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THOUGHTS ON RESTRUCTURING THE NORTHWEST ELECTRIC POWER INDUSTRY

This paper presents thoughts on how the competitive forces that are transforming the northwest energy system can be channelled into a framework that is fair and beneficial to all regional interests.

February 14, 1996

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TABLE OF CONTENTS

A. Introduction: Change Is Inevitable, Manageable, And Good

C. Defining The Problems To Be Solved

D. A Restructured Northwest Power System

E. Specific Restructuring Elements And Issues

F. Conclusion

APPENDIX A: Should the RGB Include a Federal Representative?

APPENDIX B: Statutory Provisions Governing NEWCO

APPENDIX C: NEWCO Revenues and Profits: A "Piece of the Rock

APPENDIX D: WPPSS Debt

THOUGHTS ON RESTRUCTURING THE NORTHWEST ELECTRIC POWER INDUSTRY

A. Introduction: Change Is Inevitable, Manageable, And Good

Throughout the United States, including the Northwest, the policies and structures that once characterized the electric power industry are falling away. The industry is in transition from the familiar and largely comfortable past to the unknown (and somewhat frightening) future. At the moment, in the early days of this transition, confusion and uncertainty abound; there is no longer any status quo. Yet there is also no consensus on what an optimal new electric power system should look like, nationally or in the Northwest. Change seems rapid, but without clear direction.

The premise of this paper is simple: participants in the Northwest power system cannot halt, but can manage and direct, the power industry's transformation in our region. Moreover, that transformation can be a good thing. We can create a better Northwest power system to the benefit of all electricity consumers -- but only if we first achieve a reasonable consensus on what the new system should be.

Absent this comprehensive approach -- one that focuses on the entire regional power system, not just pieces of it -- a new regional power system will still emerge. But the process will not be orderly, and the result will not be optimal. Without a comprehensive approach, the new regional power system will be created piecemeal and unpredictably (either through national legislation or in response to competitive forces, or both), as scores of public and private entities promote their individual agendas before a wide variety of government bodies, the voters, and the news media. We can do better.

Today's Northwest power system has an enormous federal component. The Bonneville Power Administration ("BPA") owns three quarters of the region's high voltage transmission and markets nearly half the region's power, most of which is produced in the vast federal Columbia River system. The federal system includes dozens of dams, reservoirs, and other facilities used not only for power production but for navigation, irrigation, recreation, flood control, fish production, and fish passage. The federal system reflects an era when government ownership and investment seemed the best way to develop the then-sparsely populated Pacific Northwest. It was an idea that worked. But times have changed.

This paper reflects one judgment that should be identified at the outset. That judgment is that it is best to acknowledge and accommodate the primary forces of change in the electric power industry: competition, deregulation, and falling prices. Denial of these forces would be futile, like denying gravity. More important, these forces can be turned to the benefit of all consumers in the region. These forces do not mean that government must abdicate its responsibilities, or that public policy decisions must be surrendered to private entities and the market -- far from it. But a restructured Northwest power system should take these forces into account and use them to the region's advantage.

The smallest adjustment the region could make today to deal with the forces of change in the electric power industry might be very difficult: free BPA to cut costs and act more like a competitive private enterprise, and stop expecting BPA to be an unlimited funding source for programs and other social purposes. This "small adjustment" is discussed below, not in detail but enough to suggest that it cannot be overlooked. Keeping costs and rates below the market price of power is a necessary -- and perhaps even sufficient -- condition of competitive success for bulk power marketers such as BPA, or any potential BPA successor.

This paper, however, focuses primarily on another idea: what a comprehensively restructured, non-federal, Northwest power system could look like, and how it could be created. The paper's purpose is to provide a starting point for discussion of comprehensive restructuring by offering a comprehensive proposal.

B. IDENTIFYING THE FORCES OF CHANGE AND THEIR IMPLICATIONS

The restructured Northwest power system described here responds to forces identified above: competition, deregulation, and falling power prices. These forces and their Northwest implications deserve discussion before turning to the proposed new system itself.

1. COMPETITION AND DEREGULATION

Like many regulated industries before it, the U.S. electric power industry is now being deregulated and opened to the forces of competition. The power industry was long considered a classic case justifying utility-style regulation: economies of scale and declining marginal costs were believed to create natural monopolies, and regulation was thought necessary (and sufficient) to bring consumers the efficiency benefits of natural monopolies while protecting the public from monopoly's potential abuses.

The same was once believed about the following industries: railroads, trucking, airlines, telecommunications, oil production, and natural gas. Each of these industries was once subject to its own regulatory regime, modeled (as is electric utility regulation) on the landmark Interstate Commerce Act. Today these industries are all deregulated, and the Interstate Commerce Commission (like the Civil Aeronautics Board, and other major regulatory agencies) has been abolished.

In these industries, competition is now allowed to operate where it can, though regulation has been retained to the extent deemed necessary. For example, although airline routes and fares are deregulated, the FAA still regulates airline safety and traffic control. Similarly, pipeline safety is still regulated, though oil and gas production and sales are not. Moreover, the FERC still regulates the tariffs of interstate oil and gas pipelines, since pipelines -- like transmission lines, but unlike the commodities that pipelines and transmission lines transport -- are still considered natural monopolies, and thus suited to economic regulation.

Deregulation and competition have created some inconveniences: folks grumble about the decline of nonstop airline service and the advertising war among MCI, AT&T, and Sprint. But there have been benefits, too. Monopolies tend to provide too few goods and services, at too high prices, and they tend to stifle technological innovation. Regulating an industry as a natural monopoly does not seem to overcome these tendencies. Allowing enterprises to consider themselves natural monopolies also tends to produce inefficiency and unresponsiveness. Regulated rates, though based on costs, may reflect costs far greater than necessary. Finally, the creation of regulatory bureaucracies has itself imposed significant costs on ratepayers and taxpayers.

The concept that makes deregulation practical is unbundling. Local telephone service has been unbundled from long distance service. Similarly, retail electric service can be unbundled from bulk power supply: the company that produces electricity can be different from the one that delivers it. Delivery facilities may be a natural monopoly -- why have more than one wire coming into your house? -- but the product delivered may be suited to sale in a competitive market. In formerly regulated industries, products are generally now unbundled and sold competitively, separate from the service of product delivery. Footnote1

The electric power industry is the only part of the U.S. energy sector still subject to utility-style regulation. But this is changing rapidly. The deregulation concept established for natural gas and oil, and now for electric utilities, splits once-integrated enterprises into separate generation, transmission, and distribution divisions -- or increasingly into separate companies. Moreover, competition and market-based (rather than regulated, cost-based) pricing are well-established at the wholesale level and among bulk power suppliers, who now include independent power producers ("IPPs") and brokers, as well as utilities and utility-owned generating companies. Footnote2

Although U.S. deregulation experience is recent and not without problems, the overall picture seems clear. Deregulation and competition tend to produce more goods and services, more innovation, and lower prices. Some might argue that the environmental impacts of the electric power industry make deregulation risky. Yet airlines, trucking, and petroleum pipelines have major environmental impacts that governments still control, despite deregulation of these industries. Deregulation is confined to the economic sphere. Even in a deregulated electric power industry, government agencies responsible for environmental protection and safety would still control the siting, construction, and operating impacts of most power generation and transmission facilities.

In a deregulated bulk power market, state government will also retain at least two important economic regulatory roles. First, deregulation of local distribution is not contemplated, at least for small consumers. Even in the United Kingdom, where industrial and commercial customers -- including relatively small ones -- are now free to choose among competing power suppliers, residential customers are not, primarily because necessary metering and administrative costs tend to eat up the cost savings that residential-level competition might achieve. Government will therefore retain regulatory responsibility for ensuring that the cost-reduction benefits of competition, available to distribution utilities as purchasers in the bulk power market, are actually attained by those utilities and passed through to consumers. Second, as described elsewhere in this paper, competition in the provision of energy efficiency services and conservation for retail consumers will require cooperation from distribution utilities, which in turn will require targeted new regulation.

2. FALLING POWER PRICES AND TECHNOLOGICAL CHANGE

Competition is driving down prices in the bulk power market. Generation, and reserve generation capacity, are being used more creatively. New market players -- such as brokers and aggregators -- are adding downward pressure on wholesale prices by using information and taking risks that traditional generators or power purchasers cannot. But technology has an impact, too.

[Graphic unavailable at this time]

This chart shows that the price of power from new generation has plummeted in recent years, not only in relation to BPA power costs, but absolutely. In the 1980s, nuclear or coal plants were the most common forms of new generation; their costs were much higher than BPA's average power cost. (This is one reason conservation seemed so cost-efficient and necessary.) Today, new generation consists of relatively small combined cycle gas turbines. Operated efficiently, these turbines can produce power at costs as low as, or lower than, BPA's average rates.

Gas prices have been low for years and appear likely to remain low (perhaps low gas prices are the rule and high gas prices are the exception). But the low cost of gas turbine power is not just the result of low gas prices. Technological improvement is a significant factor in two important ways. First, the capital cost of new turbines (in dollars per kilowatt of capacity) has also fallen dramatically. Second, in a victory for conservation and market forces, the fuel conversion efficiency (in BTUs per kilowatthour) of today's turbines has significantly improved.

Reformers worked hard to wean the power industry from huge nuclear and coal plants, and from new large dams. Market forces have worked in the same direction. Small, inexpensive generators have arrived. The implications of this change go far beyond the current boom in cogeneration, and the possible loss (to BPA and utilities) of large industrial loads and the revenues they provide. Almost every feature of power generation, transmission, and distribution systems is affected by this change, and by others propelling the industry in a more competitive direction.

3. PRIVATIZATION, DE-FEDERALIZATION, AND BPA'S FUTURE

Competition, deregulation, and falling power prices do not make it inevitable that the Federal Columbia River Power System will be privatized -- or, more accurately, de-federalized. But de-federalization is a topic the region cannot and should not avoid.

The worldwide movement to privatize government-owned industries, facilities, and functions is one of the most remarkable developments of the late 20th Century. The privatization trend is by no means confined to former communist and socialist nations. Nor is it likely to prove, in the U.S., a mere passing whim of today's Congress. Although privatization of any given enterprise (such as BPA) is not inevitable, privatization does represent a reasonable response to a basic problem: government-run enterprises generally do not (or are not allowed to) perform well in competitive environments.

At a time when government is privatizing prisons, it is very likely to privatize the sale of products -- which is what electricity is increasingly recognized to be. Congress has de-federalized one small power marketing agency (the Alaska Power Administration), and many believe de-federalization of all others, with the possible exception of BPA, is reasonably imminent.

Opinion on BPA's future is divided. One camp recognizes BPA's efforts to streamline, cut costs, and price its products competitively. BPA can compete, this camp contends. The additional steps BPA needs are well-recognized and not complex: (1) separation of BPA's transmission and generation functions into separate enterprises; (2) open-access BPA transmission services at rates reflecting transmission costs alone; (3) elimination of subsidies from BPA's power rates; and (4) flexibility to let BPA establish competitive rates to retain its customers, and to allow its utility customers to retain their own retail customers. Some would add a fifth change: BPA should be allowed to compete for other customers, such as large industrial loads, now served at higher rates by Northwest utilities.

A second opinion is more skeptical. It acknowledges that BPA is capable of competing, but predicts that we -- "we" being the region, or our elected officials, or BPA's likely competitors -- won't let BPA compete, and therefore BPA will never become competitive. Indeed, one may reasonably ask whether BPA will ever be allowed to adapt to a competitive world by becoming a competitor itself. Experience indicates that BPA's efforts to become competitive threaten BPA's potential competitors, or those that BPA subsidizes. The affected interests turn to Congress or the Administration and arrange to have a sharp tug applied to BPA's governmental leash.

But if BPA is not allowed to compete, then BPA can have little hope of recovering its costs -- particularly when so many of those costs are governmentally imposed and not, strictly speaking, necessary to power production (or to only the power production component of multi-purpose hydro projects). Footnote3 If "federal" means "non-competitive," then a federal BPA may prove untenable in today's world.

De-federalizing BPA is more complicated than cutting BPA's costs and letting BPA compete. But de-federalization is feasible. Moreover, de-federalization may provide an opportunity to acquire for the region's benefit not only the power BPA sells, but also responsibility for managing the Columbia River system and its many purposes. No activity is more regional in its impacts -- or in greater need of simplification and reform.

De-federalization does not mean turning all federal functions over to private enterprise. It includes transferring policy-making, even physical assets, from the federal government to the states. This is what the federal government has done, albeit on a small scale, by transferring the Alaska Railroad and the largest hydro project of the Alaska Power Administration to the State of Alaska. Other examples include the Metropolitan Airport Authority, to which the federal government transferred Dulles and National Airports.

This paper focuses on a de-federalization model that adapts the Alaska model to transfer control of the Columbia River system, and perhaps that system's assets, from the federal government to a "Regional Governing Body" ("RGB") to be formed by the Northwest states. Creating the RGB would not privatize all federal functions. It would, however, both regionalize and de-federalize many of the most important Columbia River system management responsibilities. The paper also discusses the possibility of transferring BPA's power marketing responsibilities at fair market value to a new, non-governmental corporation ("NEWCO") to be formed by BPA's customers and other purchasers of bulk power in the region.

C. DEFINING THE PROBLEMS TO BE SOLVED

1. THE REGIONAL PROBLEM

The regional problem is simply stated: how can we bring the cost-reduction and efficiency benefits of competition to Northwest electricity consumers and at the same time deal responsibly with related regional values and concerns?

This statement of the problem contains a vital starting point: recognition that the Northwest economy will benefit from the lower power prices competition can bring. A healthy regional economy is essential to achieving other regional goals. Our agriculture and industry, which use half the region's power, compete in national and global product markets. Other regions and nations are welcoming the cost-cutting effects of competitive power markets. If power prices fall elsewhere in the world, and not in the Northwest, total production costs will fall elsewhere compared to the Northwest, and the Northwest economy will suffer. This is one reason we should affirmatively desire a competitive Northwest power market.

It is equally important to recognize what the problem is not. The problem is not to prevent competition, or to find ways to extract above-market prices from Northwest power users in order to preserve subsidies, outmoded programs, and policies that avoid hard choices (such as the need, discussed below, to choose between "more fish" and "wild fish" for the Columbia River system). Trying to lock the Northwest power system into above-market prices would be a recipe for regional economic self-destruction. We have to find more creative means of addressing other regional values and concerns.

2. THE BPA PROBLEM

Although BPA has a strong and proud tradition, it now faces a competitive environment for which it was not designed. One fundamental BPA problem, alluded to above, can be stated as a logical syllogism:

  1. Bulk power markets have become competitive, and market prices for power have fallen;
  2. BPA's current costs are too high, because they put BPA's prices at or above the market;
  3. As a result, BPA can no longer be assured of recovering its costs consistently, year in and year out, from its existing customers; but

(4) Statutes and politics limit BPA's ability to respond by (a) cutting its costs, (b) reducing rates to hold on to existing customers, or(c) competing for other Northwest customers (i.e., those served by Northwest utilities); therefore(5) The available policy options are only four:(a) Accept that BPA will not always recover its costs, i.e., that it will periodically (and perhaps frequently) miss Treasury payments; (b) Change applicable laws (and political attitudes) to allow BPA to cut costs and reduce rates (and perhaps compete for new customers as well); (c) Impose above-market charges (through transmission or delivery taxes) in an attempt to preserve the status quo; or,(d) Privatize BPA so that its successor, as a non-governmental entity, will begin with lower costs and reduced rates (and/or compete for new customers).The first policy option -- letting BPA miss Treasury payments -- is actually inevitable in the absence of fundamental change, but would itself force fundamental change, for it has no long-term viability. The federal government will not accept it, and may well demand higher BPA rates first, before recognizing that the only real options are making BPA competitive or privatizing it. In the meantime, the cost-saving regional benefits of deregulation and competition will be delayed.The second option -- letting BPA cut costs and reduce rates to hold on to existing customers (and perhaps to let BPA compete for new customers as well) -- seems logical, necessary, and could work financially. But, as noted above, politics and policy may prevent this solution from succeeding, at least so long as BPA remains a federal agency. Nonetheless, elimination of unnecessary costs must be part of any successful solution and should remain the highest priority for BPA.The third policy option -- trying to preserve the status quo by creating regional transmission or distribution fees or taxes in some universal form that no end user can avoid -- is simply a bad idea, and one that could not long be sustained. First, the effect would be to produce unnecessarily high total prices for electric power. This would burden consumers, distort the competitive market, and disadvantage the Northwest economically. Second, such fees or taxes would be the enemy of accountability and the salvation of inefficiency and unnecessary costs, which the discipline of competition would otherwise help reduce. If today's costs can all be recovered through new taxes and fees (particularly "hidden" ones), why cut them? Why make hard business or public policy choices? Fortunately, as this paper hopes to demonstrate, there are other ways to recover Northwest power costs, preserve needed program funds, and protect important regional values.This leaves the fourth option -- privatizing BPA. How could this be done? Into what restructured Northwest power system could a privatized BPA logically fit? How would such a restructured system deal not only with competition, but with other important regional values and concerns that BPA has traditionally addressed? The remainder of this paper is devoted to sketching some tentative answers to these questions.

D. A RESTRUCTURED NORTHWEST POWER SYSTE M

The Northwest and the federal government might best be served by establishing, including through federal legislation and a federal-state compact, a new Northwest power system with the following features:

These features are discussed individually but briefly immediately below; some are discussed more fully in the next section of this paper.

1. A COMPETITIVE BULK POWER MARKET

All utilities, BPA customers, independent power producers, and brokers would continue to be recognized participants in the bulk power market. Large industrial customers (and perhaps others) served today by local distribution utilities could also participate in this market, with the consent of the relevant utility and/or if state policy so allows. Each Northwest state would continue to determine to what extent today's retail utility customers -- primarily large industrial and very large commercial customers -- could participate in the bulk market without the required consent of the local retail utility. In other words, issues of "retail wheeling" or "retail level competition" would be decided at the state level, not by federal statute.

As noted elsewhere in this paper, the states (through utility commissions and otherwise) will have the ability and responsibility to (a) ensure that even the smallest retail consumers receive the cost-saving benefits of the competitive bulk power market in which their utility suppliers will be able to purchase lower-priced power for resale, and (b) assure that distribution utilities assist and cooperate with competitive providers of conservation and energy efficiency services for end users.

There are two basic alternatives for BPA's participation in this competitive market. Both alternatives require that BPA's non-power costs be reduced. Footnote4 First, BPA could be given the pricing flexibility it needs to hold on to its customers by offering them power at competitive prices. BPA could also be authorized to reach out to new customers.

Alternatively, BPA's existing power marketing role could be divested by the federal government, and sold at fair market value to a new non-profit non-governmental entity ("NEWCO") that would be owned by its customers, i.e., by BPA's former customers and other regional purchasers of bulk power. NEWCO would sell power at rates determined by the competitive market, and would finance a lump-sum purchase of BPA's power marketing capability by issuing debt secured by NEWCO's power sales revenues.

Specified portions of NEWCO's revenues -- and profits, if any -- would be used for a variety of regional purposes, much as BPA's revenues are today. This would not affect the rates of NEWCO's customers, which would be determined by the competitive bulk power market. Instead, the decision to devote portions of NEWCO's revenues to particular purposes would simply affect the dollar amount the federal government receives when it sells to NEWCO the power marketing capabilities of BPA.

2. OPEN ACCESS TRANSMISSION AT COST-BASED RATES

To facilitate the competitive bulk power market, transmission would continue to be treated as a natural monopoly and would be regulated to provide open access at cost-based transmission rates for all buyers and sellers of bulk power in the region. A single, independent grid operator ("IGO") for the region's transmission seems most desirable today. The IGO would operate but would not necessarily own today's transmission facilities; it might also have responsibility for building needed transmission system additions. The IGO could be federal (e.g., the transmission portion of BPA, split off into a separate entity) or non-federal. (Under the auspices of the Pacific Northwest Utilities Conference Committee (PNUCC), a study is underway to examine alternates for the Northwest transmission system.)

For this paper, the specific form of new institutional arrangement ultimately adopted is less important than the basic idea that open access, cost-of-service principles should be established to govern use of the region's transmission system. An open-access, cost-of-service regional transmission system would exist for one paramount purpose: to allow a competitive bulk power market to work. For this reason, the transmission system must be protected by "firewalls" in the form of legislative prohibitions against taxes or fees that burden transmission with non-transmission costs. The creation of "firewalls" is not a separate policy decision: it is a necessary feature of transmission reorganization today.

3. REGIONAL CONTROL OF THE COLUMBIA RIVER

The Northwest, which feels the impact of Columbia River operations, needs a regional body to make and be accountable for the key operating decisions, particularly fish and wildlife policies and programs. This basic need is widely recognized. The Northwest Power Planning Council is currently undertaking, at the request of Congress, a "180-Day Review" of "Alternative Governance Structures For Fish & Wildlife Decisionmaking" for the Columbia River.

The Regional Governing Body proposed in this paper would be composed of representatives of the four Northwest states (and perhaps a federal representative) and would be responsible for the non-power operation of the Columbia River system, i.e., for decisions regarding fish and wildlife, irrigation, navigation, recreation, flood control, and the system's other non-power uses. How much and what type of power the system would be capable of producing -- in other words, what power BPA or NEWCO (as BPA's power marketing successor) would have available to sell -- would be determined by the RGB's choices about what is needed for non-power purposes.

No other region of the United States is likely to need a mechanism such as the proposed Regional Governing Body, because in no other region do the forces of competition and deregulation need to accommodate the important public values and complex multiple uses of such a dominant river and hydroelectric system. This is the Northwest's distinguishing electric power policy feature, and it requires a Northwest solution.

4. A "PIECE OF THE ROCK" THAT BENEFITS THE REGION

If the federal government sells BPA's power marketing capability to NEWCO, NEWCO would continue paying specified BPA costs (including significant salmon recovery costs, WPPSS costs, etc.). But NEWCO would presumably be spared at least some of the costs of social programs and subsidies that BPA must bear and cannot control. Thus, in many years NEWCO may be able to earn revenues in excess of its costs by selling power at competitive prices. The opportunity for NEWCO to earn "excess" revenues would also arise because conventional financing of the purchase price paid to the federal government for BPA's power marketing capability would necessarily be based on conservative assumptions of NEWCO's net revenues.

Some of this extra revenue could be returned to NEWCO's customers, since NEWCO (as proposed here) would be a cooperative or some other form of private entity owned by its customers. But some of NEWCO's "profits" would also be available for other regional purposes, including (if desired) direct payments to the Northwest states. Thus, not only would the region control the Columbia River system, the region would also benefit financially if and to the extent the system can be operated profitably.

E. SPECIFIC RESTRUCTURING ELEMENTS AND ISSUES

1. THE REGIONAL GOVERNING BODY ("RGB")

The RGB would consist of representatives of the four Northwest states, and perhaps (as discussed in Appendix A to this paper) a federal representative. The RGB would be formed through a federal-state compact, would supersede the Northwest Power Planning Council, and would exercise supreme authority over matters within its control, subject only to limits and constraints (discussed below) imposed by Congress at the time the RGB is created. The range of potential RGB responsibilities is great, as illustrated by three alternative RGB models:


· "Mini-RGB" would be responsible for Columbia and Snake River salmon issues only.

· "Midi-RGB" would be responsible for operating the Columbia River system for its many non-power uses (fish and wildlife, navigation, recreation, flood control, irrigation, etc.). But Midi-RGB would not own the system's physical facilities and would not replace the U.S. Army Corps of Engineers or the Bureau of Reclamation as the actual operators of those facilities. Power produced by the system, when operated as the RGB directs, would be marketed by NEWCO (or BPA).

· "Maxi-RGB" would have the same responsibilities as Midi-RGB, but Maxi-RGB would also acquire over time the system's facilities (except perhaps the power facilities, which NEWCO might acquire instead) and assume the responsibilities and personnel of the Corps and the Bureau.

Mini-RGB would represent an improvement over today's fragmented management of Columbia River salmon issues, but it would not go far enough to assure regional consensus over river operations or to harmonize the river's multiple (and often conflicting) uses. Midi-RGB could harmonize those uses, but would be forced to rely on the Corps and Bureau to implement its decisions; thus, its exercise of authority could prove difficult or impractical. The federal government might also be disinclined to divest itself of control over facilities for which it remains financially responsible.

Maxi-RGB, which on first impression may seem too sweeping, nonetheless deserves serious consideration -- and not only because of Mini- and Midi-RGB's limitations. The Maxi-RGB model of complete divestiture, including of physical facilities, is more the rule than the exception for privatization worldwide (and in the U.S.). The federal government chose to divest itself completely of the facilities of the Alaska Power Administration, for example, as well as the Alaska Railroad, Dulles Airport, National Airport, etc. (Elsewhere, however, such as at Hoover Dam, the federal government has thus far chosen to delegate operations alone to non-federal entities.)

Complete divestiture of the Columbia River system would nonetheless be unique in U.S. experience, for three reasons. First, the sheer extent of the facilities involved would be unmatched by past privatization. Second, the Columbia River is operated for many purposes. Balancing these competing purposes is policy-making; even though private entities can perform certain roles (e.g., power marketing), the overall operation of the river requires government decisionmaking.

Third, unlike virtually anything else privatized in the U.S., the total federal Columbia River system is -- and must be assumed to remain -- a money-losing proposition. The power sales portion of the system probably is capable of paying its way -- at least that is this paper's hopeful assumption. But the same is not true, and probably will never be true, of irrigation, navigation, flood control, recreation, and other river uses -- including salmon production. The economic benefits of these activities may outweigh the costs, but those who receive the benefits bear only some of the costs. Thus, these non-power activities produce far lower annual revenues than costs for the Columbia River system.

The lion's share of the system's annual costs are BPA's costs (including a large subsidy for irrigation, hundreds of millions of dollars for salmon, for conservation, etc., in addition to more conventional power costs, such as repaying federal and WPPSS debt). Depending on the level of BPA's costs, the quantity of power available to BPA to sell, and how much money BPA can get for that power, BPA's revenues may or may not exceed BPA's costs in any given year. But a large residual slice of the federal government's Columbia River system nonpower costs -- currently about $260 million per year Footnote5 -- is not recovered or recoverable from BPA, user fees, or any other current funding source. It is simply borne by the U.S. taxpayer.

The implications of this are significant. If the federal government chose to transfer the entire Columbia River system to the Northwest states, the transaction would be uneconomic for the states unless the federal government agreed to continue making large annual payments to the states from federal tax revenues. This might be difficult for Congress to accept initially. On reflection, however, it is not surprising that the Northwest, like every other region of the nation, cannot support such activities as irrigation, navigation, recreation, flood control, and protection of endangered species at current levels without federal tax dollars.

The bottom line may be this: although Maxi-RGB might make the most sense ultimately, the initial phase of regionalization might best take the form of Midi-RGB (combined with NEWCO, if created). Midi-RGB would be responsible for balancing the river's non-power purposes. NEWCO (or BPA) would market the river's resulting power output. The federal government would continue, for the time being, to own and operate the facilities (apart from any power facilities NEWCO might acquire), and to bear the costs of those facilities.

Eventually, however, the federal government might wish to transfer the facilities to the region, presumably in a transaction in which the federal government agreed to provide a certain level of annual funding. (The funding level might be based on what the federal government provides from tax revenues for the same activities in other parts of the U.S.). In this manner, Midi-RGB could evolve into Maxi-RGB. The federal-state compact under which the RGB is formed -- and the Northwest Power Planning Council's current "180-Day Review" of alternative governance structures -- should at least anticipate this possibility.

2. NEWCO: BPA'S NON-GOVERNMENTAL POWER MARKETING SUCCESSOR

One point bears re-emphasis: it may not be necessary for the federal government to divest itself of BPA's power marketing function. BPA's power marketing function could instead be split from its transmission function, and made (or allowed to become) more competitive. BPA costs could be cut, and BPA allowed to reduce rates to hold on to its existing customers by selling power at competitive prices. This paper does not assume such changes to be impossible; it simply focuses on the BPA divestiture alternative, which also merits consideration.

The divestiture alternative appears practical. The federal government would sell to a nongovernmental buyer, in a fair market value transaction, BPA's rights to market power. The buyer could be a new corporation -- "NEWCO" -- formed under state law, either as a tax exempt customer-owned cooperative (or other customer-owned entity), or as a private corporation where customers have an equity position. The actual power generation facilities of the federal Columbia River system would, as discussed above, either be retained by the federal government or transferred to the RGB or to NEWCO -- the choice does not affect the analysis here.

NEWCO would operate in accordance with rules established in the federal authorizing legislation. Additional rules and requirements would be set forth in NEWCO's articles of incorporation, by-laws, financing agreements, and other contracts, as well as in the laws of the state in which NEWCO is incorporated.

A description of suggested provisions of the federal statute that might govern the BPA-NEWCO transaction and NEWCO's power sales activities is set forth in Appendix B to this paper. The topics treated in Appendix B include the following:

A further explanation of how NEWCO might provide revenues for regional purposes and earn "profits" for the benefit of its customers and the region is set forth in Appendix C.

The details in Appendix B and Appendix C are important. Those who read them carefully may ask whether the federal government can realistically be expected to sell off BPA to BPA's customers, even at fair market value, rather than to the highest bidder or in some other manner designed to maximize the divestiture sales price. The question is a legitimate one. But the realism of this proposal should not be taken lightly. First, the facilities of the Columbia River system were built in the national interest, but that interest was felt to be the economic development of the Pacific Northwest. Second, the Northwest is where the facilities, and their impacts, are located. Third, Northwest customers have been paying for these facilities for decades, and have provided such equity capital as the system may now be said to possess.

Under these circumstances, it is not illogical that Congress would agree to sell this system to a regional group under terms and conditions designed to assure that regional interests continue to benefit. This is in fact what the federal government (and foreign governments) have done more frequently than not in analogous privatization.

Moreover, the alternatives would not necessarily be attractive to the federal government. As matters stand, the cost of the status quo to the federal government is a foreseeable future of missed Treasury payments. The opposite extreme -- selling the Northwest power system to parties other than Northwest regional customers -- might well be less attractive, as a policy matter, than selling to the combined regional customers at fair market value.

3. TRANSMISSION

For several reasons, including a nationwide open access transmission law enacted by Congress in 1992 and a nationwide "unbundling" ultimatum to the power industry from the FERC in 1995, the Northwest is already re-thinking and re-organizing its transmission system (particularly under the auspices of the Pacific Northwest Utilities Conference Committee). Reorganization is sufficiently advanced that Northwest transmission issues may be resolved before legislation embodying any comprehensive regional restructuring could be enacted. The legislation may therefore ratify the new transmission arrangements, rather than create them.

As noted above, it may be required that the regional transmission system have a single independent grid operator ("IGO"), i.e., an operator independent of the region's sellers and purchasers of bulk power. What matters most for restructuring purposes, however, is that the ultimate regional transmission arrangements have the following features:

(a) Open access to all participants in the bulk power market, including utilities, BPA's customers, and others;

(b) Reasonable cost-based (and probably FERC regulated) rates, including "firewalls;" and

(c) Ample but not excessive capacity and reliability.

These features should be required as standards in new Northwest power legislation. They will ensure the transmission system does what it should in a competitive bulk power market: serve well and neutrally those who engage in bulk power sales transactions. Like any other competitive commodity market, the bulk power market will be distorted and not optimal -- and consumers will pay too much -- to the extent that prices for power are burdened with costs that raise total prices above competitive levels. This is true regardless of whether those costs are added as a form of fee or tax to transmission rates, to distribution, or to the rates for electric power itself. It is also true regardless of whether the costs to be collected through such fees or taxes are labeled social costs, subsidies, externalities, or "stranded investment." Hence the need for "firewalls." Footnote6

4. WPPSS COSTS & IMPACTS ON THE WPPSS DEBT

Debt service and operating expenses of three nuclear power plants (WNP 1, 2, and 3) make up a significant portion of BPA's costs. This will continue until that debt is retired, in about twenty years. Until then, BPA's revenues will secure repayment of the outstanding debt of these completed and uncompleted WPPSS plants (not to be confused with WPPSS 4 & 5, for which BPA has no financial responsibility). This is prominent among the financial matters that must be addressed if the federal government divests itself of BPA's power marketing functions.

If no BPA divestiture occurs, these WPPSS costs will be paid in the normal course of business under current arrangements. In any divestiture of BPA or its functions, however, it would be important to ensure that (a) security for the relevant WPPSS bonds is not impaired, and (b) the tax-exempt status of these bonds is not adversely affected. This appears to be feasible, both as a legal and as a practical matter.

Several alternatives may be available to accomplish these objectives using either federal or NEWCO revenues or new debt:

(a) Defeasance of the WPPSS bonds;

(b) Substitution of equivalent security for the bondholders;

(c) Retaining the BPA Fund until the WPPSS debt is paid; or

(d) Creating a federal "safety net" for the WPPSS bondholders.

These alternatives and their pros and cons are summarized in Appendix E to this paper.

Two points matter most here. First, reasonable alternatives appear to exist, and the WPPSS debt therefore does not seem to present an insurmountable obstacle to privatizing BPA's power marketing function. Second, the security for the WPPSS bonds includes revenues from BPA's hydro system, and the fact that payments to WPPSS from BPA's revenues take priority over payments to the Treasury. This has two implications: (1) the WPPSS debt cannot be separated from the hydro system -- for example, to be collected as a separate transmission charge -- without arguably impairing the security of WPPSS bondholders in a potentially impermissible manner, and (2) conversely, the WPPSS debt is not likely to become "stranded" because, when averaged as it must be with the costs of hydro production, it is still part of a relatively low-cost power production cost pool.

5. THE U.S. ROLE IN PERFORMING TREATY OBLIGATIONS

The United States is a party to several treaties with Northwest Tribes and with Canada that affect operation of the Columbia River system. No other entity can take over U.S. treaty obligations. But this does not mean the treaties would prevent creation of the RGB or NEWCO.

The Columbia River Treaty of 1964 is a 60-year contract between the U.S. and Canada governing "downstream [power] benefits" from dams and reservoirs on the Columbia River within British Columbia. The Treaty requires each nation to designate an "entity" to carry out its Treaty obligations. The U.S. has designated BPA and the Corps as the U.S. Entity. The Treaty also creates panels to help implement it, including a "Permanent Engineering Board" (again, BPA and the Corps of Engineers are the U.S. representatives).

Although the RGB would be a federal-state compact entity, not a federal agency, nothing in the Treaty (or in Constitutional law) appears to prevent the U.S. from designating the RGB, or the RGB and NEWCO, or the RGB and the Corps, to serve as the U.S. Entity. If the RGB were designated, it could draw on NEWCO and others for assistance. The United States would remain a party and the ultimate guarantor of U.S. obligations under the Treaty. (This is one reason a federal representative on the RGB might be useful.)

The U.S. salmon treaty with Canada also allows non-federal officials to represent the U.S. The federal government can step in directly, too. It would be preferable, as in all areas related to Columbia/Snake River salmon, for the U.S. and the region to speak with one voice and in pursuit of a single set of objectives. At best, the RGB may fill this role (see below). At worst, this treaty seems to present no obstacle to creating the RGB or NEWCO.

Treaties with the Columbia River Tribes are relevant primarily because of Treaty fishing rights. The precise extent and implications of these rights are often in dispute, and not entirely settled. For present purposes, it is probably sufficient that the RGB, like any other entity -- federal or non-federal -- responsible for salmon policy on the Columbia River system, would be compelled by the Constitution to take action consistent with Treaty rights. The Tribes would presumably still present their views of those rights to non-Tribal authorities, whose decisions the Tribes may challenge. As today, the federal government would have ultimate responsibility for ensuring that Treaty rights are honored. (This is another reason a federal RGB representative might help.)

6. SALMON POLICY FOR THE COLUMBIA AND SNAKE RIVERS

Federal and regional attention has recently focused on specific operations (e.g., spill) and proposed operations (e.g., reservoir drawdowns) of the Columbia River system for salmon, and on comprehensive recovery plans for particular Snake River salmon listed under the Endangered Species Act ("ESA"). Significant attention has also focused on the cost to BPA and its ratepayers -- hundreds of millions of dollars annually -- of these and other salmon activities. The apparent conflict between fish and power has enormous visibility.

Less appreciated is the inherent conflict between the objectives of the ESA -- basically, to save "wild fish" -- and the objectives of the Northwest Power Act and related sources of law -- basically, to create "more fish," primarily for commercial harvest. It may not be possible to meet both the "wild fish" and the "more fish" objectives simultaneously for any of the "Four H's" that affect Columbia and Snake River salmon: harvest, habitat, hatcheries, and hydropower. The time has come to choose between "wild fish" and "more fish," not only for the Columbia River system as a whole, but for individual salmon stocks in individual sections of these rivers and their tributaries.

Comprehensive federal legislation for a restructured Northwest power system must deal with both areas of conflict: between fish and power (whether apparent or real), and between "wild fish" and "more fish" (which is certainly real). How these conflicts are resolved will also affect many other matters, such as how much power NEWCO has to sell, how much the federal government is therefore likely to receive for BPA's power marketing function, etc.

One point bears emphasis: Congress must face these issues with or without a comprehensive restructuring of the Northwest power system. But if Congress has not taken these steps before enacting restructuring legislation, it would need to do so as part of that legislation.

(a) Who's in charge of salmon policy for the Columbia/Snake River system? At present, authority and responsibility for salmon policy on the Columbia and Snake Rivers are not just fragmented -- they are atomized. Many federal, regional, state, and Tribal agencies are involved, trying to enforce a bewildering (and often competing) array of federal and state statutes, judicial decisions, Treaties, contracts, and values. Congress should limit the number of entities -- or put a single entity -- in charge.

(b) Making the policy choice between "wild fish" and "more fish". Congress must make this choice, because existing law is conflicting. (Alternatively, Congress must empower some other entity to make the choice.) The choice may be different for different stocks, different habitats, and may be affected by Treaties. But it must be made. The "more fish" choice might suit the Tribes, commercial fishing interests, Canada, Alaska, hatchery interests, and sport fishing interests, but it is unlikely to satisfy advocates of genetic diversity and natural spawning. It is reasonable to argue that "wild fish" is a more important objective than "more fish," or vice versa. It is not reasonable to argue that the two objectives are compatible, at least on the Columbia/Snake River system.

(c) Protecting and enforcing the choice once made. Neither a "wild fish" nor a "more fish" policy, once selected, can be effective if legal rights exist in third parties to compel the opposite policy to be adopted. Congress will have to require that, once a policy is properly selected (or modified), that policy will be pursued -- period -- regardless of conflicting policies in other federal laws. If we try to have it both ways, the fish and the regional economy will continue to suffer.

(d) Deciding how much will be spent, by whom. The RGB could determine the total amount of money to be spent on Columbia/Snake River salmon, including the ultimate de-rating of the hydro system. However, it is possible to limit, or provide a means to limit, the dollar amount that NEWCO must provide to the RGB as BPA's successor, and also to set a floor on the amount of power NEWCO will have available to sell (either from the former federal hydro system or as supplemented by power purchases paid for by someone else, perhaps the U.S.) Such limits would help the federal government obtain a higher sales price in divesting BPA, but such limits are not necessarily essential to the sale. In their absence, NEWCO might still be formed and financed; it simply could not afford to pay as much in the BPA-NEWCO transaction.

(e) Ensuring accountability. Those who make decisions either pay the bill or otherwise be accountable for the consequences. This is not true today of decisionmaking on Columbia and Snake River salmon issues. No complete solution to this problem is readily apparent, but the RGB and NEWCO proposed here would be helpful if -- as this paper also proposes -- some share of NEWCO's net revenues were returned directly to the Northwest States. This would provide the RGB and the States at least some incentive to consider overall economic impacts in policymaking on these issues.

As noted above, Congress cannot avoid these decisions. If the decisions are not made sooner, they can and should be made in legislation restructuring the Northwest power system.

7. CONSERVATION

Since 1981, under the Northwest Power Act, BPA has spent a cumulative total of nearly $1.4 billion dollars on conservation. As the chart shows, BPA has invested steadily in conservation, and these programs remain a significant portion of BPA's annual revenue requirement. What should happen to conservation funding in a competitive Northwest power system? The complete answer to that question would require a lengthy paper in itself. Footnote7 [Graphic stripped]

Here, the following points seem most important.

  1. BPA's existing debt attributable to conservation, like the WPPSS debt, can and will be paid. As noted above, if BPA's operating costs are reduced to prudent levels, BPA's unavoidable fixed costs are not too great to be recovered from competitive rates charged to BPA's customers (or NEWCO's, if NEWCO succeeds BPA).
  2. Some portion of BPA's annual revenues (or NEWCO's) can be dedicated to the RGB, or the states, and can continue to be used to invest in conservation, at least during a transition period. This would be a policy choice for the RGB, or the states, to make. But new conservation expenditures probably should decline rapidly, even during a transition period. First, falling power prices significantly undermine the basic economic rationale for spending more money, and raising rates, for the purpose of using less. Second, promotion of conservation through the Northwest Power Act has already achieved notable success, including in getting the fledgling conservation industry going and helping it become self-sufficient; the industry can now survive in the market. Third, greater conservation savings may be achieved by techniques -- some old, some strikingly new -- that do not require much RGB or state funding.
  3. First among these techniques, of course, is the setting of efficiency standards. Efficiency standards apply to new things: new appliances, new homes, new commercial buildings, new generators, new motors, new factories, new electrical transmission and distribution equipment. Such standards are established by governments and standard-setting agencies on a national, regional, state, and local level. They not only work, but cause the costs of efficiency improvements to be borne by those who receive them.
  4. For retrofit -- primarily improving the energy efficiency of existing buildings -- little or no conservation investment is still "cost effective" in Northwest Power Act terms, given today's low power production costs. But there remain reasons to promote such conservation: future power costs could rise, and conservation has virtues in addition to strictly economic ones. For example, the consumer obtains more than kilowatt hour savings from conservation: energy efficiency improvements also produce greater comfort, better indoor air quality, and higher property values. There is a way to promote such conservation in a competitive power market with low power prices: "unbundle" conservation services from the sale of electricity, and require retail distribution utilities to cooperate in this effort (as described immediately below).
  5. The need to unbundle conservation from the supply of electricity to retail consumers arises from two facts: distribution utilities have a monopoly on the actual delivery of electric power, and they currently have no adequate economic incentive to promote conservation that reduces electricity sales (such conservation simply raises rates in today's world). Consumers, on the other hand, derive value from such conservation in addition to any savings on their electricity bills. Private enterprise will cater to consumer demand for anything consumers find of value. The problem is how to get the efficiency services company ("ESCO") in touch with the end user.
  6. The most promising method of letting ESCOs sell their conservation services to end users may be "competition through the meter," i.e., making each end user's electric utility meter the billing device for a competitive market in conservation services. State-certified (or RGB-blessed) conservation providers (the ESCOs) would sell energy efficiency improvements and retrofits to end users, but the end user would be billed for those services in his/her monthly electric utility bill. It should be possible to accomplish cost-effective conservation without any net increase in that monthly bill, and, because the efficiency improvement will be paid for through the bill, it should also be possible to arrange financing for the conservation improvement that is secured by the end user's monthly payment.
  7. Retail distribution utilities would have to cooperate in this effort, of course. They should also be paid for their administrative services (billing, collection, and payment) to the ESCOs.
  8. Research and development for conservation technologies is still required. Like most R&D in the electric power industry, however, this can and should be primarily a national effort, nationally funded. To the extent the RGB believes that Northwest-specific R&D is appropriate, the RGB could choose to fund such activities from such funds as the RGB may receive from NEWCO.

8. RENEWABLE RESOURCES

Unlike conservation, renewable resources (other than the hydro system itself) do not represent a large BPA cost today. Sentiment for promoting renewable resources within the region is strong, however. People will want to know how restructuring will affect renewables.

As a preliminary matter, it is worth noting that the ongoing process of down-rating of the region's premier renewable resource, namely the Columbia River hydro system, for fish purposes vastly exceeds, in megawatts lost, even the most optimistic estimate of future renewable resource additions in the Northwest. This should remind us that (a) our preference for renewable resources is hardly absolute, and (b) renewable resources tend to have environmental impacts, too -- even if those impacts are measured in lost fish, lost land, or lost scenery rather than in "greenhouse" gases. Our regional enthusiasm for renewable resources is somewhat tempered, and justifiably so.

In some respects, there is no reason to treat renewable resources much differently from other generation technologies in a competitive market system. There are several exceptions:

  1. Some renewable resources can be installed only in particular locations. Transmission access may therefore be essential to their development. Although an open-access regional transmission system should meet the needs of such resources, it may aid financing of such resources to provide by statute that they will enjoy a priority right to any necessary and otherwise uncommitted transmission capacity existing at the time of their construction.
  2. Renewable resources, like conservation, may still require R&D funds. Like conservation, these can and should be provided on an increasingly national (and decreasingly regional) basis. But the RGB would have discretion to use some its available funds from NEWCO for this purpose.
  3. Because renewable resources are politically popular, they will continue to enjoy an effective priority in the resource acquisition programs of many Northwest utilities. Snohomish County PUD, Salem Electric and the Eugene Water & Electric Board are only three of the many regional utilities who have accorded renewable resources such a priority in recent decisions. This is a natural, democratic phenomenon. New regional power legislation does not so much need to encourage it as to avoid inadvertently discouraging it.

F. CONCLUSION


The Northwest power system will be restructured one way or the other. A comprehensive, regionally agreed-upon restructuring appears possible and potentially beneficial to the region. The challenge is to ensure that the benefits of deregulation and competition extend to all electricity consumers. The bewildering array of needed changes, some often cited as impediments, apparently can be made if necessary and desirable. Even the complete de-federalization of the Northwest power system, and the privatization of BPA, seem feasible -- and possibly quite beneficial. The alternative of allowing BPA to cut costs and reduce rates sufficiently to hold on to existing customers would be simpler conceptually, but perhaps difficult politically. But so long as these choices are examined and made in the relatively near future, control of the Northwest's electric power future can be secured for the region.

APPENDIX A: Should the RGB Include a Federal Representative?

As discussed in this paper, there are many reasons to consider potential federal representation on the RGB. First among these is that the United States has treaties with many Northwest Tribes, each of which is a sovereign and accustomed to dealing with the United States directly. Federal representation on the RGB might be one way to reflect this historical channel of communication.

The delegation of authority to the RGB would be subject to limitations. First, the federal government could, and presumably would, choose to reserve to itself certain powers over the Columbia River system, its facilities, and their operation. This could be done as part of the authorizing legislation that allows the RGB to be created. Second, in the same legislation the federal government might also impose a variety of substantive constraints on the RGB's exercise of its authorities; such constraints might take the form of standards or limits regarding specific uses of the river. The most obvious possibilities might include prescribed management objectives for salmon (discussed in the main body of this paper), power production, or other river uses.

The federal government could have various reasons to reserve to itself some authority over the Columbia River and to establish some substantive boundaries for the RGB's exercise of its authorities. These reasons might be political, legal, or financial in nature. For example, the federal government has some non-delegable obligations under its various treaties with Canada and with the Columbia River Tribes; not only Tribes but certain other groups might demand continued federal involvement in River operations; and, as discussed below, the federal government would retain a variety of financial interests in the River's operation.

Given these circumstances, it may make sense for the RGB to include a federal member. First, having a federal RGB member might aid acceptance of the RGB by various interest groups (e.g., irrigators or navigators) who have long been accustomed to dealing with federal agencies primarily or exclusively. Second, the federal member might facilitate the RGB's practical and legal ability to exercise certain treaty responsibilities, such as under the Columbia River Treaty with Canada. Third, the federal member might help the RGB understand and take into account in its decisionmaking other treaty obligations, such as those between the federal government and the Tribes. Fourth, the federal member might help ensure that the RGB complies with any federally-imposed standards or constraints on its powers.

Finally, at least during any transition period, the federal member might help protect the federal government's specific financial interests. Such interests might include: making sure the federal government's transaction with NEWCO (if undertaken) is completed successfully if the federal government decides to undertake it; making sure the former federal facilities are properly maintained; making sure the WPPSS debt is paid in timely fashion; and, if the federal government reserves a share of NEWCO's profits, making sure that NEWCO is operated as profitably as possible, given the RGB's decisions about how to operate the River.

There may be countervailing reasons not to include a federal representative on the RGB. For example, if the federal member has only one vote, but no veto power, would the federal member's role be effective -- or Constitutional? But if the federal member has a veto, would responsibility truly have been regionalized? These and other issue warrant thoughtful discussion and careful consideration.

APPENDIX B: Statutory Provisions Governing NEWCO

Described below are provisions of federal authorizing legislation that would allow NEWCO to be formed. This discussion assumes that NEWCO is either a cooperative or some other well-established form of entity owned by its customers. Other ownership forms are options that should be considered.

(a) The legislation would provide a reasonable period within which those BPA customers who wished to would be given the opportunity to form NEWCO and arrange financing for the purchase from the federal government. Thereafter, the U.S. Department of Energy would be authorized on behalf of the United states to negotiate the sale, for fair market value, of BPA's power marketing rights to NEWCO. Congress could, if it wished, reserve the right to review and approve the transaction when it has finally been agreed by the parties.

(b) This paper assumes, for simplicity, that the purchase price would be paid as a lump sum in cash, and that the lump sum payment amount would be raised in conventional capital markets through issuance of debt by NEWCO. (There are alternatives: NEWCO might make the purchase on contract, for example.) Both NEWCO and the federal government would hire professional financial advisors to assist them in negotiations, and in determining fair market value.

(c) NEWCO's debt would be secured by its power sales revenues. NEWCO and its advisors (as well as the federal government and its advisors) would estimate how much power NEWCO would have available to sell, and at what prices. NEWCO would devise a marketing strategy to maximize NEWCO's revenues, and hence the amount of debt NEWCO could issue.

(d) To this end, NEWCO would try to pre-sell, under market pricing mechanisms, all or a significant portion of its power under take or pay contracts with its customers (who would also be NEWCO's co-op members and owners). Such contracts would grant the purchaser certain rights to return to NEWCO, or resell for its own account, any power it could not use. Any remaining power that NEWCO could not sell under contracts would be sold in the competitive open bulk power market. Either way, all NEWCO power would be sold at competitive market prices, long term and short term.

(e) NEWCO's power customers, as its owners and members, would receive a significant share of any "profits" NEWCO could produce. That share might be paid as dividends, or flowed back to customers in the form of rebates that reduce the cost of power. Like customers of other co-ops, NEWCO's members would also be entitled to capital credits, i.e., specific shares of NEWCO's equity, as equity is built up. Such capital credits are typically "rotated" (i.e., paid back) over relatively long intervals, such as 10-20 years. Footnote8

(f) Who would be eligible to purchase power from NEWCO in the first instance? Existing BPA customers would be given the first opportunity to sign contracts with NEWCO. Today's "exchanging" utilities might be given the continued right to purchase NEWCO power for their residential and small farm loads -- but they would not sell power to NEWCO; NEWCO would not be a purchaser of non-federal power. Any unsubscribed amounts of NEWCO power would then be offered to other bulk buyers, first within the Northwest, then outside the region. To improve the sales price and aid financing, any customer who signed an initial contract with NEWCO would be entitled to a second contract when the first expired (this mechanism was used to help ensure the long-term sale of the output of Boulder Dam).

(g) Preference for public bodies and cooperatives would continue to apply to NEWCO power. Any NEWCO power not already committed to customers by contract would be offered first to Northwest (but not extra-regional) preference customers as defined in existing law, i.e., public bodies and cooperatives.

(h) This public power preference would not apply to public bodies and cooperatives outside the Pacific Northwest, however, assuming that "regional preference" for Northwest customers is abolished.

(i) Existing BPA customers could elect to retain their current BPA contracts instead of accepting an initial new contract from NEWCO, but would not be assured of NEWCO having enough uncommitted power to replace those BPA contracts when they expire.

(j) Unlike BPA, NEWCO would have no authority to make any new, long-term purchases of non-federal power. NEWCO would be authorized to maintain existing federal generators and to make short-term power purchases to enable it to meet its power sales obligations.

(k) In addition to having its income be exempt from federal taxation under provisions of the Internal Revenue Code applicable to cooperatives, NEWCO might also be established as a tax-exempt 501(c)(3) organization with some ability to issue tax-exempt financing as well. Section 501(c)(3) status is possible for non-governmental entities that take over responsibilities that have traditionally been performed by governmental agencies. The tax-exemption of NEWCO would probably aid the federal government in realizing a larger sales price in the transaction. If NEWCO were taxable, the impact on sales price would be the opposite. (It should be pointed out and recognized that BPA's power sales activities, to which NEWCO would succeed, are tax-free today.)

(l) NEWCO's operating expenses would include specified types or amounts of costs not strictly related to power production, but of the sort that BPA bears today. These would include all or a portion of the administrative costs of the RGB, and certain operating expenses such as a specified portion of the salmon program for the Columbia/Snake Rivers. How many such costs, and what amounts, would be key determinants of NEWCO's financial viability, hence key determinants of the price that NEWCO can reasonably agree to pay the federal government for the right to market the power that BPA markets today. (See discussion in Appendix C.)

(m) NEWCO's "profits" (so described for convenience, although NEWCO might be a co-op and thus not technically an entity that earns profits), if any, would be divided in some manner set forth in the federal authorizing legislation. Some portion of such profits, if not all, would accrue to NEWCO's customers/members, effectively in the form of patronage dividends or rebates. Some portion could also be shared directly by the four Northwest states, perhaps in proportion to NEWCO's power sales revenues from customers in each of the respective states. This might give the states a direct incentive to make sure the RGB acts responsibly, since the RGB's decisions will largely determine how much power NEWCO has available to sell. Some portion of the profits could be dedicated to other regional purposes (e.g., conservation and/or renewable resources). And some might be reserved for the federal government, at least if NEWCO's financial performance significantly exceeds that which was assumed for purposes of negotiating the purchase price for BPA's power marketing functions.

APPENDIX C: NEWCO Revenues and Profits: A "Piece of the Rock"

It may seem wishful thinking to contemplate NEWCO earning profits. But NEWCO would be different from BPA in three key financial respects. First, NEWCO would not be a governmental entity, and it would not have to bear the very substantial costs that this status imposes on BPA. Second, in order for the federal government to sell BPA's power marketing function to NEWCO at fair market value, the federal authorizing legislation will necessarily have to specify various limits on the categories and amounts of costs to be borne by NEWCO (as distinct from the federal government itself or other potential funding sources). BPA's costs, by contrast, are essentially open-ended, at least in amount, and in some particulars greater than those NEWCO might reasonably be expected to bear.

Third, and perhaps most importantly, the federal government's sales price to NEWCO should be equal to the fair market value of BPA's power marketing function. The fair market value of BPA's power marketing function, hence the sales price, cannot be greater than the maximum price the purchaser can pay and still expect to break even financially under all reasonably foreseeable circumstances. This may mean that the price the federal government can get for BPA's power marketing function in a fair market value transaction may become less, as a lump sum amount, than the amount of BPA's currently outstanding debt. The price will be very sensitive to the legislative limits on imposed costs and the degree to which BPA's internal operating costs have been reduced.

Even if NEWCO's value is enhanced by cutting operating costs before the sale, NEWCO's annual debt service obligations may have to be less than BPA's if NEWCO to be financially viable as a non-governmental corporation. NEWCO's financers are likely to insist on this; the federal government's financial advisors are likely to concur; and the financial markets are likely to make this result inevitable.

Why inevitable? Because the maximum amount of debt that NEWCO can incur in order to purchase BPA's power marketing function (hence the maximum price that can be paid to the federal government in the transaction) will be limited by NEWCO's prospective ability to meet its debt service payments reliably. This depends not only on NEWCO's other annual costs, but also on the minimum amount of revenue that NEWCO can reasonably be expected to collect from power sales customers in each year. That amount of revenue depends in turn on what minimum amount of power NEWCO can reasonably be expected to have available for sale in each year -- an amount that may be considerably less than the maximum amount that NEWCO may be able to sell in some years.

In short, NEWCO's indebtedness will be market-financed and will necessarily be based on assumptions about NEWCO's power sales that are more conservative than the average expected power sales. This has several implications:

(a) Unless other costs can be reduced significantly, NEWCO will not be able -- and cannot be required -- to assume annual debt service obligations as great as BPA's current average annual obligations to the Treasury, if the BPA-NEWCO transaction takes place at fair market value.

(b) The federal government can get a higher price for NEWCO to the extent that the authorizing legislation allows (i) NEWCO's costs to be predicted, and if possible limited, with reasonable certainty, and (ii) the amount of power available to NEWCO for sale to be predicted, and if possible protected, with reasonable certainty. The trade-offs involved are real, and presumably will be taken into account in the legislation's provisions governing the RGB and its authorities, as well as the provisions governing NEWCO.

(c) The opportunity for NEWCO to earn a profit lies in the opportunity for NEWCO to sell more power (or to have lower costs) than what will be conservatively assumed for financing purposes in a fair market value transaction. This paper proposes that those profits, or most of them, be kept by NEWCO's customers, the Northwest states, and others in the region, if and to the extent the profits can be earned. This is the region's potential "piece of the rock."

Why would the federal government agree to divest itself of BPA's power marketing function in these circumstances? The answer, of course, is that the federal government may choose not to do so. But that answer is far from complete. First, the worldwide trend toward privatization, and the U.S. trend toward de-federalization, have their own force and logic that are not necessarily driven solely by the sales prices of governmental assets. The federal government could rationally decide to sell BPA's power marketing functions even at an apparent loss, just as Britain and other governments sold off their power system, at an apparent loss.

Second, it is the rule rather than the exception that governments, including the U.S. government, accept what appear to be immediate write-downs in the value of the assets they decide to sell off, and that the purchasers appear to gain a corresponding benefit. This is particularly true where, as here, the purchasers are those the government intended to benefit by building the assets originally.

Third, the alternative confronting the federal government is not entirely rosy either. Unless something changes, BPA is not likely to be able to continue to meet its Treasury payments consistently. The federal government could react to this situation by cutting BPA's costs and freeing BPA to compete more effectively to hold on to its existing loads (or even compete for new loads). But, if BPA's status as a governmental agency reduces the cost cutting and marketing options, it may be more acceptable for the federal government to sell BPA for a fair market price than for it to accept a potentially endless stream of financial losses.

Finally, there is potential benefit to the region in proposing this transaction even if the federal government decides not to accept it. That benefit would be found in more widely educating the region and the federal government in the economic (un)reality of the existing Northwest power system. Far from being subsidized, or paying the federal government less than it should, the BPA system has been paying more to the Treasury than BPA or any non-governmental successor could afford to pay its lenders, given the other costs, obligations, and risks that federal law imposes on BPA. If nothing else, this argues for reducing BPA's costs instead of trying to raise its rates in the face of today's competitive power market prices.

APPENDIX D: WPPSS Debt

WNP 1, 2, and 3 were financed with tax-exempt bonds issued by the Washington Public Power Supply System. The revenues to pay debt service on these bonds are received by WPPSS from the Northwest utilities who agreed, many years ago, to participate in these plants. At the same time, under contracts known as "net billing agreements," those utilities effectively transferred their shares of the three plants to BPA in return for BPA agreeing to reimburse the utilities for the costs of those plants, including debt service.

At least four alternative means of dealing with the WPPSS debt in the context of this restructuring concept should be considered:

(a) Defeasance. Depending on circumstances, it might be advantageous to the region to have WPPSS exercise its right to "defease" the bonds. This would require a new debt financing, perhaps by NEWCO, to raise enough money to deposit into the WPPSS Bond Fund an amount sufficient to assure payment of the principal and interest on the existing WPPSS bonds when due. (Whether this would make financial sense would depend on the relative interest rates on the old and new debt; this in turn would depend in large measure on whether the new debt, like the old, would be tax-exempt -- a result Congress could mandate, if necessary, should Congress choose to do so.)

(b) "Equivalent security." WPPSS, BPA, and NEWCO could also agree to substitute NEWCO's revenues for BPA's as the effective security for payment of the WPPSS 1, 2, and 3 debt. This would be accomplished, in essence, by transferring BPA's WPPSS obligations to NEWCO. The WPPSS bondholders, however, might object to this change for any of several reasons. In that event, the courts might nonetheless bless the change if, given all the circumstances, they conclude that the rights of the bondholders are not "adversely affected" because the new arrangement provides them "equivalent security" with the old. Footnote9

(c) Retaining a vestigial BPA and BPA Fund until the WPPSS debt is paid off. Alternatively, NEWCO might simply agree to pay BPA in each year what BPA is obligated to pay the WPPSS participants. The monies could be deposited into, and drawn from, the existing BPA Fund, which is the actual "pool" of BPA funds available today to provide security to the WPPSS bondholders. This would require that both BPA and the BPA Fund continue in existence, to this limited extent and for this limited purpose, until the WPPSS debt is completely paid off (in 2016). Such an arrangement might assist, but certainly would not assure, a finding that the rights of the WPPSS bondholders have not been adversely affected by BPA's transfer of its power sales responsibilities to NEWCO.

(d) A federal "safety net" for the WPPSS bondholders. If Congress chose to do so (in order, for example, to improve the sales price received by the federal government in the BPA-NEWCO transaction), it could assure the WPPSS bondholders by statute that the federal government would meet any of BPA's WPPSS obligations that NEWCO for any reason fails to meet. This would presumably prevent any WPPSS bondholder from blocking the BPA-NEWCO transaction, since bondholder security would actually be better than it is today: the Treasury does not guarantee BPA's obligations. Traditionally, however, Congress and the Treasury have been reluctant as a matter of principle to provide security for tax-exempt bonds (such as those of WPPSS) in the form of federal guarantees. It is probable that the federal government would insist on the other alternatives being attempted first.

Footnote1

Thus, although interstate gas pipelines are still treated as natural monopolies, local gas distribution companies and industrial gas users are no longer required to buy gas from the pipeline company that delivers it; they are free to buy gas as a commodity from competing suppliers, and pay the pipeline company for transportation only. Oil pipelines are considered natural monopolies and regulated to ensure they provide non-discriminatory access to all shippers, but sales and purchases of the commodity they transport -- oil -- are not regulated at all.

Footnote2

For its first hundred years, the power industry was premised on limiting prices to the cost of production and delivery. The departure from cost-based pricing came not from market forces but from regulation, with the Public Utilities Regulatory Procedures Act of 1978 ("PURPA"). Under PURPA, electric utilities are required (1) to purchase power from other suppliers, in lieu of building their own power plants, and (2) to pay those suppliers a price in excess of the suppliers' costs of production.

Footnote3

Among the most significant such costs imposed on BPA are the fish and wildlife program, the "Residential Exchange" program, and centralized funding for conservation programs.

Footnote4

Over the past 18 months, BPA has accomplished much in terms of reducing and controlling costs, securing load commitments, and reinventing itself. However, much more would need to be accomplished for BPA to be truly competitive in the marketplace.

Footnote5

This includes $60 million per year in taxpayer contributions through Section 4(h)(10)(C) of the Northwest Power Act. Under this Section, the federal government reimburses BPA from general funds for fish and wildlife costs paid by BPA in the first instance but properly the responsibility of other project functions such as navigation, recreation, etc.

Footnote6

Although fears of "stranded" costs or investment are raised when competition approaches, the Northwest power system's actual "stranded cost" problems are often overstated, sometimes vastly. This is not surprising: natural gas deregulation was also feared (needlessly, as things turned out) because it might shift "stranded" pipeline costs to small consumers and drive up residential rates. In addition to such general reasons for retaining skepticism in the face of "stranded cost" alarms, the Northwest has special reasons to remain calm. We rely far more heavily than other regions on hydropower, the costs of which are not "stranded" and remain low enough to prevent most other generation and transmission costs from being "stranded," too.

BPA currently incurs some unnecessary operating costs because its internal operating policies reflect its government agency status, and because politics limits its ability to control some other costs. Although BPA's total costs are now too high by competitive market standards, those costs can and must be cut, as can the costs of most Northwest generating utilities. BPA's unavoidable or fixed costs should be recoverable from BPA's existing customers as part of the price of power sold at competitive market prices. The same is largely true of Northwest utilities -- many of whom, facing competition, now propose to cut their costs by hundreds of millions of dollars through downsizing and mergers. A power supplier that can still cut its costs does not yet have a "stranded" cost problem.

Although some residual "stranded cost" problems may remain for some Northwest utilities even after competition exerts its cost-reducing pressures, they are likely to be (1) much less than they appear in prospect, (2) trivial in comparison to the excessive costs that "captive customers" pay in non-competitive markets.

"Stranded costs" should perhaps be treated like "jobs lost to the North American Free Trade Agreement (NAFTA)," at least in the Northwest: either this is a minimal price to pay for the benefits of free trade and competition, or, at most, something that must be proven to an independent commission established for this purpose in order to be recognized and compensated. Many stranded costs are now claimed, but few if any would be proven to the satisfaction of a special, independent panel.

Footnote7

We also recognize that BPA is in the process of making many needed reforms to its conservation programs. This proposal would complement BPA's ongoing reinvention efforts. [Graphic unavailable at this time]

Footnote8

From the federal government's standpoint, the sales price to NEWCO might be higher to the extent that NEWCO's sales are greater or more secure as a result of NEWCO being a co-op or similar form of organization that is tax-exempt and whose members have some incentive to purchase their power from it (because they benefit in the form of discounts or rebates).

Footnote9

As noted in the text, the WPPSS bondholders might well have a valid argument that their security had been impaired if repayment of WPPSS costs were separated from repayment of other debt secured by power sales from the (former?) federal system.

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