Tennessee Valley Authority: Assessment of the 10-Year Business Plan
(Letter Report, 04/30/99, GAO/AIMD-99-142).

Pursuant to a congressional request, GAO provided information on the
Tennessee Valley Authority's (TVA) 10-year business plan, focusing on
whether the 10-year plan: (1) addresses key issues facing TVA; (2) takes
into consideration all applicable costs and revenue sources; (3)
contains goals and assumptions that are achievable or reasonable and in
line with industry estimates and expectations; and (4) has been updated
to reflect significant changes in key goals and assumptions or actual
experience.

GAO noted that: (1) implementation of the 10-year plan is moving TVA in
the right direction toward its strategic objectives by addressing the
key issues it faces--its high fixed financing costs and large investment
in nonproducing and other deferred assets that have not been recovered
through utility rates; (2) the plan calls for lowering fixed costs by
reducing outstanding debt by about one-half--to about $14 billion--by
2007; (3) the plan also provides for the recovery through rates of all
but about $500 million of the $8.5 billion in deferred assets
outstanding as of the plan issuance date; (4) the year 2007 is key for
TVA because it expects to face greater competitive pressures by then and
because many long-term contracts with customers could expire at about
that time; (5) the plan emphasizes changes designed to enable TVA to
offer competitive rates by the end of 2007; (6) while focusing on the
right issues, TVA's plan does not fully address certain costs; (7) the
plan does not include: (a) the capital costs of increasing generating
capacity to meet the growth in demand for power as is now planned;
instead, it provides for meeting the growth in demand for power by
purchasing power from other utilities; (b) the costs of complying with
new and proposed environmental regulations; and (c) the costs of
nonpower programs that were formerly fully funded through
appropriations; (8) TVA estimates that these additional costs will total
about $1 billion over the remaining life of the plan and will likely be
higher; (9) GAO also found that while many of the plan's goals and
assumptions were achievable or reasonable, certain of them were not,
largely due to the additional expected costs described above; (10) some
of these additional costs could be offset by increases in expected
market rates of power in 2007; (11) because of the additional costs not
addressed in the 10-year plan, it is unlikely that TVA can reduce its
debt to the extent planned by 2007; (12) estimates in TVA's fiscal year
2000 federal budget request indicate that its debt reduction goal will
likely not be achieved until 2009; (13) however, since it is not
possible to accurately predict what the market price of power will be in
2007, TVA could still achieve its objective of offering competitively
priced power, even if it does not fully achieve the plan's other goals
and objectives; and (14) while TVA has acknowledged major changes to
several of the plan's goals and assumptions and has factored these into
its internal planning, the 10-year plan has not been formally updated to
reflect these changes.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-99-142
     TITLE:  Tennessee Valley Authority: Assessment of the 10-Year
	     Business Plan
      DATE:  04/30/99
   SUBJECT:  Strategic planning
	     Financial management
	     Cost analysis
	     Financial analysis
	     Utility rates
	     Energy costs
	     Cost control
	     Electric power generation
	     Competition
	     Federal corporations
IDENTIFIER:  TVA 10-Year Business Plan

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AI99142.book GAO United States General Accounting Office

Report to Congressional Requesters

April 1999 TENNESSEE VALLEY AUTHORITY

Assessment of the 10- Year Business Plan

GAO/AIMD-99-142

  GAO/AIMD-99-142

United States General Accounting Office Washington, D. C. 20548
Lett er

Page 1 GAO/AIMD-99-142 Tennessee Valley Authority

GAO

Accounting and Information Management Division

B-281916 Letter April 30, 1999 The Honorable Bob Franks The
Honorable Marty Meehan The Honorable Zach Wamp The Honorable Bob
Clement House of Representatives

This report responds to your June 5, 1998, and September 24, 1998,
requests asking us to review the Tennessee Valley Authority's
(TVA) 10- year business plan. Increasing competition in
electricity markets led TVA management to develop this plan to
position TVA to be more competitive by, among other things,
reducing its high debt servicing and other fixed costs. Because of
concerns about TVA's ability to achieve the 10- year plan's
objectives by 2007 when competitive pressures are likely to be
greater and when many of TVA's long- term contracts could expire
you asked us to

determine whether TVA will be able to reduce debt as envisioned in
the plan and whether its goals and assumptions regarding capital
expenditures and revenues and expenses are achievable or
reasonable.

In order to obtain more information about TVA's competitive
position as you consider its role in a deregulating electricity
industry, you specifically asked us to determine whether the 10-
year plan (1) addresses key issues facing TVA, (2) takes into
consideration all applicable costs and revenue sources, (3)
contains goals and assumptions that are achievable or reasonable
and in line with industry estimates and expectations, and

(4) has been updated to reflect significant changes in key goals
and assumptions or actual experience. In addition, you asked us,
based on our analysis of the plan, to conclude whether TVA is
likely to achieve the plan's strategic objectives. Results in
Brief Implementation of the 10- year plan is moving TVA in the
right direction

toward its strategic objectives by addressing the key issues it
faces its high fixed financing costs and large investment in
nonproducing and other deferred assets 1 that have not been
recovered through rates. The plan, which was issued in July 1997,
calls for lowering fixed costs by reducing 1 Deferred assets
consist of nonproducing nuclear generating units and unamortized
regulatory assets. At the time the plan was issued, the balances
of these items were $6. 3 billion and $2.2 billion, respectively.
The costs of these assets have been deferred and have not been
recovered through rates.

B-281916 Page 2 GAO/AIMD-99-142 Tennessee Valley Authority

outstanding debt by about one- half to about $14 billion by 2007.
The plan also provides for the recovery through rates of all but
about $500 million of the $8.5 billion in deferred assets
outstanding as of the plan issuance date.

The year 2007 is key for TVA because it expects to face greater
competitive pressures by then and because many long- term
contracts with customers could expire at about that time. As a
result, the plan emphasizes changes designed to enable TVA to
offer competitive rates by the end of 2007. The

more progress TVA makes toward addressing the key issues it faces
while it maintains its legislative protections and before its
customer contracts could begin to expire, the better positioned it
will be to successfully operate in a competitive market. While
focusing on the right issues, TVA's plan does not fully address
certain costs. Not addressing these costs could jeopardize full
achievement of the plan's objectives. Specifically, the plan does
not include (1) the capital costs of increasing generating
capacity to meet the growth in demand for power as is now
currently planned; instead, it provides for meeting the growth in
demand for power by purchasing power from other utilities, (2) the
cost of complying with new and proposed environmental regulations,
and (3) the cost of nonpower programs that were formerly fully
funded through appropriations. TVA estimates that these additional
costs will total about $1 billion over the remaining life of the
plan and will likely be higher.

We also found that while many of the plan's goals and assumptions
were achievable or reasonable, certain of them were not, largely
due to the additional expected costs described above. For example,
the plan calls for capital expenditures to be limited to about
$600 million per year, which is not feasible given the additional
costs that will likely be incurred to comply with new
environmental regulations and to invest in new generating

capacity to meet growth in demand for power. However, some of
these additional costs could be offset by increases in expected
market rates of power in 2007. Specifically, since many power
producers will incur additional costs for the new and proposed
environmental regulations, it is anticipated that the market price
of power will increase across the board to help absorb these
costs. However, the extent to which different producers

will be affected, and the resultant impact on their power prices,
is unknown at this time.

B-281916 Page 3 GAO/AIMD-99-142 Tennessee Valley Authority

Because of the additional costs not addressed in the 10- year
plan, it is unlikely that TVA can reduce its debt to the extent
planned by 2007. Estimates in TVA's fiscal year 2000 federal
budget request indicate that its debt reduction goal will likely
not be achieved until 2009. The added costs will also negatively
impact TVA's ability to meet its goal of reducing the balance of
its deferred assets, since TVA may not have the ability to begin

recovering these costs through rates if it does not sufficiently
reduce its other costs first. Achieving these goals is key to TVA
meeting its strategic objective of increasing financial
flexibility by reducing fixed costs. This in turn is key to its
ability to offer competitively priced power in 2007 TVA's ultimate
objective. However, since it is not possible to accurately predict
what the market price of power will be in 2007, TVA could still
achieve its objective of offering competitively priced power, even
if it does not fully achieve the

plan's other goals and objectives. Conversely, depending on the
market price of power, TVA could fully achieve all of the goals
and objectives outlined in the plan and still not be positioned to
offer competitively priced power in 2007 and beyond. Nevertheless,
any progress it makes toward its goals and objectives will put TVA
in a better competitive position. While TVA has acknowledged major
changes to several of the plan's goals and assumptions and has
factored these into its internal planning, the 10- year plan has
not been formally updated to reflect these changes. Until the plan
is formally updated, the Congress and other external users of the

plan will not have the current information needed to make policy,
oversight, and investment decisions related to TVA. Because of
this, we have recommended that TVA (1) move quickly to formally
update the plan and (2) periodically report to the Congress and
other plan users about its progress toward meeting the plan's
objectives.

Background The Energy Policy Act of 1992 (EPAct) provides TVA with
certain protections from competition. Additionally, under the TVA
Act of 1933

(TVA Act), as amended, TVA is not subject to most of the
regulatory and oversight requirements that must be satisfied by
commercial electric utilities; instead, all authority to run and
operate TVA is vested in its threemember

board of directors. In 1959, the Congress amended the TVA Act by
establishing what is commonly referred to as the TVA fence, which
prohibits TVA with some exceptions from entering into contracts to
sell power outside the service area that TVA and its distributors
were serving on July 1, 1957. Under EPAct, TVA is exempt from
having to allow other

B-281916 Page 4 GAO/AIMD-99-142 Tennessee Valley Authority

utilities to use its transmission lines to transmit power to
customers within TVA's service area. This legislative framework
generally insulates TVA from direct wholesale competition and, as
a result, TVA remains in a position similar to a regulated utility
monopoly.

However, TVA is still subject to some forms of indirect
competition. For example, TVA has no protection against its
industrial customers relocating outside its service area or
businesses deciding not to move to its service area for reasons
related to the cost of power. In addition, customers can decide to
generate their own power. Accordingly, TVA is currently subject to
some competitive pressures.

EPAct's requirement that utilities make their transmission lines
accessible to other utilities to transmit (wheel) wholesale
electricity has enabled wholesale customers to obtain electricity
from a variety of competing

suppliers and has resulted in increased wholesale competition in
the electric utility industry across the United States. This
requirement does not apply to TVA if the power is going to be
consumed within its service territory. Most of TVA's sales are
wholesale because they are to its power distributors. In addition,
continuing deregulation efforts in some states have led to
competition at the retail level. Industry experts expect that
retail deregulation will continue to occur on a state- by- state
basis over the

next several years. As this occurs, industrial, commercial, and,
ultimately, residential consumers will be able to choose their
power supplier from among several competitors rather than from one
utility monopoly, as is now the case for long distance telephone
service and cellular phones.

Because EPAct exempts TVA from having power wheeled to consumers
in its territory, TVA has not been directly impacted by the
ongoing deregulation of the electric utility industry to the same
extent as other utilities. However, if TVA were to lose its
exemption from the wheeling

provisions of EPAct, its customers would have the option of
obtaining their power from other sources after the expiration of
their contracts. Under legislation proposed by the administration
to promote retail competition in the electric power industry,
which TVA supports, TVA's exemption from the wheeling provisions
of EPAct would be eliminated after January 1, 2003. If the
legislation is enacted, TVA may be required to use its
transmission lines

to transmit the power of other utilities for consumption within
TVA's service territory. In addition, the proposed legislation
would remove the statutory restrictions that prevent TVA from
selling power outside its service territory.

B-281916 Page 5 GAO/AIMD-99-142 Tennessee Valley Authority

Most of TVA's power is sold to municipal and cooperative power
distributors who would be directly affected in the future by
retail competition through their customers' ability to choose
alternate power suppliers. Further, deregulation and the
possibility of TVA losing its

legislative protections have made many of TVA's customers more
aware of price differences among utilities, raised expectations of
lower prices, and increased demands for more competitive pricing.
Because of these ongoing deregulation efforts, TVA management,
like many industry experts, anticipates that TVA may lose its
legislative protections in the future. Even if TVA does not lose
its legislative protections, TVA's management has recognized the
need to take action to better position TVA

to be competitive in an era of increasing competition and customer
choice and, in July 1997, issued a 10- year business plan with
that goal in mind. TVA established a 10- year horizon for
implementing the key changes outlined in the plan largely because
TVA officials expect to be facing greater competitive pressures
within that time frame and many of its longterm contracts with
customers could begin to expire in 2007. The published plan, which
formed the basis of our evaluation, contains three strategic
objectives:

 reducing TVA's cost of power in order to be in a position to
offer competitively priced power in 2007,  increasing financial
flexibility by reducing fixed costs, and  building customer
allegiance.

In developing the 10- year plan, TVA set several goals and made
certain assumptions about the future. 2 These goals and
assumptions are that  the future market price of wholesale power
will be 3. 4 to 3.5 cents per kilowatthour 3 (kWh) by 2007;
annual growth in demand through 2007 will average 2 percent;  fuel
costs will increase 1.7 percent annually through 2007;
improvements in supply chain management 4 will save $50 million

annually; 2 Dollars discussed in this report are nominal dollars.
3 A kilowatthour is 1,000 watthours. A watthour is equal to 1 watt
of power applied for 1 hour. 4 Supply chain management is a
comprehensive process that begins with examining the need for the
product, progresses through procurement, and ends with utilization
or disposition.

B-281916 Page 6 GAO/AIMD-99-142 Tennessee Valley Authority

 TVA's labor force will be reduced and additional cost savings
will be achieved through the creation of shared services 5 and
other initiatives;  debt will be reduced by about one- half to
about $14 billion, and the

balance of deferred assets will be reduced from $8. 5 billion to
$500 million TVA's estimated net realizable value of these assets;
6  capital expenditures will be limited to about $600 million
annually and increases in demand through 2007 will be met
primarily through

purchased power;  $200 million will be saved annually through cost
improvement initiatives

primarily related to refinancing Federal Financing Bank (FFB) and
public bond debt, pursuing changes to its retirement plan, and
improving business processes;  revenues from power sales will be
increased by about $325 million

annually by implementing a rate increase in 1998 and maintaining
it through 2007; and  customer relations will improve through new
contract and pricing options.

To implement the 10- year plan, TVA has developed action plans and
has linked the goals and objectives of the 10- year plan to its
corporate and business unit goals. For example, one of TVA's
corporate goals is to lower costs; one of the 10- year plan's
strategic objectives is to increase financial flexibility by
reducing fixed costs; and the Fossil and Hydro Power business
unit's business plan includes a unit goal of maximizing net return
by reducing fixed and variable costs. 7 However, TVA has not yet
completed

the process of developing performance measures to provide
accountability. TVA expects to develop these performance measures
later in 1999, business units will be expected to meet performance
goals in 2000, and unit managers and TVA executives are expected
to be held directly accountable through the use of compensation
incentives in 2001.

5 Shared services involve consolidating similar operations from
various business units and thereby reducing duplicative efforts. 6
While not specifically discussed in the published plan, TVA's
supporting materials establish a goal of recovering about $8
billion in nonproducing nuclear generating units and unamortized
regulatory assets (deferred assets) by 2007 in conjunction with
its reduction of debt.

7 Fixed costs (such as interest expense) remain fairly constant
and do not fluctuate with the volume of production. Variable costs
(such as fuel) fluctuate in the same manner as the volume of
production.

B-281916 Page 7 GAO/AIMD-99-142 Tennessee Valley Authority

Objectives, Scope, and Methodology

We evaluated the three strategic objectives of TVA's plan and the
underlying goals and assumptions for reasonableness,
achievability, and completeness. As agreed with your offices, we
did not (1) assess whether achieving the objectives of the plan
would ensure TVA's future competitiveness or (2) develop
independent estimates of key elements of the plan, such as the
future market price of power. We relied on comparisons of past
performance to future projections, the opinions of

industry experts, and economic forecasts made by knowledgeable
sources to determine whether the individual components of the plan
and the plan as a whole were achievable or reasonable. Additional
information on our objectives, scope, and methodology is contained
in appendix I.

We conducted our review from June 1998 through April 1999 in
accordance with generally accepted government auditing standards.
We provided a draft of this report to TVA for comment. While
generally agreeing with the report's contents, TVA did provide
oral and written comments, which we have incorporated, as
appropriate. TVA's written comments are reproduced in appendix II.

Plan Objectives Address Key Issues Confronting TVA

Implementation of the 10- year plan is moving TVA in the right
direction and addresses important issues facing TVA: its high
fixed financing costs and limited financial flexibility to respond
to competitive pressure and the large amount of deferred assets
that have not been recovered through rates. These deferred assets,
which totaled about $8.5 billion as of the beginning

of the plan period, are primarily the result of investments made
since the 1970s in nuclear generating plants that were never put
into production. This helped contribute to TVA's large debt, which
totaled about $27 billion as of September 30, 1998, and resultant
high fixed financing costs.

TVA's ability to meet its strategic objective of being in a
position to offer competitively priced power by 2007 and to
improve its financial flexibility hinges largely on its being able
to meet its goal of reducing debt by about one- half to about $14
billion by 2007. While not specifically stated in the plan, TVA
also plans to recover through rates all but $500 million of its

deferred asset costs by the end of the period covered by the plan.
8 8 The remaining $500 million is TVA's estimate of the net
realizable value of its deferred assets at the end of 2007.

B-281916 Page 8 GAO/AIMD-99-142 Tennessee Valley Authority

These issues were highlighted in reports 9 we issued in 1995 and
1997, in which we stated that TVA's annual financing costs and
deferred assets were substantially greater than those of the
utilities with which TVA would most likely have to compete. We
also reported that these high fixed costs and deferred assets
would limit TVA's flexibility to adjust its rates in a

competitive environment. TVA, through its 10- year plan, is taking
steps to address these issues. Other utilities are taking similar
actions to prepare for competition. For example, utilities we
previously identified as those most likely to compete with TVA are
also taking steps to refinance debt at lower interest rates and
accelerate recovery of the costs of their regulatory assets.
However, as we reported in 1995 and 1997, these other utilities
generally have fewer financing costs and deferred assets than TVA,
giving them more flexibility to respond to changing market
conditions. To the extent TVA recovers the costs of its deferred
assets and increases its financial flexibility, it will increase
its ability to adjust rates as necessary to meet changing market
conditions. TVA's focus on these areas before the full advent of
competition is key to its chances of being competitive

without legislative protections. Plan Does Not Include Certain
Major Costs

The 10- year plan includes costs that correspond to those incurred
in prior years and to those reported by other utilities. In
addition, the plan considers costs for Year 2000 compliance 10 and
likely environmental expenditures under existing Comprehensive
Environmental Response, Compensation, and Liability Act (CERCLA)
and Resource Conservation

and Recovery Act (RCRA) regulations. 11 However, the plan does not
9 Tennessee Valley Authority: Financial Problems Raise Questions
About Long- term Viability (GAO/ AIMD/ RCED- 95- 134, August 17,
1995) and Federal Electricity Activities: The Federal Government's
Net Cost and Potential for Future Losses (GAO/AIMD-97-110 and
110A, September 19, 1997).

10 The Year 2000 problem is rooted in the way dates are recorded
and computed in many computer systems. For the past several
decades, systems have typically used two digits to represent the
year such as 98 for 1998 to save electronic data storage space and
reduce operating costs. With this twodigit format, however, the
year 2000 is indistinguishable from 1900, 2001 from 1901, and so
on. As a result of this ambiguity, system or application programs
that use dates to perform calculations may generate incorrect
results when working with years after 1999. We verified that TVA's
plan had considered the cost for Year 2000 compliance. However, we
did not determine whether TVA would be Year 2000 compliant or
assess its estimated costs for becoming compliant.

11 CERCLA (as amended) governs cleanup of both federal and
nonfederal hazardous waste sites. RCRA addresses prevention and
remediation of releases of hazardous waste from both current and
past industrial operations. As a power producer, TVA has been
identified by the Environmental Protection Agency as a potentially
responsible party for releases from various sites.

B-281916 Page 9 GAO/AIMD-99-142 Tennessee Valley Authority

include certain major costs. Specifically, the plan does not
include the following:

 The capital costs of additional generating capacity that may be
acquired to meet growth in demand for power. The plan assumes that
TVA would meet the increasing demand for power over the plan
period by purchasing power from other utilities. The costs of the
power purchases are reflected as operating costs in the 10- year
plan.

 The cost of complying with new environmental regulations.  The
cost of nonpower programs that, to date, have been funded

primarily through appropriations. These appropriations, which
amounted to $70 million in fiscal year 1998, are expected to be
substantially reduced or discontinued beginning in fiscal year
2000.

By not including these costs, TVA will have less cash than
contemplated in the plan to pay down debt and reduce fixed costs,
which could jeopardize full achievement of the plan's objectives.

Plan Does Not Include Costs Associated With Investing in New
Generating Capacity

TVA estimates that the demand for peaking power 12 in its service
territory through 2007 will exceed its current and planned
generating capacity. TVA currently has several options planned or
underway to meet a portion of this excess demand, including (1)
purchasing new gas- fired combustion turbines, (2) purchasing
power that was already under contract when the 10- year plan was
issued, (3) modernizing hydro facilities, (4) improving the
efficiency of certain existing fossil plants and combustion
turbines,

(5) contracting for the power from a new lignite 13 plant, (6)
upgrading certain nuclear plants, and (7) issuing a request for
proposal for purchasing power generated from renewable resources.
TVA projected that these measures would not be sufficient to meet
the entire increase in demand, and the 10- year plan assumes that
TVA will purchase power from other utilities to make up the
difference, which is inconsistent with prior year practices.

However, since the plan was finalized, TVA officials have told us
that they plan to evaluate other power supply options and to
invest in new capacity if 12 Peaking units are used to meet the
demand for power that exceeds the capacity of generating equipment
that is operated to meet normal demand. 13 Lignite is low- grade
coal with high moisture and volatile matter content that is used
almost exclusively for electric power generation.

B-281916 Page 10 GAO/AIMD-99-142 Tennessee Valley Authority

the resulting long- term increase in costs to produce power
(interest and operating expense) would ultimately be less than the
cost of purchased power. TVA has already decided to invest in new
capacity rather than purchasing power in at least one case in
1998, TVA announced plans to

purchase eight gas- fired combustion turbine units 14 that will be
used to replace a like amount of purchased peaking power that was
assumed in the original plan.

According to TVA officials, while they expect this decision to
result in a positive cash flow by fiscal year 2010, the decision
to purchase these units will require about $65 million more in
cash disbursements through 2007 than would have been necessary to
purchase a comparable amount of power from other utilities. But,
according to TVA's analysis, while acquiring this new generating
capacity in lieu of purchasing power will initially increase
capital expenditures and thus reduce the amount of cash

available to pay down debt, it will also decrease TVA's annual
cost of power because it will be less expensive for TVA to operate
this new equipment than to purchase a like amount of power from
other utilities. Decreasing the cost of power should, in the long
term, improve TVA's ability to meet its

ultimate objective of offering competitively priced power. In
addition, purchasing new generating capacity provides the added
benefit of removing the uncertainty of having to rely on another
utility for power.

Based on our discussions with TVA officials, while it may make
economic sense in the long term, additional decisions to increase
capacity in lieu of purchasing power from other utilities will
likely further reduce TVA's cash available for debt reduction
through 2007, thus jeopardizing its ability to fully meet the
plan's debt reduction goals by 2007. Plan Does Not Include Costs

of Complying With Environmental Regulations

The 10- year plan does not include estimated costs of complying
with recent and proposed environmental regulations because TVA did
not believe the costs were estimable at the time the plan was
developed. Since that time, some of these costs have become
estimable. In October 1998, the Environmental Protection Agency
(EPA) issued a

regulation requiring states to develop plans to reduce nitrogen
oxide emissions. TVA now estimates that it could spend about $500
million to $600 million for capital modifications to its fossil
plants to comply with 14 TVA estimates that these new units will
produce about 576 megawatts of power each year beginning

in fiscal year 2000.

B-281916 Page 11 GAO/AIMD-99-142 Tennessee Valley Authority

state plans that would be implemented under this regulation, which
is commonly referred to as the NOx SIP Call. 15 The time frame for
TVA's compliance with the states' plans is 2003, within the scope
of the 10- year plan. In October 1998, EPA also issued a proposed
regulation regarding regional haze, 16 which EPA expects to be put
into effect during the life of the plan but for which EPA does not
expect compliance until after 2004.

TVA has estimated that this regulation could require capital
expenditures of about $450 million to $500 million. It is likely
that at least a portion of these costs will be incurred during the
time frame of the 10- year plan. 17 Additionally, all of the
estimated $500 million to $600 million in costs related to the NOx
SIP Call will be incurred during the plan time frame and,

thus, will negatively impact TVA's ability to meet its cost
reduction goals. 18 However, as discussed later, TVA officials
told us that they still believe TVA will be in a position to offer
competitively priced power in 2007 because these same types of
costs will be incurred by many other power suppliers and therefore
would tend to increase the future market price of power.

Plan Does Not Include Costs of Nonpower Programs Formerly Funded
Through Appropriations

The plan does not include the costs of nonpower programs that
historically have been funded through appropriations but now are
likely to be funded through power revenues. The plan assumes that
TVA will continue to receive appropriations for its nonpower
programs, such as flood control and navigation. While this
assumption was reasonable when the plan was developed, TVA's
nonpower appropriations have been sharply curtailed in recent
years, from $109 million in fiscal year 1996 to only $7 million in
TVA's

budget request for fiscal year 2000. 19 15 63 Fed. Reg. 57356,
57491 (1998) (to be codified at 40 C. F. R. pt. 51). 16 63 Fed.
Reg. 56394 (1998) (to be codified at 40 C. F. R. pts. 52 and 98)
(proposed Oct. 21, 1998). Regional haze concerns visibility
problems from airborne particles. 17 TVA estimates that the impact
of the NOx SIP Call and regional haze regulation on the future
market price of power would be to increase it by up to .3 cents
per kWh. As is discussed later, this also impacts TVA's projection
for its target price of power in 2007.

18 In addition to the EPA regulations, the Kyoto Protocol-- an
international treaty to reduce net emissions of certain greenhouse
gases-- could impact the future market price of power. Because the
treaty has not been ratified, the methods to be used and time
frame for compliance have not been established. Therefore, the 10-
year plan appropriately does not address costs related to the
treaty. 19 As of April 21, 1999, the appropriations bill
containing TVA's requested appropriations had not been passed.

B-281916 Page 12 GAO/AIMD-99-142 Tennessee Valley Authority

TVA officials have indicated publicly that future appropriations
for nonpower programs are likely to be eliminated or substantially
reduced and, in accordance with the fiscal year 1998 Energy and
Water Development Appropriations Act, have indicated they will use
power revenues to continue these nonpower activities. These costs
totaled approximately $70 million in fiscal year 1998 and are
expected to range from about $50 million to $60 million annually
in the future. 20 Since funding nonpower activities with power
revenues was not assumed in the 10- year plan, these costs will
further reduce the cash available to reduce debt to the level
envisioned in the plan.

Seven Key Goals and Assumptions Are Achievable or

Reasonable, While Three Are Unachievable or Uncertain

We assessed 10 goals and assumptions TVA made about the future in
developing the 10- year plan. Based on economic forecasts,
comparisons with TVA's results of past operations, and the
opinions of industry experts, we concluded that seven of the goals
and assumptions were achievable or reasonable, two were
unachievable, and one was uncertain. The goals and assumptions we
assessed, and our conclusions about each, are summarized

in table 1 and discussed in detail in the following sections.

Table 1: GAO Conclusions About the 10- Year Plan's Goals and
Assumptions

20 TVA officials have indicated that they will seek to identify
and implement operating efficiency measures that are expected to
reduce the costs associated with nonpower programs without
affecting program operations.

Goal or assumption assessed GAO conclusion

Future market price of power Reasonable Increase in demand for
power Reasonable Increase in fuel costs Reasonable Supply chain
savings Achievable Labor force reductions Reasonable Debt
reduction and recovery of deferred assets Unachievable Capital
expenditure limitation Unachievable Cost improvement initiatives
Achievable Increased revenues Uncertain Customer relations
improvements Achievable

B-281916 Page 13 GAO/AIMD-99-142 Tennessee Valley Authority

Assumption About the Future Market Price of Power Is Reasonable

TVA's assumption about the future market price of wholesale power
is important to the success of the plan because it establishes a
target that TVA must achieve in order to offer what it considers
to be competitively priced power in 2007. TVA estimated that the
price of wholesale power in 2007 would fall between 3.0 cents to
3.7 cents per kWh, with its best estimate being 3. 4 to 3.5 cents
per kWh. The Energy Information Administration

(EIA) within the Department of Energy (DOE) estimated that the
price of wholesale power in 2007 would be 3.69 cents per kWh,
while Standard and Poor's DRI 21 estimated that it would be 3.91
cents per kWh. The combined range of EIA and DRI estimates was
3.57 cents to 4.35 cents per kWh. 22 Since TVA's projection of the
future market price of power in the 10- year

plan is lower, TVA is forced to be aggressive in pursuing its
options to reduce costs and increase revenue.

TVA officials said that if they were to prepare the 10- year plan
today, their projection for the market price of wholesale power in
2007 would increase to between 3.5 and 3. 8 cents per kWh, due
primarily to new environmental regulations. TVA officials stated
that the new environmental regulations would likely drive up the
market price of power and affect many utilities

similarly. Any upward revision in the projected price of wholesale
power in 2007 would have a positive impact on TVA's ability to
achieve the objectives of the plan and would help offset some of
the previously identified costs that are not currently considered
in the plan specifically, costs for the new environmental
regulations.

However, the extent to which new environmental regulations affect
any utility depends on the type and condition of its generating
equipment, the portion of its power generated by coal, and the
types of controls it chooses to meet the new environmental
regulations. Although, in aggregate, the mix of generating plants
among investor- owned utilities in the states that

border on TVA's service territory is similar to its own, TVA and
these utilities will not necessarily all be affected equally,
depending on the condition of their equipment and the compliance
options they choose.

21 DRI is an economic forecasting and consulting company with
expertise in the energy industry. DRI did not project the future
market price of wholesale power based on the same criteria as TVA
and EIA; we extrapolated an estimate from the data it provided.

22 In all cases, data from other sources is not 100 percent
comparable to TVA's data because of slight differences in
geographic boundaries, timing differences (for example, TVA's plan
was developed in mid- 1997 and we conferred with other sources in
late 1998 and early 1999), and possible differences in
methodologies.

B-281916 Page 14 GAO/AIMD-99-142 Tennessee Valley Authority

Therefore, the relative impact of the new and proposed
environmental regulations on TVA, its neighboring utilities, and
the market price of power is uncertain.

Assumption About the Increase in Demand for Power Is Reasonable

The 10- year plan assumes that the increase in demand for power in
TVA's service region will average 2 percent per year over the plan
period. While TVA's recent historical increase in demand for power
has averaged over 3 percent annually, TVA officials were
conservative in this regard because they do not expect this level
of growth in demand to continue. We obtained

other estimates of the increase in demand for power in TVA's
geographic area from EIA, DRI, and ICF Kaiser Consulting Group, an
organization hired by the Edison Electric Institute (EEI), an
industry group for investorowned utilities, to analyze TVA's 10-
year plan. 23 Their estimates of growth in demand ranged from 1.7
percent to 2.5 percent. TVA's assumption about

growth in demand for power is reasonable based on this range of
estimates established by industry experts.

Assumption About the Increase in Fuel Costs Is Reasonable

The 10- year plan assumes that TVA's fuel cost, including its mix
of both nuclear and coal as a fuel source, will increase 1.7
percent annually over the plan period. We obtained a cost increase
estimate of 1.4 percent annually from EIA, which was based on a
blended coal and nuclear fuel mix. We also obtained a cost
increase estimate of 2. 2 percent annually

from DRI, which was based on using only coal as a fuel. Based on
the range of these estimates, TVA's assumption about fuel costs is
reasonable. To control fuel costs, TVA officials stated that they
competitively bid all coal contracts, use a cost model to
determine which type of coal to purchase, and have reduced
inventories to save carrying costs. These fuelhandling initiatives
are expected to reduce fuel expense by $1.6 million per year. In
addition, TVA has expanded its by- product program 24 and expects
revenue from this program to be over $5 million per year. TVA's
efforts to

23 Although ICF was hired to analyze TVA's 10- year plan by
utilities that would likely compete with TVA in a deregulated
environment and therefore lacks independence in this instance, ICF
does offer specialized knowledge of TVA and surrounding areas. We
did not rely exclusively on ICF for confirmation of TVA's
assertions.

24 By- products are produced from burning coal. Under the by-
product program, TVA avoids certain disposal costs and generates
revenues from the sale of ash for ready- mix concrete, gypsum for
wallboard, and structural landfill products.

B-281916 Page 15 GAO/AIMD-99-142 Tennessee Valley Authority

control these costs are positive steps toward the plan's cost
reduction goals.

Goal for Supply Chain Savings Is Achievable

The 10- year plan assumes that improvements made to supply chain
management will save, on average, $50 million per year over the 10
years covered by the plan. And, by expanding its supply chain
management efforts in the future, TVA officials believe that they
can increase efficiency,

save money, and maintain quality. For example, through contract
management improvements, TVA expects to realize cost savings by
consolidating its blanket purchasing contracts, reducing the
number of small purchase orders, and renegotiating the terms and
conditions of its purchases. From the publication of the 10- year
plan in July 1997 through September 1998, TVA had documented
savings of about $75 million, some of which represents categories
of savings that should occur on a monthly basis. The

balance represents savings on individual purchases and other
procurement initiatives, some of which may also recur. As TVA
implements additional supply chain management initiatives and
applies lessons learned from industry and individual plants to
other TVA functions, supply chain savings are expected to
increase. For the first 6 months of fiscal year 1999, TVA
documented savings of about $37 million, or about $6.2 million per
month. Of the $6.2 million, about $4.9 million should recur
monthly. On an annual basis, TVA's supply chain savings are
therefore likely to be at least $59 million, making this goal
achievable.

Assumption About Labor Force Reductions Is Reasonable

The 10- year plan assumed that TVA would reduce its labor costs by
reducing its labor force size from 14, 960 at June 30, 1997, to
14,275 by September 30, 1997. Although TVA did not achieve this
staffing level by September 30, 1997, it had reduced staff to
14,194 by December 31, 1997, and to 13, 818 by September 30, 1998.
Since TVA has exceeded its labor force reduction goal, the
corresponding cost savings will be greater than originally
anticipated.

In addition, TVA has taken or planned a number of other actions
that will further help reduce labor costs, including  negotiating
compensation levels with one of its large unions, which TVA

expects will help to curtail the rise in future labor costs,

B-281916 Page 16 GAO/AIMD-99-142 Tennessee Valley Authority

 replacing higher paid employees with lower paid employees as its
aging workforce retires, and  implementing a shared services
concept, which involves consolidating

similar operations and reducing duplicative efforts. Although TVA
did not quantify the dollar savings it expects through its labor
initiatives, TVA's current efforts in this area should help it
reduce costs.

Debt Reduction and Deferred Assets Recovery Goals Are Unachievable

The 10- year plan calls for reducing debt by about one- half to
about $14 billion by 2007. This reduction, in turn, would lower
TVA's annual interest costs by half from about $2 billion in 1997
to about $1 billion in 2007. The additional cash that is made
available as debt is paid down and interest costs are reduced can
be used to further reduce debt. This interrelationship is integral
to meeting the debt reduction goal. In addition

to reducing interest costs by reducing debt, TVA is pursuing other
interest savings by refinancing outstanding debt, as discussed
later in this report.

TVA's ability to meet its strategic objective of being in a
position to offer competitively priced power by 2007 depends, to a
large extent, on meeting its debt reduction goal. The plan calls
for the cash flow needed to achieve this debt reduction to be
provided by a combination of planned revenue enhancements, cost
savings initiatives, and capital expenditure limitations. However,
as discussed previously, the plan excluded additional capital
costs related to investing in new generating capacity to meet
growth in demand for power, complying with new environmental
regulations, and funding nonpower programs that were previously
funded through appropriations. As shown in figure 1, TVA exceeded
its debt reduction goals for the first 2 years of the plan but
does not expect to meet its original estimates for the remaining
years due to the additional capital expenditures

for new generating capacity and environmental regulations
discussed previously.

B-281916 Page 17 GAO/AIMD-99-142 Tennessee Valley Authority

Figure 1: Comparison of Planned to Actual and Revised Annual Debt
Reduction Plan

Source: GAO analysis based on data from TVA.

As a result of changes in certain of its cost estimates, TVA now
does not expect to reduce debt by one- half until fiscal year
2009, about 2 years after the plan's original target date. This
revised goal is reflected in TVA's fiscal year 2000 federal budget
request. TVA's original and revised debt reduction timetable is
shown in figure 2. 0 500

1,000 1,500

2,000 2,500

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Dollars in millions

Actual and Revised Debt Reduction Planned Original Debt Reduction
Planned

B-281916 Page 18 GAO/AIMD-99-142 Tennessee Valley Authority

Figure 2: Original and Revised Debt Reduction Timetable

Source: GAO analysis based on data from TVA.

TVA's planned revenue enhancements and cost savings were also
intended to provide TVA with the opportunity to recover a portion
of the cost of its deferred assets. As noted previously, TVA
expects to recover all but about $500 million its estimated net
realizable value of the deferred assets. However, TVA's ability to
include the costs of these assets in its rates

without further rate increases is directly related to its ability
to meet the plan's revenue and cost savings targets. To the extent
TVA does not recover the cost of its deferred assets while it is
legislatively protected from competition, competitive pressures
could prevent it from selling power at rates sufficient to recover
the cost of these assets indefinitely.

Capital Expenditure Limitation Goal Is Unachievable

The plan assumes that capital expenditures will be limited to
about $600 million per year and excludes any capital costs for
increasing generating capacity and complying with new
environmental regulations. However, as discussed previously, known
environmental costs alone are an

estimated $500 million to $600 million. In addition, costs for
complying with a proposed environmental regulation that is likely
to be implemented within the plan period could amount to another
$450 million to

1996 1997

1998 1999

2000 2001

2002 2003

2004 2005

2006 2007

2008 2009

0 5

10 15

20 25

30

Dollars in billions Fiscal years

Actual and Revised Debt Reduction Timetable

$13. 8 billion Original Debt Reduction Timetable

B-281916 Page 19 GAO/AIMD-99-142 Tennessee Valley Authority

$500 million, some of which would be incurred before 2007. Also,
the costs for meeting growth in demand for power with additional
generating capacity, which are not fully estimable at this time,
could further increase TVA's required capital expenditures within
the period covered by the 10year plan. 25 Even though upward
revisions in TVA's projected market price of wholesale power could
offset some of these additional costs, TVA is likely to exceed its
annual $600 million planned capital expenditures limit,

thus making this goal unachievable. Cost Improvement Initiatives
Goal Is Achievable The 10- year plan calls for TVA to undertake
cost improvement initiatives that are assumed to save about $200
million a year over the life of the plan.

These initiatives include refinancing TVA's Federal Financing Bank
(FFB) debt, refinancing and replacing other debt at lower interest
rates, changing retirement benefits, and improving business
processes. Overall, the goals related to these initiatives are
achievable.

Reducing Interest Costs by Refinancing Debt

To achieve a large portion of the $200 million annual cost
improvement initiatives, the plan called for TVA to obtain
authority from the Congress to prepay, without penalty, the $3.2
billion that TVA then owed FFB, then to

refinance that debt at lower interest rates. TVA received that
authority in the fiscal year 1999 Treasury and General Government
Appropriations Act. TVA refinanced the FFB debt with $2.7 billion
of long- term bonds having an average interest rate of 5.37
percent compared to the original 9. 67 percent FFB debt, plus $469
million of short- term debt which, as of April 1999, had a current
interest rate of about 4.8 percent. Based on the actual interest
rates of the refinanced FFB debt, we estimate that the interest
savings will total about $1 billion through 2007, providing an
average annual savings of about $116 million toward the $200
million plan goal.

In addition to reducing interest by refinancing the FFB debt, the
plan calls for reducing annual interest costs by refinancing a
portion of the $24 billion in outstanding publicly held debt and
replacing maturing debt, as needed, with lower interest rate
borrowings. Since the plan was issued, TVA has refinanced about $6
billion of long- term public bonds that had an average

interest rate of 6. 96 percent with long- term bonds having an
average interest rate of 6.00 percent and $699 million of short-
term borrowings that had about a 4.8 percent interest rate as of
April 1999. We estimate that 25 As previously discussed, TVA
believes any capital investments for generating capacity will
lower its cost of power relative to the estimate contained in the
plan.

B-281916 Page 20 GAO/AIMD-99-142 Tennessee Valley Authority

these actions will save an average of $44 million in annual
interest expense through 2007.

TVA may have further opportunities to refinance additional long-
term public bonds at favorable rates since as of April 1, 1999,
about $11 billion of TVA's outstanding long- term public debt had
interest rates higher than TVA's estimated 6.55 percent borrowing
rate. 26 Of the $11 billion, $6. 3 billion is callable during the
plan period; however, none was callable as of April 1, 1999.

Retirement Plan Changes According to TVA officials, another $20
million to $25 million a year will be saved by changes made to
TVA's retirement plan. The costs of certain retiree health
benefits that TVA was paying for from operations were
discontinued, while at the same time a supplemental pension
benefit was added to the retirement plan. The result, according to
TVA officials, was a

net cash flow saving of about $20 million to $25 million per year.
According to TVA officials and as confirmed by TVA's fiscal year
1998 audited financial statements, the pension plan is currently
overfunded because it has an

excess of plan assets over projected benefit obligations of $323
million as of September 30, 1998. TVA does not expect to have to
make any additional contributions to the pension plan through
2007.

Business Process Improvement Initiatives

TVA also expects to achieve cost savings from business process
improvement initiatives that involve bringing teams of TVA staff
together to evaluate how TVA does business. For example, TVA has
established teams from throughout the organization to (1) improve
the technology used to process information, (2) benchmark best
practices of industry as well as

individual TVA plants, and (3) adopt identified best practices
across the organization. While some teams appear to be well
established, others are only getting started. Because these
initiatives are in the early stages, their benefits have not yet
been quantified, and TVA officials told us that they are only now
beginning to identify cost saving techniques that can be shared
throughout the organization.

As shown in figure 3, TVA substantially achieved the $200 million
cost savings goal for fiscal year 1999 by reducing interest costs
and changing its retirement plan. Assuming that TVA's annual
savings from refinancing debt and changing its retirement plan
average $160 million and $20 million, 26 This rate represents an
average rate estimated to be available to TVA for callable and
noncallable long- term public bonds.

B-281916 Page 21 GAO/AIMD-99-142 Tennessee Valley Authority

respectively, TVA must save an additional $20 million annually by
improving business processes, refinancing additional debt, and
reducing other costs to achieve the $200 million savings assumed
in the plan. Since this required additional savings of $20 million
is relatively small less than half of 1 percent of TVA's fiscal
year 1998 operating revenues of

$6. 7 billion we believe that it is feasible that these changes
will enable TVA to save the additional amount needed to achieve
the $200 million annual cost reduction goal.

Figure 3: Cost Savings for Fiscal Year 1999 Under TVA's Cost
Improvement Initiatives

Source: GAO analysis based on data from TVA.

Assumption About Increased Revenues Is Uncertain

TVA's revenues increased significantly in fiscal year 1998 due to
a rate increase and to increased energy sales. TVA's fiscal year
1998 revenues totaled about $6.7 billion, compared to $5. 9
billion in fiscal year 1997 an increase of about $800 million.
According to TVA, about $350 million of the increase is attributed
to the rate increase; the balance is attributable to increased
sales volume that resulted from extreme weather in the summer
months and other factors. The 10- year plan assumes that this rate
increase is sustainable and will generate additional revenues of
about $325 million annually through 2007.

Savings from FFB debt refinancing 58%

Savings from retirement plan changes 10%

Assumed savings from additional refinancings and business process
improvements

10% Savings from public bond

refinancing 22% $116 million

$44 million $20 million

$20 million

B-281916 Page 22 GAO/AIMD-99-142 Tennessee Valley Authority

However, based on the decline in TVA's average revenue per kWh
over the past 10 years, and expectations of increasing competition
in the electricity industry, we agree with some industry experts
who question TVA's ability to meet the plan's assumption about
future revenue. Specifically, an analyst from the Congressional
Budget Office (CBO) with expertise in issues related to TVA and
consultants from ICF Kaiser (which was hired by the

Edison Electric Institute to analyze TVA's 10- year plan)
questioned TVA's ability to meet its future revenue projections
given the decline in its average revenue per kWh over the last
several years.

As shown in figure 4, from 1988 through 1997, TVA's average
revenues per kWh declined steadily, despite a steady increase in
the amount of kilowatthours of energy sold. This decline in
average revenues per kWh was attributable to credits given to
large industrial customers. The actual decline in average revenues
per kWh over the past 10 years contrasts sharply with the increase
projected in the 10- year plan for 1998 through 2007.

B-281916 Page 23 GAO/AIMD-99-142 Tennessee Valley Authority

Figure 4: Comparison of Average Revenue per kWh to Kilowatthours
Sold

Source: GAO analysis based on data from TVA.

In order to offer competitive rates to its industrial customers,
TVA offers price breaks to its larger industrial customers. In
fact, to offset the impact of the last rate increase, TVA expanded
its existing credit program to include companies with commitments
to purchase firm loads of more than 1 megawatt. (Previously this
credit had been limited to industrial customers with firm load
commitments of more than 5 megawatts.) Although deregulation of
the electric utility industry is expected to put downward pressure
on rates, the 10- year plan assumes that TVA will not have to
offer any additional price breaks to its large industrial
customers through 2007. This assumption is questionable given that
TVA has offered new credits to reduce the rates of its larger
industrial customers for the

past 10 years and competition in the industry is increasing.
Because deregulation of the electric utility industry is expected
to continue to cause future wholesale and retail electricity
prices to fall, TVA will likely  0.50

1.00 1.50

2.00 2.50

3.00 3.50

4.00 4.50

5.00 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Average revenue per kWh

50, 000

100,000 150,000

200,000 250,000

Kilowatthours sold

Average revenue per kWh Kilowatthours sold

B-281916 Page 24 GAO/AIMD-99-142 Tennessee Valley Authority

feel pressure to continue to reduce rates. In addition, recent
media coverage about competition has made many utility customers
more aware of price differences among utilities and raised
expectations of lower prices. All of these factors combined make
it uncertain whether TVA can generate an additional $325 million
in annual revenues on a sustained basis through 2007.

Goal to Improve Customer Relations Is Achievable TVA's management
recognizes that in a competitive environment, its

current customers would be free to obtain power from other
utilities after giving appropriate notice. Therefore, to improve
its future competitive position, TVA's management decided that it
must offer contract flexibility to improve relationships with its
customers 159 distributors and 64 industrial and federal concerns.
The 10- year plan calls for TVA to build customer allegiance by
developing contract and pricing structures that better meet its
customers' needs. TVA has taken actions geared toward this goal.

For example, one new contract option allows distributors to change
the length of their power contracts with TVA from a rolling 27 10-
year term to a rolling 5- year term, after a period of 5 years (5+
5 contract). This 5+ 5

contract, like all of TVA's power contracts with its distributors,
requires the distributor to purchase all of its electric power
from TVA. TVA has also implemented a new program for its large
industrial customers that permits customers with power usage of
more than 1 megawatt annually to be billed

under real- time pricing (RTP), 28 which will enable these
customers to reduce their electricity costs by adjusting usage
patterns. TVA has implemented the RTP program on a 3- year pilot
basis. TVA expects that in the long- term, the RTP program will
increase revenues by increasing the

demand for power. Both the 5+ 5 contracts and the real- time
pricing program are options that TVA developed as a result of
input from customers.

Customer groups we contacted were pleased with the efforts TVA is
making to provide more flexible contracts. Since these options
were developed in response to customer input and the initial
customer response

27 Rolling contracts automatically renew each year (referred to as
the evergreen provision). 28 RTP reflects the actual cost
differences of producing power, which vary from hour to hour. RTP
allows customers to reduce costs by scheduling production to take
advantage of variable prices.

B-281916 Page 25 GAO/AIMD-99-142 Tennessee Valley Authority

has been positive, we determined that TVA's goal to improve
customer relations is achievable. Plan Has Not Been Updated to
Reflect Significant Changes

As previously discussed, since the 10- year plan was issued in
July 1997, actual experience related to certain key goals and
assumptions has differed from that projected in the plan, and
certain expectations about the future have changed. For example,
TVA officials indicated that if they were to

update the 10- year plan today, they would increase their
projection for the future market price of power and would include
costs for new environmental regulations. However, TVA has not
formally updated the

plan to reflect these and other changes. Examples of actual
experience that differ from expectations in the plan or goals and
assumptions that have changed since the plan was developed, along
with their impact on the overall plan, are shown in table 2.

Table 2: Summary of Changes and Their Impact on TVA's 10- Year
Plan

a Due to uncertainty regarding the timing for compliance, not all
expenditures may occur during the time frame of the plan. b The
estimate is based on estimated expenditures of about $50 million
to $60 million per year. TVA officials stated that they would seek
to identify and implement operating efficiency measures that are

expected to reduce the costs associated with nonpower programs
without affecting program operations.

Changes Impact on plan

Purchase of 8 turbines in lieu of purchasing power Reduce net cash
flow by $65 million through 2007, but also expected to reduce the
cost of power

Environmental regulations: (1) Nitrogen oxide

(2) Regional haze (1) Reduce total cash flow by $500 million to
$600 million through 2007

(2) Reduce total cash flow by up to $500 million through 2007 a
Funding nonpower programs through power revenues Reduce total cash
flow by $400 million to $480 million through 2007 b

Possible upward adjustment in the future market price of power
Reduce the amount of cost reduction and/ or revenue needed to meet
a market price projection

Debt not reduced as quickly as planned Delay debt reduction goal
from 2007 to 2009;

Increase risk that TVA will be unable to offer competitively
priced power by 2007

B-281916 Page 26 GAO/AIMD-99-142 Tennessee Valley Authority

Changes in individual goals or assumptions or actual experience
that differs from that projected when the plan was developed can
affect the entire plan. For example, the unplanned purchase of
additional generating capacity results in a decrease in projected
cash flow through 2007. This affects the availability of cash to
pay down debt, which further impacts interest costs. Funding
nonpower programs through power revenues has the same effect. The
result of these and other unplanned expenditures,

such as for new environmental regulations, is that TVA's time
frame to meet its debt reduction goal has been extended from 2007
to 2009. In contrast, any upward change in TVA's assumption for
the future market price of power increases TVA's target price for
power in 2007. This means that TVA could reduce the level of cost
reduction and/ or revenue enhancement planned through 2007 and
still be in a position to offer competitively priced power at that
time.

TVA officials told us that they have internally analyzed the
combined impact of an upward revision in the projected market
price of wholesale power in 2007 and lower- than- planned debt
reduction on TVA's ultimate objective, which is to be in a
position to offer competitively priced power in 2007. While TVA
officials acknowledge that they will not meet the debt reduction
goal by 2007, they believe, based on their internal analyses, that
TVA will still be in a position to offer competitively priced
power in 2007. However, these analyses have not been formalized,
nor have the results

been communicated to users of the plan. Although TVA views the
plan as a living document and recognizes that projections in the
plan will change over time, there is no formal mechanism for
communicating changes to those who use the plan. In addition,
there is no mechanism available to plan users to gauge TVA's
progress toward achieving the plan's goals and objectives.
Therefore, while variances in results, changes in goals and
assumptions, and progress toward plan objectives may be known to
TVA, they are generally not known by the plan's users. These users
include public policymakers considering

legislation that might impact TVA's future, analysts and investors
who use information in the plan when assessing the desirability of
TVA's debt offerings, and customers who are considering
alternative sources of electricity in the future. As a result,
those who rely on the plan to make investment and policy decisions
cannot fully assess the impact of the

variances and changes in assumptions on TVA's ability to meet its
strategic objectives as set forth in the plan.

B-281916 Page 27 GAO/AIMD-99-142 Tennessee Valley Authority

The legislation proposed by the administration to promote retail
competition in the electric power industry, which was discussed
previously in this report, would require that TVA annually report
several types of information to the Congress. If enacted, the
legislation would require that TVA annually report, among other
things, its progress toward its goal of competitively priced
power, its prospects for meeting the objectives of the 10- year
plan, any changes in assumptions that may have a material effect
on its long- range financial plans, the amount by which its debt
has been reduced, and the projected amount by which its debt will
be reduced. This type of reporting to the Congress would help
provide the information needed to monitor TVA's readiness for a
competitive environment.

Conclusions TVA management recognizes the need for TVA to be
positioned to compete with other utilities in a changing
marketplace. The 10- year plan is moving TVA in the right
direction by addressing the most important issues facing TVA: its
high fixed financing costs and limited financial flexibility and
the large amount of deferred assets that TVA has not recovered
through rates. The more progress TVA makes in addressing these
issues while it maintains

its legislative protections, the greater its prospects for being
competitive if it loses these protections in the future. Because
TVA's actual experience and assumptions about the future market
price of power, capital expenditures, and planned debt reduction
have varied in significant ways from those envisioned in the 10-
year plan, it is unlikely that TVA will generate sufficient cash
flow to reduce debt and the corresponding fixed interest costs to
the extent stated in the plan through 2007. This will impact TVA's
ability to recover the cost of its deferred assets to the extent
planned. TVA has acknowledged that its debt reduction goal will
not be achieved until at least 2009. To the extent it does not

sufficiently reduce debt and related fixed costs and increase
financial flexibility during the 10- year period, TVA's ultimate
strategic objective to be able to offer competitively priced power
by the end of 2007 could be jeopardized, depending on market
conditions at the time. However, since no one knows what the
market price of power will be in 2007, it is uncertain whether TVA
will be in a position to offer competitively priced power at that
time. TVA could fall short of its objectives and still be
competitive if its cost of producing power is at or below market.
Conversely, TVA could achieve all of its objectives and not be
competitive if its cost of producing power is higher than market.

B-281916 Page 28 GAO/AIMD-99-142 Tennessee Valley Authority

Because of changing electricity markets and other economic
conditions, it is essential that TVA continuously update the plan
and communicate the results of these updates, as well as TVA's
progress toward its goals and objectives, periodically and
formally to the Congress as it considers TVA's future in a
deregulating electricity industry and to other users who have a
vested interest in TVA.

Recommendations We recommend that the Chairman of the Board of
Directors of the Tennessee Valley Authority move quickly to
improve the reporting of

information to the plan's users. Specifically, we recommend that
the Chairman ensure that TVA take the following actions:

 Revise and reissue the plan to reflect evolving conditions and
operating plans and their impact on TVA's ability to meet the
strategic objectives outlined in the plan by 2007. TVA should also
include a discussion of its

plans to recover the costs of its deferred assets. As further
significant changes occur, the plan should be updated to
communicate these changes to plan users.  Periodically communicate
its progress toward achieving the 10- year

plan's strategic objectives to those who rely on the information
contained in the plan. One option would be for TVA to expand its
discussion of the 10- year plan in its annual reports, including
reporting

 how actual results compare to all of the plan's key goals and
assumptions, including those for revenues, debt reduction, capital
expenditures, cost savings, and the market price of power;

 progress toward achieving performance measures related to the
plan, when developed; and  an overall assessment of whether TVA is
on course to provide

competitive power in 2007. Agency Comments and Our Evaluation

In oral and written comments on a draft of this report, TVA
generally agreed with the report's contents. TVA also provided us
with technical comments, which we have incorporated as
appropriate. TVA's written comments are reproduced in appendix II
and discussed below. TVA commented that the market price of power
is the most significant uncertainty in achieving its goal to be in
a competitive pricing position as the industry is deregulated. TVA
also stated that the target cost of power in the 10- year plan is
aggressive and that it has not yet altered its estimate of

B-281916 Page 29 GAO/AIMD-99-142 Tennessee Valley Authority

the future market price of power, even though there are
indications of upward movement in market price forecasts. Our
report noted that TVA's target for the cost of its power in the
10- year plan is lower than projections by other knowledgeable
sources and therefore forces TVA to be aggressive in pursuing its
options to reduce costs and increase revenue. During the course of
our review, TVA officials told us that if they were to formally
update the 10- year plan, they would increase their projection of
the future

market price of power. As we note in our report, TVA has not
formally updated the 10- year plan, even though certain
expectations about the future have changed and actual experience
related to key goals and assumptions has differed from projections
in the plan. TVA stated that while it will likely incur the costs
of funding traditional river management programs that have
historically been funded largely through appropriations, the
Congress has also enacted legislation allowing TVA to refinance
its FFB debt for a savings of over $100 million a year. While we
agree with both of these statements, the anticipated savings from
refinancing the FFB debt were included in the 10- year plan, but
the

additional cost of funding traditional river management programs
was not. Therefore, for purposes of gauging progress toward
achievement of the plan's goals, the planned savings cannot be
assumed to offset these unplanned expenditures. Our report
separately discusses each of these points.

TVA noted that although its decision to purchase additional
generating capacity for periods of peak demand rather than
purchasing power from other utilities will adversely impact its
ability to reduce debt to the extent planned, it will also help
TVA achieve a lower cost of power and improve

system reliability. Our report acknowledges these points and
states that the decision will impact TVA's ability to reduce debt,
but that TVA believes the decision will reduce the cost of its
power and remove the uncertainty of having to rely on another
utility for power. With regard to our recommendations, TVA stated
that its planning process is being refined and will improve over
time and that TVA has committed to update the 10- year plan as
material changes occur so that stakeholders will know how TVA is
doing in comparison to the plan. As we noted in our

report, TVA has made significant changes in assumptions and its
actual experience has differed from projections since the plan was
issued in July 1997, but TVA has not formally updated the plan to
reflect these changes. Therefore, it is important that TVA move
quickly to improve the reporting

Page 31 GAO/AIMD-99-142 Tennessee Valley Authority

Page 32 GAO/AIMD-99-142 Tennessee Valley Authority

Contents Letter 1 Appendix I Objectives, Scope, and Methodology

34 Appendix II Comments From the Tennessee Valley Authority

40 Appendix III Major Contributors to This Report

42 Tables Table 1: GAO Conclusions About the 10- Year Plan's Goals
and

Assumptions 12 Table 2: Summary of Changes and Their Impact on
TVA's 10- Year

Plan 25 Figures Figure 1: Comparison of Planned to Actual and
Revised Annual Debt Reduction Plan 17

Figure 2: Original and Revised Debt Reduction Timetable 18 Figure
3: Cost Savings for Fiscal Year 1999 Under TVA's Cost

Improvement Initiatives 21 Figure 4: Comparison of Average Revenue
per kWh to Kilowatthours

Sold 23

Contents Page 33 GAO/AIMD-99-142 Tennessee Valley Authority
Abbreviations

CBO Congressional Budget Office CERCLA Comprehensive Environmental
Response, Compensation, and

Liability Act DOE Department of Energy EEI Edison Electric
Institute EIA Energy Information Administration EPA Environmental
Protection Agency EPAct Energy Policy Act of 1992 FFB Federal
Financing Bank kWh kilowatthour NRC Nuclear Regulatory Commission
OMB Office of Management and Budget RCRA Resource Conservation and
Recovery Act RTP real- time pricing TVA Tennessee Valley Authority

Page 34 GAO/AIMD-99-142 Tennessee Valley Authority

Appendix I Objectives, Scope, and Methodology Appendi x I

We were asked to determine whether the goals and assumptions in
TVA's 10- year plan are achievable or reasonable in light of TVA's
strategic objectives to (1) reduce the cost of power to a
competitive level, (2) increase financial flexibility by reducing
fixed costs, and (3) build customer allegiance. Specifically, we
were asked to determine whether the

10- year plan (1) addresses key issues facing TVA, (2) takes into
consideration all applicable costs and revenue sources, (3)
contains assumptions that are reasonable and in line with industry
estimates and expectations, and (4) has been updated to reflect
significant changes in key assumptions or actual experience that
differs from TVA's expectations when the plan was developed. In
addition, you asked us, based on our analysis of the plan, to
conclude whether TVA is likely to achieve the plan's strategic
objectives.

TVA's plan consists of three strategic objectives, with goals and
assumptions designed to help accomplish the strategic objectives.
We evaluated the achievability and reasonableness 1 of 10 of the
goals and

assumptions and their impact on TVA's ability to accomplish its 3
objectives. Specifically, we assessed the achievability and
reasonableness of the following goals and assumptions:

 the future market price of wholesale power will be 3. 4 to 3.5
cents per kWh by 2007;  annual growth in demand through 2007 will
average 2 percent;  fuel costs will increase 1.7 percent annually
through 2007;  improvements in supply chain management will save
$50 million

annually;  TVA's labor force will be reduced, and additional costs
savings will be

achieved through the creation of shared services and other
initiatives;  debt will be reduced by about one- half to about $14
billion, and the

balance of deferred assets will be reduced from $8. 5 billion to
$500 million TVA's estimated net realizable value of these assets;
capital expenditures will be limited to about $600 million
annually and increases in demand through 2007 will be met
primarily through

purchased power;  $200 million will be saved annually through cost
improvement initiatives

primarily related to refinancing Federal Financing Bank (FFB) and
1 We assessed the achievability of the 5 goals and the
reasonableness of the 5 assumptions contained in TVA's 10- year
plan.

Appendix I Objectives, Scope, and Methodology

Page 35 GAO/AIMD-99-142 Tennessee Valley Authority

public bond debt, pursuing changes to its retirement plan, and
improving business processes;  revenues from power sales will be
increased by about $325 million

annually by implementing a rate increase in 1998 and maintaining
it through 2007; and  customer relations will improve through new
contract and pricing options.

As agreed with your offices, we did not (1) assess whether
achieving the objectives of the plan would ensure TVA's future
competitiveness or (2) develop independent estimates of key
elements of the plan, such as the future market price of power.
Instead, we relied on comparisons of past performance to future
projections, the opinions of industry experts, and

economic forecasts made by knowledgeable sources to determine
whether the individual components of the plan and the plan as a
whole were achievable and reasonable.

Assessing Whether the Plan Addressed Key Issues Confronting TVA

To determine whether the three objectives of the 10- year plan
addressed key issues confronting TVA as it seeks to increase its
prospects for being competitive in the future, we (1) examined the
actions that were being

taken by other utilities to prepare for competition and compared
them to TVA's plan, (2) reviewed prior GAO reports on issues
confronting TVA, (3) interviewed TVA officials, (4) reviewed TVA's
annual reports for 1997 and 1998, (5) spoke with officials from
the Congressional Budget Office (CBO) and Office of Management and
Budget (OMB) with expertise in issues pertaining to TVA, (6)
interviewed industry representatives from

TVA's customer groups, and (7) interviewed representatives from
both the public power and investor- owned segments of the industry
familiar with TVA and its service area. Assessing Whether
Appropriate Costs and Revenues Were Considered

To determine whether the 10- year plan considered appropriate
costs and revenue sources, we (1) reviewed prior GAO reports on
TVA, (2) interviewed TVA officials, (3) reviewed other electric
utilities' annual reports and audited financial statements to
determine the types of costs they were reporting, (4) reviewed TVA
fiscal years' 1997 and 1998 annual reports and audited financial
statements to determine the types of costs and revenues TVA had
reported, (5) analyzed comparative historical and forecast
operating statement percentages calculated from TVA financial
model information underlying the 10- year plan, (6) spoke with an
official from the Environmental Protection Agency (EPA) regarding
environmental

Appendix I Objectives, Scope, and Methodology

Page 36 GAO/AIMD-99-142 Tennessee Valley Authority

costs under new regulations and TVA's status as a potentially
responsible party under CERCLA and RCRA, (7) interviewed industry
experts familiar with TVA and its service area, (8) spoke with an
official from the Nuclear Regulatory Commission (NRC) on the
adequacy of TVA's nuclear decommissioning fund, (9) determined
that TVA's external financial statements auditor was satisfied
with TVA's nuclear decommissioning

obligations and trust fund assets as part of its fiscal year 1998
audit, and (10) inquired about costs related to TVA's plans to
comply with Year 2000 computer issues. However, we did not assess
TVA's readiness to deal with Year 2000 computer issues.

Assessing Whether the Plan's Goals and Assumptions Were Achievable
or Reasonable

To determine whether goals and assumptions were achievable or
reasonable and in line with industry estimates and expectations,
we (1) interviewed TVA officials, (2) compared past results of
TVA's operations to projections in the plan, and (3) spoke with
officials from (a) the Energy Information Administration (EIA),
the statistical agency within DOE, (b) Standard and Poor's DRI, an
economic forecasting and consulting company with expertise in the
energy industry, (c) EPA, (d) CBO, (e) NRC, (f) groups of TVA
customers, including both distributors and direct- served
customers, and (g) industry groups representing both the public
power and investor- owned utility segments of the industry. For
each goal or assumption, we compared TVA's projections with those
of

the appropriate agencies and with TVA's historical results.
Specifically, to determine whether each goal or assumption was
achievable or reasonable, we did the following work:

 Future market price of wholesale power: We interviewed TVA
officials and spoke with EIA, DRI, and industry experts familiar
with TVA and its service area. We then compared TVA's projections
with those of these

other entities.  Annual growth in demand: We reviewed TVA's past
annual growth history and interviewed TVA, CBO, DRI, and EIA
officials and industry

experts familiar with TVA and its service area. We also relied on
previous GAO work on TVA's demand growth methodology done in 1995;
we did not reassess this methodology because our comparison of
TVA's projections with past results and the projections of DRI and
EIA gave us no reason to believe that any changes TVA may have
made in its

methodology would have caused a significant difference. Based on
the results of our review, we determined the reasonableness of
TVA's assumptions.

Appendix I Objectives, Scope, and Methodology

Page 37 GAO/AIMD-99-142 Tennessee Valley Authority

 Increase in fuel costs: We reviewed TVA's annual fuel costs for
prior years, interviewed TVA officials, and spoke with officials
from DRI and EIA. We then compared TVA's projections to those of
these other entities to determine reasonableness.  Improvements in
supply chain management: We interviewed TVA officials and examined
documentation on (1) changes in procurement

policies and procedures, including the use of blanket contracts
versus individual purchase orders, (2) savings achieved since
1997, both recurring and nonrecurring, and (3) plans to phase in
additional cost savings programs. We then analyzed whether these
changes would be likely to enable TVA to achieve and sustain the
level of savings projected

in the 10- year plan.  Reduced labor force: We interviewed TVA
officials, reviewed the

decrease in personnel over the last 10 years, and analyzed whether
TVA's assumptions seemed reasonable.  Reduced debt and related
interest costs and recovery of deferred assets:

We interviewed TVA officials, analyzed information in the
President's fiscal year 2000 budget, contacted Moody's Investors
Service in regard to the effect of bond ratings on interest rates,
and analyzed and verified the plan's supporting documentation by
tracing it to TVA's audited financial statements. In addition, to
determine whether TVA's plan to recover through rates the costs of
deferred assets was achievable, we

interviewed TVA officials, spoke with a CBO official about the
impact of planned revenues on the availability of income to
recover the costs of these assets, and analyzed supporting
schedules provided to us by TVA. We also spoke with TVA officials
about its plans for the Bellefonte nuclear plant, which comprises
the bulk of TVA's deferred nuclear generating units.  Capital
expenditures: We interviewed TVA officials, a CBO analyst, and
industry experts. Additionally, for each of the two capital
expenditure

issues, we performed additional procedures. Specifically:  for
capital expenditures for new capacity and upgrades to existing

capacity, we compared TVA's historical capital expenditures to its
planned expenditures and analyzed whether the plan's goal of
meeting future growth in demand by purchasing power from other

utilities was achievable and  for expenditures related to new
environmental regulations, we

obtained data from EPA and EIA on projected costs under new and
proposed environmental regulations. We then compared TVA's
projections with those of EPA and EIA to determine the
achievability of TVA's goals.

Appendix I Objectives, Scope, and Methodology

Page 38 GAO/AIMD-99-142 Tennessee Valley Authority

 Cost improvement initiatives: We interviewed TVA officials,
examined documentation relating to TVA's business process
improvement efforts, reviewed information in TVA's annual report
on its pension fund, analyzed the impact of TVA's refinancing
efforts to date, obtained projected interest rates through 2007
from EIA, and compared the plan's projections to TVA's actual
portfolio interest rates and EIA's projections.  Projected
revenues: We interviewed TVA officials, reviewed TVA's revenue
experience over the past 10 years, analyzed the correlation

between kWhs sold and revenue, spoke to TVA's customer groups
about their expectations for TVA's price of power, and interviewed
CBO and industry representatives about the reasonableness of TVA's
revenue projections.  Improved customer relations: We interviewed
TVA officials,

representatives of TVA's customer groups, and industry
representatives from both the public power and investor- owned
segments of the market. Assessing Whether the Plan Had Been
Updated for Significant Changes

To determine whether TVA had updated the plan for significant
changes, we (1) determined whether significant changes had
occurred based on the procedures described above, (2) examined the
process whereby TVA internally updates its projections, and (3)
interviewed TVA officials about whether they had updated the plan
internally or externally and/ or had any plans to do so.

Assessing Whether Strategic Objectives Are Achievable

After we determined the achievability or reasonableness of each of
the underlying goals and assumptions of the plan, we assessed the
plan in its entirety to determine whether all of these separate
elements added up to a

cohesive, reasonable plan that should enable TVA to achieve its
three strategic objectives. For the two interrelated strategic
objectives reducing the total delivered cost of power and
increasing financial flexibility by reducing fixed costs we
analyzed whether achieving the goals of the plan was possible and
whether achieving the goals would

necessarily help TVA achieve the strategic objectives. For the
third strategic objective, building customer allegiance, we
analyzed the results of our discussions with both TVA's customer
groups as well as industry representatives from both the public
power and investor- owned segments of the market.

We conducted our review from June 1998 through April 1999 in
accordance with generally accepted government auditing standards.

Appendix I Objectives, Scope, and Methodology

Page 39 GAO/AIMD-99-142 Tennessee Valley Authority

Organizations Contacted

During the course of our work, we contacted the following
organizations. Federal Agencies  Congressional Budget Office

 Department of Energy's Energy Information Administration
Environmental Protection Agency  Nuclear Regulatory Commission
Office of Management and Budget  Tennessee Valley Authority

Bond Rating Agency  Moody's Investors Service, New York, New York
Customer Representative or Trade Groups

 American Public Power Association, Washington, D. C.  Tennessee
Municipal Electric Power Association, Brentwood,

Tennessee  Tennessee Valley Industrial Committee/ Associated
Valley Industries,

Columbia, Tennessee  Tennessee Valley Public Power Association,
Chattanooga, Tennessee

Consulting Firms  Gas Research Institute, Chicago, Illinois  ICF
Kaiser Consulting Group, Fairfax, Virginia

 Standard and Poor's DRI, Lexington, Massachusetts Others  Federal
Accounting Standards Advisory Board

 Edison Electric Institute's TVA Watch Group, Washington, D. C.
McMinnville Electric System, McMinnville, Tennessee

Page 40 GAO/AIMD-99-142 Tennessee Valley Authority

Appendix II Comments From the Tennessee Valley Authority Appendi x
I I

Appendix II Comments From the Tennessee Valley Authority

Page 41 GAO/AIMD-99-142 Tennessee Valley Authority

Page 42 GAO/AIMD-99-142 Tennessee Valley Authority

Appendix III Major Contributors to This Report Appendi x I I I

Accounting and Information Management Division, Washington, D. C.

Robert E. Martin, Assistant Director Donald R. Neff, Senior Audit
Manager Patricia B. Petersen, Senior Auditor John C. Warner,
Senior Auditor Meg Mills, Communications Analyst

Office of the General Counsel, Washington, D. C.

Thomas H. Armstrong, Assistant General Counsel Amy M. Shimamura,
Senior Attorney

Atlanta Field Office Marshall L. Hamlett, Senior Auditor

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