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Introduction
This chapter looks at support provided by the Federal Government to certain electric power customers. This support differs in some notable respects from the subsidies provided to other energy sectors described in Chapters 2 and 3. For one, the Federal support outlined in the following discussion does not include any direct expenditures provided to electricity producers by the Federal Government, as was the case for other programs (such as the LIHEAP expenditures discussed in Chapter 2). The support provided to electricity producers is not measured by the U.S. Treasury, and it is not reported in Federal budget documents.
In the following discussion, Federal support to the electricity generation sector is estimated from data published by the Federal Energy Regulatory Commission (FERC), the North American Electricity Reliability Council (NERC), bond rating agencies, and various company financial documents. The values provided in this chapter should be treated as estimates of support, not given to the same precision as the values provided in earlier chapters, which were generally taken directly from budget documents. The methodology used to estimate the support provided by the Federal Government to particular segments of the electric power industry includes two measures--market price support and interest rate support--that are commonly used in subsidy studies. (47) A third measure is used to estimate the value of Federal revenues forgone when returns on Federal electricity assets fall short of the returns on similar assets held by investor-owned utilities (IOUs). This measure is comparable to the standard method used by electricity regulatory bodies to determine the appropriate ratebase in reviews of IOU rate filings.
Background
The electric power industry in the United States is composed of approximately 3,200 electric utilities and 2,100 nonutility power producers. (48) Electric utilities are generally classified as either investor-owned, rural cooperative, publicly owned, or Federal utilities. The classes operate under different legal, financial, and tax environments. The main focus of this chapter is on the Federal utilities, which consist of four Power Marketing Administrations (PMAs) and the Tennessee Valley Authority (TVA). A discussion of Federal financial assistance through the Rural Utilities Service (RUS) is also included at the end of the chapter. Support to the Federal utilities is emphasized over RUS support to rural electric cooperatives, because much of the support directed at the Federal utilities is related to their Federal ownership. Hence, the Federally owned utilities are--precisely due to their ownership status--provided both price and asset advantages. In contrast, although RUS-supported entities derive support from the Federal Government in the form of interest subsidies, their non-Federal ownership status means that no direct Federal price or asset support is provided to them. Hence, this study details three means by which the Federal Government provides support to the Federal utilities (price, interest, and asset) and the one means by which the Federal Government provides support to RUS loan recipients.
Federal electric utilities are primarily producers and wholesalers of electric power. As required by law, they are nonprofit and provide certain classes of customers preference in purchasing their power. In general, preference customers include municipal utilities, cooperatives, State utilities, and irrigation districts. For some PMAs, they may also include State governments and Federal agencies. After meeting commitments for electricity to preference customers, the Federal utilities can and do sell their excess electricity to IOUs or directly to industry. Only about 16 percent of Federal power (in megawatthours) is sold to ultimate consumers, accounting for about 1.4 percent of all electricity sales to ultimate consumers. (49)
The ownership and operation of Federal electricity generation facilities fall under the responsibilities of the U.S. Department of the Interior's Bureau of Reclamation, the Army Corps of Engineers, and the International Boundary and Water Commission. (50) Most of the electricity produced by these Federal agencies is marketed by the four PMAs: Bonneville Power Administration (BPA), Southeastern Power Administration (SEPA), Southwestern Power Administration (SWPA), and Western Area Power Administration (WAPA). The Tennessee Valley Authority (TVA), the largest producer of Federal power, markets its own electricity.
Rural cooperative electric utilities are privately owned by their members (customers) and are established in rural areas to provide electricity to those members. Cooperatives, incorporated under State law, usually are directed by an elected board of directors. Cooperatives generally are nonprofit and tax-exempt, with access to low-cost Federal Government loans. Cooperatives accounted for almost 9 percent of electricity sales to ultimate consumers in 1998. (51)
Publicly owned electric utilities are State and local government agencies established to serve their communities and nearby consumers. Publicly owned electric utilities include municipals, public power districts, State authorities, irrigation districts, and other State organizations. Publicly owned electric utilities are tax-exempt and nonprofit, returning excess funds to the consumers in the form of community contributions and/or reduced rates. There are more than 2,000 publicly owned electric utilities in the United States, which in 1998 accounted for 17 percent of U.S. electricity sales for resale and 15 percent of sales to ultimate consumers. (52) Publicly owned utilities can borrow through the issuance of bonds whose interest is exempt from Federal taxation, but because the same exemption is available to all State and local government agencies (electric and otherwise) it does not meet the definition of subsidy used in this report. In addition to income tax exemptions on their bonds, publicly owned utilities are themselves exempt from Federal income taxes; however, both exemptions are also available to providers of municipal services, such as water and sewage, and hence are excluded from this report. Furthermore, as nonprofit enterprises, these companies would not, on average, realize positive income, and their tax liabilities would be minimal.
Some aspects of government support for electricity providers are not addressed in this chapter. For example, many States and localities provide various types of support to electricity producers within their jurisdictions, and some rural electricity companies and public power companies derive benefits from State and local governments similar to those derived by Federal utilities from the U.S. Government. By definition, however, such subsidies do not constitute support from the Federal Government, which is the subject of this report.
IOUs also receive some types of Federal Government support. For instance, Federal tax advantages provided to IOUs include such items as the ability to apply accelerated depreciation to assets. These advantages, however, are available not only to IOUs but also to other industries, and as such they fall outside the scope of this report, which is limited to the study of Federal interventions directed solely at a particular form of energy, or a particular energy producer or consumer. IOUs also benefit from tax exemptions applied to bonds funding certain forms of pollution abatement, but similar tax-free bonds are also used to fund a variety of traditional municipality-provided non-energy activities, such as water and sewage. Because the Federal tax exemption for interest on these industrial development bonds is available to non-electric utilities in addition to IOUs, it is not included in this analysis.
In a number of instances, this chapter compares the operating environment of the Federal utilities and rural cooperatives with that of IOUs. IOUs are privately owned but publicly regulated electric utilities. Like all private businesses, they seek to produce a return (profit) on investment to their investors. IOUs are granted service monopolies. In return, they are obligated to serve all customers in their service areas. Although the electric power industry is undergoing deregulation, most sales by IOUs still are regulated. The Federal Government regulates wholesale transactions (sales among utilities), and State agencies regulate retail sales (sales to ultimate consumers) within each State. The 239 IOUs accounted for 75 percent of all U.S. electric utility retail sales in 1998. (53)
Historically, the structure of the electric utility industry has been predicated on the concept that the industry was a natural monopoly. The result was traditional ratebase regulation for IOUs, designed to protect consumers by ensuring reliability and a fair revenue requirement to the electric utility. The revenue requirement was based on operating costs and a reasonable return on the ratebase (invested capital) of the utility. Rate schedules were based on the cost of service for different customer classes and projected sales in each customer class to capture the revenue requirement.
The issue of what constitutes a government benefit is not without controversy. It should be noted that the intention of this analysis is not to assess all the cost differences faced by Federal utilities and the IOUs. Nor is it to assess the desirability of publicly provided power versus privately provided power. Rather, the purpose is to measure any advantage conferred to consumers of electricity as a result of specific Federal Government interventions. According to this criterion, the actions must be directly targeted to a particular group of energy consumers or producers and not conferred to others. Interventions that affect not only certain electricity producers but also a host of other companies or industries (even if they may disproportionately affect electricity companies) are not covered in this report.
Federal Policies Affecting Power Costs and Pricing
Programs
The prices charged by Federal utilities are in general lower than those charged by IOUs. Federal utilities and rural cooperatives are affected by their legal status and the benefits derived from the following long-established Federal programs:
Access to Low-Cost Generation. Federal utilities are required to sell their electricity preferentially to certain users. By law, PMA electricity is sold "at the lowest possible rates consistent with sound business principles," (54) which today are typically less than the cost of alternative supplies. The "lowest possible rates" require Federal utilities to price electricity so as not to earn a profit. Essentially, taxpayers are forgoing returns they might receive if these entities were operated as competitive businesses, in exchange for lower electricity prices to particular classes of customers and economic benefits to particular regions.
Access to Low-Cost Credits. As a result of a number of Federal Government programs (some of which date back to the inception of Federal power), in some instances, Federal utilities have been able to borrow funds at interest rates below prevailing Treasury rates; in some instances, their interest rates are closely tied to the Treasury's own rates; and in other instances, Federal utilities borrow at private-sector interest rates, but their creditworthiness is enhanced by an implicit Federal guarantee that they will not default on their borrowings. All these interest rate advantages constitute Federal support to the Federal utilities. Rural electrification cooperatives, under a program dating from 1935, are eligible for low-interest long-term loans from the Federal Government, which were made at a 2-percent interest rate through 1973. Loans made between 1973 and 1993 carry a 5-percent interest rate, with loan periods up to 35 years. (55) In 1993, the 5-percent interest rate was replaced with a new interest rate structure tied to the interest rates on municipal bonds. At the end of 1998, some $33 billion (1999 dollars) in Federal loans and guarantees were outstanding to cooperatives. (56)
Measuring the Support
Three frameworks were chosen for the valuation of support conferred to Federally supported power as a result of the programs cited above. The first method is based on a comparison between the prices charged for electricity under Federal programs and an estimate of relevant "market" prices--a price advantage that is, in turn, conferred to the utilities' preference customers. The second method quantifies the benefits of favorable borrowing rates that are made available to Federal utilities and RUS borrowers. The third method answers the following question: if Federal utilities were required to achieve a competitive rate of return (similar to IOUs), how much higher would their revenues (and associated electricity prices) have to be in order to achieve that return? Of the three, the second measure of support is the most direct, because favorable interest rates directly reduce the utilities' borrowings costs.
Each of the valuation approaches has strengths and weaknesses. For example, the market price approach assumes that a fully competitive market price for wholesale power exists when, in fact, fully competitive prices do not exist today. The interest rate approach assumes that Federal utilities and RUS borrowing practices can be fairly compared with the practices of private-sector borrowers when, in fact, there are substantial differences between the two. Knowing exactly which benchmark interest rate to compare with the Federal utility rate is largely a matter of judgment. The return on asset measure assumes that taxpayers (or the owners of these facilities) are entitled to a market rate of return on their assets, (57) comparing the IOU rate of return against the Federal utility rate of return; however, the Federal utility assets in place today were not developed under fully competitive market conditions. Only the interest rate measure is applied to RUS borrowers, which, because they are not Federally owned, receive no Federal support in the areas of prices or returns on assets.
Market Price Support
There are a number of different measures of wholesale electricity prices. The one used in this analysis, "sales for resale," was the only available measure that could be readily derived from published data. (58)
In a competitive market the prices charged by different companies for the same commodity would be similar, with some variation resulting from such factors as transportation costs. Competitive forces would not allow significant price differences to persist over time. Where well-functioning markets exist, market prices can be observed directly. If Federal utilities sell power at below-market prices, the value of their preferential rates is the difference between the revenues that would be earned by selling electricity at the market price and the actual revenues of the utility. For several reasons, however, caution should be exercised in estimating competitive market prices for electricity. First, although U.S. electricity markets are becoming more competitive, they still are heavily regulated. Because the prices charged by IOUs for wholesale transactions are often based on their embedded costs, a true competitive price cannot be derived. Currently, Federal utilities are required to sell electricity at rates that cover both power and nonpower costs.
In addition, electricity is not entirely a commodity. The data available for wholesale power sales do not specify all the terms of each transaction. In some cases, a utility may be selling on the spot market power it does not need to serve its own customers. In other cases, a utility may have a contract to provide all the power generation capacity and other services (spinning reserves, reactive power support, etc.) essential to wholesale customers. Essentially, these two transactions involve different goods, and the prices for them are not directly comparable. The market price approach implicitly assumes that Federal utility wholesale power sales are directly comparable to private utility power sales within the same regions; however, this may not always be the case. Because of the large degree of uncertainty associated with this effort, the values derived using this methodology are labeled in this chapter as "support" rather than subsidies. Further, EIA has elected not to include them in the summary tables for national energy subsidies in this report. Nevertheless, they are an important aspect of Federal intervention in energy markets and, consequently, are considered here.
Apart from any government support discussed in this chapter, Federal power today is often low-price power because much of it comes from relatively cheap hydroelectricity. In a purely rate-regulated environment, conventional ratemaking policy allows low-cost producers to pass on the benefits of cheap power to their customer base. In a regulated environment, selling relatively cheap power at below-market prices does not involve a form of government support, as long as the power is sold without preference. Thus, one could argue that it is the preference, not the price, that is the conveyance of Federal Government support. However, this conveyance has a value in any environment, whether rate-regulated or free market, but it can more readily be estimated in a market where prices are freely set by supply and demand.
As electricity markets make the transition to full competition (a transition that has been in effect for a number of years), market forces play a greater role. In contrast to the rate-regulated environment, in a pure market-based environment, low-cost power producers become profit maximizers. Whatever cost advantage these producers possess relative to their competitors could be captured in the form of rents. Low-cost producers would have little incentive to price their power at anything other than market clearing rates, which in a competitive environment would be equal to the industry's marginal cost of power. Moreover, in a pure market environment, producers would be free to sell their electricity to the highest bidders without the constraints of a preference customer class. In a purely competitive environment the extent to which Federal power prices fell below the prices charged for similar power by competing utilities would constitute Federal support to the buyers of Federal power. Current efforts to deregulate U.S. electricity markets should work to further reduce the spread between Federal power prices and IOU power prices.
A comparison is made in this chapter between wholesale power prices charged by the four PMAs (along with the TVA) and wholesale prices charged by nearby IOUs (59) (see discussion on "Electricity Markets"). The intent of the comparison is to ascertain whether Federal utilities provide power at rates below those charged by neighboring IOUs, thus providing their customers with an advantage unavailable to other consumers. However, although industry regulators have become increasingly inclined to approve rates that reflect contemporaneous market conditions, U.S. wholesale electricity prices remain regulated to a significant degree. Accordingly, the value of the price differential between rates charged by Federal utilities and those charged by neighboring IOUs should be seen as only a rough estimate of any price advantage enjoyed by the customers of Federal utilities. Still, it should also be noted that the value of the price differential has fallen since the Energy Information Administration (EIA) prepared its 1992 report on Federal energy subsidies. The narrowing of the wholesale price gap reflects two related developments: first, electricity markets have grown more competitive over the past decade; and second, as IOU prices have fallen, the measured value of Federal support received by utility customers has also fallen.
Electricity Markets
The electricity market has two distinct segments—wholesale and retail power markets. Wholesale markets comprise the resale and purchase of electricity among utilities and nonutility power producers for sale to ultimate consumers. Wholesale trade transactions are categorized by the service provided: full or partial requirements, firm or non-firm, etc. Generally, different services have different associated costs of service and, under cost-of-service regulation, have different prices. Prices of wholesale electricity sales are subject to approval by the Federal Energy Regulatory Commission, with the exception of the TVA.a
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aThe TVA and its regulatory exception are discussed later in this chapter.
Federal utilities as a group have only 347 end-use customers, none of which is classified as residential or commercial. (60) In general, their end-use customers are bulk purchasers, such as the U.S. Department of Energy's national laboratories and aluminum smelters in the Pacific Northwest.
Interest Rate Support
One element of Federal aid to public power is low-cost credit. Rural cooperatives receive RUS loans, and some Federal utilities receive appropriations to be repaid at the 30-year Treasury bond rate. Even when Federal utilities borrow through publicly issued debt, the debt receives much higher credit ratings than would be attained if it were not for the widely held view in the financial community that this debt carries an implicit U.S. Treasury guarantee to prevent any default. This form of support is more direct than the price-based support measure just discussed. The magnitude of the resulting support can be computed by comparing the actual interest rates paid with various market interest rates. When Federal utilities are able to raise funds in capital markets at interest rates lower than those at which they could borrow were it not for their Federal Government status, a measure of support is conferred.
Although some Federal power producers borrow at various rates under various legal authorities, on balance they pay lower rates than privately owned utilities and, in some cases, lower than the Treasury itself. Credit markets view Federal utility debt as having an implicit Treasury guarantee, although no guarantee in fact exists. In its appraisal of a 1998 TVA bond underwriting, Standard and Poor's assigned the debt a AAA rating. In doing so, Standard and Poor's noted that "the rating reflects the implicit support of the U.S. Government and Standard & Poor's view that, without a binding legal obligation, the Federal Government will support principal and interest payments on certain debt issued by entities created by Congress. The rating does not reflect TVA's underlying business or financial condition." (61)
As a result, Federal utilities are able to float debt at rates well below those paid by all but the most highly rated of IOUs. The three smaller PMAs (SEPA, SWPA, and WAPA) have average financing costs below that of the U.S. Treasury itself, because DOE requires them to repay higher cost debt early whenever possible, a privilege not held by the Treasury. (62) Moreover, before 1983, the three smaller PMAs were allowed to finance capital projects at rates actually lower than the Treasury's rate. (63)
This analysis uses both public-sector and private-sector interest rates as benchmarks against which to measure the value of interest rate support. The public-sector benchmark is the U.S. Treasury's cost of funds for 30-year borrowings. For the private-sector rates, the benchmarks used are the rates paid by utilities using various utility bond ratings ranging from Aaa down to Baa. These ratings indicate two different measures of support. When Federal agencies achieve lower borrowing costs than the U.S. Treasury itself, the underlying advantage can be viewed as support provided directly to the borrower by the U.S. Treasury or by the public at large. The second measure of support assumes that Federal utilities are advantaged to the extent that their borrowing costs are less than they would be if they were private entities. This may be viewed as a form of indirect support from the Treasury. This measure of support compares the borrowing costs of the Federal utilities with the cost of funds realized by select groups of private utilities. The comparison rate (e.g., the A utility rating) may or may not be appropriate, depending on the presumed creditworthiness a Federal utility would command were it to lose the borrowing benefits derived from Federal ownership or its implicit financial backing from the U.S. Treasury.
Table 5 shows the 30-year Treasury bond rate and various utility bond rates for 1990 and 1998. The intent of the presentation is to illustrate that the level of estimated support varies directly with the benchmark interest rate chosen. In 1998, the average yield on 30-year Treasury bonds was 5.58 percent, and the average yield on Baa-rated utility bonds was 7.26 percent. The estimate will be higher when the Aaa IOU rate is used than when the Treasury rate is used for comparison and will increase as the comparison is graduated downward to the IOU Baa rate. The average interest rate spread between the 30-year Treasury bond and IOU Aaa bonds was 119 basis points over the 1980-1998 period, and the average spread between the 30-year Treasury bond and the Baa IOU bond rates was 168 basis points. (64)
Table 5. Interest Rates Used for Comparisons with Federal Utility Borrowing Costs, 1990 and 1998
Because the financial accounts of the four PMAs, TVA, and cooperatives borrowing from the RUS differ considerably, different calculations of Federal interest rate support are used in this analysis. One method is to measure the interest paid by Federally supported power entities against the interest paid on similar debt issued by the Treasury or by IOUs in the same year. However, several difficulties are involved. One problem is that debt maturities cannot always be matched. For instance, TVA has issued debt with maturities as great as 50 years, for which there are no similar Treasury or IOU issues. Another difficulty is that some debt is callable, which means it may never be held to maturity and therefore commands a different interest rate than debt which is not. Still another problem is lack of data. Although some of the debt on the books of the PMAs date back to the 1940s, there is little in the way of comparative interest rate data available. For instance, the U.S. Treasury did not start to issue 30-year debt until 1978. Further, much of the information provided to EIA by the Federal utilities and the RUS on their respective loan portfolios was insufficient to reconstruct their debt at market rates.
Interest rate support for BPA and TVA can be directly tied to market interest rates; therefore, a simplified calculation was used in their cases. BPA borrows at a premium to the Treasury rate for its long-term debt and appropriated debt. For its non-Federal debt, BPA borrowed essentially at the Aa municipal rate in 1998. TVA, as explained later, is currently borrowing at the Aaa IOU rate. In measuring the interest rate support provided by the Federal Government to TVA and BPA, these rates are measured against other private-sector borrowing rates. For instance, TVA's Aaa-rated borrowings are compared to what the company would have to pay in interest if it borrowed at the Aa, A, or Baa rate. The difference in borrowing costs constitutes the level of support. To calculate the difference in borrowing costs that involves moving from the Aaa rating down through the Aa, A, and Baa ratings, the average spread was calculated between interest rates on these debt instruments between the years 1980 and 1998. As an example, the average spread over this period between the Aaa and Aa rates was 33 basis points. An average spread was calculated over several years to abstract from year-to-year variations in interest rate differentials.
The three smaller PMAs have average interest rates that fall below the 30-year Treasury rate. Although currently all new debt issued by the three smaller PMAs is at the Treasury rate, much of their unretired old debt bears interest well below that of similar Treasury issues. Further, unlike TVA, the three smaller PMAs have an advantage unavailable to the Treasury in that DOE requires them to retire high-interest debt first whenever possible. As such, a different approach to measuring Federal interest rate support was taken for the three smaller PMAs. This approach attempted to compare the loan portfolio of the three smaller PMAs against a similar portfolio of Treasury and utility debt instruments. More specifically, a loan-by-loan comparison was made, going back to debt issued in the early 1940s. All debt that is currently on the books of the three smaller PMAs was compared to similar debt (i.e., debt having the same or similar maturity) issued by the U.S. Treasury or by IOUs. Where similar Treasury or IOU debt was unavailable for comparison, estimates were based on the average spread between Treasury and private-sector securities. An estimate of Federal support to RUS borrowers was undertaken in a similar fashion.
Return on Asset Support
Over the long term, in competitive markets IOUs must earn a sufficient return on invested capital to satisfy their shareholders. Historically, U.S. regulators have taken this into account when setting the price of electricity for private utilities. Regulators have set the price of electricity at a level that would allow IOUs to recover operating costs and earn a market-based return on the assets they have invested to meet their customers needs. If sales of services provided by Government-owned assets provide a below-market return on the assets, a preferential benefit is being conferred to customers. This approach measures the value of forgone Federal utility revenue that would have been needed for the Federal utilities to realize a market rate of return on their assets.
A typical textbook definition of cost for a private-sector electric utility is operating cost plus depreciation of capital assets plus some allowance for cost of capital. The extent to which actual Federal utility earnings from electricity sales fall below what they would have earned charging market rates constitutes a support to the purchasers of Federal power, with the amount of the support equal to the difference between revenues sufficient to recover costs and revenues at the actual selling price.
Like the estimates of market price and interest rate support, estimates of return on asset support are not perfect measures of the support provided to the preferred customers of Federal utilities. As stated above, U.S. electricity markets are heavily regulated, and the assets utilities have in place today were not fully developed under competitive market conditions. |
