Bonneville Power Administration: Better Management of BPA's Obligation to Provide Power Is Needed to Control Future Costs

Bonneville Power Administration: Better Management of BPA's
Obligation to Provide Power Is Needed to Control Future Costs
(09-JUL-04, GAO-04-694).

The Bonneville Power Administration (BPA) has experienced
significant financial problems in recent years. BPA's cash
reserves at the end of fiscal year 2002 had fallen to $188
million, and BPA estimated in February 2003 that it had a 74
percent chance of missing its Treasury debt payment that year.
While BPA's finances have recently improved, and the agency made
its Treasury payment in 2003, BPA's financial condition is still
far from robust. In this context, GAO was asked to report on (1)
the advantages and disadvantages BPA faces in marketing electric
power in a more competitive environment, (2) the major causes of
BPA's recent cost increases, and (3) the extent to which BPA is
taking actions to control its costs.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-694
ACCNO: A10872
TITLE: Bonneville Power Administration: Better Management of
BPA's Obligation to Provide Power Is Needed to Control Future
Costs
DATE: 07/09/2004
SUBJECT: Agency debt
Cost analysis
Cost control
Dams
Energy costs
Energy marketing
Federal funds
Financial management
Hydroelectric energy
Internal controls
Power generation
Strategic planning

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GAO-04-694

United States General Accounting Office

GAO Report to the Subcommittee on Energy and Water Development, Committee
on

Appropriations, House of Representatives

July 2004

BONNEVILLE POWER ADMINISTRATION

Better Management of BPA's Obligation to Provide Power Is Needed to Control
Future Costs

GAO-04-694

Highlights of GAO-04-694, a report to the Subcommittee on Energy and Water
Development, Committee on Appropriations, House of Representatives

GAO recommends that BPA

o reduce its future risk of being overcommitted by (1) limiting the
amount of power that BPA sells at its lowest cost-based rate and (2)
charging incremental rates for any power sold beyond this amount that
reflect BPA's cost of acquiring that power, and

o identify specific activities, resources, and time frames for
implementing its risk management initiatives.

BPA generally agreed with this report's findings and recommendations.

July 2004

BONNEVILLE POWER ADMINISTRATION

Better Management of BPA's Obligation to Provide Power Is Needed to Control
Future Costs

BPA has advantages that have typically enabled it to sell electric power
to its customers-primarily public utilities-at lower prices than other
sellers in the Pacific Northwest. Most importantly, BPA sells power
produced by the federal power system, which includes 31 hydroelectric dams
that generally have lower costs as compared with other power sources.
However, BPA also has disadvantages that potentially increase its costs.
Specifically, BPA is required by law to meet the demands of utilities in
the region, even if those demands exceed the production capacity of the
federal power system. This open-ended requirement has at times required
BPA to purchase additional power at relatively high prices. BPA has other
costly obligations as well, including providing financial benefits to
investor-owned utilities and protecting fish and wildlife that increase
its costs relative to competing sources of electricity.

BPA's open-ended obligation to provide power to the region is the major
cause of its recent cost increases. This obligation led to cost increases
as BPA purchased large amounts of relatively expensive power to meet
rising demand. BPA's rate structure also contributed to increased demand
and increased costs, because it did not reflect BPA's incremental costs of
acquiring additional power and therefore did not give customers adequate
incentives to conserve or seek power from alternative sources. In
addition, drought and other factors have also increased BPA's costs in
recent years.

BPA has not resolved problems associated with its open-ended obligation to
be the net provider of wholesale electricity in the region-the major cause
of its recent cost increases. BPA officials intend to resolve this problem
by seeking agreement with BPA's customers to limit its commitment to
provide power. BPA proposes to establish the amount of power each customer
is able to buy at its lowest cost-based rate and is considering charging
incremental rates for any power it sells beyond this amount. However, BPA
has not clearly defined the limits for its commitments or how it would
implement incremental rates. Whether this approach ultimately will be
adopted is also unclear; BPA had similar plans in the late 1990s but did
not implement them because of pressure from customers to serve more
demand. In the meantime, BPA has taken positive steps to centralize its
risk management process to better control costs. However, BPA's plan
outlining its new approach does not contain some key elements to
successful implementation, including details on specific activities,
resources, and time frames needed to implement the plan.

www.gao.gov/cgi-bin/getrpt?GAO-04-694.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jim Wells at (202) 512-3841
or [email protected].

Contents

Letter

Results in Brief
Background
Inherent Advantages Help BPA to Provide Low-Priced Power, but

Its Open-ended Obligations Are a Competitive Disadvantage BPA's Open-ended
Obligation to Provide Power and Other Factors Led to Large Cost Increases
for BPA BPA Has Not Resolved Problems That Led to Its Recent Cost

Increases, but It Has Taken Steps to Control Other Costs Conclusions
Recommendations for Executive Action Agency Comments

4 7

29 36 38 38

Appendix I Scope and Methodology

Appendix II BPA's Costs Associated with Fish and Wildlife Programs

Appendix III BPA Costs Associated with Its Power Marketing Business,
Fiscal Years 1997-2003

Appendix IV Comments from the Bonneville Power Administration

Appendix V GAO Contacts and Staff Acknowledgments 51

GAO Contacts 51 Staff Acknowledgments 51

Tables

Table 1: BPA's Costs Associated with Fish and Wildlife Programs, Fiscal
Years 1985-2003 42

Table 2: BPA Costs Associated with Its Power Marketing Business, Fiscal
Years 1997-2003 44

Figures

Figure 1: Average Monthly Prices for Wholesale Electricity in the Pacific
Northwest, 1997-2003 10

Figure 2: Average Production Costs for Different Types of Generating
Plants in Idaho, Oregon, Washington, and Western Montana, 1996-2002 12

Figure 3: Average Wholesale Prices for Electricity Sold by BPA and the
Five Largest Investor-Owned Utilities in the Pacific Northwest, 1996-2002
14

Figure 4: Average Retail Prices of Electricity, 1996-2002 16 Figure 5:
BPA's Average Power Rates, Fiscal Year 1972-2001 21 Figure 6: Power
Purchased and Power Contracts Signed by BPA's

Major Customer Groups, Fiscal Year 1993-2006 23 Figure 7: Major Events and
Electricity Prices during BPA's Subscription and Ratemaking Processes 25

Abbreviations

aMW average megawatt BPA Bonneville Power Administration FERC Federal
Energy Regulatory Commission MWh megawatt-hour

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United States General Accounting Office Washington, DC 20548

July 9, 2004

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

The Bonneville Power Administration (BPA), which markets about 45
percent of all electric power consumed in the Pacific Northwest, has
experienced significant financial problems over the past few years. BPA's
core business of selling power lost more than $300 million each year in
fiscal years 2001 and 2002, primarily as a result of increased costs. As a
result, its cash reserves of $811 million at the end of fiscal year 2000
had
fallen to $188 million by the end of fiscal year 2002. In February 2003,
BPA
announced that it had an estimated 74 percent chance of missing its
repayment of Treasury debt that year. These difficulties have necessitated
increases totaling more than 40 percent in the rates BPA charges its
customers for power since October 2001. In large part because of these
increased rates and, consequently, greater revenues, BPA's financial
condition has recently improved. BPA made its Treasury debt payment in
2003, and its cash reserves have risen above $500 million. However, BPA
has stated that its financial health is still far from robust, and BPA's
ability
to manage its costs and risks has come under scrutiny from customers and
stakeholders.

BPA was formed in 1937 to market electric power produced by the
Bonneville Dam to the Pacific Northwest. BPA's marketing responsibilities
have since 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. The 31 federal
dams along with the nonfederal nuclear plant are collectively referred to
in
this report as the federal power system. While BPA markets the power
produced, other entities are responsible for operating the system-the
Army Corps of Engineers and the Bureau of Reclamation operate the
hydroelectric dams; and Energy Northwest, a consortium of utilities,
operates the nuclear plant. The dams in the federal power system are
operated for flood control, irrigation, navigation, and recreational
benefits
as well as for the production of hydroelectric power. In addition, the
river

system is home to many species of fish and wildlife, including some
protected by the Endangered Species Act.

BPA sells some of the power from the federal power system, at cost-based
rates designed to recover BPA's full costs, via long-term contracts with
its customers in the Pacific Northwest-primarily public utilities and
large industrial facilities such as aluminum smelters in Idaho, Montana,
Oregon, and Washington. BPA distributes this power to its customers
largely on transmission lines that BPA owns and operates, which account
for more than 75 percent of the region's transmission lines. When the
federal power system generates more power than BPA has committed to
provide its customers at its cost-based rates-for example, when spring
run-off allows large volumes of hydroelectricity to be generated-BPA sells
this surplus or "secondary" power to utilities and other entities in the
Pacific Northwest and other western states. However, at times when the
electricity generation of the federal power system is insufficient to meet
BPA's commitments to its customers, BPA purchases or otherwise acquires
power from other generators to make up the difference. Because of the
variability in the amount of water resources and therefore available
power, BPA generally considers, for planning purposes, the "firm" output
of the federal power system to be only the amount of power that can be
produced in a low or "critical" water year.1

BPA is one of four power marketing administrations within the U.S.
Department of Energy.2 Unlike the other power marketing administrations,
BPA does not receive annual appropriations from Congress; instead, BPA is
a self-financing agency whose revenues are generated through its sale of
power and transmission services. In the past, federal money was
appropriated to construct the generating and transmission projects from
which BPA markets power, and BPA currently repays these appropriations on
an annual basis. As of September 30, 2003, the outstanding balance of
BPA's appropriated debt was about $4.7 billion. BPA also has authority to
borrow up to an additional $4.45 billion from the Treasury on an ongoing
basis; as of September 30, 2003, BPA had about $2.7 billion of additional
Treasury debt.

1A critical water year is a year in which the annual runoff in the
Columbia River Basin is equivalent to the amount recorded in 1937, one of
the lowest on record.

2The others are the Southeastern Power Administration, the Southwestern
Power Administration, and the Western Area Power Administration.

With the passage of the Pacific Northwest Electric Power Planning and
Conservation Act of 1980 (Northwest Power Act), BPA's role in the region
expanded in scope. For example, under the Northwest Power Act, BPA became
responsible for ensuring an adequate, efficient, economical, and reliable
power supply for the Pacific Northwest, which required BPA to address
growing demand in the region-something BPA had previously not been
required to do. In addition to its obligations to market and distribute
power, the Northwest Power Act, along with various other statutes,
treaties, and court cases, also requires BPA to "protect, mitigate, and
enhance fish and wildlife" resources affected by the federal power system.
BPA is also required under the Northwest Power Act to provide benefits to
residential and small-farm customers of investor-owned utilities-these
benefits have generally taken the form of financial payments. The
restructuring of national wholesale electricity markets that began in the
1990s also changed the competitive environment in which BPA operates.
Specifically, restructuring has created an environment with a greater
degree of competition among generators and marketers of wholesale
electricity.

In light of BPA's recent financial difficulties and cost increases, you
asked us to determine (1) the advantages and disadvantages BPA faces in
marketing electric power in a more competitive environment, (2) the major
causes of BPA's recent cost increases, and (3) the extent to which BPA is
taking actions to control its costs. To answer our first objective, we
reviewed BPA documents and historical data, as well as studies and
position papers by industry experts. In addition, we analyzed historical
data on costs, regional and national power prices, and power production at
the federal hydroelectric dams. To answer our second and third objectives,
we reviewed BPA documents related to costs, revenues, risk management
practices, and rate-setting policies, as well as studies and position
papers by industry experts. Unless otherwise noted, the financial data we
obtained refer to BPA's power business (i.e., the expenses and revenues
embodied in its power rates). We also interviewed BPA officials and
collected views from BPA's customers and stakeholders, including groups
that focus on fish and wildlife issues. In addition, we analyzed cost and
rate data from BPA. Finally, we interviewed officials from the U.S. Army
Corps of Engineers, one of the agencies that operate the dams of the
federal power system. We focused our review on the group within BPA that
is responsible for marketing power from the federal power system, and on
its costs in the current rate period, which began in fiscal year 2002. We
tested the reliability of data on generation costs in the Pacific
Northwest, and on BPA's costs and rates, and found them to be adequate to
answer the objectives of this report.

Results in Brief

We conducted our review from August 2003 through April 2004 in accordance
with generally accepted government auditing standards. For a more detailed
discussion of the scope and methodology of our review, see appendix I.

BPA has inherent advantages that have generally enabled it to sell power
at lower prices than other sellers of wholesale power in the Pacific
Northwest. BPA's most important competitive advantage is that it markets
electricity produced primarily at hydroelectric dams in the federal power
system, which generally have lower costs, as compared with power produced
by other sources. In addition, as a federal agency, BPA enjoys financial
advantages such as access to federally financed debt, which generally
offers lower interest rates than those available to private-sector
entities. However, unlike other sellers of wholesale power, BPA has
openended obligations to provide power and other benefits to its customers
and others in the Pacific Northwest that increase its costs. In
particular, unlike the other power marketing administrations, BPA is
required by its governing statutes to serve the "net" demand of utilities
in the region (that is, the demand that these utilities cannot meet with
their own generation resources) when requested. Over time, this open-ended
requirement has increased the demands on BPA's finite resources; and at
times, BPA has purchased power from other sources to augment the
generation resources of the federal power system. Other statutory
obligations that increase BPA's costs relative to some of its competitors
include providing financial benefits to certain customers of regional
investor-owned utilities and protecting fish and wildlife. Regarding
financial benefits to residential and small-farm customers of the region's
investor-owned utilities, BPA is required to provide these benefits to
off-set the higher prices that-for historical reasons-these customers
generally pay for power, as compared with public utility customers.
Regarding fish and wildlife protection, BPA is the sole source of funding
for the Northwest Power and Conservation Council-a regional agency
established by the Northwest Power Act to balance the Northwest's
environment and energy needs, including developing a program to protect
and rebuild fish and wildlife populations affected by hydropower
development in the Columbia River Basin. In addition, the multiple-use
nature of the dams in the federal power system constrains the amount of
power that BPA can sell. For example, water diverted for irrigation
purposes is generally unavailable for generating electricity. These
open-ended obligations and constraints on the generation of power have
increased pressure on BPA over time and contributed to increases in BPA's
costs relative to the costs of competing sources of power. Specifically,
BPA's costs-as reflected in its cost-based

rates-more than doubled in the 30 years between fiscal years 1972 through
2001, when adjusted for inflation, while the average costs of some other
sources of power fell. By 1995, as BPA reported in its 1995 Business Plan,
for the first time in its history, BPA's rates had risen to the level of
the costs of other sources of generation-namely gas-fired electricity
generators.

BPA's open-ended obligation to be the net provider of wholesale power to
the region is the major cause of its recent cost increases. This
obligation led to BPA's overcommitment to provide power to its customers
in the current rate period-from fiscal years 2002 to 2006-and
consequently, to BPA's cost increases as it purchased large amounts of
power at average prices much higher than the costs of the federal power
system. The demand from BPA's public utility customers in the current rate
period increased by more than 50 percent over the previous rate period-a
demand that BPA is statutorily required to serve. BPA also agreed to
provide power to investor-owned utilities and large industrial customers,
although BPA was not statutorily required to do so. To meet this increased
level of demand, BPA spent approximately $900 million in fiscal year 2002
and $760 million in fiscal year 2003, necessitating a rate increase of
more than 40 percent for the majority of BPA's customers. BPA's rate
structure also contributed to the increase in demand and increased costs,
because BPA did not charge incremental rates equal to its costs of
acquiring additional power and therefore did not give customers adequate
incentives to conserve or seek power from alternative sources. In
addition, drought conditions and other factors have also increased BPA's
costs in recent years.

3BPA has generally used the term "tiered rates" to describe the rate
design that differentiates between a rate that applies to sales at the
lowest embedded-cost rate and a rate that applies to sales beyond that
amount.

However, BPA's plan does not specify the amount of power BPA will allow
its customers to buy at its lowest rate nor the specific manner in which
incremental rates will be charged. If the amount of power sold to
customers at its lowest rate exceeds the firm output of the federal power
system-the amount of power that can be generated during a critical water
year-BPA could still need to purchase power from other sources to meet its
commitments during low water years. Further, if the incremental rates do
not fully reflect BPA's costs of acquiring any additional power it sells,
BPA's customers will not have appropriate incentives to conserve or seek
alternative sources of power. Finally, whether BPA's strategic plan will
ultimately be implemented remains unclear. BPA has not carried out similar
proposals made in the past-such as in the late 1990s, when a fourstate
panel recommended that BPA limit its commitments to the firm output of the
federal power system and charge incremental rates to cover its cost of
acquiring any additional power. BPA officials said that BPA ultimately
declined to implement such an approach under strong regional pressure from
its customers to provide more power.

Regarding other costs, BPA has taken steps to reduce costs or control the
extent of future cost increases in the areas of power generation, fish and
wildlife programs, and internal operations. For example, BPA has reduced
funding in general areas such as travel, training, supplies, and staffing,
as compared with 2001 funding levels. In addition, BPA has taken steps to
centralize its risk management process to better control its costs. Among
other things, BPA has established a management plan outlining a new
approach to risk management and has hired a Chief Risk Officer. However,
BPA's plan to date generally does not identify specific activities,
resources, and time frames for completing implementation of its new
approach; and this lack of specificity prevented us from reviewing the
plan's progress in a meaningful way.

We are making four recommendations to BPA to ensure that the agency can
control costs of future power purchases and that it clarifies key elements
of the implementation of its new risk management process. Specifically, we
are recommending that BPA reduce its future risk of being overcommitted by
(1) defining rights to purchase the firm output of the federal power
system so that the amount of power that BPA sells at its lowest,
cost-based rate is equivalent to the firm output of the existing federal
power system, (2) charging incremental rates for any power sold beyond
this amount that reflect BPA's cost of acquiring that power, and (3)
studying the feasibility of issuing a rule under the Administrative
Procedure Act to define the rights to purchase power and the terms of
incremental rates. We are also recommending that BPA identify specific

Background

activities, resources, and time frames for implementing its risk
management initiatives. In commenting on a draft of this report, BPA
generally agreed with our findings and recommendations.

Although BPA is a self-funded agency, it has ongoing authority to borrow
from Treasury to fund capital expenditures and is repaying funds
appropriated in the past to finance the construction of dams and
generating and transmission facilities. According to the Northwest Power
Act, BPA's revenues from selling power and transmission services must
cover its costs, which include repayment of its debt, interest, operating
and maintenance costs, and the cost of any power purchased for resale to
meet its customers' needs, among other things. BPA's current 5-year rates
include the ability to adjust rates in response to changing cost and
revenue conditions.

BPA's customers include public utilities in the Pacific Northwest, as well
as a few aluminum companies and other large industrial customers, known as
direct service industries. BPA also provides power to some investor-owned
utilities in the Pacific Northwest. In addition, BPA sells or exchanges
power with utilities and power marketers in Canada and the western United
States. Preference-the opportunity to obtain first access to BPA power-is
defined by statute and gives priority to public utilities and other public
entities to ensure that the federal hydropower projects are operated for
the benefit of the general public, particularly residential and rural
customers. However, BPA's nonpublic customers in the Pacific Northwest
have priority in access to BPA power over public utilities in other parts
of the country.

BPA sells power to its customers through two mechanisms. First, BPA sells
power through long-term contracts at cost-based rates that are established
in periodic rate cases, which have recently taken place every 5 years. The
Federal Energy Regulatory Commission (FERC)-pursuant to the Northwest
Power Act-approves BPA's rates after determining that the rates BPA
proposes for its firm power are sufficient to cover BPA's costs. Second,
BPA often sells secondary power, defined as power produced beyond the
amount that BPA has committed to sell to its customers at its cost-based
rates. These secondary sales are often

transacted at market-based prices.4 The time frames of these secondary
sales range from hourly to as much as 18 months in advance.

The amount of power produced by the federal power system is highly
variable, largely depending on prevailing water conditions. For example,
according to BPA, in the last 10 fiscal years, the annual runoff of the
Columbia River at The Dalles Dam has varied from a low of about 79 million
acre-feet in fiscal year 2001 to a high of about 194 million acre-feet in
fiscal year 1997; and the amount of power generated by the federal power
system has varied from a low of about 7,300 average megawatts (aMW) to a
high of nearly 12,000 aMW.5 Since BPA's revenues from secondary sales
depend on the amount of power produced by the federal power system, these
revenues are also highly variable. Because of this inherent uncertainty
about how much power BPA will have to sell in any given year, BPA
officials estimate for planning purposes that the firm output of the
federal power system is about 8,000 aMW.

To promote competition in wholesale electricity markets, the federal
government took several actions in the 1990s that affect BPA's operations.
For example, in 1992, the Congress passed the Energy Policy Act,
authorizing FERC to require utilities, on a case-by-case basis, to allow
competitors to use their transmission lines for wholesale sales of
electricity. In 1996, FERC ordered that electric transmission systems be
opened to all qualified wholesale buyers and sellers of electricity. FERC
also required utilities to separate operations and management of their
generation and transmission businesses to prevent discriminatory
practices, such as denying competitors equal access to transmission lines.
While BPA's transmission system is outside of FERC's jurisdiction, BPA
voluntarily complied with key features of FERC's orders. For example, in
1997, BPA split its operations into a Power Business Line and Transmission
Business Line. BPA took other actions to attempt to position

4BPA sells secondary power at market prices, subject to a self-imposed
average annual price cap-this average annual price cap is determined by
the cost to BPA of power produced at the Energy Northwest operated nuclear
plant. BPA may actually receive more than this amount when it sells its
power in a formal market and when the market-clearing price exceeds BPA's
self-imposed price cap.

5An acre-foot is the volume of water necessary to cover one acre to a
depth of one foot and is equivalent to 325,851 gallons. A watt-hour is a
measurement equal to 1 watt of power supplied to, or taken from, an
electrical circuit steadily for 1 hour. A megawatt-hour is one million
watt-hours, or enough power to serve the needs of about 750 homes for 1
hour. An aMW is equal to 8,760 megawatt-hours, or the average number of
megawatt-hours over the course of 1 year (i.e., 24 hours x 365 days x 1
megawatt).

itself in the more competitive market that was emerging in the 1990s. For
example, in its 1995 Business Plan, BPA announced its intent to expand its
position in the wholesale electricity market. Responding to the increased
choices and falling prices that were available to its customers, BPA
planned to increase its long-term revenue by entering new markets with new
product lines. Specifically, the Business Plan proposed an Energy Services
Business Line to provide planning and analytic services to customers and
advocated increased spot-market power purchases to provide it resource
flexibility in a time of shifting demands and increasing obligations to
migrating salmon.

In the mid-1990s, wholesale power prices dropped in the Pacific Northwest,
and power marketers began to offer wholesale power prices lower than the
prices BPA charged its customers. BPA's customers responded by reducing
their purchases of BPA power by about 1,800 aMW-a reduction in demand of
almost 25 percent. Because of this drop in demand from its customers, BPA
became concerned that it would not be able to sell its power at prices
high enough to cover its costs. In response to concerns about BPA's
competitiveness and to establish regional consensus on BPA's role in a
competitive wholesale marketplace, the governors of Idaho, Montana,
Oregon, and Washington convened a committee in 1996 representing BPA and
its major customer and stakeholder groups. The committee issued a
report-known as the Comprehensive Review of the Northwest Energy
System-recommending that BPA return to its historic role of marketing
power from the federal power system, rather than becoming an aggressive
marketer of products and services in the emerging competitive power
market.6 Accordingly, the Comprehensive Review report recommended that BPA
avoid acquiring resources to meet load growth, except on a direct
bilateral basis where the customer takes on the risk, and that BPA manage
and control its costs to remain competitive.

After the low prices of the mid-1990s, Pacific Northwest electricity
prices became more volatile. Trends in Pacific Northwest wholesale
electricity prices are shown in figure 1. Average monthly wholesale
electricity prices increased somewhat in 1998 and 1999, as demand in the
region grew while little new generation capacity was added. In mid-2000,
electricity prices in California skyrocketed due in part to low water
conditions that reduced

6Comprehensive Review of the Northwest Energy System-Final Report: Toward
a Competitive Electric Power Industry for the 21st Century, December 12,
1996.

the total supply. Because hydroelectric power provides such a large part
of the total power supply in the region, low water years tend to cause
high prices due to the consequent reduction in the total supply of power.
Because California's electricity market is integrated with the rest of the
western region, prices in the Pacific Northwest quickly followed
California's lead and rose to unprecedented levels. Average wholesale
prices in the Pacific Northwest remained high until the summer of 2001.
Since then, prices have returned to levels similar to those seen in the
late 1990s.

Figure 1: Average Monthly Prices for Wholesale Electricity in the Pacific
Northwest, 1997-2003

Dollars per megawatt-hour

450

400

350

300

250

200

150

100

50 0

Date

Source: GAO analysis of Platts'/RDI PowerDAT data.

Note: Wholesale electricity prices are expressed in dollars per
megawatt-hour (MWh) and are not adjusted for inflation. These prices are
from the Mid-Columbia Hub and are representative of wholesale electricity
prices in the Pacific Northwest.

01/1997 07/1997 01/1998 07/1998 01/1999 07/1999 01/2000 07/2000 01/2001 07/2001
01/2002 07/2002 01/2003 07/2003

Inherent Advantages Help BPA to Provide Low-Priced Power, but Its Open-ended
Obligations Are a Competitive Disadvantage

BPA has inherent advantages, including its access to power from the
federal power system, that have generally enabled it to provide power to
customers in the Pacific Northwest at prices lower than other sellers of
wholesale power. However, unlike other sellers of wholesale power, BPA has
open-ended obligations to provide power and other benefits to its
customers and others in the Pacific Northwest that have increased BPA's
costs. In addition, the multiple-use nature of the dams in the federal
power system constrains the amount of power that BPA has available to
sell. These open-ended obligations and constraints have increased pressure
on BPA over time, engendering disputes in the region over the allocation
of the limited resources of the federal power system, and contributing to
increases in BPA's costs relative to the costs of competing sources of
electricity.

BPA's Access to Hydroelectric Power and Federal Financing Offer Competitive
Advantages

BPA's most important cost advantage is that power from the federal power
system is primarily produced at hydroelectric dams, which overall have low
costs. According to BPA data, hydroelectric generation has accounted for
more than 90 percent, on average, of the generation output of the federal
power system over the past 2 decades. Many of these hydroelectric
facilities were built decades ago and had relatively low construction
costs compared with newer generating facilities. In addition, these
hydroelectric facilities tend to have lower operating costs than other
sources of electricity that consume costly fossil or other fuels. As a
result of these advantages, hydroelectric power plants in the Pacific
Northwest typically produce power for less than $5 per MWh (as shown in
fig. 2), compared with the region's coal and nuclear plants, which produce
power for between $15 to 20 per MWh, or combined cycle turbine facilities
that burn natural gas or oil, which produce power for more than $20 per
MWh.

Figure 2: Average Production Costs for Different Types of Generating
Plants in Idaho, Oregon, Washington, and Western Montana, 1996-2002

Dollars per megawatt-hour

$27.01

Type of generation

Combined-cycle turbine

Nuclear

Coal

Hydroelectric

Source: GAO analysis of Platts'/RDI PowerDAT data.

Note: In inflation-adjusted dollars, base year 2003. Production costs are
measured in dollars per MWh and reflect data for the North American
Electric Reliability Council's Northwest Power Pool subregion. Production
costs reflect variable and fixed costs associated with a generating plant.
Source dataset does not have a value for nuclear generation in 2002.
Combined cycle turbine generators use natural gas or oil.

BPA also enjoys advantages related to financing due to its status as a
federal agency. BPA has access to federally financed debt, which generally
offers lower interest rates than those available to private-sector
entities. BPA's federal financing is divided into two
categories-appropriated debt

and Treasury debt. Appropriated debt7 consists of appropriations received
by BPA and the generating agencies to construct the generating and
transmission projects from which BPA markets power. As of September 30,
2003, the outstanding balance of BPA's appropriated debt was about $4.7
billion. As a result of legislation passed in 1996, BPA's appropriated
debt was restructured in 1997 to increase the interest rates to bring them
in line with the prevailing Treasury rates. However, the principal on this
debt was adjusted downward so that, except for the interest on the $100
million that BPA paid as part of the restructuring, the annual interest
BPA pays on the debt remains the same.8

In addition to its appropriated debt, BPA has authority to borrow from the
Treasury on an ongoing basis. BPA's Treasury borrowing stems from
authority granted in the Federal Columbia River Transmission System Act of
1974, as amended, which allows BPA to have up to $4.45 billion in Treasury
debt outstanding at any one time. The $4.45 billion consists of two
separate borrowing limits: $1.25 billion is reserved for conservation and
renewable resource loans and grants, and $3.2 billion for transmission and
other capital investments. This debt is issued at market interest rates
that are comparable to other government agency obligations, and these
rates are higher than Treasury rates. As of September 30, 2003, BPA had
about $2.7 billion of debt held by the Treasury. As BPA pays off debt, it
has greater funds available for future borrowing.

BPA's status as a federal agency also has conferred advantages in securing
financing from the private sector. BPA does not have authority to borrow
directly from nonfederal sources, but BPA has secured private sector
financing by taking responsibility for the debt of other entities. For
example, BPA is responsible for the debt service of bonds issued by Energy
Northwest, a consortium of public utilities, to build three nuclear
plants, only one of which is currently operating. While the federal
government explicitly does not guarantee Energy Northwest bonds, Moody's
Investors Service views them as having an implicit federal guarantee. In
addition, Moody's Investors Service and Fitch Ratings give

7We refer to this as appropriated debt because BPA is required to repay
appropriations used for capital investments, with interest. However, these
reimbursable appropriations are not technically considered lending by the
Treasury.

8At the time this debt was restructured, BPA's appropriated debt of $6.85
billion carried a weighted-average interest rate of about 3.5 percent.
Effective the first day of fiscal year 1997, the principal of the
outstanding debt was reduced to an estimated $4.29 billion and the
associated interest rate was increased to 7.1 percent.

credit strength to BPA's ties to the federal government. Thus, the
interest that BPA pays on Energy Northwest bonds is lower than would be
paid without BPA's ties to the federal government.

As a result of BPA's inherent cost advantages, it generally has been able
to sell electricity at lower wholesale prices than other major
investor-owned utilities in the Pacific Northwest, as shown in figure 3.

Figure 3: Average Wholesale Prices for Electricity Sold by BPA and the
Five Largest Investor-Owned Utilities in the Pacific Northwest, 1996-2002a

Cents per kilowatt-hour

6.19

Average wholesale price, 1996-2002

BPA average wholesale price (2.86 cents per kilowatt-hour),1996-2002

Source: GAO analysis of Energy Information Administration data.

Note: Prices are given in inflation-adjusted dollars, base year 2003.

aAverage wholesale prices are expressed in cents per kilowatt-hour, where
a kilowatt-hour is equal to one thousand watt-hours. Average wholesale
prices are calculated by dividing a utility's total revenue from power
sales by the total amount of power it sold. The resulting weighted average
may not represent the actual price paid by any particular customer, but it
reflects the average annual prices paid by customers as a group.

BPA's advantages contribute significantly to the relatively low retail
price of electricity sold in the Pacific Northwest. Because BPA sells
about 45

AvistaCorp. Idaho

Power Co. PacifiCorp.Portland GeneralElectric Co. Energy Inc.

percent of all the electricity used in the Pacific Northwest, its
wholesale prices play a large role in determining the average retail price
of electricity throughout the Pacific Northwest. As shown in figure 4, the
average retail price of electricity (as expressed in average revenue per
kilowatthour) in states in the Pacific Northwest is generally lower than
electricity sold in much of the rest of the United States. While the
nationwide average retail price of electricity from 1996 to 2002 was 7.41
cents per kilowatthour, Washington state's average price of electricity
over this period was 4.81 cents per kilowatthour, Oregon's was 5.46 cents
per kilowatthour, Idaho's was 4.63 cents per kilowatthour, and Montana's
was 5.61 cents per kilowatthour.9

9Figures are presented in constant dollars using 2003 as the base year.

BPA Has Competitive Disadvantages That Increase Its Costs

BPA also has competitive disadvantages-stemming mainly from statutory
obligations-that increase its costs relative to other sellers of wholesale
power. Most importantly, unlike other power marketing administrations, BPA
has a legislative mandate under the Northwest Power Act to be the "net
provider" of wholesale electricity in the region-i.e., BPA must meet the
power needs of all utilities in the region to the extent that the
utilities' own generating resources are insufficient to meet the demand of
their retail customers. If a utility requests power from BPA, BPA must
provide this power regardless of whether its own generating resources are
sufficient to meet the demand.

Past attempts by BPA to meet growing regional demand have led to
significant cost increases that BPA has had to cover in its power rates.
For example, in the early 1970s, BPA entered into financing agreements
with Energy Northwest to acquire the generating capability of three
nonfederal nuclear power plants.10 Later, a variety of events, including
construction cost overruns and lower-than-estimated power demand growth,
made it clear that some of these plants would not be economical to
complete or operate. Accordingly, construction was halted on two of these
plants. As a result, BPA is currently responsible for about $3.8 billion
in nonfederal debt associated with two nonoperating nuclear plants, along
with $2.2 billion in nonfederal debt for the one operating nuclear plant,
the Columbia Generating Station. Servicing the debt related to the
nonoperating plants that don't generate any revenue to help offset this
cost has raised BPA's average costs significantly, requiring BPA to charge
more for its power sales. In 1994, BPA again tried to expand the capacity
of the federal power system by entering into a financing agreement to
acquire the capacity of a proposed nonfederal gas-fired power plant for a
20-year period. Later, as wholesale market prices for power fell, some of
BPA's customers reduced their demand for BPA power, and BPA found that it
did not need the power from the gas-fired plant. BPA then breached its
contract, which cost the agency over $280 million in net settlement
payments.

Under the requirements of the Northwest Power Act, BPA also provides
financial payments to some of its customers in lieu of providing power

10At the time these agreements were made, Energy Northwest was known as
Washington Public Power Supply System, a joint operating agency in the
state of Washington made up of representatives of public utility districts
and municipalities. Under these agreements, BPA contracted to pay all or
part of the annual project budgets, including debt service, whether or not
the projects were completed.

through a program called "residential exchange." The residential exchange
program is designed to share the benefits of low-cost power from the
federal power system with residential and small-farm customers of
investor-owned utilities.11 Because investor-owned utilities in the
Pacific Northwest have typically had higher costs than the region's public
utilities, the residential exchange program attempts to compensate for the
difference and reduce the prices paid by the investor-owned utilities'
retail customers by making financial payments to the investor-owned
utilities. The size of these payments is determined by comparing an
investor-owned utility's average cost of producing power to the rates BPA
charges its public utility customers, with BPA making up the difference.
Between fiscal years 1982 and 2003, BPA's financial records show that the
annual cost of the program has averaged about $210 million.12

The Northwest Power Act also requires BPA-along with the other federal
agencies responsible for managing, operating, or regulating hydroelectric
facilities in the Columbia River Basin-"to protect, mitigate, and enhance
fish and wildlife" resources impacted by the development and operation of
those facilities. Under the Act, BPA is required to implement and fund
measures supporting fish and wildlife in a manner consistent with the
program developed by the Northwest Power and Conservation Council-a
regional agency established by the Northwest Power Act to balance the
Northwest's environment and energy needs, including developing a program
to protect and rebuild fish and wildlife populations affected by
hydropower development in the Columbia River Basin. BPA must also
implement and fund actions contained in the biological opinions directed
at avoiding jeopardy to and recovering the 14 Columbia River Basin fish
populations listed as threatened or endangered under the Endangered
Species Act. Because BPA is the primary source of funding for the
Northwest Power and Conservation Council's program and for the
implementation of the actions contained in the biological opinions, BPA's
costs are impacted by the costs of protecting fish and wildlife to a
greater degree than some of its competitors. BPA financial records show
that between fiscal years 1985 and 2003, BPA's costs to implement these

11Some public utilities also can receive payments under this program, but
the cost to BPA is much smaller, averaging less than $23 million annually
(in 2003 dollars) from 1982 to 2003.

12Average costs are in constant dollars, base year 2003. In 2002, BPA
began providing payments and power to investor-owned utilities under a
settlement agreement rather than under the residential exchange provisions
of the Northwest Power Act. The $210 million average includes these costs.

actions have increased on an annual basis, from about $85 million in 1985
to about $256 million in 2003, in 2003 dollars. BPA's total spending on
these programs during the same period was over $3.3 billion. (For more
detailed information on the growth in BPA's program spending on fish and
wildlife from 1985 through 2003, see app. II.)

In addition, the multiple-use nature of the dams in the federal power
system can reduce the amount of power that BPA has available to sell,
which increases BPA's average costs of providing power. In addition to
generating power, the dams of the federal power system are also operated
for the protection of fish and wildlife, flood control, irrigation,
navigation, and recreational benefits. These other uses change the timing
and amount of the water flow, which in turn can reduce the total amount of
power that the federal power system produces-and therefore, the amount of
power that BPA has to market. For example, to fulfill the obligations of
the Northwest Power Act and the Endangered Species Act, water is released
from storage reservoirs in the Columbia River Basin to aid migrating
salmon and steelhead, including many threatened or endangered fish
populations. Water releases for fish migration can generate power, but
such releases typically occur during springtime when water flows are
already high and, consequently, power prices are low. As a result of these
releases, less water is retained behind the dams to be released later to
generate power when prices are higher. In addition, water is sometimes
spilled without generating electricity to aid fish migration instead of
being sent through the dams' turbines to generate power. As a result of
these constraints on power production at the federal dams, BPA must at
times purchase power to meet its contractual obligations; and at other
times, BPA's revenues from secondary sales are reduced. Purchasing
additional power and having less power to sell combine to increase BPA's
average costs-defined as BPA's total costs divided by the total power
generation that BPA sells. According to BPA estimates for fiscal years
1985 through 2003, water releases for fish and wildlife purposes have cost
BPA almost $4 billion in power purchases to meet contractual obligations
and in foregone revenues.13 Diverting water for irrigation purposes has a
similar effect on BPA's revenues and average costs. BPA estimates that
foregone

13These estimates are adjusted for inflation using 2003 as a base year.

revenues attributed to irrigation withdrawals are currently about $180
million per year.14

As population and economic activity in the Pacific Northwest region have
grown, the demand for power from the federal power system has increased.
While in the past BPA typically provided power to public utilities and had
power left over for some large industrial customers, demand from public
utilities has grown so that, according to BPA officials, this demand is
currently about equal to the entire firm output of the federal power
system. Demand from investor-owned utilities has also grown, and
consequently, the number of these utilities' customers who are entitled to
financial benefits through the residential exchange program has increased.
In addition, the demands on the operation of dams for other
uses-particularly for fish and wildlife programs-have increased. These
increasing and often competing demands for the resources of the federal
power system have led to disputes among the beneficiaries over how these
resources are distributed. For example, the method by which BPA calculates
residential exchange payments has spurred disputes within the region.
Investor-owned utilities and state regulators have argued that BPA has
manipulated the method to reduce payments below appropriate levels.
Conversely, public utilities have argued that payments to investor-owned
utilities have been too high and that BPA has inaccurately applied a
statutory provision designed to protect public utilities from increased
prices. Some public utilities recently filed a lawsuit against BPA,
claiming that a settlement agreement BPA signed with investor-owned
utilities inappropriately increased program costs.

BPA's costs-as reflected in its cost-based power rates-more than doubled
in the 30 years between fiscal years 1972 through 2001, when adjusted for
inflation, and increased by a factor of about 7 in nominal terms (not
adjusted for inflation).15 Figure 5 shows BPA's rates from 1972 through
2001 both in dollars adjusted for inflation and in nominal dollars

14BPA officials told us that they are not required to track the costs of
irrigation water releases as they are with fish and wildlife related
releases. Therefore, they do not have annual figures for the dollar impact
on revenues of irrigation releases. According to BPA officials, flood
control, navigation, and recreational uses of the dams do not have a
significant affect on the amount of power BPA has to sell.

15BPA is required by statute to set its rates to recover its costs. Thus,
when BPA's costs increase over time, its rates must increase by an equal
amount.

(not adjusted for inflation).16 During this period, BPA's backing of the
construction of the nuclear plants and the gas-fired plant, discussed
previously in this report, contributed to the agency's cost increases as
reflected in its rising rates.

Figure 5: BPA's Average Power Rates, Fiscal Year 1972-2001

Cents per kilowatt-hour

Fiscal year

1972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999
20002001

Real price (2003 dollars)

Nominal price

Source: GAO analysis of BPA data.

Note: Data are for BPA's historical average priority firm power rates.
Nominal prices refer to BPA's rates that have not been adjusted for
inflation. Real prices refer to BPA's rates that have been adjusted for
inflation with fiscal year 2003 as the base year.

Since the late 1970s, while BPA's rates increased significantly, the cost
of new sources of power generation decreased as the efficiency of new
technologies improved. For example, in its 1995 Business Plan, BPA

16The figure shows that in periods, such as in much of the 1970s, when
BPA's average nominal rates were nearly constant, inflation caused the
"real" or inflation-adjusted rates to fall, but that on average, increases
in BPA's rates exceeded inflation over the entire three decades.

reported that a number of factors, including "falling fuel prices and the
emergence of new and aggressive competition" had led to a situation where
for the first time in BPA's history, BPA's rates were as high as the costs
of alternative sources of electric power. As a result, as discussed
previously in this report, some of BPA's customers began to reduce their
demand for BPA power in favor of these cheaper sources of power. BPA has
more recently reported that since the West Coast energy crisis of 2000 and
2001, and with recent increases in natural gas prices, the costs of new
power plants are again higher than BPA's rates. However, after 1995, BPA
stopped regularly tracking and reporting consistent data on the cost of
the least expensive alternative form of power generation, so we were
unable to compare the agency's rates relative to the cost of such
alternatives after that year.

BPA's open-ended obligation to be the net provider of wholesale power to
the region is the major cause of its recent cost increases. This
obligation led the agency to overcommit to provide power to its customers
in the current rate period-from fiscal years 2002 to 2006. BPA's costs
rose dramatically as the agency purchased large amounts of power, at
average prices much higher than the costs of power from the federal power
system, and took other steps to meet its obligations. BPA's rate
structure, which did not charge incremental rates equal to BPA's costs of
acquiring additional power, contributed to the rising costs because it did
not give customers adequate incentives to conserve or seek power from
alternative sources. Drought conditions and other factors have also caused
BPA's costs associated with its power marketing business to increase in
recent years.

BPA's Open-ended Obligation to Provide Power and Other Factors Led to Large
Cost Increases for BPA

Open-ended Obligation to Provide Power and BPA's Rate Structure Led to Large
Cost Increases for BPA

BPA experienced a demand increase of more than 50 percent from its public
utility customers in the current rate period, which began in fiscal year
2002. Figure 6 shows the amount of power that BPA's three main customer
groups purchased from fiscal years 1993 to 2001 and the amount of power
these same groups signed contracts to purchase during the current rate
period. Demand from the public utilities increased from an average of
approximately 4,300 aMW during the fiscal year 1997 to 2001 rate period to
an average of approximately 6,800 aMW during the current rate period. As
described earlier, the Northwest Power Act requires BPA to serve the net
requirements of public utilities if these utilities request power,
regardless of whether BPA's own generating resources are sufficient to
meet this demand. Therefore, BPA was required to serve this increased
demand.

Figure 6: Power Purchased and Power Contracts Signed by BPA's Major
Customer Groups, Fiscal Year 1993-2006

Average megawatts

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000 0

1993 1994 1995 1996

9971

9981

1999 2000 2001 2002

0032

2004 2005

0062

Actual power sales Power sales contracts Fiscal years signed during
subscription

Public utilities

Direct service industries

Investor-owned utilities

Source: BPA.

In addition to signing contracts to provide more power to its public
utility customers, BPA also signed contracts to provide power to customers
that it was not statutorily required to serve during the current rate
period. For example, BPA agreed to provide approximately 1,500 aMW of
power to the direct service industries during the fiscal year 2002 to 2006
rate period, despite the fact that BPA's statutory mandate to serve the
direct service industries ended at the end of fiscal year 2001. BPA
officials told us that the decision to serve the direct service industries
was made at the request of the then Secretary of Energy and that BPA
management also felt it was the correct thing to do, given BPA's previous
requirement to provide power to these customers. BPA also agreed to
provide 1,000 aMW of power to the investor-owned utilities as part of a
settlement agreement-

previously, BPA had only provided financial payments to investor-owned
utilities as part of the residential exchange program.

The substantial increase in customer demand that occurred at the beginning
of fiscal year 2002 coincided with the expiration of the 20-year power
sales contracts that BPA signed with the majority of its customers after
the passage of the Northwest Power Act. To allow customers to sign new
long-term contracts for firm power, BPA established a "subscription
window"-from April to October 2000. During this subscription process, the
majority of BPA's customers signed 10-year contracts for fiscal years 2002
through 2011.

Figure 7 shows a time line of BPA's major actions during its subscription
and ratemaking processes against a backdrop of wholesale electricity
prices in the Pacific Northwest. When BPA began planning for the
subscription process in early 1997, customers had recently reduced their
power purchases from BPA by approximately 1,800 aMW to take advantage of
low wholesale market prices. BPA officials told us that, due to the
reduction in customer demand, they were concerned about the possibility
that they might not be able to sell enough power to cover their costs. In
BPA's December 1998 record of decision on the subscription process, BPA
stated that two of its principal goals were to spread the benefits of the
federal power system as broadly as possible and avoid rate increases.
Toward that end, BPA committed itself to providing power to investor-owned
utilities and direct service industries, as well as serving all public
utility demand placed on it.

Figure 7: Major Events and Electricity Prices during BPA's Subscription and
Ratemaking Processes

Dollars per megawatt-hour

lJu

y October

April

October April

October

y April

October y April

October y y y y April

yJu

anuarJ

nuar

anuarJ

1997 1998 1999 2001 2002 2003

Dec. 1998

BPA files record Oct. 2001

of decision establishing New rate period

subscription begins - BPA rates

process increase by over

40 percent BPA files rate case for FY 2002-2006

period

Source: GAO analysis of Platts'/RDI Powerdat data on wholesale electricity
prices and data from BPA officials.

Note: Wholesale electricity prices are expressed in dollars per MWh and
are not adjusted for inflation. These prices are from the Mid-Columbia Hub
and are representative of wholesale electricity prices in the Pacific
Northwest.

BPA officials told us that when wholesale electricity prices rose slightly

during the late 1990s, they became concerned about customers demanding

more power than BPA could provide from the federal power system. In

May 2000, at the beginning of the subscription window, BPA filed a rate

case with FERC to set power rates for fiscal years 2002 through 2006. In

the rate case, BPA estimated that it would be called on to serve

approximately 1,700 aMW of power beyond the firm output of the federal

power system, based on input from customers on their expected power
demand.

In June 2000, immediately after BPA filed its rates for 2002 through 2006
with FERC, wholesale power prices increased to levels never before seen in
the Pacific Northwest, and BPA's public utility customers turned to BPA to
avoid the high market prices. By the end of the subscription process,
BPA's public utility customers had requested 1,600 aMW more power than BPA
anticipated in its May 2000 rate case. In total, BPA's customers signed
subscription contracts for 3,300 aMW of power (roughly equivalent to three
times the power used by the city of Seattle) beyond the firm output of the
federal power system.

BPA's rate structure for the fiscal year 2002 to 2006 rate period
contributed to the increase in demand for BPA power. According to BPA
officials, BPA planned to meet customer demand for power by purchasing
additional power from other sources in contracts of varying durations. In
its May 2000 rate case, BPA decided to sell all of its power at a single
rate, which averaged the cost of the purchased power with the lower cost
of power produced by the federal power system. This averaged rate spread
the costs of serving the additional demand over all of BPA's customers
and, as a result, did not distinguish between the price of low-cost power
from the federal power system and the higher cost of power from other
sources. In addition, the averaged rate structure gave customers poor
incentives to seek alternative power sources during the subscription
process, because customers were not exposed to the incremental cost of
acquiring additional power on the market. While BPA considered the
possibility of charging differentiated rates prior to its May 2000 rate
case, it ultimately declined to do so.

To meet the substantial increase in customer demand, BPA spent about $900
million in fiscal year 2002 and about $760 million in fiscal year 2003 on
power purchases and payments to customers to reduce their demand. These
costs comprised approximately 25 percent of BPA's total costs in each
year. Due to large increases in the wholesale price of power, the power
that BPA purchased from other sources to meet the substantial increase in
customer demand generally cost much more than power generated by the
federal power system. For example, BPA's average cost for the power it
purchased for 2002 and 2003 is approximately $37 per MWh, while the
average price of BPA's power, as established in its May 2000 rate case,
was about $22 per MWh. When purchasing power from the wholesale market
became extremely expensive, BPA reduced its power purchases and instead
paid its customers to reduce their demand for BPA

power, in transactions referred to as "buy-backs." BPA's costs associated
with buy-backs were about $450 million in fiscal year 2002 and about $370
million in fiscal year 2003. The majority of the buy-back payments went to
investor-owned utilities and direct service industries. BPA was eventually
forced to raise its rates by more than 40 percent for the majority of
BPA's customers to recover its costs and ensure that it had the funds to
meet its payments on Treasury debt.

Drought Conditions and Other Factors Have Also Led to Cost Increases for BPA

While BPA's overcommitment to provide power is the major cause of its cost
increases in 2002 and 2003, other factors have also contributed to its
cost increases in recent years. In 2001, severe drought conditions reduced
the amount of power produced by the federal power system. According to BPA
data, the annual runoff volume in the Columbia River Basin in 2001 was 40
percent below average and the second lowest since fiscal year 1929. To
meet its customers' demand for power, BPA spent about $2.2 billion on
power purchases in fiscal year 2001, an increase of $1.9 billion over
average annual expenditures on power purchases in fiscal years 1997
through 2000.

In addition, some of BPA's other costs associated with marketing power
have increased in recent years for a variety of reasons. These costs are
associated with power generation (including costs for the residential
exchange program), the fish and wildlife program, and BPA's internal
operations. (For a more detailed presentation of BPA's costs associated
with its power marketing business from fiscal year 1997 to 2003, refer to
app. III.)

BPA's power generation costs have increased consistently since 2000
because of increases in the cost of maintaining and operating the federal
power system, as well as increases in payments to investor-owned utilities
under the terms of a settlement agreement. BPA has reported that the
increased costs for the federal power system were needed to make up for
past under-investment. For example, a benchmarking study conducted in 2000
demonstrated that the federal hydropower system had not been maintained at
the same level as comparable facilities and that increased investment was
needed to improve its reliability, capacity, and safety. In addition,
under the terms of a settlement agreement related to the residential
exchange program, BPA's payments to investor-owned utilities increased in
2002 and 2003 by about $59 million per year, on average,

compared with 1997 to 2001.17 This increase is due to a change in how BPA
calculates payments to these utilities.

BPA's average annual fish and wildlife program costs for 2002 and 2003 are
33 percent higher ($42 million) than they were from 1997 to 2001,
adjusting for inflation. According to BPA officials, the increase is due
primarily to requirements to protect fish species listed under the
Endangered Species Act. These requirements include measures designed to
improve fish passage at the dams, analyze and refine hatchery management
practices, study and report on ocean conditions, and improve spawning and
rearing habitat. Fish and wildlife costs also increased because additional
staff were needed to handle the contracting and administrative workload
associated with threatened and endangered species recovery actions. BPA's
fish and wildlife program staff increased from 35 in 1997 to 63 by 2003.

Finally, BPA's average annual internal operations costs associated with
its power marketing business for 2001 to 2003 are 34 percent higher (or
$32 million, adjusting for inflation) than they were from 1997 to 2000,
largely because of new requirements regarding employee retirement costs
and increased demand placed on BPA during the current rate period.18
Beginning in 2001, BPA began to pay certain retirement costs for its
employees and some partner agency employees that it previously was not
required to pay.19 Between 2001 and 2003, these costs averaged almost $17
million, adjusting for inflation, accounting for more than half the
increase in internal costs, as compared with 1997 to 2000 average cost
levels. In addition, according to BPA officials, a more complex rate
structure created by greater demand for BPA power and new contracts
increased

17These numbers have been adjusted for inflation, base year 2003. This
increase does not include the average annual cost to BPA of about $245
million to buy back the majority of the 1,000 aMW of power it agreed to
provide to investor-owned utilities under the settlement agreement,
according to BPA officials.

18BPA has reported to its customers that its internal costs were 10
percent lower in 2003 than in 2001. In making this calculation, BPA
excluded the costs associated with the retirement costs it was not
previously required to pay. While BPA's calculation is correct, we believe
that including these costs presents a more complete picture of BPA's
expenses. In addition, since BPA's expenses in 2001 were already higher
than in previous years, we calculated BPA's average costs for 1997 to 2000
in order to determine how much BPA's internal operations expenses have
increased, on average, since 2001.

19According to BPA officials, BPA was required to cover these costs
beginning in 1998. However, BPA deferred payment until 2001, thus
increasing BPA's payments between 2001 and 2003.

BPA Has Not Resolved Problems That Led to Its Recent Cost Increases, but It
Has Taken Steps to Control Other Costs

BPA's need for staffing and support, which raised its staffing and support
costs.

BPA has not resolved problems associated with its open-ended obligation to
be the net provider of wholesale electricity in the region-the major cause
of its recent cost increases. BPA has issued a draft strategic plan that
includes an objective of clarifying its commitments to sell power to its
customers. BPA proposes to contractually define the amount of power it
will sell its customers at its lowest, cost-based rates and is also
considering charging incremental rates for any power it sells beyond this
amount. However, BPA has not clearly defined how much power it will sell
at its lowest cost-based rates or the way it will implement incremental
rates. It is also unclear whether BPA's draft plan will be implemented.
BPA had similar plans in the late 1990s but did not implement them because
of pressure from customers to increase, rather than limit, the amount of
demand BPA served. BPA has, however, taken steps to reduce costs or
control the extent of future cost increases in the areas of power
generation, fish and wildlife programs, and internal operations. Further,
BPA is improving its risk management process in order to maintain better
control over its costs. However, regarding its risk management process,
BPA's plan outlining its new approach does not contain some key elements,
including details on specific activities, resources, and time frames.

BPA Has Not Resolved Problems That Led to Recent Cost Increases

BPA has not established a final, formal policy on how it plans to manage
its open-ended obligation to be the net provider of wholesale electricity
in the region-the major cause of its recent cost increases. In March 2004,
BPA issued a draft strategic plan to define a direction for the agency. As
part of that plan, BPA established an objective of clarifying how much
power it will provide to its customers, and at what price, starting in
fiscal year 2007. BPA's plan states that it will establish, via long-term
power contracts with its customers, the amount of power that customers are
able to buy at a low rate.20 If customers request power beyond this
amount, BPA's plan states that BPA will consider use of incremental rates
to distinguish between low-cost power from the federal power system and

20According to BPA officials, the use of long-term contracts is an
integral part of BPA's proposal and may be the best means to protect U.S.
taxpayers' investment in the federal power system.

power from higher-cost resources. According to BPA, establishing rights to
BPA's power and using incremental rates would send appropriate price
signals to its customers and would be consistent with broad customer
interest in allocating rights to power from the federal power system.

However, BPA's draft strategic plan does not provide key details on how it
plans to implement its approach to defining rights to purchase power and
using incremental rates. For example, BPA's plan does not specify the
amount of power that its customers would be able to buy at BPA's lowest
rates. If this amount exceeds the firm output of the federal power system,
then during low water years, BPA could still need to buy power to meet its
contractual obligations. In addition, BPA's plan does not clarify how
BPA's approach to incremental rates would be implemented. As long as BPA's
rates do not fully reflect its costs of acquiring power to meet excess
demand, then customers will not have appropriate incentives to conserve or
seek alternative power supplies.

In addition, it remains unclear whether BPA will succeed in making these
changes once they are more clearly defined. While BPA officials told us
that they have the discretion to implement BPA's plan, they said that they
would strongly prefer to have regional agreement before making a final
policy decision. Accordingly, BPA intends to hold a series of public
meetings with its customers and stakeholders in 2004 to discuss its
proposals. According to BPA officials, once they have received input and
comments from all their customers and other stakeholders, the BPA
Administrator will make a final policy decision and sign a record of
decision in the fall of 2004. However, even if BPA reaches regional
agreement on its plan, BPA has not followed through on similar proposals
made in the past when faced with pressure from its customers. As discussed
previously in this report, in the mid-1990s, BPA endorsed the
recommendations of the Comprehensive Review report, which represented the
views of BPA and its major customer and stakeholder groups. The report
specifically recommended that BPA not acquire additional resources to
serve its customers' load growth, except where the customers take on all
the risk of the acquisition, such as by paying incremental rates that
cover BPA's full cost of acquiring the additional power. However, under
what BPA has characterized as strong regional pressure from its customers,
BPA ultimately declined to implement such an approach in its 2000 rate
case.

The possibility remains that BPA will face similar pressures again,
although BPA officials identified several reasons why the agency is less
likely to need to purchase significant amounts of power in the future,

compared with recent years. For example, most of BPA's direct service
industry customers, such as aluminum smelters, are no longer in operation,
and some smelters are being dismantled. However, public utility demand is
currently about equal to the firm output of the federal power system,
according to BPA officials, and this demand is expected to increase over
time. Since public utilities have a statutory right to purchase power from
BPA, if future demand from public utility customers exceeds the firm
output of the federal power system, BPA may again face pressure to average
the cost of federal system power with higher cost power from other
sources.

In a recent report, the Northwest Power and Conservation Council expressed
concern that BPA's plan to allocate rights to power from the federal power
system and charge incremental rates, using policy statements and records
of decision, may not be sufficient to provide a necessary level of policy
durability, leaving open the possibility that BPA could change its policy
in the future.21 To improve the durability of BPA's plan, the Council
stated that BPA must clearly identify the priority issues that are to be
resolved, the process by which they will be addressed, and adopt an
aggressive schedule for doing so. That schedule should result in offering
new long-term contracts by October of 2007. Further, while the Council
decided not to press for substantive rulemaking at this time, it noted
that if BPA's current approach proves incapable of resolving issues within
that time frame, alternative processes should be considered, including
issuing a rule under the Administrative Procedure Act to establish a
policy on allocating rights to power from the existing federal power
system and charging incremental rates. If adopted, this policy would be
implemented through subsequent contract and ratemaking procedures. Unlike
a record of decision, a policy adopted through a rulemaking procedure
would have the force of law, bind future BPA and customer actions, and
could not be altered unless BPA conducted a similar process. Such measures
would increase assurance that BPA would not change direction in the future
because of customer pressure.

BPA Is Taking Actions to BPA has recently taken a number of actions to
reduce costs or to control Reduce and Control Costs the extent of future
cost increases in the areas of power generation, fish in Other Areas and
wildlife programs, and internal operations. When setting its current

21Northwest Power and Conservation Council, Recommendations on the Future
Role of the Bonneville Power Administration in Regional Power Supply, May
2004.

rates, BPA estimated that the average costs of its generating partners
(the Army Corps of Engineers, Bureau of Reclamation, and Energy Northwest)
for the 2002 to 2006 rate period would be $24 million less per year than
from 1997 through 2001. BPA officials based this estimate primarily on a
1998 review of BPA's costs that projected (1) savings by increasing
coordination of and investment in the federal hydropower system and (2)
operation and maintenance cost reductions and increased revenues from the
nuclear power plant. While BPA and its partner agencies developed a
strategy for jointly operating the federal power system with the goal of
reducing system costs,22 BPA has acknowledged that it did not develop
adequate cost management plans to achieve the projected reductions and
that BPA's partner agencies never committed to the reductions. For
example, Corps officials stated that they had previously underinvested in
maintenance and needed to increase expenses to improve the reliability,
capacity, and safety of the hydroelectric facilities. BPA officials agree
that increased investment in the power system is warranted but said that
BPA is working with the partner agencies to minimize these cost increases.
For instance, BPA has worked with Energy Northwest to defer maintenance
and alter the fuel replacement schedule to reduce costs for the nuclear
plant. In all, BPA has reduced the projected increase in the average
annual costs of its generating partners by $36.4 million for 2003 through
2006.

BPA has also taken several actions to control its costs associated with
the fish and wildlife direct program and reduce their uncertainty. The
direct program includes costs associated with (1) noncapital expenditures
for measures funded in support of the Endangered Species Act and the
Northwest Power and Conservation Council's fish and wildlife program, (2)
off-site capital projects (i.e., capital costs not associated with a
federal power system facility), and (3) a portion of BPA's internal costs
associated with its fish and wildlife related support activities. In light
of its financial problems, BPA directed the Northwest Power and
Conservation Council to ensure that actual expenses for the direct program
did not exceed $139 million annually for fiscal years 2002 and 2003.23 In
addition, BPA has taken other measures to control direct program costs,
including placing a temporary hold on funding for land purchases and
easements while BPA

22Bonneville Power Administration, Asset Management Strategy for the
Federal Columbia River Power System (Portland, OR., June 1999).

23BPA originally set a funding target for the direct program in the 2002
to 2006 rate period at $150 million annually, with the expectation that
actual expenses would average $139 million.

reviewed its financial and liquidity position. While BPA's actions have
achieved its desired result of holding direct program expenses in fiscal
year 2003 to approximately $139 million, they have also generated
controversy among some stakeholders. For example, some stakeholders
maintain that BPA cut funding for the direct program when it decided not
to carry over more than $38.8 million that remained when an earlier
funding agreement for the direct program expired in 2001. According to BPA
officials, this decision was made in 1996, as the funding agreement was
being negotiated, and should not be considered part of their recent
efforts to control costs. In addition, some stakeholders stated that BPA
had cut another $17.4 million from its direct program budget when it
changed its planning and budgeting methods for fish and wildlife programs
in November 2002. This change meant that because some costs incurred for
projects in 2002 and prior years were not identified and paid by a certain
date, they had to be paid from the 2003 and 2004 budgets, thereby reducing
the amount of funding available for new projects by an estimated $17.4
million in those years. According to BPA officials, BPA changed its fish
and wildlife planning and budgeting methods to align them with the
budgeting and planning processes used in its other program areas.

Finally, to reduce internal operations costs, BPA initiated two agencywide
initiatives. As a first step, BPA reduced the fiscal year 2002 budget of
each manager in its power marketing business and has reduced funding in
many general areas, such as travel, training, supplies, staffing, research
and development, and building upgrades. For example, BPA reduced agency
travel expenses by about half and training expenses by about two-thirds
from 2001 levels. According to BPA officials, these steps have helped BPA
reduce its internal operations costs by $42 million from fiscal year 2002
to 2003. Second, BPA is consolidating functions, such as procurement and
information technology, that were previously dispersed throughout the
agency. In addition, in March 2004, BPA contracted with a consulting firm
to perform a comprehensive overview of BPA's major functions, systems, and
processes to identify specific opportunities for program and performance
improvement, which may yield additional savings.

While some of these actions have led to decreased costs in certain areas,
BPA projects that its overall costs for the three categories in fiscal
years 2004 to 2006 will remain 27 percent higher than its average from
fiscal years 1997 to 2000. BPA officials said that without the cost
control measures, costs for these categories would be expected to increase
even more. They also noted that some of the cost increases-such as those
required for fish and wildlife under the Endangered Species Act-are
largely beyond BPA's control.

BPA Is Taking Steps to Improve Its Risk Management Process and Better
Control Costs

BPA recently concluded that its risk management process had not kept pace
with the changes taking place in the electricity industry and the
increasing demands being placed on it by its stakeholders, and that this
problem has contributed to BPA facing increased financial risk.
Specifically, in an April 2003 report to its customers and Northwest
citizens, BPA stated that, while it has historically assumed and managed
significant amounts of risk on behalf of its customers, BPA's decision to
take on demand beyond the firm output of the federal power system has gone
beyond the limits of risk that it can accept. As a result, BPA is taking
steps to improve its risk management process.

In June 2002, BPA hired a consulting firm to independently evaluate its
risk management process. Risk management includes risk assessment and
monitoring, which are two of the key elements of internal control.24 Risk
assessment identifies and analyzes the relevant risks associated with
achieving an organization's objectives, while monitoring assesses the
quality of performance of the risk management process over time and
identifies any departures from this process. In its contract with the
consultant, BPA asked the firm to

o identify, evaluate, and rank BPA's enterprise-wide risks;

o assess the state of BPA's risk management;

o compare BPA's risk management approach and structure with the
industry's best and emerging practices;

o identify gaps in its risk management and control framework where
improvements may be appropriate; and

o recommend an "Enterprise Risk Management" model and alternative
organizational structures.

The consultant found that although BPA had significant risk management
resources in specialized areas, based on BPA's business lines or specific
types of risk, the agency's risk management efforts were decentralized and

24Effective internal control should provide for an assessment of risks an
organization faces from both external and internal sources. U.S. General
Accounting Office, Standards for Internal Control in the Federal
Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999).

were not integrated into an enterprise-wide structured approach.25 The
consultant made numerous recommendations for improvements in the following
areas: planning and preparedness; risk identification and prioritization;
monitoring, control, and reporting; follow-through and organizational
learning; and general organization and leadership.

In March 2003, BPA developed a management plan to implement some of the
consultant's key, high-level recommendations. The plan calls for two main
strategies. First, the plan calls for the establishment of a Chief Risk
Officer position and organization. According to the plan, the Chief Risk
Officer position is designed to elevate risk issues to the senior
management level on a par with business, financial, and program
strategies. The Chief Risk Officer would lead BPA's revamped risk
assessment and mitigation efforts and work across BPA's business lines and
program offices.

Second, BPA's plan calls for the establishment of two oversight committees
to operate under the direct, delegated authority of the BPA administrator.
The Enterprise Risk Management Committee would oversee BPA's risk
management program and would identify, analyze, evaluate, treat, monitor,
and communicate risks across BPA's business lines and program offices.
This committee is to consist of senior executives and would facilitate
integration of risks across BPA and ensure that risk and strategy are
considered in tandem. The committee would also establish the acceptable
zones or boundaries for risk, often referred to as risk tolerances, within
which the business lines will operate. The second committee, called the
Transacting Risk Management Committee, would be headed by the Chief Risk
Officer and handle the more tactical and technical transacting risks
within business lines. This committee would focus on risks inherent in
commodity market transactions and counterparty credit exposures. It would
also oversee policies and procedures and establish risk monitoring and
limits that will govern the commodity transaction risks.

BPA has taken several significant actions to implement its management
plan. As of April 2004, BPA had made the following major changes to its
risk management process:

25BPA has two main business lines-Power Business Line and Transmission
Business Line. These business lines are supported by several corporate
units that also carry out significant functional responsibilities of the
agency, such as the Environment, Fish, and Wildlife group.

o centralized its risk management operations into a newly created Chief
Risk Office that is headed by a newly appointed Chief Risk Officer,
completed the initial transfer of risk-related jobs to the new Chief Risk
Office, and announced additional staff recruitment for the office through
the federal merit and competitive process;

o chartered and established the Transacting Risk Management Committee
and hired a staff manager for the Enterprise Risk Management Committee,
which has not yet been established; and

o instituted a requirement for its power marketing business that
decisions in which the total lifetime costs, revenues, or potential risks
are estimated to exceed $500,000 will be formally documented in a standard
form BPA refers to as a "Decision Support Template."

While BPA continues its efforts to implement its plan and establish a more
centralized risk management process, work remains to be done to ensure
that the plan is successful. At this point, the plan provides limited
information on how BPA will complete its implementation of the new
approach to risk management. While the plan includes strategies and
highlevel descriptions, it generally does not yet identify specific
activities, resources, and time frames for completing the implementation
of BPA's new approach. Neither does the plan address when, and to what
extent, BPA will address all of the consultant's detailed recommendations.
Without this type of information, it is unclear when BPA intends to fully
implement its new approach and to what extent its approach will address
the consultant's recommendations. According to BPA, its management plan is
not intended to provide the full details necessary to implement its
approach, and BPA intends to monitor the implementation of the plan and
perform an internal assessment by September 2004. BPA officials told us
that the Chief Risk Officer will lead the effort to revise BPA's risk
management process, including responding to the consultant's detailed
findings. However, BPA was unable to provide documentation of the
activities, resources, and time frames it plans to take to fully implement
its plan. Without such documentation, it was not possible to review the
plan's progress in a meaningful way.

Conclusions Growing population in the Pacific Northwest region, combined
with BPA's open-ended obligation to provide power, have increased
financial

pressures on BPA. Past BPA attempts to meet growing demand-by providing
financial backing for the construction of two nuclear power plants that
were never completed and one gas fired power plant, the

power from which BPA later determined it did not need-caused BPA's costs
to rise. This obligation to provide power was also the fundamental cause
of recent cost increases and financial difficulties. Looking forward, this
obligation remains a major source of risk for BPA. BPA must control its
costs or risk not being able to compete with other power producers,
potentially forcing it to default on its debt to the Treasury. One way to
avert this risk and resolve the problems associated with BPA's open-ended
obligation is to allocate (or define) the rights to purchase the firm
output of the existing federal power system and use incremental rates to
distinguish between this "low-cost" power and any other power that BPA
sells. While BPA currently plans to contractually set the amount of power
its customers can buy at its lowest rate and to use incremental rates,
similar intentions in the recent past were not implemented, in part
because of pressure from BPA's customers to provide more power. It is
therefore important for BPA to credibly commit to allocating rights to
purchase the firm output of the federal power system and using incremental
rates. To assist BPA with its commitment to implement its draft strategic
plan and increase assurance that BPA will not change direction in the
future, the Northwest Power and Conservation Council has stated that a
rule issued under the Administrative Procedure Act to establish a policy
on allocating rights to power from the existing federal power system and
charging incremental rates may provide greater durability. If established,
such a rule would be implemented through subsequent contract and
ratemaking procedures and would be more difficult to change than would an
identical plan adopted in a record of decision.

In addition to growing pressure to provide power and financial benefits,
BPA has faced a changing business environment as the electricity industry
has undergone restructuring. These changes have posed management
challenges for BPA and highlighted areas that need improvement. In
particular, BPA's decision to serve demand beyond the firm output of the
federal power system at average rates puts the agency at risk of becoming
uncompetitive. Recognizing this vulnerability, BPA has taken positive
steps by developing a new approach to managing its risks. Following
through on this approach with specific activities, resources, and time
frames to fully implement its risk management initiatives is crucial to
BPA's ability to anticipate and prepare for challenges to its overall
competitiveness. Better risk management should also help BPA in the future
to avoid the kinds of decisions that contributed to its recent financial
difficulties.

Recommendations for We recommend that the Administrator of BPA take the
following four actions:

Executive Action To reduce the risk that BPA will be overcommitted in the
future and to help BPA control the costs of future power purchases, define
the rights to purchase the firm output of the federal power system so that

o the amount of power that BPA sells at its lowest, cost-based rate is
equivalent to the firm output of the existing federal power system, and

o customers who demand additional power from BPA are charged

Agency Comments

incremental rates that fully reflect the additional costs BPA incurs in
acquiring or otherwise providing such power.

As a way to lend credibility to and reinforce BPA's actions, study the
feasibility of issuing a rule under the Administrative Procedure Act to
define the rights to purchase the firm output of the existing federal
power system and set the terms of incremental rates for any power sold
beyond that amount.

To strengthen BPA's management plan and to ensure that progress is made in
implementing its new risk management approach, identify specific
activities, resources, and time frames to implement BPA's risk management
initiatives.

We provided BPA with a draft of this report for review and comment. BPA
generally concurred with our recommendations and said that the report, as
a whole, accurately portrays the advantages and disadvantages BPA faces in
marketing electricity as well as the root causes of its financial
difficulties and associated rate increases during the last few years.
Regarding our recommendation that BPA study the feasibility of issuing a
rule under the Administrative Procedure Act to define the amount of power
it sells at its lowest cost-based rate and to charge incremental rates for
additional power, BPA stated that it plans instead to establish longterm
contracts and rates under the terms of section 7(i) of the Northwest Power
Act, which apply to the establishment of all BPA rates. However, this
statement does not directly address our recommendation. We continue to
believe that it would be prudent for BPA to consider the feasibility of
issuing a rule under the Administrative Procedure Act because such a rule
would have the force of law and could improve the durability of BPA's
policy decisions. Concerning our presentation of BPA's increasing average
annual internal operations costs associated with its

power marketing business for 1997 to 2003, BPA stated that the inclusion
by GAO of employee retirement costs in BPA's internal operations costs
skews the costs upward in the latter years because those years included
catch-up payments that accrued but were not paid in earlier years. We have
discussed this point in the report and acknowledged that a large part of
the increase in BPA's internal costs were the result of these catch-up
payments for employee retirement costs. However, we continue to believe
that including costs associated with employee retirement payments presents
a more complete picture of BPA's internal operations costs since 1997
because these retirement payments represent a significant increase in
BPA's internal costs going forward. The complete text of BPA's comments on
our draft report is presented in appendix IV. BPA also made technical
clarifications, which we incorporated in this report as appropriate.

As agreed with your offices, unless you publicly announce the contents of
this report earlier, we plan no further distribution of it until 30 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. Key contributors to this report are
listed
in appendix V.

Jim Wells
Director, Natural Resources

and Environment

Appendix I: Scope and Methodology

To address the overall objectives, we interviewed and obtained
documentation from Bonneville Power Administration (BPA) officials, BPA's
customers, and a variety of regional stakeholders. Among BPA's customers,
we interviewed representatives of public utilities from each of the four
primary states where BPA sells its power-including representatives from
small and large public utilities as well as urban and rural public
utilities. We also interviewed representatives of investorowned utilities
and direct service industries in the region, as well as members of state
commissions regulating the investor-owned utility customers of BPA. Among
BPA's regional stakeholders, we interviewed officials from the Northwest
Power and Conservation Council, Columbia Basin Fish and Wildlife
Authority, Columbia River Intertribal Fish Commission, Industrial
Customers of Northwest Utilities, Northwest Energy Coalition, and
Renewable Northwest Project. We also collected the views of several
experts on the electricity market in the Pacific Northwest and BPA's role
in that market.

To determine the advantages and disadvantages that BPA faces in marketing
electric power in a more competitive environment, we interviewed and
obtained documentation from BPA and its major customers and stakeholder
groups. To compare BPA's power rates and generation costs with those of
other wholesale providers of electricity, we obtained data from the Energy
Information Administration and Platts'/RDI PowerDat. In assessing the
reliability of these data through (1) interviews with knowledgeable
officials and (2) electronic data testing, we determined that the
reliability of these data was adequate to describe BPA's power rates and
generation costs. To understand BPA's financing mechanisms, we examined
published and unpublished financial data from BPA, interviewed BPA
officials, and interviewed representatives from Standard and Poors and
Fitch Ratings. We also reviewed pertinent laws and documents describing
the history of the federal power system.

To determine the major causes of BPA's recent cost increases, we focused
our review on the costs related to BPA's Power Business Line that are
included in the power rates that BPA charges its customers. These costs
differ from those available in BPA's annual reports, which include costs
for the entire agency. We reviewed publicly available records that BPA
produced to document the subscription and augmentation processes,
including its 1998 record of decision on its subscription policy, rate
cases filed in May 2000 and June 2001, and the April 2003 Report to the
Region. We also interviewed BPA officials and reviewed internal BPA
documents related to its power purchase and buy-back contracts. In
assessing the reliability of data related to BPA's costs through (1)
review of related

Appendix I: Scope and Methodology

documentation, (2) interviews with knowledgeable officials, and (3)
electronic data testing, we determined that the reliability of these data
was adequate to describe BPA's costs associated with its power marketing
business. Where possible, we compared data received from BPA with BPA's
audited financial statements. Finally, we interviewed Northwest Power and
Conservation Council officials, BPA customers, and other stakeholders to
obtain their views on the reasons for BPA's cost increases.

To determine the extent to which BPA has taken actions to control its
costs, we obtained relevant documentation and interviewed officials from
BPA, the Northwest Power and Conservation Council, the Corps of Engineers,
the Columbia River Intertribal Fish Commission, and the Columbia Basin
Fish and Wildlife Authority. To determine the steps BPA has taken to
improve its risk management process, we reviewed documents related to risk
management standards-including GAO's Standards for Internal Control in the
Federal Government, and Enterprise Risk Management Framework, prepared by
the Committee of Sponsoring Organizations of the Treadway Commission-and
reviewed relevant BPA documents, including reports prepared by a
consultant hired by BPA to evaluate its risk management process and make
recommendations for improvement. We also examined the BPA Administrator's
performance contract and BPA's strategic plan as they related to BPA's
risk management process. In addition, we obtained documentation and
interviewed BPA officials on proposed changes to BPA's financial
information system-the Bonneville Enterprise System- that manages its
accounting data and budgetary allocations. However, we were unable to
obtain consistent information on the nature and need for BPA's proposed
changes, and thus could not determine to what extent these proposed
changes would allow BPA to control its costs.

We conducted our work from August 2003 through April 2004 in accordance
with generally accepted government auditing standards.

Appendix II: BPA's Costs Associated with Fish and Wildlife Programs

This appendix provides details on BPA's costs associated with its fish and
wildlife programs for fiscal years 1985 to 2003. See table 1.

Table 1: BPA's Costs Associated with Fish and Wildlife Programs, Fiscal Years
1985-2003

Dollars in millions

BPA internal Reimbursable Capital investment support costsa costs costs

plan costsb Total

1985 $24.2 $0 $30.3 $30.0 $0 $84.5
1986 29.1 0 35.2 32.8 0 97.2
1987 32.1 0 43.0 41.3 0 116.4
1988 26.4 0 26.7 43.5 0 96.6
1989 31.1 0 31.9 43.1 0 106.1

42.7 0 30.5 44.7 0 117.9
1991 41.4 0 30.5 48.0 0 119.9
1992 82.1 0 34.8 51.3 0 168.2
1993 59.4 0 36.5 64.2 0 160.1
1994 65.5 0 40.9 71.9 0 178.3
1995 82.0 0 41.5 73.0 0 196.5

77.2 0 39.9 82.4 0 199.4

1997 91.0 0 39.8 84.5 0 215.3

1998 114.8 0 39.8 81.1 0 235.7

1999 107.9 9.0 42.0 82.2 0 241.1
2000 106.7 7.8 39.8 81.7 0 236.0
2001 94.3 9.1 43.9 79.7 3.0 230.0
128.9 10.5 51.9 57.5 7.2 256.0
2003 $128.7 $11.9 $52.6 $56.7 $6.5 $256.4

Source: GAO analysis of BPA data.

Note: In constant dollars, base year 2003.

aPrior to fiscal year 1999, these costs were included within direct
program costs but not shown separately.

bSpecial program implemented in fiscal year 2001 to help offset fish
losses resulting from the power emergency declarations caused by the
drought.

Definition of Cost 1. Direct program costs-These costs are the noncapital
expenditures for

Categories fish and wildlife activities funded directly by BPA as well as
off-site (not part of a federal power system facility) capital projects.
The activities funded are based on measures in the Biological Opinions and
the Council's Fish and Wildlife Program. Prior to fiscal year 1999, this

Appendix II: BPA's Costs Associated with Fish and Wildlife Programs

category also includes the part of the budget that BPA devotes internally
to fish and wildlife related support activities.

2. BPA internal support costs-These costs are BPA's internal expenditures
for program support as well as contracts and other expenditures on behalf
of the fish and wildlife program. Until fiscal year 1999, these costs were
included as part of the Direct Program. They remain part of direct program
costs but are now shown separately.

3. Reimbursable costs-These costs consist of the hydroelectric share of
operation and maintenance and other noncapital expenditures for fish and
wildlife related activities by the Corps of Engineers (Corps), Bureau of
Reclamation (Bureau), and U.S. Fish and Wildlife Service that are funded
by appropriations and then reimbursed to the U.S. Treasury by BPA. In
addition, this category includes the part of the Council's operating
budget allocated to fish and wildlife activities. These costs are now
funded under direct funding agreements signed with each of the three
agencies.

4. Capital investment costs-These costs consist of the projected
amortization, depreciation, and interest payments for (1) past fish and
wildlife related borrowing by BPA; (2) the portion of past fish and
wildlife capital investments by the Corps and Bureau for which BPA is
already obligated to repay the U.S. Treasury; (3) the hydroelectric share
of future fish and wildlife related capital investments by the Corps and
Bureau that will be funded by appropriations and then reimbursed to the
U.S. Treasury by BPA, based on activities called for in the Biological
Opinion, the Council's Fish and Wildlife Program, and other authorities;
and (4) other capital investments directly funded by BPA borrowing that
are based on activities called for in the Biological Opinion and the
Council's Fish and Wildlife program.

5. High-priority/action plan costs-Costs for a special program designed
to mitigate for damages to fish resulting from the 2001 power system
emergency. Criteria for projects included (1) addressing imminent risks to
the survival of one or more species listed under the Endangered Species
Act that represent a time-limited opportunity or are broadly recognized as
projects that would achieve direct anadromous fish benefits; (2) are
appropriate mitigation for the federal power system and not in lieu of
expenditures or actions authorized or required by other entities and are
otherwise consistent with the Power Act; and (3) the proposed project had
all planning, permitting, and landowner agreements completed so that
on-the-ground work could begin not later than September 30, 2001.

Appendix III: BPA Costs Associated with Its Power Marketing Business, Fiscal
Years 19972003

This appendix provides details on BPA's costs that are associated with its
power marketing business and are charged to its power rates for fiscal
years 1997 to 2003. (See table 2.) According to a BPA official, these data
are consistent with BPA's audited financial statements.

Table 2: BPA Costs Associated with Its Power Marketing Business, Fiscal Years
1997-2003

Dollars in millions

1997 1998 1999 2000 2001 2002 2003
Power
purchases-short $66.4 $151.8 $288.2 $661.4 $2,191.1 $306.6 $228.8
term
Power
purchases-long 0 0 0 0 0 456.0 395.1
term
Power buy-backs 0 0 0 0 123.3 461.7 368.4
Power system 639.4 647.9 503.5 477.2 591.2 641.8 672.7
generation
Fish and 109.4 133.0 136.3 135.5 127.1 170.2 170.3
wildlife
Internal 102.4 90.3 99.7 94.7 115.5 157.3 115.0
operations
Transmission
and ancillary 271.4 303.8 320.1 261.7 234.6 193.1 156.9
services
Other 896.2 994.4 1,074.5 949.5 1,020.9 992.2 932.1
Total $2,085.2 $2,321.2 $2,422.3 $2,580.0 $4,403.7 $3,378.9 $3,039.3

Source: GAO analysis of BPA data.

Note: In constant dollars, base year 2003.

Definition of Cost Categories

1. Power purchases (short term)-Costs of the power BPA purchases in the
short term to use the flexibility of the federal power system to optimize
its value and to provide operational stability to the system.

2. Power purchases (long term)-Costs of the power that BPA signed
contracts to purchase in 2002 and 2003 to meet demand beyond the firm
output of the federal power system.

3. Power buy-backs-Costs of buy-back payments that BPA made to
investor-owned utilities, direct service industries, and public utilities
in addition to power purchases.

4. Power system generation-Costs associated with operation and
maintenance costs for the federal dams, the nonfederal nuclear plant, and
long-term generating projects. Includes BPA expenditures for the
residential exchange program, energy conservation, and renewable energy
development. Also includes BPA's share of costs to decommission
nonoperating power projects and expenses for the benefits BPA receives
from storage projects in Canada. Does not include payments to
investor-owned utilities to buy back power BPA

Appendix III: BPA Costs Associated with Its Power Marketing Business,
Fiscal Years 19972003

agreed to sell under a settlement agreement of the residential exchange
program; these costs are included under power buy-backs.

5. Fish and wildlife-Costs associated with BPA's direct program, high
priority actions, the Northwest Power and Conservation Council, and Lower
Snake River Hatcheries. Direct program costs include BPA's direct
noncapital expenditures to protect, mitigate, and enhance fish and
wildlife affected by the development of the federal power system. The
activities funded are based on measures in the Biological Opinions and the
Council's Fish and Wildlife Program. Direct program costs also include
BPA's internal expenditures for program support. High priority actions
costs are for a program designed to mitigate for damages to fish resulting
from the 2001 power system emergency and designed to address imminent
risks to the survival of one or more species listed under the Endangered
Species Act. BPA funds the Northwest Power and Conservation Council's
annual operating budget, which averaged almost $8 million per year, from
fiscal year 1997 to 2003. Approximately half its budget, including staff
time, is dedicated to fish and wildlife activities. Lower Snake River
hatcheries costs include payments to the U.S. Fish and Wildlife Service to
fund fish hatcheries on the Snake River.

6. Internal operations-Costs associated with BPA power nongeneration
operations, shared services and administration, and the civil service
retirement system. Power nongeneration operations costs include BPA's
portion of expenses related to the joint management of the federal power
system; oversight of the nonfederal nuclear project, development, and
administration of power contracts; tribal relationship management;
Canadian Treaty management; public involvement and policy development;
power rates setting, power financial management, and power billing;
short-term and long-term marketing and support; development and management
of conservation and energy efficiency programs; system operations support
(such as weather and stream flow forecasting, scheduling, load
forecasting); maintenance of automated systems for Power Business Line
application and system management; and projects to improve overall
performance and meet market challenges, such as increasing forecasting
capabilities to optimize federal power system generation. Shared services
and administrative costs include the costs for information technology
services; infrastructure and maintenance; building rent, maintenance, and
security; and mail services, personnel services, library and printing
services, as well as the portion of corporate general and administrative
costs allocated to power rates. Civil service retirement system costs are
associated with the unfunded

Appendix III: BPA Costs Associated with Its Power Marketing Business,
Fiscal Years 19972003

liability of the Civil Service Retirement and Disability Fund, the
Employees Health Benefits Fund, and the Employees Life Insurance Fund,
which had not been covered prior to fiscal year 1998. These costs also
include the power related portion of the Army Corps of Engineers, Bureau
of Reclamation, and the U.S. Fish and Wildlife Pension and Post-retirement
Benefits.

7. Transmission and ancillary services-Costs associated with services
necessary to support the transmission of energy from resources to loads,
including reliability, scheduling and dispatch, spinning reserves,
emergency reserves, load following and regulation, automatic generation
control, energy imbalance, transmission losses, control area reserves for
resources and for interruptible purchases.

8. Other-Include costs associated with the nonfederal debt service,
depreciation, amortization, net interest, and bad debt/expense adjustment.
Nonfederal debt service costs include BPA's portion of the debt of Energy
Northwest and various nonfederal conservation and hydroelectric projects.
Depreciation costs are the allocation of expenses associated with
property, plant, and equipment to each period benefited by the asset.
Depreciation is calculated by dividing the costs of the asset, less any
applicable salvage value, by its estimated useful life or allowable period
of time. Amortization costs are the allocation of expenses associated with
intangible capital investments, such as for conservation and fish and
wildlife. Net interest expense costs are the net expenses resulting from
money borrowed to construct and maintain the federal power system and
other projects. Costs associated with bad debt expenses include money BPA
did not receive from parties who have declared bankruptcy. Expense
adjustments represent miscellaneous accounting entries not associated with
specific programs.

Appendix IV: Comments from the Bonneville Power Administration

Appendix V: GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

(360378)

Jim Wells (202) 512-3841 Frank Rusco (202) 512-4597

In addition to the individuals named above, Jill Berman, Jonathan Dent,
Samantha Gross, Jason Holliday, Jon Ludwigson, Don Neff, Cynthia Norris,
Eric Wenner, and Doris Yanger made key contributions to this report.
Important contributions were also made by Janice Lichty, Lisa Shames, and
Barbara Timmerman.

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