```
                                                                 
Tennessee Valley Authority: Information on Benchmarking and	 
Electricity Rates (30-MAY-02, GAO-02-636).			 
                                                                 
The Tennessee Valley Authority (TVA) declared its intent to	 
become competitive by reducing its cost of power and becoming	 
more financially flexible by reducing debt from $27.4 billion to 
$13.2 billion by 2007. Since the 1980s, TVA has used benchmarking
to assess staffing levels for its nuclear program and it began to
use benchmarking studies for its non-nuclear business units in	 
1998. Recent studies  indicate that TVA's nuclear and		 
transmission power supply units are close to the industry's best 
in terms of staffing efficiency. TVA has taken several actions to
improve performance and efficiency, including reorganizing its	 
human resources and business services organizations and 	 
automating its hydropower production facilities to reduce future 
staffing. TVA continues to utilize benchmarking to assist in	 
identifying opportunities for improvement. TVA's current	 
electricity rates are low when compared to 12 likely competitors 
and to national averages. Although TVA's electricity rates are	 
relatively low, it is legislatively protected from most 	 
competition, and it has the statutory authority to raise rates.  
If TVA were to choose to raise electricity rates selectively and 
use the additional cash generated to repay debt, it could	 
accelerate debt repayment and reduce fixed interest costs. Doing 
so would enhance TVA's ability to respond to future competitive  
pressures. But TVA is already subject to some competitive	 
pressures and a decision to raise electricity rates could result 
in potential long-term negative consequences on power sales. TVA 
also is concerned that a a rate increase could affect		 
distrubutors' perception of TVA before the they may be given the 
choice of selecting their suppliers. Increasing electricity rates
could result in the loss of some customers, lower power sales,	 
and possibly reduce revenue. Increased rates also could have an  
impact on the regional economy. Increased rates should be	 
considered differently for each rate category because the	 
difference between TVA's rates and the rates of other utilities  
varies by rate category.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-636 					        
    ACCNO:   A03445						        
  TITLE:     Tennessee Valley Authority: Information on Benchmarking  
and Electricity Rates						 
     DATE:   05/30/2002 
  SUBJECT:   Agency debt					 
	     Competition					 
	     Electric utilities 				 
	     Financial management				 
	     Utility rates					 

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GAO-02-636
     
A

Report to the Honorable Richard H. Baker, House of Representatives

May 2002 TENNESSEE VALLEY AUTHORITY Information on Benchmarking and
Electricity Rates

GAO- 02- 636

Letter 1 Results in Brief 1 Background 3 Objectives, Scope, and Methodology
6 TVA Has Used Benchmarking to Make Changes and Identify Other

Potential Areas for Improvement 8 TVA?s Electricity Rates are Relatively Low
Compared to Likely Competitors 13

Agency Comments and Our Evaluation 19 Appendixes

Appendix I: Objectives, Scope, and Methodology 20 Staffing Benchmarking
Studies 20 Comparison of Electricity Rates 20 Organizations Contacted 21

Appendix II: Comments from the Tennessee Valley Authority 22

Appendix III: GAO Contact and Staff Acknowledgments 23 GAO Contact 23
Acknowledgments 23

Tables Table 1: Comparison of TVA?s Fiscal Year 2000 Average Electricity
Rates to Likely Competitors? Average Rates and National Average Rates (cents
per kWh) 2 Table 2: Comparison of TVA?s Fiscal Year 2000 Average Electricity
Rates to Likely Competitors and the National Average

(cents per kWh) 15 Figure Figure 1: Overall Staffing Levels of Four TVA
Business Units

Compared to the Benchmarks 12

Lett er

May 30, 2002 The Honorable Richard H. Baker House of Representatives Dear
Mr. Baker: This report responds to your request of June 14, 2001, to review
potential ways for the Tennessee Valley Authority (TVA) to accelerate its
debt reduction. As competition spread in the electric utility industry, TVA
officials became increasingly aware of the need to prepare for the day when
TVA might be required to compete with other utilities. In 1997 TVA declared
its intent to reduce its cost of power and increase its financial
flexibility to respond to competitive pressure largely by reducing debt by

over half from $27.4 billion to about $13.2 billion by 2007. However,
according to estimates that TVA provided to the Office of Management and
Budget (OMB) in support of the president?s 2003 budget, TVA now plans to
reduce outstanding debt to about $22.2 billion by 2007; this represents $9
billion less debt reduction than planned in 1997. Your concern over TVA?s
decision to reduce its debt reduction goal prompted you to ask us to
determine whether TVA is in a position to reduce debt by more than currently
planned. Specifically, you asked that we

determine (1) what benchmarking studies regarding staffing levels have been
performed to compare TVA to other electricity providers, the results of
these studies, and what changes TVA has made as a result of them, and (2)
how TVA?s electricity rates compare to those of likely competitors and
whether the rates are low enough for TVA to consider raising them.

Results in Brief Since the 1980s, TVA has used benchmarking 1 as a means of
identifying ways to improve efficiency. Initially used to assess staffing
levels for its nuclear program, it also began to have benchmarking studies
performed for

its non- nuclear business units in 1998. While opportunities for improvement
exist for all of TVA?s business units, recent studies have indicated that
TVA?s nuclear and transmission power supply units are close

1 Benchmarking is a management tool used to study a competitor?s business
practices in order to improve the performance of one?s own company.
Benchmarking determines who is the very best, who sets the standard, and
what that standard is. In the electric utility industry, benchmarking is
primarily used to assess cost efficiency.

to the industry?s best in terms of staffing efficiency. Based on
observations of the benchmarking studies, TVA has taken several actions to
improve performance and efficiency, including reorganizing its human
resources and business services organizations and initiating the automation
of its hydropower production facilities to reduce future staffing. TVA
continues to utilize benchmarking to assist in identifying opportunities for
improvement.

TVA?s current electricity rates are low when compared to those of 12 likely
competitors and to national averages. TVA?s residential rates are lower than
all 12 likely competitors and its industrial rates are lower than 10 of the
12, while its commercial rates are lower than 4 of the 12. For each of the
three rate classes, TVA?s rate is lower than the national average rate.
Table 1 compares TVA?s electricity rates to the competitors? averages and to
national averages. 2

Table 1: Comparison of TVA?s Fiscal Year 2000 Average Electricity Rates to
Likely Competitors? Average Rates and National Average Rates (cents per kWh)
Residential Commercial Industrial

TVA and distributors 6. 39 6.40 3.85 TVA competitors' average 7. 99 6. 59 4.
35 National average 8. 22 7. 42 4. 59 Source: GAO analysis based on data
from RDI POWERdat. 3

Although TVA?s electricity rates are relatively low, it is presently
legislatively protected from most competition, and it has the statutory
authority to raise rates, there are several factors that would enter into
any

decision to raise rates. If TVA were to choose to raise electricity rates 2
VA primarily sells wholesale power to 158 distributors, which in turn
distribute the power on a retail basis to the ultimate consumers. TVA also
sells power directly to about 62 large customers. In doing the rate
comparisons, we used rates for TVA that reflect the rates

charged to the ultimate consumers and thus are comparable to the rates
charged by the group of likely competitors. According to a TVA official, the
distributors? costs represent about 15 percent of the retail rates charged
to the ultimate consumers. 3 The RDI POWERdat is a database of electric
power companies and their plants compiled and maintained by Resource Data
International, Inc. RDI POWERdat contains data on over 5,000 electric power
companies and their plants. It is widely used in the electric utility
industry for market and competitive information.

selectively and use the additional cash generated to repay debt, it could
accelerate debt repayment and reduce fixed interest costs. Doing so would
enhance TVA?s ability to respond to future competitive pressures. On the
other hand, TVA is already subject to some competitive pressures and any
decision to raise electricity rates would need to consider both those
pressures as well as potential long- term negative consequences on power

sales. TVA is concerned that an increase in electricity rates could affect
the distributors? perception of TVA just before the distributors may be
given the choice of selecting their suppliers. According to TVA officials,
increasing electricity rates could result in the loss of some customers,
lower power sales, and possibly less overall revenue. Another potential
negative consequence is the impact an increase in electricity rates could

have on the regional economy as a whole. Also, any decision to increase
rates would need to be considered differently for each rate category because
the difference between TVA?s rates and the rates of other utilities varies
by rate category. In written comments on a draft of this report, TVA
characterized our report as fair and insightful. Background TVA is a
multipurpose, independent, federal corporation established by the

Tennessee Valley Authority Act of 1933 (TVA Act). The act established TVA to
improve the quality of life in the Tennessee River Valley by improving
navigation, promoting regional agricultural and economic development, and
controlling the floodwaters of the Tennessee River. To those ends, TVA

erected dams and hydropower facilities on the Tennessee River and its
tributaries. To meet the subsequent need for more electric power, TVA
expanded beyond hydropower, adding coal- fired power plants and nuclear
generating units to its power system. TVA primarily sells wholesale power

to 158 municipal and cooperative distributors and about 62 directly served
large industrial customers and federal agencies. The distributors, in turn,
sell the power on a retail basis to more than 8.3 million people in an
80,000 square mile region. In fiscal year 2000, about 43 percent of the
operating revenue TVA and its distributors generated from sales to the
ultimate consumers came from sales to residential customers, 29 percent from
sales to commercial customers, and 28 percent from sales to industrial
customers. 4

4 These percentages are based on the distributors? retail sales to
residential, commercial, and industrial customers, and TVA?s direct sales to
industrial customers and federal agencies.

Under the TVA Act, as amended, TVA continues to operate like a traditional
regulated monopoly and is not subject to most of the regulatory and
oversight requirements that commercial electric utilities must satisfy. The
act vests all authority in TVA?s three- member board of directors to run and
operate TVA in a manner consistent with the purposes and objectives of the
act, including the objective of keeping TVA?s electricity rates ?as low as
are

feasible.? The board decides when to raise electricity rates and sets its
rates at whatever level it deems necessary to recover TVA?s annual budgeted
expenses, plus a margin determined by the board to help ensure

it meets financial tests and other financial objectives required by the TVA
Act and the Basic TVA Power Bond Resolution. 5 Unlike other utilities, the
rates TVA charges for its electric power are not subject to review and

approval by state public utility commissions or the Federal Electric
Regulatory Commission (FERC). In contrast, regulated investor- owned
utilities (IOUs) must justify rate changes to their public service
commissions based on cost requirements determined to be ?just and
reasonable? plus a regulated return to shareholders. However, an increasing
portion of ?wholesale? power sales have been made by independent power
producers and marketers at market- based prices which

are not subject to regulatory approval. The Energy Policy Act of 1992
(EPAct) requires utilities to use their transmission lines to transmit
wholesale electricity for other utilities. This act has enabled wholesale
customers to obtain electricity from a variety of competing suppliers, thus
increasing wholesale competition in the electric utility industry across the
United States. In addition, restructuring efforts

in many states have created competition at the retail level. If, as
expected, retail restructuring continues to occur on a state- by- state
basis over the next several years, then industrial, commercial, and,
ultimately, residential consumers will be able to purchase their power from
one of several competitors rather than from one utility monopoly.

Currently, legislation limits competition between TVA and other utilities.
The TVA Act was amended in 1959 to establish what is commonly referred to as
the TVA ?fence,? which prohibits TVA, with some exceptions, from entering
into contracts to sell power outside the service area that TVA and its
distributors were serving on July 1, 1957. In addition, EPAct provides TVA
with certain protections from competition, called the ?anti- cherry 5 In
addition to having sole authority to set wholesale electric power rates,
TVA?s board approves the retail rates charged by its distributors.

picking? provisions. Under EPAct, TVA is exempt from having to allow other
utilities to use its transmission lines to transmit (? wheel?) power to
customers within its service area. 6 This legislative framework generally
insulates TVA from direct wholesale competition. As a result, TVA remains in
a position similar to that of a regulated utility monopoly. 7

Because of ongoing restructuring efforts in the electric utility industry,
TVA management, like many industry experts, expects that in the future TVA
may lose its legislative protections from competition. TVA?s management
recognized the need to act to better position TVA to compete in an era of

increasing competition and, in July 1997, issued a 10- year business plan
with that goal in mind. TVA established a 10- year horizon because a
majority of the long- term contracts with its distributors could begin
expiring at that time, and TVA could be facing greater competitive pressures
by 2007. The plan contained three strategic objectives: (1) reduce TVA?s
cost of power in order to be in a position to offer more competitive prices
by 2007, (2) increase financial flexibility by reducing fixed costs, and (3)
build customer allegiance.

To help meet the first two strategic objectives noted above, one of the key
goals of TVA?s 10- year plan was to reduce its interest expense by reducing
debt by over half from its 1997 level, to about $13.2 billion. To increase
its financial flexibility and future competitiveness by generating cash that
could be used to reduce debt, TVA increased its electricity rates beginning

in 1998, and planned to reduce expenses and limit capital expenditures.
TVA?s plan to reduce debt while it is still legislatively protected from
competition was intended to help it achieve its ultimate goal of being in a
position to continue to offer competitively priced power after 2007. In a

competitive market, TVA would be in danger of losing customers if its high
debt service costs caused its price of power to be above market.

Over the first 4 years of the 10- year plan (through September 30, 2001),
TVA reduced its debt by about $2 billion. By reducing debt, and refinancing

6 However, TVA is subject to some forms of indirect competition. For
example, TVA has no protection against its industrial customers relocating
outside its service area or businesses deciding not to move into its service
area for reasons related to the cost of power. In addition, customers can
decide to generate their own power. 7 However, TVA primarily sells its power
at wholesale rates to 158 distributors who sell the power to the ultimate
consumers, while IOUs primarily sell power at the retail level to the
ultimate consumers.

some debt at lower interest rates, TVA has reduced its annual interest
expense. TVA?s interest expense has dropped from about $2.0 billion in
fiscal year 1997 to about $1.6 billion in fiscal year 2001. Its net interest
expense through the first 6 months of fiscal year 2002 was $717 million.
However, TVA has fallen behind in meeting the debt reduction goal in the
original 10- year plan, and consequently has revised this goal downward.
According to estimates that TVA provided to OMB in support of the
president?s 2003 budget, TVA expects to reduce its debt by about

$5. 2 billion by 2007 rather than the planned $14.2 billion, which
represents $9 billion less debt reduction than planned in 1997. TVA?s most
recent projections show a debt level of about $18 billion by 2012. The
revision to the debt reduction estimate is due primarily to lower revenues
than projected in 1997, and the use of a portion of the cash originally
targeted for debt reduction to pay for greater than estimated annual cash
operating expenses and capital expenditures for new generating capacity and
environmental controls. 8 TVA officials told us that the above debt
reduction estimates would be affected by the recent decision to recover and
restart Browns Ferry unit 1. 9 Objectives, Scope, and

To identify the benchmarking studies regarding staffing levels that have
Methodology

been performed to compare TVA to other electricity providers, the results of
these studies, and the changes TVA has made as a result of them, we
interviewed officials from TVA, Standard & Poor?s, investor- owned utility
members of TVA Exchange, and the American Public Power Association. In these
discussions of efficiency in the electricity industry, we identified several
staffing- related benchmarking studies prepared for TVA by Tim

8 TVA is now projecting that capital expenditures to comply with the
requirements of the Clean Air Act will amount to about $2. 5 billion through
fiscal year 2009. TVA's 10- year plan acknowledged that TVA's capital
expenditures would increase if it is required to comply with new
environmental regulations, and/ or increase generating capacity to meet the
growth in demand for power. 9 On May 16, 2002, TVA?s board of directors
approved a staff recommendation to return unit 1 at Browns Ferry Nuclear
Plant to service. TVA currently estimates that doing so will cost about $1.
7 to $1. 8 billion and take about 5 years to complete.

D. Martin & Associates 10 (Navigant), which we obtained and analyzed. We
analyzed staffing- related studies dated September 1998 through March 2000
that pertained to TVA?s major business units, including Fossil Power Group,
Nuclear, Transmission Power Supply, and River System Operations &
Environment. In addition, to assess the quality and reliability of data
available for this purpose, we interviewed a Navigant official to discuss
their staffing benchmarking methodology for TVA and other electric

utilities, the number of utilities included in their database, and their
overall experience in benchmarking staffing levels in the electric utility
industry. Further, we inquired of industry experts regarding their
familiarity with and use of Navigant in performing staffing analyses.
However, given the fact that Navigant?s staffing database is proprietary, we
could not verify the accuracy of the data used in the studies. To determine
how TVA?s electricity production costs and rates compare to

those of other electricity providers, we first identified its likely
competitors through discussions with officials from TVA, TVA?s Office of
Inspector General (IG), investor- owned utility members of TVA Exchange, and
the American Public Power Association. We then analyzed TVA?s costs and
electricity rates and compared them to those of a group of investor- owned
utilities that could comprise TVA?s likely competitors in a competitive
environment. We obtained electricity production cost and rate data for
fiscal year 2000 for TVA and the group of likely competitors from RDI
POWERdat, which is a database of electric power companies and their

plants compiled and maintained by Resource Data International, Inc. Further,
we reviewed various reports related to TVA finances, and our own as well as
prior TVA IG reports.

To determine whether TVA?s electricity rates are low enough to support a
rate increase, we analyzed the results of the production costs and rate
comparisons and interviewed TVA officials regarding this issue. Additional
information on our scope and methodology is in appendix I.

We conducted our review from July 2001 through May 2002 in accordance with
generally accepted government auditing standards. We requested

10 Over the past 15 years, Tim D. Martin & Associates has developed
proprietary databases with industrywide benchmarking information, which is
used to analyze and control plantstaffing levels, for organization design
and for other management programs. On June 4, 2001, Navigant Consulting,
Inc. acquired Tim D. Martin & Associates. Navigant Consulting is an energy
and management consulting company. Its energy practice provides services to
the electric utility industry.

comments from the chairman of TVA or his designated representative on a
draft of this report. TVA?s chairman provided written comments, which are
reproduced in appendix II. We also received oral comments of a technical
nature from the senior advisor to TVA?s chief financial officer (CFO), which
we incorporated as appropriate.

TVA Has Used TVA has been benchmarking since the 1980s and since the early
1990s has primarily used Navigant to perform staffing benchmarking studies.
11 These Benchmarking to Make studies initially assessed the staffing levels
of TVA?s nuclear program and, Changes and Identify in 1998, TVA began to
assess its non- nuclear business units as well. Recent

Other Potential Areas benchmarking studies performed by Navigant have
indicated that TVA?s

for Improvement nuclear and transmission units are close to the industry?s
best in terms of

staffing efficiency, but that opportunities for improvement exist in all
four of the business units most recently benchmarked- Fossil Power Group,
Transmission Power Supply, Nuclear, and River System Operations &
Environment. TVA has used these studies to initiate automation and
reorganization at the business unit level, and also to make organizationwide
changes. TVA continues to utilize benchmarking to assist in identifying
potential areas for improvement.

Because staffing needs of different business units vary and utilities have a
differing mix of business units, simply using benchmarking to compare total
number of employees would not provide meaningful comparisons. This is
further complicated by the fact that TVA primarily sells wholesale

power and other electricity providers primarily sell retail power. However,
benchmarking studies can provide meaningful comparisons at the business unit
level.

TVA?s goal is for its business units to be among the best performing in the
industry. To accomplish this, TVA?s staffing levels would have to be
comparable to those of the industry?s best. TVA?s business units include:
Nuclear, River System Operations & Environment, Fossil Power Group,
Transmission Power Supply, Bulk Power Marketing, Customer Service, and

11 According to a Nuclear Energy Institute (NEI) official, Navigant was
heavily involved in the nuclear industry as a consultant on staffing levels
and is considered influential in the nuclear industry. Navigant had
developed a proprietary database that included

approximately 70 percent of the nuclear sites. Because of this, many of
NEI?s member companies used Navigant to determine the appropriate spans of
control and size of staff for plants.

Corporate. According to TVA officials, the results of benchmarking studies
are used as a management tool to determine the best areas to target to
improve performance and operate more efficiently. TVA?s business units use
benchmarking studies that focus on staffing to identify trends by functional
areas (e. g., operations, technical engineering) in the electric utility
industry to assist in workforce planning. While the results are not strictly
used as ?performance indicators? or

?targets,? they are considered in determining appropriate staffing levels.
Since 1981, TVA has reduced staffing from a high of about 47, 000 employees
to about 13,000 employees in 2001. These reductions are primarily
attributable to the discontinuation of the nuclear construction

program in the early 1980s and a major cost- cutting program beginning in
the late 1980s. TVA had planned to build 17 nuclear facilities with its own
design and construction staff. When TVA began to curtail its nuclear
construction program, there was no longer a need for a large number of

these staff. TVA officials also told us that other electricity providers
have downsized over the years, but not as significantly as TVA since the
others had not planned to build as many nuclear facilities with their own
design and construction staff. According to TVA officials, although
significant staff reductions resulted from the curtailment of nuclear
construction activities and major cost- cutting initiatives from the 1980s
through 1997, in recent years staff reductions have been a result of process
improvements, work elimination, and efficiency gains. Navigant, the firm
primarily used by TVA in recent years, generally uses three benchmarks:
average, best, and lowest. ?Average? is the average staffing per job
function 12 of all plants and utilities in Navigant?s database.

?Best? is the median staffing per function of the best performing plants/
utilities. 13 ?Lowest? is the least number of staff in each function (that
is, a nonexistent ?ideal? company comprised of a composite of the industry?s
best performing plants/ utilities). For this reason, utilities assessed as
being in the lowest category are considered ?ideal? plants and we will refer
to this category as ?ideal? throughout the remainder of the report. To
account for differences in the type of plant such as size, fuel type, and
age, Navigant normalizes the benchmarks by plant (i. e., the 12 Job
functions are based on the duties performed and not actual job
classifications or titles.

13 While the criteria for being included in the ?best performing? subset
vary by business unit, this subset generally includes those plants or
utilities that are in the top half of Navigant?s database in terms of
performance.

benchmarks are adjusted to account for the differences to ensure a valid
comparison). Then, Navigant performs a regression analysis and produces a
report summarizing the results. The purpose of the reports is to direct
management?s attention to job functions and/ or organizations 14 within
business units where staffing levels differ from the benchmarks.

TVA has commissioned studies in several business units, including Fossil
Power Group, Transmission Power Supply, Nuclear, and River System Operations
& Environment. 15 The most recent Navigant reports (dated

September 1998 through March 2000) for each of the four business units we
reviewed showed differences between TVA?s staffing levels and the benchmark
utilities by function and by organization within the business unit. The
reports also identified possible explanations for the differences as well as
observations on functions for which management attention was warranted. 16
For example, a March 2000 nuclear benchmarking study

indicated that TVA?s nuclear unit overall was close to the industry?s best
in terms of staffing efficiency; however, several functions fell in the
average category and some warranted management attention. 17 For TVA?s non-
nuclear units, benchmarking studies performed by Navigant

within the last 4 years indicated that these units generally had fewer staff
than average staffing levels at benchmark utilities, but more staff than the
best performing utilities. For example, a March 1999 staffing analysis of
the Transmission Power Supply business unit found that it had about 9
percent fewer staff than the average benchmark and about 3 percent more
staff than the best performer benchmark, placing it among the best in the
industry. However, a March 2000 staffing analysis of the River System
Operations & Environment business unit indicated that for hydropower 14 A
business unit may have several ?organizations.? For example, Energy Research
and

Technology Applications is an ?organization? in the River System Operations
& Environment business unit. 15 TVA has not yet completed staffing
benchmarks for all business units. However, TVA officials told us that they
have studies underway in the remaining units. 16 For example, staffing
levels may be significantly above (excessive number of staff) or below
(insufficient number of staff) benchmarks, indicating possible
inefficiencies or performance limitations.

17 Of the 46 functional areas identified by the Navigant study, 20 had fewer
staff than the best performer benchmark and of these, 7 had fewer staff than
the ideal benchmark, 1 had the same staffing levels as the best performer
benchmark, and 25 had more staff than the best performer benchmark.

functions, TVA generally had more staff than the average benchmark, while
staffing for ?federal- based? functions, which include land and watershed
management and environmental protection activities, was close to the average
benchmark. 18 Figure 1 summarizes the overall results of the four most
recent staffing

benchmarking studies we reviewed. For TVA?s River System Operations &
Environment business unit, we categorized the functions into two groups to
differentiate between the ?federal- based? functions and hydropower
functions (comparable to utility benchmarks) within the business unit. The

?x? indicates, in general, how each business unit?s overall staffing level
19 compared relative to the benchmarks used by Navigant.

Figure 1: Overall Staffing Levels of Four TVA Business Units Compared to the
Benchmarks Benchmark Average Best Ideal Business Unit Fossil x

Transmission x

Nuclear x

RSOE- Hydro x

RSOE- Federal x

Legend:

Average = Average staffing Best = Median staffing of the best performing
plants/ utilities Ideal = Least number of staffing RSOE = River System
Operations and Environment

Source: GAO analysis based on data from Navigant?s benchmarking studies on
TVA staffing dated September 1998 through March 2000.

18 For Navigant?s March 2000 staffing analysis of TVA?s River System
Operations & Environment business unit, Navigant categorized the activities
into nonfederal (hydropower) and federal functions (land and watershed
management and environmental

protection). For TVA?s federal functions, Navigant included certain federal
entities (e. g., National Park Service) with the average benchmark in order
to provide more comparability for TVA?s land management functions.

19 Staff includes full- time TVA employees and long- term contractors.

TVA officials provided us information pertaining to how they addressed each
of the observations in the benchmarking studies, indicating that they took
several actions to improve performance and operate more efficiently. For
example, in Navigant?s March 2000 staffing analysis of TVA?s River System
Operations & Environment hydropower operations, staffing levels were above
the ?average? benchmarks. To address this observation, TVA

has an ongoing project to automate the hydropower production facilities as a
process improvement to enable River System Operations & Environment to
reduce future staffing levels. This change is expected to eliminate work by
turning over the operation of the generating units to a central dispatching
location and will reduce the requirement for the around- theclock onsite
operating staff at the plant sites. In addition, TVA officials cited two
other major initiatives underway

designed to improve efficiency in the hydro operations area. These are: (1)
the ?multi- skilling? program which will reduce staffing by eliminating the
need for job handoffs among multiple craft personnel, and (2) the ?hydro
modernization? program which increases the generation capacity of

existing hydro units and thereby improves system efficiency on a kWh output-
per- employee basis.

In addition, even though TVA?s Nuclear business unit overall is close to the
best performer benchmark, in Navigant?s March 2000 staffing analysis, seven
functions were identified where management attention was warranted because
the staffing levels were either considerably above the best performer
benchmark or below the ideal benchmark. According to TVA officials, they
continue to focus on areas where the March 2000 staffing analysis identified
potential efficiency gains. For example, the

staffing analysis confirmed the need to reorganize and centralize the Human
Resources organization. In June 2001, all human resources functions were
transferred to the Operations Support organization under

the chief operating officer. The human resources functions were reduced by
28 positions (i. e., 86 positions to 58 positions). 20 Although the
benchmarking studies are performed at the business unit

level, TVA has evaluated observations from benchmarking studies and
initiated organizationwide changes. For example, as a result of an 20 The
staffing reduction of 28 positions was the total reduction of human resource
functions for the Nuclear, Fossil Power Group, Transmission Power Supply,
and River System Operations & Environment business units.

observation made in the March 1999 Navigant staffing analysis of the
Transmission Power Supply business unit, and in conjunction with the results
of the 2001 Human Capital Benchmarking Report prepared by the Saratoga
Institute, 21 TVA is monitoring the number of employees supervised by a
single supervisor to determine if adjustments are needed to meet a target
ratio of 1 supervisor to every 6. 44 employees. The 1999 benchmarking study
found that the Transmission Power Supply business

unit had a higher percentage of managers supervising fewer than 6 people
than the benchmark utilities. At the time of the Saratoga Institute study,
TVA?s corporate wide ratio was 1 supervisor to 5.61 staff. TVA will decide

how to proceed upon review of the results of the performance indicator. TVA
continues to benchmark staffing levels to assist in identifying potential
areas for improvement and expects any future reductions to be the result of
(1) gains in efficiency, (2) elimination of certain types of work, and/ or
(3) process improvements, such as the previously mentioned automation of
hydropower production facilities. According to TVA officials, TVA hopes to

achieve cost savings by getting its various business units to be among the
best performing in the industry. TVA?s Electricity Rates

TVA has the statutory authority to raise its electricity rates, is
legislatively protected from most competition, and has current rates that
are low when are Relatively Low

compared to likely competitors. 22 If TVA were to choose to raise
electricity Compared to Likely rates selectively and use the additional cash
generated to pay down debt, it

Competitors 21 TVA participated in the 2001 Human Capital Benchmarking
Report prepared by the Saratoga Institute. The report contained a wide range
of data comparisons, at the corporate level, related to staffing and labor
costs across the industry. The ratio of 1 supervisor to 6.44 staff was
identified in the report as the benchmark for the best performing utilities.
22 Our assessment is based on how TVA?s fiscal year 2000 electricity rates
compare to those of its likely competitors and national average rates. It is
not possible to predict TVA?s future competitive position, which will be
affected by a number of issues, including (1) the specific requirements of
any legislation that might remove TVA?s legislative protections, including

whether it would be able to retain some or all of the competitive advantages
described previously, (2) actions being taken by TVA?s competitors, and (3)
the amount of time TVA has to prepare for competition and the actions it
takes during that time.

could reduce its financing costs (interest expense), 23 thereby
strengthening its ability to respond to future challenges (as discussed in
previous GAO reports 24 ). Although TVA?s variable costs (e. g., production
costs) are low when compared to likely competitors, previous GAO reports
have noted that its fixed costs such as financing costs and the unrecovered
costs associated with nonperforming nuclear units are high. 25 These costs
could

pose competitive challenges because they would limit TVA?s financial
flexibility to adjust its electricity rates to respond to competitive
pressures. 26 TVA is, however, currently subject to some level of
competition. Therefore, in determining whether to raise rates, TVA would
need to consider current market rates and the potential negative
consequences, such as the impact on power sales and the regional

economy. When comparing TVA?s electricity rates to those of 12 likely
competitors, 27 we found that its fiscal year 2000 (1) residential rates
were lower than all 12 of the other utilities, (2) industrial rates were
lower than 10 of the 12 others, and (3) commercial rates were lower than 4
of the 12 others. When comparing TVA?s electricity rates to the averages of
each category, we found that TVA?s fiscal year 2000 rates were lower than
the comparable averages for the 12 utilities in our comparison group as well
as the national

23 Differences in financing structures between TVA and likely private sector
competitors make direct comparisons somewhat difficult. Financing costs
include (1) interest expense on debt (TVA and IOUs), (2) returns on
appropriation investment (TVA only), and (3) preferred and common stock
dividends (IOUs only.) The fixed portion of financing costs includes
interest expense on debt and returns on appropriation investment (for TVA)
and interest expense on debt and preferred stock dividends (for IOUs). 24
Tennessee Valley Authority: Financial Problems Raise Questions About Long-
term Viability (GAO/ AIMD/ RCED- 95- 134, August 17, 1995); Federal
Electricity Activities: The

Federal Government?s Net Cost and Potential for Future Losses, Volumes 1 and
2. (GAO/ AIMD- 97- 110 and 110A, September 19, 1997); and Tennessee Valley
Authority: Debt Reduction Efforts and Potential Stranded Costs (GAO- 01-
327, February 28, 2001). 25 Fixed costs remain fairly constant and do not
fluctuate with the volume of production. Variable costs fluctuate in the
same manner as the volume of production. 26 TVA has acknowledged the need to
reduce debt (and related interest expense) and begin recovering the costs of
its deferred nuclear generating assets. In fiscal year 2001, TVA reduced the
carrying value of certain of its assets by $3. 4 billion, which included

adjustments of $2. 6 billion to the unrecovered costs of nuclear plants. TVA
officials said TVA made this adjustment to strengthen its competitive
position, more accurately reflect the value of its assets, and help TVA
maintain competitive prices in the future.

27 See appendix I for a description of how we selected the comparison group.

averages. 28 Table 2 compares TVA?s fiscal year 2000 average electricity
rates for each customer class to the national average and the utilities in
the comparison group.

Table 2: Comparison of TVA?s Fiscal Year 2000 Average Electricity Rates to
Likely Competitors and the National Average (cents per kWh) TVA competitors
Residential Commercial Industrial

American Corporation 7.28 5.99 3.74 American Electric Power Company Inc.
6.68 5.88 3.91 Cinergy Corporation 6.97 5.70 3.79 DTE Energy Company 9.10
8.45 5.27 Dominion 8.00 5.70 4.07 Duke Energy Corporation 7.24 5.83 4.06
Entergy Corporation 7.89 6.89 4.95 Exelon Corporation 9.40 6.95 4.00 FPL
Group, Inc. 7.56 6.21 4.79 FirstEnergy Corporation 10. 25 8.40 5.13 Progress
Energy, Inc. 8.29 6.32 4.77 Southern Company 7.33 6.27 4.15

TVA and distributors 6.39 6.40 3.85

TVA competitors' average 7.99 6.59 4.35

National average 8.22 7.42 4.59 Source: GAO analysis based on data from RDI
POWERdat.

28 As stated previously, in doing the rate comparisons, we used rates for
TVA that reflect the costs (TVA?s and its distributors?) to the ultimate
consumers and thus are comparable to the rates charged by the group of
likely competitors.

Since TVA remains in a position similar to that of a traditional regulated
utility monopoly, its electricity rates continue to be cost based. 29 Its
variable production costs are low when compared to likely competitors. TVA?s
fiscal year 2000 production costs, which consist of the costs of operations
and maintenance, fuel, and purchased power, were lower than 11 of the 12
utilities in the comparison group. TVA?s production costs are low primarily
because a greater portion of its power is produced by lowcost hydropower and
nuclear plants. 30

While production costs are a key factor in setting a utility?s rates, they
do not represent the total cost of power 31 because they do not include
fixed costs such as depreciation and amortization and interest expense.
While TVA?s total cost of power is relatively attractive, its cost structure
is heavily

weighted toward these fixed costs. As a result, TVA would be at risk should
its revenues decline since each unit sold would have to recover a greater
portion of the fixed costs. Our previous reports 32 have noted that TVA?s
high financing costs 33 could impede its ability to compete in the future
because they reduce its flexibility to lower rates. TVA?s financing costs
stem largely from the debt burden associated with its nuclear power

program. 29 In a regulated environment, utilities are required to meet the
demand for electricity within their service territories and to make
investments in generating assets to do so. Regulators approve the utilities?
investment decisions in advance and the costs are approved to go into the
utilities? rate bases.

30 These plants tend to require high capital investments to build but in
return produce electricity at relatively low cost. Hydropower plants are
relatively inexpensive to operate and have no fuel cost. Nuclear plants
benefit from having low- cost fuel.

31 For fiscal year 2001, production costs represented about 51 percent of
TVA?s total cost of power. 32 Tennessee Valley Authority: Financial Problems
Raise Questions About Long- term Viability (GAO/ AIMD/ RCED- 95- 134, August
17, 1995); Federal Electricity Activities: The Federal Government?s Net Cost
and Potential for Future Losses, Volumes 1 and 2, (GAO/ AIMD- 97- 110 and
110A, September 19, 1997); and Tennessee Valley Authority: Debt Reduction
Efforts and Potential Stranded Costs (GAO- 01- 327, February 28, 2001). 33
TVA?s high financing costs are primarily the result of its high outstanding
debt. TVA remains the only AAA- rated utility in the United States, and as a
result of its high bond ratings, the private lending market has provided it
with access to billions of dollars of financing at low interest rates, an
advantage that in turn results in lower interest expense

than if it had lower ratings.

Although TVA has made progress in reducing its debt and the corresponding
financing cost, 34 its financing costs are high when compared to its likely
competitors. As we reported in February 2001, 28 cents of every revenue
dollar earned by TVA in fiscal year 1999 went to pay for fixed

financing costs (i. e., interest costs related to TVA?s debt), a
considerably higher portion than the 9 cents for TVA?s competitors. 35 Since
TVA?s fiscal year 2001 interest expense represented about 24 percent of
total operating revenue, debt reduction would be a key element of any
efforts to prepare for competition. TVA would be better positioned to
operate in the future competitive environment if it continued to reduce
these fixed costs, thereby increasing its financial flexibility to lower
rates, if necessary, in response to competitive pressures. Prior GAO reports
have also pointed out that TVA has not made a final

decision on whether to complete its deferred nuclear generating units. The
recovery of the costs of these assets is not required until they are
completed and placed in service or cancelled. 36 As of September 30, 2001,
the balance of TVA?s deferred nuclear generating units amounted to $4. 1
billion, which pertained to two unfinished nuclear units (Bellefonte units 1
and 2). TVA could be vulnerable to future competition if it has to begin
recovering the costs of its deferred nuclear units at a time when

competitive pressures prevent it from setting rates at levels sufficient to
recover them. Therefore, beginning to recover these costs now would improve
TVA?s ability to offer competitively priced power in the future.

34 From September 30, 1997, through September 30, 2001, TVA reduced its debt
from about $27. 4 billion to about $25. 4 billion. This debt reduction,
along with refinancing debt at lower interest rates, enabled TVA to reduce
its annual interest expense from about $2. 0 billion (or

34 percent of revenue) in fiscal year 1997 to about $1. 6 billion (or 24
percent of revenue) in fiscal year 2001. 35 Tennessee Valley Authority: Debt
Reduction Efforts and Potential Stranded Costs (GAO01- 327, February 28,
2001). 36 TVA accounts for the financial effects of regulation in accordance
with Statement of Financial Accounting Standards No. 71, Accounting for the
Effects of Certain Types of Regulation. Under regulatory accounting, TVA is
not required to begin writing off the costs

of its deferred nuclear units until they are either completed and placed in
service or cancelled. However, in fiscal years 1999 through 2001, TVA
accelerated the amortization of certain deferred charges when earnings
exceeded levels required by the TVA Act and the Basic TVA Power Bond
Resolution. A TVA official told us that to the extent future earnings exceed
these earnings levels, TVA may begin to write off the cost of its deferred
nuclear units- even before a final decision is made on whether to complete
or cancel them.

TVA?s electricity rates are relatively low, it is presently legislatively
protected from most competition, and it has the statutory authority to raise
rates; 37 however, there are several factors that enter into a decision to
raise electricity rates. Any positive benefits that accrue to TVA from
raising rates and accelerating debt repayment would need to be weighed
against potential negative consequences. TVA officials told us that they
believe an increase in electricity rates could result in the loss of
customers, lower power sales, and possibly less overall revenue. Another
potential negative consequence is the impact a rate increase could have on
the regional economy as a whole. A rate increase could also affect the
distributors? perception of TVA just before they may be given the choice of
selecting

their suppliers. TVA officials also cited two other reasons they would be
reluctant to raise electricity rates. Because of commitments given to
customers and ongoing contract negotiations, 38 TVA officials said it would
be particularly difficult to raise rates before 2007, unless it is required
to cover additional costs,

such as for additional environmental controls. In addition, the officials
cited both the TVA board?s responsibility and pressure from customers to
abide by TVA?s statutory responsibility to provide power at rates ?as low as
are feasible.? Nonetheless, the TVA officials acknowledged that TVA?s

board has the authority and obligation to adjust TVA?s rates as necessary to
cover costs and provide adequate margin for the protection of investors. As
suggested by the data in table 2, any decision to raise electricity rates
would need to be considered differently for each rate category because the
difference between TVA?s rates and those of its likely competitors varies by
rate category. TVA?s residential and industrial rates are generally well
below the competition, while its commercial rates are lower than only 4 of
the 12 likely competitors. Therefore, while raising some rates would be 37
The TVA Act gives TVA the authority to set rates at levels sufficient to
cover all costs and generate additional revenue that could be used to repay
outstanding bonds in advance of maturity. The TVA Act also requires TVA to
sell its power at rates that are ?as low as are

feasible.? 38 TVA is currently negotiating with its distribution customers
to allow them to purchase up to 10 percent of their power needs from other
power suppliers. To plan for the needs of the system, TVA anticipates that
it will require customers to give 2- years notice to purchase power from
another source and to identify the type of power (e. g., peak, baseload)
they plan to purchase. TVA does not plan to allow its customers to purchase
more than 10 percent of their power from alternate sources unless TVA loses
its protections from competition.

feasible, TVA would need to carefully consider which rates to raise and by
how much. Agency Comments and In written comments on a draft of this report,
TVA?s chairman commended Our Evaluation

us for producing a fair and insightful report. In addition, the chairman
offered his perspectives on TVA?s responsibilities for setting rates, and on
the results of TVA?s recent efforts to bring its staffing levels in line
with the industry?s best. TVA also provided us with oral technical comments,
which we have incorporated as appropriate. TVA?s written comments are
reproduced in appendix II.

We are sending copies of this report to appropriate House and Senate
committees; interested members of the Congress; TVA?s board of directors;
the Secretary of Energy; and the Director of the Office of Management and
Budget. We will also make copies available to others upon request. In
addition, the report will be available at no charge on GAO's web site at
http:// www. gao. gov.

If you or your staff have any questions, please call me at (202) 512- 9508.
Major contributors to this report are listed in appendix III.

Sincerely yours, Linda M. Calbom Director Financial Management and Assurance

Appendi Appendi xes x I

Objectives, Scope, and Methodology Staffing Benchmarking To assess the
overall quality of the staffing benchmarking studies, we Studies

 interviewed a Navigant Consulting, Inc. (Navigant) official to obtain an
understanding of their staffing benchmarking analysis for TVA and other
electric utilities, the number of utilities in their database, and their
overall experience in benchmarking staffing levels in the electric utility
industry;  inquired of industry experts regarding their familiarity with
Navigant;

and  interviewed TVA officials involved in workforce planning in the Chief
Operating Office regarding Navigant?s observations. To determine the changes
TVA has made as a result of benchmarking studies, we interviewed TVA
officials and examined supporting documents; however, we did not
independently verify the results of TVA?s actions.

Comparison of To determine how TVA?s electricity rates compared to those of
electricity Electricity Rates

providers that could comprise TVA?s likely competitors in a competitive
environment, we identified TVA?s likely competitors through discussions with
officials from TVA, TVA?s IG, investor- owned utility members of TVA
Exchange, and the American Public Power Association. Based on these
discussions, we selected investor- owned utilities or holding companies that
had 50 million MWhs or more in net generation in fiscal year 2000 39 in the
eastern interconnect. 40 We selected utilities with net generation over 50
million MWhs to eliminate smaller utilities that do not represent a
significant portion of the annual sales in the TVA area, and are less
relevant to TVA. We limited our group to utilities in the eastern
interconnect because the high cost of transmitting electricity will limit
TVA?s competition to utilities in states located close to TVA?s service
territory. We did not include independent power producers 39 The fiscal year
2000 data were the latest available at the time of our review. 40 The
eastern interconnect is one of five electric system networks of high-
voltage power transmission wires in North America, connecting everything
from the Rockies to the Atlantic, and from Florida up into Canada.

and other power marketers in the comparison group because they are not
required by federal regulations to make certain data publicly available, and
therefore, the data needed to compare production cost and rates were not
available.

We then analyzed TVA?s electricity production costs and rates and compared
them to those of TVA?s likely competitors. We obtained electricity
production cost and rate data for fiscal year 2000 for TVA and

the group of likely competitors from RDI POWERdat. Further, we reviewed
various TVA financial- related reports, including GAO and TVA IG reports.

To determine whether TVA?s electricity rates are low enough for TVA to
consider raising them, we analyzed the results of the cost and rate
comparisons; analyzed data on the future market price of power; and
interviewed TVA officials regarding this issue. Organizations During the
course of our work, we contacted the following organizations. Contacted

Federal Agencies  Tennessee Valley Authority

 Tennessee Valley Authority Office of Inspector General Bond Rating Agency
 Standard & Poor?s Customer Representative or  TVA Exchange Trade Groups

 American Public Power Association

 Nuclear Energy Institute Other  Navigant Consulting, Inc.

Comments from the Tennessee Valley

Appendi x II Authority

Appendi x II I GAO Contact and Staff Acknowledgments GAO Contact Robert E.
Martin, (202) 512- 6131 Acknowledgments In addition to the individual named
above, Carolyn A. Frye, Mary B. Merrill,

Donald R. Neff, and Lisa J. Crye made key contributions to this report.

(190023)

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GAO United States General Accounting Office

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Appendix I

Appendix I Objectives, Scope, and Methodology

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Appendix II

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Appendix III

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