Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Financial Performance

As of September 30, 2002, the financial condition of the FERC was sound with
sufficient funds to meet program needs and adequate control of these funds in place to
ensure FERC obligations do not exceed budget authority. The FERC prepared its
financial statements in accordance with the accounting standards codified in the
Statements of Federal Financial Accounting Standards (SFFAS) and with Office of
Management and Budget (OMB) Bulletin No. 97-01, Form and Content of Agency
Financial Statements, as amended by OMB Bulletin No. 01-09.

Sources of Funds. The FERC receives an appropriation from Congress that is
available until expended. The FERC’s FY2002 new budget authority was $184
million. This represents an increase in new budget authority of $9 million over
FY2001. Additional funds available to obligate in FY2002 were $10 million from
prior-year appropriations. The sum of all funds available to obligate in FY2002 was
$194 million.

Controls, Systems, and Legal Compliance

FERC’s internal control program includes internal reviews conducted by each office.
The Financial Managers Financial Integrity Act (FMFIA) requires that agencies
identify material internal control problems and report them to management. External
auditors, such as the Department of Energy’s Office of Inspector General and the
General Accounting Office, conduct audits annually. This year’s reviews indicate a
reasonable assurance that the Commission’s management controls were working
effectively, that applicable laws were being followed, and that FERC’s resources were
safeguarded against waste, loss or unauthorized use.

Limitations of the Financial Statements

The financial statements have been prepared to report the financial position and results
of operations of the FERC, pursuant to the requirements of 31 U.S.C. 3515(b). While
the statements have been prepared from the books and records of the FERC in
accordance with generally accepted accounting principles for federal entities and the
formats prescribed by OMB, the statements are in addition to the financial reports
used to monitor and control budgetary resources which are prepared from the same
books and records. The statements should be read with the realization that they are for
a component of the U.S. Government, a sovereign entity. One implication of this is
that liabilities cannot be liquidated without legislation that provides resources to do so.

18


(ly

FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

Description of Reporting Entity

The Federal Energy Regulatory Commission (the Commission) is an independent federal agency that
oversees key operating functions of the United States’ natural gas and oil pipeline transportation, electric
utility, and hydroelectric power industries.

The Commission was created through the Department of Energy’s (DOE) Organization Act on
October 1, 1977. The Commission’s predecessor, the Federal Power Commission (FPC), established in
1920, was abolished, and the Commission inherited a significant portion of FPC’s energy agenda.

The Commission administers laws and regulations involving key energy issues. These include
transportation and sale of natural gas and oil in interstate commerce; regulation of electric utility wholesale
rates and transactions; licensing and inspection of private, municipal, and state hydroelectric projects; and
oversight of related environmental matters.

The Commission’s main legal authority is derived from the Federal Power Act of 1935 (FPA), the Natural
Gas Act of 1938, the Natural Gas Policy Act of 1978, and the Public Utility Regulatory Policies Act of
1978.

The Commission’s activities are separated into the following two segments.

The Energy Markets Program

The Commission’s overall objective in regulating oil, gas, and electric energy markets is delivery of
reliable, competitively priced services. It has fostered the emergence of competitive markets and is
addressing key market issues by formulating new regulatory approaches. The Commission monitors
markets to ensure that market-based regulatory strategies remain effective, and it continues
regulating along traditional lines where competition is not adequate. The Commission retains
responsibility for ensuring just and reasonable rates for oil pipeline transmission and for transmission
and sales for resale of natural gas and electric power.

The Energy Projects Program

The Commission licenses nonfederal hydropower projects and issues certificates for the construction
of interstate natural gas pipelines. These projects have economic, environmental, and cultural
implications, all of which must be considered in the licensing or certificating process. In addition, the
Commission determines the safety of hydropower projects and the operational safety and reliability
of liquefied natural gas storage facilities. At the core of the Commission’s efforts is the need to
determine that energy projects are sustainable environmentally and economically.

Cost Recovery

As described below, the Commission recovers 100% of its annual appropriation from the U.S. Treasury
(the Treasury) through annual charges and filing fees authorized by the Omnibus Budget Reconciliation
Act of 1986 and other laws.

39 (Continued)


FEDERAL ENERGY REGULATORY COMMISSION

Statement of Changes in Net Position

Year ended September 30, 2002

Beginning balances
Prior period adjustment (note 14)

Beginning balances, as adjusted

Budgetary financing sources (uses):
Appropriations received
Appropriations used
Transfers-out to Treasury without reimbursement

Other financing sources:
Imputed financing

Total financing uses
Net cost of operations

Ending balances

The accompanying notes are an integral part of these statements.

35

$

$

Cumulative
results of Unexpended
operations appropriations
5,003,900 15,112,335
7,222,919 =
12,226,819 15,112,335
_ 184,155,000
187,615,288 (187,615,288)
(196,621,214) _
8,557,306 =
(448,620) (3,460,288)
(311,671) =
11,466,528 11,652,047


FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

(m) Net Position Accounts

Net position account balances consist of the following components:

Unexpended appropriations - Represents amounts of spending authority that are unobligated and
available to the Commission, or obligated but not expended.

Cumulative results of operations - Represents the Commission’s net results of operations
since inception, including (1) the amount in the Special Receipts Fund Balance with
Treasury, (2) the cost of property and equipment acquired that has been financed by
appropriations, less accumulated depreciation, and (3) the amount of appropriated funding
that will be needed in future periods to liquidate liabilities incurred through the current fiscal
year. Funding for these items is generally received in the year that amounts become due and
payable.

(n) Tax Status

The Commission, as a federal agency, is not subject to federal, state, or local income taxes, and
accordingly, no provision for income tax is recorded.

(0) Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.

(3) Non-Entity Assets
Non-entity assets at September 30, 2002 and 2001 consisted of:

2002 2001

Fund balances with Treasury:
Appropriated fund balance with Treasury $ 88,025 88,930
Collections due to states 2,942,157 2,514,779
Miscellaneous receipts held in suspense 1,661 14,061
Accounts receivable, net 732 2,673
Total non-entity assets 3,032,575 2,620,443
Total entity assets 119,613,584 95,575,519
Total assets $ 122,646,159 98,195,962

44 (Continued)


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

[

a __ | Z_
/ RTOs Approved by FERC in FY 2002

}
ory

ke 7

|
{7
Z

‘RTO West. oo

Guidance Issued
~~" 9/18/2002 |
B20 |

"West Gonnect
Guidance Issued
10/19/2002 _

| R108 approved in Fvon02
ISOSIRTOs Approved Before FY2002
RTO Guidance Recently Issued by FERC

Other Regional Markets

Percentage of Customer Demand Covered
by RTOs Approved by FERC in FY 2002

RTOs Approved in
FY2002
33%

ERCOT
8%

Source: FERC Form 714 net energy for oad data for 2001

12


FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements

September 30, 2002 and 2001

Intragovernmental accrued payroll benefits at September 30, 2002 and 2001 consists of:

2002 2001
Office of Personnel Management $ 868,426 748,363
Social Security Administration 306,479 211,206
Federal Retirement Thrift Investment Board = 104,198

$ 1,174,905 1,063,767

Intragovernmental workers’ compensation payable at September 20, 2002 and 2001 totals $422,836 and
$446,147, respectively, and is due to the Department of Labor.

50


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

FY2002

Performance Measurement

Performance Target

Result

2002.

In addition, on June 17, 2002, NYMEX
and the Chicago Mercantile Exchange
(CME) introduced their e-miNY natural
gas contracts that handle smaller
volumes than standard NYMEX natural
gas contracts, extending the reach of
exchange-traded futures contracts to
smaller energy companies. E-miNY
contracts are traded on CME’s GLOBEX
electronic trading platform.

ICE began over-the counter clearing as
well, in March 2002. On November 7,
2002, ICE announced that total cleared
notional value of natural gas contracts
in the United States had surpassed $10
billion.

Success of these higher-quality
products is a positive sign for energy
markets.

Volume of financial risk-hedging
transactions, e. g. futures contracts

Viable financial markets provide critical
support for physical markets

Futures contracts for natural gas have
shown promise in 2002, strengthening
to what appears to be record levels.

To date, however, there has been no
attempt to revive electric futures
markets in the U.S.

Response of prices to external
conditions in natural gas and electricity
(e.g., events, weather, plant outages)

Large price changes should normally be
associated with some clear external
event

Price differences that have been
associated with external events in 2002
included:

* The Leona fire in California in
September 2002 caused a key
transmission path to be taken out
of service, and caused price
differences between Northern and
Southern California.

.

Hurricanes in the Gulf (Isidore and
Lilli) caused temporary price
increases in natural gas prices in
September, but prices returned to
normal levels after the storms.

Natural gas pipeline capacity into
New York City is sometimes.
constrained, causing significant
price increases. Price increases
occurred at the end of July 2002
and early in August, with prices
rising to a daily midpoint price
$7.65. Although these price
increases were related to capacity
constraints on the pipeline system,
they were nevertheless unusual for
the season and are still being
investigated to assess their cause.

Natural gas prices in Florida have
spiked due to capacity problems
that are exacerbated by lack of
storage capacity. These price
increases have occurred under

22



FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

Annual Charges

The Commission recovers most of its administrative program costs through allocated annual charges to the
entities it regulates, regardless of the number or type of services rendered to any particular entity during the
year. The annual charge assessed in a fiscal year is based on an estimate of costs to be incurred during that
year. Final program costs are determined from year-end accounting reports and time distribution reports by
office and program. The difference in assessments that results from estimated versus final program costs is
an adjustment to the following fiscal year’s assessments. In hydropower regulation, the annual charges
include the Commission’s program costs as well as the related costs incurred by several other agencies that
review the Commission’s hydro license applications under Part I of FPA.

Hydropower

Authority — Section 10(e) of FPA makes the general provision that licensees under Part I of FPA
shall pay reasonable annual charges to recompense the federal government for the costs of
administering Part I.

Implementation — The methods for assessing annual charges to hydropower licensees are codified at
18 Code of Federal Regulations (C.F.R.) Part 11. Costs are prorated based on capacity (municipal
projects), on capacity and generation (nonmunicipal projects), or on a flat rate per horsepower under
1,000 (minor projects).

Gas, Electric, and Oil

Authority — Section 3401 of the Omnibus Budget Reconciliation Act of 1986 provides that the
Commission shall “assess and collect fees and annual charges in any fiscal year in amounts equal to
all of the costs incurred by the Commission in that fiscal year.” It further provides that “fees or
annual charges assessed shall be computed on the basis of methods that the Commission determines,
by rule, to be fair and equitable.”

Implementation — The methods for assessing annual charges to gas and oil pipelines and to electric
utilities and power marketing administrations are codified at 18 C.F.R. Parts 382.201-203. Costs are
prorated to gas pipelines based on volume transported and sold, to electric utilities and power
marketing administrations based on energy sold, and to oil pipelines based on operating revenues.

Filing Fees

Filing fees are calculated annually. Regulated entities pay the current fee when filing with the Commission
for a specific service. The fees are based on the average time spent to perform the particular type of service
and the average cost per employee, including salary, benefits, and indirect costs. Fee structure and
procedures are codified in 18 C.F.R. Part 381.

The Independent Offices Appropriations Act of 1952 (IOAA) authorizes agencies to prescribe regulations
establishing charges for services, benefits, or items of value provided by an agency. In establishing a fee
under the IOAA, the Commission must:

. Identify the service for which the fee is to be assessed;

40 (Continued)


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Office of Markets, Tariffs and Rates (OMTR) — Deals with matters involving markets,
tariffs and rates relating to electric, natural gas and oil pipeline facilities and services.

Office of Market Oversight and Investigation (OMOT) — Oversees and assesses the
operations of the nation’s gas, oil pipeline and electricity markets.

Office of Administrative Law Judges (OALJ) — Resolves contested cases as directed by
the Commission effectively, efficiently and expeditiously, either through impartial
hearing and decision or through negotiated settlement, ensuring that the rights of all
parties are preserved.

Office of the General Counsel (OGC) — Provides legal services to the Commission.
OGC represents the Commission before the courts and Congress and is responsible for
the legal phases of the Commission’s activities. Included in OGC is Dispute
Resolution Service (DRS). DRS assists participants achieve resolution of disputes
through consensual decision making.

Office of Administrative Litigation (OAL) — Represents the public interest in
administrative proceedings at the Commission. OAL provides testimony, exhibits and
studies on electric rate, transmission, open access and restructuring cases and in
natural gas rate-design cases.

Office of External Affairs (OEA) — Responsible for all external communications with
the public and media for the Commission.

Office of the Secretary (OSEC) — Serves as the official focal point through which all
filings are made for proceedings before the Commission.

Office of the Executive Director (OED) — Provides administrative support services to
the Commission including human resources, procurement, organizational
management, financial, logistics, information technology and other.


FEDERAL ENERGY REGULATORY COMMISSION

Balance Sheets
September 30, 2002 and 2001

Assets

Intragovernmental assets —

fund balances with Treasury (note 4)
Accounts receivable, net (note 5)
Due from regulated entities (note 6)
Property and equipment, net (note 7)

Total assets
Liabi

Intragovernmental liabilities:
Accounts payable (note 16)
Accrued payroll benefits (note 16)
Resources transferable to Treasury (note 6)
Miscellaneous receipts transferable to Treasury
Workers’ compensation payable (notes 9 and 16)

ies and Net Position

Total intragovernmental liabilities

Accounts payable

Due to regulated entities (note 6)
Accrued payroll and benefits

Collections due to states (note 3)
Revenue collected under protest (note 13)
Accrued leave (note 9)

Total liabilities
Commitments and contingencies (notes 8 and 13)

Net position:
Unexpended appropriations (note 10)
Cumulative results of operations

Total net position

Total liabilities and net position

The accompanying notes are an integral part of these statements.

33

2001

2002 Restated
$ 93,920,722 59,651,838
14,521,092 11,021,175
_ 12,741,064
14,204,345 14,781,885
$ 122,646,159 98,195,962
$ 1,268,285 937,394
1,174,905 1,063,767
36,199,310 23,741,051
16,661 3,437,001
422,836 446,147
39,081,997 29,625,360
10,385,505 11,971,755
111,973 —
8,405,251 5,591,704
2,942,157 2,514,779
29,062,800 11,821,372
9,537,901 9,331,838
99,527,584 70,856,808
11,652,047 15,112,335
11,466,528 12,226,819
23,118,575 27,339,154
$_ 122,646,159 98,195,962



Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Other Accompanying Information:
Performance Measurement Results

Performance Measurements for Energy Infrastructure (Goal 1)

FY2002

Performance Measurement

Performance Target

Result

Percentage of cases completed in
specified time

Specified time frames for FY2002 to be
determined in FY2001

85% of cases completed within
specified time frames:

> cases that involve no precedential
issues and are unprotected, 159 days;
> cases that involve no precedential
issues and are protested, 304 days; and
> cases of first impression or
containing larger policy implications,
365 days

> cases requiring a major
environmental assessment or
environmental impact statement, 480
days

Number of days to complete 85% of the
cases:

» 119 days for Category 1

» 188 days for Category 2

> 293 days for Category 3

> 475 days for Category 4

Inspect each major onshore
construction project at least once every
four weeks during construction and at
least once after construction completion

100% of qualifying projects inspected
per established schedule

All six major onshore projects were
inspected at least once every four
weeks

Increase the percentage of licenses
issued for applications using alternative
licensing process (ALP)

2% increase over FY2001

9.4% increase over FY2001

Evaluate and improve effectiveness of
required environmental enhancement
and mitigation measures

Conduct 5 site visits to evaluate
effectiveness

Conducted 5 site visits and evaluated
the effectiveness of the targeted
environmental mitigation measures

Hold 2 regional meetings with
stakeholders

Held 3 outreach meetings, 1.e.,
shoreline management workshop in
August 2002, American Fisheries
Society meeting in August 2002, and
water quality workshop in September
2002

Initiate annual reports to evaluate the
effectiveness of this effort

Issued 2 reports titled “Mitigation
Effectiveness Studies at the FERC; An
Overview"; and “Mitigation
Effectiveness Studies at the FERC:
Draft Water Quality Report.”

Percentage of filings addressing the
development of increased capacity

25% of all relicense cases using ALP or
other collaborative process

26% of licenses issued resulted in an
increase in capacity; 27% of licenses
issued based upon collaborative
process (ALP) resulted in an increase in
capacity

Percentage of high- and significant-
hazard potential dams meeting all
current structural safety standards

Percentage remains uniformly high

‘94% of high- and significant-hazard
potential dams met all current structural
safety standards

Percentage of high- and significant-
hazard potential dams inspected
annually

100% of qualifying dams inspected
annually

100% of high- and significant-hazard
potential dams inspected in FY2002

19



Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Transmission Congestion Management
_Systems* Approved by FERC in FY 2002

PUM
Interconnection

=] LMP Appraved in Fy2002

LMP Approved Before FY2002

* A transmission congestion management system is defined as locational marginal pricing (LMP)

Transmission Congestion Management
Systems* Approved by FERC in FY 2002

LMP Approved
in FY 2002
11%

LMP Approved
Before FY 2002
10%

* Atransmission congestion
management system is defined
as Locational Marginal Pricing
(LMP)

‘Source: FERC Form 714 net energy for load data for 2001

25



Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Performance Measurements for Competitive Markets (Goal 2)

FY2002

Performance Measurement

Performance Target

Result

> Number and size of capacity holders
by market

> Number and size of natural gas and
electric secondary market participants
> Number and size of pipeline suppliers
by region and major customer

> Number and size of electric power
marketers.

» Reasonable range of suppliers should
lead to competitive pricing

» Participation indicates confidence in
market rules and oversight

Several significant energy marketers
have announced either pians to exit the
energy trading business, or
consideration of exit. Generally sited
reasons include financial
underperformance and credit concerns.
The resulting contraction can have
negative effects on liquidity in energy
markets.

Companies that have announced
complete or partial exits from energy
trading in recent months include large
players like:

* American Electric Power
* Aquila

. Dynegy

. El Paso

Companies considering exit include

«Allegheny
* CMS

Some players have announced interest
in entering as well, including the Bank
of America.

Increase in types of tariffed services
offered (e.g., parking and lending in
natural gas)

Innovation indicates markets are
working and market participants are
creating their own solutions

In its Annual Performance Report for
Fiscal Year 2001, the Commission
acknowledged the ineffectiveness of
this performance measurement to
evaluate the agency's success at
developing energy markets. New
measurements will be in effect for
FY2003 with attributes the Commission
perceives to be necessary for markets
to function

Increased services in the market
(develop a time line for different
services, e.g., new futures exchanges,
new types of products (e.g., weather
derivatives) and independent
exchanges

New service offerings show adaptation
to price volatility and help to stabilize
markets through hedging of risks

With the end of Enron Online and
Dynegy Direct, wholesale energy
services largely shifted toward stronger,
higher-quality services, including the
New York Mercantile Exchange
(NYMEX) and the Intercontinental
Exchange (ICE).

Enron Online and Dynegy Direct were
not exchanges, but extensions of
Enron’s and Dynegy's marketing efforts.
Consequently, they were susceptible to
the credit weaknesses of their owners.
Exchanges like NYMEX and ICE have
better approaches to managing credit
risk, and consequently are better for the
industry.

For example, NYMEX extended its
credit clearing ability to certain over-the-
counter natural gas and electricity
trades. On October 22, 2002, NYMEX
announced that it had cleared more than
$1.1 billion of these deals since
inception of the service on May 31,

21



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Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

FERC has transferred all of the oversight and investigation responsibilities to OMOI.
All the core functions that OMOI will perform are now within the Office. The
Commission has hired the executive team for the Office, the Office Director, the
Deputy Director for Market Oversight and Assessment and the Deputy Director for
Investigation and Enforcement.

FERC has made substantial progress in defining and implementing an effective
approach to market oversight.

FERC has developed its first working blueprint for what market oversight and
assessment must do. FERC revised Goal 3 of the Commission’s Strategic Plan to
reflect more precisely how it intends to oversee markets. Based on the revised
Strategic Plan, FERC developed a Business Plan that describes the activities OMOI is
undertaking, the products those activities will generate and the resources the
Commission plans to spend on each activity. Together the revised Strategic Plan and
the Business Plan are the best blueprint the Commission has ever had for how it will
oversee markets. While the Business Plan will evolve, it is specific enough to guide
the Commission’s work now and provide a platform for changes in the future.

FERC is already implementing its new approach to market oversight. At the heart of
OMOl’s efforts to analyze and assess energy markets, is a series of periodic reports to
the Commission, which include:

e A periodic Surveillance Report to Commissioners. This report, modeled on
the practice of the Commodities Futures Trading Commission, describes
important market developments directly to Commissioners once every two
or three weeks. The reports are part of a closed Commission meeting to
encourage full and open discussion of market developments. By the end of
the fiscal year, the Surveillance Report had become a routine part of the
Commission’s agenda cycle.

e A semi-annual Seasonal Outlook. FERC produced its first Seasonal
Outlook for the summer of 2002. In the future, FERC will produce one
outlook in the fall (covering the winter heating season) and one in the
spring (for the summer cooling season).

e An annual State of the Markets paper. This paper contains a review of
overall market performance for both gas and electricity and highlights
longer term issues identified by OMOI.

OMOI will also conduct investigations and enforcement actions closely focused on

possible market manipulations and abuses, including random investigations of
activities that could lend themselves to problematic behavior.

16


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

throughout the country and, when adopted, will:

+ Eliminate residual undue discrimination by creating uniform rules for
transmission service across the interstate grid with regional flexibility as
appropriate;

¢ Ensure transmission grid and short-term markets will be operated by a fair,
independent organization (e.g., RTO);

+ Establish procedures to monitor market operations and mitigate market
power and manipulation;

+ Preserve and expand role of states in regional planning, resource adequacy,
and pricing for new resources and facilities;

+ Supplement long-term bilateral contracts with real-time energy markets
that reveal the true costs of transmission congestion and value over
location and time;

+ Manage congestion on the electric grid by price instead of service denial,
creating economic signals for new investments in infrastructure and
technology;

+ Set procedures for minimum long-term regional resource adequacy using
generation, transmission and demand-side resources, with details set by
regional state committees;

+ Permit customers under existing contracts to keep the same level and
quality of transmission service if they choose to;

+ Allow flexible transmission pricing, including participant funding (cost
causers are cost payers) for new transmission facilities;

+ Rationalize and improve power plant transmitting siting with better
signals, participant funding, and regional resource planning; and

+ Create stability and certainty for customers and investors.

This proposal will save customers money because effective wholesale markets will:

+ Achieve more efficient use of the current electric system;

+ Increase the number of new, efficient, clean generators built, which drive
down electricity prices;

+ Treat everyone fairly;

+ Protect existing contracts and service quality for native load;


e Establishing and maintaining internal controls over financial reporting, and preparation of the
Management’s Discussion and Analysis (including the performance measures), required
supplementary information, and required supplementary stewardship information; and

¢ Complying with laws and regulations, including FFMIA.

In fulfilling this responsibility, estimates and judgments by management are required to assess the expected
benefits and related costs of internal control policies. Because of inherent limitations in internal control,
misstatements, due to error or fraud may nevertheless occur and not be detected.

Auditors’ Responsibilities

Our responsibility is to express an opinion on the fiscal year 2002 and 2001 financial statements of the
Commission based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America, the standards applicable to financial audits contained in
Government Auditing Standards and OMB Bulletin No. 01-02. Those standards and OMB Bulletin No. 01-
02 require that we plan and perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement.

An audit includes:

e Examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements;

e Assessing the accounting principles used and significant estimates made by management; and
e Evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In planning and performing our fiscal year 2002 audit, we considered the Commission’s internal control
over financial reporting by obtaining an understanding of the Commission’s internal control, determining
whether internal controls had been placed in operation, assessing control risk, and performing tests of
controls in order to determine our auditing procedures for the purpose of expressing our opinion on the
financial statements. We limited our internal control testing to those controls necessary to achieve the
objectives described in OMB Bulletin No. 01-02 and Government Auditing Standards. We did not test all
internal controls relevant to operating objectives as broadly defined by the Federal Managers’ Financial
Integrity Act of 1982. The objective of our audit was not to provide assurance on internal control over
financial reporting. Consequently, we do not provide an opinion thereon.

As required by OMB Bulletin No. 01-02, with respect to internal control related to performance measures
determined by management to be key and reported in the Management’s Discussion and Analysis, we
obtained an understanding of the design of significant internal controls relating to the existence and
completeness assertions. Our procedures were not designed to provide assurance on internal control over
performance measures and, accordingly, we do not provide an opinion thereon.

As part of obtaining reasonable assurance about whether the Commission’s fiscal year 2002 financial
statements are free of material misstatement, we performed tests of the Commission’s compliance with
certain provisions of laws and regulations, noncompliance with which could have a direct and material
effect on the determination of financial statement amounts, and certain provisions of other laws and
regulations specified in OMB Bulletin No. 01-02, including certain provisions referred to in FFMIA. We

31


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Performance Measurements for Resource Management (Goal 4)

FY2002

Performance Measurement

Performance Target

Result

Number of documents and filings
available and received electronically

10% increase over FY2001

> The percent of qualified documents
received electronically increased from
11.6% to 34.38%

> Number of filings received in FY2001
was 1,968; in FY2002 we reach 8,903.

Reliability of IT infrastructure services

> 98% network availability
> 33% annual PC replacement
> 98% Internet site availability

> 98.5% network availability
> 33% annual PC replacement
> 99.5% Internet site availability

Percentage of agenda items issued

within 5 working days of a Commission 100% 100%
meeting
Percentage of electric notices issued 95% 95%

within 5 working days of receipt of filing

Unqualified opinion on annual financial
statements

Unqualified opinion

Commission received an unqualified
opinion on its FY2001 financial
statements

Monitor manage-to-budget concept

Track biweekly; review quarterly

Performed bi-weekly updates to
manage- to-budget spreadsheets used
by managers to track spending, and
reviewed status quarterly

Effective and efficient financial and
administrative support

> Collect annual charges within 45 days
of billing

> 98% of invoices paid by electronic
funds transfer

> 1% increase in contract awards and
purchase orders to small, minority, and
women-owned businesses

» All contracts advertised online

> All contracts performance-based

> Collected 98% of the annual charges
it assessed in FY2002 within 45 days of
billing

» Processed 100% of payments
electronically

» 92% increase

> All contracts were advertised online
» All contracts were performance-
based

Increase diversity of staff in high grades

Increase diversity in GS-14, GS-15, and
SES positions by 10% over current
baseline

Increased the number of minorities in
GS-14, GS-15 and SES positions by
five (or 6 percent).

Number of new hires from recruitment
program

Meet the Commission's need for new
talent through targeted recruitment, with
50% at entry levels

Exceeded 50% target level by 2%. Of
the 103 permanent hires in FY2002, 54
were entry level recruits. Met the
Commission's need for new talent
through targeted recruitment.

Staff participation in learning and
development programs

> Expand leadership development
program

> Implement development plans for
20% of staff

> Initiate employee rotational
development program

> Completed 360-degree feedbacks
with senior staff

> Developmental plans for all new
Federal Career Intern Program (FCIP)
interns

> Draft proposal for a pilot rotational
development program in OED

Periodic manager-staff discussions
about performance accomplishments.
and improvements

Expand to 3 major offices the program
for quarterly discussions on
performance objectives

Made available to major offices the
program for quarterly discussions on
performance objectives. Completed the
program in two offices.

Percentage of awards presented for
helping accomplish specific
Commission goals

More than 50% of awards for quality
service based on accomplishments
supporting strategic objectives

The target level was met. Based on the
responses regarding FY2002 incentive
awards more than 50% of awards were
given for quality service based on
accomplishments supporting strategic
objectives.

28



Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Strategic Plan and Business Plan

The United States has the world’s most durable market economy, every sector of
which depends vitally on energy. FERC’s primary duty is to make natural gas and
electric power markets work well and thereby support a strong, stable national
economy.

During the past two years, American energy markets have suffered a series of shocks
from sustained high electric and natural gas prices in the West due to the collapse of
Enron. These shocks have had long-term as well as short-term effects. In the short
term, customers have sometimes paid very high prices for power. In the longer term,
the financial instability of the industry and uncertainty about how markets will operate
in the future has discouraged the infrastructure investment that is necessary to ensure
the long-term health of the industries. FERC has responded to both the immediate
market disruptions and the need for stable, fair long-term market structures.

California was among the first states to open its electric industry to competition,
opening a restructured market in 1998. Until June 2000, California’s electric markets
appeared to work well. However, California’s flawed market rules failed to send
generators signals to build new capacity, even while the state experienced rapid
economic growth. The lack of new capacity made the California market vulnerable. In
2000, a series of other conditions exposed that vulnerability: a severe drought curtailed
hydropower; demand-side response was virtually non-existent, partly because of fixed
retail rates; and a hot summer followed a cold winter. The balance between supply and
demand tightened, and electric prices rose dramatically.

FERC responded to the crisis in Western energy markets by mitigating unjustifiably
high electric prices and ensuring that power sellers did not withhold supplies to drive
prices up. These measures provided customers with relief from extreme spot market
prices. FERC also removed a series of regulatory obstacles to expedite providing
increased energy supplies to the West. Since June 2001, throughout the West, electric
prices have dropped to normal levels and below, and remained there. Several factors
led to this result: reduced demand, relatively mild weather, increased supplies and
FERC’s price mitigation. Nonetheless, it is abundantly clear that market crises can
erupt quickly, especially in electricity. If not prevented or treated quickly, they can do
enormous damage.

The Commission responded to allegations of market manipulation by Enron by
undertaking a large-scale investigation, not only of Enron but also of all other market
participants in the West. That investigation clearly showed ways in which Enron and
others could manipulate the markets. FERC is continuing investigations of specific
company practices. Equally important, FERC has instituted measures to prevent such
behavior in the future. Similarly, FERC showed how unregulated companies could
take loans from regulated subsidiaries in hopes that rate-payers might cover the losses
in case of default. The Commission is currently examining ways to prevent customers


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Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Finally, OMOT has begun an aggressive program of partnering with entities that must
be part of an effective overall oversight program — other Federal regulatory agencies
and MMUs at RTOs.

We are addressing our key human capital needs.

OMOI is obtaining the resources it needs. OMOI currently has about 90 employees on
board at the end of FY2002 and is recruiting for additional positions. We have
budgeted for the Office to have 110 full-time equivalents (FTEs) in FY2003. We have
also budgeted $500,000 in contract dollars to obtain other resources that possess the
expertise that we will need. We have hired more than 30 experts from outside the
Commission. These include the Office Director and Deputy Office Directors. We have
also greatly increased our expertise in financial markets, hiring a whole division of
financial experts. Finally, OMOI is actively hiring for the senior level positions
authorized by the Office of Personnel Management to recruit employees with
extensive market-oriented expertise who can lead market oversight.

The Commission as a whole is taking action. We have undertaken a number of human
capital initiatives. By offering early outs and buyouts, we are freeing up resources that
can be redirected to program offices to augment market oversight capabilities. OMTR
and OMOI are examining how to meet their needs for additional employees with
market-oriented skills. OMTR is working with the Human Resources staff to post
positions outside the Commission for high-level subject matter experts.

The Human Resources staff has begun a Workforce Planning effort involving
representatives of major program and support offices. Office representatives are
examining workload priorities, existing workforce capabilities and skills, future skills
and staffing needs and strategies for closing identified gaps. This effort is tied to the
Commission’s strategic plan and will produce a blueprint for action on critical human
capital issues.

The bottom line on market oversight and investigation is that we have moved rapidly
to establish a credible program that is already producing valuable results.

17


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

goal will ensure that competitive energy markets benefit the Nation over the long run.
FERC has established a new office to coordinate all market oversight and investigative
activity. FERC needs a much stronger ability to recognize and respond to problems in
the markets. At the systemic level, FERC needs to recognize problems when or before
they develop and craft solutions quickly. The Commission must also be able to police
individual behavior in markets much more effectively than in the past. Work toward
this goal also includes more traditional work, such as some aspects of litigation,
dispute resolution, complaints, mergers and auditing.

4. Resource Management. Goal: Strategically Manage Agency Resources. The
Commission will be unable to meet programmatic challenges without management
support. This includes enhancing the talents and skills of the staff through recruitment
and training, building effective, customer-friendly information technology (IT)
services, supporting the Commission with logistics and financial services and
strengthening strategic management processes. This goal also covers the
Commission’s communication, outreach and collaboration efforts.

FERC adopted its first annual Business Plan in September 2001, detailing the
Commission’s activities and resource allocations to meet the Strategic Plan’s goals and
objectives. The Business Plan enables management to tie budget resources to
Commission activities. To build in accountability, the Business Plan also identifies
responsible offices, due dates and priorities. Developing the Business Plan is an
iterative process. In its early stages, it is helping to identify which activities move the
Commission toward particular goals and objectives. Future iterations will better refine
priorities, identify gaps in implementation, organize resource allocation, and ensure
the results the Commission wants to see by allowing FERC to more accurately
compare estimated to actual resource use by strategic goals.

Looking Ahead — Making Markets Work

Since June 2001, electric prices across the West have dropped to normal levels and
below and remained there with relatively minor exceptions. Several factors led to this
result: reduced demand, relatively mild weather, increased supplies and the
Commission’s price mitigation. Nonetheless, it is clear that market crises can erupt
quickly, especially in electricity, and the Commission is acting to provide a much more
stable long-term platform for electricity markets. Two initiatives are especially
important:

+ Standard Market Design (SMD), and
+ Market Oversight and Investigation.

SMD. On July 31, 2002, the Commission proposed for public comment a new rule
which will facilitate the adopting of standard designs for electric power markets using
the best practices from around the country and the world. SMD, which will permit
regional flexibility, is a comprehensive proposal for shaping electric markets


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

FY2002

Performance Measurement

Performance Target

Result

higher load conditions or when
Operational Flow Orders have
limited pipeline capacity.

Level of price volatility and changes in
price volatility in electricity and gas

Changes in price patterns over time can
reveal underlying market conditions

Futures price information indicates a
slight lowering of price volatility for
natural gas since June 2002, in
comparison to 2001. From June to
September, 30-day volatilities for the
near-month contract have ranged from
40 to 70, compared with 80 to 100
during the last quarter of 2001.

Without futures prices, similar
calculations cannot be made for
electricity; however, volatility has clearly
dropped from pre 2002 levels.

Correlation of commodity prices across
regions; narrowing of commodity price
differences in the absence of
transmission constraints

Correlations should be near 1.0, except
when transmission constraints bind and
prevent free flow of commodities

This performance measure is intended
to gauge the extent to which arbitrage is
causing prices to clear across regions —
if arbitrage is effective, price difference
should narrow. For 2002, this measure
was studied by examining price
difference identifying causes that were
preventing arbitrage from being
effective, or conducting further study to
identify causes. These analyses of
external conditions are described above
under the performance measure for the
responsiveness of prices to external
conditions.

Increased use of market hub services in
natural gas and electricity

Growth of electronic services for the
commodity and/or transportation

Increased economic transmission
distance

> Increased usage of market
infrastructure indicates market depth
and liquidity

> Increased electronic commerce
reduces transactions costs and allows
broader market participation

Use has been affected negatively by
contraction in the industry (see
performance measure 1 of this section).

Higher quality options have replaced
lower quality options and are showing
some strength (see performance
measure 3 of this section).

Growth in RTOs and the associated
development of regional markets in the
Midwest (MISO) and through additions to
Pennsylvania-New Jersey-Maryland
(PJM) have begun to provide the basis
for the needed market infrastructure. PIM
has added additional utilities as part of
PJM west and is beginning the process of
adding AEP and other utilities. MISO has
begun operation and is planning the
development of markets along the lines of
the Commission's Standard Market
Design (SMD.) In addition, there are
designs being discussed among MISO
and PJM for the operation of a joint
market. These developments will begin to
reduce the transactions costs of
participation in a broader power market.

Investment in generation and
transmission

Investment should be adequate to meet
market needs

There has been substantial growth of
generation capacity in 2002.
Nationwide, approximately 71,000
megawatts of electricity capacity is
expected to be added in 2002, on top of
around 42,000 megawatts added in
2001. The total capacity added in these
two years (113,000 MW) is greater than

23



FEDERAL ENERGY REGULATORY COMMISSION

Fiscal Year 2002 Annual Financial Report


(6)

FEDERAL ENERGY REGULATORY COMMISSION

Notes to Financial Statements
September 30, 2002 and 2001

2001
Annual
charges
Entity (note 6) Other Total
Uncollected billings $ 20,386,987 19,502 20,406,489
Allowance for doubtful accounts (9,842,765) (987) (9,843,752)
Total entity accounts
receivable, net 10,544,222 18,515 10,562,737
Nonentity
Uncollected billings 1,960,608 2,673 1,963,281
Allowance for doubtful accounts (1,504,843) oe (1,504,843)
Total nonentity
accounts receivable, net 455,765 2,673 458,438
Total accounts receivable,
net $ 10,999,987 21,188 11,021,175
Resources Transferable to Treasury
Resources transferable to Treasury at September 30, 2002 and 2001 consist of:
2002 2001
Accounts receivable, net related of annual charges (note 5) $ 14,488,104 10,999,987
Fund balance with Treasury 21,823,179 —
Total net accounts receivable 36,311,283 10,999,987
Due from (to) regulated entities (111,973) 12,741,064
Total resources transferable to Treasury $

36,199,310

23,741,051

The fund balance with Treasury amount as of September 30, 2002 above relates to certain revenue initially
collected under protest which was settled in the Commission’s favor in late September 2002. The

resources were transferred to the Treasury in October 2002.

46

(Continued)


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

OMOI will give FERC the ability to identify market conditions and address market
problems quickly and effectively. This is a necessary part of restoring public
confidence in energy markets. FERC has developed a new Commission meeting
process to update Commissioners frequently on market developments, the first
essential change in how the Commission does business in many years.

Program Performance

To ensure the FERC is making strides in fulfilling its mission, the Commission
developed its Strategic Plan and Business Plan as discussed above, as well as
performance measures, in accordance with the Government Performance and Results
Act of 1993 (GPRA). Performance measures included in this overview were drawn
from the FERC’s Annual Performance Plan as submitted to Congress with the FERC’s
FY2002 Budget Request as well as the FY2001 Annual Performance Report (March
2002), which assesses FY2001 performance efforts and highlights the goals for
FY2002 and FY2003. At this point it is essential to note that the FY2002 performance
measures were developed prior to the electricity crisis in the Western United States
and the collapse of Enron. They were also developed prior to creation of the
Commission’s new Strategic Plan. Hence, FERC believes several of the measures (in
particular those associated with Competitive Markets and Market Oversight) are
ineffective. The Commission is working to develop better performance measures to
capture the effectiveness and efficiencies of its programs based on the Commission’s
new strategic direction. A complete list of the Commission’s FY2002 performance
measures and results is included at the end of this Management’s Discussion and
Analysis (MD&A) as other accompanying information.

As mentioned previously, the Commission’s most significant activities in FY2002
were the development of a Standard Market Design and the creation of the
Commission’s OMOI. The Commission has selected the following three measures for
inclusion in this MD&A relating to the formation of regional transmission
organizations as key to the success of SMD and the effective operation of OMOI.

The Commission began advancing competitive markets through establishment of
RTOs and development of a SMD. As previously stated, when a SMD is
implemented, electric markets will have a strong long-term basis for providing
customers with the very real and significant benefits that come from competition.
After the country is required to adopt some form of SMD, new performance
measurements will be developed to track its success.

10


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

+ Prevent California-type melt-downs through market oversight and market
power mitigation;

+ Reduce price volatility; and

- Assign risk to the market, not customers.

The Commission's proposal will also improve reliability and security of the nation’s
infrastructure because effective wholesale power markets will:

+ Use stable and balanced market rules to encourage investment in new
generation, transmission and demand reduction;

+ Make smart use of the existing transmission grid by using latest
technologies;

+ Encourage investment in new technologies that offer greater efficiencies
and better environmental solutions;

+ Adopt cyber-security standards that reduce grid vulnerability to terrorism;
+ Increase and identify new resources available due to long-term planning and
adequacy requirements, reducing short-term scarcity and outages; and
+ Locate resources smarter and closer to customers, making the grid more

reliable and secure.

When SMD is implemented, electric markets will have a strong long-term basis for
providing customers with the very real — and very large — benefits that come from
competition. For these reasons, the Commission is committed to properly formulating
the rule in order to support reliable competitive markets in all regions across the
country. Tailoring the market design so that the markets are established in a way that
work most effectively in each region of the country is paramount. The intent of the
standard market design proposal is to build on RTOs introduced in Order No. 2000,
where the Commission recognized the need for regional variation in certain aspects of
market design. In the Southeast and the West, for example, the Commission has
recently reaffirmed this need for reliance on the formation of RTOs and regional
differences that come naturally from that process.

Market Oversight and Investigation. One of the clearest lessons of the electric
market crisis is that FERC needs to do a much better job of policing natural gas and
electric markets and at addressing problems before they become severe. In the spring
of 2002, the Commission established a new Office of Market Oversight and
Investigation. This Office’s job is to make sure that energy markets work. It will, for
example:

+ By working with regional market monitors, serve as the “cop on the beat”
to identify individual players who abuse their market position;

+ Provide objective benchmarks to assess market conditions and
infrastructure needs; and

+ Identify and remedy problems in the way markets are structured or
operating.


(c)

(a)

(e)

FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

Basis of Accounting

The Commission’s financial statements are prepared using the accrual method of accounting. The
accrual method of accounting requires recognition of the financial effects of transactions, events, and
circumstances in the period(s) when those transactions, events, and circumstances occur, regardless
of when cash is received or paid. The Commission also uses budgetary accounting to facilitate
compliance with legal constraints and to monitor its budget authority at the various stages of
execution, including allotment, obligation, and eventual outlay.

Revenue and Financing Sources

As described above, the Commission receives funds for its operating and capital expenditures
through an appropriation allotment from DOE. For financial statement purposes, the appropriation
allotment is recognized as a financing source when operating expenses (primarily salaries and
benefits), other than depreciation, are incurred and when capital assets are purchased.

The Commission recognizes revenue for hydropower, gas, oil, and electric annual charges when
earned. Annual charges are based on estimated current year program costs and adjustments from the
prior year. At year-end, the Commission records a due from or to regulated entities to reflect the
difference between the charges and the actual program costs for the year. The Commission adjusts
the subsequent year’s charge for such amount. Revenue is recognized for filing fees when received.

The Commission recognizes an imputed financing source for the estimated annual pension and life
and health insurance costs in excess of contributions made by the Commission during the year.
These costs will ultimately be funded by the Office of Personnel Management.

Reimbursable work agreement revenue, included in other programs’ earned revenue, is recognized
when the related services are rendered.

Transfers-out represent receipts collected and remitted to the Treasury during the year and net
accounts receivable that, once collected, will be returned to the Treasury, less any amounts due to
regulated entities for the excess of estimated and billed costs over actual costs incurred.

Fund Balances with Treasury

The Commission does not maintain cash in commercial bank accounts. Cash receipts and
disbursements are processed by the Treasury. The balance of funds with the Treasury represents
appropriated funds that are available to pay current liabilities and finance authorized purchase
commitments relative to goods or services that have not been received.

Allowance for Doubtful Accounts

The Commission calculates its allowance for doubtful accounts using historical collection data and
specific account analysis.

42 (Continued)


In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of the Commission as of September 30, 2002 and 2001, its net costs and changes in
custodial activities for the years then ended and its changes in net position, budgetary resources, and
reconciliation of net costs to budgetary obligations, for the year ended September 30, 2002, in conformity
with accounting principles generally accepted in the United States of America.

As discussed in Note 13 to the financial statements, the balance sheet as of September 30, 2001 has been
restated.

The information in the Management’s Discussion and Analysis section and note 15 to the financial
statements is not a required part of the financial statements, but is supplementary information required by
accounting principles generally accepted in the United States of America or OMB Bulletin No. 01-09,
Form and Content of Agency Financial Statements. We have applied certain limited procedures, which
consisted principally of inquiries of management regarding the methods of measurement and presentation
of this information. However, we did not audit this information and, accordingly, we express no opinion on
it.

INTERNAL CONTROL OVER FINANCIAL REPORTING

Our consideration of internal control over financial reporting would not necessarily disclose all matters in
the internal control over financial reporting that might be material weaknesses under standards issued by
the American Institute of Certified Public Accountants. Material weaknesses are conditions in which the
design or operation of one or more of the internal control components does not reduce to a relatively low
level the risk that misstatements, in amounts that would be material in relation to the financial statements
being audited, may occur and not be detected within a timely period by employees in the normal course of
performing their assigned functions. However, we noted no matters involving the internal control and its
operation that we considered to be material weaknesses as defined above.

We did, however, note other matters involving internal control over financial reporting and its operation
that we will report to the management of the Commission in a separate letter.

COMPLIANCE WITH LAWS AND REGULATIONS

The results of our tests of compliance with certain provisions of laws and regulations described in the
Responsibilities section of this report, exclusive of Federal Financial Management Improvement Act
(FFMIA), disclosed no instances of noncompliance that are required to be reported herein under
Government Auditing Standards or OMB Bulletin No. 01-02.

The results of our tests of FFMIA disclosed no instances in which the Commission’s financial management
systems did not substantially comply with the three requirements discussed in the Responsibilities section
of this report.

RESPONSIBILITIES
Management’s Responsibilities
Management is responsible for:

e Preparing the financial statements in conformity with accounting principles generally accepted in
the United States of America;

30


FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

(7) Property and Equipment, Net
Property and equipment, and related accumulated depreciation at September 30, 2002 and 2001 consisted

of:
2002
Acquisition Accumulated
amount depreciation Net
Equipment $ 4,979,504 3,077,125 1,902,379
Furniture 9,070,773 6,211,587 2,859,186
Leasehold improvements 9,491,415 3,282,687 6,208,728
Software 11,246,911 8,012,859 3,234,052
Total $ 34,788,603 20,584,258 14,204,345
2001
Acquisition Accumulated
amount depreciation Net
Equipment $ 3,402,217 3,207,413 194,804
Furniture 9,070,773 5,304,510 3,766,263
Leasehold improvements 9,491,415 2,808,115 6,683,300
Software 10,527,308 6,389,790 4,137,518
Total $ 32,491,713 17,709,828 14,781,885

(8) Building Leases

The General Services Administration (GSA) enters into lease agreements for government buildings and
maintains those lease agreements. The Commission pays GSA a standard level users charge for the annual
rental of building space. The standard level users charge approximates the commercial rental rates for
similar properties. The Commission is not legally a party to any building lease agreements; therefore, the
Commission does not disclose future minimum lease payments on buildings.

(9) Liabilities Not Covered by Budgetary Resources
Liabilities not covered by budgetary resources at September 30, 2002 and 2001 consisted of:
2002 2001
Intragovernmental — workers’ compensation payable $ 422,836 446,147
Accrued leave 9,537,901 9,331,838
Total $ 9,960,737 9,777,985

47 (Continued)


Independent Auditors’ Report

The Federal Energy Regulatory Commission and the
Inspector General, United States Department of Energy:

We have audited the accompanying balance sheets of the Federal Energy Regulatory Commission (the
Commission) as of September 30, 2002 and 2001, the related statements of net costs and changes in
custodial activities for the years then ended and the related statements of changes in net position, budgetary
resources, and financing for the year ended September 30, 2002 (herein after referred to as the financial
statements). The objective of our audits was to express an opinion on the fair presentation of these financial
statements. In connection with our audits, we also considered the Commission’s internal control over
financial reporting and tested the Commission’s compliance with certain provisions of applicable laws and
regulations that could have a direct and material effect on its financial statements.

SUMMARY

As stated in our opinion on the financial statements, we concluded that the Commission’s financial
statements as of and for the years ended September 30, 2002 and 2001, as presented in the Commission’s
fiscal year 2002 Annual Financial Report, are presented fairly, in all material respects, in conformity with
accounting principles generally accepted in the United States of America.

As discussed in Note 13 to the financial statements, the balance sheet as of September 30, 2001 has been
restated.

Our consideration of internal control over financial reporting would not necessarily disclose all matters in
the internal control over financial reporting that might be material weaknesses under standards issued by
the American Institute of Certified Public Accountants. However, we noted no matters involving the
internal control and its operation that we considered to be material weaknesses.

The results of our tests of compliance with laws and regulations disclosed no instances of noncompliance
that are required to be reported herein under Government Auditing Standards, issued by the Comptroller
General of the United States, or Office of Management and Budget (OMB) Bulletin No. 01-02, Audit
Requirements for Federal Financial Statements.

The following sections discuss our opinion on the Commission’s financial statements, our consideration of
the Commission’s internal control over financial reporting, our tests of the Commission’s compliance with
certain provisions of applicable laws and regulations, and management’s and our responsibilities.

OPINION ON THE FINANCIAL STATEMENTS

We have audited the accompanying balance sheets of the Commission as of September 30, 2002 and 2001,
the related statements of net costs and changes in custodial activities for the years then ended and the
related statements of changes in net position, budgetary resources, and financing for the year ended
September 30, 2002.

29


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

from suffering from such behavior.

In the aftermath of the electricity crisis in the Western United States, the Commission
comprehensively revised and approved a new Strategic Plan on September 26, 2001.
FERC developed a comprehensive Business Plan that aligns all of the activities it
undertakes with the new Strategic Plan.

Given the experience of Western energy markets, it is now clear that the Commission’s
primary emphasis must be to facilitate a full transition to competitive wholesale energy
markets as soon as possible, and to address crucial issues that arise during the
transition. FERC’s most important responses are:

= A New Sense of Focus and Direction. This is embodied by the
Commission’s new Strategic Plan, which forms the structure for both its
budget and its efforts in the future.

= An Increased Emphasis on Market Oversight and Investigation. This
is embodied in the third of the Commission’s four goals, discussed below.

The new Strategic Plan lays out the Commission’s goals in four areas:

1. Energy Infrastructure. Goal: Promote a Secure, High-quality,
Environmentally Responsible Infrastructure Through Consistent Policies. This
goal will encourage investment in the infrastructure needed to sustain energy markets
by removing roadblocks, providing cost recovery clarity and welcoming innovative
thinking about rates and use of new technology. By focusing on infrastructure, this
goal covers many of the Commission’s important traditional responsibilities, for
example, pipeline certificates, hydropower licenses and preliminary permits,
compliance activities, environmental and other licensing conditions, dam safety
inspections and most rate determinations.

2. Competitive Markets. Goal: Foster Nationwide Competitive Energy Markets
as a Substitute for Traditional Regulation. This goal focuses on FERC’s need to
complete the transition to competitive energy markets as quickly and comprehensively
as possible. This will require the growth of many new institutions, particularly clearly
defined and independent regional transmission organizations (RTOs), to make electric
markets work. The Commission also needs to establish standardized market designs
that will apply in every wholesale electric market, and encourage continued efforts by
industry groups to standardize reliability and business practice standards, promote the
use of demand-side participation in energy markets, and establish regional
transmission planning. Along with some traditional work in the area of rate
determinations, this goal furthers work on initiatives begun in the last couple of years
such as RTOs and new policies for natural gas.

3. Market Oversight. Goal: Protect Customers and Market Participants
Through Vigilant and Fair Oversight of the Transitioning Energy Markets. This


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

FY2002

Performance Measurement

Performance Target

Result

Percentage of high- and significant
hazard potential dams in compliance
with emergency action plan
requirements

100% of qualifying dams in compliance

100% of high- and significant hazard
potential dams in compliance with
emergency action plan requirements

Update and add new chapters to the
Engineering Guidelines, as appropriate

Complete revisions to Chapter 3 Gravity
Dams

Chapter 3 — Gravity Dams and Chapter
8 — Hydrology were completed

Complete development of the dam
performance monitoring program

Performance monitoring program
established

Performance monitoring program was
established and a pilot program was
implemented

20



FEDERAL ENERGY REGULATORY COMMISSION
Statement of Financing
Year ended September 30, 2002

Resources used to finance activities:
Budgetary resources obligated:
Obligations incurred
Less: spending authority from offsetting collections

Obligations, net of offsetting collections

Other resources:
Imputed financing from costs absorbed by others
Transfers-out, net of appropriations received

Net other resources used to finance activities
Total resources used to finance activities

Resources used to finance items not part of the net cost of operations:
Change in budgetary resources obligated for goods/services/benefits ordered
but not yet provided
Resources that finance the acquisition of assets
Payments to states
Other resources and adjustments

Total resources used to finance items not part of the
net cost of operations

Total resources used to finance the
net cost of operations

Components of the Net Cost of Operations that will not require or generate resources
in the current period:
Components requiring or generating resources in future periods —
increase in exchange revenue receivable from the public

Components not requiring or generating resources:
Depreciation and amortization
Reduction in allowance for doubtful accounts receivable
Other

Total components of net cost of operations that will not
require or generate resources

Total net cost of operations that do not require or
generate resources in current period

Net cost of operations

The accompanying notes are an integral part of these statements.

37

$

$

196,490,146

(184,324,676)
12,165,470

8,557,306

(12,399,620)
(3,842,314)
8,323,156

(3,393,749)
2,760,932
5,507,239

(155,324)
4,719,098

3,604,058

(3,129,385)

3,338,473
(4,406,731)

905,256
(163,002)

(3,292,387)

311,671


FEDERAL ENERGY REGULATORY COMMISSION
Statements of Custodial Activity
Years ended September 30, 2002 and 2001

Sources of collections:
Cash collections — annual charges
Accrual adjustment

Total custodial revenue

Disposition of revenue:
Transferred to others:
United States Army — Corps of Engineers
Department of Interior
United States Treasury
Other agency costs
Increase in amounts to be transferred

Net custodial activity

The accompanying notes are an integral part of these statements.

$

2002 2001
15,958,829 25,258,662
40,697 485,190
15,999,526 25,743,852
(6,365,704) (6,387,014)
(6,086,508) (5,271,878)
(201,458) (101,245)
(2,807,648) (13,415,990)
(538,208) (567,725)



Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Performance Measurements for Market Oversight (Goal 3)

FY2002

Performance Measurement

Performance Target

Result

Number of market monitoring
institutions and systems

Increase over FY2001

Performance target achieved. See the
map “RTOs Approved by FERC in
FY2002.” Market monitoring activities
are conducted by market monitoring
units (MMUs) within approved RTOs
and independent system operators
(ISOs). A statistical breakdown is,
provided in the graph “Percentage of
Customer Demand Covered by RTOs
Approved by FERC in FY2002.” (See
map and graph on page 12)

Number of public utilities separating
ownership or operation of transmission
facilities from generation

Increase over FY2001

Performance target achieved. See the
map “RTOs Approved by FERC in
FY2002." For public utilities, separation
of ownership or operation of
transmission facilities from generation
is a condition of approval to participate
in an RTO. A statistical breakdown is
provided in the graph “Percentage of
Customer Demand Covered by RTOs
Approved by FERC in FY2002.” (See
map and graph on page 12)

Separating energy transmission
ownership or operation from energy
production and sale is a circumstance of
joining an ISO or RTO and serves to
help prevent manipulation of the
transportation system. While the
Commission promotes and encourages
forming RTOs, it has not directed
companies to join; therefore, this
performance measurement does not
attain its intended purpose of measuring
the Commission's success or failure in
achieving such separation and
effectively constrain some kinds of
market power. After implementation,
measurements that capture relevant
aspects of standard market design
should be more effective in tracking the
Commission's success at developing
energy markets (@.g., increase in the
percentage of the country covered by
independent transmission providers)

Number of requests and referrals for
Alternate Dispute Resolution (ADR)
services

25% increase over FY2001

Dispute Resolution Service (DRS):
There were 52 requests in FY2001, and
51 requests in FY2002. This represents
a slight decrease. However, this amount
also reflects an increase in the DRS
non-case projects and development of
stakeholder programs.

The 51 request or active cases includes
simple inquiries about ADR, cases in
which persons eventually indicated that
they were not interested in using ADR,
cases referred to Enforcement Hotline,
and ongoing cases.

Percentage of customers satisfied with
ADR processes

85%

QALJ/OAL: Participants report near
100% satisfaction with ADR procedures.
Satisfaction is indicated by calls from
participants and by the increase in ADR
procedures.

26



Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Mission

. Assures pro-competitive market structures and operations; and
. Remedies individual market participant behavior as needed to ensure
just and reasonable market outcomes.

The Department of Energy Organization Act created the FERC on October 1, 1977,
and abolished its predecessor, the Federal Power Commission (FPC). The
Commission is composed of five members who are appointed by the President, with
the advice and consent of the Senate. Commissioners serve five-year terms and have
an equal vote on regulatory matters. No more than three members may belong to the
same political party. The President designates one member to serve as Chairman and
administrative head of the Commission. The Commission generally meets twice a
month to transact business. Meetings are open to the public under the provisions of the
Government in the Sunshine Act.

The Commission collects the full cost of its operations from annual charges and fees
authorized by the Federal Power Act (FPA), Omnibus Budget Reconciliation Act of
1986 and other laws. Congress annually adopts a budget appropriation authorizing the
Commission to use funds from the Treasury to meet operating expenses. The
Commission returns to the Treasury all revenue from annual charges and fees;
therefore, there is no direct taxpayer funding.

The Federal Energy Regulatory Commission regulates and
oversees energy industries in the economic and environmental
interest of the American public.

Organizational Structure

Approximately 1,184 full time equivalents carried out the Commission’s mission in
FY2002 utilizing a budget of $184.2 million.

Below is a list of offices within the agency as well as a short description of the role
they play in the Commission’s operations. In FY2002, FERC established two new
offices, the Office of Market Oversight and Investigation and the Office of
Administrative Litigation. An organizational chart for the FERC, as of November 10,
2002, is included at the end of this section.

Office of Energy Projects (OEP) — Fosters economic and environmental benefits for
the nation through the approval and oversight of hydroelectric and natural gas pipeline
energy projects that are in the public interest. Included in OEP are FERC’s five
regional offices located in Atlanta, Georgia; Chicago, Illinois; New York, New York;
Portland, Oregon and San Francisco, California.


(4)

(5)

FEDERAL ENERGY REGULATORY COMMISSION

Notes to Financial Statements
September 30, 2002 and 2001

Fund Balances with Treasury

Fund balances with Treasury at September 30, 2002 and 2001 consisted of:

Fund balances:
Appropriated funds
Revenue collected under protest
Special receipts fund
Other

Total
Unobligated budgetary resources:
Available
Unavailable
Obligated balance not yet disbursed

Total

Accounts Receivable

2002 2001
47,770,932 34,655,787
29,062,800 11,821,372

7,222,919 7,222,919
9,864,071 5,951,760
93,920,722 59,651,838
1,762,681 8,488,718
42,624 2,509,653
92,115,417 48,653,467
93,920,722 59,651,838

Entity and nonentity governmental accounts receivable at September 30, 2002 and 2001 consisted of:

Entity

Uncollected billings
Allowance for doubtful accounts

Total entity accounts
receivable, net

Nonentity

Uncollected billings
Allowance for doubtful accounts

Total nonentity
accounts receivable, net

Total accounts receivable,
net

2002

Annual
charges
(note 6) Other Total
19,427,676 42,870 19,470,546
(5,436,034) (10,614) (5,446,648)
13,991,642 32,256 14,023,898
2,355,649 732 2,356,381
(1,859,187) — (1,859,187)

496,462 732 497,194

32,988

14,488,104

45

14,521,092

(Continued)


(g)

(h)

@

@

(k)

@

FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation. The Commission capitalizes
property (other than furniture) and equipment purchases with a cost greater than $25,000 and a total
useful life exceeding two years. The Commission capitalizes furniture purchases with a cost greater
than $50,000, and commercially purchased or developed software with a cost greater than $25,000.
Depreciation is calculated based on an estimated useful life of 20 years for leasehold improvements,
10 years for furniture, 2 to 5 years for commercially purchased or developed software, and 5 years
for all remaining assets. Expenditures for repairs and maintenance are charged to program costs as
incurred.

Liabilities
Liabilities represent amounts owed by the Commission as the result of transactions or events that

have occurred as of year-end. Liabilities for which Congress has not appropriated funds are disclosed
in note 9 as liabilities not covered by budgetary resources.

Revenue Collected Under Protest

Revenue collected under protest is deferred and recorded as a liability until the protest is resolved.

Collections Due to States

The Commission disburses 50% of the fees it collects from licensees for the occupancy and use of
public lands to affected states in the year following collection. These collections are initially
deposited into the Treasury’s miscellaneous receipts fund.

Accrued Leave

Annual leave is accrued as a liability as it is earned. The accrual is reduced as leave is taken. Each
year, the balance in the accrued annual leave account is adjusted to reflect current year pay rates. To
the extent that the current or prior year appropriations are not available to fund annual leave earned
but not taken, funding will be obtained from future appropriations. Sick leave and other types of
nonvested leave are charged to expense as the leave is used.

Workers’ Compensation Payable

The Federal Employees Compensation Act (FECA) provides income and medical cost protection to
cover federal civilian employees injured on the job, employees who have incurred a work-related
occupational disease and beneficiaries of employees whose death is attributable to a job-related
injury or occupational disease. Claims incurred for benefits for the Commission’s employees under
FECA are administered by the Department of Labor (DOL) and are ultimately paid by the
Commission. The workers’ compensation payable represents unpaid billings to DOL. An actuarial
estimate of unbilled claims is recorded by DOE at the departmental level and was not separately
calculated for the Commission.

43 (Continued)


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

Standard Market Design addresses all three of our strategic program goals. It will
promote the development of the energy infrastructure the nation needs by:

Providing a resource adequacy requirement for all regions of the country.
While the specifics of the requirement may differ from one region to
another, the bottom line is that no region will be able to ignore future
needs. A shortage of operating capacity is one of the factors that led to the
price run-up in California. One key to this provision of SMD is that
demand and supply alternatives will compete equally. That will promote
efficient investment in whatever resources will best meet the needs of the
region.

Encouraging market entry (in conjunction with the related interconnection
initiative). SMD and the interconnection initiative will ensure that all
resources will be treated equally in gaining access to the transmission grid.

Introducing locational pricing for electric power and congestion revenue
tights (CRRs) for those who have rights to firm transmission service. This
will identify the value of power at different places around the grid. It
makes clear where new resources would be most valuable, thereby
promoting investment where it will do the most good for customers. CRRs
provide a financial mechanism by which customers can obtain protection
from congestion costs.

Requiring a regional planning process. This will involve all states in the
region in balancing appropriate investment across the entire region with
cost recovery by the customers that benefit from the investment. Planning
across the region rather than across only a single utility's system will yield
optimal solutions for the region and will facilitate the siting of facilities
that may be located in one state but may benefit customers in a
neighboring state.

SMD will develop healthy power markets in several ways. For instance, it will:

Require that independent transmission providers (ITPs) operate day-ahead
and real-time power markets. These will be visible markets that
participants can trust, because the operator is independent of all those with
a position in the market. They will be markets that can work because they
are based on proven designs that are already being used in the Northeast.
They will be markets that ease entry into the electric business because they
will be as standard as practical around the country and will allow demand
to compete equally with supply.

At the same time, be sufficiently flexible to accommodate differences
among regions. For example, it will have provisions to address the specific

13


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

market designs in all parts of the country. While several aspects of the Commission’s
proposal have been controversial, through ISOs and RTO proposals, most regions have
implemented or have committed to implement key elements of SMD. These elements
include independent operation of the transmission grid, regional transmission
planning, common energy and ancillary service markets and a single transmission
tariff for the region, market monitoring and market power mitigation, locational
pricing and congestion management. The progress already achieved has significantly
improved and broadened the geographic scope of such markets and already provides a
defense against major market failures. FERC anticipates that SMD and RTOs will
continue to develop over 2003, resulting in better markets and better guarantees
against failure.

Market Oversight and Assessment

The events of 2000 and 2001 showed that the Commission must develop and impove
its capability to oversee and investigate energy markets. The General Accounting
Office (GAO) listed three key challenges facing the Commission:'

¢ The Commission’s organizational structure limited the effectiveness of its
oversight program because there was not sufficient focus on the problem;

¢ The Commission had not defined and implemented an effective approach
to overseeing competitive energy markets; and

e The Commission faced significant challenges in addressing its human
capital needs.

In FY2002, FERC moved aggressively to meet these challenges.

FERC has given market oversight the organizational structure it needs. OMOI
became a formal, functioning Office within the Commission, in 2002. OMOI reports
directly to the Chairman for administrative purposes. FERC has also designed a new
agenda process so that OMOI reports directly to all of the Commissioners on market
oversight and enforcement matters. As a result, market oversight and enforcement now
has equal weight with more traditional forms of regulation in the Commission’s
deliberations.

1 GAO, Energy Markets: Concerted Actions Needed by FERC to Confront Challenges That Impede Effective
Oversight, issued June 2002, but largely describing conditions as they were before formation of the Office of Market
Oversight and Investigation.

15


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

MANAGEMENT’S DISCUSSION AND ANALYSIS

Introduction

As authorized by the Reports Consolidation Act of 2000, this report presents the
Federal Energy Regulatory Commission’s (FERC’s, the Commission’s) audited
annual financial statements and its success in meeting its fiscal year 2002 performance
goals.

This document contains information about the FERC’s principal financial statements
for fiscal year 2002 (FY2002), including a balance sheet; statements of: net cost;
changes in financial position; budgetary resources; financing; and custodial activity;
and notes to the financial statements. Additionally, it presents an overview of the
FERC, its mission and organizational structure, and performance information. It serves
as a guide to key FERC initiatives and activities taking place during FY2002, and
planned for future years that demonstrate the breadth of the Commission’s work.

Overview of the FERC

The FERC is an independent regulatory agency within the Department of Energy that:

. Regulates the transmission and sale of natural gas for resale in
interstate commerce;

. Regulates the transmission of oil by pipeline in interstate commerce;

. Regulates the transmission and wholesale sales of electricity in
interstate commerce by public utilities;

. Licenses and inspects private, municipal and state hydroelectric
projects;

. Conducts environmental analyses related to the siting of natural gas
pipelines, and the licensing of hydroelectric projects;

. Administers accounting and financial reporting regulations and
conduct of jurisdictional companies;

. Approves site choices as well as abandonment of interstate pipeline
facilities;

. Promotes understanding of energy market operations and technologies;


FEDERAL ENERGY REGULATORY COMMISSION
Statement of Budgetary Resources
Year ended September 30, 2002

Budgetary resources:

Budget authority $ 5,482,057
Unobligated balance 8,488,718
Spending authority from offsetting collections earned 184,324,676

Total budgetary resources

Status of budgetary resources:

Obligations incurred $ 196,490,146
Unobligated balances available and apportioned 1,762,681
Unobligated balances — not available 42,624
Total status of budgetary resources $ 198,295,451
Relationship of obligations to outlays:

Obligated balance, net — beginning of period $ 26,145,765
Obligations incurred 196,490,146
Spending authority from offsetting collections (184,324,676)
Obligated balance, net — end of period (note 12) (34,046,107)
Total outlays $ 5,128

Outlays:
Disbursements $ 188,459,730
Collections (184,194,602)

Net outlays $ 4,265,128

The accompanying notes are an integral part of these statements.

36


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

FY2002

Performance Measurement

Performance Target

Result

the total capacity added from 1990 to
1999 (87,000 MW.) At the same time,
many future projects have been
cancelled or tabled as a result of lower
prices in forward markets and the
financial problems of many companies.
The current outlook is for adequate
generation supplies in the near term,
but an uncertain outlook in the longer
term that will require continued
assessment.

Transmission investment increased in
2002 compared with previous years,
roughly in proportion to the growth in
generation. Thus, transmission capacity
remains adequate for basic reliability
and to accommodate the basic needs of
interconnecting new generation
capacity. However, there has been no
evidence that transmission capacity has.
been expanded to address the needs of
a changing market structure.

Number and type of reliability-related
incidents (emergencies, involuntary load
reductions, transmission load relief
(TLRs))

Emergencies should be infrequent;
routine market rules should be able to
handle most situations

TLR events have not decreased in 2002.
This is one of the issues that the
Commission is addressing in the
Standard Market Design rulemaking.

Amount of load covered by regional
institutions

20% increase over FY2001

Performance target achieved. See map
“RTOs Approved by FERC in FY2002.”
The map shows a number of RTOs that
received approval or preliminary
guidance during FY2002. A statistical
breakdown is provided in the graph
“Percentage of Customer Demand
Covered by RTOs Approved by FERC
in FY2002." (See map and graph on
page 12)

Amount of load with congestion
management systems

20% increase over FY2001

Performance target (12) achieved. See
map “Transmission Congestion
Management Systems Approved by
FERC in FY2002.” A statistical
breakdown is provided in the graph
“Transmission Congestion Management
Systems Approved by FERC in
FY2002." (See map and graph on page
25)

Number of wholesale service options
available

Increase

Prior to FY2002, the Commission
believed tracking the number of
wholesale service options available
would provide a measure for increased
pricing efficiency. This indicator became
invalid once the Commission began
advancing competitive markets through
development of a standard market
design. When a standard market design
(SMD) is implemented, electric markets
will have a strong long-term basis for
providing customers with the very real
and significant benefits that come from
competition. After the country is
required to adopt some form of SMD,
new measurements will be developed to
track its success (e.g., lowering costs
through standardized features, etc.).

24



FEDERAL ENERGY REGULATORY COMMISSION
Fiscal Year 2002 Annual Financial Report

Management’s Discussion and Analysis:

Introduction

Overview of the FERC

Mission

Organizational Structure

Strategic Plan and Business Plan
Looking Ahead — Making Markets Work
Program Performance

Financial Performance

Controls, Systems, and Legal Compliance
Limitations of the Financial Statements
Other Accompanying Information

Financial Statements:

Independent Auditors’ Report
Balance Sheets

Statements of Net Cost

Statement of Changes in Net Position
Statement of Budgetary Resources
Statement of Financing

Statements of Custodial Activity
Notes to Financial Statements

Table of Contents


(10)

(11)

(12)

FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

Unexpended Appropriations
Unexpended appropriations at September 30, 2002 and 2001 consist of:

2002 2001
Unobligated — available $ 1,762,681 8,488,718
Undelivered orders 9,889,366 6,623,617
Total unexpended appropriations $ 11,652,047 15,112,335

Pension Expense

Commission employees participate in either the Civil Service Retirement System (CSRS) or the Federal
Employees’ Retirement System (FERS). Employees participating in CSRS contribute 7% of their gross
pay to the plan, and the Commission makes a matching contribution.

On January 1, 1987, FERS went into effect pursuant to Public Law 99-335. Most employees hired after
December 31, 1983, are automatically covered by FERS and Social Security. Employees hired prior to
January 1, 1984, could elect either to join FERS and Social Security or remain in CSRS. FERS offers a
savings plan in which the Commission automatically contributes 1% of employees’ pay and matches any
employee contribution up to an additional 4% of pay. For most employees hired since December 31, 1983,
the Commission also contributes the employer’s matching share for Social Security.

The actuarial present value of accumulated benefits, assets available for benefits, and unfunded pension
liability of CSRS and FERS is not allocated to individual departments and agencies and is therefore not
disclosed by the Commission. Total pension expense paid by the Commission for both plans for fiscal
years 2002 and 2001 was approximately $10.9 million and $10.3 million, respectively. During fiscal year
2002 and 2001, an additional $8.6 million and $7.5 million, respectively, of pension and life and health
insurance expense was recognized by the Commission for amounts that will ultimately be funded through
the Office of Personnel Management. This amount is also recorded as an imputed financing source.

Statement of Budgetary Resources

The obligated balance, net - end of period at September 30, 2002 is comprised of the following
components:

Accounts receivable $ (732)
Unfilled customer order from Federal sources (18,630)
Undelivered orders 9,889,366
Accounts payable 24,176,103

Total obligated balance, net — end of period $ 34,046,107

48 (Continued)


limited our tests of compliance to the provisions described in the preceding sentence, and we did not test
compliance with all laws and regulations applicable to the Commission. Providing an opinion on
compliance with laws and regulations was not an objective of our audit and, accordingly, we do not
express such an opinion.

Under OMB Bulletin No 01-02 and FFMIA, we are required to report whether the Commission’s financial
management systems substantially comply with (1) Federal financial management systems requirements,
(2) applicable Federal accounting standards, and (3) the United States Government Standard General
Ledger at the transaction level. To meet this requirement, we performed tests of compliance with FFMIA
Section 803(a) requirements.

DISTRIBUTION

This report is intended for the information and use of the Commission’s management, the Department of
Energy's Office of the Inspector General, OMB and the U.S. Congress, and is not intended to be and
should not be used by anyone other than these specified parties.

KPMG LEP

January 3, 2003

32


FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

. Explain why that particular service benefits an identifiable recipient more than it benefits the
general public;

e Base the fee on as small a category of service as possible; and

. Demonstrate what direct and indirect costs are incurred by the Commission in rendering the
service.

Section 3401 of the Omnibus Budget Reconciliation Act of 1986 also provides for fees and annual charges
“computed on the basis of methods that the Commission determines, by rule, to be fair and equitable.”

(2) Summary of Significant Accounting Policies

(a)

(b)

Basis of Presentation

The accompanying financial statements have been prepared to report the financial position of the
Commission and its net costs, changes in net position, budgetary resources, reconciliation of net
costs to budgetary obligations, and custodial activity in accordance with accounting principles
generally accepted in the United States of America applicable to federal government entities.

These financial statements have also been prepared in accordance with the form and content for
financial statements specified by Office of Management and Budget (OMB) in Bulletin 01-09, Form
and Content of Agency Financial Statements. As permitted by that Bulletin, the Commission has
presented comparative fiscal year 2001 information for only the Balance Sheet, the Statement of Net
Cost, and Statement of Custodial Activities.

The financial statements include all activity related to the Commission’s portion of appropriation
(89X0212), including the budget authority allotted by DOE to other DOE agencies. In addition, the
Commission receives small allotments from six DOE appropriations: (8990224), (8980224),
(89X0224), (89X0240), (89X0243), and (89X5105). All of the Commission’s appropriations relate
to budget functional classification code 276, Energy Information Policy and Regulation.

Entity assets disclosed in notes 3 and 5 include those assets that the Commission has the authority to
use in its operations.

Nonentity assets disclosed in notes 3 and 5 include those assets that result from the Commission’s
custodial billing activities for other federal agencies, including the Army Corps of Engineers and the
Bureau of Reclamation.

Budgets and Budgetary Accounting

Congress annually adopts a budget appropriation that provides the Commission with authority to use
funds from the Treasury to meet its operating and capital expenditure requirements. The appropriated
funds are not restricted to use in a specific fiscal year. All revenue from annual charges and filing
fees is remitted to the Treasury when received.

41 (Continued)


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

FY2002

Performance Measurement

Performance Target

Result

DRS: 90% (21 out of 23 completed
cases).

Note: This includes 10 cases that were
begun prior to FY2002 but completed in
FY2002. It does not include simple
inquiries about ADR (6), cases in which
persons eventually said they were not
interested in using ADR (7), cases
referred to Enforcement Hotline (1), or
cases that were ongoing into FY2003
(14).

Percentage of processes that achieve
consensual agreements

> ADR processes

> Cases set for litigation resolved, at
least in part, through consensual
agreement

» 25% increase over FY2001
» 5% increase over FY2001

QALJ/OAL: Settlements were achieved
in 69 out of 79 cases through ADR
procedures.

During FY-2002: 69 out of 79 cases
(86.3%) were completed through ADR.
In FY-2001: 62 out of 77 cases were
completed through ADR (80.5%)

DRS: 20 of 23 cases (87%) that were
completed in FY2002 achieved
settlement. Note: This includes 10
cases that were begun prior to FY2002
but completed in FY2002. It does not
include simple inquiries about ADR (6),
cases in which persons eventually said
they were not interested in using ADR
(7), cases referred to Enforcement
Hotline (1), or cases that were ongoing
into FY2003 (14).

Percentage of cases in time frames.
» ADR processes completed

» litigated cases reaching initial
decision

> 20% of ADR cases within 60 days

> 30% of ADR cases within 100 days
> 75% of ADR cases within 150 days
» 100% of ADR cases within 200 days
> 95% of simple litigated cases within
206 days (29.5 weeks)

> 95% of complex litigated cases within
329 days (47 weeks)

> 95% of exceptionally complex cases,
441 (63 weeks)

> 95% of regular complaints, 60 days
> 95% of fast track complaints, 8 days

ADR Cases - OALJ/OAL: 69 cases
were completed by settlement:

4 out of 69 cases were settled within 60
days (5.8%).

11 out of 69 cases sere settled within
100 days (15.9%).

18 out of 69 cases were settled within
150 days (26%).

11 out of 69 cases were settled within
200 days (16%).

25 out of 69 cases were settled after
200 days (36%).

ADR Cases - DRS : Of 23 completed
cases:

5 were completed within 60 days (21%
total).

7 more were completed within 100 days
(52% total).

1 more was completed within 150 days
(57% total).

2 more were completed within 200 days
(60% total).

The remaining 8 were completed in over
200 days.
Litigated Cases — OALJ/OAL:

Track | Cases — Standard processing
Time = 29.5 weeks ~ None during FY-
2002.

Track Il Cases ~ Standard Processing
time = 47 weeks — FY-2002 average
Processing Time 32.5 weeks

Track Ill Cases — Standard Processing
Time = 63 weeks — FY-2002 Average
39.42 weeks

Complaint Cases - FY-2002
Complaints

All took > 60 days to resolve.

27



Federal Energy Regulatory Commission

Fiscal Year 2002 Annual Financial Report

FY2002

Performance Measurement

Performance Target

Result

Amount of load covered by regional
institutions

20% increase over FY2001

Performance target achieved. See map
“RTOs Approved by FERC in FY2002.”
The map shows a number of RTOs that
received approval or preliminary
guidance during FY2002. A statistical
breakdown is provided in the graph
“Percentage of Customer Demand
Covered by RTOs Approved by FERC in
FY2002.” (See map and graph on page
12)

Number of public utilities separating
ownership or operation of transmission
facilities from generation

Increase over FY2001

Performance target achieved. See the
map on page 11 titled "RTOs Approved
by FERC in FY2002.” For public utilities,
separation of ownership or operation of
transmission facilities from generation is
a condition of approval to participate in
an RTO. A statistical breakdown is
provided in the graph “Percentage of
Customer Demand Covered by RTOs
Approved by FERC in FY2002." (See
map and graph on page 12)

Note: Separating energy transmission
‘ownership or operation from energy
production and sale is a circumstance of
joining an ISO or RTO and serves to
help prevent manipulation of the
transportation system. While the
Commission promotes and encourages
forming RTOs, it has not directed
companies to join; therefore, this
performance measurement does not
attain its intended purpose of measuring
the Commission's success or failure in
achieving such separation and
effectively constrain some kinds of
market power. After implementation,
measurements that capture relevant
aspects of standard market design
should be more effective in tracking the
Commission's success at developing
energy markets (e.g., increase in the
percentage of the country covered by
independent transmission providers).

Number of market monitoring
institutions and systems

Increase over FY2001

Performance target achieved. See the
map “RTOs Approved by FERC in
FY2002.” Market monitoring activities
are conducted by market monitoring
units (MMUs) within approved RTOs
and independent system operators
(ISOs). A statistical breakdown is
provided in the graph “Percentage of
Customer Demand Covered by RTOs
Approved by FERC in FY2002.” (See
map and graph on page 12)

1



(13)

(14)

(ds)

(16)

FEDERAL ENERGY REGULATORY COMMISSION
Notes to Financial Statements
September 30, 2002 and 2001

Contingencies

Certain licensees have filed appeals with the Commission challenging the basis for other agencies’ costs
included in the annual charges billed by the Commission. These appeals total $29.1 million and
$11.8 million as of September 30, 2002 and 2001, respectively, and are included in revenue collected
under protest. If these licensees were to prevail in their argument that there is no substantial evidence to
support the other agencies’ costs at issue, then the Commission might be obligated to grant relief not only
for the appellants, but also to all other similarly situated licensees, of which there are over 600. Related
losses cannot be estimated at this time.

Prior Period Adjustment

During the year ended September 30, 2002, the Commission corrected its balance sheet for the omission of
certain fund balances identified by the Treasury as unavailable receipts. This adjustment totaled
$7,222,919 and increased fund balances with Treasury and cumulative results of operations as of
September 30, 2001.

The Commission currently bills regulated companies as a custodian for certain federal agencies, including
the Army Corps of Engineers and the Bureau of Reclamation. The receivables are maintained by the
Commission, and the collections are processed directly to each federal agency on a monthly basis. In
addition to the annual charges billed yearly, penalty and administrative costs are assessed on past-due bills
and remitted to the Treasury when received. For fiscal years 2002 and 2001, these custodial transactions
totaled approximately $16.0 million and $25.7 million, respectively.

Custodial Activity

The Commission currently bills regulated companies as a custodian for certain federal agencies, including
the Army Corps of Engineers and the Bureau of Reclamation. The receivables are maintained by the
Commission, and the collections are processed directly to each federal agency on a monthly basis. In
addition to the annual charges billed yearly, penalty and administrative costs are assessed on past-due bills
and remitted to the Treasury when received. For fiscal years 2002 and 2001, these custodial transactions
totaled approximately $16.0 million and $25.7 million, respectively.

Required Supplementary Information — Intragovernmental Balances (Unaudited)

Intragovernmental accounts payable at September 30, 2002 and 2001 consists of:

2002 2001
Government Printing Office $ 641,763 647,725
General Services Administration 416,518 135,007
Veterans Administration 63,933 60,000
Office of Personnel Management 18,215 50,000
Department of Health and Human Services 27,308 32,000
Others 100,548 12,662

$ 1,268,285 937,394

49 (Continued)


Federal Energy Regulatory Commission
Fiscal Year 2002 Annual Financial Report

issues raised by energy-limited resources (such as hydroelectric power),
and intermittent power sources (such as wind and some other renewables).

Respect state prerogatives in relation to bundled retail load. It works with
state systems that include retail access and those that do not. It respects the
rights of States to use cost-of-service rate-making to price power for retail
customers. It anticipates the use of participant funding for new
transmission, thereby protecting retail customers from paying for lines
needed to serve other loads. And it lets entities that serve retail customers
receive the CRRs needed to ensure that retail customers need not pay for
congestion that may arise from increased market activity.

Finally, SMD will protect customers and market participants from market abuses. For
instance, it will:

Require the transmission operator to be fully independent of market
participants.

Impose market mitigation to prevent the exercise of market power. This
mitigation begins with the resource adequacy requirement that is designed
to prevent shortages from arising. It includes an absolute bid cap that will
ensure offers to sell cannot exceed a certain level (perhaps $1,000 per
megawatt hour as is currently done in Northeast markets). It also includes
provisions directed specifically at load pockets that prevent any generator
which is located in the load pocket from bidding an amount greater than its
costs plus a reasonable return during periods of transmission congestion.
Finally, it includes optional mitigation measures that could apply during
periods of sustained market stress.

Create market monitoring units (MMUs) in each region. The MMUs will
be responsible for overseeing market performance, identifying problems
and responding as needed. The MMUs will work closely with the
Commission’s new OMOI to ensure that there is fair and vigilant oversight
in the markets to prevent market abuses.

While at this time, SMD is only a proposed rule in many parts of the country, RTOs
and independent system operators (ISOs) are already implementing the key features of
SMD. In the Northeast, most SMD features are already in place — and the region is
continuing to move toward a single market design across all three ISOs. For example,
New England will implement locational marginal pricing (LMP) in 2003. California,
Texas (ERCOT) and the Midwest also are already implementing most SMD features.
Even in regions that do not yet have functioning independent system operators or
RTOs, RTO proposals have incorporated much of SMD. This is particularly true of
the Northwest (RTO West) and parts of the Southeast (SeTrans).

In summary, over the past year, the Commission has led a major effort to improve

14