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. 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. 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.