Tennessee Valley Authority: Assessment of the 10-Year Business Plan
Published: 1999-04-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Pursuant to a congressional request, GAO provided information on the Tennessee Valley Authority's (TVA) 10-year business plan, focusing on whether the 10-year plan: (1) addresses key issues facing TVA; (2) takes into consideration all applicable costs and revenue sources; (3) contains goals and assumptions that are achievable or reasonable and in line with industry estimates and expectations; and (4) has been updated to reflect significant changes in key goals and assumptions or actual experience.
section_title: What GAO Found
paragraphs: GAO noted that: (1) implementation of the 10-year plan is moving TVA in the right direction toward its strategic objectives by addressing the key issues it faces--its high fixed financing costs and large investment in nonproducing and other deferred assets that have not been recovered through utility rates; (2) the plan calls for lowering fixed costs by reducing outstanding debt by about one-half--to about $14 billion--by 2007; (3) the plan also provides for the recovery through rates of all but about $500 million of the $8.5 billion in deferred assets outstanding as of the plan issuance date; (4) the year 2007 is key for TVA because it expects to face greater competitive pressures by then and because many long-term contracts with customers could expire at about that time; (5) the plan emphasizes changes designed to enable TVA to offer competitive rates by the end of 2007; (6) while focusing on the right issues, TVA's plan does not fully address certain costs; (7) the plan does not include: (a) the capital costs of increasing generating capacity to meet the growth in demand for power as is now planned; instead, it provides for meeting the growth in demand for power by purchasing power from other utilities; (b) the costs of complying with new and proposed environmental regulations; and (c) the costs of nonpower programs that were formerly fully funded through appropriations; (8) TVA estimates that these additional costs will total about $1 billion over the remaining life of the plan and will likely be higher; (9) GAO also found that while many of the plan's goals and assumptions were achievable or reasonable, certain of them were not, largely due to the additional expected costs described above; (10) some of these additional costs could be offset by increases in expected market rates of power in 2007; (11) because of the additional costs not addressed in the 10-year plan, it is unlikely that TVA can reduce its debt to the extent planned by 2007; (12) estimates in TVA's fiscal year 2000 federal budget request indicate that its debt reduction goal will likely not be achieved until 2009; (13) however, since it is not possible to accurately predict what the market price of power will be in 2007, TVA could still achieve its objective of offering competitively priced power, even if it does not fully achieve the plan's other goals and objectives; and (14) while TVA has acknowledged major changes to several of the plan's goals and assumptions and has factored these into its internal planning, the 10-year plan has not been formally updated to reflect these changes.

section_title: Letter
paragraphs: This report responds to your June 5, 1998, and September 24, 1998, requests  asking us to review the Tennessee Valley Authority’s (TVA) 10-year  business plan.  Increasing competition in electricity markets led TVA  management to develop this plan to position TVA to be more competitive  by, among other things, reducing its high debt servicing and other fixed  costs.  Because of concerns about TVA’s ability to achieve the 10-year plan’s  objectives by 2007—when competitive pressures are likely to be greater  and when many of TVA’s long-term contracts could expire—you asked us to  determine whether TVA will be able to reduce debt as envisioned in the  plan and whether its goals and assumptions regarding capital expenditures  and revenues and expenses are achievable or reasonable.
In order to obtain more information about TVA’s competitive position as  you consider its role in a deregulating electricity industry, you specifically  asked us to determine whether the 10-year plan (1) addresses key issues  facing TVA, (2) takes into consideration all applicable costs and revenue  sources, (3) contains goals and assumptions that are achievable or  reasonable and in line with industry estimates and expectations, and (4) has been updated to reflect significant changes in key goals and  assumptions or actual experience.  In addition, you asked us, based on our  analysis of the plan, to conclude whether TVA is likely to achieve the plan’s  strategic objectives.
subsections: section_title: Background
paragraphs: The Energy Policy Act of 1992 (EPAct) provides TVA with certain  protections from competition.  Additionally, under the TVA Act of 1933  (TVA Act), as amended, TVA is not subject to most of the regulatory and  oversight requirements that must be satisfied by commercial electric  utilities; instead, all authority to run and operate TVA is vested in its three- member board of directors.  In 1959, the Congress amended the TVA Act by  establishing what is commonly referred to as the TVA “fence,” which  prohibits TVA—with some exceptions—from entering into contracts to sell  power outside the service area that TVA and its distributors were serving  on July 1, 1957.  Under EPAct, TVA is exempt from having to allow other  utilities to use its transmission lines to transmit power to customers within  TVA’s service area.  This legislative framework generally insulates TVA  from direct wholesale competition and, as a result, TVA remains in a  position similar to a regulated utility monopoly.
However, TVA is still subject to some forms of indirect competition.  For  example, TVA has no protection against its industrial customers relocating  outside its service area or businesses deciding not to move to its service  area for reasons related to the cost of power.  In addition, customers can  decide to generate their own power.  Accordingly, TVA is currently subject  to some competitive pressures.
EPAct’s requirement that utilities make their transmission lines accessible  to other utilities to transmit (wheel) wholesale electricity has enabled  wholesale customers to obtain electricity from a variety of competing  suppliers and has resulted in increased wholesale competition in the  electric utility industry across the United States.  This requirement does not  apply to TVA if the power is going to be consumed within its service  territory.  Most of TVA’s sales are wholesale because they are to its power  distributors.  In addition, continuing deregulation efforts in some states  have led to competition at the retail level.  Industry experts expect that  retail deregulation will continue to occur on a state-by-state basis over the  next several years.  As this occurs, industrial, commercial, and, ultimately,  residential consumers will be able to choose their power supplier from  among several competitors rather than from one utility monopoly, as is  now the case for long distance telephone service and cellular phones.
Because EPAct exempts TVA from having power wheeled to consumers in  its territory, TVA has not been directly impacted by the ongoing  deregulation of the electric utility industry to the same extent as other  utilities.  However, if TVA were to lose its exemption from the wheeling  provisions of EPAct, its customers would have the option of obtaining their  power from other sources after the expiration of their contracts.  Under  legislation proposed by the administration to promote retail competition in  the electric power industry, which TVA supports, TVA's exemption from the  wheeling provisions of EPAct would be eliminated after January 1, 2003.  If  the legislation is enacted, TVA may be required to use its transmission lines  to transmit the power of other utilities for consumption within TVA's  service territory.  In addition, the proposed legislation would remove the  statutory restrictions that prevent TVA from selling power outside its  service territory.
Most of TVA’s power is sold to municipal and cooperative power  distributors who would be directly affected in the future by retail  competition through their customers’ ability to choose alternate power  suppliers.  Further, deregulation and the possibility of TVA losing its  legislative protections have made many of TVA’s customers more aware of  price differences among utilities, raised expectations of lower prices, and  increased demands for more competitive pricing.
Because of these ongoing deregulation efforts, TVA management, like many  industry experts, anticipates that TVA may lose its legislative protections in  the future.  Even if TVA does not lose its legislative protections, TVA’s  management has recognized the need to take action to better position TVA  to be competitive in an era of increasing competition and customer choice  and, in July 1997, issued a 10-year business plan with that goal in mind.   TVA established a 10-year horizon for implementing the key changes  outlined in the plan largely because TVA officials expect to be facing  greater competitive pressures within that time frame and many of its long- term contracts with customers could begin to expire in 2007.  The  published plan, which formed the basis of our evaluation, contains three  strategic objectives: reducing TVA’s cost of power in order to be in a position to offer  competitively priced power in 2007, increasing financial flexibility by reducing fixed costs, and building customer allegiance.
In developing the 10-year plan, TVA set several goals and made certain  assumptions about the future.  These goals and assumptions are that the future market price of wholesale power will be 3.4 to 3.5 cents per  kilowatthour (kWh) by 2007; annual growth in demand through 2007 will average 2 percent; fuel costs will increase 1.7 percent annually through 2007; improvements in supply chain management will save $50 million  annually;
TVA’s labor force will be reduced and additional cost savings will be  achieved through the creation of shared services and other initiatives; debt will be reduced by about one-half to about $14 billion, and the  balance of deferred assets will be reduced from $8.5 billion to $500 million—TVA’s estimated net realizable value of these assets; capital expenditures will be limited to about $600 million annually and  increases in demand through 2007 will be met primarily through  purchased power; $200 million will be saved annually through cost improvement initiatives  primarily related to refinancing Federal Financing Bank (FFB) and  public bond debt, pursuing changes to its retirement plan, and  improving business processes; revenues from power sales will be increased by about $325 million  annually by implementing a rate increase in 1998 and maintaining it  through 2007; and customer relations will improve through new contract and pricing  options.
To implement the 10-year plan, TVA has developed action plans and has  linked the goals and objectives of the 10-year plan to its corporate and  business unit goals.  For example, one of TVA’s corporate goals is to lower  costs; one of the 10-year plan’s strategic objectives is to increase financial  flexibility by reducing fixed costs; and the Fossil and Hydro Power  business unit’s business plan includes a unit goal of maximizing net return  by reducing fixed and variable costs.  However, TVA has not yet completed  the process of developing performance measures to provide accountability.   TVA expects to develop these performance measures later in 1999,  business units will be expected to meet performance goals in 2000, and unit  managers and TVA executives are expected to be held directly accountable  through the use of compensation incentives in 2001.
section_title: Objectives, Scope, and Methodology
paragraphs: We evaluated the three strategic objectives of TVA’s plan and the underlying  goals and assumptions for reasonableness, achievability, and  completeness.  As agreed with your offices, we did not (1) assess whether  achieving the objectives of the plan would ensure TVA’s future  competitiveness or (2) develop independent estimates of key elements of  the plan, such as the future market price of power.  We relied on  comparisons of past performance to future projections, the opinions of  industry experts, and economic forecasts made by knowledgeable sources  to determine whether the individual components of the plan and the plan as  a whole were achievable or reasonable.  Additional information on our  objectives, scope, and methodology is contained in appendix I.
We conducted our review from June 1998 through April 1999 in accordance  with generally accepted government auditing standards.  We provided a  draft of this report to TVA for comment.  While generally agreeing with the  report’s contents, TVA did provide oral and written comments, which we  have incorporated, as appropriate.  TVA’s written comments are  reproduced in appendix II.
section_title: Plan Objectives Address Key Issues Confronting TVA
paragraphs: Implementation of the 10-year plan is moving TVA in the right direction and  addresses important issues facing TVA: its high fixed financing costs and  limited financial flexibility to respond to competitive pressure and the large  amount of deferred assets that have not been recovered through rates.   These deferred assets, which totaled about $8.5 billion as of the beginning  of the plan period, are primarily the result of investments made since the  1970s in nuclear generating plants that were never put into production.   This helped contribute to TVA’s large debt, which totaled about $27 billion  as of September 30, 1998, and resultant high fixed financing costs.
TVA’s ability to meet its strategic objective of being in a position to offer  competitively priced power by 2007 and to improve its financial flexibility  hinges largely on its being able to meet its goal of reducing debt by about  one-half—to about $14 billion—by 2007.  While not specifically stated in  the plan, TVA also plans to recover through rates all but $500 million of its  deferred asset costs by the end of the period covered by the plan.
These issues were highlighted in reports we issued in 1995 and 1997, in  which we stated that TVA’s annual financing costs and deferred assets were  substantially greater than those of the utilities with which TVA would most  likely have to compete.  We also reported that these high fixed costs and  deferred assets would limit TVA’s flexibility to adjust its rates in a  competitive environment.  TVA, through its 10-year plan, is taking steps to  address these issues.  Other utilities are taking similar actions to prepare  for competition.  For example, utilities we previously identified as those  most likely to compete with TVA are also taking steps to refinance debt at  lower interest rates and accelerate recovery of the costs of their regulatory  assets.  However, as we reported in 1995 and 1997, these other utilities  generally have fewer financing costs and deferred assets than TVA, giving  them more flexibility to respond to changing market conditions.  To the  extent TVA recovers the costs of its deferred assets and increases its  financial flexibility, it will increase its ability to adjust rates as necessary to  meet changing market conditions.  TVA’s focus on these areas before the  full advent of competition is key to its chances of being competitive  without legislative protections.
section_title: Plan Does Not Include Certain Major Costs
paragraphs: The 10-year plan includes costs that correspond to those incurred in prior  years and to those reported by other utilities.  In addition, the plan  considers costs for Year 2000 compliance and likely environmental  expenditures under existing Comprehensive Environmental Response,  Compensation, and Liability Act (CERCLA) and Resource Conservation  and Recovery Act (RCRA) regulations.  However, the plan does not  include certain major costs.   Specifically, the plan does not include the  following:
The capital costs of additional generating capacity that may be acquired  to meet growth in demand for power.  The plan assumes that TVA would  meet the increasing demand for power over the plan period by  purchasing power from other utilities.  The costs of the power  purchases are reflected as operating costs in the 10-year plan.
The cost of complying with new environmental regulations.
The cost of nonpower programs that, to date, have been funded  primarily through appropriations.  These appropriations, which  amounted to $70 million in fiscal year 1998, are expected to be  substantially reduced or discontinued beginning in fiscal year 2000.
By not including these costs, TVA will have less cash than contemplated in  the plan to pay down debt and reduce fixed costs, which could jeopardize  full achievement of the plan’s objectives.
subsections: section_title: Plan Does Not Include Costs Associated With Investing in New Generating Capacity
paragraphs: TVA estimates that the demand for peaking power in its service territory  through 2007 will exceed its current and planned generating capacity.  TVA  currently has several options planned or underway to meet a portion of this  excess demand, including (1) purchasing new gas-fired combustion  turbines, (2) purchasing power that was already under contract when the  10-year plan was issued, (3) modernizing hydro facilities, (4) improving the  efficiency of certain existing fossil plants and combustion turbines, (5) contracting for the power from a new lignite plant, (6) upgrading  certain nuclear plants, and (7) issuing a request for proposal for purchasing  power generated from renewable resources.  TVA projected that these  measures would not be sufficient to meet the entire increase in demand,  and the 10-year plan assumes that TVA will purchase power from other  utilities to make up the difference, which is inconsistent with prior year  practices.
However, since the plan was finalized, TVA officials have told us that they  plan to evaluate other power supply options and to invest in new capacity if  the resulting long-term increase in costs to produce power (interest and  operating expense) would ultimately be less than the cost of purchased  power.  TVA has already decided to invest in new capacity rather than  purchasing power in at least one case—in 1998, TVA announced plans to  purchase eight gas-fired combustion turbine units that will be used to  replace a like amount of purchased peaking power that was assumed in the  original plan.
According to TVA officials, while they expect this decision to result in a  positive cash flow by fiscal year 2010, the decision to purchase these units  will require about $65 million more in cash disbursements through 2007  than would have been necessary to purchase a comparable amount of  power from other utilities.  But, according to TVA’s analysis, while  acquiring this new generating capacity in lieu of purchasing power will  initially increase capital expenditures and thus reduce the amount of cash  available to pay down debt, it will also decrease TVA’s annual cost of power  because it will be less expensive for TVA to operate this new equipment  than to purchase a like amount of power from other utilities.  Decreasing  the cost of power should, in the long term, improve TVA’s ability to meet its  ultimate objective of offering competitively priced power.  In addition,  purchasing new generating capacity provides the added benefit of  removing the uncertainty of having to rely on another utility for power.   Based on our discussions with TVA officials, while it may make economic  sense in the long term, additional decisions to increase capacity in lieu of  purchasing power from other utilities will likely further reduce TVA’s cash  available for debt reduction through 2007, thus jeopardizing its ability to  fully meet the plan’s debt reduction goals by 2007.
section_title: Plan Does Not Include Costs of Complying With Environmental Regulations
paragraphs: The 10-year plan does not include estimated costs of complying with recent  and proposed environmental regulations because TVA did not believe the  costs were estimable at the time the plan was developed.  Since that time,  some of these costs have become estimable.
In October 1998, the Environmental Protection Agency (EPA) issued a  regulation requiring states to develop plans to reduce nitrogen oxide  emissions.  TVA now estimates that it could spend about $500 million to  $600 million for capital modifications to its fossil plants to comply with  state plans that would be implemented under this regulation, which is  commonly referred to as the NOx SIP Call.  The time frame for TVA’s  compliance with the states’ plans is 2003, within the scope of the 10-year  plan.  In October 1998, EPA also issued a proposed regulation regarding  regional haze, which EPA expects to be put into effect during the life of  the plan but for which EPA does not expect compliance until after 2004.   TVA has estimated that this regulation could require capital expenditures of  about $450 million to $500 million.  It is likely that at least a portion of these  costs will be incurred during the time frame of the 10-year plan.  Additionally, all of the estimated $500 million to $600 million in costs  related to the NOx SIP Call will be incurred during the plan time frame and,  thus, will negatively impact TVA’s ability to meet its cost reduction goals.   However, as discussed later, TVA officials told us that they still believe TVA  will be in a position to offer competitively priced power in 2007 because  these same types of costs will be incurred by many other power suppliers  and therefore would tend to increase the future market price of power.
section_title: Plan Does Not Include Costs of Nonpower Programs Formerly Funded Through Appropriations
paragraphs: The plan does not include the costs of nonpower programs that historically  have been funded through appropriations but now are likely to be funded  through power revenues.  The plan assumes that TVA will continue to  receive appropriations for its nonpower programs, such as flood control  and navigation.  While this assumption was reasonable when the plan was  developed, TVA’s nonpower appropriations have been sharply curtailed in  recent years, from $109 million in fiscal year 1996 to only $7 million in TVA’s  budget request for fiscal year 2000.
TVA officials have indicated publicly that future appropriations for  nonpower programs are likely to be eliminated or substantially reduced  and, in accordance with the fiscal year 1998 Energy and Water  Development Appropriations Act, have indicated they will use power  revenues to continue these nonpower activities.  These costs totaled  approximately $70 million in fiscal year 1998 and are expected to range  from about $50 million to $60 million annually in the future.  Since  funding nonpower activities with power revenues was not assumed in the  10-year plan, these costs will further reduce the cash available to reduce  debt to the level envisioned in the plan.
section_title: Seven Key Goals and Assumptions Are Achievable or Reasonable, While Three Are Unachievable or Uncertain
paragraphs: We assessed 10 goals and assumptions TVA made about the future in  developing the 10-year plan.  Based on economic forecasts, comparisons  with TVA’s results of past operations, and the opinions of industry experts,  we concluded that seven of the goals and assumptions were achievable or  reasonable, two were unachievable, and one was uncertain.  The goals and  assumptions we assessed, and our conclusions about each, are summarized  in table 1 and discussed in detail in the following sections.
subsections: section_title: Assumption About the Future Market Price of Power Is Reasonable
paragraphs: TVA’s assumption about the future market price of wholesale power is  important to the success of the plan because it establishes a target that TVA  must achieve in order to offer what it considers to be competitively priced  power in 2007.  TVA estimated that the price of wholesale power in 2007  would fall between 3.0 cents to 3.7 cents per kWh, with its best estimate  being 3.4 to 3.5 cents per kWh.  The Energy Information Administration  (EIA) within the Department of Energy (DOE) estimated that the price of  wholesale power in 2007 would be 3.69 cents per kWh, while Standard and  Poor’s DRI estimated that it would be 3.91 cents per kWh.  The combined  range of EIA and DRI estimates was 3.57 cents to 4.35 cents per kWh.   Since TVA’s projection of the future market price of power in the 10-year  plan is lower, TVA is forced to be aggressive in pursuing its options to  reduce costs and increase revenue.
TVA officials said that if they were to prepare the 10-year plan today, their  projection for the market price of wholesale power in 2007 would increase  to between 3.5 and 3.8 cents per kWh, due primarily to new environmental  regulations.  TVA officials stated that the new environmental regulations  would likely drive up the market price of power and affect many utilities  similarly.  Any upward revision in the projected price of wholesale power in  2007 would have a positive impact on TVA’s ability to achieve the objectives  of the plan and would help offset some of the previously identified costs  that are not currently considered in the plan—specifically, costs for the  new environmental regulations.
However, the extent to which new environmental regulations affect any  utility depends on the type and condition of its generating equipment, the  portion of its power generated by coal, and the types of controls it chooses  to meet the new environmental regulations.  Although, in aggregate, the  mix of generating plants among investor-owned utilities in the states that  border on TVA’s service territory is similar to its own, TVA and these  utilities will not necessarily all be affected equally, depending on the  condition of their equipment and the compliance options they choose.
Therefore, the relative impact of the new and proposed environmental  regulations on TVA, its neighboring utilities, and the market price of power  is uncertain.
section_title: Assumption About the Increase in Demand for Power Is Reasonable
paragraphs: The 10-year plan assumes that the increase in demand for power in TVA’s  service region will average 2 percent per year over the plan period.  While  TVA’s recent historical increase in demand for power has averaged over 3  percent annually, TVA officials were conservative in this regard because  they do not expect this level of growth in demand to continue.  We obtained  other estimates of the increase in demand for power in TVA’s geographic  area from EIA, DRI, and ICF Kaiser Consulting Group, an organization  hired by the Edison Electric Institute (EEI), an industry group for investor- owned utilities, to analyze TVA’s 10-year plan.  Their estimates of growth  in demand ranged from 1.7 percent to 2.5 percent.  TVA’s assumption about  growth in demand for power is reasonable based on this range of estimates  established by industry experts.
section_title: Assumption About the Increase in Fuel Costs Is Reasonable
paragraphs: The 10-year plan assumes that TVA’s fuel cost, including its mix of both  nuclear and coal as a fuel source, will increase 1.7 percent annually over  the plan period.  We obtained a cost increase estimate of 1.4 percent  annually from EIA, which was based on a blended coal and nuclear fuel  mix.  We also obtained a cost increase estimate of 2.2 percent annually  from DRI, which was based on using only coal as a fuel.  Based on the  range of these estimates, TVA’s assumption about fuel costs is reasonable.
To control fuel costs, TVA officials stated that they competitively bid all  coal contracts, use a cost model to determine which type of coal to  purchase, and have reduced inventories to save carrying costs.  These fuel- handling initiatives are expected to reduce fuel expense by $1.6 million per  year.  In addition, TVA has expanded its by-product program and expects  revenue from this program to be over $5 million per year.  TVA’s efforts to  control these costs are positive steps toward the plan’s cost reduction  goals.
section_title: Goal for Supply Chain Savings Is Achievable
paragraphs: The 10-year plan assumes that improvements made to supply chain  management will save, on average, $50 million per year over the 10 years  covered by the plan.  And, by expanding its supply chain management  efforts in the future, TVA officials believe that they can increase efficiency,  save money, and maintain quality.  For example, through contract  management improvements, TVA expects to realize cost savings by  consolidating its blanket purchasing contracts, reducing the number of  small purchase orders, and renegotiating the terms and conditions of its  purchases.
From the publication of the 10-year plan in July 1997 through September  1998, TVA had documented savings of about $75 million, some of which  represents categories of savings that should occur on a monthly basis.  The  balance represents savings on individual purchases and other procurement  initiatives, some of which may also recur.  As TVA implements additional  supply chain management initiatives and applies lessons learned from  industry and individual plants to other TVA functions, supply chain savings  are expected to increase.  For the first 6 months of fiscal year 1999, TVA  documented savings of about $37 million, or about $6.2 million per month.   Of the $6.2 million, about $4.9 million should recur monthly.  On an annual  basis, TVA’s supply chain savings are therefore likely to be at least $59 million, making this goal achievable.
section_title: Assumption About Labor Force Reductions Is Reasonable
paragraphs: The 10-year plan assumed that TVA would reduce its labor costs by  reducing its labor force size from 14,960 at June 30, 1997, to 14,275 by  September 30, 1997.  Although TVA did not achieve this staffing level by  September 30, 1997, it had reduced staff to 14,194 by December 31, 1997,  and to 13,818 by September 30, 1998.  Since TVA has exceeded its labor  force reduction goal, the corresponding cost savings will be greater than  originally anticipated.
In addition, TVA has taken or planned a number of other actions that will  further help reduce labor costs, including negotiating compensation levels with one of its large unions, which TVA  expects will help to curtail the rise in future labor costs, replacing higher paid employees with lower paid employees as its aging implementing a “shared services” concept, which involves consolidating  similar operations and reducing duplicative efforts.
Although TVA did not quantify the dollar savings it expects through its  labor initiatives, TVA’s current efforts in this area should help it reduce  costs.
section_title: Debt Reduction and Deferred Assets Recovery Goals Are Unachievable
paragraphs: The 10-year plan calls for reducing debt by about one-half to about $14 billion by 2007.  This reduction, in turn, would lower TVA’s annual  interest costs by half—from about $2 billion in 1997 to about $1 billion in  2007.  The additional cash that is made available as debt is paid down and  interest costs are reduced can be used to further reduce debt.  This  interrelationship is integral to meeting the debt reduction goal.  In addition  to reducing interest costs by reducing debt, TVA is pursuing other interest  savings by refinancing outstanding debt, as discussed later in this report.
TVA’s ability to meet its strategic objective of being in a position to offer  competitively priced power by 2007 depends, to a large extent, on meeting  its debt reduction goal.  The plan calls for the cash flow needed to achieve  this debt reduction to be provided by a combination of planned revenue  enhancements, cost savings initiatives, and capital expenditure limitations.   However, as discussed previously, the plan excluded additional capital  costs related to investing in new generating capacity to meet growth in  demand for power, complying with new environmental regulations, and  funding nonpower programs that were previously funded through  appropriations.  As shown in figure 1, TVA exceeded its debt reduction  goals for the first 2 years of the plan but does not expect to meet its original  estimates for the remaining years due to the additional capital expenditures  for new generating capacity and environmental regulations discussed  previously.
As a result of changes in certain of its cost estimates, TVA now does not  expect to reduce debt by one-half until fiscal year 2009, about 2 years after  the plan’s original target date.  This revised goal is reflected in TVA’s fiscal  year 2000 federal budget request.  TVA’s original and revised debt reduction  timetable is shown in figure 2.
TVA’s planned revenue enhancements and cost savings were also intended  to provide TVA with the opportunity to recover a portion of the cost of its  deferred assets.  As noted previously, TVA expects to recover all but about  $500 million–its estimated net realizable value–of the deferred assets.   However, TVA’s ability to include the costs of these assets in its rates  without further rate increases is directly related to its ability to meet the  plan’s revenue and cost savings targets.  To the extent TVA does not  recover the cost of its deferred assets while it is legislatively protected  from competition, competitive pressures could prevent it from selling  power at rates sufficient to recover the cost of these assets indefinitely.
section_title: Capital Expenditure Limitation Goal Is Unachievable
paragraphs: The plan assumes that capital expenditures will be limited to about $600 million per year and excludes any capital costs for increasing  generating capacity and complying with new environmental regulations.   However, as discussed previously, known environmental costs alone are an  estimated $500 million to $600 million.  In addition, costs for complying  with a proposed environmental regulation that is likely to be implemented  within the plan period could amount to another $450 million to $500 million, some of which would be incurred before 2007.  Also, the costs  for meeting growth in demand for power with additional generating  capacity, which are not fully estimable at this time, could further increase  TVA’s required capital expenditures within the period covered by the 10- year plan.  Even though upward revisions in TVA’s projected market price  of wholesale power could offset some of these additional costs, TVA is  likely to exceed its annual $600 million planned capital expenditures limit,  thus making this goal unachievable.
section_title: Cost Improvement Initiatives Goal Is Achievable
paragraphs: The 10-year plan calls for TVA to undertake cost improvement initiatives  that are assumed to save about $200 million a year over the life of the plan.   These initiatives include refinancing TVA’s Federal Financing Bank (FFB)  debt, refinancing and replacing other debt at lower interest rates, changing  retirement benefits, and improving business processes.  Overall, the goals  related to these initiatives are achievable.
subsections: section_title: Reducing Interest Costs by Refinancing Debt
paragraphs: To achieve a large portion of the $200 million annual cost improvement  initiatives, the plan called for TVA to obtain authority from the Congress to  prepay, without penalty, the $3.2 billion that TVA then owed FFB, then to  refinance that debt at lower interest rates.   TVA received that authority in  the fiscal year 1999 Treasury and General Government Appropriations Act.   TVA refinanced the FFB debt with $2.7 billion of long-term bonds having an  average interest rate of 5.37 percent compared to the original 9.67 percent  FFB debt, plus $469 million of short-term debt which, as of April 1999, had  a current interest rate of about 4.8 percent.  Based on the actual interest  rates of the refinanced FFB debt, we estimate that the interest savings will  total about $1 billion through 2007, providing an average annual savings of  about $116 million toward the $200 million plan goal.
In addition to reducing interest by refinancing the FFB debt, the plan calls  for reducing annual interest costs by refinancing a portion of the $24 billion  in outstanding publicly held debt and replacing maturing debt, as needed,  with lower interest rate borrowings.  Since the plan was issued, TVA has  refinanced about $6 billion of long-term public bonds that had an average  interest rate of 6.96 percent with long-term bonds having an average  interest rate of 6.00 percent and $699 million of short-term borrowings that  had about a 4.8 percent interest rate as of April 1999.  We estimate that  these actions will save an average of $44 million in annual interest expense  through 2007.
TVA may have further opportunities to refinance additional long-term  public bonds at favorable rates since as of April 1, 1999, about $11 billion of  TVA’s outstanding long-term public debt had interest rates higher than  TVA’s estimated 6.55 percent borrowing rate.  Of the $11 billion, $6.3 billion is callable during the plan period; however, none was callable as  of April 1, 1999.
section_title: Retirement Plan Changes
paragraphs: According to TVA officials, another $20 million to $25 million a year will be  saved by changes made to TVA’s retirement plan.  The costs of certain  retiree health benefits that TVA was paying for from operations were  discontinued, while at the same time a supplemental pension benefit was  added to the retirement plan.  The result, according to TVA officials, was a  net cash flow saving of about $20 million to $25 million per year.  According  to TVA officials and as confirmed by TVA’s fiscal year 1998 audited financial  statements, the pension plan is currently overfunded because it has an  excess of plan assets over projected benefit obligations of $323 million as  of September 30, 1998.  TVA does not expect to have to make any additional  contributions to the pension plan through 2007.
section_title: Business Process Improvement Initiatives
paragraphs: TVA also expects to achieve cost savings from business process  improvement initiatives that involve bringing teams of TVA staff together to  evaluate how TVA does business.  For example, TVA has established teams  from throughout the organization to (1) improve the technology used to  process information, (2) benchmark best practices of industry as well as  individual TVA plants, and (3) adopt identified best practices across the  organization.  While some teams appear to be well established, others are  only getting started.  Because these initiatives are in the early stages, their  benefits have not yet been quantified, and TVA officials told us that they are  only now beginning to identify cost saving techniques that can be shared  throughout the organization.
As shown in figure 3, TVA substantially achieved the $200 million cost  savings goal for fiscal year 1999 by reducing interest costs and changing its  retirement plan.  Assuming that TVA’s annual savings from refinancing debt  and changing its retirement plan average $160 million and $20 million,  respectively, TVA must save an additional $20 million annually by  improving business processes, refinancing additional debt, and reducing  other costs to achieve the $200 million savings assumed in the plan.  Since  this required additional savings of $20 million is relatively small—less than  half of 1 percent of TVA’s fiscal year 1998 operating revenues of $6.7 billion—we believe that it is feasible that these changes will enable  TVA to save the additional amount needed to achieve the $200 million  annual cost reduction goal.
section_title: Assumption About Increased Revenues Is Uncertain
paragraphs: TVA’s revenues increased significantly in fiscal year 1998 due to a rate  increase and to increased energy sales.  TVA’s fiscal year 1998 revenues  totaled about $6.7 billion, compared to $5.9 billion in fiscal year 1997—an  increase of about $800 million.  According to TVA, about $350 million of the  increase is attributed to the rate increase; the balance is attributable to  increased sales volume that resulted from extreme weather in the summer  months and other factors.
The 10-year plan assumes that this rate increase is sustainable and will  generate additional revenues of about $325 million annually through 2007.
However, based on the decline in TVA’s average revenue per kWh over the  past 10 years, and expectations of increasing competition in the electricity  industry, we agree with some industry experts who question TVA’s ability to  meet the plan’s assumption about future revenue.  Specifically, an analyst  from the Congressional Budget Office (CBO) with expertise in issues  related to TVA and consultants from ICF Kaiser (which was hired by the  Edison Electric Institute to analyze TVA’s 10-year plan) questioned TVA’s  ability to meet its future revenue projections given the decline in its  average revenue per kWh over the last several years.
As shown in figure 4, from 1988 through 1997, TVA’s average revenues per  kWh declined steadily, despite a steady increase in the amount of  kilowatthours of energy sold.  This decline in average revenues per kWh  was attributable to credits given to large industrial customers.  The actual  decline in average revenues per kWh over the past 10 years contrasts  sharply with the increase projected in the 10-year plan for 1998 through  2007.
In order to offer competitive rates to its industrial customers, TVA offers  price breaks to its larger industrial customers.  In fact, to offset the impact  of the last rate increase, TVA expanded its existing credit program to  include companies with commitments to purchase firm loads of more than  1 megawatt.  (Previously this credit had been limited to industrial  customers with firm load commitments of more than 5 megawatts.)   Although deregulation of the electric utility industry is expected to put  downward pressure on rates, the 10-year plan assumes that TVA will not  have to offer any additional price breaks to its large industrial customers  through 2007.  This assumption is questionable given that TVA has offered  new credits to reduce the rates of its larger industrial customers for the  past 10 years and competition in the industry is increasing.
Because deregulation of the electric utility industry is expected to continue  to cause future wholesale and retail electricity prices to fall, TVA will likely  feel pressure to continue to reduce rates.  In addition, recent media  coverage about competition has made many utility customers more aware  of price differences among utilities and raised expectations of lower prices.   All of these factors combined make it uncertain whether TVA can generate  an additional $325 million in annual revenues on a sustained basis through  2007.
section_title: Goal to Improve Customer Relations Is Achievable
paragraphs: TVA’s management recognizes that in a competitive environment, its  current customers would be free to obtain power from other utilities after  giving appropriate notice.  Therefore, to improve its future competitive  position, TVA’s management decided that it must offer contract flexibility  to improve relationships with its customers—159 distributors and 64  industrial and federal concerns.  The 10-year plan calls for TVA to build  customer allegiance by developing contract and pricing structures that  better meet its customers’ needs.  TVA has taken actions geared toward this  goal.
For example, one new contract option allows distributors to change the  length of their power contracts with TVA from a rolling 10-year term to a  rolling 5-year term, after a period of 5 years (5+5 contract).  This 5+5  contract, like all of TVA’s power contracts with its distributors, requires the  distributor to purchase all of its electric power from TVA.  TVA has also  implemented a new program for its large industrial customers that permits  customers with power usage of more than 1 megawatt annually to be billed  under real-time pricing (RTP), which will enable these customers to  reduce their electricity costs by adjusting usage patterns.  TVA has  implemented the RTP program on a 3-year pilot basis.  TVA expects that in  the long-term, the RTP program will increase revenues by increasing the  demand for power.  Both the 5+5 contracts and the real-time pricing  program are options that TVA developed as a result of input from  customers.
Customer groups we contacted were pleased with the efforts TVA is  making to provide more flexible contracts.  Since these options were  developed in response to customer input and the initial customer response  has been positive, we determined that TVA’s goal to improve customer  relations is achievable.
section_title: Plan Has Not Been Updated to Reflect Significant Changes
paragraphs: As previously discussed, since the 10-year plan was issued in July 1997,  actual experience related to certain key goals and assumptions has differed  from that projected in the plan, and certain expectations about the future  have changed.  For example, TVA officials indicated that if they were to  update the 10-year plan today, they would increase their projection for the  future market price of power and would include costs for new  environmental regulations.  However, TVA has not formally updated the  plan to reflect these and other changes.  Examples of actual experience  that differ from expectations in the plan or goals and assumptions that have  changed since the plan was developed, along with their impact on the  overall plan, are shown in table 2.
Changes in individual goals or assumptions or actual experience that  differs from that projected when the plan was developed can affect the  entire plan.  For example, the unplanned purchase of additional generating  capacity results in a decrease in projected cash flow through 2007.  This  affects the availability of cash to pay down debt, which further impacts  interest costs.  Funding nonpower programs through power revenues has  the same effect.  The result of these and other unplanned expenditures,  such as for new environmental regulations, is that TVA’s time frame to meet  its debt reduction goal has been extended from 2007 to 2009.  In contrast,  any upward change in TVA’s assumption for the future market price of  power increases TVA’s target price for power in 2007.  This means that TVA  could reduce the level of cost reduction and/or revenue enhancement  planned through 2007 and still be in a position to offer competitively priced  power at that time.
TVA officials told us that they have internally analyzed the combined  impact of an upward revision in the projected market price of wholesale  power in 2007 and lower-than-planned debt reduction on TVA’s ultimate  objective, which is to be in a position to offer competitively priced power in  2007.  While TVA officials acknowledge that they will not meet the debt  reduction goal by 2007, they believe, based on their internal analyses, that  TVA will still be in a position to offer competitively priced power in 2007.   However, these analyses have not been formalized, nor have the results  been communicated to users of the plan.
Although TVA views the plan as a living document and recognizes that  projections in the plan will change over time, there is no formal mechanism  for communicating changes to those who use the plan.  In addition, there is  no mechanism available to plan users to gauge TVA’s progress toward  achieving the plan’s goals and objectives.  Therefore, while variances in  results, changes in goals and assumptions, and progress toward plan  objectives may be known to TVA, they are generally not known by the  plan’s users.  These users include public policymakers considering  legislation that might impact TVA’s future, analysts and investors who use  information in the plan when assessing the desirability of TVA’s debt  offerings, and customers who are considering alternative sources of  electricity in the future.  As a result, those who rely on the plan to make  investment and policy decisions cannot fully assess the impact of the  variances and changes in assumptions on TVA’s ability to meet its strategic  objectives as set forth in the plan.
The legislation proposed by the administration to promote retail  competition in the electric power industry, which was discussed previously  in this report, would require that TVA annually report several types of  information to the Congress.  If enacted, the legislation would require that  TVA annually report, among other things, its progress toward its goal of  competitively priced power, its prospects for meeting the objectives of the  10-year plan, any changes in assumptions that may have a material effect  on its long-range financial plans, the amount by which its debt has been  reduced, and the projected amount by which its debt will be reduced.  This  type of reporting to the Congress would help provide the information  needed to monitor TVA’s readiness for a competitive environment.
section_title: Conclusions
paragraphs: TVA management recognizes the need for TVA to be positioned to compete  with other utilities in a changing marketplace.  The 10-year plan is moving  TVA in the right direction by addressing the most important issues facing  TVA: its high fixed financing costs and limited financial flexibility and the  large amount of deferred assets that TVA has not recovered through rates.   The more progress TVA makes in addressing these issues while it maintains  its legislative protections, the greater its prospects for being competitive if  it loses these protections in the future.
Because TVA’s actual experience and assumptions about the future market  price of power, capital expenditures, and planned debt reduction have  varied in significant ways from those envisioned in the 10-year plan, it is  unlikely that TVA will generate sufficient cash flow to reduce debt and the  corresponding fixed interest costs to the extent stated in the plan through  2007.  This will impact TVA’s ability to recover the cost of its deferred assets  to the extent planned.  TVA has acknowledged that its debt reduction goal  will not be achieved until at least 2009.  To the extent it does not  sufficiently reduce debt and related fixed costs and increase financial  flexibility during the 10-year period, TVA’s ultimate strategic objective—to  be able to offer competitively priced power by the end of 2007—could be  jeopardized, depending on market conditions at the time.
However, since no one knows what the market price of power will be in  2007, it is uncertain whether TVA will be in a position to offer competitively  priced power at that time.  TVA could fall short of its objectives and still be  competitive if its cost of producing power is at or below market.   Conversely, TVA could achieve all of its objectives and not be competitive if  its cost of producing power is higher than market.
Because of changing electricity markets and other economic conditions, it  is essential that TVA continuously update the plan and communicate the  results of these updates, as well as TVA’s progress toward its goals and  objectives, periodically and formally to the Congress as it considers TVA’s  future in a deregulating electricity industry and to other users who have a  vested interest in TVA.
section_title: Recommendations
paragraphs: We recommend that the Chairman of the Board of Directors of the  Tennessee Valley Authority move quickly to improve the reporting of  information to the plan’s users.  Specifically, we recommend that the  Chairman ensure that TVA take the following actions:
Revise and reissue the plan to reflect evolving conditions and operating  plans and their impact on TVA’s ability to meet the strategic objectives  outlined in the plan by 2007.  TVA should also include a discussion of its  plans to recover the costs of its deferred assets.  As further significant  changes occur, the plan should be updated to communicate these  changes to plan users.
Periodically communicate its progress toward achieving the 10-year  plan’s strategic objectives to those who rely on the information  contained in the plan.  One option would be for TVA to expand its  discussion of the 10-year plan in its annual reports, including reporting how actual results compare to all of the plan’s key goals and  assumptions, including those for revenues, debt reduction, capital  expenditures, cost savings, and the market price of power; progress toward achieving performance measures related to the plan, an overall assessment of whether TVA is on course to provide  competitive power in 2007.
section_title: Agency Comments and Our Evaluation
paragraphs: In oral and written comments on a draft of this report, TVA generally  agreed with the report’s contents.  TVA also provided us with technical  comments, which we have incorporated as appropriate.  TVA’s written  comments are reproduced in appendix II and discussed below.
TVA commented that the market price of power is the most significant  uncertainty in achieving its goal to be in a competitive pricing position as  the industry is deregulated.  TVA also stated that the target cost of power in  the 10-year plan is aggressive and that it has not yet altered its estimate of  the future market price of power, even though there are indications of  upward movement in market price forecasts.  Our report noted that TVA’s  target for the cost of its power in the 10-year plan is lower than projections  by other knowledgeable sources and therefore forces TVA to be aggressive  in pursuing its options to reduce costs and increase revenue.  During the  course of our review, TVA officials told us that if they were to formally  update the 10-year plan, they would increase their projection of the future  market price of power.  As we note in our report, TVA has not formally  updated the 10-year plan, even though certain expectations about the  future have changed and actual experience related to key goals and  assumptions has differed from projections in the plan.
TVA stated that while it will likely incur the costs of funding traditional  river management programs that have historically been funded largely  through appropriations, the Congress has also enacted legislation allowing  TVA to refinance its FFB debt for a savings of over $100 million a year.   While we agree with both of these statements, the anticipated savings from  refinancing the FFB debt were included in the 10-year plan, but the  additional cost of funding traditional river management programs was not.   Therefore, for purposes of gauging progress toward achievement of the  plan’s goals, the planned savings cannot be assumed to offset these  unplanned expenditures.  Our report separately discusses each of these  points.
TVA noted that although its decision to purchase additional generating  capacity for periods of peak demand rather than purchasing power from  other utilities will adversely impact its ability to reduce debt to the extent  planned, it will also help TVA achieve a lower cost of power and improve  system reliability.  Our report acknowledges these points and states that  the decision will impact TVA’s ability to reduce debt, but that TVA believes  the decision will reduce the cost of its power and remove the uncertainty of  having to rely on another utility for power.
section_title: Objectives, Scope, and Methodology
paragraphs: We were asked to determine whether the goals and assumptions in TVA’s  10-year plan are achievable or reasonable in light of TVA’s strategic  objectives to (1) reduce the cost of power to a competitive level, (2) increase financial flexibility by reducing fixed costs, and (3) build  customer allegiance.  Specifically, we were asked to determine whether the  10-year plan (1) addresses key issues facing TVA, (2) takes into  consideration all applicable costs and revenue sources, (3) contains  assumptions that are reasonable and in line with industry estimates and  expectations, and (4) has been updated to reflect significant changes in key  assumptions or actual experience that differs from TVA’s expectations  when the plan was developed.  In addition, you asked us, based on our  analysis of the plan, to conclude whether TVA is likely to achieve the plan’s  strategic objectives.
TVA’s plan consists of three strategic objectives, with goals and  assumptions designed to help accomplish the strategic objectives.  We  evaluated the achievability and reasonableness of 10 of the goals and  assumptions and their impact on TVA’s ability to accomplish its 3  objectives.  Specifically, we assessed the achievability and reasonableness  of the following goals and assumptions: the future market price of wholesale power will be 3.4 to 3.5 cents per annual growth in demand through 2007 will average 2 percent; fuel costs will increase 1.7 percent annually through 2007; improvements in supply chain management will save $50 million
TVA’s labor force will be reduced, and additional costs savings will be  achieved through the creation of shared services and other initiatives; debt will be reduced by about one-half to about $14 billion, and the  balance of deferred assets will be reduced from $8.5 billion to $500 million—TVA’s estimated net realizable value of these assets; capital expenditures will be limited to about $600 million annually and  increases in demand through 2007 will be met primarily through  purchased power; $200 million will be saved annually through cost improvement initiatives  primarily related to refinancing Federal Financing Bank (FFB) and  public bond debt, pursuing changes to its retirement plan, and  improving business processes; revenues from power sales will be increased by about $325 million  annually by implementing a rate increase in 1998 and maintaining it  through 2007; and customer relations will improve through new contract and pricing  options.
As agreed with your offices, we did not (1) assess whether achieving the  objectives of the plan would ensure TVA’s future competitiveness or (2) develop independent estimates of key elements of the plan, such as the  future market price of power.  Instead, we relied on comparisons of past  performance to future projections, the opinions of industry experts, and  economic forecasts made by knowledgeable sources to determine whether  the individual components of the plan and the plan as a whole were  achievable and reasonable.
subsections: section_title: Organizations Contacted
paragraphs: During the course of our work, we contacted the following organizations.
subsections: section_title: Federal Agencies
section_title: Bond Rating Agency
section_title: Customer Representative or Trade Groups
section_title: Consulting Firms
section_title: Others
section_title: Comments From the Tennessee Valley Authority
section_title: Major Contributors to This Report
subsections: section_title: Accounting and Information Management Division, Washington, D.C.
section_title: Office of the General Counsel, Washington, D.C.
section_title: Atlanta Field Office
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