The three PMAs we studied (Southeastern, Southwestern, and Western) market primarily wholesale power in 30 states produced at large, multiple-purpose water projects. Collectively, in fiscal year 1995, they had revenues of almost $1 billion. Most of the power they sell is produced at 102 hydroelectric dams built and run primarily by the U.S. Army Corps of Engineers or the Department of the Interior’s Bureau of Reclamation, commonly referred to as “operating agencies.” The operating agencies constructed these facilities as part of a larger effort in developing multipurpose water projects that have functions other than power generation, including flood control, irrigation, navigation, and recreation. To transmit this power, Southwestern and Western have their own transmission facilities. Southeastern relies on the transmission services of other utilities. The three PMAs receive annual appropriations to cover operating and maintenance (O&M) expenses and, if applicable, the capital investment in transmission assets. Federal law calls for PMAs to set power rates at levels that will repay these appropriations as well as the power-related O&M and capital appropriations expended by the operating agencies generating the power. The Department of Energy’s (DOE) implementing order specifies that unless otherwise prescribed by law, appropriations used for O&M expenses be recovered in the same year the expenses are incurred, but that appropriations used for capital investments (which we refer to as appropriated debt) be recovered, with interest, over periods that can last up to 50 years. At the end of fiscal year 1995, the three PMAs had about $5.4 billion of appropriated debt outstanding. In addition, Western is required to recover about $1.5 billion of capital costs related to assistance on completed irrigation facilities (which we refer to as irrigation debt), without interest, with repayment periods of up to 60 years. Because PMAs and operating agencies generally receive financing from appropriations, Department of the Treasury checks are issued for their disbursements. Operating agencies allocate power-related costs to the PMAs for recovery. PMAs set rates to recover power-related costs, bill customers, and the resultant revenue is returned to Treasury. The chart in attachment I demonstrates the flow of appropriated funds, costs to be recovered, and how repayment is made to Treasury from the revenues collected from power customers. It also outlines the costs that have not been recovered through this process, as well as the financing subsidy, that are discussed in detail in this testimony. The Reclamation Project Act of 1939 and the Flood Control Act of 1944 generally require that the PMAs recover through power rates the costs of producing and marketing federal hydropower. However, these acts do not define which costs are required to be recovered. In addition, DOE’s implementing Order RA 6120.2, which was issued in 1979 and last revised in 1983, excludes certain costs associated with nonoperational facilities and is not specific about recovery of others. Where the order is not specific, PMAs have interpreted it to exclude certain costs from rates. To define the full cost of power production and marketing, we referred to Office of Management and Budget (OMB) Circular A-25, “User Charges,” industry practice, and federal accounting standards. These criteria indicate that the full cost of producing and marketing federal hydropower would include all direct and indirect costs incurred by the PMAs, operating agencies, and other agencies involved in power-related activities. We identified five main power-related costs that meet these criteria that have not yet been fully recovered through electricity rates. First, the three PMAs do not recover the full cost of power-related postretirement health benefits and Civil Service Retirement System (CSRS) pensions for current PMA and operating agency employees. For fiscal year 1995, we estimate that these unrecovered costs were about $16 million for these three PMAs. The annual funding shortfall associated with CSRS pension benefits will be eliminated over time as CSRS employees leave the government and are replaced by employees covered by the Federal Employees Retirement System (FERS), for which pension benefits are fully funded. The annual funding shortfall associated with postretirement health benefits, however, will not be eliminated as a result of this transition, since it is an entirely separate benefit program. As of September 30, 1995, we estimate that the cumulative unrecovered costs associated with postretirement health benefits and CSRS pension benefits were about $436 million for these three PMAs. Second, all three PMAs had incurred costs and/or had costs allocated to them for projects that were completed or under construction for which full costs were not being recovered. In some cases, this was because the power-generating projects had never operated as designed. In accordance with DOE guidance, PMAs set rates that exclude the costs of nonoperational parts of power projects, including capitalized interest. For example, at the Russell Project, partially on line since 1985, litigation over excessive fish kills has kept four of the eight turbines from becoming operational. As a result, about one-half of the project’s construction costs have been excluded from Southeastern’s rates. It is unclear whether these costs, totalling $488 million as of September 30, 1995, will be recovered if the project never operates to the capacity designed. In other cases, the tenuous financial condition of completed projects also raises questions about whether power-related costs will be recovered. For example, Western is currently selling electricity from the Washoe Project for less than 20 percent of what it costs to produce. According to Western, this situation is the result of relatively high construction costs and drought conditions. According to Western’s 1995 annual report: “Based on current conditions, it is unlikely the project will be able to generate sufficient revenues to repay the Federal investment.” For the same reasons, we believe that the Washoe Project is unlikely to generate sufficient revenue to repay all O&M and interest expenses. Third, as we reported in May 1996, at the Pick-Sloan Missouri Basin Program (Pick-Sloan), about $454 million of capital costs for hydropower facilities and water storage reservoirs has been allocated to authorized irrigation facilities that are infeasible and, therefore, not expected to be completed. Western is currently selling electricity to its power customers that would have been used by the irrigators had the irrigation facilities been completed. As long as the $454 million is allocated to incomplete irrigation facilities, recovery by Western will not be required. If the facilities were completed but the capital costs were determined to be beyond the irrigators’ ability to repay, then Western would be required to recover most of these irrigation costs without interest. If these costs had been allocated based on the actual use of the hydropower facilities and water storage reservoirs, they would have been allocated primarily to power production and recovered, with interest, through electricity rate charges within 50 years of completion. Under the current repayment criteria, it is unlikely that Western will be required to recover the principal or any interest on these capital costs. In addition, since 1987, $13.7 million ($15.3 million in constant 1995 dollars) of power-related O&M expenses incurred by the Army Corps of Engineers at Pick-Sloan have been allocated to incomplete irrigation facilities and thus are not being recovered through power rates. The methodology that resulted in allocating power-related capital and O&M costs to the incomplete irrigation facilities was developed decades ago in anticipation of the completion of all planned irrigation facilities. This methodology is still being used and will continue to increase these unrecovered power costs. However, as we also reported in May 1996, changing the terms of repayment to cover any of the $454 million investment would require congressional action. In addition, any changes between the program’s power and irrigation purposes may also necessitate reviewing other aspects of the agreements—specifically, the agreements involving areas that accepted permanent flooding from dams in anticipation of the construction of irrigation facilities that are now not likely to be constructed. Fourth, the Central Valley Project’s Shasta Dam and the Colorado River Storage Project’s Glen Canyon Dam have incurred power-related environmental mitigation costs that are legislatively excluded from Western’s rates. For the Shasta Dam, these costs totaled $9.7 million in 1995 and $5.4 million in 1994. For the Glen Canyon Dam, they totaled $13.9 million and $12.5 million for the same 2 years. The total cumulative legislatively excluded environmental costs for the two projects were $134.3 million ($152.5 million in constant 1995 dollars) as of September 30, 1995. Fifth, as of September 30, 1995, Western had unrecovered O&M and interest expense payments relating to nine of its 15 projects. These “deferred payments” are to be repaid to Treasury, with interest. According to Western, these deferred payments are primarily due to drought conditions which reduced streamflow and hence the ability to generate electricity in the late 1980s and early 1990s. The balance of Western’s deferred payments decreased from about $250 million as of September 30, 1994, to about $196 million as of September 30, 1995. Western officials have told us they expect to recover the majority of these costs over time. In the aggregate, we estimate that the annual unrecovered costs for the three PMAs was about $83 million for fiscal year 1995 for the five main power-related activities identified above. As of September 30, 1995, the cumulative unrecovered power costs could be as much as $1.8 billion. Table 1 provides a summary of our estimates of these unrecovered costs. Power-related capital projects are financed primarily with appropriated funds. Federal legislation and DOE policy enable PMAs to implement flexible financing terms that allow the accumulation of large amounts of appropriated debt at low interest rates. PMAs have low interest rates on appropriated debt for two primary reasons.