Federal Power Dinosaurs

New power-generating technologies and low natural gas prices are spurring competition in the electricity market. This has led a growing number of lawmakers to want to help break up the utility industry’s monopolies, but few have paid attention to the utility monopolies owned by the federal government. The time has come for them to face up to the cost of government ownership and to confront the question of whether federally-owned power companies have a place in a competitive utility marketplace.

No doubt there was a time when the Tennessee Valley Authority (TVA), Power Marketing Administrations (PMAs), and Rural Electrification Administration (REA) were needed. As late as 1935, when only 15 percent of rural Americans had electricity and trying to obtain electricity often required a pitched battle with what were then unregulated utility trusts, TVA, PMAs, and REA were necessary and effective. But the electricity market has changed dramatically in the past 60 years, and federal utilities have become dinosaurs, creations that worked well in one environment but are resisting the changes needed to adjust to the realities of a new era. Moreover, the government’s power program, designed originally to help poor farmers, now provides subsidized electricity to a vast array of individuals that includes condo owners in Aspen, golfers in Hilton Head, and the fabulously wealthy entrepreneurs of Palo Alto.

The federal government has become this nation’s largest generator of electricity, supplying some 9 percent of U.S. power. TVA (the country’s biggest producer of electricity), Bonneville, and the other PMAs typically sell electricity wholesale, giving preference to rural electric cooperative or municipal utilities serving communities in the West and South; 21 percent of their generation is sold directly to customers, most notably aluminum companies in the Pacific Northwest. These federal utilities receive substantial taxpayer subsidies and aim to provide power to their “preference” customers at below market rates.

Although current beneficiaries would like their federal power subsidies to continue indefinitely, those benefits distort the market, discourage efficiency, waste taxpayer dollars, and pit regions against each other. As lawmakers try to create a level playing field in the electricity market, they simply cannot exempt from competition some of this nation’s largest utilities. Perhaps most important, they cannot prohibit a large number of U.S. consumers from enjoying the advantages of competition.

A waking giant

Electric utilities are this nation’s largest industry. They have assets in excess of $600 billion and annual revenues of about $200 billion, almost 30 percent more than the U.S.-based manufacturers of automobiles and trucks. They operate a vast technological complex, with thousands of power plants and hundreds of thousands of miles of transmission lines. Virtually every American is connected to this industry, confidently able to flick switches and turn on lights, heaters, and appliances. Emerging businesses, computers, robotics, and electronics, rely on electric companies to supply the reliable and standardized power that is necessary for sophisticated machinery to operate.

For almost three generations, utilities have guaranteed universal access to power in exchange for government-sanctioned returns on their investments. Most utilities have been integrated monopolies, generating, transmitting, and distributing electricity to consumers in their exclusive service territories. These monopolies provided Americans with relatively low-cost and reliable power.

Technological changes and relatively low natural gas prices (caused in part by natural gas deregulation), however, are dismantling this utility industry compact and structure. Small-scale electricity generators, using combined-cycle gas-fired turbines and other innovative technologies, now are able to produce electricity below the utility industry’s average price, creating substantial pressure to open power markets. These technologies are being advanced by a new generation of entrepreneurs, who have quickly created a multibillion-dollar business and introduced competition into the electricity market for the first time in 60 years. State and federal regulators, following the example of telephone deregulation, plan to break up electricity monopolies, allowing consumers to purchase power from an array of competitors.

Much has happened in just the past few years. The Energy Policy Act of 1992 and the Federal Energy Regulatory Commission’s subsequent orders have opened the wholesale power market to competition and required utilities to provide nondiscriminatory access to their interstate transmission lines. California, New Hampshire, Pennsylvania, Massachusetts, and Rhode Island have adopted specific plans to achieve retail competition, and most other states are considering the issue. Numerous federal lawmakers have introduced bills to advance utility deregulation.

The traditional utility’s functions are being divided. It seems likely that competitive electricity-generation firms will produce the power, federally regulated companies will transport it across high-voltage transmission lines, and state-regulated monopolies will distribute the power through their wires to individual consumers and businesses. Federally chartered independent system operators will ensure the grid’s stability and fair competition.

Optimists see enormous benefits from competition: lower prices, technological innovations, higher efficiencies, and better services. A study by Citizens for a Sound Economy, which has been criticized for being overly rosy, estimates that retail competition will cut electricity bills by as much as 43 percent and save customers $107.6 billion annually in the long run. Even less upbeat forecasts, however, predict significant consumer benefits. When New Hampshire began its pilot program in spring 1996, for instance, some 30 companies offered to provide electric power to consumers at advertised rates ranging from 10 to 20 percent below the state’s current average. Beyond reduced prices, advocates of retail electricity competition see an opportunity for utilities to follow the example of the telephone industry, which developed a host of new consumer services after deregulation.

The profound changes associated with utility deregulation, of course, raise numerous challenges for policymakers and regulators. They also have launched a cottage industry of lobbyists trying to influence this restructuring. The prospect of increased competition in electricity generation changes the industry’s political dynamics. For almost a century, the major struggle within the electricity market pitted government-owned against shareholder-owned utility monopolies. But a more significant contest has emerged: a battle among an array of businesses , including independent power generators and marketers as well as spin-offs of traditional private and public utilities , competing to supply electric power to consumers. The need for government-owned power companies, therefore, has been called into question.

Living in the past

The early history of federal power still dictates the tone of the debate by some public power advocates and critics. For many proponents of the status quo, even though circumstances have changed dramatically, TVA and the PMAs remain a political cause, and the conflict between shareholder-owned and government-owned utilities remains the key to competition.

In the 1920s, the absence of electric power in the countryside, wrote historian William Leuchtenberg, divided America into two nations, “the city dwellers and the country folk.” Farmers, he said, “toiled in a nineteenth-century world; farm wives, who enviously eyed pictures in the Saturday Evening Post of city women with washing machines, refrigerators, and vacuum cleaners, performed their backbreaking chores like peasant women in a preindustrial age.”

Country folk certainly tried to “go electric.” Time and again they asked the power trusts for service, only to hear utility executives decry rural electrification as too expensive. Power company officials also argued that profits would be low because farmers couldn’t afford appliances that used substantial electricity. Although rural politicians published studies to disprove the company statistics, utility holding trusts, which at that time were unregulated, multistate monopolies, controlled the switch, and lighting America’s farms and small towns remained a dim hope.

The debate during the early part of this century was personified by George Norris, a Republican senator from Nebraska, and Sam Insull, chairman of Commonwealth Edison, at that time a giant utility holding company that controlled electric service in 6,000 communities in 32 states. Although both men believed that electricity would be generated and distributed by a monopoly (a point now called into question), they debated fiercely about whether electric power should be privately or publicly controlled. Insull and other business leaders felt that U.S. strength depended upon the marketplace allocating resources and production; they ridiculed public ownership as “socialism.” But Norris and a growing group of progressives and conservationists believed that a privately owned monopoly would “eventually … come to tyranny,” and that U.S. power development must “be under public control, public operation, and public ownership.”

Spirited arguments long focused on control of dams along the Tennessee, Columbia, Colorado, and other mighty rivers. President Franklin Roosevelt capped a lengthy battle by promoting the Tennessee Valley Authority, which he considered a cornerstone of his New Deal and “the widest experiment ever conducted by a government.” FDR also advanced the Rural Electrification Administration, which was to provide low-interest loans to public cooperatives that would build their own power lines and generate their own electricity. It was in the same era that FDR and Congress approved the Public Utilities Holding Company Act (PUHCA), which limited each utility holding company to a single integrated operating system and which is the source of much current debate. In addition, during this period states began to regulate private utility companies more intensely.

By the 1930s, public power had become a political cause. TVA’s first director, for instance, titled his book on the federal agency, TVA: The March of Democracy. Even Woody Guthrie, admittedly with a payment from the federal Bureau of Reclamation, wrote a ballad, Roll on Columbia, that praises the huge hydroelectric projects and is still sung in elementary schools and at utility picnics throughout the region.

Although federal power’s early history still stirs the political fervor of some public power advocates, the electricity market has changed dramatically since the 1920s and 1930s. Consider several of these changes. First, although only 15 percent of U.S. farms enjoyed electric power by 1935, electric lines now reach 99.9 percent of U.S. homes. Senator Frank Murkowski (R-Alaska), chairman of the Senate Energy Committee, recently noted, “Once upon a time it was good public policy to bring power to regions of the country that did not have it, but that need has long since ended.”

Second, the economies of the Tennessee Valley and many other rural areas have improved significantly. Rural America now is home to thriving businesses such as Saturn Automotive and Gateway Computer. Third, the missions of federal power entities, particularly TVA and Bonneville, have changed dramatically. Less and less of their focus is on economic development, recreation, or navigation. They have become primarily power companies, looking very much like investor-owned utilities, their former nemeses. TVA, in fact, recently proposed abandoning all of its nonpower activities, including navigation, land stewardship, and economic development.

Fourth, and perhaps most important: The original justification for government-owned power providing a competitive yardstick by which to judge private power companies is irrelevant in today’s era of independent power producers, power marketers, and load aggregators. All of these entities including federal power managers are vying to compete in the new electricity market.

Denying the obvious

The “s” word (“subsidies”) provokes heated arguments from PMA/TVA beneficiaries, largely because taxpayer subsidies are the soft underbelly of public power’s lobbying stance. When lawmakers are trying to reduce the federal deficit, it’s simply hard to defend taxpayer benefits going to help the people of Aspen, Palo Alto, or Hilton Head pay their electricity bills.

PMA and TVA backers on Capitol Hill long have used their political clout to forbid the expenditure of government funds even to study subsidies provided to government-owned utilities. Yet the political dynamics are changing, and independent auditors have begun to document substantial taxpayer benefits being provided to a few preferred customers. The General Accounting Office (GAO), an investigative arm of Congress, has conducted perhaps the most extensive audit to date. Its September 1996 report found that together the three smallest PMAs, Western, Southeastern, and Southwestern, fail each year to recover some $300 million of their costs, shifting that burden from their ratepayers to taxpayers across the country.

Economists have tried to calculate the subsidy to government-owned utilities in several ways. Whereas the above-mentioned GAO report examines PMA costs that are not covered by electricity charges, the Congressional Budget Office (CBO), in its annual review of how to reduce the federal deficit, argues that the federal Treasury could obtain an additional $350 million each year if PMA power were sold at market rates. The U.S. Energy Information Administration takes yet another approach, calculating that PMAs benefit from government loans that provide an annual interest rate subsidy of approximately $1.2 billion. Thus, although government auditors may differ in their methodologies, they all agree that federal power subsidies are substantial.

Putnam, Hayes & Bartlett, an international economics firm in a report for investor-owned utilities, examined taxpayer benefits to the Tennessee Valley Authority, including the agency’s exemption from federal and state income taxes and from other state and local taxes, and its lower financing costs because the agency’s bonds are partially tax exempt. The researchers quantified those subsidies and competitive advantages at more than $1.2 billion annually.

Not counted in these studies are the favorable borrowing rates that PMAs and TVA obtain by being associated with the federal government. TVA, for instance, despite having a massive debt of $28 billion (and a negative net worth after subtracting unproductive assets), enjoys a AAA bond rating, the highest available. No shareholder-owned utility, despite much better balance sheets, has such a rating. Even though the federal government does not guarantee TVA bonds, the rating agencies assume that such backing exists. According to Moody’s Investors Service, “Although TVA’s debt is not an obligation of the U.S. government, the company’s status as an agency and the fact that the government is TVA’s only shareholder, indicates strong `implied support’ (that) would afford assistance in times of difficulty. This implied support provides important bondholder protection. TVA’s extensive nuclear risk, average competitive position, and high level of debt would make it unlikely to maintain its current (AAA) status.” Several analysts suggest that TVA’s large debt and low cash flow should cause its bonds to be rated as below investment grade–that is junk bonds. TVA’s artificially high credit rating, therefore, allows the giant utility to issue high levels of debt at low cost. If the agency’s credit rating went from AAA to A (a typical utility’s level), its additional financing charges each year would be some $2.2 billion. Such charges would be even higher if TVA bonds were rated as below investment grade.

PMA and TVA accounting practices have been designed to protect a few select ratepayers in the West and South at the expense of taxpayers throughout the country. Consider that when PMAs constructed their turbines and transmission lines they got to borrow at below-market rates, and to obtain 50-year repayment periods. Although federal legislation said PMA activities were to be “consistent with sound business practices,” the agencies were allowed to pay simple rather than compound interest, to backload the payments, to repay the debt having the highest rates first, and to cover any additional construction costs under the original low-interest loan.

The American Public Power Association (APPA) and the National Rural Electric Cooperative Association (NRECA), the lobbying groups representing the municipal utilities and cooperatives receiving PMA and TVA power, continue to deny the existence of taxpayer benefits. Responding to the above-mentioned GAO study, for instance, NRECA declared: “The PMAs operate as a self-sustaining, no-cost program that actually will return billions of dollars in revenue to the U.S. Treasury each year.” GAO auditors subsequently rebutted each of the lobbyists’ claims, again demonstrating how U.S. taxpayers are picking up the slack. The TVA/PMA beneficiaries themselves inadvertently acknowledge the subsidies when they oppose privatization on the grounds that it will drive the price of power through the roof. They can’t have it both ways, and increasingly lawmakers believe the subsidy calculations of the nation’s top independent auditors rather than of the self-interested recipients of TVA/PMA power.

To divert attention from subsidy studies, TVA/PMA beneficiaries often complain that shareholder-owned utilities are the ones with all the breaks. Yet this approach is backfiring on the managers of government-owned power companies. In a March 1997 hearing before the House Appropriations Committee, TVA’s chairman stated, “If there are any advantages at all, they go to the private power companies and not to us.” Rep. Mike Parker (R-Miss.) quickly retorted: “If private power companies have it so good, then TVA should become one. If they’ve got it so good, I want you to be in that system.”

The existence of taxpayer subsidies for the preferred consumers of government-owned utilities can no longer be hidden or denied. Such benefits will be increasingly hard to defend in this era of deficit reduction and electricity competition because they waste taxpayer dollars as well as distort a competitive market.

Managers of federally-owned utilities often argue that they are more efficient than their private counterparts. Yet the Tennessee Valley Authority suffers a debt of $28 billion, enough to cause the U.S. General Accounting Office to question the giant utility’s long-term viability. The Bonneville Power Administration has a $16.1-billion debt, much of it the result of ill-fated investments or stranded costs in overpriced and unneeded nuclear power plants. The Rural Utilities Service, which provide low-interest loans to cooperative utilities, holds more than $11 billion in government-guaranteed rural electric loans that are in default or classified as problematic. No doubt investor-owned utilities also overbuilt and face stranded costs. Yet policymakers should be skeptical of assertions that public power managers have a monopoly on foresight and management skills.

A key issue of the utility deregulation debate will be if and how utilities should recover their investments in power plants that are no longer competitive. Stranded costs in the public power context take on some particularly troubling aspects. For private utilities, the worry is that shareholders will lose out if stranded costs are not recovered from ratepayers. For TVA, PMAs, and rural electric cooperatives, however, it is the U.S. taxpayer who will lose out if public power’s stranded costs are not recoverable. A growing number of fiscal conservatives worry about a massive government bailout and a big headache for taxpayers if ratepayers fail to pay for public power’s stranded costs.

Other evidence of PMAs’ poor management has been revealed by the House Committee on Resources: “The federal power program suffers, in many areas, from poor operating and maintenance practices, questionable `investments’ in the underlying facilities, and in some cases poor design and construction criteria.” [It’s unusual to see a statement from a committee. Is this in some type of report approved by the whole committee?] These practices have led to power outages lasting days or even years. The August 1996 massive power outage in the West has been attributed in large part to the failure of the Bonneville Power Administration to maintain its equipment and appropriately manage the federal facilities.

Manning the barricades

TVA/PMA customers are beginning to wage an aggressive lobbying campaign to save their taxpayer benefits. One of their chief claims is that reforming government-owned electricity companies will hurt rural consumers. Yet it’s shareholder-owned utilities that supply a full 60 percent of rural America’s power. These private firms also service four out of five small-town consumers. Based on these statistics, lawmakers need to resist equating the welfare of rural consumers with the interests of rural public power managers.

Federal power advocates also try to paint a threatening picture that competition will leave certain rural customers behind, just as airline deregulation reduced service to remote locations. But electric poles and wires in rural areas, be they owned by public power or private power, are already in place and will not be torn down. Unlike airline routes, the electricity distribution infrastructure is a fixed, immovable asset. If lawmakers set a truly level and competitive electricity market, the result will be that rural consumers can choose from scores of competitive enterprises wanting to provide power to those distribution networks.

Some public power advocates also claim that deregulation will raise the price of electricity to rural consumers, but electricity rates for 70 percent of rural cooperatives are already higher than the rates charged by neighboring investor-owned utilities. In 15 percent of the cases, rates charged by rural cooperatives are 40 percent higher than those of private power companies, demonstrating that even with subsidies some government-owned utilities cannot compete with shareholder-owned firms.

Federal power managers also argue that the status quo is necessary to protect against market domination by shareholder-owned utilities. They suggest that recent mergers among private companies signal a return to the giant utility holding companies of the 1930s. Charges of market domination require a moment’s reflection. What are we talking about? Market domination certainly doesn’t exist in the transmission system, noting that the Energy Policy Act and recent FERC actions require open access to all transmission lines and that FERC regulates transmission charges. It certainly won’t exist in the distribution system, which will continue to be a state-regulated function.

Is there, therefore, domination within the generation market? No. A plethora of companies want to compete in the electricity market. Independent power marketers are providing competition, and they don’t fear market domination by anyone. In fact, market domination will exist only if policymakers allow today’s utilities, be they shareholder-owned or government-owned, to maintain monopolies over their service territories. Monopolists opposing customer choice, those not wanting to open their systems to competition, are the only ones to fear when it comes to market domination.

In another scare tactic, PMA/TVA managers and their beneficiaries suggest that reform will cause environmental damage. Privatization, of course, would get the federal government out of the electricity business, but it certainly would not eliminate the federal role in protecting America’s rivers. Even the most ardent of privatization advocates talk about selling only the hydroelectric assets of PMAs and TVA. Their plans would have the federal government still control the dams and the water flows and still provide navigation, irrigation, fishing, habitat protection and restoration, and other recreational benefits.

Reform actually offers the opportunity for substantial environmental improvements, largely because today’s below-market electricity rates charged by TVA and PMAs provide little incentive for efficiency. A recent study by the Natural Resources Defense Council found that TVA was one of the most polluting utilities in the United States. Market discipline, in contrast, would curb wasteful energy consumption, the construction of unnecessary power plants, and the generation of inordinate pollution caused by the government’s subsidies. Privatization also would allow renegotiation of the terms for operating hydropower facilities, setting future dam-use priorities and improving the protection of endangered species and habitats.

Paths to progress

PMA/TVA beneficiaries are a powerful special interest group. In 1996, rural coops alone contributed almost $1.5 million to favored candidates. But the political dynamics of the utility debate have changed dramatically in the past few years. The arguments of PMA beneficiaries, for instance, have become harder to defend. When lawmakers are trying to cut the federal deficit, it makes little sense for taxpayers to subsidize the electricity bills of a few select consumers. When lawmakers are trying to encourage energy efficiency, it makes little sense for the federal government to offer below-market power that encourages consumption, waste, and pollution. When lawmakers are trying to bring competition into the electricity market, it makes little sense for Congress to exempt a large segment of the industry from that competition.

TVA/PMA reform finally has become a real possibility. Reform options, of course, vary substantially. The most direct approach would be to privatize the federal government’s hydroelectric assets. Another would be for the federal government to maintain control of its turbines and transmission lines but to sell its power to the highest bidder. To assuage the current beneficiaries of federal power, lawmakers could provide them with the right of first refusal for that power at market rates.

Over the past decade, electricity privatization programs have been launched by at least two dozen other countries, including highly developed nations such as Australia and Britain, developing countries such as Argentina and Brazil, and former communist states such as Hungary and Poland. Senator Murkowski, who knows first hand about the privatization of the Alaska Power Administration, argues: “When the rest of the world is trying to get government out of business, so should we.”

Some conservative lawmakers who represent TVA/PMA beneficiaries have conflicting positions on the issue of privatization. Most argue vehemently that the federal government should get out of all business ventures and let the free enterprise system work its wonders. Yet when it comes to subsidized electricity for their constituents, some of those same politicians maintain that Washington should continue to own and control the nation’s largest electric utilities. This is not the 1930s, and there is no market failure to justify government intervention in the electricity market. Indeed, one could argue that there’s far more justification for the Air Force to provide rural airplane service than there is for the federal government to generate electricity.

Power brokers, independent power producers, shareholder-owned utilities, and investment bankers all have expressed an interest in buying PMA/TVA assets. Peter Lynch, the former manager of Fidelity’s Magellan Fund, noted, “There has never been a serious effort to privatize the TVA, but if there was I would be the first in line to get a copy of the prospectus.” William Malec, TVA’s former chief financial officer, agrees that the time for privatization has arrived and that TVA’s hydroelectric assets could fetch some $10 billion on the open market. “Selling off TVA is a natural next step,” says Malec. Tucson Electric, a shareholder-owned utility, has offered $550 million for just the Arizona assets of the Western Area Power Administration (WAPA). Otter Tail Power Company, another private utility, has submitted a separate offer to purchase other WAPA assets.

Rather than sell federal hydroelectric assets outright, some economists argue that the government should simply auction off its power. Yet even such a straightforward proposal for having all U.S. electricity sold at market rates frightens TVA/BPA beneficiaries. Bonneville’s chief recently argued that over the long term the status quo would “be a super deal for Northwest customers, much better than market-based pricing.”

Current procedures for selling federal electricity are troubling. When Bonneville recently contracted 200 megawatts of power to a Southern California marketer, for instance, it did not need to conform with the Mineral Leasing Act of 1920, which sets safeguards and procedures associated with federal sales of coal, oil, or natural gas in order to ensure that taxpayers receive “fair market value.” PMAs and TVA, in fact, are not beholden to any procedures that require full disclosure, minimum bid procedures, appeals, audits, and judicial reviews. As a result, billions of dollars worth of power produced at taxpayer expense are being sold with less care than would accompany the sale of surplus federal property such as used typewriters or fill dirt.

Representatives Bob Franks (R-NJ) and Marty Meehan (D-MA), co-chairs of the Northeast-Midwest Congressional Coalition, have introduced legislation to ensure that federal taxpayers get fair market value for federal electricity. Electricity sales to the highest bidder then would return to U.S. taxpayers the billions of dollars they’ve invested in generating facilities and transmission lines. It would provide a reliable source of funding for maintenance and upgrades at these facilities. With audits, appeals, and judicial reviews, such a system also would curtail today’s backroom deals and block potential corruption.

Utility restructuring legislation must address federal power, if for no other reason than the fact that government-owned utilities represent a significant segment of the electricity industry. While acknowledging public power’s proud history, it’s important to realize that the electricity market has changed substantially, and it will change even more dramatically in the next few years. TVA and the PMAs, just like the rest of the electricity industry, must change as well. Federal utilities cannot continue to be sacred cows. The status quo is simply too expensive for both taxpayers and ratepayers.