TVA is a multipurpose, independent, federal corporation established by the Tennessee Valley Authority Act of 1933 (TVA Act). The act established TVA to improve the quality of life in the Tennessee River Valley by improving navigation, promoting regional agricultural and economic development, and controlling the floodwaters of the Tennessee River. To those ends, TVA erected dams and hydropower facilities on the Tennessee River and its tributaries. To meet the subsequent need for more electric power, TVA expanded beyond hydropower, adding coal-fired power plants and nuclear generating units to its power system. TVA primarily sells wholesale power to 158 municipal and cooperative distributors and about 62 directly served large industrial customers and federal agencies. The distributors, in turn, sell the power on a retail basis to more than 8.3 million people in an 80,000 square mile region. In fiscal year 2000, about 43 percent of the operating revenue TVA and its distributors generated from sales to the ultimate consumers came from sales to residential customers, 29 percent from sales to commercial customers, and 28 percent from sales to industrial customers. Under the TVA Act, as amended, TVA continues to operate like a traditional regulated monopoly and is not subject to most of the regulatory and oversight requirements that commercial electric utilities must satisfy. The act vests all authority in TVA’s three-member board of directors to run and operate TVA in a manner consistent with the purposes and objectives of the act, including the objective of keeping TVA’s electricity rates “as low as are feasible.” The board decides when to raise electricity rates and sets its rates at whatever level it deems necessary to recover TVA’s annual budgeted expenses, plus a margin determined by the board to help ensure it meets financial tests and other financial objectives required by the TVA Act and the Basic TVA Power Bond Resolution. Unlike other utilities, the rates TVA charges for its electric power are not subject to review and approval by state public utility commissions or the Federal Electric Regulatory Commission (FERC). In contrast, regulated investor-owned utilities (IOUs) must justify rate changes to their public service commissions based on cost requirements determined to be “just and reasonable” plus a regulated return to shareholders. However, an increasing portion of “wholesale” power sales have been made by independent power producers and marketers at market-based prices which are not subject to regulatory approval. The Energy Policy Act of 1992 (EPAct) requires utilities to use their transmission lines to transmit wholesale electricity for other utilities. This act has enabled wholesale customers to obtain electricity from a variety of competing suppliers, thus increasing wholesale competition in the electric utility industry across the United States. In addition, restructuring efforts in many states have created competition at the retail level. If, as expected, retail restructuring continues to occur on a state-by-state basis over the next several years, then industrial, commercial, and, ultimately, residential consumers will be able to purchase their power from one of several competitors rather than from one utility monopoly. Currently, legislation limits competition between TVA and other utilities. The TVA Act was amended in 1959 to establish what is commonly referred to as the TVA “fence,” which prohibits TVA, with some exceptions, from entering into contracts to sell power outside the service area that TVA and its distributors were serving on July 1, 1957. In addition, EPAct provides TVA with certain protections from competition, called the “anti-cherry picking” provisions. Under EPAct, TVA is exempt from having to allow other utilities to use its transmission lines to transmit (“wheel”) power to customers within its service area. This legislative framework generally insulates TVA from direct wholesale competition. As a result, TVA remains in a position similar to that of a regulated utility monopoly. Because of ongoing restructuring efforts in the electric utility industry, TVA management, like many industry experts, expects that in the future TVA may lose its legislative protections from competition. TVA’s management recognized the need to act to better position TVA to compete in an era of increasing competition and, in July 1997, issued a 10-year business plan with that goal in mind. TVA established a 10-year horizon because a majority of the long-term contracts with its distributors could begin expiring at that time, and TVA could be facing greater competitive pressures by 2007. The plan contained three strategic objectives: (1) reduce TVA’s cost of power in order to be in a position to offer more competitive prices by 2007, (2) increase financial flexibility by reducing fixed costs, and (3) build customer allegiance. To help meet the first two strategic objectives noted above, one of the key goals of TVA’s 10-year plan was to reduce its interest expense by reducing debt by over half from its 1997 level, to about $13.2 billion. To increase its financial flexibility and future competitiveness by generating cash that could be used to reduce debt, TVA increased its electricity rates beginning in 1998, and planned to reduce expenses and limit capital expenditures. TVA’s plan to reduce debt while it is still legislatively protected from competition was intended to help it achieve its ultimate goal of being in a position to continue to offer competitively priced power after 2007. In a competitive market, TVA would be in danger of losing customers if its high debt service costs caused its price of power to be above market. Over the first 4 years of the 10-year plan (through September 30, 2001), TVA reduced its debt by about $2 billion. By reducing debt, and refinancing some debt at lower interest rates, TVA has reduced its annual interest expense. TVA’s interest expense has dropped from about $2.0 billion in fiscal year 1997 to about $1.6 billion in fiscal year 2001. Its net interest expense through the first 6 months of fiscal year 2002 was $717 million. However, TVA has fallen behind in meeting the debt reduction goal in the original 10-year plan, and consequently has revised this goal downward. According to estimates that TVA provided to OMB in support of the president’s 2003 budget, TVA expects to reduce its debt by about $5.2 billion by 2007 rather than the planned $14.2 billion, which represents $9 billion less debt reduction than planned in 1997. TVA’s most recent projections show a debt level of about $18 billion by 2012. The revision to the debt reduction estimate is due primarily to lower revenues than projected in 1997, and the use of a portion of the cash originally targeted for debt reduction to pay for greater than estimated annual cash operating expenses and capital expenditures for new generating capacity and environmental controls. TVA officials told us that the above debt reduction estimates would be affected by the recent decision to recover and restart Browns Ferry unit 1. To identify the benchmarking studies regarding staffing levels that have been performed to compare TVA to other electricity providers, the results of these studies, and the changes TVA has made as a result of them, we interviewed officials from TVA, Standard & Poor’s, investor-owned utility members of TVA Exchange, and the American Public Power Association. In these discussions of efficiency in the electricity industry, we identified several staffing-related benchmarking studies prepared for TVA by Tim D.Martin & Associates (Navigant), which we obtained and analyzed. We analyzed staffing-related studies dated September 1998 through March 2000 that pertained to TVA’s major business units, including Fossil Power Group, Nuclear, Transmission Power Supply, and River System Operations & Environment. In addition, to assess the quality and reliability of data available for this purpose, we interviewed a Navigant official to discuss their staffing benchmarking methodology for TVA and other electric utilities, the number of utilities included in their database, and their overall experience in benchmarking staffing levels in the electric utility industry. Further, we inquired of industry experts regarding their familiarity with and use of Navigant in performing staffing analyses. However, given the fact that Navigant’s staffing database is proprietary, we could not verify the accuracy of the data used in the studies. To determine how TVA’s electricity production costs and rates compare to those of other electricity providers, we first identified its likely competitors through discussions with officials from TVA, TVA’s Office of Inspector General (IG), investor-owned utility members of TVA Exchange, and the American Public Power Association. We then analyzed TVA’s costs and electricity rates and compared them to those of a group of investor-owned utilities that could comprise TVA’s likely competitors in a competitive environment. We obtained electricity production cost and rate data for fiscal year 2000 for TVA and the group of likely competitors from RDI POWERdat, which is a database of electric power companies and their plants compiled and maintained by Resource Data International, Inc. Further, we reviewed various reports related to TVA finances, and our own as well as prior TVA IG reports. To determine whether TVA’s electricity rates are low enough to support a rate increase, we analyzed the results of the production costs and rate comparisons and interviewed TVA officials regarding this issue. Additional information on our scope and methodology is in appendix I. We conducted our review from July 2001 through May 2002 in accordance with generally accepted government auditing standards. We requested comments from the chairman of TVA or his designated representative on a draft of this report. TVA’s chairman provided written comments, which are reproduced in appendix II. We also received oral comments of a technical nature from the senior advisor to TVA’s chief financial officer (CFO), which we incorporated as appropriate. TVA has been benchmarking since the 1980s and since the early 1990s has primarily used Navigant to perform staffing benchmarking studies.