TNdereg

Deregulation in Tennessee?

August 18, 1998

Senator Fred Thompson

523 Dirksen Senate Office Building

Washington, DC 20510

Dear Senator Thompson:

Enclosed for your information is some material we provided the Tennessee General Assembly Study Committee on Utility Deregulation.

As you know, something needs to be done regarding TVA if competition is ever going to come to the Tennessee Valley. In my opinion, the ratepayers in the State of Tennessee should not be made to suffer because some federal appointees with no regulatory oversight, and over whom they had no control, made disastrous business decisions. I am referring to the TVA Board and the $27 billion debt amassed by TVA as a result of imprudent investments no state commission would allow any investor-owned utility to recover from its ratepayers.

Please give this material your consideration. Thank you.

Sincerely,

Michael R. Knauff

Enclosures

August 17, 1998

Senator Jerry Cooper, Chairman

Representative Kathryn Bowers, Member

Tennessee General Assembly

Study Committee on Utility Deregulation

Dear Sir and Madam:

On August 11, 1998 I had the pleasure of attending a meeting of the Tennessee General Assembly Study Committee on Utility Deregulation, and meeting each of you personally. I indicated to both of you that in my opinion certain of the panel were evading some of the questions the committee was asking. The questions being evaded related to why deregulation should be supported in the Tennessee Valley if the Valley already had some of the lowest electric rates in the country, and would deregulation lower or raise electric rates in the Valley.

It is true that the Tennessee Valley currently has some of lowest electric rates in the nation, but the $27 billion debt amassed by TVA is a very dark cloud hanging over those low rates. Marvin Runyon, a former chairman of the TVA Board, froze TVA's rates over a decade ago, and TVA's current chairman, Craven Crowell, was only recently forced to lift this rate freeze because TVA's debt was approaching its statutory limit of $30 billion. The first thing you need to realize is that TVA has been concealing the financial implications of decades of mismanagement by not raising rates sufficiently to cover its misdeeds (primarily in the nuclear area), and allowing the debt to increase. Visualize TVA as a mammoth dam that has held back a river of debt for decades, but now it is beginning to crumble and this huge debt is going to inundate the ratepayers of the Tennessee Valley unless something is done. Deregulation may afford an opportunity to avert the massive rate increases that are certain to come if TVA is left in control.

Two decades ago, TVA's average wholesale rate was 1.98¢ per kilowatt-hour and its long-term debt was $5.5 billion. A decade later, TVA's average wholesale rate was 4.37¢ per kilowatt-hour and its long-term debt increased to $17.5 billion. TVA's debt has steadily increased since then an average of approximately $1 billion a year. Today totals about $27 billion with wholesale rates averaging around 5¢ per kilowatt-hour. To put this in perspective and to give you an idea of the magnitude of TVA's mismanagement, for approximately $20 billion TVA could today replace all of its existing generating plants with new, clean burning combine cycle natural gas plants. TVA now needs additional generating capacity if it is going to continue to supply all of the power needs of the 159 distributors, which means additional new debt on top of significant rate increases to keep the existing debt in check.

Without deregulation and with TVA remaining the unregulated, sole supplier in the Tennessee Valley, significant rate increases are a certainty. With deregulation it may be possible to maintain the low rates. To accomplish this, two arguments can be made that TVA should not be allowed to impose its $27 billion debt on Tennessee Valley ratepayers in the form of stranded investment costs. Both arguments are based on the fact that the vast majority, if not all, of TVA's $27 billion debt is a result of unregulated mismanagement, and not the result of prudent investments in facilities that will become stranded as the result of competition. The first argument is that TVA simply does not meet the criteria established by the industry for stranded cost recovery. This argument is presented in the enclosure entitled "Preparing For Fundamental Changes in the Tennessee Valley Power Industry."

The second argument is more of a legal/fairness argument that basically says that since 1959 the ratepayers in the Tennessee Valley have never had any manner of due process to protect them from TVA mismanagement, and now it is time for due process.

When TVA was created in 1933, Congress appropriated all money needed by TVA to finance all of its operations. This allowed Congress to control TVA through its appropriations.

In 1959 Congress amended the TVA Act to authorize TVA to sell bonds to finance its power operations, with only TVA's much smaller non-power operations dependent on congressional appropriations.

The federal government failed to provide for ratepayer protection from TVA mismanagement at the time that it freed TVA from the control of Congress by freeing it from dependency on congressional appropriations.

Because of a lack of oversight, TVA made many imprudent business decisions, especially in the area of nuclear power. There were no independent checks and balances; no independent determinations as to prudence or used and useful.

Tennessee ratepayers have been denied due process. Now that TVA is seeking to recover $27 billion in debt resulting from mismanagement and imprudent investments that have never been used or useful in supplying electricity, it is time to institute due process and disallow it.

Investors and not ratepayers should pay for company mismanagement, and in TVA's case the investors are those who purchased TVA bonds.

If TVA were disallowed recovery of its current debt in stranded investment charges, then deregulation would help to ensure that electric rates in Tennessee remain among the lowest in the nation. If TVA is allowed to recover its massive debt, then rates will significantly increase regardless of deregulation.

States have typically determined the amount a utility is allowed to recover as stranded investment in conjunction with ordering retail competition (deregulation). In theory, the State of Tennessee should be able to order retail competition and set the amount to be recovered as stranded investment; however, TVA owns the bulk of the transmission system and could deny transmission access. Through a convoluted interpretation of the TVA Act, TVA may also maintain that it has regulatory authority over the distributors and their customers; therefore, the State of Tennessee cannot order retail competition. It may require an amendment to the TVA Act and the Federal Power Act, or a class action suit in federal court, to clearly provide states in the Tennessee Valley with the ability to order and implement retail competition.

Thank you for affording me this opportunity to share with you my views on deregulation. I hope you find this information useful. Again, it was a pleasure meeting both of you.

Sincerely

Michael R. Knauff

Enclosure

Preparing For Fundamental Changes in the

Tennessee Valley Power Industry

Fundamental changes have already taken place in the electric power industry in several states from California to Massachusetts, and Congress is considering legislation to restructure the entire industry on a national basis, including the state of Tennessee and TVA. While no one can precisely predict exactly how this may affect distributors of TVA power, a few things are pretty obvious: Competition and Customer Choice. Another very obvious regional issue is the $27 billion debt amassed by TVA. Tennessee Power Company (TPCO) is uniquely qualified and would appreciate the opportunity to assist distributors in preparing for the inevitable changes that will take place within the next few years.

The TVA known by our parents and grandparents is not the TVA that exists today. Notwithstanding TVA's commendable, world renown, historic successes of the past in taming the river, restoring the soil, and bringing economic development to a severely depressed region; TVA's massive power program and accompanying debt has grown to the point that it now overshadows everything else. Today TVA is more like a huge power company determined to maintain its market share, and woe to any distributor or power marketer who threatens TVA's market share. We have all witnessed what 4-County EPA went through, and even though Bristol, VA managed to leave the system, TVA is still postured to cherry pick its system. The point is that TVA is in a mode of self-preservation, and what is in TVA's best interest may no longer be in the best interest of the distributors of TVA power, or their customers. The disposition of TVA's $27 billion debt is a case in point.

The criteria established for recovery of stranded cost has been well established by the electric utility industry. It is based on (1) a long-standing obligation to serve all consumers of electricity in a given area in exchange for an assured return on investment, (2) prudent investments made to carry out that obligation, (3) past pervasive regulatory oversight, and (4) government imposed programs. TVA undoubtedly considers its $27 billion debt as stranded investment, and has dictated the conditions under which a distributor may avoid the possibility of stranded investment claims by TVA. The truth of the matter is that TVA simply does not meet the criteria established by the industry to claim stranded investment. Attached is a February 27, 1998 letter to the Tennessee Senate Commerce Committee explaining this in more detail. It is not in the best interest of distributors or their customers to allow TVA to unilaterally declare itself eligible to collect stranded investment when it fails to meet the criteria established by the industry.

What does the future hold for TVA? Again, no one really knows at this time, but it appears certain that Congress will do something to make TVA more accountable, and possibly even dramatically change TVA. Divestiture of generating assets and becoming an independent system operator (ISO) is not beyond the realm of possibility for TVA. In Massachusetts, for instance, an ISO is being formed and the state has ordered all electric utilities to put their generating assets on the market for sale. These utilities were free to purchase back their own assets, with the purchase price being subtracted from stranded investment; however, only Northeast Utilities chose to remain in the generating business. All the other former generating utilities will be purchasing their power needs in the open market, most likely from the entities that purchased the generating assets. This could happen in the Tennessee Valley.

While retail choice may be farther down the road, wholesale customer choice may be right around the corner, and distributors need to prepare now. Distributors do not need a trading floor like TVA and other large utilities to participate in the power market, but there are several things they need to know and which need to be done. TPCO personnel have had several years of experience in the bulk power wholesale market and interutility arrangements and transactions. We are also up to date on the latest technical market requirements such as security certification, FERC mandated OASIS sites, and NERC tagging requirements. TPCO is fully capable of preparing distributors to enter into the interutility wholesale power market with confidence. By preparing now, distributors can observe real-time market activity, hone employee skills, and be fully confident of its ability to be an active market player when the opportunity comes.

TPCO is flexible and will work with distributors to obtain whatever level of expertise and preparation is desired, in the most efficient, cost-effective manner. Distributors may call TPCO at (423) 624-0852 to set up an appointment.

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