The electricity industry has been predominantly monopolistic and noncompetitive. Utilities (primarily investor-owned utilities—IOU) build power plants and power lines to provide all of the electricity needed by all existing and future customers in their exclusive service areas. Regulators in the states allow utilities to charge electricity rates that give them a regulated, specified level of return on these investments. IOUs were initially reluctant to provide electricity to rural areas, mostly because the sparse population made it difficult for them to recover their costs and to earn a profit. The federal government has played an important role in the traditional market by selling power to rural America. The Department of the Interior’s Bureau of Reclamation (the Bureau) and the Department of the Army’s Corps of Engineers (the Corps) generate electricity at hydropower plants located at major federal water projects. The Department of Energy’s (DOE) power marketing administrations (PMA) generally sell this power in wholesale markets, mostly to publicly and cooperatively owned utilities that, in turn, sell power to end-use (retail) consumers. The PMAs repay the federal investment in the government’s power plants, power lines, and related assets through the revenues they earn by selling power. The Tennessee Valley Authority (TVA), a federal corporation, generates and markets power throughout Tennessee and parts of six other southeastern states. Moreover, the Department of Agriculture’s Rural Utilities Service (RUS) makes and guarantees loans to rural utilities to finance the construction and development of electric power systems. Although critics question the federal government’s role in providing power or in financing improvements to rural utility systems as markets restructure, the activities continue. However, the traditional structure of the electricity industry has begun to change. Legislation and new generating technologies have introduced increased competition into the market, changing the environment in which the PMAs must operate successfully if they are to repay the federal investment in the power program. Federal and state agencies regulate the activities of electric utilities. Traditionally, electricity service was viewed as a “natural monopoly”: A central source of power was seen as the most efficient way of generating, transmitting, and distributing electricity at a reasonable cost. Under the traditional regulatory compact between electric utilities and their state regulators, electric utilities were guaranteed monopolies within their exclusive service areas and regulated rates of return on their capital investments. In return, these utilities built generating and other facilities to provide all of the electricity needed by all current and future customers in their service areas. Under traditional “cost-of-service” regulation, electricity rates approved by state regulators reflected the utilities’ costs of building new generating plants and operating the power system. As shown in table 1.1, IOUs dominate the electricity markets: Although they account for only about 8 percent of the nation’s almost 3,200 electric utilities, they have over 75 percent of utility sales to ultimate customers and over 77 percent of total utility power generation. Most IOUs sell power at retail rates to several different classes of consumers and at wholesale rates to other utilities, including other IOUs; federal, state, and local government utilities; public utility districts; and rural electric cooperatives. The traditional regulatory role of the federal and state governments was established under the Constitution and developed by federal law. Specifically, the Federal Power Act (formerly the Federal Water Power Act), which was enacted in 1920, and the Public Utility Holding Company Act established a regime of regulating electric utilities that gave specific and separate powers to the states and the federal government. State regulatory commissions (generally called “public utility” or “public service commissions”) regulate utilities’ activities within state boundaries, including the setting of wholesale and retail electric rates. At the federal level, the Securities and Exchange Commission regulates interstate electric utility holding companies by requiring them to register and divest holdings so that each company becomes a single consolidated system serving a specific geographic area. In addition, the Commission regulates how the holding companies issue and acquire securities. Under the Federal Power Act, the Federal Energy Regulatory Commission (FERC), formerly the Federal Power Commission, regulates interstate aspects of the electric utility industry, including financial transactions, wholesale rates, and interconnection and transmission arrangements. In addition to IOUs, 932 customer-owned rural electric cooperatives and 2,014 publicly owned utilities provided power in 1996. Most rural electric cooperatives, usually formed and owned by residents of rural areas, distribute electricity only to their members. Operating throughout the nation except for Connecticut, Hawaii, and Rhode Island, cooperatives constituted 29 percent of all the nation’s electric utilities in 1996. Publicly owned electric utilities are nonprofit state and local government agencies, such as municipal utilities, state authorities, public power districts, and irrigation districts. DOE views publicly owned power as providing competition for IOUs and as charging power rates against which the power rates of IOUs can be compared. In 1996, almost 63 percent of all electric utilities in the nation were publicly owned utilities. Cooperatives and publicly owned utilities buy power from wholesale providers for sale to retail customers. However, some cooperatives and publicly owned utilities also generate their own power and transmit it to other utilities or distribute it to their own retail customers. The generation and share of the national energy supply for these types of utilities are provided in table 1.1. The federal government has played a significant role in the development of electricity markets. Because it was too expensive for IOUs to serve rural areas, federal power agencies provided power to those areas. In addition, the government provided financing to rural utilities to assist them in building and maintaining electricity distribution systems that provide electricity to rural users. In 1996, federal utilities provided almost one-tenth of the nation’s power. As a result of these activities, the federal agencies that generate and/or market electricity and that make or guarantee loans to finance improvements to rural electric systems had incurred a debt of over $84 billion as of September 30, 1996. This debt, it should be noted, can be classified as direct and indirect. The direct debt, totaling over $53 billion, is owed directly to the federal government—for example, RUS’ borrowers owe about $32 billion. The indirect debt, over $31 billion, is owed by the federal agencies to nonfederal parties—for example, TVA owed about $24 billion to nonfederal bondholders. Federal entities that generate and/or market electricity—primarily the Bureau, the Corps, the PMAs, and TVA—provided about 10 percent of the nation’s electricity supply in 1996. The Bureau and the Corps generate hydropower at about 130 federally owned power plants located at federal water projects. Because these projects are managed for multiple purposes (for example, providing water for irrigation, water supplies, navigation, flood control, and recreation), the amount of power generated and marketed is affected by the availability and use of water for these other purposes. Power generated by the Bureau and the Corps is marketed by four of DOE’s five PMAs: the Bonneville Power Administration (Bonneville), plus the three that are the focus of this report: the Southeastern Power Administration (Southeastern), the Southwestern Power Administration (Southwestern), and the Western Area Power Administration (Western). The fifth PMA, the Alaska Power Administration, differs from the others in that it operates its own power plants and distributes power directly to end-use (retail) customers. The PMAs in 1996 provided about 5 percent of the nation’s power. The PMAs’ mission is to market federal hydropower at the lowest possible rates that are consistent with sound business practices. The power the PMAs market is the power that remains after it has been consumed for project purposes—for example, to pump water to fields that are being irrigated. By law, the PMAs are to give priority in the sale of power to “preference customers”—public bodies (such as municipal utilities, irrigation districts, military installations, and other federal agencies) and cooperatives. Each PMA has its own specific geographic boundaries, federal water projects from which it markets power, statutory responsibilities, and operation and maintenance responsibilities. Except for the Alaska Power Administration, the PMAs generally do not own, operate, or control the facilities that generate electric power; the generating facilities are controlled by the operating agencies—most often the Bureau and the Corps. The PMAs, except for Southeastern, do own and operate transmission facilities. Southeastern relies on the transmission services of other utilities to transmit the power it sells to its customers. The PMAs are generally required to recover all costs incurred as a result of producing, transmitting, and marketing power, including repayment of the federal investment in the power generating facilities and other debt, with interest. Certain nonpower costs are also allocated to power revenues for repayment. For example, under the concept of aid-to-irrigation, revenues earned from the sale of power repay the federal investment in irrigation facilities that the Secretary of the Interior deems is beyond the ability of irrigators to repay. According to Bureau officials, power revenues are ultimately expected to cover about 70 percent of the federal investment in completed irrigation facilities. As of September 30, 1996, the PMAs and TVA had an outstanding debt of about $52 billion related to financing the construction and operation of power plants, transmission lines, and related electricity assets, as well as other costs that are allocated to be repaid through revenues earned from the sale of electricity. TVA owed about $28 billion; Bonneville owed about $17 billion; and Southeastern, Southwestern, and Western owed the balance—about $7 billion. Together, DOE’s five PMAs and TVA market power within 34 states. They do not serve Hawaii and states in the Northeast and upper Midwest. Figure 1.1 shows the service areas of the PMAs.