United States Government Accountability Office

GAO Report to the Chairman, Subcommittee 

on Water Resources and Environment, 

Committee on Transportation and 

Infrastructure, House of 

Representatives 

TENNESSEE VALLEY 

AUTHORITY 

Plans to Reduce Debt 

While Meeting 

Demand for Power 

August 2006 

 

GAO-06-810 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

August 2006

TENNESSEE VALLEY AUTHORITY

Plans to Reduce Debt While Meeting 

Highlights of GAO-06-810, a report to the Demand for Power 

Chairman, Subcommittee on Water 

Resources and Environment, Committee 

on Transportation and Infrastructure, 

House of Representatives 

Competition in the electricity 

industry is expected to intensify, 

and restructuring legislation may 

dramatically change the way

electric utilities do business in the 

future. To be competitive, the

Tennessee Valley Authority (TVA) 

needs to reduce fixed costs and 

increase its flexibility in order to 

meet market prices for power.

TVA plans to reduce its financing 

obligations, which include

statutory debt and other financing 

arrangements, by $7.1 billion by the

end of fiscal year 2015. GAO was 

asked to (1) describe how TVA 

plans to meet its goal for reducing

financing obligations, (2) assess the 

reasonableness of TVA’s approach 

in developing its plan, (3) identify 

key factors that could impact TVA’s 

ability to successfully carry out its 

plan, and (4) identify how TVA’s 

plans for meeting the growing 

demand for power in the 

Tennessee Valley may impact its 

ability to reduce financing

obligations. To fulfill these

objectives, GAO interviewed TVA 

officials and others, and reviewed

budget submissions, financial 

projections, and other 

documentation supporting the plan. 

What GAO Recommends

GAO makes two recommendations

to help TVA (1) augment its data

sources for estimates of key input

variables in its cash flow model, 

and (2) better illustrate the range of 

outcomes of the model. In

comments on a draft of this report, 

TVA agreed with these 

recommendations. 

TVA plans to reduce its financing obligations by about $7.1 billion from fiscal 

years 2004 through 2015 by increasing revenue, controlling the growth of its 

operating expenses, and limiting capital expenditures. TVA’s financing 

obligations include statutory debt, which it plans to reduce by $6.7 billion, 

and alternative financing obligations such as energy prepayments, which it 

plans to reduce by $0.4 billion. 

Overall, GAO’s review found TVA’s approach to developing its plan to reduce 

financing obligations reasonable. TVA performed detailed competitive 

analyses and modeled different market scenarios to estimate its future 

competitive environment, then used its internal budget process to project 

annual cash flows and refine its goal with a cash-based accounting model. 

Many of the variables used in the models were based on recognized data

sources. Augmenting these sources with prices from options markets could 

provide more accurate estimates in volatile markets. TVA also made fixed 

assumptions about actions it would take, such as building new power 

generation, and events, such as the advent of new environmental regulations. 

While these assumptions are reasonable, they carry uncertainty that is not 

reflected in the model. Modeling them as variables might better reflect that 

uncertainty and provide broader information for planning purposes. 

GAO identified several key factors that could impact TVA’s ability to 

successfully carry out its plan. Factors such as the timing of electricity 

industry restructuring, potential increases in interest rates, and costs 

associated with meeting potential new environmental requirements, are key 

factors that are difficult for TVA to control. TVA has more control over 

other key factors, such as its decisions on whether or not to construct new 

power generating facilities before 2015 and to limit operating and 

maintenance expenses, but these are also affected by outside forces and 

contain an element of uncertainty. Future rate increases and a fuel-cost 

adjustment clause are factors that should help cover any unforeseen costs, 

capital expenditures, or revenue shortfalls. 

TVA’s plan includes the capital expenditures it believes will be needed to 

expand capacity of existing generating facilities to meet the growing demand 

for power in its service area through 2015; however, any new or unplanned 

expenditures prior to 2015 could lessen TVA’s ability to achieve the $7.1 

billion goal. By 2015, TVA has estimated that it will need more baseload 

generation to meet growth in demand. TVA officials are considering a

number of options to meet this projected increase in demand for power, 

including partnering with outside parties to build new generation. TVA’s

current projections assume that it will not invest in any new generation 

through 2015 other than restarting Browns Ferry Nuclear Plant Unit 1; 

however, any new or unplanned capital expenditures could use cash 

otherwise intended to be used to reduce financing obligations. 

www.gao.gov/cgi-bin/getrpt?GAO-06-810.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Robert E. 

Martin at (202) 512-6131 or martinr@gao.gov. 
Contents 

Letter 1

Results in Brief 2

Background 4

Scope and Methodology 11 

TVA Plans to Increase Revenue, Control Operating Expenses, and 

Limit Capital Expenditures 12 

TVA Used a Reasonable Approach to Developing Its Plan to 

Reduce TFOs 17 

Several Key Factors Could Impact TVA’s Ability to Successfully 

Carry Out Its Plan for Reducing TFOs 21 

Growing Demand for Power Could Affect TVA’s Ability to Meet Its 

TFO Reduction Goal 27 

Conclusions 30

Recommendations 30

Agency Comments and Our Evaluation 31 

Appendix I Comments from the Tennessee Valley Authority 32 

Appendix II GAO Contact and Staff Acknowledgments 34 

Tables 

Table 1: TVA’s Total Financing Obligations at Year-end for Fiscal 

Years 1997 through 2005 10 

Table 2: TVA’s Actual and Targeted Reduction of Total Financing 

Obligations for Fiscal Years 2004 through 2015 14 

Table 3: TVA’s Planned Capital Expenditures by Major Category 

from Fiscal Year 2006 through Fiscal Year 2015 16 

Figures 

Figure 1: TVA’s Service Territory 4

Figure 2: Generation Capacity by Fuel Type, TVA vs. Nearest NERC 

Regions 25

Page i GAO-06-810 Tennessee Valley Authority
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Page ii GAO-06-810 Tennessee Valley Authority
United States Government Accountability Office

Washington, DC 20548 

August 31, 2006 

The Honorable John J. Duncan, Jr. 

Chairman, Subcommittee on Water Resources 

 and Environment 

Committee on Transportation and Infrastructure 

House of Representatives 

Dear Mr. Chairman: 

Competition in the electricity industry is expected to intensify, and 

restructuring legislation may dramatically change the way electric utilities

do business in the future. To remain competitive, the Tennessee Valley 

Authority (TVA) needs to have low fixed costs and the flexibility to meet 

market prices for power. Recognizing this, in 1997, TVA embarked on a 

plan to reduce its debt by one half to about $13.2 billion by 2007. It will not 

meet this goal, however, and in fiscal year 2004 it issued a strategic plan 

that included a target to reduce debt by $3 to $5 billion from 2004 through

2015. TVA continues to carry a relatively high level of debt, currently about 

$23.1 billion, and acknowledges that reducing debt is critical to improving 

its financial condition and competitive prospects. 

Because of concerns that TVA might not meet the targets in its debt 

reduction plan and that this could negatively impact its future 

competitiveness, you asked us to (1) describe how TVA plans to meet the 

debt reduction goal identified in its 2004 strategic plan, (2) assess the 

reasonableness of TVA’s approach in developing its debt reduction plan, 

(3) identify key factors that could impact TVA’s ability to successfully 

carry out its debt reduction plan, and (4) identify how TVA’s plans for 

meeting the growing demand for power in the Tennessee Valley may 

impact its ability to meet its debt reduction goal. 

In performing our work, we interviewed officials from TVA, TVA’s 

inspector general’s office, the Tennessee Valley Public Power Association, 

the Congressional Budget Office, and the Knoxville Utilities Board. We 

also reviewed TVA’s 2004 strategic plan, budget submissions, annual 

reports, and documents and analyses supporting the debt reduction plan.

To determine the types of revenue and costs TVA had reported, we 

reviewed TVA’s audited financial statements. In addition, we reviewed 

prior GAO reports. We conducted our work from June 2005 through 

Page 1 GAO-06-810 Tennessee Valley Authority
August 2006 in accordance with generally accepted government auditing

standards. 

TVA set a goal of reducing statutory debt by $3 to $5 billion in its 2004 

strategic plan. Subsequently, TVA expanded the scope of its debt 

reduction efforts to include debt-like transactions such as lease-leasebacks 

and energy prepayment arrangements, referred to in this report as 

alternative financing. TVA calls this larger group of obligations total 

financing obligations, or TFOs. In its 2007 budget, TVA increased its TFO 

reduction goal to $7.1 billion. This includes reducing statutory debt by $6.7 

billion and alternative financing obligations by $0.4 billion. TVA plans to 

meet this goal by increasing revenue, controlling the growth of its 

operating expenses, and limiting capital expenditures. TVA projects it will 

gain additional revenue through its October 2005 rate increase, a fuel-cost 

adjustment clause to automatically adjust rates up or down when fuel 

prices change, and increased sales from growth in the demand for 

electricity. TVA’s plan also calls for controlling the growth of operating 

costs and limiting spending on capital expenditures to $12.1 billion for 

fiscal years 2006 through 2015. TVA officials believe that this plan will 

allow it to be financially flexible while continuing to offer competitive 

electricity rates. 

Results in Brief 

Overall, we found TVA’s approach to developing its plan to reduce 

financing obligations to be reasonable. TVA used a strategic planning 

process to develop its plan, which focused on its core mission as a longterm provider of low-cost power. As part of this process, TVA looked not 

only at its financing obligations, but at external business and market risks. 

To assess these outside risks, TVA performed detailed competitive 

analyses and modeled different market scenarios to estimate its future 

competitive environment. It considered the results of these market risk 

analyses in formulating its strategic plan and determining the initial 

possible range for reducing financing obligations through 2015. As part of 

its annual internal budget process, TVA then used an accounting model to

project annual cash flows and refine its goal. Many of the variables used in

the models were based on data from Global Insight, The Wall Street 

Journal, and other recognized sources of economic data and forecasts. 

TVA estimated the price volatility of commodities such as coal and natural 

gas with a combination of historical data and projected trends. It did not, 

however, use prices from options markets, which could help identify more 

accurate estimates of the range of possible prices in volatile markets. In 

using the results of the accounting model to refine its TFO reduction goals, 

TVA also made assumptions about actions it would or would not take, 

Page 2 GAO-06-810 Tennessee Valley Authority
such as building new baseload generation, and events outside its control,

such as the speed of electricity market restructuring and the advent of new 

environmental regulations. While these assumptions are reasonable, they 

carry uncertainty that is not reflected in the model. Modeling them as 

variables rather than fixed assumptions might better reflect that 

uncertainty and provide TVA with a broader range of potential outcomes 

for planning purposes. 

We identified several key factors that could impact TVA’s ability to 

successfully carry out its plan. The timing of electricity industry 

restructuring, potential increases in interest rates, and costs associated 

with meeting potential new environmental requirements are key factors 

that are difficult for TVA to control. TVA has more control over other key 

factors, such as its decisions not to build new power generating capacity 

before 2015 and to limit operating and maintenance expenses, but these 

are also affected by outside forces and contain an element of uncertainty.

Rate increases that were not considered in TVA’s current plan, as well as 

adding a fuel-cost adjustment clause to its customer contracts in fiscal 

year 2007, are factors that should help cover any unforeseen costs, capital 

expenditures, or revenue shortfalls. 

TVA’s plan includes the capital expenditures it believes will be needed to

meet the growing demand for power in the Tennessee Valley through 2015;

however, any additional, unplanned capital expenditures prior to 2015 

could affect TVA’s ability to achieve its plan. By 2015, TVA has estimated 

that it will need more electricity generation to meet growth in demand and 

its plan includes the estimated costs to restart one of its idle nuclear 

generating units, Browns Ferry Nuclear Unit 1. TVA officials are 

considering a number of additional options to meet this projected increase 

in demand for power, including partnering with outside parties. Since 

TVA’s current projections assume that it will not invest in any new 

generation through 2015, other than restarting Browns Ferry Nuclear Unit 

1, any new or unplanned capital expenditures would use cash otherwise 

intended to be used to reduce financing obligations, thus affecting TVA’s

ability to meet its planned TFO reduction. 

We are making two recommendations to help TVA (1) augment its data 

sources for estimates of key input variables in the model, and (2) better 

illustrate the range of outcomes in its cash flow model for planning 

purposes. In comments on a draft of this report, TVA agreed with these 

recommendations. 

Page 3 GAO-06-810 Tennessee Valley Authority
Background TVA is an independent, wholly owned federal corporation established by 

the TVA Act of 1933 (TVA Act), as amended.1

 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 built dams and hydropower facilities on the Tennessee River and its 

tributaries. To meet the subsequent need for more electric power, TVA 

expanded beyond hydropower to other types of power generation such as 

natural gas, coal, and nuclear plants. As of September 30, 2005, TVA sold 

electricity at wholesale rates to 158 retail distributors that resell electricity 

to consumers, and sold electricity directly to 61 large retail customers. As 

illustrated in figure 1, TVA’s service territory includes most of Tennessee 

and parts of Alabama, Georgia, Kentucky, Mississippi, North Carolina, and

Virginia. The area covers 80,000 square miles with a population of more 

than 8.6 million. 

Figure 1: TVA’s Service Territory 

Source: TVA.

Tennessee

Alabama

Mississippi Georgia

South

Carolina

Kentucky

Virginia

North

Carolina

 1

 16 U.S.C. §§ 831-831ee. 

Page 4 GAO-06-810 Tennessee Valley Authority
From its inception in 1933 through fiscal year 1959, TVA received 

appropriations to finance its internal cash and capital requirements. In 

1959, however, the Congress amended the TVA Act to provide TVA the 

means to self-finance its power program and required it to repay a 

substantial portion of appropriations2

 it had received to pay for its capital

projects. At the same time, the Congress required that TVA’s power 

programs be self-financing through revenues from electricity sales. For its 

capital needs in excess of funds generated from operations, TVA was 

authorized to borrow by issuing bonds and notes. TVA’s authority to issue 

bonds and notes is set by the Congress and cannot exceed $30 billion 

outstanding at any given time. 

Until recently, TVA had been administered by a three-member board of 

directors appointed by the President of the United States and confirmed 

by the U.S. Senate. An Executive Committee worked with the board to 

determine TVA’s strategic mission and future direction, provide 

management oversight, and ensure policies of the board were carried out. 

The Consolidated Appropriations Act, 2005, which was signed into law in

December 2004, changed the structure of TVA’s management. The act 

contained provisions that restructured the board from three full-time 

members to nine part-time members, established the position of Chief 

Executive Officer (CEO) to be appointed by the board, required TVA to 

begin filing financial reports with the Securities and Exchange 

Commission (SEC), and required TVA’s new board to create an Audit 

Committee to be composed solely of board members independent of 

management. The audit committee will be responsible for reviewing 

inspector general and external audit reports and making recommendations 

to the board. The legislation specifies that seven of the nine board 

members must be legal residents of TVA’s service area and that the 

members will be appointed by the President and confirmed by the Senate. 

After a transition period, members will serve 5-year rather than the current 

9-year terms. In general, the board will establish TVA’s strategic direction 

and policies while the CEO will oversee their implementation as well as 

TVA’s overall operations. The new board became effective on March 31, 

 2

 16 U.S.C. § 831n-4(e). TVA makes annual principal payments to Treasury from net power 

proceeds plus interest expense on the balance of this amount, which was about $428

million as of September 30, 2005. The annual principal payments, which totaled $20 million 

for fiscal year 2005, are to continue until the unpaid balance of the appropriation debt is 

paid down to $258.3 million. TVA is to continue paying interest on the remaining balance

each year. The interest on the unpaid appropriation balance was $16 million in fiscal year 

2005. 

Page 5 GAO-06-810 Tennessee Valley Authority
2006, when six new board members took the oath of office and joined two 

existing members to hold the first board meeting under the new 

governance structure.3

Along with annual reporting to the SEC, in fiscal year 2006 TVA will also 

be required to comply with certain provisions of the Sarbanes-Oxley Act of

2002, including the requirement that its officers certify annual and 

quarterly financial reports and report on the effectiveness of internal 

controls over financial reporting. TVA’s external auditor, in addition to 

auditing and issuing an opinion on TVA’s financial statements, will be 

required to issue an opinion on the effectiveness of TVA’s internal controls 

over financial reporting. Based on the current guidance from the SEC, TVA 

will file the first report on internal controls with its September 30, 2007,

financial statements. 

Under the TVA Act, as amended, TVA has not been subject to most of the 

regulatory oversight requirements that commercial utilities must satisfy. 

Legislation has also limited competition between TVA and other utilities. 

When the TVA Act was amended in 1959, it prohibited TVA, with some 

exceptions, from entering into contracts to sell power outside the service 

area that it and its distributors were serving on July 1, 1957. This is 

commonly referred to as the “fence” because it limits TVA’s ability to 

expand outside its July 1, 1957, service area. In addition, the Energy Policy 

Act of 1992 (EPAct) exempted TVA from being required to allow other 

utilities to use its transmission lines to send power to customers within its 

service area, effectively reducing the opportunities for TVA’s wholesale 

customers to choose other suppliers. This exemption is often referred to

as the “anti-cherrypicking” provision. TVA is still subject to some forms of 

indirect competition common to all utilities. For example, the cost of 

power would affect decisions by TVA’s customers to move or expand 

outside TVA’s service area or by businesses to move into its service area. 

In addition, customers can decide to generate their own power for on-site 

use. However, as long as the legislative framework continues to insulate 

TVA from direct competition for its wholesale customers, it will remain in 

a position similar to that of a regulated utility monopoly. 

 3

 As of August 15, 2006, the ninth member of the board had been nominated by the

President, but not yet confirmed by the Senate. 

Page 6 GAO-06-810 Tennessee Valley Authority
For more than 20 years, the federal government has been taking a variety 

of steps to restructure the electricity industry with the goal of increasing 

competition in wholesale markets and thereby increasing benefits to 

consumers, including lower electricity prices and a wider variety of retail

services. Electricity restructuring is evolving against a backdrop of 

constraints and challenges, including shared responsibility for 

implementing and enforcing local, state, and federal laws affecting the 

electricity industry and an expected substantial increase in electricity 

demand by 2025, which will require significant investment in new power 

plants and transmission lines. 

Prior to this restructuring, electricity was generally provided by electric 

utilities that exclusively served all customers within a specific geographic 

region. Under these conditions, the federal government, through the 

Federal Energy Regulatory Commission (FERC) and its predecessors, 

regulated wholesale electricity sales (sales for resale) and interstate 

transmission by electric utilities4

 and set prices at cost-based rates. 

Because the utilities were monopolies, states regulated retail markets, 

approving utility company investments and rates paid by customers. In 

1978, the federal government laid the groundwork for restructuring and 

competition in the electricity industry with the Public Utility Regulatory 

Policies Act, which opened wholesale power markets to electricity 

producers that were not regulated utility monopolies. In the 1990s the 

federal government greatly expanded these efforts. First the EPAct 

provided for broader participation in wholesale electricity markets by 

nonutilities5

 and allowed these entities to produce and sell electricity at 

market prices. Second, in 1996 the FERC issued Orders 888 and 889, which 

greatly expanded opportunities for competition by requiring utilities to 

provide access to their transmission lines to all users under the same 

prices, terms, and conditions. This change allowed the new nonutilities to 

compete with utilities and others for the opportunity to sell electricity in 

wholesale markets on more equal terms.6

 By 2002 a number of states had 

 4

 Some entities such as utilities owned by municipalities, rural electric cooperatives, and 

others were not generally subject to federal oversight on rates. 

5

 Nonutility generators or power producers can be corporations, persons, or other entities

that own electric-generating capacity and are not electric utilities. They can include mining

and manufacturing establishments, railroads, and other small or independent power 

producers that do not have a designated service area. 

6

 Although it was not required by the Federal Power Act to comply with these orders, TVA

took steps to do so, consistent with its obligations under the TVA Act. 

Page 7 GAO-06-810 Tennessee Valley Authority
made efforts to introduce competition to the retail markets that they 

oversee, allowing nonutilities to compete with utilities and others for the 

opportunity to sell electricity directly to consumers. 

Beginning in 2000, some restructured wholesale and retail electricity 

markets encountered a number of problems. From the summer of 2000 

through early 2001, California saw a sharp increase in wholesale electricity

prices, electricity shortages leading to rolling blackouts, and the 

deteriorating financial stability of its three major investor-owned utilities. 

These problems, along with the largest blackout in U.S. history along the 

East Coast in 2003, drew attention to the need to examine the operation 

and direction of the industry. Efforts to expand restructuring slowed down 

as many states analyzed the factors that contributed to these problems, 

among them failure to meet increasing demand for electricity with new 

generation and transmission capacity.

TVA management and many industry experts, however, expect that TVA 

will eventually be drawn into the restructuring of the electric utility 

industry and will eventually lose its legislative protections from 

competition. There have already been some indications of such changes. 

For instance, S.1499, introduced in July 2005, would remove any area 

within Kentucky from coverage by the “anti-cherrypicking” provision in 

the EPAct. If the bill becomes law, TVA would be required to transmit 

power from another supplier over its transmission lines for use inside the 

Kentucky portion of its service area without being able to similarly expand

its service area. The bill was referred to the Senate Energy and Natural 

Resources Committee, where it remained as of August 15, 2006. 

Our prior reports have indicated that TVA’s high debt and related interest

expense could place it at a disadvantage in continuing to offer 

competitively priced power if it were to lose its legislative protections 

from competition.7

 TVA’s management has also recognized the need to 

reduce its debt and other financing obligations to increase its flexibility to 

 7

 GAO, Tennessee Valley Authority: Financial Problems Raise Questions About LongTerm Viability, GAO/AIMD/RCED-95-134 (Washington, D.C.: Aug. 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 (Washington, D.C.: Sept. 19, 1997);

Tennessee Valley Authority: Assessment of the 10-Year Business Plan, GAO/AIMD-99-142 

(Washington, D.C.: Apr. 30, 1999); Tennessee Valley Authority: Debt Reduction Efforts and 

Potential Stranded Costs, GAO-01-237 (Washington, D.C.: Feb. 28, 2001); and Tennessee 

Valley Authority: Information on Lease-Leaseback and Other Financing Arrangements,

GAO-03-784 (Washington, D.C.: June 30, 2003).

Page 8 GAO-06-810 Tennessee Valley Authority
meet competitive challenges. In July 1997, TVA issued a 10-year business 

plan with steps necessary to improve its financial position for an era of 

increasing competition. Two key strategic objectives of the plan were 

(1) to reduce the cost of power by reducing debt and the corresponding 

financing costs, and (2) increase financial flexibility by reducing fixed 

costs. To help meet these objectives, the plan called for TVA to reduce its 

debt by half over a 10-year period to about $13.2 billion by increasing its 

electricity rates beginning in 1998, reducing certain expenses, and limiting

capital expenditures. 

TVA did not meet the 1997 debt reduction goal because it used cash 

intended for debt reduction to cover greater than estimated annual 

operating costs and capital expenditures. In fiscal year 2000, TVA began 

entering into alternative financing in the form of lease-leaseback 

arrangements to obtain a lower cost of capital than it could by selling 

bonds. TVA entered into these arrangements in fiscal years 2000, 2002, and 

2003 to refinance 24 existing power generators that were designed for use

during periods of peak power demand. TVA financed and built the 

generating units and leased them to investors in exchange for cash. It then

leased the generators back and is making payments to investors. TVA also 

implemented other alternative financing arrangements that allowed its 

customers to prepay for power in exchange for discounted rates. For 

example, in November 2003, TVA entered into an energy prepayment 

agreement with its largest customer, Memphis Light, Gas, and Water 

Division (MLGW). Under this agreement, MLGW prepaid TVA $1.5 billion 

for electricity to be delivered over a 15-year period. TVA also offered a 

discounted energy units program in fiscal years 2003 and 2004, under 

which TVA customers could purchase power, usually in $1 million 

increments, in return for a discount on a specified quantity of power over 

a certain period of years. TVA did not offer the DEU program in 2005. 

During our review, TVA’s management8

 told us they have no current plans 

to enter into additional alternative financing arrangements. 

 8

 The majority of our field work was conducted before the restructured board took office 

on March 31, 2006, and included interviews with key members of TVA’s management, 

including the Chairman of the Board; Chief Operating Officer; Executive Vice President and 

General Counsel; Chief Financial Officer; Senior Vice President for Strategic Planning and 

Analysis; and Vice President, Risk Management and Economic Analysis. Our references to

TVA management in this report apply to the TVA management team in place before the new 

board took effect on March 31, 2006. 

Page 9 GAO-06-810 Tennessee Valley Authority
Generally accepted accounting principles require that lease-leaseback and

other alternative financing arrangements be classified as liabilities. In 2003

we reported9

 that the lease-leaseback arrangements, while not considered 

debt for purposes of financial reporting, had the same effect on TVA’s 

financial condition as traditional debt financing. The Office of 

Management and Budget (OMB) treats the cash proceeds TVA receives 

from private parties at the inception of lease-leaseback arrangements as 

borrowing. Accordingly, in the President’s Budget for fiscal year 2004,

OMB began classifying TVA’s lease-leaseback arrangements as debt. Table 

1 shows that although TVA reduced its outstanding statutory debt by about

$4.3 billion from fiscal years 1997 through 2005, its use of alternative 

financing arrangements rose, adding nearly $2.5 billion to its total 

financing obligations as of September 30, 2005, resulting in a net reduction

of about $1.8 billion. 

Table 1: TVA’s Total Financing Obligations at Year-end for Fiscal Years 1997 through 2005 

Dollars in millions 

Debt and obligations 1997 1998 1999 2000 2001 2002 2003 2004 2005

Statutory debt $27,379 $26,684 $26,376 $25,985 $25,375 $25,255 $24,875 $23,250 $23,088

Lease-leaseback 0 0 0 300 271 559 1,238 1,178 1,143

Energy prepayments 0 0 0 0 0 0 47 1,455 1,350

Total financial obligations

(Debt + alternative financing) $27,379 $26,684 $26,376 $26,285 $25,646 $25,814 $26,160 $25,883 $25,581

Source: GAO analysis of information obtained from TVA. 

In fiscal year 2004, burdened with total financing obligations of almost $26 

billion, TVA’s board adopted a new strategic plan for reducing debt that

called for increasing revenue, controlling costs, and reducing the growth 

of capital expenditures. However, TVA also began measuring its debt 

reduction more realistically and transparently in terms of TFOs, which, as 

shown in table 1, are comprised of its statutory debt as well as its 

liabilities under alternative financing arrangements. 

Since issuing its strategic plan in 2004, TVA has raised its power rates 

twice—a 7.52 percent increase in firm wholesale electric rates effective

October 1, 2005, and a 9.95 percent increase effective April 1, 2006. On July 

28, 2006, TVA’s board approved a 4.5 percent decrease in firm wholesale 

 9

 GAO, Tennessee Valley Authority: Information on Lease-Leaseback and Other 

Financing Arrangements, GAO-03-784 (Washington, D.C.: June 30, 2003). 

Page 10 GAO-06-810 Tennessee Valley Authority
power rates in conjunction with a fuel-cost adjustment clause. Utilities 

surrounding the Tennessee Valley also increased rates in 2005, and 12 of 

the 14 surrounding utilities have fuel-cost adjustment clauses that allow 

them to pass increases in the price of fuel to customers automatically. TVA 

is working with distributors and the Tennessee Valley Public Power 

Association (TVPPA)10 to develop future wholesale pricing options and 

new long-term contract options. 

To determine how TVA plans to meet the debt reduction goal identified in

its 2004 strategic plan, we: (1) interviewed TVA officials, (2) reviewed 

documentation and analyses supporting TVA’s debt reduction plan 

including its 2004 strategic plan and budget submissions for fiscal years 

2006 and 2007, and (3) reviewed TVA’s fiscal years 2004 and 2005 annual

reports, information statements, and audited financial statements. 

Scope and 

Methodology 

To assess the reasonableness of TVA’s approach in developing its debt 

reduction plan, we interviewed TVA officials responsible for developing

the 2004 Strategic Plan and performing analyses with the Competitive Risk 

Model and the Enterprise Risk Model. To assess these models, we 

obtained documentation describing the structure of the models and the 

sources of variables used in the models, and discussed this information 

with relevant TVA staff. We examined the structure of the models in order 

to ascertain whether the relationships between the variables in the models

were logical and included the most important sources of costs and 

revenues, and considered the extent to which the data are independent,

widely used, and relevant. 

To identify the key factors that could impact TVA’s ability to successfully 

carry out its debt reduction plan we (1) interviewed officials from TVA, 

TVA’s Office of Inspector General, the Tennessee Valley Public Power 

Association, and the Knoxville Utilities Board; (2) reviewed prior GAO 

reports on issues confronting TVA; (3) reviewed TVA’s fiscal years 2004 

and 2005 annual reports, information statements, and audited financial 

statements to determine the types of revenue and costs TVA had reported;

and (4) interviewed an official from CBO with expertise in issues 

pertaining to TVA. 

 10 TVPPA is a nonprofit, regional service organization that represents the interests of

consumer-owned electric utilities operating within the TVA service area.

Page 11 GAO-06-810 Tennessee Valley Authority
To identify the impact that growth in demand for power in the Tennessee 

Valley may have on TVA’s ability to meet its debt reduction plan, we 

(1) interviewed officials from TVA, TVA’s Office of Inspector General, the 

Tennessee Valley Public Power Association, and the Knoxville Utilities 

Board; (2) reviewed prior GAO reports on issues confronting TVA; 

(3) reviewed TVA’s fiscal years 2004 and 2005 annual reports, information 

statements, and audited financial statements to determine the types of 

revenue and costs TVA had reported; and (4) interviewed an official from 

CBO with expertise in issues pertaining to TVA. 

During the course of our work, we contacted the following organizations:

• Congressional Budget Office 

• Tennessee Valley Authority 

• Tennessee Valley Authority, Office of Inspector General 

• Tennessee Valley Public Power Association, Chattanooga, Tennessee 

• Knoxville Utilities Board, Knoxville, Tennessee 

We provided a draft of this report to officials at TVA for their review and 

incorporated their comments where appropriate. We conducted our work 

from June 2005 through August 2006 in accordance with generally 

accepted government auditing standards. 

TVA set a goal of reducing statutory debt by $3 to $5 billion in its 2004 

strategic plan. Subsequently, TVA expanded the scope of its debt 

reduction efforts to include debt-like transactions such as lease-leasebacks 

and energy prepayment arrangements, referred to in this report as 

alternative financing. TVA calls this larger group of obligations total 

financing obligations, or TFOs. In its 2007 budget, TVA increased its TFO 

reduction goal to $7.1 billion.11 This includes reducing statutory debt by 

$6.7 billion and alternative financing obligations by $0.4 billion. TVA plans 

to meet this goal by increasing revenue, controlling the growth of its 

operating expenses, and limiting capital expenditures. TVA projects it will 

gain additional revenue through its October 2005 rate increase, a fuel-cost 

TVA Plans to Increase 

Revenue, Control 

Operating Expenses, 

and Limit Capital 

Expenditures 

 11 GAO was asked to look at TVA’s 2004 Strategic Plan, which addressed debt reduction 

plans through 2015. This report is based on information supporting the $7.1 billion figure 

made public in December 2005, which covers the original debt reduction period.

Subsequently, TVA expanded its debt reduction period to 2016 and raised its TFO reduction

goal to $7.8 billion. This increased TVA’s goal for reducing statutory debt to $7.3 billion and 

alternative financing arrangements to $0.5 billion.

Page 12 GAO-06-810 Tennessee Valley Authority
adjustment clause to adjust rates up or down automatically when fuel 

prices change, and increased sales from growth in the demand for 

electricity. TVA’s plan also calls for controlling the growth of operating 

costs and limiting spending on capital expenditures to $12.1 billion 

through fiscal year 2015.

TVA’s management told us that they are committed to reducing TFOs and 

that achieving the $7.1 billion TFO reduction goal would give TVA an 

estimated 3.1 interest rate coverage ratio12 by fiscal year 2015. As of fiscal 

year 2005, TVA’s interest coverage ratio was 2. The interest coverage ratio 

is a quick way to identify a company’s ability to pay interest on debt, 

which TVA uses to gauge its financial health. TVA officials said the 3.1 

ratio would allow TVA to be a financially flexible enterprise and continue

to offer competitive electricity rates. Table 2 shows TVA’s annual and 

cumulative targets for reducing total financing obligations for fiscal years 

2004 through 2015. 

 12 An interest coverage ratio of 1.5 is considered the minimum for any company in any 

industry. For an established utility, an interest coverage ratio of 2 is acceptable, while 3 is 

the minimum for more volatile industries. This ratio is generally calculated by dividing a 

company’s earnings before interest expense and taxes by its interest expense. Because 

TVA’s capital structure differs from investor-owned utilities, it calculates this ratio by

dividing the sum of cash from operations plus interest expense by interest expense, which

we believe is reasonable. 

Page 13 GAO-06-810 Tennessee Valley Authority
Table 2: TVA’s Actual and Targeted Reduction of Total Financing Obligations for Fiscal Years 2004 through 2015 

Dollars in millions

Actual and projected

reductions by fiscal 

year 2004a, b 2005a

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total

Alternative financing $(1,347) $140 $140 $142 $148 $147 $152 $160 $165 $172 $169 $176 $364

Statutory debt 1,625 161 200 387 404 545 556 537 605 654 412 649 6,735

Total annual TFO

reduction 278c

301c340 529 552 692 708 697 770 826 581 825 $7,099

Cumulative TFO 

reduction $278 $579 $919 $1,448 $2,000 $2,692 $3,400 $4,097 $4,867 $5,693 $6,274 $7,099

Source: GAO analysis of information obtained from TVA. 

a

Reflects actual amount. 

b

During fiscal year 2004, TVA reduced the balance of its TFOs by $278 million by using $1.5 billion from a prepayment agreement with Memphis Light, Gas, and Water Division (MLGW) plus $125 million generated from operations to reduce statutory debt by $1.625 billion. At the same time, the 

balance of TVA’s alternative financing arrangements increased by $1.5 billion from the MLGW 

prepayment agreement minus a reduction in the balance of other alternative arrangements of $153 

million for a net increase of $1.347 billion. 

c

Targeted reduction was $225 million. 

TVA exceeded its targets for reducing TFOs for the first 2 years of the 

plan. In fiscal year 2004, TVA reduced its TFOs by $278 million, or 24 

percent more than its target of $225 million. In fiscal year 2005, TVA 

reduced its TFOs by $301 million, or 34 percent more than its target of 

$225 million. 

TVA Projects Several 

Sources of Additional 

Revenue 

The projections supporting TVA’s current TFO reduction goal show that 

the annual increases in operating revenue over the fiscal year 2004 level

for fiscal years 2005 through 2015 will total $16.7 billion. TVA plans to use 

the additional revenue to cover projected increases in operating costs and 

capital expenditures, and to reduce TFOs. About $9.6 billion of this 

additional revenue will come primarily from increased sales from growth 

in demand. TVA also projects that about $5.7 billion will come from the 

October 1, 2005, rate increase. From fiscal years 2007 through 2015, TVA 

expects about $1.4 billion to come from the fuel-cost adjustment (FCA) 

clause that will be added to customer contracts in fiscal year 2007. The 

FCA will automatically increase or decrease rates to cover changes in the 

cost of fuel and purchased power. TVA plans to use the budgeted fuel and 

purchased power estimates for fiscal year 2006 as the baseline for fuel and 

purchased power prices it pays. In subsequent years, it will compare those 

prices to the baseline and automatically adjust rates upward or downward 

for changes in these expenses. Although the FCA will not generate 

Page 14 GAO-06-810 Tennessee Valley Authority
additional cash that can be applied to TFO reduction, it will prevent 

increases in the cost of fuel and purchased power from eroding cash 

balances that TVA planned to apply toward TFO reduction. 

The revenue projections supporting the current TFO reduction goal do not 

include several factors, such as the 9.95 percent rate increase that took 

effect on April 1, 2006, the 4.5 percent decrease approved on July 28, or 

any future rate increases. The April 1, 2006, increase took effect after TVA 

approved its 2007 budget and was undertaken to cover projected increases 

in the cost of fuel and purchased power. The rate decrease was approved 

in conjunction with the FCA. Future rate increases (excluding the FCA) 

were not included because TVA plans to use them as necessary to cover 

increases in operating costs (excluding fuel and purchased power) that 

exceed estimates that were used in formulating the current TFO reduction 

goal. The revenue projections also assume that an environmental 

surcharge that was added to rates on October 1, 2003, to fund anticipated 

clean air compliance costs for the next 10 years will be discontinued at 

fiscal year end 2013, as originally planned. 

TVA Plans to Control the 

Growth of Its Operating 

Costs 

TVA’s TFO reduction plan includes an emphasis on controlling the growth

of operating costs. Management plans to constrain TVA’s baseline 

operating and maintenance (O&M) costs, excluding fuel and purchased 

power, by limiting the growth of these expenses to one-half of a 

percentage point below inflation, as measured by the consumer price 

index (CPI). TVA estimates that this will make about $1.1 billion in cash 

available from fiscal year 2007 through fiscal year 2015. TVA plans to hold 

O&M expenses down by implementing better discretionary spending 

discipline through top-down budgeting guidance and performance 

measures, and then maintaining the efficiency gains throughout the 

planning period. The plan includes establishing overall financial targets 

and allocating them to TVA’s individual business units. 

TVA officials also project that bringing Browns Ferry Nuclear Unit 1 

(BFN 1)13 on line will help control the growth of operating costs. A 2002 

analysis prepared by TVA shows that the completion of BFN 1 will allow 

TVA to reduce the cost of its fuel, purchased power, and other operating 

 13 BFN 1 was taken off line in 1985 for plant modifications and regulatory improvements. In

May 2002, TVA’s Board determined the restart of BFN 1 could reduce TVA’s delivered cost 

of power relative to the market and initiated activities to return BFN 1 to service. 

Page 15 GAO-06-810 Tennessee Valley Authority
costs. Because completion of BFN 1 is embedded in TVA’s current 

forecasts, it could not provide current projections of the incremental 

savings from completing and bringing BFN 1 on line. The 2002 analysis 

projected that TVA’s cash flow would improve when BFN 1 is brought on 

line in May 2007, and TVA would recover all of its costs from the project, 

including interest expense, by 2015. This analysis, however, could not 

consider subsequent changes, such as the significant increases in power 

supply costs that have occurred since 2002, which will increase TVA’s 

projected savings from bringing BFN 1 on line. TVA also projects that its 

interest expense will be reduced over time as it lowers the balance of its 

outstanding debt. 

TVA Plans to Spend $12.1 

Billion on Capital 

Expenditures through 

Fiscal Year 2015 

TVA’s TFO reduction plan includes $12.1 billion from fiscal year 2006 

through fiscal year 2015 for capital expenditures to complete BFN 1, meet 

known requirements of the Clean Air Act, and cover ongoing efforts to 

uprate its generating assets and maintain transmission assets. Any changes 

in this amount would affect the cash available for TFO reduction. Table 3 

shows TVA’s planned capital expenditures by major category from fiscal 

year 2006 through fiscal year 2015. 

Table 3: TVA’s Planned Capital Expenditures by Major Category from Fiscal Year 

2006 through Fiscal Year 2015 

Dollars in millions 

Category 

Planned 

expenditures

Percentage of planned

expenditures

Browns Ferry Nuclear Unit 1 $501 4

Clean Air Act Requirements 3,481 29

Fossil 2,552 21

Nuclear 1,462 12

Transmission 2,828 24

Hydro 762 6

Corporate 529 4

 Total $12,115 100

Source: TVA. 

To help meet its capital expenditure goals, TVA will consider deferring or 

canceling capital projects when necessary and adjusting its investment 

criteria to reflect changes in its customer contracts and commitments. 

Page 16 GAO-06-810 Tennessee Valley Authority
TVA’s plan includes estimated capital expenditures for its current 

environmental program to reduce sulfur dioxide, nitrogen oxide, and 

particulates, which are expected to reach a cumulative total of about $5.7 

billion by 2010. TVA had already spent about $4.4 billion, or 77 percent of 

this amount, by September 30, 2005. TVA’s plan, however, does not factor

in costs for additional reductions in airborne pollutants that it may be 

required to meet in the future, or the potential cost to comply with 

proposed legislation that would require reductions in carbon dioxide. 

Projections for meeting TVA’s TFO reduction goal do not include capital 

expenditures for building any major new generating assets through 2015, 

other than completing BFN 1. 

Overall, we found TVA’s approach to developing its TFO reduction goal

was reasonable. TVA used a strategic planning process to develop its 

current goal, which focused on its core mission as a long-term provider of 

low-cost electricity. As part of this process, TVA looked not only at its 

financing obligations, but at external business and market risks. To assess 

these outside risks, TVA performed detailed competitive analyses and 

modeled different market scenarios to estimate its future competitive 

environment. It considered the results of these market risk analyses in 

formulating its strategic plan and determining the initial range of possible 

debt reduction through 2015. As part of its annual internal budget process, 

TVA used an accounting model to project annual cash flows and refine its 

goal. TVA continues to project cash flows annually and to analyze 

changing market conditions as necessary using the accounting model. 

TVA assessed its competitive environment and performed detailed 

analyses of business and market risks to determine the effect of possible 

future conditions on its ability to reduce debt. Among the tools used in 

TVA’s strategic planning process was a competitive risk model (CRM). The 

CRM is a scenario model that shows the range of financial outcomes TVA 

might face if electricity industry restructuring moved forward and its 

distributors were free to choose alternative suppliers. Scenario analysis 

develops a set of potential events and conditions that management may 

wish to consider, and calculates the likely impact on cash flow and debt 

reduction in each. TVA’s CRM shows the probability of loss of load, or 

customer demand for energy, over many market scenarios. The model 

calculated the potential impact of each market scenario on TVA assuming 

that distributors could choose other suppliers and modeled the potential

for loss of load using three pricing scenarios: 

TVA Used a 

Reasonable Approach 

to Developing Its Plan 

to Reduce TFOs 

TVA Assessed Its Business 

and Market Risks to

Prepare Its Strategic Plan 

Page 17 GAO-06-810 Tennessee Valley Authority
• holding prices flat at current levels, 

• setting prices equal to TVA’s projected costs, and 

• setting prices equal to the projected average competitor price.

The results were then used to produce probabilities of different potential 

financial outcomes to identify types of market conditions under which 

load loss was likely to occur. 

TVA included the following assumptions in the CRM: 

• it would begin facing competitive pressures in 2008; 

• its contracts would include provisions for distributors to satisfy some 

of their power needs from sources other than TVA, referred to as 

partial requirements; and 

• it could sell power elsewhere. 

TVA conducted its competitive risk analysis in 2003. In a little less than 

one-third of the scenarios, the CRM showed that TVA could lose load if 

other utilities had both cheap natural gas and high reserve margins, or 

unused available capacity. Because natural gas prices have risen and 

movement toward electricity competition has slowed, TVA has not 

considered it necessary to run the model again. 

TVA used the results of its competitive risk analysis as well as professional 

judgment in developing its 2004 strategic plan and the initial range of $3

billion to $5 billion for its statutory debt reduction goal. The plan looks at 

the larger picture of what TVA needs to do to succeed in a more 

competitive environment. It concluded that TVA needs to concentrate on 

four areas over the next few years. These are: 

• developing new, more differentiated pricing structures, services, and 

contract terms that more closely tie the cost and risk of TVA’s products 

to their terms and pricing; 

• addressing issues related to wholesale market design and transmission 

pricing, including how it will interface with surrounding markets to 

ensure reliable power and how it will charge for transmitting power 

inside its service area when distributors can choose other suppliers; 

• accelerating debt reduction to increase financial flexibility; and 

• maintaining and operating company assets to continue to meet

electricity supply obligations safely and reliably.

Page 18 GAO-06-810 Tennessee Valley Authority
TVA Uses an Accounting 

Model to Refine Its TFO 

Reduction Targets by 

Determining Likely Cash 

Flow 

TVA uses the Enterprise Risk Model (ERM) as part of its annual internal 

budgeting process to refine its TFO reduction targets by determining likely 

cash flow in given situations. The ERM is a simplified cash-based 

accounting model that can project key financial data by modeling TVA’s 

system based on a power supply plan and a long-range financial plan. The 

ERM uses Monte Carlo simulation14 to assess the probable range of 

uncertain inputs, or variables, such as interest rates or coal prices, 

redispatch the TVA system,15 and recalculate cash flows multiple times 

while showing a range of probable values for each variable.

The ERM’s Monte Carlo simulations use 13 variables that include key costs 

and key determinants of revenue: 

• electricity market peak ($/MWh) 

• electricity market off-peak ($/MWh) 

• natural gas prices ($/mmBtu) 

• coal prices ($/mmBtu) 

• long-term interest rates (%) 

• short-term interest rates (%) 

• total operating and maintenance expenses 

• capital expenditures 

• selling, general and administrative expenses 

• benefits expense 

• coal plant availability 

• nuclear plant availability 

• hydro generation 

For example, a simulation might use key costs such as prices for coal and 

natural gas, and combine this information with key determinants of 

revenue, such as peak and off-peak electricity prices, and quantities sold at 

those prices. The output of the model is an estimate of the annual net cash 

flow for TVA. For each scenario estimated, the model shows net cash 

flows and financing obligations repayment over each of the next 20 years 

 14 Monte Carlo simulation is an approach to risk assessment that allows an analyst to assess

the probable range of various uncertain inputs, such as interest rates or coal prices, and

recalculate cash flows multiple times while drawing values that fall within a probability 

distribution for each of the uncertain inputs. The results are examined in the context of

their probability distribution covering all potential outcomes of the analysis as well as 

reporting the average or other values. 

15 Dispatch is the process of allocating load among the available generation units so that the 

cost of operation is minimized. The ERM uses an economic dispatch routine to simulate the 

operation of TVA generating assets to achieve the lowest possible cost of generation. 

Page 19 GAO-06-810 Tennessee Valley Authority
for the values assumed in that scenario. Assuming that this net cash flow is 

applied to reducing financing obligations, the model provides an estimate 

of the level of obligations at the end of the simulation, which can then be 

used to refine projections used in coming up with its goals. 

The model uses a variety of reliable sources for estimates of the key input

variables. For instance, the variability of rainfall for hydropower is 

calculated using historical data. Interest rates are based on forecasts from 

Global Insight and the Wall Street Journal. The volatility of commodity 

prices for coal or natural gas is estimated with a combination of historical

data and projected trends. Other sources may also provide reasonable 

estimates for key variables in the model, however. For example, some of 

the commodities used in the model, such as natural gas, have active

options markets, which could help identify more accurate estimates of the 

range of possible future prices in volatile markets. For example, when 

Hurricane Katrina destroyed a large number of natural gas rigs in the Gulf

of Mexico, there was an enormous increase in implied volatility for natural 

gas prices. This was because no one knew how long it would take to repair 

the rigs or what the market consequences would be of a sudden 

withdrawal of a large percentage of the natural gas supply. In such a case,

the options market may provide a more accurate estimate of price 

volatility than historical activity and might result in a more comprehensive 

characterization of the distribution of possible TFO reduction levels.16

In designing the ERM and using its output to devise its current goal for 

reducing financing obligations, TVA made the following key business 

assumptions: 

• Brown’s Ferry Nuclear Unit 1 will be completed on time, 

• TVA will not self-fund any new baseload generation, 

• distributors who have given notice they will not be renewing contracts 

are excluded, 

• TVA will meet or exceed current environmental regulations, 

 16 In many energy markets, options are traded that give purchasers the right to buy or sell 

commodities in the future at a set price. From the prices on these options, it is possible to 

determine traders’ expectations about the extent to which prices are likely to fluctuate in 

the future. At times of fundamental changes in a market, such as storm damage to 

production facilities, traders may reasonably believe that price fluctuations in the future

will be larger than those based on past history.

Page 20 GAO-06-810 Tennessee Valley Authority
• TVA’s credit rating remains AAA,17 and

• distributors do not gain rights to partial requirements or transmission. 

TVA has generally made reasonable assumptions concerning the level and 

variability of the key inputs to its Monte Carlo model. As with any 

modeling effort, there are some inherent limitations, and areas in which 

the modeling may be improved. TVA’s key business assumptions, while 

reasonable, limit the range of outcomes from the model by making certain 

events appear more fixed or settled than they are. Allowing the range of 

possible outcomes attached to some of the fixed assumptions to be 

modeled as variables may better reflect the uncertainty attached to TVA’s 

TFO reduction estimates. For example, TVA could determine a range of 

likely dates for the completion of Brown’s Ferry Nuclear Unit 1, and use 

these dates as part of the Monte Carlo simulation. Another example might 

be to use the range of possible costs from potential environmental 

legislation as inputs to the model. Modeling these and other fixed 

assumptions as variables might better illustrate the range of outcomes for 

TVA to evaluate in setting and refining its TFO reduction goals. 

We identified several key factors that could impact TVA’s ability to 

successfully carry out its plan. Some factors are more difficult for TVA to 

control than others. The timing of electricity industry restructuring, 

potential increases in interest rates, and costs associated with meeting 

potential new environmental regulations are factors outside TVA’s control. 

Future rate increases and a fuel-cost adjustment clause are factors that 

will help TVA cover unforeseen costs, which will help TVA meet its TFO 

reduction goal. TVA’s planned reduction in interest expense could be 

affected by increases in interest rates. Although the TFO reduction plan 

includes the capital expenditures TVA estimates it will need to comply 

with all existing environmental regulations, the plan does not include 

potential capital expenditures needed to comply with any changes to the 

current environmental regulations. Building new generating capacity could 

require capital expenditures not included in the plan. 

Several Key Factors 

Could Impact TVA’s 

Ability to Successfully 

Carry out Its Plan for 

Reducing TFOs 

 17 AAA is a bond rating category assigned to an electric utility by bond analysts to represent 

their opinion on the general creditworthiness of an entity. AAA is the highest bond rating 

category representing the smallest degree of investment risk and an extremely strong 

ability to pay interest and principal. 

Page 21 GAO-06-810 Tennessee Valley Authority
The Timing of 

Restructuring within the 

Electricity Industry and 

the Changes It May Impose 

Are Key Variables in TVA’s 

TFO Reduction Plan 

Restructuring is the major reason TVA has undertaken TFO reduction, and

its timing and the organizational and structural changes it may impose are 

key variables in TVA’s plans. TVA’s management and industry experts 

believe TVA may eventually lose its legislative protections from 

competition and have to compete with other utilities. Even if TVA does not 

lose its legislative protections, its management has recognized the need to

take action to better position the agency to be competitive in an era of 

increasing competition and customer choice. TVA management undertook 

both the 1997 business plan and the 2004 strategic plan to position TVA to 

meet the challenges it would likely face in the coming restructured 

marketplace. 

The extent to which TVA would be affected by loss of its legislative 

protections from competition would be influenced by (1) when TVA loses 

its protections, which would affect how much time it has to continue to 

improve its competitive position; (2) how TVA would be structured to 

operate in a competitive environment, including whether it would be given 

the ability to compete for customers outside its service area; and (3) how 

TVA’s financial condition compares to its competitors at the time it loses 

its protections from competition. Loss of its protections from competition 

could affect TVA’s ability to set rates at levels sufficient to recover all 

costs, which could negatively impact the amount of cash available to 

reduce TFOs. 

According to a TVA official, one option TVA could pursue to help meet its 

goal for reducing TFOs is to negotiate long-term contracts with its 

customers. Long-term contracts would help reduce TVA’s risk by 

providing a steady revenue stream for a certain period of time. If TVA’s 

distributors were to gain the rights to purchase a portion of their electric 

power requirements from other utilities, it could have a negative material

effect on TVA’s ability to meet its TFO reduction goal. For example, 

excluding the Kentucky portion of TVA’s service area from the anticherrypicking provision of the EPAct is currently under consideration.18 In 

the event this legislation is enacted, TVA officials believe other 

distributors would seek similar treatment. 

 18In July 2005, Senators Jim Bunning and Mitch McConnell introduced S.1499, which would

remove any area within Kentucky from coverage by the “anti-cherrypicking” provision in

EPAct. 

Page 22 GAO-06-810 Tennessee Valley Authority
Future Rate Increases and 

a Fuel-cost Adjustment 

Clause Will Help TVA 

Reduce Total Financing 

Obligations 

Future rate increases and a fuel-cost adjustment clause allowing TVA to 

adjust rates for the rise and fall in the prices of fuel and purchased power 

that result from changes in market conditions will help TVA meet its TFO 

reduction goal. TVA’s TFO reduction goal reflects the October 2005 rate 

increase and the FCA that TVA plans to implement in fiscal year 2007. The 

plan does not reflect any additional rate increases through 2015. TVA 

estimates that the FCA will cover net increases in the cost of fuel and 

purchased power of $1.4 billion from fiscal year 2007 through 2015, which 

will free this amount of cash to apply toward TFO reduction. In addition, 

TVA’s management told us that they would consider additional rate 

increases if necessary to cover increases in operating costs other than fuel 

and purchased power. In determining whether to raise rates, TVA’s 

management recognizes that they would need to consider current markets 

and any potential negative consequences, such as the impact on power 

sales and the regional economy. The April 2006 rate increase and any 

future increases will help TVA cover any unforeseen increases in projected 

operating costs or capital expenditures, as well as shortfalls in projected 

revenue. 

Limiting the Growth of 

Operating and 

Maintenance Expenses 

Will Be Difficult for TVA to 

Achieve 

TVA will be challenged to meet its goal of reducing projected O&M 

expenses by $1.1 billion from fiscal year 2007 through 2015. TVA has been

focusing on reducing O&M expenses since it issued its 1997 business plan, 

and has already taken many steps to trim these expenses. TVA officials 

have said that the $1.1 billion savings will come from baseline O&M 

expenses, which TVA defines as the ongoing costs of operating and 

maintaining its internal business units that are routine and recurring. In 

fiscal year 2005, these expenses represented about $1.3 billion, or about 54 

percent of the $2.4 billion reported for O&M expenses, and about 20 

percent of TVA’s total operating expenses. According to a TVA official, the 

growth limit for the baseline O&M expenses will be applied to the total for 

all business units and any excess increases in these expenses by one unit

will have to be absorbed by the other business units. For example, the 

amount budgeted for one of TVA’s business units in fiscal year 2007 was 

$30.7 million over what it would have been if it had been limited to 

projected inflation less one half of a percentage point, and according to a 

TVA official, this excess will have to be absorbed by the other business 

units in order for TVA to meet its overall growth limit. 

Page 23 GAO-06-810 Tennessee Valley Authority
Planned Reduction in 

Interest Expense Could Be 

Affected by Increases in 

Interest Rates 

TVA projects that it will continue to reduce annual interest expense as it 

reduces the balance of outstanding debt and, if the situation presents 

itself, refinance debt at lower interest rates. Like all outstanding debt 

approaching maturity dates, TVA’s interest expense is subject to interest 

rate risk. As TVA’s outstanding debt matures, the portion that is not repaid

will need to be refinanced at current rates, thus exposing TVA to the risk 

of rising interest rates and higher interest costs. TVA has reduced its 

annual interest expense from more than $2 billion in fiscal year 1997 to 

about $1.3 billion in fiscal year 2005, a 35 percent reduction. TVA was able 

to lower its interest expense by refinancing debt at lower interest rates, 

reducing the outstanding balance of debt, and entering into alternative 

financing arrangements. Alternative financing arrangements help reduce 

interest expense because they are classified as liabilities in TVA’s financial 

statements. This means that rather than being classified as interest on 

debt, the costs of these arrangements are recorded as increases in 

operating expenses or reductions in revenue. TVA attributes 

approximately 80 percent of the reduction of interest expense from fiscal 

year 1997 to 2005 to refinancing debt at lower interest rates. 

As of September 30, 2005, TVA had about $8.3 billion in outstanding debt 

that will mature and either need to be repaid or refinanced over the next 5 

years ($3.1 billion in long-term debt and about $5.2 billion in short-term 

debt). By the end of this 5-year period, for every 1 percentage point change 

in TVA’s average borrowing costs for the $8.3 billion, its annual interest 

expense would increase or decrease by about $83 million. If future interest 

rates are higher than the rates used in TVA’s projections, TVA may have 

difficulty meeting its targets for reducing interest expense. 

Changes to Current 

Environmental Regulations 

Could Require Substantial 

Capital Expenditures 

Although TVA’s TFO reduction plan includes all of the capital 

expenditures it projects will be needed to comply with existing 

environmental regulations, the plan does not include potential capital 

expenditures needed to comply with any changes to the current 

environmental regulations. According to TVA’s 2005 Information 

Statement, several existing regulatory programs are being made more 

stringent in their application to fossil-fuel units19 and additional regulatory 

programs affecting fossil-fuel units have been announced. According to 

TVA, its TFO reduction plan does not include the estimated future costs to 

comply with more stringent regulations because it is difficult to predict 

 19 Fossil-fuel plants use coal, petroleum, or gas as their source of energy. 

Page 24 GAO-06-810 Tennessee Valley Authority
how these regulations would affect TVA. However, TVA officials estimate 

that the cost to comply with future regulations could run between $3.0

billion and $3.5 billion through 2020. TVA officials said they would include 

an estimate of these costs in the plan if their level of certainty ever 

increases. The plan also does not include the potential cost of complying 

with legislation that has been introduced, but not yet passed, in the 

Congress to require reductions in carbon dioxide. If this legislation is 

enacted, TVA estimates that the cost of complying with it could be 

substantial. 

The extent to which new environmental regulations affect any utility 

depends on several factors, including the type and condition of its 

generating equipment, the portion of its power generated by fossil fuels, 

the types of controls it chooses to meet the new environmental 

regulations, and the availability of excess generating capacity. Compared 

to surrounding regions, TVA has roughly the same amount of coal-fired 

capacity, nearly twice as much nuclear, nearly four times as much hydro, 

and less than half as much natural gas fired capacity. Figure 2 shows TVA’s 

generation mix compared to the surrounding North American Electric 

Reliability Council (NERC) regions. 

Figure 2: Generation Capacity by Fuel Type, TVA vs. Nearest NERC Regions

0

10

20

30

40

50

60

Coal Hydroelectric Nuclear Natural gas/Oil

Percent generation

Fuel type

Source: TVA.

Nearest NERC regions (excluding TVA)

TVA

47 49

5

18

11

18

36

15

Page 25 GAO-06-810 Tennessee Valley Authority
The extent to which different producers will be affected by new 

environmental regulations, and the resultant impact on their power prices, 

is unknown at this time. Although new environmental regulations would 

likely present challenges to TVA in meeting its TFO reduction goal, they

may not necessarily affect its competitive position relative to its 

neighboring utilities. 

Building new generating capacity during the current TFO reduction period 

to meet the projected demand for power beginning in 2015 would likely 

cause TVA to incur new debt and use cash that is currently projected to be

available to reduce TFOs. TVA officials told us they plan to meet load 

growth in the TVA service area through 2015 by completing BFN 1, 

increasing the capacity of existing generating units, and purchasing power 

from the marketplace. TVA’s current projections include the capital 

expenditures it projects will be needed to meet this plan. TVA also 

projects that it will need additional generating capacity beginning in 2015.

TVA plans to satisfy this need by partnering with other power providers. 

Its current goal assumes that it will not finance any new baseload plants,20

other than BFN1, through 2015. If growth in demand or market changes 

force TVA to build new generation, as happened after its 1997 plan, TVA’s

ability to reduce TFOs could be affected. 

TVA officials told us they recognize that in order to improve TVA’s 

financial situation, it will need to operate within its means and reduce 

TFOs. TVA will require continued management commitment to continue 

reducing financing obligations. According to officials, TVA did not meet 

the debt reduction goal in the 1997 business plan because the amount of 

cash left over after meeting its other business needs was not sufficient to 

meet the goal. Since issuing its 2004 strategic plan, TVA’s management has 

demonstrated its commitment by exceeding the planned targets for the 

first 2 years of the TFO reduction plan. In addition, their actions have 

included adding annual TFO reduction targets as revenue requirements in 

the budgets used for its annual rate reviews, tying portions of its overall 

incentive payroll compensation to accomplishing the TFO reduction goal, 

and demonstrating a willingness to raise rates to meet the goal. Although 

Building New Generating 

Capacity Could Require 

Capital Expenditures Not 

Included in the Plan 

TVA Will Require 

Continued Management 

Commitment to Reducing 

TFOs 

 20 Baseload plants are normally operated to take all or part of the minimum load of a 

system, and consequently run continuously, producing electricity at an essentially constant

rate. These units are operated to maximize system mechanical and thermal efficiency and 

minimize system operating costs. 

Page 26 GAO-06-810 Tennessee Valley Authority
TVA has a new board structure as of March 31, 2006, the continued 

commitment of the board toward TFO reduction will be needed to meet 

the current goal. 

The growing demand for power could affect TVA’s ability to meet its goal

since TVA’s current projections assume that it will not invest in any new 

generation through 2015, other than restarting BFN 1. TVA’s plan includes

the capital expenditures needed to expand generating capacity in existing

generating facilities to meet projected increases in demand for power 

through 2015. By 2015, however, TVA estimates that it will need more 

baseload generation to meet growth in demand. As a result, it will need to

take action to meet that need during the current TFO reduction period. 

TVA officials are considering a number of options to meet this projected 

increase in demand for power, including partnering with outside parties. 

Growing Demand for 

Power Could Affect 

TVA’s Ability to Meet 

Its TFO Reduction 

Goal 

TVA’s current plan assumes that one option for meeting the growth in 

demand for electricity is by uprating, which is the process of increasing 

the capacity of existing generating assets. To its 30,644 megawatts of 

generating capacity, TVA currently plans to add: 

• 1,280 total megawatts of capacity a year by restarting Browns Ferry 

Unit 1 in fiscal year 2007;

• 125 megawatts each, for a total of 250 megawatts a year, by uprating or 

adding capacity to Browns Ferry Units 2 and 3; 

• approximately 15-30 megawatts of capacity a year through 2015, or a 

total of approximately 150 to 300 megawatts of annual capacity by the 

end of the TFO reduction period, by continuing to modernize its 

hydropower facilities; 

• 36 total megawatts a year by uprating the Raccoon Mountain Pumped 

Storage Plant; and 

• 16 total megawatts a year by uprating the Cumberland Fossil Plant 

through 2010. 

TVA also plans to meet future needs by continuing to purchase low-cost 

power from the Southeastern Power Administration and through other 

long-term contracts. In addition, TVA plans to purchase power from the 

market when it is cheaper than generating its own power. 

Even with these plans in place, TVA expects that it will still need new 

baseload capacity beginning in 2015. TVA officials told us they will 

consider partnering with others to help finance the acquisition of new 

assets or they will consider building new assets themselves if they cannot 

find a suitable partner. TVA expects a partner would help share risk. 

Page 27 GAO-06-810 Tennessee Valley Authority
Although the benefits, costs, and risks would vary depending on the type

of partnership it eventually enters into, according to TVA officials, forming 

a partnership would help meet new demand for electricity while reducing 

the cash requirements for building new generating assets. As of April 2006, 

TVA management did not have any firm plans for a partnership, but were 

discussing potential partnerships with several interested parties. 

One partnering option TVA is considering includes working with the 

NuStart Consortium,21 which selected TVA’s Bellefonte site as one of the 

two potential sites in the country for a new advanced design nuclear plant.

In the late 1980s, TVA stopped construction on Bellefonte, a nuclear plant 

which has never been operated. NuStart plans to use the Bellefonte site, as 

well as one other potential site, on applications for licenses it plans to 

submit for new nuclear plants, but currently there have been no decisions 

to construct a plant. Another option being considered by TVA is entering 

into a partnership with another industry consortium22 to build an 

Advanced Boiling Water Reactor on the Bellefonte site. 

TVA and TVPPA also indicated that TVA’s customers are interested in 

partnering with TVA. Partnering with a customer would allow TVA to earn 

fee income for operating a new generating asset, while its customer would 

finance and own all or a share of the asset. TVA officials also noted that 

TVA’s customers have not owned generating assets before and, as a result, 

may not have the needed in-house expertise, or be familiar with the risks 

involved. Despite ongoing conversations between TVA and potential 

partners, however, there are no current firm plans to partner with another 

party, and TVA could not provide us with criteria it would use in selecting 

partners. As a result, it is difficult to determine TVA’s likelihood of finding 

suitable partners to help meet the growth in demand projected in its 

service territory. 

 21 NuStart Energy Development, LLC, is a limited liability company formed in 2004 with 

nine member companies. These members, plus TVA and two reactor vendors, form the 

NuStart Consortium. The consortium objectives are to: 1) demonstrate the U.S. Nuclear 

Regulatory Commission’s licensing process for obtaining a combined Construction and

Operating License for an advanced nuclear power plant, and 2) complete the design 

engineering for the two selected reactor technologies. 

22 TVA led an industry consortium that prepared a cost and schedule study on building an

Advanced Boiling Water Reactor on the Bellefonte site. This consortium included Toshiba

Corp., General Electric Corp., Bechtel Corp., United States Enrichment Corp., and Global 

Nuclear Fuels—Americas. 

Page 28 GAO-06-810 Tennessee Valley Authority
One of TVA’s largest distributors noted that TVA could also pursue other 

options to reduce the demand for power. These include giving customers 

access to obtaining a portion of their power needs from other suppliers or 

changing the rate structure to provide incentives to reduce the peak

demand for electricity. In 2002, we reported that TVA’s demand-side 

management programs, which are designed to reduce the amount of 

energy consumed or to change the time of day when it is consumed, were

limited in scope and impact when compared to similar programs managed

by other utilities and recommended that, as appropriate, TVA expand its 

demand-side management programs.23 TVA officials told us they have 

continued to expand the use of demand-side-management programs, 

which will reduce the amount of power TVA would need to generate or 

purchase from the market. 

TVA’s decision to complete BFN 1 reversed a policy dating from the late 

1990s to rely primarily on purchasing power from other power suppliers 

when its own power system cannot meet demand. Building new capacity

itself provides two potential key benefits for TVA. First, TVA would likely 

be able to generate power at a lower cost than purchasing a like amount of

power from other utilities, thereby reducing its cost of power. Second, a 

decision to build new generating capacity would give TVA control over its 

source of power and remove the uncertainty of having to rely on other 

utilities for power. It would reduce the chances that TVA would need to 

purchase power from the market when there may be limited excess 

capacity and high prices, but increases the risk that its generating costs 

could be higher than market prices. According to TVA, if it can recover the 

cost of building new generating assets through rates, increased demand 

would have no effect on its ability to meet its TFO reduction goal. 

However, TVA officials acknowledged the need to be sensitive to rate 

increases, stating that raising rates too quickly could trigger action that 

would jeopardize its relationship with customers and ultimately threaten 

its current monopoly status. 

TVA’s $7.1 billion goal for reducing TFOs through 2015 assumes that any 

demand for power not met by its generating capacity will be purchased 

from the marketplace. TVA’s 1997 business plan also assumed that it 

would not invest in any new generating capacity. Ultimately, the need to 

build its own additional generating capacity in lieu of purchasing power 

 23 GAO, Air Quality: TVA Plans to Reduce Air Emissions Further, but Could Do More to 

Reduce Power Demand, GAO-02-301 (Washington, D.C.: Mar. 8, 2002). 

Page 29 GAO-06-810 Tennessee Valley Authority
from the market in the late 1990s meant that TVA increased its capital 

expenditures and reduced the amount of cash available for debt reduction, 

which contributed to its failure to meet the debt reduction goal in its 1997 

business plan. Although TVA currently has no specific plans to build new 

generation, any decision to build new generating assets would likely affect 

its ability to fully meet its TFO reduction goal. 

TVA’s TFO reduction goal was based on a strategic planning approach and

an assessment of market risks and projected cash flow. As with any effort 

that incorporates economic models, there are some limitations and areas

where they could be improved. While TVA’s key business assumptions are 

reasonable, holding them fixed, rather than modeling them as variable 

assumptions, limits the range of outcomes from the model. Modeling 

different scenarios under which TVA may need to meet new 

environmental regulations or pay for new capacity, for instance, would 

allow TVA to better illustrate the possible range of outcomes, and thus the 

uncertainties of many factors in its plan. In addition, while TVA uses a 

variety of factors to estimate key variables, in the case of commodity 

prices, expanding the sources would provide a more comprehensive 

characterization of the range of possible TFO reduction levels in situations

where markets are volatile. Finally, given the numerous factors that could 

affect TVA’s ability to meet its goal, management’s continued commitment 

to reducing TFOs will be necessary to keep TVA on course. 

We are making two recommendations to the Chairman of the Board of 

Directors of the Tennessee Valley Authority to (1) explore additional data 

sources for estimates of key input variables in the Enterprise Risk Model, 

and (2) better illustrate the range of outcomes in the Enterprise Risk 

Model used for planning purposes. Specifically, we are recommending 

that: 

Conclusions 

Recommendations 

• TVA consider incorporating the variability surrounding certain

assumptions that are now held fixed, such as the starting date for 

Browns Ferry Nuclear Unit 1 or possible new environmental 

legislation. In cases where professional judgment is used to quantify 

the uncertainty, the effects of incorporating that judgment should be 

documented.

• TVA augment its sources for projections of key model inputs with 

sources such as commodity prices and the volatility of those prices. 

Market prices for commodities with active futures and options markets 

Page 30 GAO-06-810 Tennessee Valley Authority
can be used to determine the expectations of market participants 

concerning prices and their volatility. 

Agency Comments 

and Our Evaluation 

In written comments on a draft of this report, TVA’s Acting Chief 

Executive Officer, President, and Chief Operating Officer agreed with our 

report and recommendations. We also discussed technical comments with 

TVA officials, which we have incorporated into the final report as 

appropriate. TVA’s written comments are reproduced in appendix I. 

As agreed with your office, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days from its 

date. At that time, we will send copies of this report to appropriate House 

and Senate committees, interested members of the Congress, TVA’s board 

of directors, 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 on matters discussed in this report, 

please contact me at (202) 512-6131, or martinr@gao.gov. Contact points 

for our Offices of Congressional Relations and Public Affairs may be found 

on the last page of this report. GAO staff who made major contributions to 

this report are listed in appendix II. 

Sincerely yours, 

Robert E. Martin 

Director, Financial Management 

and Assurance 

Page 31 GAO-06-810 Tennessee Valley Authority
Appendix I: Comments from the Tennessee Appendix I: Comments from the T Valley Authority ennessee 

Valley Authority 

Page 32 GAO-06-810 Tennessee Valley Authority
Appendix I: Comments from the Tennessee

Valley Authority 

Page 33 GAO-06-810 Tennessee Valley Authority
Appendix II: 

A

GAO Contact and Staff 

cknowledgments 

Page 34 GAO-06-810 

Appendix II: GAO Contact and Staff 

Acknowledgments 

GAO Contact Robert E. Martin, (202) 512-6131 or martinr@gao.gov

In addition to the contact named above, Donald Neff (Assistant Director), 

Lisa Crye, Austin Kelly, Mary Mohiyuddin, and Brooke Whittaker made key 

contributions to this report. 

Tennessee Valley Authority

Acknowledgments 

(197008) 
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