Bonneville Power Administration: Long-Term Fiscal Challenges	 
(01-JUL-03, GAO-03-918R).					 
                                                                 
The Bonneville Power Administration (BPA) provides about 45	 
percent of all electric power consumed in the Pacific		 
Northwest--Idaho, Montana, Oregon, and Washington. The power that
BPA markets and distributes is generated in large part at	 
hydroelectric projects including dams in the Federal Columbia	 
River Power System. BPA also owns and operates about 75 percent  
of the region's services. Under the Pacific Northwest Electric	 
Power Planning and Conservation Act of 1980, BPA is responsible  
for ensuring an adequate, efficient, economical, and reliable	 
power supply for the Pacific Northwest. To do so, BPA balances	 
the needs of its customers against the highly variable water	 
resources available for generating electricity. In maintaining	 
this balance, BPA sometimes buys and sells or otherwise exchanges
power with utilities with entities within and outside the Pacific
Northwest. In addition to providing power, BPA is required under 
the 1980 act, various other laws, treaties and court cases, to	 
"protect, mitigate, and enhance" fish and wildlife resources.	 
Recently, BPA has witnessed a substantial deterioration in its	 
financial condition. For example, BPA's cash reserves of $811	 
million at the end of fiscal year 2000 had fallen $188 million by
the end of fiscal year 2002. To cope with its financial 	 
difficulties BPA has increased the rates that it charges its	 
customers for power by over 40 percent since 2001. In 2002, BPA  
asked Congress to increase its ceiling on Treasury debt by about 
$1.4 billion to fund capital spending and, in 2003, Congress	 
approved a smaller increase of $700 million dollars. In addition,
in February 2003, BPA announced that it estimated a 74 percent	 
chance that it would miss a Treasury payment this year. In light 
of BPA's deteriorating financial condition, request for increased
borrowing authority, and increased risk of missing a Treasury	 
payment, Congressional requesters asked GAO to (1) identify cost 
advantages, disadvantages, and challenges BPA may face in	 
providing power and meeting its debt and other obligations; (2)  
identify the causes of BPA's recent financial difficulties; (3)  
determine how BPA plans to use its additional borrowing 	 
authority; and (4) evaluate how the risk of default to Treasury  
has changed over the past 5 years.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-918R					        
    ACCNO:   A07316						        
  TITLE:     Bonneville Power Administration: Long-Term Fiscal	      
Challenges							 
     DATE:   07/01/2003 
  SUBJECT:   Electric energy					 
	     Electric utilities 				 
	     Financial analysis 				 
	     Financial management				 
	     Strategic planning 				 
	     Utility rates					 

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GAO-03-918R

GAO- 03- 918R Bonneville Power Administration United States General
Accounting Office

Washington, DC 20548

July 1, 2003 The Honorable David L. Hobson Chairman The Honorable Peter J.
Visclosky Ranking Minority Member Subcommittee on Energy and Water
Development Committee on Appropriations House of Representatives

Subject: Bonneville Power Administration: Long- Term Fiscal Challenges The
Bonneville Power Administration (BPA) provides about 45 percent of all
electric power consumed in the Pacific Northwest* Idaho, Montana, Oregon,
and Washington. The power that BPA markets and distributes is generated in
large part at hydroelectric projects including dams in the Federal
Columbia River Power System (federal power system). BPA also owns and
operates about 75 percent of the region*s transmission lines. BPA charges
for the power it sells and for its transmission services. Under the
Pacific Northwest Electric Power Planning and Conservation Act of 1980,
BPA is responsible for ensuring an adequate, efficient, economical, and
reliable power supply for the Pacific Northwest. To do so, BPA balances
the needs of

its customers against the highly variable water resources available for
generating electricity. In maintaining this balance, BPA sometimes
exchanges power through purchases, sales, or otherwise with utilities and
other entities within and outside the Pacific Northwest. In addition to
providing power, BPA is required under the 1980 act, various other
statutes, treaties and court cases, to *protect, mitigate, and enhance*
fish and wildlife resources affected by the federal power system.

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

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

GAO- 03- 918R Bonneville Power Administration Page 2

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

Results in Brief

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

BPA*s current financial difficulties are largely the result of decisions
that caused rising costs and lower- than- projected revenues. BPA signed
long- term contracts to buy power to serve demand that exceeds the supply
of the federal power system. Of the additional demand BPA agreed to serve,
a significant proportion was for industrial customers that BPA was not
required to serve during the fiscal year 2002- 2006 rate period. The
prices BPA agreed to in these contracts turned out to be significantly
higher than recent market prices and were higher than the

rates BPA initially set for selling its own power. BPA also projected
revenues from its own sale of surplus power that did not materialize when
market prices turned out to be lower than BPA had projected.

BPA plans to use its expanded borrowing authority to upgrade and improve
the transmission system and dams in the federal power system. These
capital expenditures are expected to increase the reliability and
efficiency of the system and may also increase generating capacity to some
degree. BPA staff told us that

these capital expenditures are, for the most part, not expected to solve
BPA*s current financial problems.

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

GAO- 03- 918R Bonneville Power Administration Page 3 Background

BPA was formed in 1937 to market electric power produced by the Bonneville
Dam to the Pacific Northwest. BPA*s role in the region has since evolved.
BPA*s marketing responsibilities were broadened to include power from 31
federally owned hydroelectric projects, most located in the Columbia River
Basin. BPA also markets power from one nonfederal nuclear plant and power
purchased from other sources. In addition, under the Pacific Northwest
Electric Power Planning and Conservation Act of 1980 (Northwest Power
Act), BPA is charged with providing the Pacific Northwest with an
adequate, efficient, economical, and reliable power supply. In this

role, BPA serves its customers* electricity demand at rates that BPA sets
to cover its costs, including debt payments and operations- and-
maintenance costs. 1 BPA*s rates are fixed in the sense that they do not
typically vary to reflect changes in the prices of power in the market on
an hourly or even daily basis, but rather are set periodically to cover
BPA*s costs on average over a long period of time. At times when the
electricity generation of the federal power system is insufficient to meet
the demand of all BPA*s customers, BPA has purchased or otherwise acquired
power from other sources, including utilities and other suppliers in the
Northwest, California, and other western states, to make up the
difference. In addition, BPA generates surplus power when demand from its
firm customers is low or when water levels are high, and has traditionally
exchanged this power under various terms with utilities and other entities
in the Northwest and other western states.

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

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

1 BPA*s customers include public and investor owned utilities. BPA serves
the net needs of these customers* the difference between what these
customers produce themselves and what they sell to their retail customers.
In addition, BPA sells power to some industrial customers. BPA*s rates
include charges for the electricity BPA generates and for the use of
transmission lines that BPA owns. 2 For example, prior to this change, BPA
frequently provided power to California utilities during the spring when
BPA had surplus electricity and, in return, the California utilities
provided electricity to

BPA during the fall and winter when BPA was typically short of
electricity. This sort of trading also sometimes took place in a single
day; BPA would send power to California utilities during the peak air
conditioning hours of the day and receive power back during the night.
Now, BPA more commonly sells its surplus power to utilities or power
marketers.

GAO- 03- 918R Bonneville Power Administration Page 4

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

BPA Has Inherent Cost Advantages and Some Disadvantages and Faces
Challenges in Meeting Competing Demands on Its Resources 3 BPA has
inherent cost advantages that have generally allowed it to keep its
electricity

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

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

3 This section is not intended as a complete enumeration of BPA*s
advantages, disadvantages, and challenges. Nor have we tried to assess the
relative weight or importance of the examples provided in this section. 4
Many of the newer built generating facilities burn fossil fuels to
generate electricity. While the

efficiency of fossil fuel burning power plants has generally increased
over time, hydroelectric power plants still tend to have cost advantages
because of the length of life of dams and the cost of fossil fuels.

5 While publicly owned utilities typically do not pay income taxes, many
do make payments in lieu of taxes to local governments.

GAO- 03- 918R Bonneville Power Administration Page 5

or retained earnings) to finance some capital spending. BPA cannot issue
stock and generally operates without a profit and, therefore, cannot
generally use equity to finance its capital investments. As a result, BPA
generally relies on debt for financing capital investments. Carrying
higher levels of debt translates into greater average fixed costs that
ultimately must be recovered in BPA*s power rates. In addition, BPA*s
obligation to protect, mitigate, and enhance fish and wildlife resources
adds to

its total costs, thereby increasing its power rates. 6 For example, from
fiscal years 1997 through 2001, BPA spent over $1.1 billion in support of
fish and wildlife* primarily to benefit salmon and steelhead. These
expenditures have funded fish and wildlife efforts, including those
undertaken by BPA, other federal agencies, American Indian tribes, and the
four northwest states (Idaho, Montana, Oregon, and Washington) and have
funded operations- and- maintenance and capital costs for the U. S. Army
Corps of Engineers, Bureau of Reclamation, and the Fish and Wildlife
Service for projects such as fish bypass facilities at dams and fish
hatcheries. BPA also estimates that from fiscal years 1997 through 2001,
spilling water from dams and augmenting river flows to enhance fish
survival resulted in over $2.2 billion in forgone revenues or increased
power purchases. 7 BPA*s dual roles* as supplier of economical and
reliable power and as protector of

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

demand for its electricity and also with regard to its costs for fish and
wildlife protection. For example, while the regional demand for BPA*s
electric power has generally grown throughout BPA*s existence, demand for
BPA*s power fell in the mid1990s as some of its customers found lower
prices in the market. Demand for BPA*s power increased dramatically after
market prices rose during the western electricity crisis of 2000 and 2001.
While other utilities face similarly uncertain demand and market
conditions, BPA appears to have greater competing pressure from its
various stakeholders. For example, in an April 18, 2003 open letter to its
customers and Northwest citizens, BPA stated that it had been influenced
by arguments and

demands from its stakeholders on such issues as how much power it would
provide and how it would structure its power rates. In addition, over the
past two decades, BPA*s spending and actions in support of fish and
wildlife have grown considerably with the enactment of various
environmental laws and with increased regulations put

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

GAO- 03- 918R Bonneville Power Administration Page 6

in place to protect the environment. BPA provides the majority of fish and
wildlife program money in the region, which increases its challenges
relative to its competitors.

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

BPA*s current financial difficulties have been largely caused by decisions
resulting in rising costs and lower than projected revenues. In April
2003, BPA estimated that its costs over the current 5- year rate period,
covering fiscal years 2002 through 2006, would be $5.3 billion dollars
greater than over the previous 5 years. This increase in costs is quite
substantial given that BPA*s total operating revenues* funds available to
cover its costs* were about $13.7 billion over the previous 5- year period
from 1997* 2001. 8 A large part of the increase in costs is related to
serving demand at levels

above the estimated average power production of the federal power system
during a *critical water year.* 9 BPA agreed to serve this additional
demand and, to do so, BPA signed long- term contracts to purchase power
from other sources. 10 Of the additional demand BPA agreed to serve, a
significant proportion was for industrial customers that BPA was not
required to serve during the fiscal year 2002- 2006 rate period. The
prices that BPA paid for the additional power were significantly higher on
average than the rates BPA initially set for the current rate period and
are also higher than recent market prices. More generally, BPA*s costs
attributed to both its sale of electric power (power business line) and
sale of transmission services (transmission

business line) have risen in almost every cost category since 1997.
Further, BPA*s fish and wildlife expenditures increased from about $80.5
million in fiscal year 1997 to $109.6 million in 2001 in constant 2001
dollars* an increase of about 36 percent* and are projected to be even
higher over the next few years. Finally, staffing levels have also
increased, from a recent low of 2,738 full- time- equivalent positions
(FTEs) in 1999 to an estimated 3,206 in 2003* an increase of about 17
percent.

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

8 Neither the $5. 3 billion nor the $14.6 billion figure has been adjusted
for inflation. 9 BPA estimates its available power based on water
conditions in a *critical water year.* In a critical water year less than
normal amounts of water are available to generate hydroelectricity. 10
These contracts were for periods of up to 5 years. Many of the contracts
were signed before and during BPA*s formal rate- setting process for the
fiscal year 2002* 2006 period. 11 As discussed previously in this report,
BPA sometimes has surplus power to sell, even in years when its capacity
is insufficient to serve its entire demand.

GAO- 03- 918R Bonneville Power Administration Page 7

impacts of the drought of 2000 and 2001, which have reduced the amount of
water available to generate surplus electricity.

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

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

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

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

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

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

the transmission system.

GAO- 03- 918R Bonneville Power Administration Page 8

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

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

BPA also faces greater uncertainty than it did 5 years ago. The 1997
report stated that BPA may face greater market uncertainty in the future,
and our current review indicates that market uncertainty has indeed been
an increased problem for BPA. For example, as discussed previously, BPA
had difficulty making accurate projections of market prices for its
surplus power sales and this difficulty led BPA to sign long- term
contracts to purchase power at high prices and resulted in a downward
revision in BPA*s expected revenues from surplus

electricity sales. BPA also experienced an unanticipated increase in
demand for its power following the 2000* 2001 western electricity crisis.
Further, BPA faces uncertainty with regard to future fish and wildlife
costs with the recent federal court decision that rejected the National
Oceanographic and Atmospheric Administration*s National Marine Fisheries
Service (NOAA Fisheries) 2000 biological opinion* a document setting out
how NOAA plans to avoid jeopardizing the existence of certain listed
species. Any changes to the operations of these projects resulting from
the federal court decision may diminish BPA*s ability to control costs
and/ or earn revenue. For example, physical alterations to

dams, changes in how the dams are operated, and changes to river flows or
reservoir levels to improve fish survival may increase capital and
operations costs for the projects and reduce the flexibility to generate
power.

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

GAO- 03- 918R Bonneville Power Administration Page 9

because of improvements in operating efficiency. 14 In contrast, BPA*s
current costs, as reflected in its power rates, are at historical highs
and are currently higher than regional market prices for wholesale
electricity have been in most weeks from January 1, 2002, through March
17, 2003. 15 If demand for BPA*s power falls, BPA*s revenue may be subject
to greater volatility because BPA will have to sell more of the power
generated by the federal power system in the market where prices have been
quite volatile. Greater revenue volatility increases the risk to Treasury,
especially as BPA*s debt increases over the next few years.

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

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

Another factor that BPA believes mitigates risk to Treasury is that many
of BPA*s customers have signed contracts requiring them to pay BPA for
power, whether or not they take the power. These contracts, referred to as
*take- or- pay* contracts, may shield BPA from the risk in the short run
that customers will leave if BPA*s rates remain high or rise further.
Further, the take- or- pay obligation may make it easier for BPA to
recover its costs as long as the contracts are in force. However, BPA*s
high rates may increase the likelihood that it will alienate its customers
or drive them to lower cost suppliers in the long term or even out of
business in some cases. For

14 As of January 2003, average natural gas prices for the entire nation at
the wellhead were over 50 percent higher than the average in 2002.
However, the Energy Information Administration forecasts that natural gas
prices will fall in the future from recent levels. 15 These market prices
in the Northwest were obtained from the Energy Information Administration.
In addition, we reviewed average monthly prices in the Northwest from
January 1997 through December 2001, published by Dow Jones. This review
indicated that in 41 out of 60 of these months (about 68 percent), average
prices were below BPA*s current rates of around $32 per megawatt- hour.
These prices are for wholesale electricity sold at the Mid- Columbia hub
in the Northwest. Because these prices have not been adjusted for
inflation, the number of months that average prices have been lower than
BPA*s current rates may be less than 41 when measured in constant dollars.

GAO- 03- 918R Bonneville Power Administration Page 10

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

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

Agency Comments and Our Evaluation

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

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

We believe that the risk is greater than projected in BPA*s comments. We
agree that the fundamental advantages of the federal power system* most
notably the relative low cost of hydroelectric generation* continue to
create an opportunity for BPA to provide economical power to its
customers. However, we also believe BPA*s large rate increases make
alternative supplies of electricity more attractive. Moreover, BPA*s power
rates are currently over 40 percent higher than they were in the mid1990s
when some BPA customers left to find cheaper power, while the costs of new
electricity generation have generally fallen in recent years. While some
of these customers returned to BPA during and after experiencing extremely
high electricity prices during the western electricity crisis of 2000 and
2001, prices in many months since the crisis have returned to levels much
closer to prices in the mid- 1990s.

GAO- 03- 918R Bonneville Power Administration Page 11

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

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

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

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

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

BPA also made a number of detailed technical comments that addressed,
among other things, its roles and responsibilities, the causes of its
financial difficulties, additional advantages and disadvantages BPA has
compared with its competitors,

and actions that BPA has taken to improve its financial condition. We have
incorporated these comments as appropriate in our draft.

GAO- 03- 918R Bonneville Power Administration Page 12 Scope and
Methodology

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

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

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

Director, Natural Resources and Environment

Enclosure

GAO- 03- 918R Bonneville Power Administration Page 13

Enclosure (360331)
*** End of document. ***