Electric Utility Restructuring: Implications for Electricity R&D
(Testimony, 03/31/98, GAO/T-RCED-98-144).

Pursuant to a congressional request, GAO discussed funding for
electricity research and development (R&D) and the implications for
electricity R&D resulting from electric utility restructuring
initiatives.

GAO noted that: (1) Congress provided the Department of Energy (DOE)
over $6.7 billion for electricity R&D in fiscal years (FY) 1993 through
1998; (2) however, except for FY 1994 and FY 1995, funding levels have
declined; (3) specifically, funding increased by about 15 percent from
1993 to 1995, then it decreased by about 30 percent; (4) key budget
categories comprising electricity R&D also show wide variation; (5) as
stated in GAO's 1996 report, the primary reason for DOE's reduction
since FY 1995 has been Congress's overall effort to reduce the federal
budget; (6) during calendar years 1993 through 1996, funding for
electricity R&D by electric utilities decreased about 33 percent to $476
million ($506 million in 1998 constant dollars), and further reductions
were expected; (7) utilities, in an effort to cut costs in anticipation
of a shift from a regulated to a deregulated environment, were reducing
their R&D budgets because of the expected increase in competition in the
electricity market; (8) state-sponsored electricity R&D programs that
GAO reviewed had also reduced their spending; (9) the declines in state
programs were attributable to reductions in major funding sources,
including utilities' contributions; (10) concurrent with the reduction
in R&D funding, a shift in the types of R&D funded by electric utilities
had occurred, primarily resulting in a decrease in collaborative and
longer-term projects; (11) many utilities were shifting away from these
projects, which may benefit all electric utilities, to those they
believed would help their own competitiveness in the near term, that is,
proprietary R&D projects with a short-term payback; (12) electricity R&D
funding by the federal government, the electric utility industry, and
most states is declining because of budget reductions and restructuring
prospects; (13) at the same time, as the electric utility industry
undergoes rapid changes in an era of emerging competition, pressure
exists for all federal agencies to demonstrate that they are making
effective use of the taxpayers' dollars; and (14) given the inherent
difficulties in measuring the benefits of R&D, the economic consequences
of these funding declines are unclear.

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

 REPORTNUM:  T-RCED-98-144
     TITLE:  Electric Utility Restructuring: Implications for 
             Electricity R&D
      DATE:  03/31/98
   SUBJECT:  Energy research
             Electric energy
             State programs
             Research and development costs
             Electric utilities
             Energy industry
             Research program management
             Budget cuts
             Economic analysis
             Competition

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


Before the Subcommittee on Energy and Environment, Committee on
Science, House of Representatives

For Release
on Delivery
Expected at
10 a.m.  EST
Tuesday
March 31, 1998

ELECTRIC UTILITY RESTRUCTURING -
IMPLICATIONS FOR ELECTRICITY R&D

Statement of Victor S.  Rezendes,
Director, Energy, Resources, and Science Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-98-144

GAO/RCED-98-144T


(141167)


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

  DOE -
  R&D -
  PUC -
  FERC -
  EPRI -
  GAO -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We appreciate the opportunity to appear before you today to discuss
funding for electricity research and development (R&D) and the
implications for electricity R&D resulting from electric utility
restructuring initiatives.  Our testimony is based on our 1996
report\1 and updated analysis of changes in the Department of
Energy's (DOE) electricity R&D appropriations using more recent data,
including DOE's 1999 budget request. 

As the electric power industry moves toward less regulation and
increased competition, utilities face significant changes. 
Historically, electric utilities have operated as monopolies in
protected geographic areas regulated by state public utility
commissions (PUC).  These commissions have allowed utilities to
recoup their expenditures on electricity R&D from their customers. 
Today, the electric utility industry is undergoing large-scale
restructuring to promote competition among electricity providers. 
Because electricity prices will no longer be set by regulation but
rather by competitive forces in the marketplace, funding for
electricity R&D will likely be affected. 

In summary, our work has shown the following: 

  -- The Congress provided DOE over $6.7 billion for electricity R&D
     in fiscal years 1993 through 1998;\2

however, except for fiscal years 1994 and 1995, funding levels have
declined.  Specifically, funding increased by about 15 percent from
1993 to 1995, then it decreased by about 30 percent.  Key budget
categories comprising electricity R&D also show wide variation.  As
stated in our 1996 report, the primary reason for DOE's reduction
since fiscal year 1995 has been the Congress's overall effort to
reduce the federal budget. 

  -- During calendar years 1993 through 1996, funding for electricity
     R&D by electric utilities decreased about 33 percent to $476
     million\3 ($506 million in 1998 constant dollars), and further
     reductions were expected.  Utilities, in an effort to cut costs
     in anticipation of a shift from a regulated to a deregulated
     environment, were reducing their R&D budgets because of the
     expected increase in competition in the electricity market. 
     State-sponsored electricity R&D programs that we reviewed had
     also reduced their spending.  The declines in state programs
     were attributable to reductions in major funding sources,
     including utilities' contributions. 

  -- Concurrent with the reduction in R&D funding, a shift in the
     types of R&D funded by electric utilities had occurred,
     primarily resulting in a decrease in collaborative and
     longer-term projects.  Many utilities were shifting away from
     these projects, which may benefit all electric utilities, to
     those they believed would help their own competitiveness in the
     near term, that is, proprietary R&D projects with a short-term
     payback. 

  -- Electricity R&D funding by the federal government, the electric
     utility industry, and most states is declining because of budget
     reductions and restructuring prospects.  At the same time, as
     the electric utility industry undergoes rapid changes in an era
     of emerging competition, pressure exists for all federal
     agencies to demonstrate that they are making effective use of
     the taxpayers' dollars.  Given the inherent difficulties in
     measuring the benefits of R&D, the economic consequences of
     these funding declines are unclear. 


--------------------
\1 Federal Research:  Changes in Electricity-Related R&D Funding
(GAO/RCED-96-203, Aug.  16, 1996). 

\2 Dollar amounts are in fiscal year 1998 constant dollars unless
otherwise noted. 

\3 Dollar amounts are in calendar year 1995 constant dollars. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

Electricity R&D encompasses both basic and applied research and
includes all aspects of electricity generation, including nuclear,
fossil, and renewable energy technologies; transmission and
distribution technologies; energy storage technologies; and
environmental studies of electricity-related issues, according to the
Executive Director of DOE's Energy Resources Board.\4 Funding for
electricity R&D comes from several sources, including DOE, electric
utilities, and states.  However, as the electric power industry moves
toward less regulation and increased competition, electricity R&D
funding will likely be affected. 

Driven by a combination of factors, the movement toward less
regulation gained impetus with the enactment of the Energy Policy Act
of 1992, which promotes increased competition in the wholesale power
market.  Other factors spurring the move toward competition include
large differences in electricity rates among utilities; new low-cost
electricity generation technologies; and recent experiences in
reduced regulation in other industries, such as telecommunications
and the natural gas industry. 

In April 1996, pursuant to its authorities under the Federal Power
Act, the Federal Energy Regulatory Commission (FERC) issued a final
rule that requires electric utilities to make their transmission
lines accessible to other utilities or power producers for the
transmission of wholesale power.  FERC Order 888 requires that this
open access be made available at the same cost that these public
utilities incur to transmit their own power.  As of February 1998,
all 50 states and the District of Columbia had considered reforming
their respective retail electricity markets, according to the
National Regulatory Research Institute and records obtained from
state regulatory agencies.  As of last month, at least 17 states had
implemented plans to restructure the industry by enacting legislation
or adopting final orders.\5 These states represent over 50 percent of
the nation's retail electricity customers, according to DOE's Pacific
Northwest National Laboratory.  Under these plans, activities at the
retail level to choose electricity suppliers are only now beginning. 


--------------------
\4 Because DOE does not define electricity R&D but includes it within
energy R&D, we used this definition as the basis for the information
we present. 

\5 The 10 states that had enacted legislation to restructure their
retail markets were California, Illinois, Maine, Massachusetts,
Montana, Nevada, New Hampshire, Oklahoma, Pennsylvania, and Rhode
Island.  The seven states that had adopted final orders without
enacting legislation were Arizona, Maryland, Michigan, New Jersey,
New York, Texas, and Vermont. 


   CHANGES IN ELECTRICITY R&D
   FUNDING
---------------------------------------------------------- Chapter 0:2

As we reported in 1996, electricity R&D funding was reduced in 1996
from 1993 levels by the federal government, the electric utility
industry, and most of the states that we reviewed.  Mr.  Chairman, I
now refer to figure 1, which shows DOE's and investor-owned
utilities' funding for electricity R&D.  In fiscal years 1993 through
1999, DOE's electricity R&D budget in real terms--that is, correcting
for the effects of inflation--has declined slightly (by about 3
percent), assuming the Congress approves the funding levels in DOE's
1999 budget request.  However, year to year funding has been uneven. 
Funding levels increased by about 15 percent in fiscal years 1993
through 1995; decreased by about 30 percent in fiscal years 1995
through 1998; and, for fiscal year 1999, DOE has requested an
increase of about 20 percent from the 1998 level.  Figure 1 also
shows that in 1993 through 1996, utilities' investments have
decreased each year.\6

In 1996, utility R&D managers told us that this funding would most
likely continue to decline.  Among the 80 companies we contacted at
that time, the R&D managers of 38 companies predicted decreases in
R&D spending, while the managers of only 2 companies predicted
increases.  The managers from the remaining 40 companies were either
unsure, believed their expenditures would remain about the same, or
did not provide the information. 

   Figure 1:  DOE's and
   Investor-Owned Utilities'
   Funding for Electricity R&D,
   1993-99

   (See figure in printed
   edition.)

Notes:  The decline in utilities' funding is expected to continue. 

DOE's time periods are fiscal years; utilities' time periods are
calendar years. 

DOE's 1993-97 funds are actual; 1998, appropriated; and 1999,
requested. 

Source:  GAO's presentation of data from DOE's budgets, FERC, and
selected electric utility companies. 

For this testimony, we updated our 1996 analysis of changes in DOE's
electricity R&D funding to add more recent data, including the
Department's 1999 budget request.\7 While the overall percentage
change from fiscal year 1993 is small, key budget categories
comprising electricity R&D show much greater variation.  For example,
as shown in appendix I, "DOE's Appropriations for Major Electricity
R&D Programs, Fiscal Years 1993-99," while funding for renewable
energy and energy efficiency R&D would increase by nearly 40 percent,
funding for fossil energy and nuclear energy R&D would decrease by
about 24 and 51 percent, respectively.  We stated in our 1996 report
that the primary reason for DOE's reduction in R&D spending in fiscal
year 1996 was the Congress's overall effort to reduce the federal
spending.  According to a senior-level DOE official, current funding
levels are driven by recent program goals and budget agreements that
were implemented to reduce the overall federal budget. 

As stated in our 1996 report, utility R&D managers told us their
budgets were reduced primarily because their companies were preparing
for deregulation and competition by cutting costs wherever they
could.  In the past, utilities were allowed to earn a fixed rate of
return on all R&D projects that the PUCs allowed in the rate base. 
In a more competitive marketplace, utilities will be forced to price
electricity to compete with other utilities and other power
producers.  As a result, these R&D managers said that they evaluate
potential R&D projects on the basis of their likelihood of providing
a near-term return to the utility in terms of allowing it to reduce
electricity rates. 

The state electricity R&D programs that we reviewed for our 1996
report were also experiencing reductions.  Of the 11 large programs
in the nine states that we reviewed,\8 7 had been reduced from 1993
to 1996.  Overall, the programs had seen a 30-percent reduction in
funding, from $83 million to $58 million,\9 since 1993.  Most of
these programs involved energy efficiency R&D, and some involved
generation technologies of particular interest to that state, such as
ones for coal power and renewable energy. 

We also reported in 1996 that concurrent with the decline in funding,
a shift in the type of R&D being funded had also occurred, primarily
resulting in a decrease in collaborative and longer-term projects. 
Many utilities were shifting their R&D to proprietary R&D and to
projects with a short-term payback.  Utility R&D managers viewed this
shift as part of the effort to recast the utility companies as
competitive businesses rather than regulated providers of public
services.  In addition, as a result of these changes and the
reduction in DOE's funding in fiscal year 1996, advanced technology
projects in the six technology areas we reviewed were often delayed,
scaled back, or canceled.  This shift was reflected in the declining
support for the Electric Power Research Institute (EPRI),\10 which is
the utilities' main vehicle for collaborative R&D.  Between 1994 and
1996, membership contributions to EPRI declined by nearly 30 percent,
from $424 million to $300 million,\11 and EPRI officials expected a
further decline in 1997.  Of the 80 companies we contacted, 12
dropped out of EPRI between 1994 and 1996, but most remained members
and simply decreased their contributions. 

Our 1996 report stated that utility R&D managers and DOE and state
government officials had expressed concerns about the funding levels
of electricity R&D and suggested alternative funding sources.  These
sources include (1) a state-administered surcharge on all in-state
retail sales of electricity and (2) a nationwide charge on all
electricity entering a transmission system--a "nonbypassable wires
charge."\12

Several states that are considering deregulating their utilities have
proposed surcharges to fund public-benefit R&D the states include
California, Massachusetts, New York, and Rhode Island.  For example,
one proposal would fund R&D that served a broad public interest that
might otherwise be lost in the transition to a more competitive
marketplace.  The proposal calls for establishing a consortium or
public authority to administer the funds but does not specify a
funding level. 

Some utility R&D managers and state and EPRI officials suggested that
a national nonbypassable wires charge could provide an alternative
funding mechanism for EPRI and longer-term collaborative R&D.  It
would ensure that those who do not fund R&D do not achieve a
competitive advantage over those who do.  Under this proposal, a
small charge would be assessed on all electricity entering a
transmission grid, whether it be interstate or intrastate.  The Gas
Research Institute--the R&D counterpart to EPRI for the natural gas
industry--is funded by a somewhat similar charge on gas flowing
through interstate pipelines.  In the past, the Institute has
encountered problems with this funding mechanism because individual
pipeline companies are allowed to reduce their payments to the
Institute if their rates are discounted as a result of competition
from other pipeline companies.  Many utility R&D managers, although
generally reluctant to support any additional charges for
electricity, said that a nonbypassable wires charge would be a more
equitable way to provide funding than the current system, to which
some utilities and independent power producers were not contributing. 


--------------------
\6 Utility R&D managers told us that on average they devoted about
0.3 percent of their 1994 revenues to R&D. 

\7 To update DOE's electricity R&D funding, we reviewed DOE's budget
justifications for fiscal years 1998 and 1999.  As appropriate, for
existing budget categories, we updated appropriation totals that had
been estimated in earlier budget justifications with actual amounts
provided in more recent ones.  We also included appropriation totals
for new electricity-related budget categories that DOE had created. 
We discussed our methodology and calculations with the Executive
Director of DOE's Energy Resources Board, who agreed with the funding
levels contained in appendix I.  We included adjustments and
clarifications he suggested as appropriate.  We conducted this update
of our analysis in March 1998 in accordance with generally accepted
government auditing standards. 

\8 The 11 programs represented the major state programs involved in
electricity R&D, according to the available data and discussions with
key state program officials. 

\9 Amounts in 1995 constant dollars. 

\10 Founded by the utility industry in 1972 to do R&D, EPRI is funded
by the utilities' contributions. 

\11 Amounts in 1995 constant dollars. 

\12 A nonbypassable wires charge is one that would be assessed on all
electricity entering a transmission grid, whether it be interstate or
intrastate. 


   IMPLICATIONS FOR ELECTRICITY
   R&D FUNDING
---------------------------------------------------------- Chapter 0:3

Given the inherent difficulties in measuring the benefits of R&D, the
economic consequences of these funding changes are unclear.  Our past
work has demonstrated the difficulty in measuring the impact of
technology programs.\13 For example, a wide range of factors
determines if and when a particular R&D project will result in
commercial or other benefits; it can also take many years for a
research project to achieve results.  We have found that no single
indicator or evaluation method adequately captures the results of
R&D.  We also have found that it is difficult to establish a causal
link between a successful project and government funding early in the
project.  The commitment to reduce the federal deficit is causing the
Congress to reexamine the value of programs across the federal
government, exerting pressure on all federal agencies to demonstrate
that they are making effective use of the taxpayers' dollars.  This
greater emphasis on results is evident in the passage of the
Government Performance and Results Act of 1993 (Results Act).  The
Results Act provides a legislative vehicle for agencies to use as
they seek to demonstrate and improve their effectiveness. 
Experiences from the act's pilot efforts reinforce the fact that
output measures are highly specific to the management and mission of
each federal agency and that no single indicator exists to measure
the results of research.  If successfully implemented, the Results
Act should help the Congress make the difficult funding, policy, and
program decisions that the current budget environment demands. 


--------------------
\13 See Federal Research:  Challenges to Implementing the Advanced
Technology Program (GAO/RCED/OCE-98-83R, Mar.  2, 1998); Measuring
Performance:  Challenges in Evaluating Research and Development
(GAO/T-RCED-97-130, Apr.  10, 1997); Measuring Performance: 
Strengths and Limitations of Research Indicators (GAO/RCED-97-91,
Mar.  21, 1997); and Measuring Performance:  The Advanced Technology
Program and Private-Sector Funding (GAO/RCED-96-47, Jan.  11, 1996). 


-------------------------------------------------------- Chapter 0:3.1

Mr.  Chairman, this concludes my prepared statement.  I would be glad
to answer any questions that you or other Members of the Subcommittee
may have. 


THE DEPARTMENT OF ENERGY'S
APPROPRIATIONS FOR MAJOR
ELECTRICITY R&D PROGRAMS
=========================================================== Appendix I



                                        Table I.1
                         
                                The Department of Energy's
                         Appropriations for Major Electricity R&D
                              Programs, Fiscal Years 1993-99

                           (1998 constant dollars in thousands)

                                                                                     1999
Budget item              1993      1994      1995      1996      1997      1998   request
-------------------  --------  --------  --------  --------  --------  --------  --------
Renewable & energy   $404,055  $491,909  $566,943  $436,840  $422,232  $451,481  $563,224
 efficiency
Nuclear energy\a      137,679   104,515   113,697    70,238    61,496    19,000    67,317
Fossil energy         395,104   389,723   375,489   316,909   286,665   285,967   299,126
Energy research,      106,149   102,476   193,385    91,754    92,514    91,042    97,939
 including fusion
Biological &          137,510   137,336   109,312   117,133   110,909   108,400   116,329
 environmental\b
Policy Office\c         3,775         0     6,451     4,155     2,543     1,936     2,439
=========================================================================================
Total                $1,184,2  $1,225,9  $1,365,2  $1,037,0  $976,359  $957,826  $1,146,3
                           72        60        76        28                            74
-----------------------------------------------------------------------------------------
Notes:  The Department of Energy's (DOE) Office of Energy Efficiency
and Renewable Energy developed an estimate of DOE's budget for
utility-related activities for fiscal year 1993, which we used
together with other budget data to estimate DOE's budget for
electricity R&D activities. 

Figures sometimes do not add to totals because of rounding. 

\a Includes $12 million provided by the Department of Defense in
fiscal year 1998. 

\b Includes R&D on the effect of carbon dioxide on the earth's
atmosphere and on people. 

\c Includes environmental policy studies, analysis of DOE's R&D
activities, and evaluation of proposed regulations' effect on the
energy system. 

Source:  GAO's presentation of data from DOE's budgets. 

   Figure I.1:  DOE's
   Appropriations for Major
   Electricity R&D Programs,
   Fiscal Years 1993-99

   (See figure in printed
   edition.)


*** End of document. ***