    Tennessee Valley Authority: Financial Problems Raise Questions About
    Long-Term Viability (Chapter Report, 08/17/95, GAO/AIMD/RCED-95-134).

    The Tennessee Valley Authority (TVA) is $26 billion in debt and has
    invested $14 billion in nonproducing nuclear assets that are not
    included in its electricity rates. As a result, TVA has far more
    financing costs and deferred assets than its likely competitors have,
    which gives TVA little flexibility to meet competitive challenges. To
    the extent that TVA cannot compete effectively and improve its financial
    condition, the federal government may have to pick up the tab for some
    of TVA's debt. TVA's troubled financial condition has been caused
    largely by construction delays, cost overruns, and operational shutdowns
    in its nuclear program. TVA's links to the federal government and its
    high debt limit have allowed it to borrow the billions of dollars needed
    for its nuclear construction program. Although no cash crisis exists
    today, GAO believes that TVA's financial condition threatens its
    long-term viability and places the federal government at risk. GAO
    highlights several options that could reduce risk to federal taxpayers
    and help prepare TVA to compete in the electricity market.

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

     REPORTNUM:  AIMD/RCED-95-134
         TITLE:  Tennessee Valley Authority: Financial Problems Raise
                 Questions About Long-Term Viability
          DATE:  08/17/95
       SUBJECT:  Electric utilities
                 Utility rates
                 Electric power generation
                 Federal corporations
                 Energy costs
                 Energy law
                 Financial management
                 Internal controls
                 Competition

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    Cover
    ================================================================ COVER

    Report to Congressional Requesters

    August 1995

    TENNESSEE VALLEY AUTHORITY -
    FINANCIAL PROBLEMS RAISE QUESTIONS
    ABOUT LONG-TERM VIABILITY

    GAO/AIMD/RCED-95-134

    Tennessee Valley Authority

    Abbreviations
    =============================================================== ABBREV

      COMMEND - Commercial End-Use Energy Planning System
      DOE - Department of Energy
      DRI - Data Resources, Inc.
      EFM - Electricity Forecasting Model
      ELCON - Electricity Consumers Resource Council
      FERC - Federal Energy Regulatory Commission
      FFB - Federal Financing Bank
      FINESSE - financial model
      GAAP - generally accepted accounting principles
      GAO - General Accounting Office
      HELM - Hourly Energy Load Model
      INFORM - Industrial Energy End-Use Model
      IPP - independent power producer
      IOU - investor-owned utility
      IRP - integrated resource plan
      kwh - kilowatt hour
      MW - megawatt
      NRC - Nuclear Regulatory Commission
      PP&E - property, plant, and equipment
      REEPS - Residential End-Use Energy Planning System
      RESM - Regional Economic Simulation Model
      SFAS - Statement of Financial Accounting Standards
      TVA - Tennessee Valley Authority
      TVPPA - Tennessee Valley Public Power Association

    Letter
    =============================================================== LETTER

    B-259411

    August 17, 1995

    Congressional Requesters

    As requested, this report presents the results of our review of the
    Tennessee Valley Authority's (TVA) financial condition.  Our report
    provides information and analyses on the implications of TVA's
    financial condition for TVA and the federal government in light of
    the increasingly competitive electric utility market.  This report
    discusses several options available for TVA and congressional
    decisionmakers in deciding what types of financial and other changes
    may be needed to protect the interests of all those, including the
    taxpayer, who have a stake in TVA's future.

    As arranged with your offices, unless you publicly announce the
    contents of this report earlier, we will not distribute it until 7
    days from the date of this letter.  At that time, we will send copies
    to appropriate House and Senate committees, interested Members of the
    Congress, the Chairman of TVA's Board of Directors, the Director of
    the Office of Management and Budget, and other interested parties.
    We will also make copies available to others upon request.

    This report was prepared under the direction of Lisa Jacobson,
    Director, Civil Audits in the Accounting and Information Management
    Division, who may be reached at (202) 512-9508, and Victor S.
    Rezendes, Director of Energy and Science Issues in the Resources,
    Community, and Economic Development Division, who may be reached at
    (202) 512-3841, if you have any questions.  Major contributors to
    this report are listed in appendix VI.

    Gene L.  Dodaro
    Assistant Comptroller General
    Accounting and Information
     Management Division

    Keith O.  Fultz
    Assistant Comptroller General
    Resources, Community, and
     Economic Development Division

    List of Requesters

    The Honorable Bud Shuster
    Chairman
    The Honorable Norman Y.  Mineta
    Ranking Minority Member
    Committee on Transportation and Infrastructure
    House of Representatives

    The Honorable John R.  Kasich
    Chairman
    Committee on the Budget
    House of Representatives

    The Honorable Howell Heflin
    United States Senate

    The Honorable Trent Lott
    United States Senate

    The Honorable Bob Clement
    House of Representatives

    The Honorable Bud Cramer
    House of Representatives

    The Honorable John J.  Duncan, Jr.
    House of Representatives

    The Honorable James H.  Quillen
    House of Representatives

    The Honorable Zach Wamp
    House of Representatives

    EXECUTIVE SUMMARY
    ============================================================ Chapter 0

       PURPOSE
    ---------------------------------------------------------- Chapter 0:1

    The Tennessee Valley Authority (TVA), established in 1933 as a
    multipurpose, independent, government-owned corporation, is one of
    the nation's largest utilities.  In March 1994, the Subcommittee on
    Investigations and Oversight of the House Committee on Public Works
    and Transportation held a hearing on TVA that raised concerns about
    TVA's nuclear program and its financial condition--including the
    growth of TVA's debt toward the $30 billion ceiling established by
    the Congress in 1979.  At the request of several Members of the
    Congress, GAO examined the implications for TVA and possibly the
    federal government of TVA's financial condition in light of the
    increasingly competitive electric utility market.  More specifically,
    this report presents information on TVA's financial condition
    compared with neighboring utilities, power resource decisions,
    competitive prospects in the short term, and options for addressing
    TVA's problems.

       BACKGROUND
    ---------------------------------------------------------- Chapter 0:2

    TVA is a unique federal corporation that supplies electricity and
    develops resources to serve more than 7 million people in an
    80,000-square-mile area covering Tennessee and parts of Alabama,
    Georgia, Kentucky, Mississippi, North Carolina, and Virginia.

    TVA's multibillion-dollar power program, which generated about $5.4
    billion in 1994 revenues, is required by the Tennessee Valley
    Authority Act to be self-supporting from power revenues.  TVA issues
    bonds to provide most of the financing needed to construct its power
    facilities.  Under section 15d of the TVA Act, these bonds are not
    guaranteed by the federal government.  However, the financial
    community views them as having an implicit federal guarantee.
    Existing legislation also gives TVA a great deal of independence in
    deciding how it is to be operated and managed.  TVA's three-member
    Board of Directors has the sole authority to set electricity rates
    for its 160 distributors and decide what kinds of power plants to
    build.

    Because of protections provided in legislation and contracts with its
    distributors, TVA generally has not had to compete with other
    utilities.  TVA has recently acknowledged through its actions and
    announcements that it will have to compete in the future.  In
    addition, industry experts have stated that TVA's service area cannot
    remain isolated from competition.

       RESULTS IN BRIEF
    ---------------------------------------------------------- Chapter 0:3

    TVA is $26 billion in debt and has invested $14 billion in
    nonproducing nuclear assets (called "deferred assets") that are not
    included in its electricity rates.  As a result, TVA has far more
    financing costs and deferred assets than its likely competitors have,
    which gives TVA little flexibility to meet competitive challenges.
    To the extent that TVA cannot compete effectively and improve its
    financial condition, the federal government is at risk for some
    portion of TVA's debt.

    TVA's troubled financial condition has been largely caused by
    construction delays, cost overruns, and operational shutdowns in its
    nuclear program.  Because TVA has excluded the costs of its
    nonproducing nuclear assets from its electricity rates for a long
    period, its current rates are too low to recover all relevant costs.
    To complete its nuclear construction activities and modernize its
    coal and hydroelectric plants, TVA will have to spend billions of
    dollars more, adding further pressure to increase electricity rates.

    TVA's links to the federal government and its high debt limit have
    enabled it to borrow the billions of dollars needed for its nuclear
    construction program.  TVA's electricity rates and power production
    decisions are not subject to the same oversight that other utilities
    routinely face.  Although protected from competition by legislation
    and its customer contracts in the short run, TVA will have to compete
    with other utilities in the long run.  Because of its heavy debt
    burden and resultant high financing costs, TVA lacks the flexibility
    to successfully compete in this environment.

    While no cash-flow crisis exists today, GAO believes that TVA's
    financial condition threatens its long-term viability and places the
    federal government at risk.  Resolving TVA's financial problems will
    be costly and require painful decisions.  GAO is highlighting several
    options that could reduce risk to federal taxpayers and help prepare
    TVA to compete in the electricity market.

       GAO'S ANALYSIS
    ---------------------------------------------------------- Chapter 0:4

          TVA'S FINANCIAL CONDITION
          PUTS IT AT A COMPETITIVE
          DISADVANTAGE
    -------------------------------------------------------- Chapter 0:4.1

    Compared with neighboring utilities, TVA's financial
    condition--especially its high financing costs and deferred
    assets--places it at a competitive disadvantage.  For example, TVA's
    high debt resulted in its paying $1.9 billion, or 35 percent of its
    power revenues in 1994, for financing costs.  Similar expenses for
    TVA's neighboring utilities averaged only 16 percent of revenues.
    Furthermore, 69 percent of TVA's $28 billion of net property, plant,
    and equipment was related to the nuclear program, which generated
    only 14 percent of TVA's electricity in 1994.  In contrast, only 19
    percent of these assets were related to TVA's coal and hydroelectric
    programs, which generated almost 86 percent of TVA's electricity.

    Among other factors, TVA's decisions to defer from its electricity
    rates the costs for nonproducing nuclear assets that do not generate
    electricity or produce revenue have permitted TVA to maintain stable
    electricity rates since 1988.  When these costs are recognized,
    pressure to increase TVA's rates appears likely, despite recent
    management steps to reduce TVA's operating costs.  These steps,
    including a substantial reduction in employees and refinancing of
    debt, leave little room for TVA to further reduce its controllable
    costs.  TVA has recognized the problems created by high debt.  In
    December 1994, TVA announced plans to limit its debt to about $2
    billion to $3 billion below the $30 billion ceiling and to reach this
    limit by the end of fiscal year 1997.

    In contrast to TVA, neighboring utilities have far less financing
    costs and deferred assets.  These two factors provide neighboring
    utilities with greater flexibility to meet price competition.  For
    example, in 1994, TVA's ratio showing costs deferred from current
    rates to be recouped in the future was more than 15 times higher than
    the average ratio for neighboring utilities.  Furthermore, despite
    having excluded its deferred assets, TVA's rates, while low, are not
    the lowest compared to neighboring utilities.

          TVA'S POWER RESOURCE
          DECISIONS INCREASE
          FINANCIAL, OPERATING, AND
          COMPETITIVE RISKS
    -------------------------------------------------------- Chapter 0:4.2

    TVA's nuclear power program has had a long history of construction
    and operating problems.  For example, one unit currently under
    construction--Watts Bar 1--is expected to cost $6.8 billion at
    completion and has been under construction for over 22 years.
    Another unit--Browns Ferry 3--went into commercial service in 1977,
    was shut down in 1985, and is not expected to be restarted until
    1996.  Furthermore, the total estimated costs to bring Watts Bar 1
    and Browns Ferry 3 into commercial operation increased about $1.6
    billion and $1.2 billion, respectively, between fiscal years 1990 and
    1994.  In addition, TVA has $6.2 billion in deferred assets
    associated with three nuclear units that are currently in a
    "mothballed" status.

    Because of changing market conditions and uncertain levels of demand
    for electricity, many utilities are investing in alternative power
    resource options.  Many other utilities are planning to meet their
    future power needs by building lower cost natural gas fired units or
    purchasing power from outside sources.  During fiscal year 1994, TVA
    spent $2 million a day at Watts Bar 1 and Browns Ferry 3.  TVA also
    anticipates spending from $240 million to $301 million annually (in
    constant 1994 dollars) for the next 26 years to upgrade its aging
    coal and hydroelectric plants.  TVA will continue to rely on these
    coal and hydroelectric plants to produce most of its electricity.
    Further delays and cost overruns at its nuclear units could limit
    funds available for needed improvements to these plants.

          TVA'S COMPETITIVE PROSPECTS
          ARE PROTECTED IN THE SHORT
          RUN
    -------------------------------------------------------- Chapter 0:4.3

    Although TVA's financial condition is troubled, in the short run TVA
    is protected from the pressures of competition.  For example, in
    nearly all instances, contracts with TVA's 160 distributors require
    that a 10-year notice be given before they can switch to another
    power company.  Also, TVA is not required under existing legislation
    to allow other utilities to use its transmission lines to provide
    service to TVA's customers.

    However, even these protections do not guarantee that TVA will remain
    isolated from competition.  For instance, because they are concerned
    about potential rate increases, some of TVA's distributors have
    solicited and received bids to buy power from other suppliers.
    Furthermore, industrial representatives said that TVA needs to reduce
    its rates to be competitive with the low-cost utilities in the
    region.

    An April 1995 report commissioned by TVA concluded that TVA is
    well-positioned to meet competitive challenges because its financial
    condition is sufficiently flexible and strong.  The report
    recommended a phased approach to remove legislative restrictions so
    TVA could become fully competitive.

    While agreeing that TVA will have to compete in the future, GAO
    disagrees that TVA's financial condition will allow it to compete
    successfully.  Furthermore, GAO disagrees that removing existing
    legislative protections would make TVA more competitive at this time.
    On the contrary, these protections keep TVA from being placed in a
    position where competition could adversely affect its long-term
    financial viability.

          OPTIONS FOR ADDRESSING TVA'S
          PROBLEMS
    -------------------------------------------------------- Chapter 0:4.4

    TVA has taken various actions and has announced other plans to reduce
    its costs and limit its debt to make itself more competitive.
    However, GAO does not believe that these actions will be sufficient
    in the long term to adequately protect the interests of federal
    taxpayers and enable TVA to meet competitive challenges.  TVA does
    not face a cash-flow problem today only because it has nearly $4
    billion of remaining borrowing authority.

    A number of options are available to address TVA's financial
    problems.  For example, TVA could raise rates.  With the additional
    cash generated from operations, TVA could reduce its borrowing or pay
    down its debt; however, this course of action would make TVA's rates
    less competitive, thus aggravating its long-term financial health.

    The Congress also has a broad range of options.  For example, the
    Congress could allow TVA to continue to try and work the problems out
    on its own, remove statutory barriers to competition, or privatize
    TVA.  Each of these options would involve tradeoffs.  The Congress
    could also forgive TVA's federal debt or restructure some or all of
    its debt so that TVA repays at a lower interest rate.  These options
    would have a negative impact on the federal deficit.  And the
    Congress could subject TVA to greater management oversight by
    requiring that its rates and resource decisions be reviewed and
    approved by an external body, or by expanding its Board to include a
    broader spectrum of interests.

    These and other options that are discussed in this report are not
    intended to suggest a specific course of action but rather to provide
    a basis for discussion on how to protect the interests of everyone
    who has a stake in TVA's future.

       AGENCY COMMENTS
    ---------------------------------------------------------- Chapter 0:5

    TVA strongly disagreed with GAO's assessment in many areas.  TVA
    officials stated that TVA is a financially healthy corporation that
    is well able to service its debt now and in the future.  TVA
    officials further stated that it has made the tough decisions
    necessary to prepare for the coming era of deregulation and
    competition in the utility industry.

    GAO agrees that TVA has taken a number of actions in recent years to
    improve its financial position, including downsizing its work force
    and refinancing its debt at lower interest rates.  These actions,
    however, do not significantly diminish the financial problems
    identified in this report that raise questions about TVA's long-term
    viability.  As a result, GAO continues to believe that TVA has little
    flexibility to meet the competitive challenges that lie ahead; and to
    the extent that TVA cannot compete effectively and improve its
    financial condition, the federal government is at risk for some
    portion of TVA's debt.  For these reasons, GAO continues to believe
    that a dialogue is needed among the key decisionmakers concerning
    options available to better protect the government's interests and
    help TVA fulfill its announced intention of becoming a competitive
    and financially viable utility.

    TVA's written comments are presented in appendix IV, and GAO's
    responses are discussed in chapter 5 and appendix IV.

    INTRODUCTION
    ============================================================ Chapter 1

    The Tennessee Valley Authority (TVA) is a multipurpose, independent,
    federal corporation established by the Tennessee Valley Authority Act
    of 1933.  The act established TVA to improve the quality of life in
    the Tennessee River Valley by improving navigation, promoting
    regional agricultural and economic development, and controlling the
    flood waters of the Tennessee River.  To those ends, TVA erected dams
    and hydroelectric power facilities on the Tennessee River and its
    tributaries.

    To meet the need for more electric power during World War II, TVA
    expanded beyond hydropower, building coal-fired power plants.  In the
    1960s, TVA decided to add nuclear generating units to its power
    system.  Today, TVA operates one of the nation's largest power
    systems, with a dependable capacity in service of about 26,000
    megawatts (MW).\1 The system consists primarily of 113 hydroelectric
    units, 59 coal-fired units, and 3 operating nuclear units.  TVA sells
    power in seven states--Alabama, Georgia, Kentucky, Mississippi, North
    Carolina, Tennessee, and Virginia--as illustrated in figure 1.1.

       Figure 1.1:  Map of TVA's
       Service Area

       (See figure in printed
       edition.)

    Source:  TVA 1994 Annual Report.

    TVA sells power at wholesale rates to 160 municipal and cooperative
    distributors and to a number of directly served large industrial
    customers and federal agencies.  These distributors, in turn, sell
    the power on a retail basis to more than 7 million people in an
    80,000 square mile region.  TVA had about 19,000 employees on
    September 30, 1994.  TVA's power program generated about $5.4 billion
    in 1994 revenues, with about $4.6 billion of this amount coming from
    the 160 distributors.

    TVA's programs are divided into two types of activities--the nonpower
    programs and the power program.  The nonpower programs, such as water
    resources, navigation, and flood control, are primarily funded
    through federal appropriations and user fees.  These programs
    received about $140 million in funding in fiscal year 1994 and are
    operated primarily within the 41,000 square mile Tennessee River
    watershed.  TVA's power program is included in the federal budget as
    a public enterprise revolving fund called the TVA Fund.  Revolving
    funds are generally intended to be self-supporting, such that their
    operating expenses are paid for by operating revenues.

    --------------------
    \1 A megawatt is one million watts of electricity.

       AUTHORIZING LEGISLATION
       ESTABLISHED TVA AS A WHOLLY-
       OWNED GOVERNMENT CORPORATION
    ---------------------------------------------------------- Chapter 1:1

    TVA's authorizing legislation allows it to operate with a high degree
    of independence.  The TVA Act of 1933 did not subject TVA to the
    regulatory and oversight requirements that must be satisfied by other
    power administrations or electric utilities.  For example, unlike
    other utilities, the rates TVA charges for its electric power and its
    power resource decisions are not subject to review and approval by
    state public utility commissions or the Federal Energy Regulatory
    Commission (FERC).

    Under existing legislation, FERC is primarily responsible for (1)
    regulating rates, terms, and conditions for the sale and transmission
    of electricity sold at wholesale in interstate commerce, (2)
    regulating mergers, dispositions, and acquisitions of facilities used
    for the transmission of electricity in interstate commerce or the
    sale of wholesale power in interstate commerce (referred to as
    jurisdictional facilities), and (3) authorizing the issuance of
    securities in those instances where states do not regulate them.
    Existing legislation requires that rates for wholesale electric
    energy sales and for the transmission of electric energy in
    interstate commerce be "just and reasonable," without undue
    preferences or advantages to buyer or seller.  State public utility
    commissions are primarily responsible for approving retail
    electricity rates and resource decisions for utilities under their
    jurisdiction.

    In recent years, both federal and state regulators have acted to
    promote competition in wholesale electricity markets.  For example,
    FERC has approved wholesale electricity rates that were market based
    (determined through a competitive or negotiated process between the
    purchasing utility and the potential supplier).  Previously, FERC
    generally approved rates only if they were cost based (based on the
    seller's cost of supplying power).

    As opposed to the regulatory environment faced by other utilities,
    all authority to run and operate TVA is vested in TVA's three-member
    Board of Directors, including the sole authority to set wholesale
    electric power rates and approve the retail rates charged by TVA's
    distributors.\2 The three board members are full-time employees of
    TVA.  They are appointed by the President, with the advice and
    consent of the Senate, and serve 9-year, overlapping terms of office.
    The President designates one member as the chairman.

    The issue of TVA's oversight has been examined several times in the
    past.  For example, in a 1982 report, we pointed to a growing concern
    with TVA activities and identified options for improving oversight
    and accountability.\3 These options included periodic congressional
    oversight hearings and/or placing the TVA rate-setting process under
    FERC.  In a 1983 report, we reported on our concerns about TVA's
    management and concluded that the issue of the adequacy of TVA's
    oversight needed greater attention.\4 In a 1987 report entitled
    "TVA--A Path to Recovery," the Southern States Energy Board\5
    concluded that "...additional mechanisms are needed to ensure that
    TVA is accountable for its actions to its ratepayers, Congress, and
    the American public." The report further stated that "There must be a
    fundamental change in TVA's structure to effectively respond to
    today's challenges and meet the necessary standards of
    accountability.  A larger Board should be established, comprised of
    part-time directors who would be responsible for policy-making and
    oversight of TVA's management."

    In 1959, the Congress amended the TVA Act to authorize the use of
    debt financing to pay for capital improvements for power programs.
    Under this legislation, the Congress required that TVA's power
    program be "self-financing" through revenues from electricity sales.
    For capital needs in excess of internally generated funds, TVA was
    authorized to borrow by issuing bonds.  TVA's debt limit is set by
    the Congress and was established at $750 million in 1959.  Since
    then, TVA's debt limit has been increased four times by the Congress:
    to $1.75 billion in 1966, $5 billion in 1970, $15 billion in 1975,
    and $30 billion in 1979.

    The 1959 amendments to the TVA Act also protected surrounding
    utilities from competition with TVA because it was a low-cost federal
    utility.  By establishing what is commonly referred to as the "TVA
    fence," the 1959 act prohibited TVA--with some exceptions--from
    entering into contracts to sell power outside the service area TVA
    and its distributors were serving on July 1, 1957.  TVA was allowed
    to sell power to other utilities outside of its service area if the
    power is surplus to the requirements of TVA's own customers.  TVA can
    also buy power when needed.

    --------------------
    \2 TVA is subject to some other regulatory actions, such as the
    Nuclear Regulatory Commission's (NRC) role in licensing and
    inspecting nuclear facilities and the Environmental Protection
    Agency's environmental regulations.

    \3 Tennessee Valley Authority--Options for Oversight (GAO/EMD-82-54,
    Mar.  19, 1982).

    \4 Triennial Assessment of the Tennessee Valley Authority--Fiscal
    Years 1980-1982 (GAO/RCED-83-123, Apr.  15, 1983).

    \5 The Board was comprised of government and industry experts with
    diverse experience in energy operations, management, and regulation.

       LEGISLATIVE CHANGES CREATE A
       COMPETITIVE ELECTRICITY MARKET
       FOR OTHER UTILITIES
    ---------------------------------------------------------- Chapter 1:2

    Historically, investor-owned utilities (IOU) and other electricity
    providers have operated as regulated monopolies.  Under traditional
    utility regulation, electric utilities' rates and investments in
    generation, transmission, and distribution facilities were regulated
    by state public utility commissions.  Under these arrangements, IOUs
    were required to provide electric service to all customers within
    their power service areas.  In exchange, they received exclusive
    service areas.  To serve their customers, utilities could incur costs
    for building new generating plants and operating the power system.
    IOUs generally recoup these costs plus a regulated return through
    their electricity rates.

    In the last 25 years, laws have encouraged the creation of a
    competitive market.  The Public Utilities Regulatory Policies Act of
    1978 facilitated the creation of small (less than 80 MW of capacity)
    electricity generators that were exempt from many state and federal
    regulations.  Called "nonutility generators" or "independent power
    producers" (IPP),\6 these entities typically used new technologies to
    generate power, such as cogenerating plants\7 or small natural gas
    fired generation units.  According to the National Independent Energy
    Producers,\8 by the end of 1994, these entities accounted for about
    51,000 MW of capacity in the United States (or about 6 percent of
    total capacity in the nation)--directly competing with utility-owned
    capacity and placing downward pressures on electricity rates.

    Today, many IPPs pose a threat to IOUs, in part because IPPs can
    establish generation facilities near large industrial and municipal
    customers and sell power to these customers for a lower rate than the
    established utility.  For example, in upstate New York, an IPP is
    building a 1,000 MW cogeneration plant next to two industrial plants,
    thereby luring away from the established utility one of its largest
    customers as well as a smaller one.  The IPP plans to sell 65 MW to
    the two industrial customers and its remaining power to other
    utilities.

    The Energy Policy Act of 1992 promoted increased competition in the
    electricity market.  The act encouraged open transmission of
    electricity by allowing wholesale electricity customers, such as
    municipal distributors, to purchase electricity from any supplier,
    even if that power must be transmitted over lines owned by another
    utility--referred to as wheeling of power.\9 Under the act's
    provisions, FERC can compel a utility to transmit electricity
    generated by another utility into its service area for resale.
    However, the act protects TVA from the new wheeling requirements by
    preventing competitors from using TVA's transmission system to sell
    to customers inside TVA's service area.  In addition, the act
    required TVA to conduct a least-cost planning program--also referred
    to as an integrated resource plan (IRP).  For further information
    about TVA's ongoing IRP process, see appendix I.

    Electricity markets are becoming more competitive and, as a result,
    FERC expects wholesale and retail electricity rates to drop.  For
    example, according to Virginia Power officials, a subsidiary of
    American Electric Power offered to sell electricity to a rural
    electric cooperative in Virginia--a wholesale customer of Virginia
    Power.  To retain this business, Virginia Power cut its rates by over
    5 percent.  State regulators are now exploring opportunities to make
    retail markets competitive.  Several states, including California,
    Michigan, and Washington, are exploring whether to introduce "retail
    wheeling"--a concept under which end-use customers will choose the
    utility that provides them with electric power, much like consumers
    today choose a long distance telephone company.

    While TVA is currently exempt from wheeling requirements and has
    other barriers to protect it from competition in the short term, it
    has recently acknowledged through its actions and announcements that
    it will have to compete in the future.  Industry experts and
    representatives of TVA's customers have also stated that TVA's
    service area cannot remain isolated from competition over the long
    run.

    --------------------
    \6 IPPs, which are firms that produce electric power to be sold at
    wholesale rates, are not considered utilities because they do not
    produce power for a service area and do not engage in transmitting or
    distributing power.

    \7 The cogeneration of power involves the use of steam, waste heat,
    or resultant energy from a commercial or industrial plant or process
    for generating electricity.

    \8 National Independent Energy Producers is a trade association
    representing many nonutility generators of electricity and IPPs.

    \9 Wheeling of power refers to the use of a utility's transmission
    system when the power is being bought and sold by parties other than
    the transmitting utility.  Fees are paid to the transmitting utility
    for use of its system.

       HISTORY OF TVA'S NUCLEAR POWER
       PROGRAM
    ---------------------------------------------------------- Chapter 1:3

    TVA made its commitment to nuclear power in the late 1960s and early
    1970s, when power sales were growing at a steady rate and were
    expected to double every 10 years.  In the Tennessee Valley, the
    number of electricity customers rose to over 2 million in the 1960s
    and about 30 percent of all the homes were heated with electricity.
    By 1970, TVA customers used nearly twice as much electricity as the
    national average.  At that time, TVA was experiencing an annual
    growth rate of about 8 percent in demand for electricity, and TVA's
    forecasts through the mid-1970s were showing continued high growth in
    demand.

    TVA believed, along with many in the utility industry, that new
    generating capacity was needed to satisfy its forecast demand.  To
    meet that need and lessen the environmental problems associated with
    its coal plants, TVA embarked on a highly ambitious nuclear power
    plant construction program.  In 1966, TVA announced plans to build 17
    nuclear units at seven sites in Tennessee, Alabama, and Mississippi.
    In 1967, it started building the nation's largest nuclear power
    facility--Browns Ferry in north Alabama.

    However, instead of increasing, electricity consumption declined in
    the mid-1970s following the 1973 energy crisis and again in the late
    1970s and 1980s as a result of higher energy costs and lower economic
    growth.  Also, in 1975, after an electrical insulation fire damaged
    the Browns Ferry plant and again in 1979 after the Three Mile Island
    nuclear accident, NRC issued extensive new safety regulations that
    applied to all plants, including those under construction or in
    operation.  The decreasing demand for electricity, coupled with the
    increased regulation surrounding nuclear power, caused the electric
    utility industry to rethink the role that nuclear power would play in
    meeting the nation's demand for electricity.

    By the early 1980s, most utilities had chosen to cancel ongoing or
    planned nuclear plants.  After reassessing its forecast demand using
    a more sophisticated methodology, TVA began scaling back its nuclear
    plans by canceling 8 of its 17 planned nuclear units in 1982 and 1984
    after investing almost $5 billion\10 in the 8 units.  The costs
    associated with these plants were written off over 10 years and
    recovered through rates.

    TVA's nine remaining nuclear units have had a long history of
    operating and construction problems.  The status of these units as of
    March 1, 1995, was as follows:

      Three units were operational:  Browns Ferry 2, Sequoyah 1, and
         Sequoyah 2.

      Two units were actively under construction:  Watts Bar 1 has been
         under construction for 22 years and has not yet operated.
         Browns Ferry 3 began operations in 1977, but was shut down in
         1985 because of repeated operational and maintenance errors.

      Four units were in a "mothballed" status:  Browns Ferry 1 was shut
         down because of ineffective management and technical
         deficiencies.  Construction has been suspended indefinitely on
         Watts Bar 2, Bellefonte 1, and Bellefonte 2.  TVA plans to
         maintain these units in their present status until completion of
         its IRP in late 1995.  At that time, it will consider such
         alternatives as (1) converting the units to another technology
         such as natural gas, (2) replacing them with different types of
         supply- and demand-side resource options, (3) completing the
         construction of one or more units as nuclear plants in
         partnership with others, or (4) maintaining them in a mothballed
         state pending a later decision.

    Today, TVA is the only utility in the nation actively constructing
    nuclear power plants.  To date, its investment in nuclear units has
    totaled about $25 billion, of which about $5 billion has been spent
    on units that are now operating.  Table 1.1 summarizes the current
    status of TVA's nuclear program.

                              Table 1.1

                Status of TVA's Originally Planned 17
                    Nuclear Units as of July 1995

                              Year           Year
    Nuclear plants/   construction     commercial        Current
    units                  started  service began         status
    ---------------  -------------  -------------  -------------
    Browns Ferry              1967           1974     shutdown\a
     unit 1                   1967           1975      operating
     unit 2                   1968           1977  construction\
     unit 3                                                    b
    Sequoyah
     unit 1                   1970           1981      operating
     unit 2                   1970           1982      operating
    Watts Bar
     unit 1                   1973         1996\c   construction
     unit 2                   1973           none   unfinished\a
    Bellefonte
     unit 1                   1974           none   unfinished\a
     unit 2                   1974           none   unfinished\a
    Phipps Bend
     unit 1                   1977           none      cancelled
     unit 2                   1977           none           1982
                                                       cancelled
                                                            1982
    Hartsville
     A units 1&2              1976           none      cancelled
     B units 1&2              1977           none           1984
                                                       cancelled
                                                            1982
    Yellow Creek
     unit 1                   1978           none      cancelled
     unit 2                   1978           none           1984
                                                       cancelled
                                                            1984
    ------------------------------------------------------------
    \a Considered to be in "mothballed" status.

    \b Browns Ferry unit 3 was originally opened in 1977 and shut down in
    1985.  TVA plans to have the unit in full commercial operation by
    February 1996.

    \c TVA's estimated date of commercial operation is February 1996.

    Source:  GAO analysis of TVA data.

    --------------------
    \10 Unless noted otherwise, amounts in this report are in
    current-year dollars.

       OBJECTIVES, SCOPE, AND
       METHODOLOGY
    ---------------------------------------------------------- Chapter 1:4

    On March 9, 1994, the Subcommittee on Investigations and Oversight of
    the House Committee on Public Works and Transportation held an
    oversight hearing on TVA.  The hearings focused on TVA's nuclear
    power program, debt level, load forecasting, and resource planning
    process.  During these hearings, concerns were expressed about TVA's
    ability to construct and operate its nuclear units reliably, the
    impact of TVA's debt on its rates and competitiveness, and the
    accuracy of TVA's load forecasts.

    Because of concerns raised during and after the March 1994 hearing,
    several Members of the House and Senate requested that we undertake
    an examination of TVA.  On the basis of subsequent briefings and
    meetings with the requesters' offices, we agreed to examine the
    implications for TVA and possibly the federal government of the
    financial issues facing TVA in light of the increasingly competitive
    electric utility market.

    In this report, we present information and analyses on (1) TVA's
    financial condition compared with neighboring utilities (in chapter
    2), (2) TVA's power resource decisions (in chapter 3), (3) TVA's
    short-term competitive prospects (in chapter 4), and (4) options for
    addressing TVA's problems (in chapter 5).  In response to other
    issues raised, we also discuss TVA's integrated resource planning
    process in appendix I, its past and present load forecasting
    methodologies in appendix II, and its use of in-substance defeasance
    to refinance debt in appendix V.  Additional information on our
    objectives, scope, and methodology, including a listing of the
    various organizations and groups we contacted, is contained in
    appendix III.

    Where possible, we used audited fiscal year 1994 financial data for
    TVA and the neighboring utilities.  We conducted our review between
    June 1994 and July 1995 in accordance with generally accepted
    government auditing standards.  We requested written comments from
    the chairman of the Tennessee Valley Authority or his designee.  TVA
    provided written comments on a draft of this report.  These comments
    are reprinted in appendix IV.

    TVA'S FINANCIAL CONDITION WILL
    MAKE IT DIFFICULT TO COMPETE
    ============================================================ Chapter 2

    As of September 30, 1994, TVA had about $26 billion of total debt.
    This debt resulted in TVA paying $1.9 billion in financing costs,\1
    which represented 35 percent of its revenues in fiscal year 1994.  At
    the same time, $14 billion of nonproducing nuclear assets\2 have not
    been included in TVA's revenue requirements\3 and are thus excluded
    from current rates.  Inclusion of these costs in future revenue
    requirements will likely increase TVA's rates.

    TVA's financing costs and deferred assets\4 place it at a competitive
    disadvantage when compared to the financial condition of surrounding
    IOUs.  IOUs have substantially less financing costs and deferred
    assets than TVA.  These factors provide the surrounding IOUs with
    greater flexibility to meet rate competition.  Despite having
    excluded its deferred assets from current rates, TVA's rates are not
    the lowest when compared with these surrounding IOUs.

    --------------------
    \1 Financing costs include interest expense on short- and long-term
    debt, interest on appropriation investment (TVA only), and dividends
    on preferred and common stock (IOUs only).  Since TVA does not issue
    stock, its financing costs consist of interest charges only.
    Preferred and common stock dividends were included in the IOUs'
    financing costs to reflect the difference in the capital structure of
    these entities and TVA.

    \2 TVA's nonproducing nuclear assets include investment in nuclear
    units that are recorded in the construction in progress and deferred
    nuclear units accounts on TVA's balance sheet.  These units neither
    generate electricity nor produce revenue.

    \3 Revenue requirements refer to the amount of revenue necessary to
    cover all operating expenses and debt service for TVA's power
    program.  Increases in revenue requirements will cause a rate
    increase only if TVA cannot offset them.  TVA projects its
    requirements annually and uses this estimate as the basis for setting
    electricity rates.

    \4 In addition to its nonproducing nuclear assets, TVA has an
    additional $2 billion of construction in progress involving
    non-nuclear assets.  For IOUs, deferred assets include only
    construction in progress.

       TVA HAS SUBSTANTIAL DEBT AND
       SIGNIFICANT COSTS FOR
       NONPRODUCING NUCLEAR ASSETS
    ---------------------------------------------------------- Chapter 2:1

    TVA has financed its large nuclear investment primarily by issuing
    debt (borrowing).  Current rates must recover the substantial amount
    of annual interest on this debt, including the portion related to
    TVA's nonproducing nuclear assets.  In addition, we estimate that
    TVA's $14 billion of nonproducing nuclear assets will increase its
    future revenue requirements by at least 9 percent.

          LARGE INVESTMENT IN NUCLEAR
          POWER ASSETS
    -------------------------------------------------------- Chapter 2:1.1

    On the basis of historic costs reflected in TVA's balance sheets,
    since its construction program began in 1966, TVA has spent over $25
    billion on nuclear assets.  This includes the costs of eight
    cancelled nuclear plants that were previously written off, along with
    all other nuclear costs on TVA's balance sheet as of September 30,
    1994.  As stated in chapter 1, only 3 of the planned 17 units are
    currently operating.

    On September 30, 1994, TVA's power program had net assets of almost
    $32 billion, ranking it in terms of assets as one of the largest
    electric utilities in the United States.  TVA's asset composition
    reflects the capital intensive requirements of the electric utility
    industry.  Nearly 90 percent ($28.1 billion) of TVA's net assets were
    classified as property, plant, and equipment (PP&E), including coal,
    hydroelectric, and nuclear power units and transmission lines.  Of
    the $28.1 billion of net PP&E, $19.3 billion was invested in nuclear
    power generation assets at September 30, 1994.

    The substantial investment in nonproducing nuclear assets is evident
    by comparing the residual investments, net of depreciation, in TVA's
    various fuel sources with actual power generated, as shown in figure
    2.1.  Although investment in nuclear assets accounted for nearly 69
    percent of TVA's net PP&E as of September 30, 1994, TVA's nuclear
    units supplied only 14 percent of its total system power generation.
    In contrast, TVA's coal and hydroelectric units accounted for nearly
    19 percent of net PP&E on September 30, 1994, while supplying almost
    86 percent of TVA's generated power.

       Figure 2.1:  TVA's $28 Billion
       in Net Property, Plant, and
       Equipment as of September 30,
       1994, and Power Generation by
       Fuel Source for Fiscal Year
       1994

       (See figure in printed
       edition.)

    Note:  Assets are net of accumulated depreciation.

    Source:  TVA 1994 financial statements.

          SUBSTANTIAL DEBT INCURRED
    -------------------------------------------------------- Chapter 2:1.2

    TVA finances its PP&E primarily with debt.  As of September 30, 1994,
    TVA had cumulatively financed 77 percent of its gross PP&E with debt.
    In practice, TVA issues debt when its expenditures for PP&E exceed
    the net cash it generates from operations.  For example, in fiscal
    year 1994, TVA's expenditures for PP&E were $2 billion while net cash
    from operations amounted to about $1.1 billion.  As a result, TVA's
    total outstanding debt increased during 1994 by approximately $900
    million.

    As of September 30, 1994, TVA's debt consisted primarily of about
    $22.2 billion of outstanding long-term debt, about $3.3 billion of
    short-term debt, and approximately $0.4 billion of appropriated
    debt.\5 This last form of debt represents funds appropriated or
    property transferred by the federal government to TVA for power
    facilities and is not included in its statutory debt calculation.
    TVA is required by section 15d of the TVA Act to repay the
    approximate $0.4 billion debt with interest to the United States
    Treasury.  TVA's outstanding debt subject to the $30 billion
    statutory limit has grown steadily from $15 billion at the end of
    fiscal year 1983 to $25.5 billion at the end of fiscal year 1994.
    TVA's debt resulted in fiscal year 1994 total interest expense of
    nearly $1.9 billion,\6 representing about 35 percent of TVA's
    operating revenue.  We estimate that $833 million of TVA's gross
    interest expense is associated with its $14 billion investment in
    nonproducing nuclear assets.  Figure 2.2 breaks down TVA's
    capitalization\7 and liabilities by balance sheet account.

       Figure 2.2:  TVA's $32 Billion
       in Total Capitalization and
       Liabilities as of September 30,
       1994

       (See figure in printed
       edition.)

    Source:  TVA 1994 financial statements.

    TVA's $30 billion statutory debt limit provided TVA with authority to
    borrow billions of dollars without seeking congressional approval.
    In 1979, TVA's debt ceiling was doubled from $15 billion to $30
    billion.  The $15 billion increase in borrowing authority greatly
    exceeded what was then envisioned as being required to complete TVA's
    nuclear construction program.  Therefore, TVA did not have to request
    any additional borrowing authority despite the operational and
    construction problems associated with its nuclear program over the
    last 15 years.

    According to credit rating agencies, TVA's creditworthiness is based
    on its links to the federal government rather than on the criteria
    applied to a stand-alone corporation.  As a result, the private
    lending market has provided TVA with access to billions of dollars of
    financing at favorable rates.  In accordance with section 15d of the
    TVA Act, TVA's debt issuances explicitly state on the bond prospectus
    that the bonds are neither legal obligations of, nor guaranteed by,
    the U.S.  government.  Nevertheless, TVA's bonds are rated by the
    major credit rating agencies as if they have an implicit federal
    guarantee.  The Standard & Poor's credit rating agency's "AAA" rating
    for TVA bonds is not based on a default, risk-based analysis.
    Instead, the credit rating agency based its rating on the
    determination that TVA's bonds have characteristics that would confer
    "agency status,"\8 similar to securities issued by
    government-sponsored enterprises.\9 TVA's "AAA" rating provides it
    with the ability to borrow at lower interest rates and provides it
    with a competitive advantage.  An official from Moody's credit rating
    agency confirmed that it employs substantially the same criteria as
    employed by Standard & Poor's when rating TVA's bonds.

    --------------------
    \5 Of TVA's total debt, $3.9 billion is owed to the federal
    government ($3.4 billion is owed to the Federal Financing Bank, about
    $0.4 billion is appropriated debt, and about $0.1 billion is owed to
    the U.S.  Treasury).  For purposes of comparison later in this
    chapter, TVA's total debt includes $215 million in capital lease
    obligations.

    \6 Total interest expense equals the sum of gross interest expense
    plus the interest on appropriated debt.

    \7 Capitalization represents the sum of all equity accounts and
    long-term debt.

    \8 Standard & Poor's rating criteria attribute agency status to
    securities issued by entities related to the federal government
    because the securities have some of the attributes of U.S.  Treasury
    securities, such as being exempt from Securities and Exchange
    Commission registration requirements.

    \9 Government-sponsored enterprises are federally established,
    privately owned corporations designed to increase the flow of credit
    to specific economic sectors.  Examples include the Federal National
    Mortgage Association, Federal Home Loan Mortgage Corporation, and
    Student Loan Marketing Association.

          TVA HAS DEFERRED SIGNIFICANT
          COSTS
    -------------------------------------------------------- Chapter 2:1.3

    TVA is excluding $14 billion in nonproducing nuclear assets from its
    revenue requirements and, hence, from its rates.  TVA considers these
    assets to be construction in progress.  As such, the costs of these
    assets will not be included in rates until the units are either
    completed and placed into service or cancelled.  TVA charges the cost
    of its PP&E and cancelled plant to ratepayers through depreciation
    and amortization expense.\10 TVA is required by law to set rates so
    that power revenues cover all operating expenses, including
    depreciation and amortization.  While the nonproducing nuclear assets
    are not presently being depreciated or amortized, the estimated $833
    million of annual interest expense from the debt associated with
    these assets is included in current rates.

    Any business in a capital-intensive industry would likely have a
    certain level of PP&E that is under construction and not being
    depreciated.  However, the size and length of TVA's deferral is
    unique.  On September 30, 1994, the $14 billion in nonproducing
    nuclear assets accounted for about 73 percent of TVA's $19.3 billion
    net nuclear PP&E.  In addition, Watts Bar 1 has been under
    construction for 22 years--about double the average construction
    period for TVA's three operating nuclear plants.  Figure 2.3 shows
    the components of net nuclear PP&E for fiscal year 1994.

       Figure 2.3:  TVA's $19.3
       Billion in Net Nuclear
       Property, Plant, and Equipment
       as of September 30, 1994

       (See figure in printed
       edition.)

    Note:  Assets are net of accumulated depreciation.

    Source:  TVA 1994 financial statements.

    By the end of fiscal year 1994, TVA had depreciated $1.4 billion, or
    about 7 percent, of its $20.7 billion investment in gross nuclear
    PP&E.  Therefore, 93 percent of TVA's gross nuclear PP&E as of
    September 30, 1994, must be paid for by future ratepayers.

    --------------------
    \10 Depreciation is the allocation of the expense associated with
    PP&E to each period benefited by the asset.  Amortization is the
    allocation of expenses associated with intangible and other assets,
    such as abandoned plant, to each period benefitted.  Both are
    calculated by dividing the costs of the asset by its estimated useful
    life or allowable period of time.  In this report, we use
    depreciation to describe allocation of costs related to PP&E, and
    amortization to describe allocation of costs for all other assets.

          NONPRODUCING NUCLEAR ASSETS
          WILL IMPACT REVENUE
          REQUIREMENTS
    -------------------------------------------------------- Chapter 2:1.4

    The extent of the increase in revenue requirements will depend on
    when and over what period of time TVA begins recovering its nearly
    $14 billion of nonproducing nuclear assets.  A shorter time period
    increases costs for current ratepayers while giving TVA more
    flexibility in future years; in contrast, a longer period minimizes
    the impact on current rates.  To date, TVA has not decided the time
    period for recovering the $6.2 billion invested in deferred nuclear
    units.  According to TVA, it is considering cancelling the deferred
    units and amortizing the associated costs over 30 years.  When TVA
    cancelled the eight nuclear units during the 1980s, it wrote them off
    over an amortization period of only 10 years.  According to TVA, its
    bond covenants prevent it from charging the deferred nuclear assets
    against retained earnings.  However, TVA has great latitude in
    determining when and over what period the $6.2 billion of costs for
    deferred nuclear units will be brought into revenue requirements.

    If TVA is able to bring Watts Bar 1 and Browns Ferry 3 on line as
    planned, the $8.5 billion of total estimated cost to complete and
    restart these units would be depreciated over their estimated useful
    lives.  TVA has established the useful life of a nuclear reactor to
    be 40 years based on its NRC operating license.  Thus, Watts Bar 1
    would be depreciated over 40 years.  Presently, costs associated with
    restarting Browns Ferry 3, which went into commercial service in
    1977, would be depreciated over the 22 years remaining on its
    operating license.

    For illustrative purposes, we estimated the impact of including
    depreciation and amortization expense for the nonproducing nuclear
    assets on future revenue requirements.  We used the depreciation and
    amortization periods as described above.  Using TVA's cost-to-
    complete projections, we estimated, as shown in table 2.1, that the
    nonproducing nuclear assets would increase TVA's revenue requirements
    by a total of $454 million per year for at least the next 22 years.
    This would result in a 9-percent increase in revenue requirements.
    If the maximum amortization period for its deferred nuclear assets
    was only 15 years, then TVA's annual revenue requirements would
    increase by $660 million, or 12 percent.\11

                              Table 2.1

                 Estimated Annual Increase in Revenue
                Requirements for Nonproducing Nuclear
                   Assets as of September 30, 1994

                        (Dollars in billions)

                             Total      Estimated      Estimated
                         estimated  depreciation/         annual
                        cost to be   amortization    increase in
    Nonproducing      depreciated/     period (in        revenue
    nuclear assets     amortized\a         years)   requirements
    ---------------  -------------  -------------  -------------
    Deferred Nuclear Units
    ------------------------------------------------------------
    Watts Bar 2
     Bellefonte 1             $6.2             30         $0.207
     Bellefonte 2

    Construction In Progress
    ------------------------------------------------------------
    Watts Bar 1                6.8             40          0.170
    Browns Ferry 3             1.7             22          0.077
    ============================================================
    Total                  $14.7 /             --         $0.454
    ------------------------------------------------------------
    \a Total estimated cost assumes TVA will (1) not spend additional
    capital on Watts Bar 2 or Bellefonte 1 and 2 and (2) spend
    approximately $900 million to complete Watts Bar 1 and Browns Ferry 3
    in addition to the $7.6 billion already spent.

    Source:  GAO analysis of TVA data.

    --------------------
    \11 The 9-percent and 12-percent increases were calculated by
    dividing our estimated $454 million and $660 million increases in
    revenue requirements by TVA's 1994 total revenue requirements of $5.3
    billion.  These estimated annual increases do not include any
    additional operating and maintenance expenses.

       TVA HAS SUBSTANTIALLY HIGHER
       FINANCING COSTS AND DEFERRED
       ASSETS THAN NEIGHBORING
       UTILITIES
    ---------------------------------------------------------- Chapter 2:2

    To put TVA's financial condition in perspective, we compared its
    financing costs and deferred assets to nine nearby IOUs.  According
    to industry experts, TVA's competition is most likely to come from
    nearby utilities because of the cost of wheeling power.  In addition,
    as discussed in chapter 4, some of these utilities have submitted
    bids to provide electricity to TVA's customers that are seeking power
    sources other than TVA.  Differences in financing structures between
    TVA and IOUs make a direct comparison somewhat difficult.  However,
    TVA's customers are primarily concerned about electricity rates, not
    financing structure.  Thus comparing TVA to its neighboring IOUs is
    essential.  We believe the ratios we use in our comparison are
    indicators of the ability of TVA to compete with neighboring IOUs.
    Figure 2.4 shows a map of the service areas of TVA and neighboring
    IOUs.

       Figure 2.4:  Map of Service
       Areas of TVA and Neighboring
       IOUs

       (See figure in printed
       edition.)

    Source:  Moody's 1994 Public Utilities Manual and 1993 and 1994
    annual reports of the neighboring IOUs.

    TVA has substantially more financing costs and deferred assets than
    its neighboring utilities.  In five key financial ratios we examined,
    TVA's ratios, overall, indicated that it would be less competitive
    than the other nine utilities.  Three of these ratios are indicators
    of flexibility.  First, TVA's ratio of financing costs to revenue is
    more than twice as high as the average for other utilities, despite
    TVA's ability to borrow at lower interest rates.  TVA's high
    financing costs provide it with less flexibility to reduce costs and
    hence lower its rates to meet price competition.  Because TVA
    continues to borrow and is not currently repaying any principal on
    its nonappropriated debt, this ratio is not likely to decrease soon.
    In addition, TVA's substantial debt subjects it to a much greater
    risk of rising interest rates than its competitors.  To illustrate
    TVA's interest rate risk, if the interest rates at which TVA must
    refinance its approximately $8.4 billion in debt maturing by 1998
    increase by 1 percent, TVA's annual finance costs will increase by
    about $84 million (about 1.6 percent of TVA's 1994 operating
    revenue).

    Second, TVA's ratio of fixed financing costs to revenue is four times
    higher than the average of its neighboring IOUs.  All of TVA's
    financing costs are interest expense and thus are fixed.  On the
    other hand, IOUs common stock dividends are not contractual
    obligations that have to be paid.  Thus, this ratio further shows
    that IOUs have more flexibility than TVA.

    Third, TVA's ratio of net cash from operations\12 to expenditures for
    PP&E and common stock dividends in 1994 was only 57 percent; in
    contrast, the average for the nine IOUs was 95 percent.  Three of the
    nine IOUs had sufficient net cash provided by operations to pay for
    100 percent of their PP&E expenditures and common stock dividends and
    the other six IOUs had ratios ranging from 54 percent to 92 percent.
    This ratio reflects TVA's inability in fiscal year 1994 to pay for
    its PP&E with cash generated from operations.  Unlike most of TVA's
    neighboring IOUs that generated sufficient cash to pay for all or a
    substantial portion of their expenditures for PP&E and common stock
    dividends, TVA had to borrow to pay for about half of its
    expenditures for PP&E.

    The other two ratios are indicators of deferred assets.  For the
    first indicator, TVA's ratio of accumulated depreciation and
    amortization to gross PP&E is 17 percent of its $34 billion
    investment.  The other utilities have ratios averaging 35 percent.
    This ratio indicates that little of TVA's PP&E has been taken into
    its rates via depreciation and amortization, and therefore TVA's
    rates do not reflect all relevant costs.  Second, TVA's deferred
    assets represent 47 percent of its gross PP&E, while the ratio for
    the nine IOUs averaged 3 percent.  The costs that are being deferred
    from current rates must be recouped either through future rates or
    written off against retained earnings.  Including TVA's $15.7 billion
    of deferred assets (as of September 30, 1994) in future rates will
    make TVA less competitive.  In addition, as mentioned previously, TVA
    paid nearly $833 million of interest expense in fiscal year 1994 for
    these assets that do not currently benefit them.

    Table 2.2, which compares these key financial ratios of TVA with the
    nine neighboring IOUs, shows that TVA's high financing costs and
    deferred assets will make it difficult for TVA to compete.  Appendix
    III describes the methodology used for computing these ratios.

                                        Table 2.2

                          Comparison of Key Financial Ratios for
                              TVA and Neighboring IOUs, 1994

                                  ((Figures in percent))

                                         Net cash from
                                 Fixed   operations to     Accumulated
               Financing     financing    expenditures   depreciation/      Deferred
    Utilit      costs to      costs to    for PP&E and    amortization     assets to
    y            revenue       revenue             CSD   to gross PP&E    gross PP&E
    ------  ------------  ------------  --------------  --------------  ------------
    AEP               16             8              90              38             1
    CP&L              16             7             132              35             2
    DR                19             9              86              34             5
    DP                16             7              81              36             4
    ENT               20            13             121              32             2
    IL                14            11             115              31             5
    KU                15             6              54              40             4
    LG&E              14             6              82              35             1
    SC                18             9              92              31             4
    TVA               35            35              57              17            47

    IOU Summary
    --------------------------------------------------------------------------------
    Averag            16             8              95              35             3
     e
    High              20            13             132              40             5
    Low               14             6              54              31             1
    --------------------------------------------------------------------------------
    Note:  CSD - common stock dividends, AEP - American Electric Power,
    CP&L - Carolina Power and Light, DR - Dominion Resources, DP - Duke
    Power, ENT - Entergy, IL - Illinova, KU - KU Energy, LG&E - LG&E
    Energy Corp., and SC - Southern Company.

    Source:  GAO analysis of 1994 annual reports.

    To further illustrate how difficult it will be for TVA to compete
    with neighboring utilities, we compared it with American Electric
    Power.  American Electric has excess electricity to sell and has
    already bid to supply power to two TVA-served distributors.  American
    Electric had about the same amount of system capacity and operating
    revenues as TVA in fiscal year 1994.  However, as shown in table 2.3,
    at the end of fiscal year 1994, TVA had net total assets that were
    more than double those of American Electric.  Thus, in order to
    produce approximately the same amount of power and revenues from its
    operations, TVA needed twice the investment in assets as American
    Electric.

                              Table 2.3

               Fiscal Year 1994 Key Statistics for TVA
                     and American Electric Power

                        (Dollars in millions)

                                              TVA            AEP
    ------------------------------  -------------  -------------
    System capacity (MW)                 25,913\a         23,670
    System sales (in millions of          122,574        116,714
     kilowatt hours)
    Net total assets                      $31,842        $15,713
    Deferred assets\b                     $15,726           $259
    Total debt                            $26,136         $6,309
    Operating revenues                     $5,401         $5,505
    Net financing costs                    $1,772           $887
    Net fixed financing costs              $1,772           $443
    Depreciation and amortization            $639           $572
     expense
    ------------------------------------------------------------
    \a Represents dependable capacity currently in service.  It excludes
    about 2,230 MW of capacity for Watts Bar 1 and Browns Ferry 3 that
    TVA plans to bring into commercial service in 1996.

    \b Deferred assets are included in net total assets.  The deferred
    assets include about $8 billion associated with Watts Bar 1 and
    Browns Ferry 3.

    Source:  1994 annual reports.

    TVA's debt was four times greater than American Electric's, and TVA's
    net financing costs were $1,772 million, or about double that of
    American Electric's.  Because TVA's financing costs are twice as high
    and its net fixed financing costs are four times higher than American
    Electric, it is unlikely that TVA, over the long run, can sustain
    rates that are competitive with those of American Electric.  TVA had
    $67 million more of depreciation and amortization expense in fiscal
    year 1994 than American Electric.  Because TVA will ultimately have
    to amortize or depreciate its nonproducing nuclear assets, its future
    amortization and depreciation expense could be substantially higher
    than American Electric's--possibly twice as high.

    We do recognize that TVA has certain cost advantages over American
    Electric.  For example, TVA had lower fuel costs and does not pay
    federal income tax.  However, these advantages do not offset the
    substantial financing costs advantage of American Electric.

    --------------------
    \12 Net cash from operations represents cash received primarily from
    customers less cash paid for operating expenses.  The cash in excess
    of operations is available for expenditures for PP&E, payment of
    dividends, and other investing and financing activities.  Since TVA
    does not issue common stock, it pays no dividends.

       TVA'S AVERAGE RETAIL RATES ARE
       MIXED COMPARED TO NEIGHBORING
       UTILITIES BUT EXCLUDE
       SUBSTANTIAL COSTS
    ---------------------------------------------------------- Chapter 2:3

    TVA's average retail\13 electricity rates are mixed--some higher and
    some lower--when compared with the rates of neighboring utilities.
    However, as discussed previously, TVA's rates do not include its
    nonproducing nuclear assets and thus do not reflect all relevant
    costs.  In the evolving competitive market, utilities with the lowest
    costs and lowest rates will be at a competitive advantage.

    As shown in figure 2.5, TVA's residential, commercial, and industrial
    rates are low compared with the rates charged by several neighboring
    utilities; however, TVA's rates are less competitive than those of
    some of its neighbors.  Appendix III describes the methodology used
    for computing the rates in figure 2.5.

       Figure 2.5:  TVA's and
       Neighboring Utilities' Average
       Retail Residential, Commercial,
       and Industrial Rates for 1993

       (See figure in printed
       edition.)

    Source:  TVA data and GAO analysis of Financial Statistics of Major
    U.S.  Investor-Owned Utilities 1993, Energy Information
    Administration, U.S.  Department of Energy, January 1995.

    Including TVA's $14 billion of nonproducing nuclear assets and the
    estimated $900 million to complete Watts Bar 1 and Browns Ferry 3 is
    likely to increase TVA's rates and make it less competitive with
    neighboring utilities.  Further compounding TVA's competitive
    position, FERC is projecting that electricity rates will fall.
    Specifically, FERC stated that "more competition will mean lower
    rates for wholesale customers and, ultimately, for consumers."\14

    To analyze TVA's competitiveness with its nine neighboring utilities,
    we compared the investment in PP&E per megawatt of capacity--which
    depicts a utility's efficiency in building generating plants--with
    the average system rates.  TVA's ratio includes the estimated $900
    million to complete Watts Bar 1 and Browns Ferry 3 and their expected
    generating capacity.  As shown in figure 2.6, KU Energy has invested
    less in power plants to meet its demand and thus enjoys lower rates.
    Although TVA's average system rate is currently competitive, once TVA
    brings its nonproducing nuclear assets and costs to complete Watts
    Bar 1 and Browns Ferry 3 into its revenue requirements, it will be
    difficult for TVA to offer rates competitive with its neighbors.
    Appendix III describes the methodology used for computing the average
    system retail rates and ratios in figure 2.6.

       Figure 2.6:  Investment in PP&E
       Per Megawatt of Generating
       Capacity and Average System
       Retail Rates for TVA and
       Neighboring IOUs for Fiscal
       Year 1993

       (See figure in printed
       edition.)

    Source:  GAO analysis of financial data in 1993 annual reports and
    Financial Statistics of Major U.S.  Investor-Owned Utilities 1993,
    Energy Information Administration, U.S.  Department of Energy,
    January 1995.

    --------------------
    \13 Retail rates are the rates paid by the ultimate consumer.  For
    TVA, this would include the cost added by its wholesale distributors.

    \14 Notice of Proposed Rulemaking and Supplemental Notice of Proposed
    Rulemaking (70 FERC 61.357), FERC (Mar.  29, 1995).

    CONTINUING COST OVERRUNS IN
    NUCLEAR PROGRAM COULD IMPACT OTHER
    POWER RESOURCES
    ============================================================ Chapter 3

    TVA has a troubled history of building and operating nuclear plants.
    As mentioned earlier, TVA has "mothballed" four nuclear units and is
    continuing construction and modification at two units to bring them
    into commercial operation in calendar year 1996.  Watts Bar 1 has
    been under construction for over 22 years and is currently estimated
    to cost $6.8 billion at completion.  Browns Ferry 3, shut down in
    1985, is not expected to be put back into commercial operation until
    1996 at a total restart cost of about $1.7 billion.  Both facilities
    have experienced continual delays in their scheduled completions and
    resultant increases in their estimated costs to complete--called cost
    overruns.

    TVA also faces the need for a substantial investment in its primary
    power resources--its aging coal and hydroelectric plants.  TVA
    expects its coal and hydroelectric system to continue to produce most
    of its electricity.  It anticipates spending hundreds of millions of
    dollars per year for the next 26 years to upgrade these plants and
    meet Clean Air Act requirements.  However, further delays and cost
    overruns with Watts Bar 1 and Browns Ferry 3 could limit capital
    funds available for needed improvements to the coal and hydroelectric
    plants.

       CONSTRUCTION ACTIVITIES AT TWO
       NUCLEAR UNITS CONTINUE TO
       INCREASE DEBT AND DEFERRED
       ASSETS
    ---------------------------------------------------------- Chapter 3:1

    Construction activities at two nuclear units, Watts Bar 1 and Browns
    Ferry 3, have involved years of schedule slips and billions of
    dollars of cost overruns.  Despite the problems, according to TVA's
    management, these units are TVA's most cost- effective resource
    options, given its short-term energy needs.  According to TVA, the
    high costs of stopping work while the IRP process determined future
    resources precluded TVA from including these units in the process as
    options.

          SCHEDULE DELAYS AND COST
          OVERRUNS CONTINUE AT WATTS
          BAR 1
    -------------------------------------------------------- Chapter 3:1.1

    Although TVA certified to NRC that Watts Bar 1 qualified for an
    operating license in 1985, NRC did not grant one because of
    unresolved safety concerns--NRC received over 5,000 employee concerns
    regarding construction deficiencies and management practices.
    Between 1990 and 1993, TVA and NRC jointly agreed on 28 major
    corrective programs that must be completed before Watts Bar 1 could
    receive its operating license.  According to TVA, one of these
    corrective programs necessitated that TVA replace 457 miles of
    electrical cable for the unit's safety systems at a cost of $22
    million.  As of March 1995, TVA had closed out 10 of the 28
    corrective programs with NRC.

    Table 3.1 shows the growth in total estimated cost at completion and
    the slipped scheduled operation date for Watts Bar 1 over the last 5
    fiscal years.  Total estimated cost at completion has increased about
    $1.6 billion during this period.

                              Table 3.1

                   Watts Bar 1 Estimated Costs and
               Scheduled Operation Dates as of the End
                      of the Last 5 Fiscal Years

                        (Dollars in millions)

                        1990     1991     1992     1993     1994
    ---------------  -------  -------  -------  -------  -------
    Balance sheet     $4,773   $5,151   $5,553   $6,035   $6,445
     investment at
     year-end
    TVA estimated        476      805      479      516      355
     cost to
     complete
    TVA total         $5,249   $5,956   $6,032   $6,551   $6,800
     estimated
     cost
    Scheduled          March    March     June     Jan.     Feb.
     commercial         1992     1994     1994     1995   1996\a
     operation date
    ------------------------------------------------------------
    \a This date was established in June 1995.

    Source:  GAO analysis of TVA data.

    At an October 1994 meeting with NRC, TVA's management disclosed
    numerous construction problems, first identified in the mid-1980s,
    that TVA had been unable to correct to NRC's specifications.
    According to TVA's management, these problems should have been
    corrected years ago.  However, due to poor quality controls, TVA has
    not been able to show that the deficiencies were corrected.  In some
    instances, TVA had certified to NRC that safety issues were "closed"
    when, according to NRC, they were still unresolved.  At the meeting,
    NRC officials stated that the problems at Watts Bar 1 were the result
    of TVA's inability to manage the project and TVA's lack of quality
    assurance and oversight.  In a December 1994 memorandum, NRC's
    Regional Administrator overseeing Watts Bar 1 stated, "These
    deficiencies have raised concerns about TVA's ability to correct
    problems that must be resolved before Watts Bar can be licensed to
    operate."

    Subsequently, in June 1995, NRC informed us that it had seen
    improvement in TVA's performance at Watts Bar 1.  The Regional
    Administrator stated that "problems continue to be identified by both
    NRC and TVA, but NRC issues have become more isolated in nature, and
    TVA has become more proactive in addressing both TVA and NRC issues."
    He said that a Fall 1995 fuel load date was achievable, "assuming no
    new and significant issues emerge."

    During fiscal year 1994, TVA spent an average of about $1.1 million
    per day at Watts Bar 1.  In February 1995, TVA's estimated commercial
    operation date for Watts Bar 1 slipped again, from October 1995 to
    December 1995, and then in June 1995 the date slipped again to
    February 1996.  On the basis of TVA's fiscal year 1993 and 1994
    expenditures, we estimate that the 4-month slip at Watts Bar 1 will
    cost TVA about $130 million.

          RESTART OF BROWNS FERRY 3
          HAS BEEN SLOW AND COSTLY
    -------------------------------------------------------- Chapter 3:1.2

    According to TVA, bringing Browns Ferry 3, which was shut down in
    1985, back into commercial operation is not expected to occur until
    1996 at a total estimated restart cost of about $1.7 billion.  Browns
    Ferry 3 went into commercial service in 1977.  Between 1980 and 1984,
    it received NRC's lowest ratings for quality assurance and plant
    operations.  After repeated safety and regulatory concerns, in 1985,
    TVA shut down Browns Ferry 3 along with its other four licensed
    nuclear units (Sequoyah 1 and 2 and Browns Ferry 1 and 2).  Prior to
    the shutdown, Browns Ferry 3 operated an average of 60 percent of the
    time while on-line.

    Table 3.2 shows growth in total estimated cost at completion and the
    slipped scheduled operation date for Browns Ferry 3 over the last 5
    fiscal years.  Total estimated cost at completion has increased about
    $1.2 billion during this period.

                              Table 3.2

                  Browns Ferry 3 Estimated Costs and
               Scheduled Operation Dates as of the End
                      of the Last 5 Fiscal Years

                        (Dollars in millions)

                        1990     1991     1992     1993     1994
    ---------------  -------  -------  -------  -------  -------
    Balance sheet       $296     $406     $775   $1,171  $1,475\
     investment at                                             a
     year-end\
    TVA estimated        510      610      318      780      524
     cost to
     complete
    TVA total           $806   $1,016   $1,093   $1,951   $1,999
     estimated
     cost
    Scheduled           Jan.    Sept.    March     Dec.     Feb.
     commercial         1993     1993     1994     1995     1996
     operation date
    ------------------------------------------------------------
    \a Approximately $296 million of Browns Ferry 3's costs are included
    in completed plant and are being depreciated and included in current
    rates.  As a result, at the end of fiscal year 1994, TVA's estimated
    cost to restart Browns Ferry 3 was about $1.7 billion.

    Source:  GAO analysis of TVA data.

    After TVA shut down all of its operating nuclear units in 1985, it
    concentrated on restarting the two Sequoyah units first.  TVA did not
    begin its efforts to restart Browns Ferry 3 until January 1991.
    Management at Browns Ferry stated that prior to August 1993, TVA's
    start-up schedules and completion costs for restarting Browns Ferry 3
    were overly optimistic.  As of December 1994, TVA officials reported
    that current expenditures at Browns Ferry 3 were still in line with
    its August 1993 estimate, and that the unit's construction activities
    had remained on schedule for over a year.

    TVA is planning to reload fuel at Browns Ferry 3 in October 1995, and
    plans to have the unit in full commercial operation by February 1996.
    NRC stated that approval of Browns Ferry 3 for restart should go
    smoothly because the unit shares many systems with Browns Ferry 2,
    whose systems were inspected and approved by NRC between 1989 and
    1991, when it became operational.  During fiscal year 1994, TVA spent
    an average of $833,000 per day at Browns Ferry 3.

          COST OF COMPLETING NUCLEAR
          UNITS MAY BE HIGHER THAN TVA
          ANTICIPATED
    -------------------------------------------------------- Chapter 3:1.3

    TVA's incremental "to go" costs of completing its two nuclear units
    under construction may be understated.  As shown previously, TVA has
    experienced problems building and operating nuclear power plants.
    However, during its IRP, TVA stated that continued investment in
    Watts Bar 1 and Browns Ferry 3 was economically justified because (1)
    TVA needed the power soon and (2) these two nuclear units were TVA's
    most cost-effective options for meeting expected growth in demand for
    power.

    According to its forecast, TVA needs to bring Watts Bar 1 and Browns
    Ferry 3 into operation by the beginning of 1996 to have sufficient
    capacity\1 to meet peak demand.  TVA's load forecasting methodology
    is discussed in appendix II.  After establishing its need for power,
    in February 1994, TVA's calculated the economic cost of meeting
    future demand with these two units.  Excluding its sunk cost, TVA
    calculated the incremental costs of completing Watts Bar 1 and Browns
    Ferry 3 and compared these costs with other alternative resource
    options.  TVA's analysis projected that Watts Bar 1 and Browns Ferry
    3 would generate power at a first year incremental cost of 2.1 and
    2.8 cents per kilowatt hour (kwh), respectively.  According to TVA,
    alternative resource options such as demand side management were in
    the range of 3.5 cents per kwh.

    If TVA's historical cost overruns and operating problems continue for
    either of these two units, the actual "to go" cost will be greater
    than planned.  Cost overruns for these plants increase deferred
    assets, debt, and financing costs, and will ultimately put upward
    pressure on rates.  To demonstrate, we analyzed TVA's incremental
    cost calculation for Watts Bar 1.  We have illustrated, by using two
    scenarios, how the two most significant assumptions, cost-to-complete
    and capacity factor,\2 affect the incremental cost calculation.
    Table 3.3 shows the results of this analysis.  Our two scenarios, a
    discussion of which follows, yielded incremental cost estimates of
    2.8 and 5.6 cents per kwh, in contrast with TVA's estimate of 2.1
    cents per kwh.

                              Table 3.3

               Estimate of First Year Incremental Cost
                       Analysis For Watts Bar 1

                                         TVA
                                    estimate  Scenario  Scenario
    Major assumptions\a             Feb.1994         1         2
    ------------------------------  --------  --------  --------
    Estimated cost-to-complete\b        $515      $765    $1,165
     (millions of dollars)

    Capacity factor                       76        66        38
     (percentage)

    First year incremental cost          2.1       2.8       5.6
     (cents per kwh)

    ------------------------------------------------------------
    \a For all assumptions other than estimated cost-to-complete and
    capacity factor, we used TVA's estimates.  These assumptions include
    estimates for inflation, interest rates, discount rates,
    decommissioning, nuclear fuel cost, nuclear fuel escalation rate,
    capital improvement and additions, and operations and maintenance
    cost.

    \b Cost-to-complete represents estimated costs incurred from
    September 30, 1993, to completion.

    Source:  GAO analysis of TVA data.

    Our analysis was based on assumptions that were different than TVA's
    for estimated cost-to-complete and capacity factor.  For scenario 1,
    our analysis used TVA's actual expenditures for fiscal year 1994 of
    $410 million, and added TVA's cost-to- complete estimate of $355
    million as of September 30, 1994.  For scenario 2, we assumed
    start-up of Watts Bar 1 would be delayed by 1 year, which would not
    be inconsistent with the unit's history.  We assumed a delay cost of
    $1.1 million per day, which is approximately what TVA spent per day
    on the unit in fiscal year 1994.  Such a schedule slip could add
    approximately $400 million to the cost-to-complete estimate.  The
    scenario 1 analysis used a capacity factor of 66 percent because
    TVA's three nuclear units currently in operation (Sequoyah 1,
    Sequoyah 2, and Browns Ferry 2) have a combined average capacity
    factor of 66 percent since their restarts in 1989, 1988, and 1991,
    respectively, as shown in figure 3.1.

       Figure 3.1:  TVA's Three
       Operating Nuclear Units'
       Average Capacity Factor Since
       Restart, as of September 30,
       1994

       (See figure in printed
       edition.)

    Source:  GAO analysis of TVA data.

    In the scenario 2 analysis, we decreased TVA's anticipated capacity
    factor for Watts Bar 1 from 76 percent to 38 percent.  Our analysis
    of TVA's nuclear generating capacity, as illustrated in figure 3.2,
    shows that TVA's five licensed nuclear units have operated at a
    combined average capacity factor of 38 percent since their original
    start-up.

       Figure 3.2:  TVA's Five
       Licensed Nuclear Units' Average
       Capacity Factor Since Original
       Start-Up

       (See figure in printed
       edition.)

    Source:  GAO analysis of TVA data.

    --------------------
    \1 Capacity is the amount of electric power that can be delivered by
    a generating unit at one time.  TVA's current system capacity is
    approximately 26,000 MW, and Watts Bar 1 and Browns Ferry 3 together
    will bring an additional 2,230 MW of capacity to the system.

    \2 Capacity factor is the actual gross power generation of a unit
    divided by the maximum potential power generation for a given period
    of time.  The resulting figure indicates the percentage of time a
    unit is available.

       COST FOR NUCLEAR CONSTRUCTION
       COULD AFFECT COAL AND
       HYDROELECTRIC PROGRAM
       IMPROVEMENTS
    ---------------------------------------------------------- Chapter 3:2

    The outcome of TVA's nuclear program could limit capital funds
    available for needed improvements to its coal and hydroelectric
    plants.  TVA is dependent on its coal and hydroelectric generating
    plants, and since the early 1980s, has generated the vast bulk of its
    power from these sources.  Yet, while relying more on hydroelectric
    and coal-fired sources of power, TVA decreased its capital
    expenditures for these plants during the 1980s in anticipation of
    nuclear generation coming on-line.  Despite having made significant
    improvements recently to its coal and hydroelectric units, TVA
    anticipates needing between $240 million and $301 million per year in
    constant 1994 dollars for these plants over the next 26 years.  In
    addition, TVA estimates that it will need substantial capital to meet
    the requirements of the Clean Air Act.

          SYSTEM GENERATION DEPENDENT
          UPON COAL AND HYDROELECTRIC
          UNITS
    -------------------------------------------------------- Chapter 3:2.1

    TVA's system of hydroelectric dams and coal-fired plants generated
    almost 86 percent of TVA's total 1994 electricity.  Figure 3.3 shows
    that for the 15-year period from 1980 to 1994, the plants supplied an
    average of 86 percent of TVA's electric power, ranging from a low of
    75 percent in 1982 and 1983 to a high of 100 percent in 1986 and 1987
    when TVA's nuclear units were shut down.

       Figure 3.3:  TVA Power
       Generation by Fuel Source,
       Fiscal Years 1980-1994

       (See figure in printed
       edition.)

    Source:  TVA data.

          REDUCED CAPITAL EXPENDITURES
          FOR COAL AND HYDROELECTRIC
          GENERATION DURING 1980S
    -------------------------------------------------------- Chapter 3:2.2

    In the 1960s and 1970s, TVA and many other utilities shared the
    belief that nuclear power could supplement or even replace much of
    their power from coal plants.  During the 1980s, TVA, like some other
    utilities, decreased expenditures for capital improvements in its
    coal and hydroelectric plants in anticipation of its nuclear units
    coming on line.  For example, TVA's expenditures for capital
    improvements to its coal plants declined from $522 million in 1980 to
    $118 million in 1987 (expressed in constant 1994 dollars).  Capital
    expenditures for the hydroelectric plants were also uneven during the
    1980s.  By the mid-1980s, performance of these plants had severely
    deteriorated.  The age\3 and reduced capital expenditures at TVA's
    coal and hydroelectric plants began to affect performance.  The
    frequency of unplanned unit outages was high, the availability of
    units to produce power was low, and, according to TVA, the cost of
    operating and maintaining these units had reached historically high
    levels.

    --------------------
    \3 The average age of TVA's coal and hydroelectric units as of
    December 1994 was 37 years and 49 years, respectively.

          CAPITAL IMPROVEMENT PROGRAM
          INITIATED AND EXPENDITURES
          INCREASED
    -------------------------------------------------------- Chapter 3:2.3

    Recognizing the need to improve the performance and reduce the
    operating costs of its aging power-producing facilities, TVA in 1991
    initiated a modernization program for the coal and hydroelectric
    plants and increased expenditures for capital improvements for them.
    Figure 3.4 shows TVA's capital expenditures for coal and
    hydroelectric plants for fiscal years 1980 through 1994.

       Figure 3.4:  TVA's Capital
       Expenditures for Coal and
       Hydroelectric Generation in
       Constant 1994 Dollars, Fiscal
       Years 1980-1994

       (See figure in printed
       edition.)

    Source:  TVA data.

    Since 1991, TVA data show an improvement in the performance of the
    coal and hydroelectric system.  According to TVA, the availability of
    coal and hydroelectric units to produce power has improved,
    unexpected forced outages have declined, and the cost of producing
    power has decreased.

    Despite recent expenditures and improvements, TVA anticipates that it
    will still need large amounts of capital to continue to improve and
    upgrade its coal and hydroelectric plants.  TVA has projected these
    costs from 1995 to 2020.  These projections show that annually TVA
    will need an average of $211 million to $266 million in constant 1994
    dollars for capital expenditures for the coal plants and $29 million
    to $35 million in constant 1994 dollars for capital expenditures for
    the hydroelectric plants.  Over the next 26 years, TVA expects to
    spend between $5.5 billion and $6.9 billion on coal plant upgrades
    and from $748 million to $914 million on hydroelectric plant upgrades
    (expressed in constant 1994 dollars).

          CLEAN AIR ACT REQUIRES
          SIGNIFICANT CAPITAL
          EXPENDITURES FOR COAL PLANTS
    -------------------------------------------------------- Chapter 3:2.4

    The Congress passed legislation in 1990 under title IV of the Clean
    Air Act Amendments to mitigate adverse impacts of acid rain by
    reducing emissions of sulfur dioxide and nitrous oxides.  The
    amendments will have a significant impact on TVA's coal operations,
    because TVA is one of the largest coal-burning electric utilities in
    the country and has one of the largest emissions reduction
    obligations.  The amendments will require substantial expenditures to
    reduce emissions at several of TVA's coal-fired generating plants.
    Specific reductions in emissions are required in two phases.  Phase 1
    compliance was to be implemented by January 1, 1995, and Phase 2 by
    January 1, 2000.  TVA has stated that Phase 1 requirements have been
    met.  TVA's compliance strategy for Phase 2 is a component of its IRP
    decision-making process.

    According to data TVA prepared for its IRP, compliance with the Clean
    Air Act Amendments is estimated to cost from $1.1 billion to $1.6
    billion for fiscal years 1995 to 2015 (expressed in constant 1994
    dollars).  According to TVA, because not all regulations have been
    issued, these estimates may not reflect the actual cost of
    compliance.  These costs are in addition to the previously discussed
    estimates.

    TVA IS PROTECTED FROM COMPETITION
    IN THE SHORT TERM
    ============================================================ Chapter 4

    The wholesale electricity market is becoming increasingly
    competitive.  Like other utilities, TVA has taken some steps to
    remain competitive.  However, in the short run, several factors
    protect TVA from direct competition.  For example, TVA has been
    granted special protections from the competitive market by the Energy
    Policy Act.  Furthermore, TVA's power supply contracts with its
    distributors require the distributors to give TVA 10 years advance
    notice before cancelling the contracts.  Despite these short-term
    protections, some of TVA's customers are concerned about the
    possibility of future TVA rate increases and are actively seeking
    alternative sources from which to buy less expensive power in the
    future.

       OTHER UTILITIES ARE CHANGING TO
       MEET NEW COMPETITIVE PRESSURES
    ---------------------------------------------------------- Chapter 4:1

    Since enactment of the Energy Policy Act of 1992, electric utilities
    have taken steps to become more competitive.  According to 1994
    studies of utility business practices\1 and utilities we contacted, a
    primary action utilities have taken or expect to take is to satisfy
    demand by buying power or adding small gas-fired units.  Other
    actions include (1) downsizing staff and restructuring, including
    merging with other utilities, (2) actively competing on a price basis
    with other utilities to serve municipal or industrial wholesale
    customers, and (3) quickly absorbing into the rates or writing off
    costs associated with uneconomical plants.

    Recognizing that demand levels may be uncertain in a competitive
    market, many utilities are beginning to acquire new kinds of power
    resources.  Some utilities will not commit financial resources to
    satisfy demand levels projected any further than 5 to 10 years in the
    future.  Many utilities plan to build less in-house capacity and rely
    more on power purchased from other utilities or IPPs.  When adding
    capacity is necessary, utilities are planning to build smaller units,
    frequently gas-fired combustion turbines, that are less capital
    intensive and more flexible resources for satisfying changing demand.
    These types of units allow utilities to build in relatively small MW
    increments (for example, 50 MW to 150 MW), at perhaps one-quarter of
    the cost of larger power plants.

    As figure 4.1 shows, the nine IOUs that serve areas near TVA plan to
    satisfy about 54 percent of additional demand through the year 2003
    by building gas-fired plants.

       Figure 4.1:  Plans of TVA's
       Neighboring IOUs to Satisfy
       Additional Demand Through 2003

       (See figure in printed
       edition.)

    Note:  The chart excludes planned capacity purchases and demand-side
    management savings for specific subsidiaries of the Southern Company
    and planned capacity purchases for Duke Power.

    Source:  DOE and utilities' IRPs.

    We discussed the evolving competitive market with utilities and
    utility holding companies that sell electricity near TVA's service
    area.  These entities repeated some of the findings of the surveys
    mentioned above.  For example, according to Virginia Power officials,
    the utility has taken actions to improve its competitiveness.  After
    cancelling four of its originally planned eight nuclear units,
    Virginia Power began writing off $500 million in related costs over
    15 years.  Virginia Power does not plan to build new nuclear units,
    although it may seek ways of extending the lives of existing units.
    According to data filed with the Department of Energy (DOE), Virginia
    Power through the year 2003 plans to meet up to 65 percent of its
    additional demand by purchasing energy and capacity, completing two
    coal-fired baseload units (constituting about 18 percent of expected
    demand), and implementing demand-side management programs (reducing
    expected demand by up to 16 percent).

    According to company officials, Kentucky Utilities has acquired
    flexible, low-cost resources; purchased power instead of building
    baseload units; and trained its workforce to perform several
    different types of duties, instead of specializing in only one type
    of task.\2 The utility's existing capacity does not include nuclear
    assets and is primarily coal-fired (82 percent), with reliance on
    purchased power (14 percent).  According to data filed with DOE,
    through the year 2003 almost all of Kentucky Utilities' additional
    requirements will be satisfied by building gas-fired plants of 110 MW
    to 220 MW.  Kentucky Utilities does not plan to build nuclear units.

    Officials of American Electric Power, a holding company with about
    24,000 MW of capacity that serves areas north of TVA's service area,
    affirmed that the regional market is becoming increasingly
    competitive.  American Electric maintains low fixed expenses through
    such actions as quickly writing off expenses associated with
    cancelled nuclear units and financing its PP&E with cash flow from
    operations.  Although its existing capacity is primarily coal fired
    (86 percent), with smaller amounts of nuclear (8 percent) and hydro
    (3 percent), the company plans to satisfy almost all of its
    additional capacity requirements through the year 2003 by building
    gas-fired plants, according to DOE.

    --------------------
    \1 1994 Electric Utility Outlook, Washington International Energy
    Group, Washington, D.C., Jan.  1994; and Issues and Trends Briefing
    Paper:  18 Key Trends Affecting the Electric Utility Industry, Edison
    Electric Institute, Washington, D.C., May 1994.

    \2 Kentucky Utilities provides the lowest electricity rates of any of
    TVA's neighboring IOUs.  It has a capacity of about 3,700 MW.

       TVA HAS TAKEN SOME ACTIONS TO
       ENHANCE ITS COMPETITIVENESS
    ---------------------------------------------------------- Chapter 4:2

    TVA has taken a number of actions in an attempt to maintain
    competitive rates.  TVA estimates that, since 1988, its savings from
    all cost reduction and efficiency measures total more than $800
    million a year.  According to TVA, it reduced the size of its
    workforce by over 50 percent--from about 34,000 in 1988 to about
    16,500 in 1995--achieving payroll reductions of about $400 million.
    TVA also decreased its fuel and purchase power costs through measures
    that reduced the forced outage rates at power plants ($100 million
    savings).  The remaining cost reductions resulted from debt
    refinancing during the 1989 to 1994 period ($300 million).  Since
    1986, TVA's total operating expenses have remained relatively flat.
    At the end of fiscal year 1994, TVA offered its employees early
    retirement and financial incentives to leave.  TVA stated that this
    was necessary to reduce operating expenses in order to avoid a rate
    increase or layoffs in fiscal year 1996.

    Despite TVA's debt increasing substantially from 1988 to 1994, TVA's
    refinancing efforts have allowed it to keep its total interest
    expense fairly level, as shown in figure 4.2.

       Figure 4.2:  TVA's Total
       Interest Expense, Fiscal Years
       1988-1994

       (See figure in printed
       edition.)

    Note:  Total interest expense equals the sum of gross interest
    expense plus the interest on appropriated debt.

    Source:  TVA's 1988-1994 financial statements.

    According to TVA, since 1989 it has refinanced approximately $20
    billion in outstanding debt and reduced its average interest rate on
    outstanding debt from 10.1 percent to 7.3 percent.  A majority of the
    high interest debt that TVA refinanced was owed to the Federal
    Financing Bank (FFB).  As of September 30, 1994, FFB held $3.4
    billion of TVA's outstanding long-term debt.  See appendix V for more
    details on TVA's refinancing of FFB debt.

    In December 1994, TVA's Chairman announced that the agency planned to
    place an internal cap on its debt below the $30 billion limit set by
    the Congress.  The announcement came as a result of a study by TVA's
    Chief Financial Officer concluding that TVA could limit its level of
    debt from $27 billion to $28 billion by the end of fiscal year 1997.
    This conclusion assumed TVA would build no power plants, other than
    Watts Bar 1 and Browns Ferry 3, unless reductions of equal magnitude
    were taken in other capital programs.  Consistent with this policy,
    TVA also announced in December 1994 that it would not, by itself,
    complete the deferred nuclear units at Bellefonte and Watts Bar 2.
    TVA plans to maintain these units until completion of its Integrated
    Resource Plan in late 1995.  At that time it will consider such
    alternatives as (1) converting the units to another technology such
    as natural gas, (2) replacing them with different types of supply-
    and demand-side resource options, (3) completing the construction of
    one or more of them as nuclear units in partnership with others, or
    (4) maintaining them in a mothballed status pending a later decision.
    As of the end of fiscal year 1994, TVA had invested $6.2 billion in
    these units and estimated that the cost to complete them could be as
    much as $8.8 billion more.  TVA plans to complete Watts Bar 1 and
    Browns Ferry 3 and bring the units into commercial service in
    February 1996.

    In August 1994, TVA solicited bids to purchase up to 2,000 MW of
    additional baseload resources and up to 2,000 MW of additional
    peaking resources; in December 1994, TVA announced it had received
    bids totaling 21,800 MW.  Also, in February 1995, TVA's Chairman
    stated that in recognition of evolving competitive markets,
    legislative provisions that prevent TVA from transmitting and
    marketing its power outside of its established service area should be
    eliminated, so that TVA can compete on an equal footing with its
    neighbors.\3 The Chairman added that the "fence" should come down,
    "unleashing the agency's potential as a nationally competitive
    electric utility."

    As part of the Chairman's February 1995 announcement, he also stated
    that TVA had commissioned a study to examine all aspects of removing
    the fence before seeking necessary legislation.  The study's report,
    released in April 1995,\4 recognized that TVA faces radically
    different conditions today because of the realities of the rapidly
    changing electric industry.  The report included the following
    findings.

      The electric utility industry is becoming increasingly competitive
         and, like other utilities, TVA is making the tough choices to
         implement a vision and strategy to successfully compete.
         Specifically, the Board has suspended construction on three
         nuclear units and completed a 50 percent reduction in its
         workforce.  In addition, the Board has taken steps to control
         the size and costs of TVA's capital base, including limiting
         TVA's debt and suspending construction projects.  These steps,
         by 1997, are said to enable TVA both to continue to service its
         debt and to internally generate the funds necessary for ongoing
         capital additions to the system.  TVA's financial condition is
         sufficiently flexible and strong for entry into and success in a
         competitive market--but only if it has the freedom to compete
         effectively.

      Nationally, electric utilities are implementing market priced
         wholesale power transactions, open access transmission,
         diversifying into independent power at home and abroad, and
         actively pursuing the convergence of energy and communications.
         TVA is largely prevented from participation in these
         developments.

      So that TVA can evolve as a fully competitive enterprise and assure
         its current wholesale power customers a wide range of choices in
         the future--including supplies from other power generators--the
         Board is recommended to undertake a two-phase effort to remove
         the "fence" and related restrictions.  Phase 1 would allow TVA
         to conduct all conventional types of wholesale business with
         utilities bordering TVA and beyond.  During Phase 1, TVA would
         not be allowed unbalanced access to traditional nonprofit
         wholesale customers of neighboring utilities, with which TVA's
         relationship has been severely restricted since 1959 and which
         cannot serve in the TVA territory under the TVA Act.  Phase 2
         would remove the "fence" entirely, giving TVA's current
         wholesale customers free market access and at the same time
         permitting TVA to seek markets outside the Valley on the same
         basis that competitors could enter the Valley to provide
         service.

      TVA's transition to a fully competitive posture is not hindered by
         an inherent inability to compete on a vigorous and equal basis
         with others.  Instead, the barriers to TVA's competitiveness are
         largely found in ties to the past and the limitations imposed by
         unusual and unique provisions in federal law.

      TVA's power program is self-supporting and largely free of federal
         financial support.

    We agree that electricity markets are rapidly changing and TVA will
    have to compete with other utilities; however, we disagree that TVA's
    recent actions have positioned it to meet the competitive challenges
    that lie ahead.  Certainly, some of TVA's announced intentions are
    steps in the right direction.  However, the planned actions do not
    significantly diminish TVA's major problems of paying down its $26
    billion of debt, paying financing costs of about $1.9 billion per
    year, and including in its electricity rates $14 billion of deferred
    costs for nonproducing nuclear assets.

    The Palmer Bellevue study does not recommend immediately opening the
    market to full competition.  The study recommends that TVA be allowed
    to sell to customers outside its current service area for an
    unspecified period while continuing the restrictions that make it
    difficult for competitors to enter TVA's market.  An important issue
    to consider in analyzing the study's recommendation is the equity of
    a proposal that solely benefits TVA to the potential detriment of
    TVA's competitors.

    We also believe that other issues will affect TVA's competitiveness.
    For example, TVA's high debt and resultant financing costs severely
    limit its ability to cut rates in response to competitive pressures
    or to invest in new technologies that may decrease its costs of
    generating electricity.  Under one scenario, in a competitive market,
    if TVA charges rates above the market-based rates of other utilities,
    TVA's distributors could give notice and leave the TVA system at the
    end of 10 years (or sooner if contracts can be renegotiated) to buy
    power from cheaper sources.  That would leave a dwindling number of
    TVA distributors and customers to pay off the substantial debt that
    TVA has accumulated from previous years.  Under another scenario, TVA
    could try to compete by selling power at market rates, even if they
    were below TVA's generating and financing costs.  However, in our
    view, TVA could maintain these rates for only a limited time.

    TVA's power program is required to be self-financing; nevertheless we
    disagree that the program's finances are primarily separate from the
    federal government.  The government has a great financial interest in
    ensuring that TVA is a going concern and that its debt becomes
    manageable, because $4.2 billion of TVA's debt is owed directly to
    the government.  In addition, the remaining $22 billion of debt,
    primarily in the form of publicly held bonds, is perceived by the
    financial community as having an implicit federal guarantee.

    --------------------
    \3 The Chairman's announcement, however, did not indicate that TVA
    wished to remove statutory provisions in the Energy Policy Act of
    1992 which generally prohibit other utilities from transmitting power
    over TVA's transmission network and selling the power to TVA's
    customers.

    \4 The Ties That Bind:  TVA in a Competitive Electric Market, Palmer
    Bellevue, a division of Coopers & Lybrand L.L.P., April 1995.

       IN THE SHORT RUN, SEVERAL
       FACTORS MAY PROTECT TVA FROM
       COMPETITION
    ---------------------------------------------------------- Chapter 4:3

    Despite TVA's large outstanding debt and problems with its nuclear
    program, several factors may allow TVA to remain financially viable
    over the next decade.  First, TVA is currently protected from
    competition by special provisions in the Energy Policy Act, as well
    as by the stringent cancellation requirements in its power contracts.
    Second, the departure of some of TVA's industrial load in the 1980s
    left behind a remaining customer base that is much less responsive to
    rate increases, because it is less able than industry to take
    advantage of alternative and cheaper sources of power.  And third, in
    the short run, because of tight capacity margins or transmission
    costs, some low-cost competitors may not be able to sell power to TVA
    distributors.

          STATUTORY AND CONTRACTUAL
          PROVISIONS MAY MINIMIZE THE
          IMPACT OF COMPETITION ON TVA
    -------------------------------------------------------- Chapter 4:3.1

    In the short run, TVA is shielded from competition by statutory and
    contractual provisions.  In 1959, the Congress amended the TVA Act to
    freeze TVA's service area as it existed in 1957.  This restricted
    TVA's ability to compete with neighboring utilities.  Conversely, in
    the Energy Policy Act of 1992, the Congress safeguarded the integrity
    of TVA's service area from lower cost producers in the Southeast by
    restricting their sales to TVA's distributors.  FERC cannot compel
    TVA to provide transmission services to another utility if the
    electricity to be transmitted will be consumed within TVA's service
    area, with the exception of Bristol, Virginia.

    TVA's wholesale power supply contracts also restrict the ability of
    TVA distributors to buy electricity from other utilities.  According
    to TVA contracting officials and TVA distributors, until the late
    1980s, TVA distributors signed contracts which required them to
    satisfy all of their power needs by buying from TVA.  These contracts
    contained 20-year terms, but after 6 years of service had elapsed,
    distributors could cancel them by giving TVA 4-years advance notice.
    However, in 1989, after the city of Memphis began seeking other
    sources of power, TVA revised its contracts with distributors to
    increase the cancellation notice period from 4 years to 10 years.
    Specifically, the new contracts automatically renew each year and
    require TVA's distributors to give 10 years advance notice before
    cancelling TVA's services.  The contracts continue to require that
    distributors satisfy all of their power requirements by buying from
    TVA.  According to the Tennessee Valley Public Power Association
    (TVPPA), which represents most of TVA's distributors, and individual
    TVA distributors that we contacted, these terms severely limit a
    distributor's options to buy from cheaper sources.  If a distributor
    chooses to break its contract, it is subject to monetary penalties
    specified in the contract.  TVA officials said, however, that no
    distributor has broken its contract.

    Utilities that are low cost and able to deliver power to the TVA
    service area may be frustrated, at least in the short run, by TVA's
    contractual and statutory protections.  American Electric officials
    stated that its subsidiaries are low-cost producers who are willing
    and able to supply TVA's larger distributors with power.  American
    Electric has power to sell to TVA's largest distributors and
    industrial customers; its all-time peak demand, said company
    officials, equals about 19,000 MW of a total capacity of about 24,000
    MW.  However, TVA's statutory and contractual provisions prevent
    American Electric from selling power to almost all of TVA's
    distributors.

          REDUCTIONS IN TVA'S
          INDUSTRIAL CUSTOMERS
          RESULTED IN A MORE STABLE
          LOAD
    -------------------------------------------------------- Chapter 4:3.2

    TVA has a relatively stable load consisting primarily of residential
    and commercial customers.  According to representatives from TVA,
    distributors, and industry, the presence of a large industrial load
    within a service area indicates a large amount of potential change in
    a utility's load.  Because electricity rates are a significant cost
    for many industrial customers, the larger industrial entities are
    willing and able to leave a utility's service area to find
    alternative, cheaper sources of power.  According to officials of the
    Electricity Consumers Resource Council (referred to as ELCON),\5 the
    cost of electricity for such industries as aluminum smelters, glass,
    chemicals, and chlor-alkali, can equal from about 30 percent to 40
    percent of production costs.

    According to representatives of TVA's directly served and
    distributor-served industrial customers,\6 TVA's industrial rates
    were increasing at double-digit rates each year in the 1970s.  For
    example, according to these officials, TVA's industrial rates
    increased by 22 percent in 1971, 38 percent in 1975, and 46 percent
    in 1976.  According to their analysis, TVA's basic industrial rates
    went from an average 0.9 cents per kwh in 1970 to over 4.0 cents per
    kwh in 1983.  In response, industries closed or moved many plants.
    TVA's sales to industrial customers declined from about 25 billion
    kwh in 1979 to about 16 billion kwh in 1993.  According to TVA
    officials, because of this loss of industrial customers, TVA's load
    today is more stable than it otherwise would have been.  The increase
    in load stability decreases the possible adverse short-term impact of
    competition on TVA's electricity sales and revenues.

    --------------------
    \5 ELCON is the national association of large industrial customers.
    They buy about 4 percent of the nation's electricity.

    \6 These associations include the Tennessee Valley Industrial
    Coalition (represents directly served TVA industrial customers) and
    the Associated Valley Industries (represents distributor-served
    industrial customers in the TVA service area).

          LOW-COST COMPETITORS MAY NOT
          BE ABLE TO SELL POWER TO TVA
          DISTRIBUTORS
    -------------------------------------------------------- Chapter 4:3.3

    Some low-cost competitors may not be able to deliver power into the
    TVA area at a competitive price because transmission charges levied
    by intervening utilities would make the cost of the power
    noncompetitive.  For example, Virginia Power officials stated that
    the utility's rates are competitive with TVA's rates, but the utility
    is not now, nor will it be in the foreseeable future, in direct
    competition with TVA.  The officials said that to sell power to TVA's
    distributors, Virginia Power's electricity must be transmitted
    through Appalachian Power's service territory to the interchange
    between Appalachian Power and TVA near Bristol, Virginia.  According
    to Virginia Power officials and our analysis of data they provided to
    us, Appalachian Power's transmission tariff of $2 per kilowatt month
    plus an energy charge of $1 per megawatt hour\7 may increase the
    delivered cost of Virginia Power's electricity by about 10 percent.\8

    A cost-competitive utility that may be willing to sell power to TVA's
    customers may be limited by a lack of capacity.  For example, a
    Kentucky Utilities official stated that because Kentucky Utilities
    operates under a relatively small capacity margin of 15 percent, the
    company cannot serve TVA's larger customers.  At the present time, it
    could only serve TVA's smaller distributors (generally those with
    loads of about 100 MW or less).

    --------------------
    \7 Transmission tariffs are approved by FERC.

    \8 This analysis is based on a hypothetical arrangement to deliver
    100 MW of capacity for a year, assuming a load factor of 60 percent.
    The hypothetical charge for bulk power, excluding the transmission
    tariff, includes a capacity component of $8.50 per kilowatt month and
    an energy component of $30 per megawatt hour delivered.

       TVA'S CUSTOMERS REACT TO
       EVOLVING MARKETS
    ---------------------------------------------------------- Chapter 4:4

    TVA's distributors and remaining industrial customers are concerned
    about potential rate increases and are reacting cautiously.  Some
    distributors told us they wish to modify their contracts with TVA to
    buy some or all of their power from other suppliers.  Industrial
    representatives said that industrial customers currently benefit from
    special TVA rates, but TVA needs to reduce its rates more if it
    wishes to be competitive with the low-cost providers of power in the
    region.

          DISTRIBUTORS' CONCERNS ABOUT
          TVA'S RATES HAVE LED SOME TO
          SEEK OPTIONS TO BUY POWER
          FROM OTHER SOURCES
    -------------------------------------------------------- Chapter 4:4.1

    Concerns about TVA's rates have caused some distributors to consider
    buying power from sources other than TVA.  For example, in the late
    1980s, the city of Memphis's Light, Gas, and Water Division explored
    the possibility of buying power from sources other than TVA.  Memphis
    analyzed the prospects for TVA's future rates, given assumptions
    about such factors as TVA's nuclear program and future electricity
    load.  At the optimistic end of its analysis, Memphis projected that
    TVA's overall wholesale rates would decline in real terms from 4.3
    cents per kwh in 1989 to 4.0 cents per kwh in 2010 (expressed in 1988
    dollars).  At the pessimistic end, Memphis projected that TVA's
    average wholesale rates would almost double in real terms to 8.2
    cents per kwh in 2010 (expressed in 1988 dollars).  Memphis's
    pessimistic analysis was based on assumptions that TVA's nuclear
    program would continue to experience cost overruns, complications,
    and delays.  Ultimately, Memphis, which represents over 10 percent of
    TVA's load, decided to stay in TVA's system because TVA addressed the
    city's concerns.  For example, TVA compensated the city for operating
    its own transmission system by providing a credit.

    In May 1990, the city of Bristol, Virginia, gave TVA written notice
    that it intended to cancel its power contract effective June 30,
    1995.\9 To keep Bristol as a customer, TVA offered Bristol an
    extension on its existing contract through 1997.  TVA also offered
    the city special rates for industrial customers, as well as other
    concessions.  The city agreed to extend its existing terms, and
    according to Bristol officials, several industrial customers have
    recently saved over $80,000 per month because of the new industrial
    rates.  Once its contract with TVA expires, Bristol can purchase
    power from utilities other than TVA.  Bristol received an exemption
    in the Energy Policy Act of 1992 that allows other utilities to
    transmit their electricity to Bristol over TVA's power lines.
    According to its General Manager, Bristol plans to solicit bids
    during the summer of 1995 for electricity to be delivered in 1997.

    The Four County Electric Power Association near Columbus,
    Mississippi, notified TVA in December 1993 of its intent to cancel
    its power contract.  After analyzing TVA's financial statements, Four
    County's Chief Executive Officer became convinced that TVA's nuclear
    fixed costs are "uncompetitive." Four County officials said that
    according to a study they commissioned, TVA's wholesale rates may
    increase by 30 percent over a 10-year period.  They said their study
    analyzed TVA's current and future rates, along with the rates of such
    utilities as Mississippi Power and Light, Mississippi Power, and
    Alabama Power.  However, because Four County is subject to the
    10-year cancellation provisions in its contract with TVA, it cannot
    stop buying power from TVA until 2003 without risking legal action.
    Furthermore, under the Energy Policy Act of 1992, TVA cannot be
    compelled by FERC to transmit through its transmission system the
    electricity of another utility to Four County.  Four County officials
    believe that it will be able to finance the construction of power
    lines into its service area, thus tying the cooperative into the
    power grid of other utilities.  In August 1994, Four County requested
    competitive bids from other electric utilities, IPPs, and power
    marketers, to provide it with 175 MW of power and received 22
    proposals totaling 2,000 MW.  By buying power from sources other than
    TVA, Four County expects to reduce its power costs by about 25
    percent.

    Officials we spoke with from TVPPA said TVA's rates and service
    reliability must remain competitive with the rates and services of
    neighboring utilities and regional IPPs.  If not, distributors may
    seek alternative sources of power because they are under pressure
    from their customers to charge low rates.  According to TVPPA
    officials, some TVA distributors believe that, because of changes
    brought by the Energy Policy Act of 1992, their contracts with TVA
    should be renegotiated.  TVPPA and some of its members (including
    some of TVA's largest distributors--Memphis, Nashville, Knoxville,
    and Huntsville) favor renegotiating TVA's contracts to allow them the
    option to buy from other utilities and IPPs, as well as TVA, and to
    decrease the length of the 10-year cancellation notice provision.

    --------------------
    \9 Bristol's existing contract with TVA, signed in 1985, allows
    Bristol to terminate TVA's services not earlier than 10 years after
    the contract was signed with a 4-year advance notice requirement,
    according to Bristol's General Manager.

          TVA'S INDUSTRIAL CUSTOMERS
          ARE CONCERNED, BUT PRAISE
          TVA'S EFFORTS TO HOLD RATES
          STEADY
    -------------------------------------------------------- Chapter 4:4.2

    Although officials that represent TVA's remaining industrial
    customers are concerned about prospects for rate increases, they
    praised TVA's steps to enhance the agency's competitiveness, such as
    cutting costs and freezing electricity rates since 1988.  They stated
    that TVA's innovative industrial rate structures have succeeded in
    keeping TVA's special industrial rates competitive with other
    regional utilities.  The officials credited TVA's interruptible
    economy power with decreasing some of TVA's industrial rates to about
    3 cents per kwh.

    However, they are concerned that TVA's commitment to nuclear power
    may jeopardize TVA's ability to maintain competitive industrial
    rates.  The officials stated that TVA's basic industrial rates need
    to drop about 9 percent to match TVA's most inexpensive competitors.
    Because IPPs can today locate power plants near factories and sell
    power directly to those facilities, competition to provide electric
    services to industrial customers has intensified.  Moreover, TVA's
    industrial customer power contracts that can be canceled with 2-year
    to 5-year termination notices are less restrictive than distributors'
    contracts.

    OPTIONS FOR ADDRESSING TVA'S
    PROBLEMS
    ============================================================ Chapter 5

    We believe that the enormous size of TVA's debt and resultant
    financing costs in the long term jeopardize TVA's ability to meet
    competitive challenges from neighboring utilities, thus placing the
    federal government at risk for some portion of TVA's debt.  TVA's $26
    billion in outstanding debt and $1.9 billion of annual financing
    costs severely limit TVA's future financial flexibility.  In
    addition, TVA is burdened with $14 billion in nonproducing nuclear
    facilities that have not been included in its electricity rates.
    Despite a number of actions by TVA in recent years to improve its
    financial position, including downsizing its workforce and
    refinancing its debt at lower interest rates, further actions will be
    necessary.

    Resolving TVA's financial problems will be costly and require painful
    decisions.  In this chapter, we discuss a number of options available
    to TVA and the Congress and highlight issues for consideration in
    analyzing each option.  There may well be other alternatives, and
    resolving TVA's financial situation likely will require a combination
    of actions.  Our intent is not to present a particular solution to
    TVA's dilemma; rather, our intent is to stimulate a dialogue among
    the key decisionmakers concerning options available to protect the
    government's interests and help TVA fulfill its announced intention
    of becoming a competitive and financially viable utility.

       TVA'S ACTIONS, PLANS, AND OTHER
       OPTIONS ARE UNLIKELY TO MAKE IT
       FULLY COMPETITIVE OR TO PROTECT
       FEDERAL FINANCIAL INTERESTS
    ---------------------------------------------------------- Chapter 5:1

    As illustrated in our report, we agree with TVA that it is operating
    in a rapidly changing environment and that it will have to compete
    like other utilities in the future.  We disagree, however, that TVA's
    recent actions and announced plans put it in a strong position to
    meet the competitive challenges that lie ahead.  In contrast, we
    believe that because of TVA's substantial debt and resultant
    financing costs, it is doubtful that TVA will be able to compete
    successfully in the long run.

    TVA's steps to reduce operating costs and interest expense, while
    commendable, may be insufficient.  These actions, which according to
    TVA have resulted in $800 million in annual savings, have helped TVA
    to keep its rates stable and remain competitive.  However, because of
    the size of operating cost savings already achieved, it is unclear
    whether further significant reductions are available.

    Likewise, TVA's plan to stop borrowing when its debt reaches $27
    billion or $28 billion, while a step in the right direction, will not
    resolve TVA's debt problem.  To accomplish this goal, TVA will have
    to substantially reduce its capital expenditures.  In fiscal year
    1994, TVA borrowed $900 million because its capital expenses ($2
    billion) exceeded its cash flow from operations ($1.1 billion).
    According to TVA's 1994 annual report, new borrowing is estimated to
    be $1 billion for 1995 and $500 million for 1996.  During fiscal year
    1994, TVA spent approximately $2 million per day on its Watts Bar 1
    and Browns Ferry 3 nuclear units, which represented approximately 40
    percent of TVA's total capital expenditures.  This construction
    activity continues to increase TVA's debt, financing costs, and
    deferred assets.  Construction activity and the potential for future
    operating problems at these two plants increase TVA's operating,
    financial, and competitive risks.  Given TVA's history of
    construction cost overruns at Watts Bar 1 and Browns Ferry 3, along
    with the tremendous capital requirements of its aging coal and
    hydroelectric plants,\1 staying within its internal debt limit will
    be difficult.

    Assuming that TVA does limit its debt to the $27 billion or $28
    billion level, it still faces annual financing costs of almost $2
    billion.  This financing cost places TVA at a competitive
    disadvantage with its neighboring utilities and makes TVA highly
    subject to interest rate fluctuations.  In 1994 TVA's financing costs
    represented 35 percent of its revenues, whereas neighboring IOUs'
    financing costs averaged only 16 percent of their revenues.  Further,
    neighboring IOUs' fixed financing costs averaged only 8 percent
    compared to 35 percent for TVA.  We believe this difference in fixed
    financing costs makes it doubtful that TVA can lower its rates to
    match the projected decrease in industry rates.

    TVA's current electricity rates do not include $14 billion of costs
    for nonproducing nuclear assets, which TVA considers to be
    construction in progress.  Compared to other utilities, the dollar
    amount and length of time of TVA's deferral are unique.  In contrast,
    IOUs absorb into their rates or write off in a much shorter time
    frame costs associated with uneconomic plants.  If TVA began to
    amortize and depreciate its deferred assets according to its current
    amortization/depreciation schedules, its revenue requirements would
    increase by about $454 million per year for at least 22 years.  If
    all of these costs had been included in TVA's electricity rates in
    1994 and TVA had not been able to offset the costs by reducing other
    expenses, TVA's rates would have been increased by 9 percent which
    would have decreased TVA's competitiveness compared to neighboring
    utilities.

    We believe that the $6.2 billion of costs associated with the three
    mothballed nuclear units (Watts Bar 2, and Bellefonte 1 and 2) does
    not represent a viable construction project because of the following
    factors.  First, these three units have not had significant
    construction activity for nearly 7 years.  Second, TVA recently
    stated that it will not complete these units by itself.  TVA lacks
    the available capital to complete these units given its commitment to
    cap its debt at $28 billion.  Third, in a preliminary draft of its
    IRP, TVA stated that it will continue to defer a final decision on
    Bellefonte 1 and 2 for up to 2 more years, while studying an option
    to convert the units to alternative fuel sources.  Fourth, under all
    of the strategies except one in the preliminary draft of the IRP, TVA
    will defer a final decision on Watts Bar 2 until the year 2000, at
    which time it will likely cancel the unit.  Given these factors, in
    our judgment, it is no longer reasonable for these costs to be
    deferred from current revenue requirements.  Generally accepted
    accounting principles (GAAP) require these costs to be reclassified
    from construction in progress to "regulatory assets" and amortization
    begun immediately.\2

    Although TVA's Board of Directors has announced plans to keep
    electricity rates stable through 1997, TVA could consider a rate
    increase.  With the additional cash generated from operations, TVA
    could reduce its borrowing or pay down its debt.  Because of TVA's
    management autonomy, no outside approval would be needed.  If TVA
    raised its electricity rates, certain issues would need to be
    considered, including the impact a rate increase might have on TVA's
    competitive position.  In analyzing this, we found that assuming all
    other factors remain constant,\3 a one-time rate increase of 10
    percent could allow TVA to pay off about $5 billion of debt over 10
    years.  This would still leave TVA with an outstanding debt of about
    $23 billion and with substantial annual financing costs.  In
    addition, TVA's customers could respond to a rate increase by
    consuming less electricity, thereby offsetting some of the revenue
    that TVA could derive from its rate increase.

    A rate increase in a competitive environment also could cause many of
    TVA's remaining industrial customers to shut down their plants and
    move their operations or to cogenerate or buy power from other
    electricity generators.  In addition, TVA's distributors could react
    by giving notice and leaving the TVA system after giving TVA the
    required 10-year notice (or sooner if the contracts could be
    renegotiated) to buy power from cheaper sources.  One TVA distributor
    recently solicited bids from other suppliers and told us it expects
    to reduce its power costs by as much as 25 percent.  If TVA's
    distributors or other customers leave, a dwindling number would be
    left behind to pay off the substantial debt that TVA has accumulated
    from previous years.  With fewer customers, there could be pressure
    to further increase rates and this, in turn, could cause more
    customers to seek other sources of electricity.

    Oversight of TVA's management decisions, similar to that provided to
    other utilities, might have resulted in different decisions than TVA
    has made to date.  Other than its $30 billion statutory debt ceiling,
    TVA is subject to essentially no external oversight when deciding
    what kinds of electricity generating facilities to build, how much
    debt to incur, and what electricity rates to charge.  Other utilities
    are subject to the scrutiny of independent boards of directors,
    public utility commissions, and the financial community.  It is
    doubtful that a public utility commission would have allowed TVA to
    indefinitely defer from rates billions of dollars of construction
    costs.  Moreover, because TVA is a government corporation, the
    financial community views TVA's bonds as having an implicit federal
    guarantee.  TVA's "AAA" bond rating and resultant easy access to
    credit has relieved it from needing to exercise the same degree of
    financial restraint as other utilities.

    Because of TVA's high fixed costs and impending competition, we
    believe the federal government may be at risk for some portion of
    TVA's $26 billion debt.  Of this amount, $3.9 billion is owed
    directly to the government.  The remaining $22 billion of debt
    consists primarily of publicly held bonds.

    TVA does not face a cash flow problem today only because it has
    nearly $4 billion of remaining authority to borrow for its capital
    needs.  Also, in the short run, TVA is protected from competition by
    statutory provisions and the 10-year cancellation provisions in its
    power contracts with distributors.  However, TVA could face cash
    shortfalls in the future if its capital expenditures continue to
    exceed its net cash from operations by nearly $1 billion per year.

    --------------------
    \1 For example, TVA anticipates spending from $240 million to $301
    million per year (constant 1994 dollars) over 26 years for
    improvements to its hydroelectric and coal plants.

    \2 Statement of Financial Accounting Standards No.  71, Accounting
    for the Effects of Certain Types of Regulation.

    \3 This example assumes that TVA brings Watts Bar 1 and Browns Ferry
    3 into commercial operation and freezes its debt at about $28
    billion; and that items such as fuel costs remain the same and
    ratepayers stay in TVA's system due to TVA's legislative and
    contractual protections.

       OPTIONS FOR CONGRESSIONAL
       CONSIDERATION
    ---------------------------------------------------------- Chapter 5:2

    For TVA to be competitive in the long term, we believe it needs,
    among other things, to reduce its financing costs to levels that are
    similar to neighboring IOUs.  Since TVA's financing costs are
    approximately double those of the neighboring IOUs, for TVA to have
    comparable financing costs, it would have to reduce its debt by an
    estimated 50 percent--$13 billion.\4 It is unlikely that TVA can do
    this on its own.  Some form of federal government intervention may be
    required.

    There are various options for the Congress to consider to reduce risk
    to taxpayers as well as help prepare TVA to compete in the
    electricity market.  Among others, these options include allowing TVA
    to try to manage its way through this situation (the "no action"
    option), limiting or restructuring TVA's debt, removing statutory
    barriers to competition, privatizing TVA, or increasing oversight of
    TVA's activities.

    --------------------
    \4 This estimate is presented only for illustrative purposes.  It
    assumes that all of TVA's debt has the same interest rate as TVA's
    current average annual rate of 7.4 percent.  Thus, all reductions of
    debt would have an equal impact on TVA's financing costs.

          THE "NO ACTION" OPTION
    -------------------------------------------------------- Chapter 5:2.1

    One option available to the Congress is to allow TVA to continue
    operating as it has done in the past to see if it can survive in a
    competitive market.  This option would allow TVA to continue to make
    the decisions it deems appropriate, postponing for a few years a
    decision on congressional intervention until a determination is made
    as to whether TVA's actions have improved its competitive position.

    Under this option, market forces could be allowed to run their
    course, and if TVA could not make bond interest payments, then the
    bondholders would have to absorb the losses.  This alternative could
    allow for restructuring of debt through agreements reached between
    TVA and the bondholders.  However, if such agreements could not be
    reached, the financial market perceives that the federal government
    would prevent any default by TVA on its bonds.  It could be argued
    that such a default may call into question the government's financial
    backing of other federally-related organizations.  For instance, the
    total outstanding borrowing of government-sponsored enterprises was
    about $1.5 trillion at the end of fiscal year 1994.  This alternative
    also raises the question of whether it would be considered equitable
    to allow a default on investments by mutual funds, pension funds, and
    insurance companies.  These investors may have been attracted by
    TVA's "AAA" bond rating, which is based on TVA's perceived
    relationship with the government and not on its financial condition.

    Important issues to consider under this option would be whether (1)
    adequate assurances are provided that TVA will aggressively address
    its serious financial problems and (2) TVA's planned reductions in
    costs and capital expenditures go far enough.  The potential risk
    with this option is that TVA's financial condition could worsen,
    increasing the risk to the federal government.

          LIMITING OR RESTRUCTURING
          TVA'S DEBT
    -------------------------------------------------------- Chapter 5:2.2

    The Congress could reduce TVA's current $30 billion statutory debt
    limit or restructure TVA's debt.  As mentioned in our 1983 report,\5

    the current statutory debt ceiling for TVA could be reduced from $30
    billion to a lesser amount.  For example, it could be reduced to the
    $27 billion to $28 billion self-imposed ceiling that TVA has
    announced, or even to a lesser amount.  Decreasing the debt ceiling
    could force TVA to make difficult decisions about its capital and
    operating expenses.  It should also be recognized that limiting its
    debt could adversely affect TVA's competitiveness by limiting its
    ability to borrow money to finance needed improvements to its power
    system.

    TVA's debt could be restructured under several different
    alternatives.

      TVA's $3.9 billion debt owed to the federal government and the
         interest on that debt could be forgiven.  This action would
         immediately reduce TVA's debt and financing costs and help it to
         become more competitive.  However, this action could set a
         precedent which may encourage TVA to make management decisions
         that could further increase its debt.  In addition, taxpayers
         who received no benefit from TVA operations would be asked to
         pay for TVA's management decisions of the last several decades.

      The government could explicitly guarantee TVA's bonds in exchange
         for the bondholders accepting lower interest rates and longer
         repayment periods.  Under this arrangement, the bondholders
         would bear some of the costs for TVA's financial problems.

      The government could pay off all or some of TVA's remaining $22
         billion of debt and then require TVA to repay the debt at lower
         interest rates.  This option would immediately reduce TVA's
         financing costs and improve its financial viability and
         competitiveness.  However, this alternative would entail
         substantial financial costs to the taxpayer.

    TVA's annual borrowing/financing activities are included in the
    federal deficit.  To the extent that TVA's capital and operating
    outlays exceed TVA's collections from power revenues, the federal
    deficit is increased by that amount.  Because TVA's $26 billion of
    outstanding debt financed its capital outlays, the entire debt
    balance has already been included in previous years' calculations of
    the federal budget deficit.  Restructuring TVA's debt as described
    above could either reduce the federal government's interest income or
    increase its interest expense.  Thus, depending on the extent of
    federal intervention, the annual cost to the government for
    restructuring TVA's debt would be a portion of TVA's financing cost,
    which in 1994 was $1.9 billion.

    --------------------
    \5 Triennial Assessment of the Tennessee Valley Authority--Fiscal
    Years 1980-1982 (GAO/RCED-83-123, April 15, 1983).

          REMOVING STATUTORY BARRIERS
          TO COMPETITION
    -------------------------------------------------------- Chapter 5:2.3

    The statutory provisions in the Energy Policy Act of 1992 that exempt
    TVA from having to wheel the power of other utilities to its
    distributors could be repealed.  In such an event, FERC could compel
    TVA to transmit the power of such low-cost utilities as Kentucky
    Utilities or American Electric Power into TVA's service area for sale
    to TVA's distributors.  As a matter of reciprocity, TVA could also be
    allowed to sell its power to the customers of other utilities.
    Although TVA's distributors would still be required by TVA's
    contracts to buy power from TVA for some period of time, distributors
    that gave cancellation notices would be able to buy power from other
    sources 10 years after giving the notice.  Under this scenario, all
    of TVA's distributors would have a choice of utilities from which to
    buy power, thus introducing full competition at the wholesale level
    to the TVA service area.

    Removing the "fence" and other restrictions and exposing TVA to
    competition would be consistent with competitive and less regulated
    markets.  TVA would have to operate with increased discipline in
    response to competition and other market forces.  However, it could
    be argued that TVA would enjoy some advantages not available to IOUs
    because TVA pays no federal taxes and has access to low-cost
    financing because of its status as a government corporation.  Despite
    these advantages, given TVA's current financial condition, TVA would
    likely be unable to compete with its neighboring utilities in the
    long term.  If that proved to be the case, the bondholders would be
    at risk of TVA's defaulting on its bonds unless the Congress
    intervened.

          PRIVATIZING TVA
    -------------------------------------------------------- Chapter 5:2.4

    Another option involves "privatizing" TVA--that is, selling TVA in
    its entirety, or breaking it up and selling off individual assets.
    Such a move could reduce future risk to taxpayers while subjecting
    TVA fully to market conditions.  However, TVA's dams and reservoirs
    serve multiple purposes, such as flood control, navigation, and
    recreation.  These purposes would have to be considered in any
    privatization effort.

    Because of TVA's $26 billion debt, it is very unlikely that anyone
    would want to buy TVA in its entirety.  Therefore, it is more likely
    that TVA's assets would be sold and the net proceeds of the sale used
    to pay down all or part of TVA's debt.  There may be willing buyers
    for TVA's transmission system and coal and hydroelectric plants.
    However, it is doubtful that anyone would buy TVA's nuclear plants,
    because of their troubled history and future decommissioning costs.\6
    In recent congressional testimony, the Chairman of TVA's Board
    discussed the potential privatization of TVA and stated, "And so I
    think you would find the situation in which some people would like to
    come and buy some of the plants, take the cream and leave the skim to
    the taxpayers.  The taxpayers would end up, I believe, in a bailout
    situation involving the nuclear program."

    We did not assess the market value of TVA's assets.  However, because
    $14 billion of TVA's total of about $32 billion in assets are
    nonproducing, it is possible that privatizing TVA and selling its
    assets would not pay off all of its debt.\7 As discussed above, any
    shortfall would negatively impact the federal deficit because the
    interest expense associated with any remaining debt would be borne by
    the federal government.

    --------------------
    \6 In its Integrated Resource Plan, TVA estimates that the
    decommissioning costs for its nuclear power plants will range from
    $200 million to $700 million each.  TVA projects that the medium cost
    estimate will be $300 million to $350 million per unit in 1994
    dollars.

    \7 Whether the proceeds from the assets sold would be sufficient to
    pay off all of TVA's outstanding debt depends on numerous assumptions
    and analyses that were not part of the scope of our review of TVA.

          INCREASING OVERSIGHT OF TVA
          ACTIVITIES
    -------------------------------------------------------- Chapter 5:2.5

    The management decisions that placed TVA in its current financial
    condition were made without any external oversight or review.
    Providing TVA with greater external oversight may help ensure that
    its decisions protect the financial interests of the federal
    government, ratepayers, bondholders, and other stakeholders.  Also,
    establishing strengthened external oversight for TVA's decision
    making could provide a forum for considering a broader range of
    options to resolve TVA's financial problems.

    At the same time, providing oversight of TVA's management could
    entail the costs and burdens associated with a new layer of
    bureaucracy.  Establishing a regulatory or oversight body runs
    counter to the current trends in the electricity
    industry--specifically, promoting competition between utilities in
    wholesale transactions and prices.  It should also be noted that
    oversight by itself does not ensure that utilities make sound
    business decisions.  Many utilities that are regulated by public
    utility commissions still experienced financial problems stemming
    from overbuilding nuclear plants during the 1970s and 1980s.\8

    Following are several oversight options.

      TVA's wholesale rates could be placed under FERC's regulatory
         authority.  FERC already regulates the wholesale rates of IOUs,
         as well as those of some publicly-owned utilities such as the
         Bonneville Power Administration.  However, FERC's regulation of
         rates is limited to examining and approving the "reasonableness"
         of the wholesale rates that a utility proposes.  That might not
         provide the detailed level of oversight needed to ensure that
         TVA's financial and resource decisions are consistent with
         paying down its debt and becoming more competitive.  Providing a
         more detailed level of regulatory oversight of TVA could result
         in expanding FERC's mission.

      A regional planning council, with representatives from key regional
         and industrial stakeholders, could be established.  The
         Northwest Power Planning Council, for example, was created by
         the Congress to emphasize local control of resource development
         and power planning.  The Council, with representatives from all
         affected Northwestern states, develops a regional plan.  All
         Bonneville Power Administration proposals involving major
         resources must be found consistent with the Council's plan.  If
         a proposal is found to be inconsistent, then Bonneville must get
         specific congressional authorization for the proposal.  By
         establishing such a council, TVA could be made accountable to
         the people of the Tennessee Valley for the actions it takes to
         meet the power needs of residents and industry.

      As suggested by the Southern States Energy Board, TVA's 3-member
         Board of Directors could be expanded to include more members to
         represent the interests of residents of the service area and
         other stakeholders, such as the federal government.  Unlike the
         current Board, an expanded Board would not be part of the
         day-to-day management of TVA's operations, thereby providing
         more independent oversight.  This alternative would avoid
         instituting a new bureaucratic structure.  At the same time,
         because TVA has no stockholders who could hold an expanded Board
         accountable, it is possible that over time that Board could
         adopt similar policies and make the same types of decisions as
         TVA's 3-member Board has done in the past.

      A federal public utility commission could be established to
         formally review and approve TVA's rate and resource decisions.
         Again, stakeholders--such as the federal government--that are
         affected by TVA's financial decisions could be represented on
         this commission.  Like a state public utility commission, a
         federal commission would have authority to approve or disapprove
         TVA's rate and resource decisions.

    --------------------
    \8 Electricity Supply:  What Can Be Done To Revive the Nuclear
    Option?  (GAO/RCED-89-67, March 23, 1989).

       AGENCY COMMENTS AND OUR
       EVALUATION
    ---------------------------------------------------------- Chapter 5:3

    In commenting on a draft of this report, TVA strongly disagreed with
    our assessment in many areas.  In addition, TVA stated that in its
    opinion, the report was inaccurate in the analysis of TVA's financial
    condition and made inappropriate comparisons to IOUs.  TVA's comments
    fell into five general areas--capital structure and debt issues,
    competitiveness, deferred assets, cash flow, and options.  TVA also
    enclosed comments on the draft from Palmer Bellevue, an affiliate of
    Coopers & Lybrand.  Our response to TVA's comments related to the
    five general areas and the Palmer Bellevue comments follows.

          CAPITAL STRUCTURE AND DEBT
    -------------------------------------------------------- Chapter 5:3.1

    TVA states that we fault it for having too little equity and that we
    inappropriately compared it with neighboring IOUs.  TVA maintains
    that its capital structure is different from that of IOUs, its
    capitalization is not out of line with other utilities, and its debt
    does not place taxpayers at risk or keep TVA from being competitive.
    We disagree with TVA's conclusions.  In chapter 2, we recognize that
    TVA's only option for raising external capital is borrowing, while
    IOUs also issue common and preferred stock.  Our report focuses on
    the financing costs resulting from each utility's capitalization
    regardless of source.  Our ratio of financing costs to revenue
    accurately reflects the costs of debt, preferred stock, and common
    stock for TVA and the IOUs.  TVA's customers are not concerned about
    the capital structure of TVA or neighboring IOUs; rather, they are
    concerned about the rates they are charged, which are directly
    affected by financing costs.  TVA does not address in its comments
    one of the key issues raised in our report--that TVA's financing
    costs to revenue ratio is more than double (35 percent for TVA versus
    16 percent for IOUs) and its fixed financing costs to revenue ratio
    is more than 4 times greater (35 percent for TVA versus 8 percent for
    IOUs) than the average of comparable ratios of neighboring IOUs.  We
    believe that the enormous financing costs resulting from TVA's $26
    billion debt severely limit TVA's flexibility and makes it doubtful
    that TVA can compete with neighboring IOUs in the long term, placing
    the government at risk for some portion of TVA's debt.

    TVA states in its comments that based on total capitalization, TVA is
    not out of line with IOUs and presents a "Market Value Capitalization
    Comparison" chart as of December 31, 1993, to illustrate this point.
    We believe that capitalization per megawatt shown on this chart is
    not relevant because it is not indicative of future revenue
    requirements.  In contrast, our calculation of investment in PP&E per
    megawatt of generating capacity in figure 2.6 shows that TVA has the
    third highest investment in PP&E per megawatt of generating capacity
    among the neighboring IOUs--even assuming Watts Bar 1 and Browns
    Ferry 3 come on line as planned.  These investments ultimately must
    be depreciated or amortized and included in revenue requirements.
    Although TVA's average system rate is currently competitive, we
    believe that when TVA brings its nonproducing nuclear assets into
    revenue requirements, its comparatively high investment, as shown by
    our calculation, is likely to adversely affect TVA's future
    competitiveness.

          COMPETITIVENESS
    -------------------------------------------------------- Chapter 5:3.2

    TVA states:  "The bottom line...  is that deregulation in the utility
    industry is here, and that TVA, as a corporation, is ready to
    compete, not retreat." TVA points to actions taken to date and future
    plans to improve its competitive position.  In chapter 4, we state
    that these TVA actions are steps in the right direction.
    Nevertheless, we do not believe that TVA's actions and future plans
    significantly mitigate the competitive disadvantages created by its
    substantial financing costs and deferred assets.

    Our analysis of the overall competitive situation facing TVA was
    echoed by Standard & Poor's, a major independent bond rating
    organization in its May 1995 analysis of TVA's global power bond
    issue.  According to this analysis, "TVA's power program operations
    are characterized by a high fixed cost burden relating to $27.1
    billion of long- and short-term debt outstanding, diverse resource
    mix, significant challenges remaining under its nuclear program, and
    higher marginal costs of production than surrounding competitors." In
    addition, Moody's, another major independent bond rating
    organization, stated in its analysis of the same power bond issue
    that without TVA's status as a U.S.  agency, "It is highly unlikely,
    however, that TVA would retain its Aaa bond rating because of, among
    other things, nuclear risk and an average competitive position."

    As further evidence of its competitiveness, TVA cites a study it
    commissioned, The Ties That Bind:  TVA in a Competitive Electric
    Market (referred to as the Palmer Bellevue study), that concludes
    that TVA is ready for competition.  However, as discussed in chapter
    4, the study recommends that TVA be allowed to sell to customers
    outside its current service area for an unspecified period while its
    potential competitors would be prevented from selling to customers
    within TVA's service area.  Creating this "one-way fence" may be
    viewed as inequitable because neighboring utilities would not be
    allowed to compete for customers in TVA's service area.  It should be
    noted that taking down the fence would be very complex given TVA's
    current financial condition and that IOUs already believe that TVA
    has unfair competitive advantages due to the implicit federal
    guarantee on its debt and its exemption from federal taxes.

          DEFERRED ASSETS
    -------------------------------------------------------- Chapter 5:3.3

    TVA states that our analysis misrepresents construction projects in
    progress as $14 billion in deferred assets.  As discussed in chapter
    2, we grouped TVA's construction in progress units (Watts Bar 1 and
    Browns Ferry 3) and deferred nuclear units (Watts Bar 2 and
    Bellefonte 1
    and 2) into a single category called deferred assets.  This grouping
    is entirely appropriate as none of these units generate electricity
    or produce revenue and, therefore, are excluded from current revenue
    requirements.  Anywhere there was a distinction in accounting
    treatment, we disaggregated these assets.  Regardless of how labeled,
    these $14 billion of assets, along with TVA's substantial financing
    costs, will leave it with little flexibility to meet future
    competition.

    TVA also states that we advocate depreciating and/or amortizing
    deferred assets in violation of GAAP.  Throughout the report, we have
    treated the nearly $8 billion of deferred assets associated with
    Watts Bar 1 and Browns Ferry 3 as construction in progress that would
    be depreciated beginning in 1996 when the two units are expected to
    be brought into commercial operation.  We disagree with TVA's
    position that including amortization of the $6.2 billion of costs
    associated with the 3 mothballed units in current revenue
    requirements is not in accordance with GAAP.  On the contrary, we
    believe that these units no longer represent viable construction
    projects and that deferral of these costs from current revenue
    requirements is no longer reasonable.  GAAP require these costs to be
    reclassified from construction in progress to "regulatory assets" and
    amortization begun immediately.\9

    TVA disagrees that there will be pressure to increase rates as a
    result of bringing Watts Bar 1 and Browns Ferry 3 into commercial
    operation.  Based on TVA's analysis, annual revenue will increase by
    $626 million when Watts Bar 1 and Browns Ferry 3 begin operating.
    TVA's projected annual revenue increase is very optimistic.  TVA's
    analysis assumes that all of the electricity generated by these two
    units will be sold at current prices.  For this to occur, the annual
    demand for TVA's electricity would need to increase by more than 10
    percent by the year the plants come on line.  This is extremely
    optimistic given that TVA's own load forecast shows that electricity
    demand will grow by 2.4 percent per year through the year 2003.  If
    TVA's first-year demand increases by its projected 2.4 percent, then
    revenue from increased sales within its service area (assuming no
    rate increase) would only be about $130 million.  The rest of the
    electricity would either displace current capacity or be sold on the
    spot market at, on average, significantly lower prices.  In addition,
    TVA assumes that these 2 units will generate electricity at 75
    percent of capacity.  TVA's 3 operating nuclear plants have operated
    at 66 percent of capacity since restart.

    We also found that TVA's scenario understates depreciation at Watts
    Bar 1 by $43 million.  TVA officials stated that its analysis
    reallocated nearly $1.5 billion in costs from Watts Bar 1 to Watts
    Bar 2.  As discussed, TVA has deferred until at least the year 2000
    decisions about canceling Watts Bar 2, and hence continues to defer
    amortizing the costs associated with the unit indefinitely.  As
    stated earlier, we believe that the costs associated with Watts Bar 2
    should no longer be deferred and should be amortized along with the
    other two mothballed units, increasing current revenue requirements
    by $207 million, assuming a 30-year amortization period.  It should
    be noted that using a 15-year amortization period, which would be
    more consistent with IOUs, would increase revenue requirements by
    $414 million per year.

    --------------------
    \9 Statement of Financial Accounting Standards No.  71, Accounting
    for the Effects of Certain Types of Regulation.

          CASH FLOW
    -------------------------------------------------------- Chapter 5:3.4

    TVA states that it generates more than enough cash to fund ongoing
    operations and service its debt.  The fact that TVA borrowed $900
    million in 1994 and plans to borrow $1 billion in 1995 shows that it
    does not currently generate sufficient cash from operations to
    finance its capital expenditures.

    TVA maintains that once Watts Bar 1 and Browns Ferry 3 are completed,
    its need for capital will decrease significantly.  We generally agree
    that completion of Watts Bar 1 and Browns Ferry 3, assuming all other
    factors remain constant, would reduce TVA's capital needs
    significantly; however, the funding needed to continue work at these
    two units continues to increase TVA's debt.  Information previously
    developed by TVA demonstrates this point.  For example, TVA's
    December 1994 Report on Controlling the TVA Debt projected that from
    fiscal year 1995 through 1997, TVA's capital expenditures would
    exceed net cash from operations by a total of about $1.7 billion.  As
    a result, TVA forecast that its outstanding debt would reach about
    $27.6 billion by the end of fiscal year 1997.  TVA reiterated this
    point in February 1995 congressional testimony when it estimated that
    its total debt would increase by $1 billion in fiscal year 1995 and
    an additional $585 million in fiscal year 1996.

          OPTIONS
    -------------------------------------------------------- Chapter 5:3.5

    TVA states that few utilities operate under as much oversight and
    scrutiny as TVA, adding that the marketplace conducts the toughest
    oversight possible.  Moreover, TVA states that to compete effectively
    in this competitive business environment, it must be free to make
    sound business decisions to meet the needs of its customers.

    We disagree with TVA's conclusion that it operates under intense
    scrutiny and oversight.  TVA can set its own rates and reach whatever
    resource decisions it wants with little external scrutiny and without
    approval from parties, such as state public utility commissions,
    boards of municipal governments or customer-owners, independent
    boards of directors, or stockholders.  Furthermore, TVA faces only
    limited oversight from the financial marketplace because the bond
    market grants TVA's bonds the highest possible rating on the
    assumption that the bonds are implicitly backed by the federal
    government.  This point was emphasized in May 1995 analyses by
    Standard & Poor's and Moody's.  According to Standard & Poor's
    analysis, the "AAA" rating on TVA's debt "reflects the implicit
    support of the U.S.  The rating on TVA debt does not reflect TVA's
    underlying business or financial condition.  Implicit support is
    Standard & Poor's view that the federal government will support
    payment of principal and interest on certain debt issued by entities
    created by Congress even though there is no legal obligation to do
    so."

    Resolving TVA's financial problems will be costly and require painful
    decisions.  The various options in our report were meant to stimulate
    a dialogue among the key decisionmakers concerning options available.
    We do not present a particular solution to TVA's dilemma; we
    highlight issues for consideration in analyzing each option and
    recognize that there may well be other alternatives.

          PALMER BELLEVUE COMMENTS
    -------------------------------------------------------- Chapter 5:3.6

    Palmer Bellevue states that we give "short shrift" to some important
    issues relating to TVA's competitive position.  The Palmer Bellevue
    comments relate primarily to the issues of taking down the fence and
    TVA's production costs.  In our response to TVA's comments on
    competitiveness in this chapter, we clearly explain that what Palmer
    Bellevue calls for in its study is the creation of a "one-way fence,"
    followed at some future date by full competition.  We believe this is
    an unrealistic and very unlikely scenario.

    Palmer Bellevue states that we ignore its conclusion that TVA is a
    low-cost producer of electricity when compared to neighboring
    utilities.  Palmer Bellevue states that comparing TVA's incremental
    and average cost of production to neighboring utilities shows that
    TVA is in a relatively strong position.  Because Palmer Bellevue's
    calculation of TVA's incremental and average cost of producing
    electricity excludes $1.9 billion of annual interest expense and
    TVA's other fixed costs such as depreciation expense, we believe
    their analysis is incomplete and presents a misleading view of TVA's
    competitiveness.  Interest expense alone represents over one-third of
    TVA's total expenses while depreciation is over 10 percent more.  In
    addition, their analysis does not consider the impact of TVA's $14
    billion of deferred assets on TVA's future rates and competitiveness.
    We estimate that inclusion of deferred assets would increase TVA's
    revenue requirements by 9 to 12 percent.  Thus, Palmer Bellevue's
    incremental and average production cost analysis excludes, at a
    minimum, over half of TVA's 1994 revenue requirements.  We believe
    that the full cost of producing electricity is more relevant to a
    utility's current and future competitiveness.  A utility cannot sell
    electricity at incremental costs (or average cost as calculated by
    Palmer Bellevue) for too long and remain financially viable,
    especially when it has $14 billion of deferred assets, $6.2 billion
    of which no longer even represent viable construction projects.

    -------------------------------------------------------- Chapter 5:3.7

    In summary, we remain confident that our analysis is sound and
    well-grounded, and that we carefully considered trends in the
    electric utility industry through extensive interviews of key
    industry representatives and consultants.  Appendix III (1) details
    the overall methodology we followed and (2) lists the numerous
    organizations and groups we contacted.  We have extensive internal
    control processes to ensure the accuracy of data included in our
    reports and to be confident that our conclusions are based on those
    facts.  As part of our methodology, we frequently retain industry or
    other subject matter expertise to achieve the proper reporting
    perspective and/or to validate our message.  We provided copies of a
    draft of this report to two external reviewers--Charles Luce and
    Robert Fri.  As discussed in appendix III, Mr.  Luce is the retired
    Chairman of the Board and CEO of Consolidated Edison of New York and
    former Administrator of the Bonneville Power Administration, and Mr.
    Fri is President and Senior Fellow of Resources for the Future.  In
    addition, both were members of the Southern States Energy Board
    Advisory Committee on the Tennessee Valley Authority that issued the
    1987 report TVA--A Path to Recovery.  The comments received from
    these reviewers were considered in drafting this report and both
    concurred with our overall message and conclusions.

    TVA also inappropriately concludes several times in its comments that
    our report was influenced by IOUs.  As shown by our methodology
    described in appendix III, we contacted a much broader range of
    industry trade groups/associations representing the interests of
    public power, rural cooperatives, and TVA customers, as well as IOUs.
    We also contacted relevant federal agencies, bond rating agencies and
    financial analysts, TVA's auditor, load forecasting experts, and a
    number of large and small TVA distributors.  Consequently, we believe
    our report provides the Congress with an independent and in-depth
    analysis of TVA's financial condition and competitive prospects.

    TVA'S INTEGRATED RESOURCE PLANNING
    PROCESS
    =========================================================== Appendix I

    The purpose of this appendix is to describe TVA's Integrated Resource
    Planning (IRP) process that is currently underway.  The IRP is a
    process that helps utilities evaluate a variety of supply and demand
    resources to determine which ones can most cost effectively meet the
    energy needs of their customers.  Until the 1970s, the demand for
    electricity was strong, and electricity prices were declining.  As a
    result, resource planning in the utility industry was
    straightforward, consisting primarily of simple trend analyses to
    forecast the future demand for electricity and plans for the addition
    of large baseload power plants to meet the demand.  During the 1970s
    and 1980s, the oil embargo, high inflation, and stronger regulatory
    requirements for nuclear power plants created higher utility costs
    and forced utilities to increase electricity rates.  As a result, the
    growth in the demand for electricity decreased.  Utilities began to
    realize that because of the uncertainty of future electricity demand,
    the construction of large power plants may not be the most economical
    resource option available.  As the future demand for electricity
    became more difficult to predict, the industry began to experiment
    with more sophisticated planning approaches and techniques.  The IRP
    process has evolved to address the uncertainty about the future
    growth of electricity demand, as well as other changes in the utility
    industry, such as the public's increasing concern with the
    environmental effects of power generation and growing competition
    from other power suppliers.

       THE ENERGY POLICY ACT OF 1992
    --------------------------------------------------------- Appendix I:1

    The Energy Policy Act of 1992 requires TVA to conduct a least-cost
    planning program\1 for new energy resources that evaluates the full
    range of existing and incremental resources in order to provide
    adequate and reliable service to its electric customers at the lowest
    system cost.

    In developing this least-cost plan, the act requires TVA to (1)
    consider the factors of risk in power system operation, such as the
    reliability and flexibility of power plants, (2) assess the ability
    to verify energy savings achieved through energy conservation and
    efficiency programs and the projected durability of such savings
    measured over time, and (3) treat demand and supply resources on a
    consistent and integrated basis.  The act also requires TVA to (1)
    provide an opportunity for its distributors to recommend resource
    options for inclusion in the IRP, (2) encourage and assist
    distributors in the planning and implementation of cost-effective
    energy efficiency options, and (3) provide an opportunity for public
    review and comments prior to the selection and addition of any major
    new energy resource.

    --------------------
    \1 TVA uses the term Integrated Resource Planning when referring to
    the least-cost planning process required by the act.

       UNLIKE TVA'S PAST IRP EFFORTS,
       TVA'S CURRENT IRP INCLUDES
       PUBLIC PARTICIPATION
    --------------------------------------------------------- Appendix I:2

    TVA's past resource planning efforts were primarily internal analyses
    with little, if any, participation from the general public.  TVA's
    resource planning consisted of an evaluation of the trade-offs
    between supply-side and demand-side management options.\2

    TVA periodically developed resource planning reports primarily to
    provide analyses to support major resource decisions.  For example,
    TVA's review of its load growth and nuclear plant construction
    situation in 1982 eventually led to the cancellation of certain
    nuclear plants.  In the 1980's, TVA began to produce long-term
    resource plans that incorporated the uncertainties of future events.
    TVA's last resource plan was completed in 1991.

    TVA's current IRP process, which TVA calls Energy Vision 2020,
    officially began in February 1994 and is scheduled to be completed in
    December 1995.  TVA issued a draft IRP plan in July 1995 and plans to
    issue the final IRP plan in December 1995.  The IRP report will
    provide TVA with (1) a 25-year long-term energy strategy and (2) a
    3-year to 5-year short-term action plan, which will identify the
    initial actions or tasks that TVA will undertake in order to achieve
    the objectives of its long-term plan.  As part of the IRP process,
    TVA will also prepare an Environmental Impact Statement to evaluate
    the impacts of TVA's IRP resource decisions.  TVA will prepare this
    statement in accordance with the National Environmental Policy Act of
    1969, which requires federal agencies to consider the environmental
    impact of a new facility or modification of an existing facility.

    TVA's stated main objective of the IRP process is to ensure that TVA
    is competitive with other utilities and energy suppliers throughout
    the United States in many aspects of its business.  These aspects
    include TVA's electricity rates, quality and value of services, power
    system reliability, and economic development and environmental
    efforts.  TVA designed its IRP process using two interrelated
    methods, the technical process and the public participation process.

    --------------------
    \2 Supply-side resources, according to TVA, are resources that meet
    customer needs by increased production of electricity.  TVA defines
    demand-side management as programs that promote activities which
    influence the customer's electricity use.

          THE TECHNICAL PROCESS WILL
          USE TEAMS
    ------------------------------------------------------- Appendix I:2.1

    As illustrated in figure I.1, TVA divided the technical process into
    11 major steps or "building blocks." For each building block, TVA
    formed an interdisciplinary study team.  TVA gave each team specific
    objectives and required the teams to develop and analyze data for the
    IRP process.  The progress of the teams is reviewed as they present
    their work to the TVA Forecast Review Board (consisting of the
    managers of the major departments in TVA) and the Board of Directors.
    The teams have also presented their work to the IRP Review Group (a
    panel of about 20 members who represent TVA distributors, large
    industrial customers, environmental and public advocacy groups, and
    academicians).  TVA created the IRP Review Group to provide input and
    advice on IRP data and to propose additional issues or options for
    further consideration in the IRP process.

       Figure I.1:  TVA's IRP Process
       Building Blocks

       (See figure in printed
       edition.)

    Source:  TVA.

             ISSUES AND VALUES
             TRANSLATION TEAM
    ----------------------------------------------------- Appendix I:2.1.1

    Early in the IRP process, the Issues and Values Translation team met
    with representatives of industrial customers, distributor customers,
    and environmental groups to obtain initial comments, issues, and
    concerns relating to TVA and TVA's IRP process.  In addition, the
    team reviewed over 20 different IRP reports from other utilities to
    ensure that TVA did not omit any important issues in its IRP process.
    The team compiled a list of the initial issues and concerns from
    these various sources and categorized them according to evaluation
    criteria, objectives, constraints (absolute limits on criteria),
    options, and uncertainties (factors beyond TVA's control).  The team
    then distributed these issues and concerns to the appropriate
    building-block teams, which were required to address the issues and
    concerns while developing the data for their building-block teams.
    For example, the list of issues and concerns that relate to options
    were disseminated to the Customer Service Options team and
    Supply-Side Options team.  Throughout the IRP process, TVA gathers
    issues and concerns raised by the public and by TVA employees.  The
    building-block teams are to address these issues and concerns.

             EVALUATION CRITERIA TEAM
    ----------------------------------------------------- Appendix I:2.1.2

    The Evaluation Criteria team developed criteria for assessing the
    individual options considered in the IRP process.  The team sorted
    the evaluation criteria into eight categories.  TVA is using each
    category to evaluate the options and strategies (combinations of
    options) being considered in the IRP.  The eight categories are:  (1)
    long-run cost/value, (2) electricity rates and competitiveness, (3)
    reliability, (4) environment, (5) economic development, (6)
    financial, (7) risk management, and (8) equity.\3 The team then
    selected the measurement methodology for each criterion.  For
    example, TVA utilizes the Participant Test, Rate Impact Measure Test,
    Total Resource Cost Test, and Total Value Test in its analysis of the
    long-run cost and value of TVA's customer service options.\4

    --------------------
    \3 The environmental evaluation criteria was actually developed by
    TVA's Environment team.

    \4 According to TVA, the Participant Test measures the quantifiable
    benefits and costs of an option from the point of view of the
    participating customer.  The Rate Impact Measure Test measures the
    difference between the change in total revenues paid to a utility and
    the change in total costs to a utility resulting from the option.
    The Total Resource Costs Test measures the total net resource
    expenditures of an option from the point of view of the utility and
    ratepayers as a whole.  The Total Value Test measures not only the
    total cost of an option, but also the benefits or "value" that
    participants and ratepayers receive.

             LOAD FORECASTING TEAM
    ----------------------------------------------------- Appendix I:2.1.3

    TVA's IRP Load Forecasting team predicted TVA's future demand for
    power for the next 25 years.  Predicting future demand is essential
    to long-term resource planning, because if TVA underforecasts its
    power demand, it may not possess sufficient resources to meet its
    power needs.  On the other hand, if TVA develops resources too far in
    advance of actual demand, customers may face the risk of higher rates
    to pay for unproductive power plants.

    The team generated a long-term forecast for the growth in electricity
    demand by predicting (1) TVA's system energy requirements (the amount
    of total energy in kilowatt hours that TVA must produce each year to
    satisfy its customers' needs) and (2) TVA's peak demand (the maximum
    amount of power drawn from TVA's power system over a given period of
    time).  The team produced the TVA load forecast for the next 25 years
    using econometric and end-use load forecasting models, most of which
    were developed by the Electric Power Research Institute.

             EXISTING CAPABILITIES
             TEAM
    ----------------------------------------------------- Appendix I:2.1.4

    Before TVA can decide how it will meet the forecast demand, it must
    first assess the capabilities of its existing generating system.  The
    Existing Capabilities team determined that in fiscal year 1994, TVA
    had approximately 25,600 megawatts (MW) of dependable generating
    capacity\5 .  Because of the possibility of power outages caused by
    equipment failures or other unforeseen events, TVA assumes that its
    power system is not 100 percent reliable.  To estimate the future
    availability of its power system, the Existing Capabilities team made
    certain assumptions about the future reliability of TVA's existing
    power generating facilities.  For example, the team assumed that all
    of TVA's nuclear power units will operate at an equivalent
    availability of 67 percent.\6 The team also assumed that TVA's coal
    units will operate at an equivalent availability of 85 percent, its
    hydroelectric power plants will operate at an equivalent availability
    of 93 percent, and its combustion turbines and pumped storage
    facility will operate at equivalent availabilities of 95 percent and
    89 percent, respectively.

    Because its power system is not 100 percent reliable, TVA plans for
    additional capacity to provide a reserve margin sufficient to
    maintain the reliability of the power system.  TVA estimates its
    reserve margins based on an evaluation of the costs of maintaining a
    reliable power system, the past and projected performance of the TVA
    system, and a comparison of the performance of TVA's system with the
    performance of other power systems.  Using these data, the team
    estimated that TVA must maintain an average annual capacity reserve
    margin of 15 percent for the years 1995 through 1997 and 12.5 percent
    for 1998 through 2020.

    TVA also has industrial interruptible-power contracts, which allow it
    to interrupt power to industrial customers during peak demand
    periods.  The team assumed that the amount of industrial load
    available for interruption during peak periods will decrease from
    1,765 MW to 1,023 MW between 2000 and 2020, due to the termination of
    several interruptible-power contracts.

    Based on these assumptions and TVA's fiscal year 1994 load forecast,
    the team estimated that by fiscal year 1998, TVA will need
    approximately 700 MW of additional capacity and several thousand more
    MW by fiscal year 2005.

    --------------------
    \5 TVA defines dependable capacity as the amount of electric power
    that TVA can deliver from a generating unit, as determined by the
    manufacturer's nameplate ratings or by testing.  For example, the
    dependable capacity of a combustion turbine power plant, based on its
    nameplate rating, would be stated as 225 MW.

    \6 TVA defines the equivalent availability of a generating unit as
    the maximum achievable capacity of the unit, expressed as a
    percentage, after the consideration of forced outages, planned
    outages, and deratings of the unit.

             SUPPLY-SIDE OPTIONS TEAM
    ----------------------------------------------------- Appendix I:2.1.5

    TVA defines supply-side options as actions that TVA can undertake to
    increase the amount and reliability of the power available for its
    customers.  The Supply-Side Options team compiled a list of
    supply-side options that included nuclear, coal, and natural gas
    units, as well as power generated by independent power producers and
    cogeneration facilities.  The team concentrated on identifying new
    options that had a reasonable likelihood of commercialization within
    the next 10 years.  Many of the options were developed from TVA's
    internal research, data available at the Electric Power Research
    Institute, and data provided by outside consultants and contractors.

    The team compiled several pieces of data for each supply-side option,
    including the type of energy the option would provide (baseload,
    intermediate, or peak), operation and maintenance costs, availability
    dates, capacity figures, fuel requirements, emission rates, and
    decommissioning costs.  Examples of supply-side options under
    consideration include the cancellation, conversion, deferment, or
    completion of nuclear plants; improvements to existing hydroelectric
    plants; and the construction of new coal plants and combustion
    turbines.  The team also included options for renewable energy
    sources, such as wind power or solar power.

    The team is also evaluating proposals that give TVA the option to
    purchase power from other utilities.  In July 1994, TVA formally
    solicited bids for option purchase agreements up to 2,000 MW of
    peaking capacity in the 1997 to 2006 time period and beyond, and up
    to 2,000 MW of baseload capacity in the 2000 to 2006 time period and
    beyond.  By December 1994, TVA had received 138 different proposals
    from 38 power producers.  The team will evaluate the proposals and
    incorporate the most promising proposals in the IRP process.  The
    Integration team is evaluating each available supply-side and other
    option to determine the ones or combinations that may best meet TVA's
    future power needs.

             CUSTOMER SERVICE OPTIONS
             TEAM
    ----------------------------------------------------- Appendix I:2.1.6

    TVA's Customer Service Options team has a primary goal of identifying
    feasible customer service options--actions that TVA can take to
    influence the nature of its customers' electric power demands.  For
    example, load management programs, such as a program that would
    provide commercial customers with bill credits to curtail load when
    notified by TVA, are customer service options designed to shift the
    time of energy consumption from peak to off-peak hours.  Utilizing
    input from TVA customers, reviews of other utilities' IRP reports,
    and assistance from outside consultants, the Customer Service Options
    team developed customer service options for consideration in the IRP
    process.  Options under consideration by the team include demand-side
    management programs, load management programs, self generation by
    commercial and industrial customers, two types of rate options, and
    beneficial electrification options.\7

    In developing these options, the team identified a list of customer
    service technologies, such as high efficiency heat pumps and compact
    fluorescent lamps, that exist in today's market or are emerging
    technologies in the utility industry.  For each technology, the team
    gathered data, including the costs to install the technology, the
    costs to maintain the technology, the overall costs to the
    distributor or industry, and the effects on energy consumption and
    peak demand.

    As the team created this list of technologies, it qualitatively
    screened them to eliminate unfeasible ones.  For example, a
    technology may be screened out because it was not a good application
    for the Tennessee Valley's climate.  Also, an emerging technology may
    not be considered if adequate data to assess its costs and impacts
    were unavailable or could not be adequately estimated.  During any
    point in the IRP process, TVA may reconsider the technologies
    eliminated from consideration during the preliminary screening.

    The team ranked the load management and demand-side management
    technologies by using the Total Resource Cost Test as a quantitative
    test to determine the benefit/cost ratios for the technologies.  The
    beneficial electrification technologies were ranked using the Rate
    Impact Measure Test to determine their effects on rates.  The team
    also evaluated the technologies using the Participant Test and the
    Total Value Test.

    The team then designed programs, such as financing plans and direct
    appliance installation plans, that would incorporate the technologies
    to achieve desired levels of voluntary customer participation, meet
    TVA's financial and economic goals, and provide options for all
    customer classes.  In constructing the programs, the team examined
    TVA's past and present customer service options, and the IRP reports
    and the customer service programs of other utilities.  The team also
    studied 80 effective demand-side management programs compiled by the
    IRT Results Center, an organization that reviews hundreds of
    demand-side management programs and reports examples of the best
    programs in the industry.  The team evaluated the program designs
    they developed using the Total Resource Cost Test, Rate Impact
    Measure Test, and the Participant Cost Test.

    The team then integrated the program designs and the technologies to
    create customer service options.  The team based the integration on
    the characteristics of (1) the technologies under consideration, (2)
    the customers that would benefit from the options, and (3) the
    methods of delivering the energy services to the customer.  Finally,
    the team evaluated the options, using the various cost and impact
    tests, to determine their estimated impact on TVA, its customers, and
    the region as a whole.

    --------------------
    \7 Beneficial electrification options tend to increase sales of, and
    demand for, electricity by promoting the new use of electricity or
    the substitution of electricity for other fuels.  These effects
    should provide customer value, such as increased convenience, or
    environmental benefits.  For example, the electronic sterilization of
    medical instruments is in TVA's IRP process.

             ENVIRONMENT TEAM
    ----------------------------------------------------- Appendix I:2.1.7

    The Environment team developed criteria to evaluate the environmental
    impacts of the various options and combinations of options that are
    under consideration in the IRP process.\8 The team linked the various
    environmental issues and concerns that were identified by the public
    with measurable scientific or environmental pollutants or activities.
    The team then developed 15 different criteria to address these issues
    and concerns.  The team also determined the measurements for each of
    the criteria.  For example, the team is evaluating the effects of
    potential resource options on human health and fish and aquatic life
    by determining the level of various emissions released by the
    options.  These emissions and other criteria measurements will be
    weighted by the Environment team to estimate each strategy's effects
    on the environmental criteria.  The team also used the list of
    environmental concerns to develop environmental uncertainties, or
    future events that are beyond TVA's control.  The team is conducting
    probability analyses of possible future regulations concerning
    environmental issues and determining the effects on TVA's operations.
    The team also assisted in the development of environmental strategies
    (combinations of resource options) that will specifically address
    existing or pending environmental legislation, such as the Clean Air
    Act Amendments of 1990.

    --------------------
    \8 In conjunction with the IRP, TVA plans to issue an Environmental
    Impact Statement, as required by the National Environmental Policy
    Act of 1969, that will describe the environmental effects that are
    regional, national, or global in scale, or which are generic, for a
    range of strategies under consideration in the IRP process.
    Strategies selected by TVA may result in site-specific resource
    projects in future years.  For such projects, the Environmental
    Protection Agency suggested that TVA conduct detailed, site-specific
    Environmental Impact Statements in the future that will address the
    potential environmental impacts of the projects for the particular
    location or area at which the option will be implemented.

             RANKINGS TEAM
    ----------------------------------------------------- Appendix I:2.1.8

    The Rankings team ranks the supply-side and customer service options
    using TVA's IRP evaluation criteria.  The team uses a computer
    simulation model to create the rankings of the options.  Typical
    option rankings could be based on lowest total resource cost, least
    amount of emissions released, highest power output, lowest impact on
    rates, or any combination of these factors.  The Strategic
    Development team used the results of the rankings in developing
    strategies.

             STRATEGY DEVELOPMENT TEAM
    ----------------------------------------------------- Appendix I:2.1.9

    The Strategy Development team constructed unique strategies by
    combining various options developed by the Customer Service Options
    and Supply-Side Options teams.  Each strategy consists of options
    that are categorized as supply-side, customer service, pricing/rates,
    environment, and/or transmission options.  By using the data provided
    by the Rankings team, the Strategy Development team created several
    strategies to address specific criteria, such as total cost,
    emissions rates, and electricity rates; and to address specific
    uncertainties, such as future load growth, natural gas prices, and
    carbon dioxide regulations.  For example, if the team wanted to
    create a strategy that minimized costs, it would select the lowest
    cost options determined by the ranking process for each of the above
    strategy categories.  The Strategy Development team forwarded these
    strategies to the Integration team, which is evaluating the
    strategies using TVA's evaluation criteria and the uncertainties
    developed by the Uncertainties team.

             UNCERTAINTIES TEAM
    ---------------------------------------------------- Appendix I:2.1.10

    The Uncertainties team evaluated a list of issues and concerns that
    refer to uncertain events in TVA's future that are beyond TVA's
    control.  These items were referred by the public and other
    building-block teams.  The Uncertainties team quantified each
    uncertainty in order to evaluate impacts on resource decisions.  The
    team also developed a range of low, medium, and high levels for these
    uncertainties.  The team conducted sensitivity analyses to determine
    the effect of changes to the uncertainty level on TVA's evaluation
    criteria.  For example, given the existing TVA generating system, an
    increase in load growth could cause TVA's electricity rates to
    increase.  On the other hand, increases in nuclear fuel costs have a
    minimal effect on TVA's electricity rates.  As a result of these
    analyses, the team identified load growth, nuclear issues (capacity
    factor, operation and maintenance cost, and capital cost),
    environmental issues (carbon dioxide compliance and air/water
    environmental controls), natural gas prices, co-product prices, and
    demand-side management effectiveness as the most sensitive
    uncertainties in its IRP process.\9 The Uncertainties team provided
    these uncertainties to the Integration team for the formation of
    "futures" (combinations of two or more uncertainties), and for
    analyses to determine the effects that changes to uncertainties have
    on the strategies developed by the Strategy Development team.

    --------------------
    \9 Even though the team determined the environmental uncertainties
    and the demand-side management program effectiveness uncertainties to
    be marginally sensitive in most cases, TVA included them in the
    integration process because of the interest of the Review Group
    members in these two areas.

             INTEGRATION TEAM
    ---------------------------------------------------- Appendix I:2.1.11

    The Integration team analyzes the effects of the strategies on
    evaluation criteria and determines the "flexibility" and "robustness"
    of these strategies when the uncertainties of the future fluctuate.
    TVA defines a "flexible" strategy as a strategy that can be changed
    in the future to adapt to changing conditions.  A "robust" strategy,
    according to TVA, is a strategy that, once implemented, should
    withstand shifts in long-term conditions in the utility industry.
    For example, a flexible strategy may include the deferment of Watts
    Bar 2 and Browns Ferry 1.  This would give TVA the flexibility to
    complete the plants in the future if TVA's load growth were higher
    than expected, but it would also allow TVA the option of canceling
    the plants in the future if TVA's predicted future load growth does
    not warrant the completion of the plants.  A "robust" strategy would
    have effects on TVA's evaluation criteria (for example, costs,
    electricity rates, and emissions rates) that do not vary
    significantly with future changes in the uncertainties (for example,
    changes in load growth, natural gas prices, and nuclear unit capacity
    factors).

    To generate this analysis, the team utilizes computer-based
    simulation models and analytic software to simulate the power system
    and analyze multi-attribute trade-offs.  These tools help TVA to
    determine the strategies that best satisfy the IRP evaluation
    criteria and provide TVA with flexible and robust strategies for the
    future.  These models allow TVA to analyze and compare strategies
    associated with particular futures\10 and determine the effects on
    different evaluation criteria.  As a result of these analyses,
    "trade-offs" may occur.  For example, one strategy may have lower
    costs and emissions, but higher short-term rates.  In this case, the
    Integration team would attempt to improve the strategy by removing
    options that cause the higher short-term rates.  The team would
    replace them with options that have lower short-term rates and that
    would not significantly change the strategy's effects on costs and
    emissions.

    The team plans to complete these analyses in three phases.  At the
    end of January 1995, the team had completed the first phase of the
    integration process by analyzing the 35 strategies developed by the
    Strategy Development team.  Some of TVA's key observations resulting
    from this phase include:  (1) supply-side and demand-side options
    that have low costs also have low electricity rates in the short run
    and low debt; (2) several options reduce environmental emissions but
    increase long-term costs or electricity rates; (3) increased amounts
    of demand-side management produce low costs and debt but increase
    electricity rates in the short run; (4) the deferral of nuclear units
    and formation of a partnership at Bellefonte have lower costs, lower
    electricity rates in the short run, and reduced emissions; (5)
    several strategies that lower costs and emissions have higher
    electricity rates in the short run; and (6) the deferral of nuclear
    units can provide flexibility in adjusting to uncertain nuclear
    performance.

    By the end of February 1995, the Integration team had compiled the
    results of the second phase of the integration process.  The team
    eliminated many of the simpler strategies, referred to as customer
    service and supply-side strategies, because the team wanted to
    identify options to be included in more complex strategies.  The team
    also developed new strategies and revised several existing strategies
    to reflect new data for certain options.  The Integration team
    finished the second phase of the integration process with 22
    different strategies, each of which had been developed to address
    certain criteria and/or uncertainties.

    During the third phase of the integration process, which TVA
    completed at the end of March 1995, the integration team continued to
    analyze and revise its list of strategies.  The team reduced the
    number of strategies under consideration in the IRP by combining the
    best options from existing strategies and by modifying existing
    strategies to improve their effects on TVA's evaluation criteria
    given different futures.  These remaining strategies will be
    incorporated into the IRP report submitted to TVA's Board of
    Directors.

    --------------------
    \10 TVA refers to a strategy associated with a future as a
    "scenario."

          PUBLIC PARTICIPATION PROCESS
    ------------------------------------------------------- Appendix I:2.2

    Pursuant to the public participation requirements of the Energy
    Policy Act of 1992 and the National Environmental Policy Act of 1969,
    TVA's Public Participation team developed a plan to involve the
    public in TVA's IRP process.  The team, with the help of consultants
    and reviews of the public participation processes used by other
    utilities, developed a four-part public participation process.

    First, the team met with TVA's distributors, industrial customers,
    environmental groups, and others, to identify initial issues,
    concerns, and comments about TVA and the IRP process.  TVA has also
    collected written comments from the public during the IRP process.
    Many of the concerns, such as concerns about TVA's debt, the future
    impact of TVA's rates, and the environmental impact of various
    generating options, have been incorporated into the IRP process as
    evaluation criteria.  For example, TVA consulted with Tennessee
    Valley Public Power Association (TVPPA) on the various customer
    service options in the IRP.  TVA held two meetings with the TVPPA
    Energy Services Committee, which consists of representatives from
    TVA's distributor customers, to discuss the feasibility and cost of
    various customer service options that are under consideration in the
    IRP process.

    Second, TVA interviewed approximately 100 opinion leaders in the TVA
    service area to gather opinions on issues TVA is evaluating in its
    IRP process.  A consulting firm analyzed the results of the surveys,
    and TVA is considering the opinion leaders' comments and concerns in
    the IRP process.

    Third, TVA held a series of open public meetings throughout the
    Tennessee Valley.  The meetings consisted of interactive computer
    displays presenting information on TVA's operations and the IRP
    process.  TVA staff were available to answer questions from the
    public about TVA and/or the IRP.  In response to complaints from the
    public that concerns were not being heard, TVA added an hour-long
    discussion period in subsequent meetings to provide the public an
    opportunity to voice their concerns to TVA.  After the release of the
    IRP draft report, TVA intends to hold another series of public
    meetings to obtain the public's comments on the report.

    Finally, TVA created the IRP Review Group, which meets monthly with
    TVA to hear presentations by the different building-block teams and
    to provide input concerning TVA's IRP assumptions and options for
    consideration in the IRP.  TVA also expects the Review Group to
    provide their perspectives on issues facing TVA and to review TVA's
    analyses and IRP results.

       REVIEWS OF TVA'S IRP PROCESS
    --------------------------------------------------------- Appendix I:3

    In addition to the multitude of consultants that TVA has utilized in
    developing and conducting its IRP process, several additional
    consulting firms are reviewing TVA's IRP process.  For example, in
    April 1994, TVA hired the Tellus Institute of Boston,
    Massachusetts--a consulting firm with expertise in the electricity
    generation market--to review and assist with TVA's IRP process.
    According to TVA officials, Tellus provides an independent review for
    the TVA Board of Directors of the IRP's criteria, assumptions,
    analyses, and building-block team presentations.  Tellus also advises
    TVA on improving the IRP methodology and data.

    TVPPA selected a consulting firm in September 1994 to assist it in
    analyzing certain aspects of TVA's operations, including TVA's
    nuclear power plants and other power supply options, TVA's debt,
    TVA's load forecasting, and the reliability of TVA's service.  The
    study will assist the distributors to plan the least-cost future
    power supply that satisfies accepted standards of reliability,
    safety, and environmental sensitivity.  The consultant's findings
    will be presented to TVPPA's members and to TVA prior to the issuance
    of the final IRP report.  Also, TVA has hired several consulting
    firms on behalf of the IRP Review Group to review certain aspects of
    the IRP.  For example, TVA has entered into contracts with consulting
    firms to review TVA's load forecast, nuclear power assumptions, and
    the integration analyses of the IRP.  In addition, individual IRP
    Review Group members have hired consultants to review certain IRP
    data presented to the IRP Review Group.

       STATUS OF THE IRP PROCESS
    --------------------------------------------------------- Appendix I:4

    TVA distributed a preliminary draft of its Integrated Resource Plan
    to the IRP review group on May 31, 1995.  The draft report included a
    25-year long-term action plan and a 3-year to 5-year short-term
    action plan.  The short-term plan identified possible actions or
    tasks that TVA could undertake initially in order to achieve the
    objectives of its long-term plan.  The long-term plan consists of a
    range or "portfolio" of preferred resource options identified through
    analyses of strategies during the integration process.

    TVA released its draft plan to the public at the end of July 1995.
    TVA will schedule meetings to obtain comments from the general public
    on its draft and publish its final IRP report in December 1995.
    Finally, the IRP resource decisions that will determine TVA's overall
    energy strategy for the next 25 years will be made by TVA's Board of
    Directors in January 1996.

    REVIEW OF TVA'S LOAD FORECASTING
    ========================================================== Appendix II

    The purpose of this appendix is to review TVA's load forecasting
    methodology, the economic inputs and assumptions that TVA used to
    calculate these forecasts, and the accuracy of the results.  We found
    that TVA's current load forecasting methodology is generally
    reasonable and state of the art when compared to other forecasting
    tools available in the electric utility industry.  In addition, TVA's
    current methodology is substantially more sophisticated than
    forecasting techniques TVA used in the 1970s and early 1980s.  As a
    result, the accuracy of TVA's load forecasts has improved.  However,
    because the past forecast accuracy cannot be extrapolated to the
    future, we reviewed the general reasonableness of TVA's current
    long-range 1995 load forecast by comparing it with forecasts made by
    some neighboring utilities.  We found that in comparison to the
    neighboring utilities, TVA's current load growth forecast is at the
    high end of the range.

       TVA'S FORECASTING METHODOLOGY
       IS GENERALLY REASONABLE
    -------------------------------------------------------- Appendix II:1

    In comparison with what is generally available in the utility
    industry as well as what is actually used by other utilities we
    contacted, TVA's forecasting methodology is generally reasonable.\1

    The strength of TVA's methodology lies in its use of an extensive
    forecasting system, including (1) state-of-the-art forecasting
    models, (2) region-specific data, and (3) a probability analysis
    assessing the uncertainty associated with key variables in the load
    forecast.

    --------------------
    \1 This discussion refers to TVA's long-term forecasting methodology.
    TVA also develops a short-term (1 year to 3 years) load forecast,
    which is based on a less extensive modeling system.

          TVA USES SEVERAL DIFFERENT
          MODELS TO FORECAST LOAD
    ------------------------------------------------------ Appendix II:1.1

    Three "end-use" and one "econometric" forecasting models form the
    core of TVA's forecasting methodology.\2 TVA uses the output from
    these models to calculate its long-term forecast for electricity load
    demand by three customer classes--residential, commercial, and
    industrial.  Figure II.1 is a simplified representation of TVA's load
    forecasting system.

       Figure II.1:  Simplified
       Representation of TVA's Load
       Forecasting System

       (See figure in printed
       edition.)

    Source:  GAO analysis of TVA data.

    Each of the three end-use models is designed to forecast demand for a
    specific customer type and end use.  For example, TVA uses the
    Residential End-Use Energy Planning System (REEPS) model to forecast
    load in the residential sector.  The model forecasts household demand
    as a function of electricity required for specific residential uses
    like space heating and cooking.  In turn, residential demand for
    electricity in the region is greatly affected by growth in such
    economic factors as per capita income and population.  In addition,
    because the model allows consumers to choose between electric and gas
    appliances, the prices of electricity and natural gas are important
    inputs.

    Similarly, the Commercial End-Use Energy Planning System (COMMEND)
    model is used to forecast electricity load in the commercial sector.
    In COMMEND, the load for various building types such as offices,
    restaurants, and retail stores, is derived from energy use in
    specific end-uses, such as lighting, computers, and air conditioning.
    The key determinant of electricity demand in this customer class is
    the amount of commercial floor space, which, in turn, is related to
    such economic factors as the growth in economic activity and
    employment, the price of electricity, and the intensity of
    electricity use within each building type.  For example, an increase
    in economic activity leads to an increase in the demand for office
    space (for example, square footage) as well as increase in the need
    for lighting and heating/cooling.

    Finally, the Industrial Energy End-Use Model (INFORM) model is used
    to forecast load for TVA's industrial customers that are served
    through its distributors.  However, TVA has had limited success with
    the INFORM model to date and has, instead, used its econometric model
    to forecast the load for these customers.  In addition, TVA forecasts
    separately the load it expects to sell directly to several industrial
    customers.  This load forecast is developed using primarily
    professional judgment and contractual agreements with individual
    customers.

    A fourth model that forms the core of TVA's forecasting system is the
    Electricity Forecasting Model (EFM).  TVA also uses this model to
    forecast demand by residential, commercial, and industrial customers.
    However, EFM forecasts are based on more aggregate data, including
    such factors as the regional price of electricity and income and
    employment, rather than specific end-uses.\3

    As shown in figure II.1, TVA relies on several other models to derive
    its load forecasts.  For example, the Regional Economic Simulation
    Model (RESM) is used to forecast key regional economic factors for
    the TVA region, and a financial model (FINESSE) is used to develop
    electricity prices which are key inputs to the load forecasting
    system.

    To develop the final load forecast for each customer class, TVA's
    analysts use the forecasts produced by the end-use models and the
    econometric models as well as professional expertise.  In other
    words, during a "chalkboard session," the analysts compare and
    contrast the models' forecasts with their own professional judgment,
    the prior year's forecast, and basic trends in electricity demand in
    order to derive a forecast for each customer class.  For example, the
    analysts might compare the REEPS and the EFM residential forecasts
    with last year's forecast and an extrapolation of recent consumption
    patterns to select the most plausible forecast for this customer
    class.

    Finally, using the load forecasts calculated from the core
    forecasting models as an input into the Hourly Energy Load Model
    (HELM), TVA's analysts develop the reference load forecast for the
    entire TVA system.  HELM is also used to derive TVA's peak demand
    forecast.

    --------------------
    \2 In an end-use model, demand is derived from specific end uses of
    electricity (for example, cooking) and the factors that influence
    such uses.  The econometric approach uses past statistical
    relationships between electricity sales and key variables (for
    example, economic activity and price) to forecast future sales.

    \3 According to TVA analysts, the combination of the end-use and
    econometric forecasting models allows the analysts to take advantage
    of the strengths of both approaches.  For example, one of the
    benefits of using the end-use models is that TVA can assess the
    potential effect of future energy efficiency standards on electricity
    demand.  Conversely, because the econometric approach relies
    primarily on historical relationships among key variables to project
    load, the use of EFM's forecasts ensures that the load forecast
    incorporates past customer behavior.  However, neither approach can
    accurately predict all future changes, such as changes in consumer
    taste and technology.

          TVA USES REGION-SPECIFIC
          DATA IN DEVELOPING ITS
          FORECASTS
    ------------------------------------------------------ Appendix II:1.2

    We found that TVA has made a reasonable attempt to use region-
    specific data to modify its models to reflect the characteristics of
    TVA's power service area.  Because some of TVA's forecasting models
    were designed and built by industry consultants for use by utilities
    nationwide, their structure and data may reflect a national average
    and, as a result, can be modified to reflect the characteristics of
    the region in which they are used.  For example, TVA has developed
    region-specific data to modify REEPS for such things as the type of
    appliances used by the residential customers in its power service
    area.  However, neither TVA nor any other utility we contacted has
    developed a complete region-specific data system.

    However, among the utilities that we contacted, TVA more than other
    utilities has developed its own regional modeling capability in order
    to forecast economic factors for the TVA region.  For example, key
    regional economic variables, such as economic growth and employment,
    which are used in TVA's modeling system are developed by TVA's
    analysts using this regional economic forecasting model.

          TVA USES PROBABILITY
          ANALYSIS TO ADDRESS
          UNCERTAINTY IN KEY VARIABLES
    ------------------------------------------------------ Appendix II:1.3

    After the reference forecast is derived, TVA analysts use probability
    analysis to address the uncertainty associated with a few key
    variables used in its models and to develop a range of alternative
    forecasts.  Although TVA's uncertainty analysis is limited to a few
    key variables, we found that TVA's probability analysis is generally
    more extensive than that used by other utilities we contacted.

    Using this uncertainty analysis, TVA's analysts can assess the impact
    of a range of values for the key variables on the reference forecast.
    For example, using a high and low value for regional economic growth
    and the probability associated with each growth assumption, high and
    low alternative load forecasts and their probabilities are
    calculated.  These high and low forecast alternatives include
    cumulative effects of the variation of all key variables.  At this
    point, all alternative forecasts are ranked from high to low, and two
    forecasts are selected from this range.  The analysts select the two
    forecasts that reflect an acceptable high and low probability.  For
    example, TVA's current low forecast reflects a load demand with a
    cumulative probability of 10 percent; that is, TVA's analysts believe
    there is only a 10-percent chance that the actual load will be lower
    than this low forecast.  Similarly, the high growth demand has a
    90-percent cumulative probability, which means that TVA's analysts
    believe there is only a 10-percent chance that the actual load will
    be higher than this high forecast.

       ACCURACY OF TVA'S CURRENT
       LONG-TERM FORECAST IS UNCERTAIN
    -------------------------------------------------------- Appendix II:2

    Primarily as a result of an improvement in its load forecasting
    methodology, the accuracy of TVA's medium-term load forecasts has
    improved over time.  However, we could not independently verify the
    accuracy of TVA's long-term forecasts.  Because of changes in TVA's
    methodology, the record of TVA's past forecast performance cannot be
    used to assess the ability of TVA's current methodology to forecast
    accurately.  In addition, such an assessment would require the future
    values for forecast variables.  On the other hand, the general
    reasonableness of the current load forecast can be determined by
    comparing it with forecasts made by other neighboring utilities.  We
    found that TVA's 1995 reference load forecast is at the high end of a
    range of forecasts made by these other utilities.

          IMPROVEMENT IN METHODOLOGY
          HAS LED TO INCREASED
          ACCURACY
    ------------------------------------------------------ Appendix II:2.1

    TVA's load forecasting methodology progressed from a simple trend
    approach in the mid-1970s to the more sophisticated methods used
    today.  As a result, the accuracy of TVA's medium-term (4 years to 5
    years) forecasts made in the 1980s and the early 1990s improved
    substantially.  As shown in figure II.2, the mean absolute error\4

    of TVA's medium-term load forecasts declined from 17.7 percent in the
    1970s to 2.7 percent in the early 1990s.\5

       Figure II.2:  Accuracy of TVA's
       Medium- term Historic Load
       Forecasts

       (See figure in printed
       edition.)

    Note:  Mean absolute error is calculated using the average of the
    4-year and 5-year forecasts for each vintage between 1970 and 1990,
    and the 4-year forecast for vintage 1991.  Vintage is the fiscal year
    for which the forecast is prepared.

    Source:  GAO analysis of TVA's load forecasts.

    Trend analyses, or extrapolations of past consumption patterns, were
    used by TVA and other electric utilities in the 1970s to forecast
    load demand.  Because the early 1970s was a period of growth in
    demand for energy, forecasts made using this approach in the
    mid-1970s projected increasing load demand throughout the 1980s.
    Partly as a result of these forecasts, TVA began an ambitious program
    to build additional nuclear generating capacity.  However,
    electricity consumption declined in the mid-1970s following the 1973
    energy crisis and declined again in the late 1970s and early 1980s as
    a result of high energy prices and lower economic growth.

    To improve its forecasts, TVA analysts turned to more sophisticated
    modeling techniques, which enabled them to relate the load forecast
    directly to the key variables that affect electricity demand, such as
    growth in regional economic activity.  As a result of these
    improvements, TVA's load forecasts in the early 1980s were revised
    downward.  Based partly on these revised lower forecasts, TVA
    cancelled construction on eight nuclear units.

    An additional factor, according to TVA analysts, that contributed to
    an improvement in the accuracy of TVA's load forecasts was an
    increase in the diversity of its customer base.  TVA's customer base
    diversified in the 1980s as more energy-intensive firms, such as
    several primary producers of aluminum, ferro-alloys, and chemicals,
    terminated or scaled back production.  Load demand based on a more
    diversified customer base will be less susceptible to fluctuations in
    demand for electricity by any one customer.  Similarly, load
    forecasts made by TVA in the late 1970s included load required by the
    Department of Energy's (DOE) uranium enrichment facility.  Because
    DOE cancelled this contract, TVA's earlier forecasts overstated
    actual load demand.

    --------------------
    \4 Mean absolute error is the mean difference, regardless of sign,
    between the actual value and the forecast value, calculated using
    each year of the forecast.

    \5 Although there is no agreement among experts about the acceptable
    level of accuracy, some utility forecasters believed that a 5
    percent, plus or minus, medium term accuracy is reasonable.

          TVA'S 1995 REFERENCE LOAD
          FORECAST IS AT HIGH END OF
          RANGE FOR NEIGHBORING
          UTILITIES
    ------------------------------------------------------ Appendix II:2.2

    We found that TVA's fiscal year 1995 reference load forecast is at
    the high end of the range of available load forecasts made by TVA's
    neighboring utilities and DOE's Energy Information Administration.\6
    However, we could not independently assess the accuracy of TVA's 1995
    forecast.  As shown in figure II.3, TVA's 1995 forecast projects a
    2.4 percent annual increase (compound growth) in demand for
    gigawatt-hours between 1994 and 2003.

       Figure II.3:  Growth in
       Electricity Load Forecast by
       TVA, Neighboring Utilities, and
       the Energy Information
       Administration for 1994-2003

       (See figure in printed
       edition.)

    Notes:  The Southeastern Electricity Reliability Council's (SERC)
    Southern Subregion forecast includes forecasts made by several
    utilities, including those represented by the Southern Company.
    Energy Information Administration's forecast is for the SERC region,
    excluding Florida.

    Load forecasts are based on the economic and energy-use
    characteristics of a utility's service territory and may not be fully
    comparable.  We used 1994 as the base year for this analysis.

    Source:  GAO analysis of data from TVA, neighboring utilities, and
    DOE.

    Figure II.4 compares TVA's peak forecasts in MW with the forecasts of
    other utilities.

       Figure II.4:  Growth in
       Electricity Peak Demand
       Forecast by TVA and Neighboring
       Utilities for 1994-2003

       (See figure in printed
       edition.)

    Notes:  The Southeastern Electricity Reliability Council's (SERC)
    Southern Subregion forecast includes forecasts made by several
    utilities, including those represented by the Southern Company.

    Load forecasts are based on the economic and energy-use
    characteristics of a utility's service territory and may not be fully
    comparable.  We used 1994 as the base year for this analysis.

    Source:  GAO analysis of TVA's and neighboring utilities' data.

    We used this comparison to assess the general reasonableness of TVA's
    current load forecast because TVA's record of past performance cannot
    be used to assess the accuracy of the current load forecast.  That
    is, due to changes in TVA's methodology over the last 20 years, TVA's
    historic forecasts cannot be used to develop appropriate measures of
    long-term (10 to 20 years) accuracy.

    --------------------
    \6 Because the load forecasts are based on different geographic areas
    as well as different types of electricity consumers, they are not
    entirely comparable.  We make the comparison to illustrate generally
    how different utilities and the Energy Information Administration
    view future load demand in the southern region of the United States.
    We based this comparison on the reference forecast because this
    forecast has the highest probability.  However, TVA's low forecast
    alternative, which has a lower probability, projects lower load
    growth for the same time period.

          TVA'S KEY REGIONAL ECONOMIC
          GROWTH ASSUMPTION IS MORE
          OPTIMISTIC THAN DATA
          RESOURCES, INC.'S
    ------------------------------------------------------ Appendix II:2.3

    TVA's reference forecast is driven partly by TVA's forecast of
    economic activity.  We found that TVA's assumption about future
    economic activity is at the high range when compared to other
    available forecasts for the region.  Based on RESM, its own economic
    forecasting model, TVA estimates that its service area will grow at a
    3.9 percent annual rate between 1993-2000, and a 2.4 percent annual
    rate between 2000-2020.\7 TVA's projection of 3.9 percent annual
    growth over the 1993-2000 period is based primarily on an expectation
    that durable industries such as transportation will expand at a
    greater rate in its service area than in the U.S.  as a whole.

    In comparison, growth projections made by Data Resources, Inc., (DRI)
    for the East South Central Region of the United States, including
    Kentucky, Alabama, Mississippi, and Tennessee, are less optimistic.\8
    As shown in figure II.5, DRI projects a growth rate of 1.1 percent in
    total employment over 1994- 2004 versus TVA's 1.8 percent projection
    over the same period.

       Figure II.5:  Growth in Total
       Employment Forecast by TVA and
       Data Resources, Inc., for
       1994-2004

       (See figure in printed
       edition.)

    Note:  TVA's employment growth forecast is for the TVA power service
    area, and DRI's growth projection is for Tennessee, Kentucky,
    Alabama, and Mississippi combined.  We used 1994 as the base year for
    this analysis.

    Source:  GAO's analysis of TVA and DRI data.

    In addition, figure II.6 shows that both DRI and the Energy
    Information Administration project a negative growth in manufacturing
    employment for the region over the same period, whereas TVA projects
    a slightly positive growth.  Because economic growth is a key factor
    in determining future load growth, a lower forecast economic growth
    would result in lower load demand projections for TVA's power service
    area.

       Figure II.6:  Growth in
       Manufacturing Employment
       Forecast by TVA, Data
       Resources, Inc., and the Energy
       Information Administration for
       1994-2004

       (See figure in printed
       edition.)

    Note:  TVA's growth projection is for the TVA power service area, and
    the DRI and Energy Information Administration projections are for
    Tennessee, Kentucky, Alabama, and Mississippi combined.  We used 1994
    as the base year for this analysis.

    Source:  GAO's analysis of TVA, DRI, and DOE data.

    --------------------
    \7 Growth rates are for gross regional product for the power service
    area.

    \8 We used DRI's employment projections for East South Central
    because comparable gross regional product data were not available
    from DRI and these four states comprise an important portion of TVA's
    power service area.

          OTHER KEY VARIABLES THAT
          AFFECT TVA'S REFERENCE
          FORECAST ARE REASONABLE
    ------------------------------------------------------ Appendix II:2.4

    According to TVA analysts, the 1995 reference load forecast is also
    dependent on several other key variables, including the price of
    natural gas and TVA's future competitive success.  We found that
    TVA's forecast of the price of natural gas is generally comparable to
    projections made by DRI.  However, the reasonableness of TVA's
    assumption about future competitive success could not be determined.
    These other key variables are discussed below.

      Natural Gas Prices:  TVA's reference load forecast is based in part
         on an expectation that the average natural gas price will
         increase by 3.8 percent annually in nominal terms between
         1993-2000.  This forecast is in the general range of DRI's May
         1994 forecast of 4.5 percent annual growth rate.

      Competition:  TVA analysts recognize that the upcoming changes in
         the utility industry could have a significant impact on their
         competitive position and future load forecast.  However, TVA's
         1995 reference load forecast assumes that TVA will neither gain
         nor lose customers to its competitors.  Because it is unclear at
         this point how competition will impact TVA and the utility
         industry, we could not determine the reasonableness of TVA's
         assumption.\9

    In addition to the assumption regarding its competitive position, TVA
    also assumed that there will be some increase in customers generating
    their own electricity through cogeneration, but no increases from
    other electricity suppliers, such as independent power producers.
    According to TVA, its historical data show that in the TVA power
    service area, few firms are willing to develop an independent
    electricity plant.  Assumptions made by other utilities in this area
    ranged from growth to no growth in these alternative power sources.
    Again, given the uncertainty associated with the direction of the
    industry, we cannot determine the reasonableness of these
    assumptions.

    --------------------
    \9 TVA is currently attempting to model in a more systematic way the
    potential impact of a more competitive market.  If successful, this
    information will be incorporated into the fiscal year 1996 load
    forecast and revised IRP.

    OBJECTIVES, SCOPE, AND METHODOLOGY
    ========================================================= Appendix III

    On March 9, 1994, a hearing on TVA was held by the Subcommittee on
    Investigations and Oversight of the House Committee on Public Works
    and Transportation.  As a result of concerns raised during and after
    this hearing, several Members of the House and Senate requested that
    we examine various TVA issues.  On the basis of subsequent
    discussions with the requesters' offices, we agreed to examine the
    implications for TVA and possibly the federal government of the
    financial issues facing TVA in light of the increasingly competitive
    electric utility market.  More specifically, we agreed to provide our
    views on the issues that can impact TVA's financial condition,
    including how TVA's rates compare with those of its competitors, and
    examine the status of TVA's power program.  In response to other
    issues raised, we also examined the status of TVA's Integrated
    Resource Planning (IRP) process (app.  I), reviewed TVA's past and
    present load forecasting methodologies (app.  II), and analyzed TVA's
    use of in-substance defeasance to refinance debt (app.  V).

          ASSESSING ISSUES THAT CAN
          IMPACT TVA'S FINANCIAL
          CONDITION
    ----------------------------------------------------- Appendix III:0.1

    In assessing the issues that can affect TVA's financial condition, we
    reviewed appropriate legislation affecting TVA, such as the Tennessee
    Valley Authority Act of 1933 as amended, and the applicable sections
    of the Energy Policy Act of 1992.  We discussed TVA's accounting
    policies and practices with its Chief Financial Officer, Treasurer,
    and auditor and analyzed TVA's financial statements for the past 12
    years.  TVA's annual financial statements are audited by Coopers &
    Lybrand L.L.P.  (Coopers & Lybrand), an independent public accounting
    firm.  These audits are conducted in accordance with private sector
    and government auditing standards.  On the basis of its audits,
    Coopers & Lybrand issues opinions on the fairness of TVA's financial
    statements and on the adequacy of TVA's internal controls and
    compliance with key laws and regulations.  Coopers & Lybrand issued
    an unqualified opinion on TVA's 1994 financial statements, indicating
    that they are fairly presented in all material respects.  However, in
    1994, the opinion also included a "matter of emphasis" relating to
    TVA's $6.2 billion of deferred nuclear assets.  While it was not
    within the scope of our work to assess the overall quality of the
    auditors' work, we reviewed selected 1993 audit work papers to obtain
    background information.  Throughout our report, where possible, we
    used audited numbers from TVA's 1994 and prior years' annual reports.

    To determine TVA's relative financial health, we computed and
    analyzed five different financial indicators for TVA and neighboring
    investor-owned utilities (IOU) for fiscal year 1994.\1

    These indicators, which are expressed as ratios, were computed as
    follows.

      The ratio of financing costs to revenue was calculated by dividing
         financing costs by operating revenue for the fiscal year.  The
         financing costs include interest expense on short-term and
         long-term debt, appropriated investment (TVA only), and
         preferred and common stock dividends (IOUs only).  Note that
         preferred and common stock dividends were included in the IOUs'
         financing costs to reflect the difference in the capital
         structure of these entities and TVA.

      The ratio of fixed financing costs to revenue was calculated by
         dividing financing costs less common stock dividends by
         operating revenue for the fiscal year.  Common stock dividends
         were excluded from the IOUs' financing costs because they are
         not contractual obligations that have to be paid.

      The ratio of net cash from operations to expenditures for PP&E and
         common stock dividends was calculated by dividing net cash from
         operations by expenditures for PP&E and common stock dividends
         for the fiscal year.  Net cash from operations represents the
         cash received from customers minus the cash paid for operating
         expenses.  Thus, net cash from operations represents the cash
         available for expenditures for PP&E, common stock dividends
         (IOUs only), and other investing and financing transactions.
         Again, we included common stock dividends in the IOUs ratios to
         reflect the difference in cash flow requirements for these
         entities and TVA.

      The ratio of accumulated depreciation and amortization to gross
         PP&E was calculated by dividing accumulated depreciation and
         amortization by gross PP&E at fiscal year-end.

      The ratio of deferred assets to gross PP&E was calculated by
         dividing deferred assets by gross PP&E at fiscal year-end.
         Deferred assets include construction in progress and deferred
         nuclear units (TVA only).  Deferred nuclear units are included
         for TVA because they are treated by TVA as construction in
         progress (i.e., not depreciated).

    For purposes of this report, we refer to utility holding companies
    and their subsidiaries as IOUs.  We limited our selection to nine
    IOUs that border on TVA's service area because industry experts told
    us that due to the cost of transmitting electricity, TVA's
    competition would most likely come from IOUs located close to its
    service area.  In addition, some of these utilities have submitted
    bids to provide electricity to TVA customers who are seeking power
    sources other than TVA.  We did not include any publicly owned
    utilities in our analysis because the publicly owned utilities that
    provide electricity in the states served by our IOU comparison group
    generally only distribute but do not generate electricity.  The IOUs
    and their subsidiary utilities used in our comparisons included:  (1)
    American Electric Power, Inc.  (including Appalachian Power, Columbus
    Southern Power, Indiana Michigan Power, Kentucky Power, Kingsport
    Power, Ohio Power, and Wheeling Power), (2) Carolina Power and Light
    Company, (3) Duke Power Company, (4) Dominion Resources, Inc.
    (including North Carolina Power and Virginia Power), (5) Entergy
    Corporation (including Arkansas Power and Light, Gulf States
    Utilities, and Mississippi Power and Light), (6) Illinova Corporation
    (including Illinois Power), (7) KU Energy Corporation (including
    Kentucky Utilities), (8) LG&E Energy Corp.  (including Louisville Gas
    and Electric), and (9) The Southern Company (including Alabama Power,
    Georgia Power, Gulf Power, and Mississippi Power).  The financial
    data used in computing the ratios were obtained from the audited
    financial statements in the utilities' fiscal year 1994 annual
    reports.

    We reviewed the financial statements contained in the 1993 and 1994
    annual reports of TVA and the IOUs.  To obtain information on various
    issues facing utilities, we also reviewed the management discussions
    and analyses contained in TVA's 1993 and 1994 annual reports, and the
    IOUs' 1993 annual reports.  These issues included competition, energy
    arrangements with other utilities, nuclear power issues, efforts and
    costs related to meeting the Clean Air Act requirements, capital
    structure, growth rates, accounting issues that could affect the
    utilities' current and future financial condition, and electricity
    rates.  In addition, we contacted financial analysts to identify the
    criteria they use to evaluate the financial condition of electric
    utilities.

    We discussed TVA's current financing and investment policies and
    strategies with TVA's Chief Financial Officer and Treasurer.  We
    discussed TVA's financing policies and current borrowing options with
    an official at the Federal Financing Bank (FFB).  We also interviewed
    government bond analysts at Moody's and Standard & Poor's--two major
    bond rating organizations--to determine the factors that underlie
    TVA's "AAA" bond rating.  In addition, we examined TVA's in-substance
    defeased debt issues (as discussed in appendix V) to determine if
    this debt should apply against TVA's $30 billion borrowing limit.  We
    also discussed TVA's December 12, 1994, Report on Controlling the TVA
    Debt (debt study) with TVA's Chief Financial Officer.

    In comparing retail rates, we calculated the average system,
    residential, commercial, and industrial rates for TVA's nine
    neighboring IOUs by dividing the revenue from the sale of electricity
    to each group by the respective total kilowatt hours sold.
    Residential sales are to households, and industrial sales are to
    businesses generally engaged in mining or manufacturing.  Commercial
    sales are to businesses not covered in the industrial category.  We
    recognize that most of TVA's sales are at the wholesale level.
    However, to compare TVA to IOUs, we obtained TVA's retail rates from
    its December 1994 Report on TVA's Nuclear Options.

    To analyze the effect of TVA's nuclear construction program on TVA's
    future rates, we estimated amortization and/or depreciation expense
    for TVA's investment in nuclear assets over the likely amortization
    and/or depreciation time periods.  These investments are currently
    excluded from TVA's rates.

    We examined the increase in competition among electric utilities
    caused by the Energy Policy Act of 1992 and TVA's prospects for
    competing successfully in the evolving market.  We contacted the
    Edison Electric Institute, American Public Power Association, and the
    National Rural Electric Cooperatives Association, as well as
    individual electric utilities or utility holding companies, such as
    American Electric Power, Dominion Resources, and KU Energy, and we
    reviewed their financial reports and resource plans to determine (1)
    past resource decisions that could enhance or decrease their
    competitiveness, (2) current plans for responding to increasing
    competition, and (3) relative financial well-being.

    We contacted national and regional associations\2 that represent
    TVA's electricity distributors and large industrial customers to
    understand their concerns about TVA's future competitiveness and
    future rates.  For a more detailed examination of these topics, we
    interviewed officials from TVA's largest distributors (representing
    about 29 percent of TVA's power demand), including the municipal
    utilities of Memphis, Nashville, Knoxville, and Chattanooga,
    Tennessee and Huntsville, Alabama.  We also interviewed officials
    from the Decatur and Fort Payne, Alabama, utilities in order to gain
    the perspectives of TVA's smaller municipal customers.  We
    interviewed officials from the municipal power agency in Bristol,
    Virginia, and the Four County Electric Power Association in Columbus,
    Mississippi, because these utilities, along with the Memphis utility,
    have explored leaving the TVA power system to procure cheaper power
    from other suppliers.  In addition, we analyzed the provisions of
    TVA's contracts to determine how difficult it would be for a TVA
    distributor to end its contract and leave the TVA system.

    --------------------
    \1 The fiscal year ends for TVA on September 30 and the IOUs on
    December 31.

    \2 The National Rural Electric Cooperatives Association, American
    Public Power Association, Tennessee Valley Public Power Association,
    Electricity Consumers Resource Council, and the Tennessee Valley
    Industrial Coalition.

          ASSESSING THE STATUS OF
          TVA'S POWER PROGRAM
    ----------------------------------------------------- Appendix III:0.2

    In assessing the status of TVA's power program, we examined the
    history and current operation of TVA's nuclear power program, and
    TVA's prospects for having the Watts Bar 1 and Browns Ferry 3 nuclear
    units in operation by 1995 and 1996, respectively.  We focused on
    TVA's nuclear power program because it is associated with a
    substantial portion of TVA's $26 billion debt, and because it has
    experienced problems over the past 20 years.

    We interviewed TVA's Vice President of Nuclear Operations and the
    Executive Staff Support Manager for Nuclear Operations; and we
    discussed the current and past construction and operational problems
    of the Browns Ferry, Sequoyah, and Watts Bar nuclear units with the
    Vice President of each of the nuclear plants.  We discussed current
    and past safety and licensing issues at TVA's nuclear plants with
    various officials of the Nuclear Regulatory Commission (NRC),
    including the Director for the Office of Nuclear Reactor Regulation,
    the Regional Administrator for NRC Region II, the Branch Chief for
    Nuclear Licensing Renewal, and the Senior Resident Inspector at the
    Watts Bar Nuclear Plant.  We also met with the Vice President for
    Governmental Affairs at the Institute for Nuclear Power Operations.

    We reviewed previous GAO, TVA, and NRC reports on TVA's nuclear power
    program.  We also examined TVA and NRC reports regarding allegations
    of safety, engineering, operational, and managerial problems.  Many
    of these allegations are significant because NRC has determined that
    TVA must resolve them to NRC's satisfaction before TVA can bring into
    commercial operation its Watts Bar 1 and Browns Ferry 3 nuclear
    units.  We also reviewed NRC's most recent "Systematic Assessment of
    Licensee Performance" reports for each of TVA's nuclear units,
    because these reports provide information on how well nuclear plant
    management is directing operations and providing needed resources to
    assure plant safety.

    We examined data on how much power was generated by TVA's nuclear
    units from each unit's initial date of commercial operation through
    the end of fiscal year 1994.  We reviewed TVA documents showing the
    unplanned and planned outages at each of TVA's nuclear units from
    first commercial operation date through fiscal year 1994.

    For TVA's Watts Bar 1 and Browns Ferry 3 nuclear units, we reviewed
    TVA documents showing historic and recent construction schedule slips
    and cost overruns, and cost estimates to complete these units from
    1990 to 1994.  We discussed TVA's decision to complete the Watts Bar
    1 and Browns Ferry 3 nuclear units with TVA resource planning
    officials.  We also reviewed TVA's costs and assumptions included in
    its incremental cost analysis for completing these units.  Using
    TVA's methodology, we conducted our own incremental cost analysis on
    Watts Bar 1, using less optimistic assumptions than those considered
    by TVA.  We used our Watts Bar 1 analysis for illustrative purposes
    in this report.

    We also reviewed TVA's program for operating, maintaining, and
    upgrading its nonnuclear power assets, primarily its hydroelectric
    and coal-fired units.  The hydroelectric and coal-fired units are
    important because they accounted for an average of 86 percent of
    TVA's electric power during fiscal years 1980 to 1994.  These units
    also supplied the bulk of TVA's power during 1986 and 1987 when TVA's
    nuclear operations were completely shut down.  During this time, TVA
    relied on its nonnuclear power plants in order to satisfy almost all
    of its customers' requirements.

    For TVA's hydroelectric and coal-fired units, we obtained and
    analyzed data from fiscal years 1980 to 1994 on annual generation;
    capital expenditures; operating and maintenance expenditures; unit
    availability to produce power; and planned, unplanned, and
    maintenance outage rates.  We also reviewed TVA's projected capital
    and operating and maintenance costs through the year 2020.  We
    obtained data on the age of the coal-fired and hydroelectric units;
    plans to upgrade or retire these units; and TVA's assessments of its
    costs of complying with environmental requirements, including Clean
    Air Act requirements.  We discussed operations and expenditures with
    various TVA officials, including the Manager of Fossil and Hydro
    Generation Planning and the Manager of Financial Services.

          DETERMINING THE STATUS OF
          TVA'S INTEGRATED RESOURCE
          PLANNING PROCESS
    ----------------------------------------------------- Appendix III:0.3

    To examine the status of TVA's IRP process, we reviewed the
    requirements for the process as established in the Energy Policy Act
    of 1992.  We also attended TVA's monthly IRP meetings between July
    1994 and March 1995 and interviewed responsible TVA officials.  We
    reviewed various documents pertaining to the IRP process.  These
    included documents on TVA's projected need for additional power
    resources, such as its December 1994 report entitled, Report on TVA's
    Nuclear Options; demand- and supply-side resources proposed by TVA in
    its IRP process; and planning considerations that TVA associated with
    a cleaner environment.  We also contacted members of TVA's "Review
    Group," which is providing TVA with advice on its IRP process and
    resources the IRP should consider.

    We monitored the progress of outside consultant reviews of TVA's IRP
    process by discussing the status of the consultants' work with TVA
    officials and stakeholders, and by obtaining and examining
    documentation that describes the scope and status of the consultants'
    work.

    We did not review the effectiveness of TVA's IRP process because it
    was still subject to change during the course of our review, and the
    final IRP plan was not scheduled to be completed until December 1995.

          ASSESSING TVA'S PAST AND
          PRESENT LOAD FORECASTING
          METHODS
    ----------------------------------------------------- Appendix III:0.4

    To gain an understanding of TVA's load forecasting process, we
    examined TVA's past and present methodology for projecting
    electricity load.  We interviewed TVA's load forecasting officials
    and reviewed energy and economic forecasting documentation that
    describes TVA's forecasting methodology.  To compare TVA's
    forecasting models and methods against the state-of-the-art
    forecasting practices within the utility industry, we interviewed
    forecasting experts at the Electric Power Research Institute,
    Lawrence Berkeley Laboratory, Edison Electric Institute, Energy
    Information Administration, and several energy consulting firms,
    including Barakat and Chamberlin, LCG Consulting, and HBRS.  We also
    obtained and reviewed modeling documentation provided by these
    organizations.

    We compared TVA's methodology with the methodologies of other
    utilities by interviewing forecasting officials and reviewing
    forecasting documentation at a number of utilities or utility holding
    companies in the Southeast, including Dominion Resources, Kentucky
    Utilities, and Duke Power.  We also interviewed forecasting officials
    from the Wisconsin Electric Power Company, New England Electric
    Systems, Pacific Gas and Electric Company, and the California Energy
    Commission.

    To examine the accuracy of TVA's historic load forecasts, we compared
    its annual net system requirement forecasts from 1970 to 1991 with
    the actual net system requirements for the same years.  We used
    standard measures of accuracy, such as the mean absolute percentage
    error and the root mean square error, in our evaluation of each
    forecast year.  To assess the relative accuracy of TVA's forecasts,
    we reviewed the forecasting literature and discussed historical
    forecasts with officials from other utilities, including Wisconsin
    Electric Power Company, Duke Power, and Kentucky Utilities.

    To examine the reasonableness of TVA's fiscal year 1995 long-term
    load forecast, we compared it with the load forecasts of neighboring
    utilities, including Virginia Power/North Carolina Power, Duke Power,
    and Kentucky Utilities.  We evaluated the reasonableness of TVA's
    economic assumptions by interviewing economists at 11 different
    universities in or near the TVA service area.  We also compared TVA's
    1994 regional economic forecast with comparable regional forecasts,
    including those produced by Data Resources, Inc., and the Energy
    Information Administration.

    Our evaluation of TVA's forecasting system was limited to a review of
    the overall integration of the load forecasting system, the general
    structure of the individual forecasting models, and TVA's uncertainty
    analysis.  We did not evaluate TVA's calibration of equations or
    models, or the specific input data used to develop the load
    forecasts.

    A list of the organizations and groups we contacted during the course
    of our work follows.  We conducted our review between June 1994 and
    July 1995 in accordance with generally accepted government auditing
    standards.  We obtained written TVA comments on a draft of our
    report, which are contained in appendix IV.  We also requested and
    received comments from two external reviewers--Mr.  Charles Luce\3
    and Mr.  Robert Fri\4 --on a draft of this report.  Both reviewers
    concurred with the overall message and conclusions of our draft
    report and offered other comments that we have incorporated in this
    report, where appropriate.

    --------------------
    \3 Mr.  Luce is the retired Chairman of the Board and CEO of
    Consolidated Edison of New York and is currently a consultant for
    Consolidated Edison.  He is also a former Undersecretary of the U.S.
    Department of the Interior and Administrator of the Bonneville Power
    Administration.  In addition, Mr.  Luce was a member of the Southern
    States Energy Board Advisory Committee on the Tennessee Valley
    Authority that issued the 1987 report entitled TVA--A Path to
    Recovery.

    \4 Mr.  Fri is President of Resources for the Future.  He is also a
    former Deputy and Acting Administrator for the Environmental
    Protection Agency and a former Deputy and Acting Administrator for
    the Energy Research and Development Administration.  In addition, Mr.
    Fri was a member of the Southern States Energy Board Advisory
    Committee on the Tennessee Valley Authority that issued the 1987
    report entitled TVA--A Path to Recovery.

       ORGANIZATIONS AND GROUPS THAT
       GAO CONTACTED
    ------------------------------------------------------- Appendix III:1

          FEDERAL AGENCIES
    ----------------------------------------------------- Appendix III:1.1

    Bonneville Power Administration
    Department of Energy, including the Energy Information
     Administration
    Environmental Protection Agency
    Federal Energy Regulatory Commission
    Federal Financing Bank
    Nuclear Regulatory Commission, Headquarters, Atlanta Region, TVA
     Sites

          BOND RATING AGENCIES AND
          FINANCIAL ANALYSTS
    ----------------------------------------------------- Appendix III:1.2

    Standard & Poor's, New York, NY
    Moody's Investors Service, New York, NY
    Fitch Investors Service, Inc., New York, NY

          INDEPENDENT PUBLIC
          ACCOUNTING FIRM
    ----------------------------------------------------- Appendix III:1.3

    Coopers & Lybrand L.L.P.

          NEIGHBORING ELECTRIC
          UTILITIES OR HOLDING
          COMPANIES
    ----------------------------------------------------- Appendix III:1.4

    American Electric Power, Columbus, OH
    Dominion Resources (Virginia Power/North Carolina Power), Richmond,
     VA
    Kentucky Utilities, Lexington, KY

          LOAD FORECASTING EXPERTS,
          RESOURCE PLANNING EXPERTS,
          AND REGIONAL ECONOMICS
          EXPERTS
    ----------------------------------------------------- Appendix III:1.5

    Barakat and Chamberlin, Inc., Oakland, CA
    California Energy Commission, Sacramento, CA
    Oak Ridge National Laboratory, Oak Ridge, TN
    New England Electric Systems (load forecasting unit), Westboro, MA
    Duke Power Company, Charlotte, NC
    Kentucky Utilities, Lexington, KY
    Pacific Gas and Electric Company, San Francisco, CA
    Wisconsin Electric Power Company, Milwaukee, WI
    Lawrence Berkeley Laboratory, Berkeley, CA
    Electric Power Research Institute, Palo Alto, CA
    Data Resources, Inc., Lexington, MA
    LCG Consulting, Los Altos, CA
    HBRS, San Francisco, CA
    XENERGY, Inc., Burlington, MA
    Mississippi State University, Starkville, MS
    University of Tennessee at Martin, Martin, TN
    East Tennessee State University, Johnson City, TN
    Memphis State University, Memphis, TN
    Middle Tennessee State University, Murfreesboro, TN
    Eastern Kentucky University, Richmond, KY
    University of Alabama at Huntsville, Huntsville, AL
    Tennessee State University, Nashville, TN
    Virginia Tech, Blacksburg, VA
    Western Carolina University, Cullowhee, NC
    Louisiana State University, Baton Rouge, LA

          TRADE OR INTEREST GROUP
          ASSOCIATIONS
    ----------------------------------------------------- Appendix III:1.6

    American Public Power Association, Washington, DC
    Edison Electric Institute, Washington, DC
    Electricity Consumers Resource Council, Washington, DC
    Institute for Nuclear Power Operations, Atlanta, GA
    National Rural Electric Cooperatives Association, Washington, DC
    Tennessee Valley Industrial Coalition/Associated Valley Industries,
     Columbia, TN
    Tennessee Valley Public Power Association, Chattanooga, TN
    Tennessee Valley Energy Reform Coalition, Knoxville, TN

          TVA DISTRIBUTORS
    ----------------------------------------------------- Appendix III:1.7

    Bristol, VA
    Chattanooga, TN
    Decatur, AL
    Huntsville, AL
    Four County Electric Power Association, Columbus, MS
    Fort Payne, AL
    Knoxville, TN
    Memphis, TN
    Nashville, TN

    (See figure in printed edition.)Appendix IV
    COMMENTS FROM THE TENNESSEE VALLEY
    AUTHORITY
    ========================================================= Appendix III

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    Note:  GAO comments on TVA's executive summary are found in chapter
    5.

    (See figure in printed edition.)

    (See figure in printed edition.)

    See comment 1.

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    See ch.  5.

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    14, and 22.

    See comment 12.

    (See figure in printed edition.)

    See comment 14.

    See comment 15.

    (See figure in printed edition.)

    (See figure in printed edition.)

    See comment 15.

    (See figure in printed edition.)

    See comment 17.

    (See figure in printed edition.)

    See comment 18.

    (See figure in printed edition.)

    See ch.  5.

    (See figure in printed edition.)

    See ch.  5.

    (See figure in printed edition.)

    (See figure in printed edition.)

    See comment 21.

    (See figure in printed edition.)

    See comment 22.

    (See figure in printed edition.)

    See comment 23.

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    See comment 21.

    (See figure in printed edition.)

    The following are GAO's comments on TVA's letter dated June 15, 1995.

    1.  We agree with TVA that differences exist between the amounts and
    types of regulation faced by publicly-owned and cooperative utilities
    and private ones (i.e., IOUs).  However, we disagree with TVA's view
    that (1) publicly-owned and cooperative utilities receive almost no
    oversight from public utility commissions and (2) TVA does not need
    regulatory oversight because it is publicly owned.  Regarding the
    first point, TVA pointed out that publicly- owned utilities are
    overseen by municipal or independent boards, or boards comprised of
    customer-owners.  Moreover, according to a 1992 study by the National
    Association of Regulatory Utility Commissioners, 21 states (out of 46
    with rural electric cooperatives) regulate the rates of those
    cooperatives.  TVA does not receive these types of scrutiny.
    Regarding the second point, TVA's decisions to invest billions of
    dollars in nonproducing assets over an extended time period using
    debt financing may indicate that TVA merits special regulatory
    attention in order to better safeguard the interests of both TVA's
    ratepayers and the federal government.

    2.  As stated in appendix III, we did not review the effectiveness of
    TVA's IRP process in appendix I because it is subject to change and
    the final IRP was not scheduled to be completed until December 1995.
    We reviewed the preliminary draft of TVA's IRP, presented to the IRP
    Review Group on May 31, 1995, and concluded that the information it
    contains provides further support for some of the major conclusions
    in our report.  For example, on the basis of the potential
    recommendations in TVA's preliminary draft, key TVA decisions about
    the future of Watts Bar 2 would continue to be deferred until the
    year 2000 and TVA would also study for 18 to 24 months a potential
    option to convert the two Bellefonte units to another fuel source.
    As a result of this information, we conclude in chapter 5 that it is
    no longer reasonable for TVA to defer the $6.2 billion of costs
    related to these units from current revenue requirements.  Moreover,
    it proposed plans that the Board may or may not act upon in the
    future.  We have updated the information included in appendix I to
    recognize that the preliminary draft was provided to the IRP Review
    Group on May 31, 1995, and TVA issued a draft IRP plan to the public
    at the end of July 1995.

    3.  We show in our report how TVA's residential, commercial, and
    industrial rates compare with the nine IOUs.  We note that TVA's
    rates, while low, are not the lowest compared to neighboring
    utilities.  TVA states that its low operation and maintenance costs
    will be a crucial factor in future rates.  We continue to believe
    that TVA's enormous financing costs and deferred assets are the key
    to the competitiveness of TVA's future rates.  Inclusion of deferred
    assets in TVA's revenue requirements will put significant pressure on
    TVA to raise its rates in the future.

    TVA states that the interest component of deferred assets is included
    for TVA but that IOUs have not included these costs in current rates.
    TVA has not capitalized interest related to the Watts Bar 1 and
    Bellefonte plants since 1990.  However, of TVA's $14 billion in
    deferred assets at September 30, 1994, over $5 billion represents
    interest capitalized during the lengthy construction of these assets,
    which is excluded from current rates.  In addition, we compared TVA's
    current capitalization of interest to similar capitalized costs of
    the neighboring IOUs and found that, for fiscal year 1994, TVA
    capitalized $123 million of interest, whereas similar capitalized
    costs for the 9 IOUs ranged from $0 to $112 million, with 8 of the 9
    IOUs having $29 million or less.  Thus, in addition to the $5 billion
    of capitalized interest related to deferred assets, TVA is currently
    deferring more interest expense from current rates than neighboring
    IOUs.

    4.  We have revised our report to reflect that at the end of fiscal
    year 1994, TVA's appropriated debt was $390 million.  This amount
    represents the
    $1 billion repayment required by law less the $610 million repaid at
    September 30, 1994.  We consider the balance to be repaid as
    appropriated debt because TVA must repay this amount to the Treasury
    with interest and, therefore, it has the same effect on TVA as any
    other debt obligation.

    5.  Based on additional information provided by TVA, we have revised
    our report to reflect that TVA's outstanding line of credit as of
    September 30, 1994, was $126 million.

    TVA stated that our definition of capitalization in footnote 7 was in
    error because it did not include current taxes payable, deferred
    taxes payable, and deferred investment-tax credits for IOUs.  We
    disagree with TVA's definition of capitalization.  Industry practice
    as indicated by all nine of the IOU annual reports we reviewed does
    not include these items in capitalization.  Further, TVA's inclusion
    of these items in capitalization is inconsistent with the Palmer
    Bellevue study, which does not include deferred taxes payable in
    capitalization for IOUs.

    6.  We agree that TVA is subject to congressional and Office of
    Management and Budget review.

    7.  Book value represents the costs of assets that must be included
    in TVA's future revenue requirements.  The primary purpose of our
    analysis was to show that inclusion of TVA's nonproducing assets in
    revenue requirements will put pressure on TVA to raise its rates.  A
    market value analysis of TVA's assets is not relevant to revenue
    requirements.

    8.  We agree that short-term stock prices would be negatively
    impacted by an IOU's decision not to pay dividends.  However, IOUs
    have this flexibility and some have elected this option in the past.

    9.  As reflected in the table in TVA's comments and table 2.3 of our
    report, TVA and American Electric Power have about the same amount of
    system capacity.  We also state in our report that TVA had net total
    assets that were double those of American Electric Power.  The major
    purpose of our comparison between TVA and American Electric Power was
    to show that primarily because of its investment in nonproducing
    assets, TVA had almost twice the investment in assets in 1994 as
    American Electric Power, yet TVA produced approximately the same
    amount of power and revenues from its operations.  Our analysis also
    highlights that TVA has far more total net assets than American
    Electric Power--costs that TVA will have to recover in future revenue
    requirements.  We have added a footnote to table 2.3 to reflect that
    nearly $8 billion of TVA's deferred assets are associated with Watts
    Bar 1 and Browns Ferry 3 and that TVA's capacity would increase by
    about 2,230 MW if these units become operational.

    10.  We agree that Kentucky Utilities has lower rates than TVA and
    relatively tight capacity margins.  However, TVA is incorrect in
    saying that because Kentucky Utilities has not built new capacity, it
    cannot market power in competition with TVA.  As stated in our
    report, a Kentucky Utilities official said that the utility has
    sufficient existing capacity to compete for some of TVA's smaller
    customers, generally those with loads of 100 MW or less.  TVA's
    comments do not acknowledge that other low-cost utilities in the
    region, such as American Electric Power, have surplus capacity and,
    therefore, would be able to compete for some of TVA's larger
    customers.  In addition, TVA does not acknowledge the threat of
    competition from IPP's.  Several companies have recently developed
    natural-gas fired generating units that are 50 percent more efficient
    than earlier units and require minimal capital investment.  IPP's
    typically use such new technologies to generate electricity, which
    places downward pressure on electricity rates.

    The comparison of investment in PP&E per MW of generating capacity to
    rates was used to illustrate the general relationship between these
    two items.  The fact that this relationship does not hold true for
    each utility does not diminish its general validity.  The chart shows
    that because of TVA's comparatively large investment in PP&E, its
    rates are likely to increase in the future when it begins to
    recognize the costs of its deferred assets in its revenue
    requirements.

    11.  In chapter 3, we show the cost overruns and schedule slippage
    TVA has experienced in its nuclear program and also recognize that
    TVA faces the need for a substantial investment in its aging coal and
    hydroelectric plants.  We further recognize that TVA anticipates
    spending hundreds of millions of dollars annually for the next 26
    years to upgrade these plants.  We concluded that further delays in
    completing the construction of its nuclear plants could limit capital
    funds available for needed improvements to coal and hydroelectric
    plants, especially if TVA honors its commitment to maintain its debt
    at below $28 billion.  Our report recognizes TVA's efforts, beginning
    in 1991, to initiate a capital improvement program for its coal and
    hydroelectric plants and TVA's future significant funding plans
    through the year 2020.  TVA's comments do not mention that Watts Bar
    1 is again delayed from December 1995 to February 1996 and has
    exceeded its latest budget targets.

    TVA states that our analysis of first-year operating costs for
    nuclear units is "incorrect" and leads to "erroneous conclusions"
    about expected costs.  TVA further states that a panel of experts
    independent of TVA performed a thorough analysis of TVA's nuclear
    assumptions used in the IRP and has not indicated any potential
    conflicts.  We reviewed the analysis done by the panel of experts in
    February 1995 and found that there was no analysis of TVA's estimated
    cost to complete Watts Bar 1 and Browns Ferry 3.  As our analysis in
    chapter 3 shows, cost to complete these units is one of the two most
    significant factors in determining future incremental costs.  Since
    fiscal year 1990, Watts Bar 1 and Browns Ferry 3 have had cost
    overruns of over $2.7 billion.  On the basis of TVA's fiscal year
    1994 expenditures, TVA's further schedule slippage for Watts Bar 1's
    commercial operation date from October 1995 to February 1996 will
    result in an additional cost overrun of about $130 million.  We
    continue to believe that the cost of completing these two units may
    be higher than TVA anticipated.

    12.  Our report was not intended to imply that TVA was continuing to
    maintain that Watts Bar 1 qualifies for an operating license.  We
    have clarified this point in our report.  In addition, we have
    updated our report to show TVA's latest schedule change and NRC's
    views of TVA's recent performance at Watts Bar 1.  In its comments,
    TVA referred to 27 major corrective action programs, but NRC lists 28
    programs.  We used NRC's number in our report.

    13.  Our report states that Browns Ferry 3's construction activities
    have been on schedule for over a year.

    14.  Our report states that an assumption of one additional year's
    delay in the estimated date of commercial operation for Watts Bar 1
    would not be inconsistent with its long construction history.  Watts
    Bar 1 has been under construction for over 22 years and since 1990
    the estimated date of commercial operation has slipped by nearly 4
    years.  As discussed under comment 11, the commercial operation date
    for Watts Bar 1 was recently delayed again.  To provide a reasonable
    basis for estimating the range of possible cost increases, our report
    calculates the cost of a delay based on the average amount TVA spent
    per day during fiscal year 1994 at the unit, $1.1 million.

    Our analysis used capacity factors of both 66 percent and 38 percent
    to demonstrate the sensitivity of TVA's estimate for Watts Bar 1's
    first year incremental cost to this factor and provide a range of
    possible outcomes.  The 66 percent capacity factor acknowledges the
    recently improved performance of TVA's nuclear program.  The 38
    percent capacity factor is based on the combined average capacity
    factor for TVA's 5 licensed nuclear units since their original
    start-up.  This lower assumption is used to illustrate what could
    happen to first year incremental costs if TVA incurred significant
    problems after bringing the unit into commercial operation.  For
    example, for the 3 years ending in 1994, the average capacity factor
    for 2 of TVA's 3 operating nuclear units--Sequoyah 1 and 2--was about
    50 percent.

    15.  In discussing TVA's coal and hydroelectric programs, we
    recognize TVA's past performance, the capital improvement program
    initiated in 1991, and TVA's plans for spending billions of dollars
    during the next 26 years.  Our report also states that TVA has met
    Phase 1 requirements, and we acknowledge that, according to TVA, the
    availability of coal and hydroelectric units to produce power has
    improved, unexpected forced outages have declined, and the cost of
    producing power has decreased.  We do not state in the report that
    TVA's capital expenditures for its coal and hydroelectric plants are
    unusual, but rather that these costs are substantial.  This is
    especially true given TVA's limited remaining borrowing authority and
    its history of delays and cost overruns at Watts Bar 1 and Browns
    Ferry 3.

    16.  Although some distributors praised TVA's rate freeze, several
    distributors we contacted voiced concerns about TVA's debt and
    potential rate increases.  Most of the distributors we contacted,
    including some of TVA's largest ones, stated they would like to
    satisfy at least partial requirements from outside sources.  Most TVA
    distributors we contacted said that TVA's contracts, which self-renew
    automatically every year and contain 10-year advance notice
    cancellation requirements, are too stringent, and deny distributors
    the source flexibility needed to function in a competitive
    environment.

    17.  TVA's comments inaccurately indicate that our report does not
    recognize the positive steps taken by TVA.  We disagree that the
    extent of these changes will make TVA a successful competitor in the
    new marketplace.  According to financial analysts, utilities with
    large deferred regulatory assets and high fixed costs related to
    prior investments will be at greater financial risk than other
    utilities.

    The statement in our report concerning industrial load refers to a
    gain in TVA's load stability due to the departure of some of TVA's
    industrial load during the 1980s.  We agree, as stated in our report,
    that industrial customers are always looking for better rates.

    18.  We take no position regarding the validity of the study by GDS
    Associates or TVA's analysis of this study.  Our discussion is
    strictly descriptive, showing that a TVA distributor is actively
    seeking to buy power from sources other than TVA.

    We do however disagree with TVA's comment concerning monetary damages
    in its electric power contracts.  If a distributor cancels its power
    contract with TVA, provisions in the contracts would require a
    distributor to pay for a "minimum bill amount," a percentage of the
    capacity specified in the contract.

    19.  According to TVA's fiscal year 1994 financial statements, about
    $3.3 billion of TVA's debt was short-term debt with less than a
    1-year term to maturity, and about $5.1 billion was long-term debt
    maturing between fiscal year 1996 and fiscal year 1998.  Our report
    illustrates TVA's interest rate risk by stating that if the interest
    rates at which TVA must refinance its approximately $8.4 billion in
    debt maturing by 1998 increase by 1 percent, TVA's annual financing
    costs will increase by about $84 million.

    20.  We believe because of TVA's substantial debt and resultant
    financing costs, it is doubtful that TVA will be able to successfully
    compete in the long run.  As a result, we discuss a number of options
    available to TVA, including a rate increase, that could help to
    reduce its debt and financing cost and highlight issues for
    consideration in analyzing these options.  TVA's comments correctly
    recognize that if TVA raised its electricity rates, certain issues
    would need to be considered, including the impact a rate increase
    might have on TVA's competitive position.  However, we estimate that
    even a 10 percent rate increase would leave TVA with $23 billion of
    outstanding debt and significant financing costs after 10 years.

    21.  In chapter 5, we state that resolving TVA's financial problems
    will be costly and require painful decisions.  We believe it is
    unlikely that TVA can solve its problems on its own and that some
    form of federal government intervention may be required.  The options
    we present for the Congress to consider include a "no action" option,
    limiting or restructuring TVA's debt, removing statutory barriers to
    competition, privatizing TVA, and/or increasing oversight of TVA's
    activities.  There may well be other alternatives.  TVA raises
    objections to all options presented except the "no action" option.
    Resolving TVA's financial situation likely will require a combination
    of actions.  We did not intend to present a particular solution to
    TVA's dilemma; rather, we wanted to stimulate a dialogue among the
    key decisionmakers concerning options available to protect the
    government's interests and help TVA fulfill its announced intention
    of becoming a competitive and financially viable utility.

    TVA states that it "has offered to pay off the debt owed to the
    federal government" which "would have been a benefit to the U.S.
    taxpayer and at the same time allowed TVA to reduce operating costs."
    Most of TVA's federal debt is owed to the Federal Financing Bank
    (FFB) and has no call provisions.  We agree that allowing TVA to
    refinance its FFB debt by issuing its own bonds would reduce TVA's
    interest expense since most of this debt is currently at a higher
    interest rate than recent issuances of TVA bonds.  However, TVA is
    incorrect in assuming this refinancing transaction would benefit the
    U.S.  taxpayer.  TVA's FFB debt had interest rates ranging from 7.3
    percent to 11.7 percent at September 30, 1994, while Treasury Bill
    yields for the week ended July 28, 1995, ranged from 5.7 percent for
    1 year to 6.9 percent for 30 years.  Thus, without a substantial
    refinancing premium paid by TVA, this transaction would result in a
    greater decrease in interest income than the decrease in interest
    expense for the federal government.

    TVA states that "TVA and distributors currently pay approximately 25
    percent more in tax-equivalent payments to state and local
    governments than IOUs." Determining whether this statement is true
    was beyond the scope of our review; however, we did find that TVA
    paid no federal income tax and on the average, the IOUs paid more
    than twice as much in total taxes as TVA.

    22.  As shown under comment 2, in appendix I we did not review the
    effectiveness of TVA's IRP process.  Because TVA's "preliminary
    draft" of the IRP proposes that TVA continue to defer key decisions
    about Watts Bar 2 and the two Bellefonte units and because the
    preliminary draft will not be acted upon by the Board until January
    1996, information contained therein provided further support for some
    of the major conclusions of this report.

    23.  While it is true that DRI has revised its growth estimate for
    the region upward since its 1994 forecast (ranked ninth or last among
    the nine regions; it was moved to seventh in their latest forecast),
    DRI's projected growth for the East-South Central region is still
    less than the national average and less optimistic than TVA's
    projected growth for the power service area.

    24.  Overall, we believe that the Palmer Bellevue study is incomplete
    and presents an optimistic view of TVA's competitiveness because its
    calculation of TVA's incremental and average cost of producing
    electricity excludes TVA's $1.9 billion of annual interest expense
    and TVA's other fixed costs, such as depreciation expense.  We
    believe that the full cost of producing electricity is more relevant
    to a utility's current and future competitiveness.  A utility cannot
    sell electricity at incremental costs (or average costs as calculated
    by Palmer Bellevue) for too long and remain financially viable.

    25.  We disagree that our report is inconsistent.  Taking down the
    "fence" and opening TVA up to competition is a complicated matter.
    While subjecting TVA to competition would force it to operate in a
    more businesslike manner, our report states that TVA's substantial
    financing costs and deferred assets make it unlikely that it can
    compete successfully with neighboring IOUs in the long term.  In
    order for TVA to compete effectively, costly and painful decisions
    need to be made.

    26.  To clarify our position, we doubt that if TVA were subject to a
    public utility commission whether it would have been allowed to incur
    $14 billion for nonproducing assets over a 20-year period.  Our
    report does not assert that state regulators force utilities to
    immediately begin reflecting capital and interest costs associated
    with unfinished or abandoned plants in their rates.  Rather, our
    report states that utilities are "quickly absorbing into rates or
    writing off costs associated with uneconomical plants."

    TVA'S USE OF IN-SUBSTANCE
    DEFEASANCE OF DEBT AS A
    REFINANCING TOOL
    =========================================================== Appendix V

    As part of our review, we analyzed whether defeased debt should be
    included as part of overall debt for purposes of determining whether
    TVA had exceeded its statutory $30 billion debt limit.  This appendix
    describes TVA's use of in-substance defeasance of debt as a
    refinancing mechanism.  We also discuss the accounting, budgetary,
    and financial implications of these transactions and assess the
    reasonableness of TVA's position that defeased debt should not be
    included in the $30 billion debt limit.  We briefed the requesters'
    staff on our analysis of the in-substance defeasance issues during
    September and December 1994 meetings.

          DESCRIPTION OF IN-SUBSTANCE
          DEFEASANCE OF DEBT
    ------------------------------------------------------- Appendix V:0.1

    As interest rates began to fall in recent years, TVA has looked for
    ways to lower interest expense on existing debt.  Beginning in 1989,
    TVA began refinancing high interest rate bonds by using in-substance
    defeasance arrangements.  An in-substance defeasance of debt occurs
    when the borrower creates a trust with an independent trustee and
    irrevocably funds it with essentially risk-free monetary assets so
    that the cash flow from the trust assets is sufficient to service the
    outstanding debt.  Specifically, TVA issues new debt and the proceeds
    are used to purchase investments (direct obligations of the U.S.
    government) that are sufficient to service the original debt
    including interest payments.  The investments purchased from the
    proceeds of the new debt are placed into an irrevocable trust.  This
    arrangement results in retiring the original debt and refinancing it
    with new debt at a lower interest rate.

          FINANCIAL IMPLICATIONS
    ------------------------------------------------------- Appendix V:0.2

    TVA has used in-substance defeasance of debt primarily to refinance
    its Federal Financing Bank (FFB) debt at lower interest rates.  Since
    1989, $12 billion of debt has been refinanced through defeasance,
    with $7.5 billion of this debt being FFB debt issued between 1980 and
    1984 at interest rates ranging from 10.4 percent to 14.9 percent.

    As of September 30, 1994, there were three outstanding bond issues
    totalling approximately $3.8 billion that had been defeased.  The
    first two issues, totalling approximately $2.6 billion, matured on
    October 1, 1994.  The third issue, totalling approximately $1.2
    billion, will mature on November 15, 1996.

    To illustrate the impact of these refinancing transactions, we will
    use the $1.2 billion debt issue.  In this example, an in-substance
    defeasance arrangement was used to refinance the $1.2 billion of debt
    which has an interest rate of 8.25 percent.  The new bonds that were
    issued to generate sufficient proceeds to defease the $1.2 billion
    issue had maturities of 3 and 50 years and interest rates of 4.6
    percent and 6.9 percent, respectively.

          ACCOUNTING TREATMENT
    ------------------------------------------------------- Appendix V:0.3

    TVA's in-substance defeasance of debt transactions are being
    accounted for in accordance with Statement of Financial Accounting
    Standards No.  76 (SFAS 76), Extinguishment of Debt.  Debt that is
    treated in accordance with circumstances established by SFAS 76 is
    considered extinguished for financial reporting purposes and is
    removed from the balance sheet.  TVA's in-substance defeasance
    transactions previously described clearly fall within the
    circumstances described in SFAS 76.  TVA's use of direct obligations
    of the U.S.  government as trust assets satisfies the funding
    requirements of SFAS 76.  Coopers and Lybrand L.L.P.  TVA's
    independent auditor, has reviewed these transactions and concurred
    with TVA's treatment for financial reporting purposes.

          BUDGETARY IMPLICATIONS
    ------------------------------------------------------- Appendix V:0.4

    As previously mentioned, TVA's electricity operations are included in
    the overall federal budget.  TVA's $26 billion of debt at September
    30, 1994, has been included in previous years' calculations of the
    budget deficit.  We found that defeased debt has no impact on the
    federal budget.  Proceeds from new borrowing are not considered
    budgetary receipts, and cash used to defease outstanding debt is not
    considered a budgetary outlay.

          ASSESSMENT OF TVA'S
          TREATMENT OF DEFEASED DEBT
    ------------------------------------------------------- Appendix V:0.5

    Under each of TVA's in-substance defeasance arrangements, the
    irrevocable trust agreement requires the deposit of the proceeds of
    the sale of new power bonds with an independent trustee.  Under the
    trust arrangements, the payment of the defeased bonds becomes the
    responsibility of the trustee; it is accomplished without further
    action by TVA.  From TVA's standpoint, therefore, the defeased bonds
    were paid when it entered into the irrevocable trust, and the
    proceeds of the new bonds were placed under the control of the
    independent bond trustee.  We believe that TVA has a reasonable basis
    for its conclusion.

    TVA states that the majority view taken by state courts has been that
    the issuance of debt, where the proceeds of which are used to refund
    outstanding debt, does not result in an increase of outstanding debt
    for the purpose of state statutory or constitutional limitations.

    MAJOR CONTRIBUTORS TO THIS REPORT
    ========================================================== Appendix VI

       ACCOUNTING AND INFORMATION
       MANAGEMENT DIVISION,
       WASHINGTON, DC
    -------------------------------------------------------- Appendix VI:1

    Gregory D.  Kutz, Assistant Director
    Donald R.  Neff, Senior Audit Manager
    Caryn Catignani, Auditor
    Glenn A.  Thomas, Financial Analyst

       RESOURCES, COMMUNITY, AND
       ECONOMIC DEVELOPMENT DIVISION,
       WASHINGTON, DC
    -------------------------------------------------------- Appendix VI:2

    Bernice Steinhardt, Associate Director
    Ernie Hazera, Deputy Project Manager
    Mehrzad Nadji, Assistant Director - Economic Analysis Group
    Timothy J.  Guinane, Senior Economist
    Michael F.  Duffy, Senior Evaluator
    Cassandra Joseph, Senior Evaluator

       OFFICE OF THE GENERAL COUNSEL,
       WASHINGTON, DC
    -------------------------------------------------------- Appendix VI:3

    Thomas H.  Armstrong, Assistant General Counsel
    Doreen S.  Feldman, Assistant General Counsel
    Jackie Goff, Senior Attorney
    Amy M.  Shimamura, Senior Attorney

       ATLANTA REGIONAL OFFICE
    -------------------------------------------------------- Appendix VI:4

    John P.  Hunt, Jr., Project Manager
    Martha C.  Vawter, Site Senior
    Suzanne Murphy, Auditor
    Philip Amon, Evaluator
    Stacey E.  Keisling, Evaluator
    Pamela A.  Scott, Reports Analyst

    *** End of document. ***