. --A study conducted by t'i-.e Prnnsylvania Department of Community Affairs early in 1976 showed that,29 of. the 74 communities responding to a questionnaire had problems with the environmental review pro- cess. Many of the problems directly related to the quality of guidance received. An EPA representative, after reviewing ERRs referred by us, expressed his opinion that communities are badly in need of environmental training. EPA representatives from Region II in New York expressed similar opinions after reviewing environ- mental evaluations prepar ed by communities in that region. Also, as discussed on page 15, HEW was critical of the guidance given to the communities. The HUD Inspector General audit discussed on page 16 cited several reasons for the deficiencies observed in com- munity environmental reviews. These include (1) lack of employee training and experience in environmental matters, (2) inadequate guidance and assistance, (3) omissions and lack of clarity in the environmental regulations, and (4) the possibility that some communities may not have fully under- stood or accepted their environmental responsibilities. The Inspector General report concluded that communities "urgently need substantive training and assistance" to perform their environmental responsibilities. Communities also believe they ne ed training in the environmental review process. For instance, over 85 percent of the communities responding to the Pennsylvania Department of Community Affairs questionnaire indicated that such a need exists. HUD's philosophy on training community environmentalists has been to decentralize responsibility to its field offices. No training programs have been developed and implemented by HUD's Central Office for community environmentalists. HUD regional offices have generally allowed area offices under their jurisdiction to provide technical assistance through monitoring visits or other contacts with community representatives or by formal training sessions. Eight of the nine HUD area offices we visited, for example, have sponsored community development seminars which included environmental concerns as part of the agenda. In addition, all of these area offices made monitoring visits and had other contacts with communities in their jurisdiction. Although we were unable to obtain specifics regarding the quality of HUD training or the scope of community coverage, only 11 of 26 community representatives we interviewed could 18 recall having attended HUD-Sponsored seminars. However, 24 of the 26 did acknowledge telephone or personal contacts with HUD representatives. HUD re cognizes that communities are in need of environ- mental training and guidance and, since the inception of the block grant program, various steps have been taken to meet these needs in addition to thv..e described above, as follows:, --In-house training ha-% been provided.to HUD field office personnel. --HUD staffs have participated in environmental seminars given by State and local agencies. --Some HUD regional offices have provided unique technical assistance to communities, such as the Kansas City's issuance of a directory to provide grantees with a list of sources for technical.assis- tance, and the New York Region's,use of closed.circult television seminars. --HUD awarded a contract on September 30, 1976, for the development of a program for training community cnvironmentalists. To further aid communities in the execution of their environmental resporsibi-lities, HUD distributed two technicalL publications.for use in performing environmental reviews. Both "Environmental Reviews at the Community Level--A Program Guide" which was published in October 1975, and "Interim Gui,le for Environmental Assessments" which wa's sent to communities in May 1976, were intended as guidance. Use of the publications is not mandatory. The use of either publication could help assure consideration of all environ- mental factors prescribed in the HUD regulations.and provide communities with an-aceeptable ERR format. The HUD Inspector General audit cited the lack of a HUD prescribed ERR fornat as one reason for the reported defic4_c@icies.. In this connection, of the nine communities whose first-year ERRS we evaluated, only five were planning to utilize all or some variation of the format in the. above-mentioned publications in preparing ERRS for their second program year. 19 Improved monitoring needed To assure that communities are effectively complyi ng with HUD's environmental regulations, HUD needs to improve its monitoring program by performing more indepth evaluations of ERRs. HUD regional offices were delegated responsibility for developing and implementing systems for monitoring grantee performance. Regional monitoring systems were designed to meet general requirements established by HUD Central Office and were to include various types of monitoring activities conducted bv the HUD area offices, including (1) scheduled site visits by program representatives for coverage of the entire community development program at varying levels of intensity and(2) Special site visits to provide intensive coverage of special problem areas such as the environment. Special site visits for environmental monitoring are usually made by environmental clearance officers assigned to the area office. For environmental monitoring, HUD Central Office ha s specified that "monitoring should be directed toward as- certaining procedural compliance." For example, HUD field personnel are to determine whether the community has pre- pared an ERR for each project and whether the community has qenerally complied with HUD environmental regulations for such required elements as (1) describing projects, (2) determining existing environmental conditions, (3) identifying environmental impacts, and (4) considering modifications and alternatives. However, HUD field offices are not required to question the adequacy of community decisions concerning the significance of environmental impacts or determi ne whether all environmental impacts have been identified and assessed. In developing monitoring guidelines, HUD field offices generally followed Central Office direction to monitor only the procedural aspects of community environmental reviews. Although some HUD field personnel do more detailed moni- toring during individual visits, we were informed that in-depth evaluations of the adequacy of community environ- mental decisions and the substantive quality of environmental assessments is not normally being accomplished during HUD monitoring visits. Regional offices are required to submit quarterly reports of their monitoring activities to the Central Office. For the 9-month period January 1, 1976, to September 30, 20 1976, these rer)orts showe( that 357 special site visits for environmental monitoring had been made by the 10 HUD regional offices'. The Central Office analysis of the environmental findings showed that various problem areas had been identified by. the HUD field offices. The majority of these problems were of a procedural nature (i.e., improper drawdowns of grant funds; improper advertising to the public; and inadequate ERR documentation). However, several HUD regions did identify substantive problem areas (e.g., identification and assess- ment of environmental impacts; and historic analysis). CONCLUSIONS We believe that environmental reviews are not needed in many cases because of the environmental insignificance of some types of community projects. For such projectc, realistic determinations can be made before anv detailed. review that expected impacts will not be significant. Elimination of environmental reviews for certain types of projects would streamline the review process and allow 'communities to (I' have more immediate use of grant funds, .(2) have more grant funds available for projects, and*(3) perform more effective reviews for significant projects. Also, some co.mmuni.ties are not effectively carrying out their responsibilities because, in performingenviron- mental reviews, they are not --totally describing the work to be performed-or defining the environmental conditions existing in project areas, --identifying and evaluating all environmental impacts of proposed projects, --considering modifications to or alternatives for proposed projects, or @--performing the required historic analysis of properties in project areas. We believe these problems have resulted from in- adequate training of and guidance to communitv environmental- ists. lie also believe that these problems will continue if indeTDth.evaluations ofcommunity environmental reviews are not made by HUD. 21 RECOMMENDATIONS To make the environmental review process easier and to make sure that communiti es carry out their responsibilities, the Secretary Uf Housing and Urban Development should-.' .--Work with the Council on Environmental Quality to identify, and exempt f.rom review, those in- significant types of projects which do not need environmental reviews. --Clarifv an(. expand the Department's environmental review procedures, particularly the scope of environ- mental reviews requi.red by communities.. --Establish a mandatory environmental review format for communities to use, --EmDhasize training of community environmentalists. Revise the Deoartment's monitorinq procedures, so communities' e nvironmental reviews are evaluated indepth. AGENCY COMMENTS AND OUR EVALUATION We provided CEQ, FPA, HUD, and HEW with the opportunity to comment on the matters discussed in the report. Their, comments follow. (See apps. II through V for the agencies' responses.) CEQ The Council said that'.the report's recommendations would greatly improve the environmental review process for the block grant proaram and were basically similar to its own evalua- tiort and recomme.n dations. EPA EPA essentially agreed with the conclu-,ions reached in the repor.t. EPA said the report findings coincided with its own experience with the program. In addticn, EPA said thalt the recommendations seem eminently reasonable. HEW HEW agreed that BUD need not attempt to r.eview the environmental impact of. all Federal actions, and that HUD 22 should identify thosL programs and activities which do not. have the potential for 1-roducing an environmental impact- and exclude them from unnecessary and time consuming paperwork.. However, HEW said care must be taken because histo.ric.,.prop- erties are not always thought of in terms of environmental .,Protection and there should be some provision for revi,:-w of ctctions with potential for producing impacts on historic properties. HEW's concern regarding historic properties is well taken. In developing o ur criteria to classify projects which we believed to be environmentally insignificant,- we recognized that for some projects a determi.iation of.the projects' effect on historic properties may be necessary. (See p. 8.) HEW also said that there was a need for technical assis'-ance to those intimately involved in prognamaffairs --n order to improve the quality of environmental documents. HUD HUD agreed with our recon.mendations a-d plans to im- olement them as discussed below. HUD said that our f indings were substantially in agree.-nent with its December 1976 Insoec"--or General audit report and other information which has come to its attention. HUD said it was soliciting criticism of the existing regulations (24.CFR Part 58),and. suggestions for their improvement before making a major revision of the environmental procedures in the fall.of 1977 which will include identifying the types of activities unlikely to involve significant adverse environmental impacts and exempting them from the current procedural requirements. In addition, HUD said. that it will --expand and clarify t*,-,e revised regulations to better definathe scope of reviews which are required of communities, --require a standard ERR format, a nd 7 revise its monitoring pro cedures to reflect its concern about substantive compliance with,the. objectives of the 1974 act.. Finally., HUD said that the need for training.,gran tees in the environmental review process is unquestioned.and the development of-a training p Iw-ogram should be completed by late summer 1977. The first courses under this program are scheduled for September 1977. 23 We believe the above actions, if properly implemented, should resolve the problems discussed by our review. 24 CHAPTER 3 SCOPE OF REVIEW We made our review -at HUD Central Office in Washington, D.C.; 4 HUD regional offices; 9 HUD area offices; and,26 communities in 8 States. (See app. I for listing of HUD and community locations.) We reviewed environmental and grant files and other documents and reports. We also interviewed officials and other representatives of HUD, communities receiving block grants, EPAi HEW, CEQ, and consulting firms hired.by communities to make en vironmental reviews. For 9 of the 26 communities visited, we ev.aluated.the adequacy of their environmental reviews-supplementing our evaluations with technical input from EPA and HEW regional offices in Philadelphia, Pennsylvania. .. For all 26 commun.ities visited, we examined a selected number of environmental reviews to determine the types of projects being assessed and evaluated the need for such dssessments. 25 APPENDIX I APPENDIX HUD REGIONAL AND AREA OFFICES AND COMMUNITY LOCATIONS VISITED DURING OUR REIVEW Communities HUI Area Fiscal year Region, Location office Location .1975. grants (thousands) 2 New York, Camden,. Camden, N.J. N.Y. N.J. Vineland, N.J. 1,519.0. Burlington County, New Jersey 509.0 Trenton, N.J. Newark, N.J. New Brunswick, N.J.@. 1,399.0 Lambertville, N.J. 3 Philadelphia, Philadelphia, Philadelphia, Pa. Pa. Pa. .60,829.0 Harrisburg, Pa. 4 8 2 i 0 Lancaster,,:Pa. 4,20B.0 Scranton, Pa. 7,747.0 Reading, Pa. 4,186.0 Carlisle. Pa. 210.0 Wilmington, Del. 4,490.0 Pittsburgh, Allegheny County'. Pa. Pa. 6r456.0 Monessen, Pa. 2,069.0 Baltimore, Baltimore, Md. 3 2 , 7 4 9 . 0 Md. 7 Kansas City, Kansas City, Kansas City, MO. 17,859.0 Mo. Kans. Kansas City, Kans.. 6,206.0 ArkanEas City, Kans. 274.0, Omaha, Neb. Omaha, Neb. Lincoln, Neb. .486.0 9 San Francisco, San Francisco, Berkeley, Calif.. 2,812.0 Calif. Calif. Fresno, Calif. 10,038.0 Los Angeles, Los Angel-s County,. Calif. Calif. 10,099.4 Anaheim, Calif.. 511.0 Baldwin Park, Calif. 118.4 26 APPENDIX II APPE.NDIX II DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT WASHINGTON, D.C, 20410 June 30, 1§77 OFFICE OF T@E ASSISTANT SECRETARY FOP COMMUNITY PLANNING AND CEVELOPME%T 11 RE- -E@ER C S @1 Mr. Henry Eschwege Director, Community and Economic Development Division, General Accounting Office Washington, D. C. 20548 Dear Mr. Eschwege: This is in response to your May 12, 1977 draft report: Community RtyflomF@nt j_ Block Grant Environmental Reviews.At The Community Level: Lrt They Needed? Are They Adequate? The findings of your report are substantially in agreement with the findings in the audit report issuef December 29, 1976 by HLI)'s Office of made a Inspector General and with other information which has come to my atten- tion. They support your recommendations, whichl find most helpful.and which I intend to implement, as follows: On May 16, 1977, we published in the Federal Register a.Notice of Proposed Rulemaking (42 FR 24755), soliciting comments from agencies and the general public concerning the Community Development Block Grant (CDBG).Environmental Procedures which are contained in 24 CFR Part 58. The Notice, a copy of which is enclosed, also solicits criticisms of the existing regulations and suggestions for their improvement. We plan a major revision of these pt-ocedures in the early Fall, utilizing comments received in response to the Notice, from your audit and the one conducted by our own Inspector General and any changed national policy guidelines emanating from the proceedings currently underway at the Council on Environmental Quality. More specifically, we do intend to identify types of activities which are unlikely to involve significant adverse environmental impacts and exempt them from the procedural requirements of 24.CFR Part 58. Wng before join- ing HUD, I recognized the need for this And action to bring it about was one of my first priorities upon assuming office. When these regulations are revised, they will be expanded and clarified, not with a view toward,increasing their complexity, but, as your report suggests, to better define the scope of reviews which are required to be carried out by communities. 27 APPENDIX II APPENDIXII The environmental review record format contained in the guidebook Environmental ils@views At The Community Level will, as you recommend, become a required format. This should aid the communities in the formulation of their administrative records and will aid HUD in its.monitoring efforts. It will.also bring an element.of uniformity to the procedures, the lack,of which has, in the past, made it difficult for HUD staff to assess perfor- mance. I am aware that the Department's monitoring policy has, in the past, focused primarily upon the review.of procedural compliance. However, that limited policy is not the policy of this administration, ag the Secretary has informed the Subcommittee on Housing and Urban Affa@rs of the Senate. Our concern abo-it gubstantive compl iance with the objectives of the Housing and Community Development Act of 1974 was communicated to both HUD personnel and to the CDBG grantees on April 15, 1977. Also, on April 6, 1977., 1 advised our Field Offices that the CDBG Monitoring Handbook (6500.1), mentioned in your report, will be revised to reflect this new policy and we are T,ow in the process of seeking Field Office recommendations on such revision, We intend to preserve local initiative and flexibility in the CDBG Program, but I can.assure you, we shall better inform ourselves in the futur@! as to the substantive performance of its grantees. The need for training CDBG grantees in the environmental review process 1, unquestioned; the feasible method of providing it is difficult to identify. A-s you point out, there are sever.-.1 th-iusand communities and they are not easily categorized in terms of need for this kind of training. We have, as you mentioned, contracted,,for the development of a training pro- gram. This should be completed by late Summer, but I cannot, at this time, indicate exactly how, or to what extent, we will be putting it into effect. I can report that we have scheduled, as a test, the first two one-week courses of training under this program. These will be held the weeks of September 12-16 and September 26-30, 1977. I can assure you that to the extent our resources permit, we shall make every effort to provide the klne@i of training and guidance which your report demonstrates is needed at the local level. we shall, tor instance,- through our changes in monitoring policieG, become more directly available to the localities than we have been in the past and more willing to express obj(-c- tive judgments about local performance. This, in itself, will serve as a means of delivering training and teohnical guidance considerably more exten- sive than has been delivered previously. Your report is most constructive and helpful and I dant you to know it is received with appreciation. 28 APPENDIX II APPENDIX II (See GAO note below.) While the matters contained in your report will be taken into account by us when we undertake to review 24 CFR Part 58, it occurs to me that you, or members of your staff might have additional comments, suggestions or criti- cisms not mentioned in the report. If this is the case, your additional response to the attached Notice would be most helpful. Sincerely, Robert C. Embry, Jr. Assistant Secretary GAO note: The deleted comments relate to matters which were discussed in the draft report but omitted in this final report. 29 APPENDIX III APPENDIX III DEPARTMENT OF HEALTH, EDUCATION AND WELFARE OFFICE OF THE SECRETARY WASHINGTON, DC 20201 JUN 10 1977 Mr. Gregory J. Ahart Director, Human Resources Division U.S. General Accounting Office Washington, D.C. 20548 Dear Mr. Ahart: The Secretary asked that I respond to your May 13 request for the Department's comments on your draft report, "Community Development Block Grant Environmental Reviews at the Community Level: Are They Needed? Are They Adequate?" Our comments, prepared by the Office of Environmental Affairs, are enclosed. We appreciate the opportunity to comment on this report in draft form. Sincerely yours, Thomas D. Morris Inspector General Enclosure 30 APPENDIX III APPENDIX TII Comments of the Department of Health, Education, and Welf:ire (Office. of Environm.,ental Affairs) on. the.General Accounting Office Draft Audit Report,."Coiriunity Development Block Grant Environmental Reviews at the Community Level: Are They Needed? Are They Adequate?" The Office.of Environmental Affairs has reviewed the subject report and has the following comments: A key messdge contained in the GAO report is that HUD (and other agencies) need not attc,,Ppt to review the environmental impact of all Federal actions, an-' toat HUD (Vand the other Federal agencies) should identify those programs and activities which do rit have the potential for producing &n environmental impact-and exclude those actions from unnecessary and time-consuming paperwork. The Office, of Environmental Affairs concurs with. this auproach, and in fact, impl&;-,@ients the approach in its Generic Review process. However, care MLISt be taken in usirg this approach on historic properties an@-; other protected assets which are not always thought of in terms of -ies identified by GAO en-iron:nental protection. Some of those activi 4. would, based upon the exp,!,.,ience of this office, appear to have the potent".al for producing -mpacts on historic properties. GAO's approach therefore should contair@ some provision for review of the actions with this in mind. The GAO report also speaks tc the need for technical assistance'to those intimately involved in program affairs in order to improve the quality of environmental documents. The Ofl;'ice of Environmental Affairs concurs, in this approach. While the opportunities are limited for this office to engage in technical assistance, the need exists and with required resources, we would be moreheavily engaged in this activity. .31 APPENDIX IV APPENDIX.IV EXECUTIVE OFFICE OF THE PRESIDENT COUNCIL ON ENVIRONMENTAL QUALITY 722 JACKSON PLACE, N W WASHINGTON. D. C 20006 JUN 7 1977 Dear 11r. Fschwege:, Thank you for your flay 12 letter reques ting the Council's Comments on y@@ur draft report examining environmental responsibilities in the community development block grant program of the Department of Housing and.Urban Development. The Council believes that.the report's recorrnendat ions would greatly improve the environmental review process for the block grant program, and we encourage you to issue the report as soon as possible. We have recently completed our own evaluation, and our recommendations are baiically similar. A copy of our rpport is enclosed. Thank you for providing us the opportunity to comment on your report. Sincerely, A!@@th Ilember ir. Henry Eschwege Director Community and Economic Development Division General Accounting Office Washington, D.C. 2.0548 Enclosure cc: Honorable Patricia R. Harris, Secretary of Housing and Urban Development Washington, D.C. 20410 32 APPENDIX V APPENDIX V UNITED STATES ENVIRONMENTAL PROTECTION AIGENCY 7 WASHINGTON. D.C. 20460 JUL 15 1977 OFFICE OF. PLANNING AND MAN&GEIAFNT Mr. Henry Eschwege Director, Community and Economic Development Division U.S. General Accounting office Washington, D.C. 20548 Dear Mr. Eschwege: We have reviewed your draft report on "Communit y Development Block Grant Environmental Reviews at the Community Level: Are They Needed? Are They Adequate?'% and,essentially agree with the conclusions reached. The findings it contains coincide with our experience with this program, and the recommendations,which the General Accounting Office has based.on these findings seem eminently reasonable to this Agency. Sincerely yours, @ V -Ctlng AsVavnt tor for Planning and Management 33 APPENDIX-VI APPENDIX VI PRINCIPAL OFFICIALS OF THE DEPARTi-'.SNT OF HOUSING AND URBAN DEVELOPMENT RESPONSIBLE FOR ACTIVITIES DISCUSSED IN THIS REPORT Tenure of office From To SECRETARY OF HOUSING AND URBAN DEVELOPMENT: Patricia Rober.'-s Harris Jan. 1977 Present.. Carla A. Hills Mar. 1975 Jan. 1977, James T. Lynn. Feb. 1973 Feb. 1975 ASSISTANT SECRETARY FOR COMMUNITY PLANNING AND DEVELOPMENT: 1977 Present Robert C. Embry, Jr. Mar John Tuite (acting Deputy) Jan. 1977 Mar.. 1977 Warren H. Butler (acting) Nov. 1976, Jan. 1.977 7 J David 0. Meeker, J r Mar. 1973 Sept. 1976 38455 34