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1,000 | nal revenue from its 1998 rate increase to reduce its debt. TVA officials attribute about an additional $1.24 billion in revenue over the first 3 years of the plan to the rate increase. During this period, TVA has reduced its outstanding debt by more than a comparable amount—about $1.4 billion. A key element of TVA’s plan was not only to reduce the cost of its power by reducing its debt and the corresponding interest expense, but also to recover a substantial portion of the costs of its deferred assets. By |
1,001 | increasing operating revenues and reducing interest and other expenses to generate cash flow that could be used to reduce debt, TVA would have the opportunity to use revenues in excess of expenses to recover a portion of the costs of its deferred assets. However, as noted previously, the proposed revision to the plan contains additional operating and other expenses over the remainder of the 10-year period, which, absent any future rate increases, will decrease the amount of revenue available to recover defe |
1,002 | rred assets. TVA has also added about $600 million in deferred assets, some of which will have to be recovered in the future. Although TVA recovered the costs of deferred assets to the extent planned over the first 3 years of the plan, it is reducing its overall deferred asset recovery goals through 2007. TVA has a significant amount of unrecovered capital costs associated with three uncompleted and nonproducing deferred nuclear units—about $6.3 billion as of September 30, 2000. At that time, TVA’s investme |
1,003 | nt in its deferred nuclear units represented about 26 percent of the cost of TVA’s total undepreciated generating property, plant, and equipment. The deferred units do not generate power, and TVA has chosen not to begin to recover their costs through rates. In contrast, the unrecovered costs of TVA’s operating nuclear plants, which produced about 31 percent of TVA’s power in 2000, represented about 45 percent of the cost of TVA’s total undepreciated generating assets as of September 30, 2000. At the time TV |
1,004 | A issued the original 10-year business plan, the unrecovered balance of TVA’s deferred assets, including both its nuclear units and other deferred assets, was about $8.5 billion. TVA recovered the cost of deferred assets to the extent planned for over the first 3 years of the plan. Through September 30, 2000, $1.1 billion in other deferred assets had been recovered through rates, but recovery of the cost of the deferred nuclear units had not begun. However, since the original plan was issued, TVA has also a |
1,005 | dded about $600 million in other deferred assets, some of which will have to be recovered in the future; its current total is about $8 billion. TVA’s overall plan for recovering the costs of its deferred assets through 2007 is being reduced significantly. TVA now plans to reduce the balance of its deferred assets, including both its nuclear units and other deferred assets, to about $3.9 billion; this represents much less deferred asset recovery than TVA’s original estimate of $500 million. Figure 4 compares |
1,006 | the annual estimated remaining balances of deferred assets (both the deferred nuclear units and other deferred assets) contained in TVA’s July 1997 10-year plan to TVA’s actual deferred asset balances as of the end of fiscal years 1998 through 2000 and to TVA’s estimated balances for fiscal years 2001 through 2007. Not reducing debt and recovering deferred assets to the extent planned by 2007 while still legislatively protected from competition could diminish TVA’s future competitive prospects. Specificall |
1,007 | y, not meeting these goals could cause the price of its future power to be above market, if TVA’s debt service costs remain relatively high at the time it is required to compete and if TVA is at the same time attempting to recover the costs of its deferred assets through rates. Assuming that TVA’s outstanding debt balance is $19.6 billion as of September 30, 2007, and its weighted average interest rate remains about 6.5 percent, we estimate that TVA’s interest expense in the year 2008 will be about $1.27 bi |
1,008 | llion, about $416 million higher than if debt were reduced to $13.2 billion. As we stated in our April 1999 report, the more progress TVA makes in addressing these issues while it has legislative protections, the greater its prospects for being competitive if it loses those protections in the future. Although reducing debt and the amount of deferred asset costs that have not yet been recovered are important to TVA as it prepares for competition, TVA’s future competitiveness will be based to a large degree o |
1,009 | n market conditions and how TVA will be restructured if and when TVA loses its legislative protections. Of particular importance is the uncertainty of the future market price of power. In our 1999 assessment of TVA’s 10-year plan, we found that TVA’s projection of the future market price of wholesale power in 2007 was somewhat lower than the projections of leading industry experts. This lower projection prompted TVA to be aggressive in its planning to reduce costs to position itself to offer competitively p |
1,010 | riced power by 2007. TVA and other industry experts are continuing to revise their projections of the future market price of power in 2007. TVA’s projection is a load-shaped forecast—i.e., its projection is based specifically on how TVA’s load varies during different hours of the day and different days of the week. TVA officials told us that higher projections are warranted now than when it prepared its plan in 1997 primarily due to projected increases in the price of natural gas, but also due to a combinat |
1,011 | ion of other factors, including the extreme volatility of spot prices (in the summer months), increasing power demands beyond what they expected 3 years ago, shortages (or at least, shrinking surpluses) of both generating and transmission capacity, and a better understanding of the increased costs of complying with environmental regulations that are likely to take effect between now and 2007. TVA has stated that the impact of these factors can be seen in higher current trading prices, higher forward prices |
1,012 | being offered by suppliers, higher long-term contract prices, and higher energy prices. TVA officials are now forecasting a market price of power in 2007 in the range of 4.0 to 5.0 cents per kilowatthour (kWh), which would be sufficient to cover its projected costs of about 3.8 to 3.9 cents per kWh in 2007. An analysis by Salomon Smith Barney, which extends through 2004, supports TVA’s position that market indicators suggest that the future market price of power will be higher during this part of the plan p |
1,013 | eriod. Not all industry experts agree with TVA’s belief that the price of natural gas will necessarily drive electricity prices higher. For example, the Energy Information Administration (EIA) projects a downward price trend (in current dollars) between now and 2007 in the region in which TVA operates, in part due to declining coal prices that EIA projects would more than offset increasing gas prices. EIA also projects that nuclear fuel prices will remain stable. However, when projecting future prices by ge |
1,014 | ographic region, EIA and other industry experts generally forecast the future market price of power on an average yearly price that includes all peaks and valleys. Such average yearly price forecasts are not directly comparable to TVA’s load-shaped forecast. Differing forecasts by various industry experts underscore the uncertainty of predicting the future market price of power. The higher actual market prices are, the better positioned TVA will be to generate revenue that could be used to pay down debt and |
1,015 | recover costs, including the costs of deferred assets. However, by increasing its projections for the future market price of power, TVA assumes it can accommodate a higher debt level than originally planned. Because of the uncertainly surrounding whether TVA’s projections of higher market prices in 2007 are accurate, TVA’s higher debt projections increase the risk that it will not be able to generate the revenue needed to recover all costs or offer competitively priced power at that time. In a competitive |
1,016 | environment, these assumptions could increase the federal government’s risk of loss due to its financial involvement with TVA. A key objective of TVA’s 1997 plan was to alter its cost structure from a rigid, high fixed-to-variable cost relationship to a cost structure with more financial flexibility that is better able to adjust to a more volatile marketplace. However, while TVA has made positive steps, its financial flexibility remains below that of likely competitors, largely because its debt remains rela |
1,017 | tively high. Another key objective of TVA’s 1997 plan was to reduce its cost of power. One of the components of the cost of power is the recovery of the costs of its capital assets. Similar to improvements in flexibility, while TVA has made some progress in recovering the costs of its capital assets, financial indicators show that TVA has recovered fewer of these costs than its likely competitors. In 1995 we reported that one option available for TVA to improve its financial condition was to raise rates whi |
1,018 | le it is still legislatively protected from competition and use the proceeds to reduce its debt. In 1998, TVA implemented its first rate increase in 10 years. For the previous 10 years, TVA had chosen to keep rates as low as possible rather than generate additional revenue that could have been used to reduce debt. Revenue from TVA’s 1998 rate increase has reduced debt (and corresponding interest expense) and recovered some of the costs of deferred assets over the first 3 years of its 10-year plan. From Sept |
1,019 | ember 30, 1997, through September 30, 2000, TVA reduced its debt from about $27.4 billion to about $26.0 billion. This debt reduction, along with the refinancing of debt at lower interest rates, enabled TVA to reduce its annual interest expense from about $2.0 billion in fiscal year 1997 to about $1.7 billion in fiscal year 2000. In addition, TVA has recovered about $1.1 billion of its deferred assets through rates. While not reducing debt and recovering the costs of deferred assets to the extent anticipate |
1,020 | d in its original plan, these actions are important because they are a step toward giving TVA more financial flexibility to adjust its rates in a competitive environment. To assess the progress TVA has made in achieving its key objective of altering its cost structure from a rigid, high fixed-to-variable cost relationship to a cost structure with more financial flexibility, and to put TVA’s financial condition in perspective, we compared TVA to likely competitors in terms of (1) total financing costs, (2) f |
1,021 | ixed financing costs, and (3) net cash generated from operations as a percentage of expenditures for property, plant, and equipment and common stock dividends. These ratios are indicators of TVA’s flexibility to withstand competitive or financial challenges. To assess TVA’s financing costs compared to these competitors, we computed the total financing costs to revenue ratio, which is the percentage of an entity’s operating revenue that is needed to cover all of its financing costs. A lower percentage indica |
1,022 | tes greater flexibility to respond to financial or competitive challenges. Financing costs for TVA, which consist of the interest expense on its outstanding debt and payments made to the federal government as returns on past appropriations, are fixed costs in the short term that must be paid even in times of financial or competitive difficulty. In contrast, for the IOUs, financing costs include preferred and common stock dividends in addition to interest expense, because part of the IOUs’ capital is derived |
1,023 | from preferred and common stock and dividends represent the cost of this equity capital. Figure 5 shows that TVA’s total financing costs, although improved since 1994, remain high when compared to those of likely competitors. Next, we computed the fixed financing costs to revenue ratio, which indicates the percentage of operating revenues needed to cover the fixed portion of the financing costs. For this ratio, we excluded the common stock dividends paid by IOUs because these are not contractual obligation |
1,024 | s that must be paid. They can be reduced—or even suspended in extreme cases—to allow an entity to respond to financial or competitive challenges. As with the total financing costs to revenue ratio, the lower the percentage of the fixed financing costs to revenue, the greater the financial flexibility of the entity. Figure 6 shows that, while TVA has made progress since 1994, its fixed financing costs remain high compared to those of likely competitors. For example, for fiscal year 1999, 28 cents of every re |
1,025 | venue dollar earned by TVA went to pay for fixed financing costs compared to about 9 cents on average for its likely competitors. Another key indicator of financial flexibility is the ratio of net cash from operations (i.e., cash in excess of operating and interest expenses) to expenditures for property, plant, and equipment (PP&E) and common stock dividends. This net cash in effect represents the amount available for management’s discretionary use. A percentage of 100 would indicate sufficient net cash pro |
1,026 | vided by operations to pay for 100 percent of annual PP&E expenditures and common stock dividends. By necessity, utilities that are unable to pay for capital expenditures from net cash are forced to pay for them through retained earnings or by borrowing funds or issuing stock. Issuing debt to cover capital expenditures increases a utility’s cost of power by requiring annual interest payments, and issuing stock could also increase the cost of power through the payment of dividends. Since TVA does not pay div |
1,027 | idends, its ratio only includes expenditures for PP&E. A higher percentage indicates greater flexibility. Because of increased revenue from TVA’s recent rate increase, a significant reduction in annual capital expenditures for its nuclear power program, and cost control measures that reduced certain expenses, TVA’s ratio has improved significantly and now compares favorably to those of likely competitors. Figure 7 illustrates the improvement TVA has made to date compared to likely competitors. Electricity p |
1,028 | roviders, including TVA, generally recover their capital costs once the capital assets have been placed in service by spreading these costs over future periods for recovery through rates. This way, customers “pay” for the capital assets over time as the assets provide benefits. When a decision is made not to complete a capital asset, it becomes “abandoned.” Accounting standards require that abandoned assets be classified as regulatory assets and amortized into operating expense; therefore, they would be inc |
1,029 | luded in rates over time. Thus, even though abandoned assets are nonproductive, the costs may still be recovered. TVA’s three uncompleted deferred nuclear power units have not been classified as abandoned, even though no construction work has been done in the last 12 to 15 years. In 1995 and 1997, we reported that TVA should classify them as regulatory assets and begin to recover the costs immediately. However, TVA continues to assert that there is a possibility the units will be completed in the future and |
1,030 | has not classified them as regulatory assets and begun to recover their costs. As of September 30, 2000, the deferred cost of the three uncompleted nuclear generating units was about $6.3 billion. If TVA is required to compete with other electricity providers, depending on the market price of power and TVA’s cost of providing power, recovery of these deferred assets could be difficult. Effective for 1999, TVA began emphasizing the accelerated recovery of certain of its other deferred assets in its planning |
1,031 | and adopted accounting policies that would enable it to recover more of these costs earlier. However, as the following analysis indicates, TVA’s continued deferral of the $6.3 billion related to the three nuclear units would hinder its ability to compete in a restructured environment, if TVA tries to recover the costs through rates. This would increase the risk of loss to the federal government from its financial involvement in TVA. The extent to which the costs of deferred capital assets have not been rec |
1,032 | overed by TVA compared to its likely competitors can be shown by two analyses. The first analysis compares the amount of capital assets that have not yet begun to be taken into rates to gross PP&E. For TVA, this consists of construction work in progress (CWIP) and the costs of the deferred nuclear units; for the other entities this consists of CWIP only. A lower ratio indicates fewer capital costs to be recovered through future rates, and therefore more flexibility to adjust rates to meet future competition |
1,033 | . TVA’s ratio improved—dropping by more than half—when it brought two nuclear plants on line in 1996 and began to recover their costs. However, as figure 8 shows, the portion of TVA’s capital assets that has not yet begun to be taken into rates remains significantly higher than that of likely competitors. This is due largely to the deferral of TVA’s three uncompleted nuclear units. For example, about 19 percent of the total cost of TVA’s PP&E as of September 30, 1999, was not in rates, while the highest per |
1,034 | centage for TVA’s likely competitors was only 10 percent. A second way to analyze the extent to which capital costs have been recovered through rates is to compare accumulated depreciation/amortization to gross PP&E. A higher ratio indicates that a greater percentage of the cost of PP&E has been recovered through rates. A utility that has already recovered a greater portion of its capital costs could be in a better financial condition going into an increasingly competitive environment because it would not h |
1,035 | ave to include those costs in future rates. TVA has also made progress in this area since 1994, as have, in general, its likely competitors. However, figure 9 shows that as of September 30, 1999, TVA had recovered a substantially smaller portion of its capital costs than most of its likely competitors, again, largely due to the deferred nuclear units. When considering its financing costs and unrecovered deferred assets, TVA’s financial condition compares unfavorably to its likely competitors. Although TVA’s |
1,036 | ratio of net cash from operations to expenditures for PP&E and common stock dividends is better than its likely competitors, this advantage is negated by TVA’s relatively higher financing costs, including fixed financing costs, and relatively higher deferred asset costs. These factors reduce TVA’s financial flexibility to respond to future financial or competitive pressures, a key objective of TVA’s 10-year plan. Bond analysts with experience rating TVA’s bonds confirmed our assessment by stating that if f |
1,037 | orced to compete today, TVA’s financial condition would pose a serious challenge. The analysts further stated that their Aaa rating of TVA bonds is based on TVA’s ties to the federal government and the belief that any restructuring legislation would give TVA sufficient time to prepare for competition. According to the analysts, their bond rating of TVA was not based on the same financial criteria applied to the other entities rated. When assessing the progress TVA has made in achieving the key objectives of |
1,038 | its 1997 plan, TVA’s financial condition remains unfavorable compared to its likely competitors in the current environment. However, TVA also has certain competitive advantages. Specifically, it remains its own regulator; is not subject to antitrust laws and regulations; enjoys a high bond rating, and associated lower interest costs, based on its ties to the federal government; is a government entity that is not required to generate the level of net income that would be needed by a private corporation to p |
1,039 | rovide an expected rate of return; is not required to pay federal and state income taxes and various local taxes, but is required to make payments in lieu of taxes to state and local governments equal to 5 percent of gross revenue from sales of power in areas where its power operations are conducted; in addition, TVA’s distributors are also required to pay various state and local taxes; and has relatively more low-cost hydroelectric power than neighboring utilities. Although TVA enjoys these competitive adv |
1,040 | antages, its high debt and unrecovered costs would present challenges in a competitive environment. However, it is not possible to predict TVA’s future competitive position. In addition to uncertainties over the future market price of power, TVA’s future competitive position will be affected by a number of issues, including the specific requirements of any legislation that might remove TVA’s legislative protections, including whether it would be able to retain some or all of the competitive advantages descr |
1,041 | ibed previously; actions being taken by TVA to prepare for competition in relation to those being taken by TVA’s competitors; the amount of time before TVA might lose its protections from competition and is required to compete with other utilities—the longer TVA is legislatively protected from competition, the longer it will have to reduce its debt and related financing costs and recover deferred costs through rates; the extent to which TVA would write off all or a portion of the cost of its deferred nuclea |
1,042 | r units to retained earnings should it go from a regulated to a restructured, competitive environment. To the extent retained earnings is sufficient to cover the cost of the write-offs, any costs written off directly to retained earnings would not have to be recovered through future rates; and total cost of delivering power in relation to likely competitors, generation capacity and mix, transmission capability, and geographic location. Stranded costs can generally be defined as costs that become uneconomica |
1,043 | l to recover through rates when a utility moves from a regulated to a competitive environment. Stranded costs arise in competitive markets as a result of uneconomic assets, the costs of which are not recoverable at market rates. There are two commonly used methods for calculating stranded costs, and various mechanisms have been used to recover them in the states that have restructured their electricity markets. TVA’s potential for stranded costs arises mainly from its uneconomic assets—primarily its three n |
1,044 | onproducing nuclear units with unrecovered costs totaling about $6.3 billion—and the fixed costs associated with its high debt. The mechanism(s) that would be available to TVA to recover stranded costs would determine which customer group would pay for them. Stranded costs occur when a utility moves from a regulated to a competitive environment and is unable to recover certain costs because the market price of power will not allow it to generate revenue at a level sufficient to recover these costs. Such cos |
1,045 | ts result from past decisions that were considered prudent when they were made, and the costs would have been recoverable in a cost-based, regulated environment. However, in a competitive environment, recovery of these costs would force a utility’s price above market, and it consequently could not recover them by charging market-based rates. As discussed below and in appendix II, states that have restructured their electricity markets have addressed the issue of mitigating and recovering potential stranded |
1,046 | costs in various ways. Stranded costs can be the result of, among other things: investment in generation assets that may not be able to produce competitively priced power in a restructured environment, even though the investments were considered prudent at the time they were made; power purchase contracts made in anticipation of future needs that would become uneconomical should market prices for power in a competitive market become lower; regulatory assets, such as deferred income taxes that regulators wou |
1,047 | ld have eventually allowed utilities to collect but may not be recoverable in a competitive market; future decommissioning costs for nuclear facilities; and social programs where public utility commissions mandated spending for programs such as demand side management−such costs would typically be capitalized and amortized in a regulated environment, but, since the costs are not part of generating power, the market price for electricity under competition may not allow recovery of them. Two methods are common |
1,048 | ly used to calculate the amount of allowable stranded costs—the FERC “revenues lost” methodology and the “asset-by- asset approach.” FERC has jurisdiction over stranded cost recovery related to wholesale power sales and power transmission and uses the revenues lost method in determining allowable stranded costs for these activities. If legislation is enacted providing for TVA to compete in a restructured environment, TVA would likely fall under FERC jurisdiction for stranded cost recovery for its wholesale |
1,049 | customers. TVA’s wholesale sales to its 158 distributors were about $6 billion in fiscal year 2000, or about 88 percent of TVA’s total operating revenues. Under the FERC methodology, whether a utility’s plants are nonproducing or productive is immaterial to the stranded cost calculation, as long as the costs associated with the plants are included in rates at the time a customer departs TVA’s system. According to FERC officials, stranded cost recovery assumes the costs are already in the rate base; if not, |
1,050 | FERC officials told us they would likely not consider them in a stranded cost recovery claim. The three deferred nuclear units, with costs of about $6.3 billion as of September 30, 2000, that TVA has not yet begun recovering, are a primary reason for TVA’s potential exposure to stranded costs. However, TVA’s projections through 2007, using its current power rates, show that by the end of 2007 the costs will have been reduced to about $3.8 billion. Depending on the timing of any restructuring legislation aff |
1,051 | ecting TVA and assuming that FERC would have jurisdiction over TVA, it is unclear whether FERC would consider these costs to be in TVA’s rate base and, thus, allow TVA to include some or all of these costs in a stranded cost recovery claim. In the past when TVA calculated its stranded costs, it used the FERC “revenues lost” methodology. When the 4-County Electric Power Association (near Columbus, Mississippi) and the city of Bristol, Virginia, threatened to find other sources of power, TVA used the FERC met |
1,052 | hodology to calculate stranded costs, and TVA officials told us that they would continue to use the FERC methodology to calculate stranded costs in the future. TVA’s calculations of stranded costs for the 4-County Electric Power Association ranged from $57 million to $133 million. The 4-County Electric Power Association ultimately decided not to leave the TVA system and therefore no stranded costs were assessed. In contrast, Bristol did leave the TVA system. TVA again calculated stranded costs using the FER |
1,053 | C methodology and initially attempted to assess Bristol for $54 million for stranded costs. However, TVA and the city of Bristol ultimately negotiated a settlement that included an agreement under which Bristol would not be assessed for stranded costs, but would purchase transmission and certain ancillary services from TVA. According to a FERC official, under the revenues lost method, when a customer leaves a utility’s system, stranded costs are calculated by first taking the revenue stream that the utility |
1,054 | could have expected to recover if the customer had not left, then subtracting the competitive market value of the electricity capacity released by the departing customer (that the utility will sell to other customers), then multiplying the result by the length of time the utility could have reasonably expected to continue to serve the departing customer. Figure 10 illustrates TVA’s potential application of the FERC methodology. The second commonly used method to calculate stranded costs is the “asset-by-as |
1,055 | set” or “bottoms up” approach. This method has been used by the states when they restructure their retail markets. In this method, the market value of a utility’s generating assets is determined and compared to the amount at which those assets are currently recorded on the utility’s books (book value). The difference would be reflected on the income statement as a gain or loss and recorded in the retained earnings of the organization. If the total book value of a utility’s generating assets exceeds their to |
1,056 | tal market value, the utility would have stranded costs equal to the difference between book and market values. Because TVA is a unique self-regulator that crosses state borders and is not currently subject to FERC regulation, it is unclear what entity would have jurisdiction over any stranded cost recovery at the retail level. Sales to TVA’s direct service industrial customers and other nondistributors, which we consider retail sales because they are sales to final users, were about $0.7 billion in fiscal |
1,057 | year 2000, or about 10.4 percent of TVA’s total operating revenues. In the states that have restructured their electricity markets, there have been five commonly used mechanisms to recover stranded costs. Depending on the approval of state regulators, utilities have the following options; the choice of option affects which customer group pays. Exit fees − fees charged to departing customers, either via a lump sum or over a set number of years. Competitive transition charge (or competitive transition assessm |
1,058 | ent) − either (1) a one time charge applied to all customers at the time the state initiates restructuring, or (2) charges based on kilowatthour (kWh) usage, usually charged to remaining customers over a set number of years. Wires charge (also called transmission surcharge) − a predetermined surcharge that is not based on kWh usage, which is added to remaining customers’ power bills during a set period of time; sometimes considered a subset of competitive transition charges. Rate freeze or cap − regulators |
1,059 | set a cap on the total amount a utility can charge; however, under the cap, the regulator would allow the utility to recover stranded costs by charging higher prices for the two components of the market that are still regulated (distribution and transmission). The cap is usually frozen for the estimated length of time needed to recover the stranded costs. Remaining customers bear the burden. Write off to retained earnings − In the case where a utility moves from a regulated to a competitive environment and |
1,060 | has assets whose book value is in excess of market value, it would mark its assets to market value, and recognize any excess of book value over market value as a loss on the income statement, which would flow through to retained earnings. Retained earnings represent cumulative net profit from past operations that can be used to benefit either stockholders or current and future customers, by keeping profits in the company for future use. In addition, the change to a competitive environment, with overvalued a |
1,061 | ssets, could result in stranded costs. However, the legislation that caused the change to a competitive environment could give utilities the option of recovering the amount of overvalued assets over time, rather than charging all the cost to retained earnings immediately. Writing off the costs of the overvalued assets to retained earnings immediately would mitigate potential stranded costs and eliminate the need to recover the cost of these assets from future ratepayers, making a utility’s power rates poten |
1,062 | tially more competitive. TVA continues to operate similar to a regulated monopoly because of its legislative protections from competition. Since regulatory changes requiring TVA to compete with other electricity providers have not been made, TVA does not currently have stranded costs. However, as discussed previously, TVA has uneconomic assets—primarily its three nonproducing nuclear units with unrecovered costs totaling about $6.3 billion that do not generate revenue. In 1998, TVA estimated the net realiza |
1,063 | ble value of these assets to be about $500 million. TVA has not made a final decision on whether to abandon these three units or complete them and place them into service. If it abandons them, under current accounting standards, This action would require approval of TVA’s Board. If its retained earnings are not sufficient to cover any losses arising from revaluation of these units, TVA could find itself with stranded costs if legislation were enacted that would require TVA to compete with other electricity |
1,064 | providers before it completes these units and brings them into operation. TVA’s ability to recover costs that could ultimately become stranded is compounded by TVA’s high debt and corresponding financing costs. FASB 90 would apply because TVA remains in a regulated environment. restructuring legislation would have required these contracts to be renegotiated; however, it is possible that this clause will remain in effect. Thus, if TVA enters a competitive environment with stranded costs, it may be unable to |
1,065 | collect them from certain departing customers after 2007, and the burden for recovering these costs may fall on remaining customers or retained earnings from prior customers. According to TVA officials, if TVA were unable to collect any stranded costs from departing customers under its contracts, remaining customers would bear the burden of stranded cost recovery. To the extent stranded cost recovery is spread among remaining customers, it would become more difficult for TVA to price its power competitively |
1,066 | . A key element of TVA’s 10-year business plan is to reduce its cost of power. TVA planned to accomplish this by reducing expenses, limiting capital expenditures, and instituting a rate increase in 1998 to increase the cash flow available to pay down debt. Reducing debt, in turn, reduces the corresponding annual interest expense. By reducing interest expense, TVA frees up cash that can be used to further reduce debt. In addition, these actions increase the portion of revenue that would be available to recov |
1,067 | er the costs of its deferred assets. To the extent that TVA reduces costs, it will be able to offer more competitively priced power and its distributors will be less likely to leave TVA’s system for alternate suppliers. At the wholesale level, under current FERC rules, if its distributors do not leave, TVA does not have the option of recovering stranded costs. If its distributors decide to leave, TVA would have potential stranded costs if TVA is either unable to sell the power released by the departing dist |
1,068 | ributor or is forced to sell the power that would have been purchased by the departing distributor for lower rates. Figure 11 illustrates the link between debt reduction and stranded costs. This circular relationship is key to understanding how TVA’s 10-year plan links to potential stranded costs. In its original 10-year plan, a key element of TVA’s plan was to reduce its cost of power by cutting its debt in half by September 30, 2007. By reducing debt, TVA would also reduce future interest expense, which w |
1,069 | ould free up additional cash that could be used to further reduce debt. However, not explained in the published plan was how the revenue generated from its 1998 rate increase would give TVA the opportunity to recover the cost of its deferred assets. By increasing revenue and reducing expenses, TVA would free up revenue that could be used to recover the cost of its deferred assets and cash that could be used to pay down debt. As discussed previously, TVA estimates the additional revenue from the rate increas |
1,070 | e over the first 3 years of the plan to be about $1.24 billion. TVA had the option to use that revenue for any authorized purpose, such as adding any excess revenue to retained earnings, accelerating depreciation, or amortizing its deferred assets, including writing down its deferred nuclear units. TVA planned to first amortize some of its other deferred assets before writing down its deferred nuclear units. To accomplish this, TVA’s Board of Directors approved a resolution to begin accelerating amortizatio |
1,071 | n of these other deferred assets. This means that in any given year in which TVA has revenue sufficient to meet all of its legal requirements to recover all costs and comply with all laws and regulations regarding revenue levels, any excess revenue can be used to accelerate the write-down of a portion of the costs of its deferred assets; this would result in TVA recovering these costs over time. In relation to its deferred nuclear units, TVA’s original plan was to recover all but $500 million of these $6.3 |
1,072 | billion costs by September 30, 2007, at which time TVA officials believed it could be subject to a competitive environment through legislative changes and expiring customer contracts. Its proposed revision to the 10-year plan now calls for a balance of about $3.8 billion by 2007, or about $3.3 billion more than originally planned. To the extent TVA recovers the costs of the deferred nuclear units before such time as the Congress may remove its legislative protections, it would no longer have to recover thes |
1,073 | e costs through future rates, potentially making its power more competitive, and giving it more flexibility to operate in a competitive environment. And, as noted above, if TVA is able to offer competitively priced power by 2007, its distributors would be less likely to leave and TVA would be less likely to have stranded costs. If TVA were to lose its legislative protections today, its high level of debt and corresponding high financing costs would be a competitive challenge. This competitive challenge woul |
1,074 | d be even greater if it were at the same time attempting to recover costs of deferred assets through rates. Despite having reduced its debt and deferred assets over the past 3 years, TVA still compares unfavorably to its likely competitors in these regards. In addition, TVA is revising its goals for reducing debt and deferred assets downward significantly. Whether or not the deferred assets will contribute to stranded costs that are recoverable from customers depends on the specific requirements of any legi |
1,075 | slation that might remove TVA’s legislative protections and TVA’s ability to retain its current competitive advantages in a restructured environment. In addition, the longer that TVA has to prepare for competition, the longer it will have to reduce debt and recover the costs of its deferred assets and position itself more competitively. Ultimately, TVA’s ability to be competitive will depend on the future market price of power, which cannot be predicted with any certainty. TVA, in a letter from its Chief Fi |
1,076 | nancial Officer, disagreed with our findings in three areas—the future market price of electricity, TVA’s financial condition compared to other utilities, and the relationship between TVA’s deferred assets and potential stranded costs. TVA’s comments are reproduced in appendix III and discussed below. In addition, TVA officials provided technical comments on the draft report, which we have incorporated as appropriate. TVA also took the opportunity to comment, in a section called “Looking Back,” on progress |
1,077 | it has made since issuing its 10-year plan in 1997, including reducing debt and recovering the costs of certain deferred assets, and its goals and strategies for the future. We discuss these comments at the end of this section. Market Prices for Electricity TVA agreed that the future market price of electricity is a key factor in assessing the likelihood of success in a competitive environment and that the price cannot be predicted with any certainty, but disagreed on the general direction of prices. TVA an |
1,078 | d its consultants are projecting higher future market prices. As evidence of projected increases in market prices, TVA cites higher trading prices, higher “forward” prices offered by suppliers, higher long-term contract price offerings, and higher prices for fuel sources such as natural gas. Our report discusses TVA’s views in this regard; however, we underscore the uncertainty of projections of the future price of power by citing a knowledgeable source that projects lower prices. In the draft we provided t |
1,079 | o TVA for comment, we included point estimates from various sources for the future market price of power. Considering TVA’s comments, we agree that point estimates imply more certainty about future prices than we intended or is warranted. As a result, we revised our report by removing those estimates. However, to underscore the uncertainty of future market prices, we have included the Energy Information Administration’s (EIA) projection of a downward trend in the future market price of power in the region i |
1,080 | n which TVA operates. EIA’s analysis was based in part on a projected decline in coal prices that, according to EIA, would more than offset projected increases in gas prices. EIA is also projecting that nuclear fuel prices will remain steady. We believe these are relevant points to consider since, in the year 2000, TVA’s power generation fuel mix was about 63 percent coal, 31 percent nuclear, 6 percent hydropower (which has no fuel cost), and less than 1 percent natural gas. Our main point is that the futur |
1,081 | e market price of power “cannot be predicted with any certainty.” TVA cites prices for electricity and natural gas for December 2000 as an example of market direction and volatility to support their projection of future higher prices. We agree that the market has shown volatility at certain times. In fact, this volatility strengthens our view that future prices are uncertain. In addition, according to data from the National Oceanic and Atmospheric Administration, in the entire region in which TVA markets po |
1,082 | wer, December 2000 was one of the 10 coolest periods on record over the last 106 years. We would not predict the future on the basis of such an anomaly. TVA commented that it appreciated our recognition of its progress in improving its financial condition, but objected to our findings that TVA’s financial condition compares unfavorably to likely competitors. In particular, TVA questioned our choice of financial ratios in comparing it to other utilities. TVA noted that most of our ratios ignore total cost an |
1,083 | d merely reflect the differences between the capital structure of TVA and that of IOUs. We disagree with TVA in this regard. Our choice of ratios was appropriate because they result in meaningful information regarding the relative financial conditions of the entities. To assess the financial condition of the entities, we selected two types of ratios. The first type indicates an entity’s financial flexibility to successfully respond to competitive and financial challenges. In this regard, we compared TVA to |
1,084 | other utilities in terms of (1) total financing costs, (2) fixed financing costs, and (3) the ability of an entity to pay for capital expenditures and common stock dividends from net cash generated from operations. Each of these ratios is an indicator of an entity’s ability to withstand stressful financial conditions. Interest costs are particularly important to consider because they are fixed costs that must be paid even in times of competitive or financial pressures. Contrary to TVA’s comment letter, we r |
1,085 | ecognize the differences between TVA’s financial structure and those of IOUs and accounted for those differences in performing our analyses. As our report notes, TVA’s financing (except for internally generated cash, as with all entities we assessed) is obtained by issuing debt, while IOUs also have the option of equity financing. The requirement that TVA obtain financing only by issuing debt could be considered a competitive disadvantage because of the corresponding fixed financing costs which affect TVA’s |
1,086 | financial flexibility. The ratio of total financing cost to revenue compares TVA interest costs, as a percent of revenue, to the IOUs’ costs of (1) interest, (2) preferred stock dividends, and (3) common stock dividends as a percent of revenue. The ratio of fixed financing costs to revenue compares TVA interest costs, as a percent of revenue, to the fixed portion of the IOUs’ financing costs (i.e., their interest costs and preferred stock dividends) as a percent of revenue. These analyses appropriately adj |
1,087 | ust for the different financing structures of the entities in assessing financing costs, and assessing the extent to which entities have fixed costs that limit their financial flexibility is a valid means by which to consider their respective financial conditions. The second type of financial ratio we used indicates the extent to which capital costs, including the costs of deferred assets, have been recovered. In this regard, we compared TVA to other utilities in terms of the (1) portion of capital assets t |
1,088 | hat has not begun to be included in rates and (2) the portion of gross property, plant, and equipment that has already been recovered. These indicators are important because a high level of unrecovered capital costs could compound an entity’s challenges as it enters a competitive market. In the case of TVA, if it enters a competitive environment with the relatively high debt service costs it now carries, its ability to price its power competitively could be jeopardized, thus increasing its potential for str |
1,089 | anded costs. Our report notes that TVA’s competitive challenges would be even greater if it were at the same time attempting to recover the costs of deferred assets through rates. We disagree with TVA’s statement that a single statistic—the residential price of electricity in TVA’s region—best reflects TVA’s competitiveness. While we agree that selling price is a function of cost, we note that TVA has a large amount of unrecovered costs. Since TVA remains in a regulated environment, with the ability to set |
1,090 | its own rates and to recover or defer recovering the costs of some of its capital assets, this single statistic does not provide a complete picture of TVA’s costs nor its ability to operate in a competitive environment. In addition, TVA’s current cost of delivering power does not provide a complete picture of the competitive environment TVA would likely be subject to if its legislative protections and the benefits of being a wholly owned government corporation were removed. We also disagree with TVA’s state |
1,091 | ment that our ratios are distorted because they do not recognize the uniqueness of TVA’s business compared to others. According to TVA, a distortion results when TVA, which has predominantly wholesale sales, is compared to other entities that have predominantly retail sales. However, these other entities also sell at wholesale and would be competing with TVA at that level. Regardless, an entity’s fixed costs and portion of capital assets that have not been recovered are relevant and important considerations |
1,092 | as one considers an entity’s prospects in a competitive market, be it wholesale or retail. We also note that, in its comment letter, TVA compared its total production costs to those of the 50 largest power producers in the United States, which for the most part are providers of retail power, but objected to our comparing TVA to some of the same utilities. TVA states “the report is misleading when it implies that the historical accounting value of any particular set of assets determines the potential for st |
1,093 | randed costs,” and that it is the net market value of all assets combined that is germane to the determination of stranded costs, and only if their amortization drives total cost above market. While we do not disagree with TVA’s interpretation of stranded costs, we do disagree that historical accounting value plays no part in determining stranded costs. Historical accounting value, less accumulated depreciation and/or amortization, shows the amount of remaining capital costs to be recovered in the future. I |
1,094 | f TVA is attempting to recover more of these costs than other utilities in a competitive market and, as a result, its rates are above market, it could have stranded costs. TVA also implies that we consider its deferred assets to be a proxy for stranded costs. On the contrary, our report clearly states that TVA could have stranded costs if it were unable to recover all its costs when selling power at or below market rates. In addition, we state that TVA’s potential for stranded costs relates to its high debt |
1,095 | and deferred assets, which as of September 30, 2000, totaled about $26 billion and $8 billion, respectively. Recovery of these costs could drive the price of TVA’s power above market, leading to stranded costs. This is consistent with TVA’s definition of stranded costs. Our report reaches no conclusion on whether TVA will have stranded costs; it merely points out that if TVA is unable to price its power competitively because it is attempting to recover costs it incurred in the past, it could have potential |
1,096 | stranded costs, depending on market conditions at the time. As noted above, due to the uncertainty of the future market price of power, we also do not conclude on whether TVA will be competitive in the future. TVA notes that it has made progress in reducing debt, and corresponding interest expense, and recovering the costs of deferred assets since it released its 1997 plan. For example, by the end of fiscal year 2001, TVA expects to have reduced its debt by about $2.2 billion and its annual interest expens |
1,097 | e by about $300 million, and expects to have recovered about $2 billion in costs associated with its deferred assets. While we agree that TVA is moving in the right direction, TVA’s current proposed revisions to its 10-year plan project significantly less progress than envisioned in 1997 and these changes are not without consequence. As our report states, TVA’s current revisions to the plan estimate that debt outstanding at the end of fiscal year 2007 will be about $19.6 billion versus the $13.2 level antic |
1,098 | ipated when TVA issued its 1997 plan. TVA notes that since issuing the plan in 1997, it changed its strategy by investing cash in new generating capacity that otherwise would have been used for debt reduction. However, in our report we correctly point out that, while TVA has made this change, the cash it has invested in new capacity is far less than its debt reduction shortfall. TVA’s current projections show its debt reduction through 2007 being about $6.4 billion less than planned in 1997, and its investm |
1,099 | ent in new generating capacity about $1.3 billion more. As a consequence of this debt reduction shortfall, we estimate that TVA’s interest expense in 2008 will be about $416 million greater than if it had reduced debt to $13.2 billion. In the 1997 plan, one of TVA’s key stated objectives was to “alter its cost structure from its currently rigid, high fixed-to-variable cost relationship to a structure that is more flexible and better able to adjust to a volatile marketplace.” TVA’s 1997 plan further stated t |
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