TVA is an independent, wholly owned federal corporation established by the TVA Act of 1933 (TVA Act), as amended. 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 built dams and hydropower facilities on the Tennessee River and its tributaries. To meet the subsequent need for more electric power, TVA expanded beyond hydropower to other types of power generation such as natural gas, coal, and nuclear plants. As of September 30, 2005, TVA sold electricity at wholesale rates to 158 retail distributors that resell electricity to consumers, and sold electricity directly to 61 large retail customers. As illustrated in figure 1, TVA’s service territory includes most of Tennessee and parts of Alabama, Georgia, Kentucky, Mississippi, North Carolina, and Virginia. The area covers 80,000 square miles with a population of more than 8.6 million. From its inception in 1933 through fiscal year 1959, TVA received appropriations to finance its internal cash and capital requirements. In 1959, however, the Congress amended the TVA Act to provide TVA the means to self-finance its power program and required it to repay a substantial portion of appropriations it had received to pay for its capital projects. At the same time, the Congress required that TVA’s power programs be self-financing through revenues from electricity sales. For its capital needs in excess of funds generated from operations, TVA was authorized to borrow by issuing bonds and notes. TVA’s authority to issue bonds and notes is set by the Congress and cannot exceed $30 billion outstanding at any given time. Until recently, TVA had been administered by a three-member board of directors appointed by the President of the United States and confirmed by the U.S. Senate. An Executive Committee worked with the board to determine TVA’s strategic mission and future direction, provide management oversight, and ensure policies of the board were carried out. The Consolidated Appropriations Act, 2005, which was signed into law in December 2004, changed the structure of TVA’s management. The act contained provisions that restructured the board from three full-time members to nine part-time members, established the position of Chief Executive Officer (CEO) to be appointed by the board, required TVA to begin filing financial reports with the Securities and Exchange Commission (SEC), and required TVA’s new board to create an Audit Committee to be composed solely of board members independent of management. The audit committee will be responsible for reviewing inspector general and external audit reports and making recommendations to the board. The legislation specifies that seven of the nine board members must be legal residents of TVA’s service area and that the members will be appointed by the President and confirmed by the Senate. After a transition period, members will serve 5-year rather than the current 9-year terms. In general, the board will establish TVA’s strategic direction and policies while the CEO will oversee their implementation as well as TVA’s overall operations. The new board became effective on March 31, 2006, when six new board members took the oath of office and joined two existing members to hold the first board meeting under the new governance structure. Along with annual reporting to the SEC, in fiscal year 2006 TVA will also be required to comply with certain provisions of the Sarbanes-Oxley Act of 2002, including the requirement that its officers certify annual and quarterly financial reports and report on the effectiveness of internal controls over financial reporting. TVA’s external auditor, in addition to auditing and issuing an opinion on TVA’s financial statements, will be required to issue an opinion on the effectiveness of TVA’s internal controls over financial reporting. Based on the current guidance from the SEC, TVA will file the first report on internal controls with its September 30, 2007, financial statements. Under the TVA Act, as amended, TVA has not been subject to most of the regulatory oversight requirements that commercial utilities must satisfy. Legislation has also limited competition between TVA and other utilities. When the TVA Act was amended in 1959, it prohibited TVA, with some exceptions, from entering into contracts to sell power outside the service area that it and its distributors were serving on July 1, 1957. This is commonly referred to as the “fence” because it limits TVA’s ability to expand outside its July 1, 1957, service area. In addition, the Energy Policy Act of 1992 (EPAct) exempted TVA from being required to allow other utilities to use its transmission lines to send power to customers within its service area, effectively reducing the opportunities for TVA’s wholesale customers to choose other suppliers. This exemption is often referred to as the “anti-cherrypicking” provision. TVA is still subject to some forms of indirect competition common to all utilities. For example, the cost of power would affect decisions by TVA’s customers to move or expand outside TVA’s service area or by businesses to move into its service area. In addition, customers can decide to generate their own power for on-site use. However, as long as the legislative framework continues to insulate TVA from direct competition for its wholesale customers, it will remain in a position similar to that of a regulated utility monopoly. For more than 20 years, the federal government has been taking a variety of steps to restructure the electricity industry with the goal of increasing competition in wholesale markets and thereby increasing benefits to consumers, including lower electricity prices and a wider variety of retail services. Electricity restructuring is evolving against a backdrop of constraints and challenges, including shared responsibility for implementing and enforcing local, state, and federal laws affecting the electricity industry and an expected substantial increase in electricity demand by 2025, which will require significant investment in new power plants and transmission lines. Prior to this restructuring, electricity was generally provided by electric utilities that exclusively served all customers within a specific geographic region. Under these conditions, the federal government, through the Federal Energy Regulatory Commission (FERC) and its predecessors, regulated wholesale electricity sales (sales for resale) and interstate transmission by electric utilities and set prices at cost-based rates. Because the utilities were monopolies, states regulated retail markets, approving utility company investments and rates paid by customers. In 1978, the federal government laid the groundwork for restructuring and competition in the electricity industry with the Public Utility Regulatory Policies Act, which opened wholesale power markets to electricity producers that were not regulated utility monopolies. In the 1990s the federal government greatly expanded these efforts. First the EPAct provided for broader participation in wholesale electricity markets by nonutilities and allowed these entities to produce and sell electricity at market prices. Second, in 1996 the FERC issued Orders 888 and 889, which greatly expanded opportunities for competition by requiring utilities to provide access to their transmission lines to all users under the same prices, terms, and conditions. This change allowed the new nonutilities to compete with utilities and others for the opportunity to sell electricity in wholesale markets on more equal terms. By 2002 a number of states had made efforts to introduce competition to the retail markets that they oversee, allowing nonutilities to compete with utilities and others for the opportunity to sell electricity directly to consumers. Beginning in 2000, some restructured wholesale and retail electricity markets encountered a number of problems. From the summer of 2000 through early 2001, California saw a sharp increase in wholesale electricity prices, electricity shortages leading to rolling blackouts, and the deteriorating financial stability of its three major investor-owned utilities. These problems, along with the largest blackout in U.S. history along the East Coast in 2003, drew attention to the need to examine the operation and direction of the industry. Efforts to expand restructuring slowed down as many states analyzed the factors that contributed to these problems, among them failure to meet increasing demand for electricity with new generation and transmission capacity. TVA management and many industry experts, however, expect that TVA will eventually be drawn into the restructuring of the electric utility industry and will eventually lose its legislative protections from competition. There have already been some indications of such changes. For instance, S.1499, introduced in July 2005, would remove any area within Kentucky from coverage by the “anti-cherrypicking” provision in the EPAct. If the bill becomes law, TVA would be required to transmit power from another supplier over its transmission lines for use inside the Kentucky portion of its service area without being able to similarly expand its service area. The bill was referred to the Senate Energy and Natural Resources Committee, where it remained as of August 15, 2006. Our prior reports have indicated that TVA’s high debt and related interest expense could place it at a disadvantage in continuing to offer competitively priced power if it were to lose its legislative protections from competition. TVA’s management has also recognized the need to reduce its debt and other financing obligations to increase its flexibility to meet competitive challenges. In July 1997, TVA issued a 10-year business plan with steps necessary to improve its financial position for an era of increasing competition. Two key strategic objectives of the plan were (1) to reduce the cost of power by reducing debt and the corresponding financing costs, and (2) increase financial flexibility by reducing fixed costs. To help meet these objectives, the plan called for TVA to reduce its debt by half over a 10-year period to about $13.2 billion by increasing its electricity rates beginning in 1998, reducing certain expenses, and limiting capital expenditures. TVA did not meet the 1997 debt reduction goal because it used cash intended for debt reduction to cover greater than estimated annual operating costs and capital expenditures. In fiscal year 2000, TVA began entering into alternative financing in the form of lease-leaseback arrangements to obtain a lower cost of capital than it could by selling bonds.