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Related link: Final report (CR98-2) IntroductionIn 1997, the four Northwest governors asked the Northwest Power Planning Council (Council) to establish a cost control forum to assist Bonneville in controlling costs preparatory to a subscription process for the post-2001 period. The Cost Review has covered planned costs of the Federal Columbia River Power System (FCRPS), including transmission, with a focus on projected costs in the 2002-2006 period. The objective has been to ensure that Bonneville's near and long-term power and transmission costs are as low as possible, consistent with sound business practices, thereby enabling full cost recovery with power rates at or below market prices. Following are draft recommendations of the Management Committee for public comment before they are finalized and forwarded to the Bonneville Administrator for decision and action. The recommendations identify $150 million in reductions to FCRPS agency planned costs for 2002-2006. These reductions are in addition to substantial cost cutting already undertaken. The Council and Bonneville assembled a Management Committee for carry out the Cost Review. The Committee has 11 members, including five "outside" experts in corporate management and finance, and representatives from the Council and Bonneville. The management and finance experts bring fresh business perspectives and the benefit of private-sector experience in leading large organizations through restructuring, cost cutting and downsizing. The committee members are: Curtis Bostick, Marco Island, Florida Joyce Cohen, Portland, Oregon Charles Collins, Seattle, Washington Jim Curtis, Portland, Oregon John Etchart, Helena, Montana Steve Hickok, Portland, Oregon Mike Kreidler, Olympia, Washington Robert J. Lane, Portland, Oregon Todd Maddock, Lewiston, Idaho Rosemary Mattick, Seattle, Washington William Vititoe, Seattle, Washington Public comment on these recommendations will be taken at hearings
on Comment can also be submitted to the Northwest Power Planning Council
through February 20, 1998. The Goal In July 1998, the Bonneville Power Administration (Bonneville) will begin a subscription process for selling its core power products, with the objective of getting new long-term power sales contracts in place for fiscal year (FY) 2002 through 2006 and beyond. Achieving a very high level of subscription by Northwest wholesale power customers is a high priority. It is the most certain way to satisfy obligations to the U.S. Treasury, third-party bondholders, and fish and wildlife recovery, and retain for the Northwest substantial long-term benefits of the federal Columbia River Power System (FCRPS). The work of the Cost Review Management Committee has been driven by the objective of achieving a high level of Northwest subscription. Bonneville's wholesale customers are facing a period of unprecedented uncertainty and risk. There are new suppliers and increased price competition in the marketplace. With the onset of retail competition, utilities are uncertain of their future loads. It is the Committee's view that these utilities are unlikely to buy power from Bonneville on a long-term basis unless they perceive Bonneville's price to be very low relative to these risks. Thus, the Committee believes that the key to a high level of long-term subscription is for Bonneville to reduce its costs as much as possible consistent with the Comprehensive Review and sound business practices, thereby enabling Bonneville to price its core subscription products well below market price expectations. Bonneville has been working toward a cost structure that would allow it to compete successfully in a 2 cents market. The Management Committee has challenged Bonneville and other agencies of the power system (U.S. Army Corps of Engineers, the Bureau of Reclamation and the Washington Public Power Supply System) to beat that goal by a substantial margin. The Committee believes that the goal of pricing power well below market expectations will enable Bonneville to return to its roots ? a focus on its core missions of marketing and transmitting the firm power output of the FCRPS for relatively long terms to regional customers, and meeting its environmental responsibilities. This is a role that is sustainable, both competitively and politically. While Bonneville will continue short-term marketing of nonfirm power, the emphasis on long-term firm contracts will allow Bonneville to reduce staff and expenses associated with many marketing and related support activities. In this environment, Bonneville will not be engaged in acquiring additional power resources to meet the load growth of customers. Nor will it have a large responsibility for the development of conservation and renewable resources. Staffing and other expenses related to these activities can be reduced. These directions all are consistent with the recommendations of the Comprehensive Review of the Northwest Energy System. Challenges and Opportunities Since late 1993, Bonneville has made substantial strides in reengineering its operations and reducing its planned costs. Indeed, FCRPS financial results for FY 1997 and reductions to date in Bonneville staffing demonstrate new, aggressive cost management practices. Bonneville staffing today is the lowest it has been since 1965. Recent efforts of the Bureau of Reclamation and the Washington Public Power Supply System (Supply System) to reduce costs and improve financial margins likewise reflect responsiveness to the marketplace for wholesale power. In August and September of 1997, Bonneville completed its annual planning and budget process. This process covered the remaining four years of the current rate period (FY 1998-2001) and the initial five-year subscription period (FY 2002-2006). A number of cost-cutting actions were planned beyond those reflected in the 1996 Rate Filing. These actions would result in average annual expenses in the FY 2002-2006 period that are $89 million lower than the expenses planned to be recovered through Bonneville's rates for FYs 1997-2001. The results constitute the "cost baselines" that Bonneville proposed to the Cost Review Management Committee for review and recommendation last October. Included in the baselines for FYs 2002-2006 are assumptions that the costs of the Residential Exchange program are eliminated either statutorily or through the "in lieu" provisions of the current statute, and that fish and wildlife costs remain stable. The Management Committee adopted these baselines as it's starting point. The Management Committee recognizes that Bonneville faces significant challenges and opportunities in achieving further savings; for example:
The Recommendations Bonneville should undertake extraordinary efforts in its power, corporate and transmission organizations to reduce the costs of its commercial operations and constrain the costs of its public benefit programs. Similarly, other agencies of the FCRPS -- the Corps of Engineers, the Bureau of Reclamation, and the Supply System -- should act in concert with Bonneville by taking aggressive action to maximize the value of the FCRPS, both financial returns and public benefits, by reducing O&M costs and improving asset productivity. The Committee's recommendations are summarized in the following table. If
achieved by the FCRPS agencies, the cost reductions identified will provide
a cost structure designed to permit Bonneville to price its core
subscription products well below currently expected market prices.
In addition, the Transmission Business Line should meet the cost management objectives in its baseline, in particular:
Work on Transmission Business Line recommendations has not been concluded, and the Committee expects to reflect more savings in its final recommendations.
For several reasons, it is critical that Bonneville, the Corps, the Supply System, and the Bureau begin implementing these recommendations and the cost reductions in the October cost baselines as quickly as possible. Doing so will demonstrate to customers and other interests the commitment of Bonneville and the other FCRPS agencies to reducing costs. Implementing some of the recommendations will entail new investment in systems and up-front costs to reduce staffing levels that can be paid for in part with near-term cost savings available from early implementation of the recommendation. Forging an integrated asset management strategy will take a concerted effort and is critical to improving the productivity of the FCRPS. Finally, Bonneville should move quickly to obtain Administration support for legislation to improve its administrative effectiveness and efficiency. The Management Committee has not addressed fish and wildlife costs. The Committee believes there are opportunities for improved efficiencies in the planning and implementation of fish and wildlife measures on the part of Bonneville, the Corps, the Bureau, the National Marine Fisheries Service, the Fish and Wildlife Service, state agencies and the tribes. These efficiencies should be sought with the same aggressiveness that efficiencies are being sought elsewhere in the FCRPS. Greater efficiency in these expenditures can only benefit fish and wildlife. The Risks Bonneville and the region face many risks in achieving the cost reductions discussed above. Implementing many of the recommendations will be difficult and success is not assured. There is no antidote for that, other than the skill and dedication of the managers and employees of Bonneville and the other FCRPS agencies. It is essential that these people be given the statutory authority and other tools necessary to be able to implement the cost reductions while maintaining the effectiveness of the agencies in carrying out their core functions. Bonneville's financial risks are substantial. For the remainder of the current FY 1997-2001 rate period, hydro and thermal resource costs are the greatest risks to FCRPS net revenues. Market price risk during this period is limited due to sales contracts that are largely fixed. Financial risks are substantially greater post 2001, with added hydro risk, fish recovery and enhancement cost risk, and market price risk. The magnitude of the risks can be as much as $200 million or more in a given year. Bonneville can reduce its risk profile significantly by reducing its power costs and by creating greater flexibility in its cost structure over time. The cost baselines and the Committee's recommendations do not include two key elements of a Bonneville revenue requirement for power: (1) a planned margin (planned net revenues) for risk and (2) acceleration of repayment, as recommended by the Comprehensive Review when certain pricing conditions occur. There is a risk that the sense of urgency in the need to reduce costs and improve productivity is not fully shared throughout the FCRPS agencies. Bonneville has been forced to confront this need by the realities of the market. Others have been insulated from those realities to varying degrees. In particular, the Management Committee concludes that the Corps must be more aggressive in reducing expenses and improving productivity. The recommendation for the implementation of an integrated capital/asset management strategy is essential if the FCRPS is to maximize asset value for the region. The Supply System has made great strides in reducing costs and increasing availability. The Committee can anticipate a viable market for the power from WNP-2. However, the Supply System must reduce costs further to meet and sustain its year 2000 cost target, and the Committee has challenged it to produce further savings. Toward this end, the Committee recommends the Supply System continue its examination of additional cost reduction measures and initiatives, including the potential adoption of a twenty-four-month fuel cycle, improved outage planning, industry benchmarking of "best practices", and the use of other fuel options. Unforeseen costs, lower than expected market prices, or performance problems could alter the situation. Increasing flexibility to deal with such circumstances should be a priority. The Committee expects that marketing WNP-2 separately from the subscription product should, depending on market conditions and costs, offer the opportunity for WNP-2 to generate net operating revenues. Bonneville should pursue marketing the plant's output at market prices, either as a "2nd tier" subscription product or outside the subscription process, unless legal or other issues prevent doing so. If the plant is operated and marketed in a way that results in the generation of net operating revenues, the decommissioning fund should be built up to improve flexibility in the event the plant cannot recover its operating costs in the future. Under the Northwest Power Act, Northwest utilities have the right to sell to Bonneville an amount of power equal to that required to serve their residential and small farm customers at the their average system costs, and to receive an equal amount of power at Bonneville's average system cost. In reality, this has been an accounting transaction. The exchange was intended as a means of allowing wider access to the benefits of the federal hydro system. In the past, the exchange has been a major cost to Bonneville, but it cannot be allowed to be so again in the future. The Comprehensive Review suggested an alternative way of providing access to the benefits of the federal system. It recommended that the residential and small farm customers of exchanging investor owned utilities be given the opportunity of being served with Bonneville power. Access to that power would be on a priority basis second only to public agencies. The Committee believes this can meet the objective of providing wide access to the benefits of federal power. The recommendations of the Cost Review will translate into low power prices only if subsidies and cost transfers inherent in the 1980 Northwest Power Act and in past Bonneville practices are held in check. At the time the Act passed, the argument was that these subsidies and cost transfers were affordable and necessary because Bonneville's costs were so far below market. The Committee's recommendations, seriously pursued, are designed to recreate those circumstances, but in a substantially changed market environment. Bonneville now faces competition. Competitive markets mean price volatility, product innovation and aggressive marketing. Bonneville can limit its costs and risks appropriately in this environment, only by being able to price its standard products well below market. Competitive markets also make discounts and subsidies less effective and less appropriate forms of public policy. Therefore, achieving the goal of the Cost Review likely will require a number of policy and legislative changes that the Committee did not address in detail. Bonneville and other regional entities must take the necessary steps to eliminate any further costs impacts from subsidies, discounts, and other cost transfers. Finally, the Committee would like to conclude with a note of caution. The
Committee realizes there are many calls on Bonneville's funds. But there is
a need for restraint. To the extent the Committee's cost reductions are
absorbed by increased expenditures for other purposes, the value of this
Cost Review will have been significantly diminished. Driving Bonneville's
costs back to or above market levels will discourage subscription and
jeopardize the fundamental goal of securing the long-term economic benefits
of the federal system for the region. It will confirm to potential
subscribers that Bonneville's costs are not manageable. Relying on stranded
cost recovery mechanisms is a high-risk path. If a high level of long-term
subscription is achieved, long-term funding for fish recovery and other
public benefits will be more stable; the US Treasury and other creditors
will be more secure; stranded cost recovery mechanisms will likely be
avoided; and, most importantly, the benefits of the Columbia River Power
System will be retained in the Northwest. Recommendations Recommendation #1: Further reduce staffing and support costs of power marketing, scheduling, and generation oversight Baseline: $50.0 million/year (2002-06 annual average)
Recommendation: $35.3 million/year (2002-06 annual average)
Recommendation: Reduce by approximately 50 percent the staffing for Power Marketing and other Power Business Line functions, except staffing for core operations (Generation Scheduling and Resource Optimization) and Bulk Hub activities necessary to maximize net revenues from the hydro system in commodity and spot markets (an overall reduction of about 125 full time employees [FTE], or about 1/3 of total PBL staffing). Also reduce related staff support costs (supplies, travel, training, support service contracts, etc.), legal and environmental services, and technical contracts. Rationale: The underlying assumption is that as a result of implementing the cost cutting recommendations, the price of federal power in 2002 and the foreseeable future thereafter will be significantly lower than market alternatives, and therefore a less aggressive long-term marketing and customer relations effort would be necessary. There would continue to be a need for a core staff to operate the system and buy and sell power to match resource output with regional loads, even with the longer-term firm load carrying capability of the system fully subscribed. This core team would not need the kind of management, market intelligence, product development, and analytic capability that are currently needed to make the initial subscription successful. This staff would perform the following basic services: Duty and Interchange scheduling, generation schedule and short term operations planning, weather and streamflow forecasting, regional system operational coordination, sales and purchase of power (trading), transmission acquisition and scheduling, billing, sales of reserve services and contract administration. Traditional account servicing would be minimal. Implementation: Transition to this kind of operation would begin in 2000, if subscription has achieved very high levels of Northwest commitment to Bonneville's long-term firm power products. Investment in new technology would begin earlier, however, and would focus on developing generic marketing tools, automating risk analyses, automating customer bills, etc. Cost to Implement: Prior to 2002, additional unplanned expenditures likely will be needed for severance packages and new technology investment and implementation. The amounts are not yet defined. Implications: This recommendation would change the relationship between Bonneville and its long-term power customers. Most traditional customer support services would no longer be provided. Power Marketing would focus on maximizing the value from the seasonal and monthly changes in the hydro system. Risks:
If market prices are close to the prices for federal power, either as a result of low market prices or inability to hold targeted cost levels (either in 2002 or later), then the Agency likely would lose revenue due to a lack of competitiveness (estimated risk: $50-150 million/year). With federal power prices of 18 mills/kWh or less (delivered), this imposes a minimal risk; with federal prices of 20 mills/kWh or more (delivered), this risk is substantial.
A greatly reduced staff may not be able to respond to the many upcoming changes in the power business such as new market flexibilities, scheduling protocols, and new independent system operators (ISOs). Complex and highly tailored products and support services would not be offered.
Developments on this front are forcing increased and sometimes redundant staffing.
Northwest customers cannot exercise their statutory right to obligate Bonneville to provide new resources and expanded service if this recommendation is to hold.
There is plenty of time to accomplish the initial subscription, note the changed operating environment that results from it, and re-focus the PBL marketing effort accordingly.
If the technology does not lead to anticipated efficiency improvements, there is a risk that some of the anticipated staff reductions will not be achieved.
Some market analysis, particularly for purposes of managing river operations in relation to both fish and excess power, may need to increase, not decrease, depending on how overall industry restructuring affects operations of the FCRPS. It is anticipated that fewer analysts will be required in the future for this function, but this is very tentative. Recommendation #2 Eliminate conservation market transformation initiatives post-2001 Market Transformation: Recommendation: End Bonneville funding for conservation market transformation activities beginning FY 2002. Work with retail utilities and states to secure funding for conservation market transformation through state public purpose funds as recommended by the Comprehensive Review. Rationale: Bonneville is currently contributing $14.6 million per year to the operation of the Northwest Energy Efficiency Alliance (Alliance). The Alliance is a non-profit organization funded by Bonneville on behalf of the public utilities in the region, and proportionately by the investor-owned utilities of the region. The purpose of the Alliance is to make targeted interventions on a regional scale in the markets for promising efficiency technologies, services or practices. The intent is to transform those markets ? induce permanent positive changes so that the target efficiency products can maintain or build market share without further utility support. While market transformation is a promising approach to encouraging conservation in a manner more consistent with competitive markets, it is inappropriate for Bonneville to be providing funding long term. The Committee recognizes that, unlike the rest the Comprehensive Review's conservation recommendations, the Review included provisions for long term funding of market transformation by Bonneville. This apparently was included because the Comprehensive Review thought it would be difficult administratively to get the states or local utilities to support such a regional effort. However, this cost is not one that is borne by Bonneville's wholesale competitors. Consequently, this cost can put Bonneville at a competitive disadvantage. The Committee believes that market transformation, along with other conservation, is most appropriately supported through the state public purpose funds called for by the Comprehensive Review. In the interim, Bonneville should work with other interests to secure such funding. Implementation: Notify the Alliance regarding the termination of funding and ensure that no contractual obligations are incurred that would require funding beyond 2001. Consider legislation removing Bonneville's obligation to encourage conservation. Risks: Bonneville has a statutory responsibility to encourage conservation. Withdrawal of support for all conservation activities might be challenged without statutory change. Recommendation #3: Reduce projection of legacy conservation contract and staffing expenses Legacy Recommendation: Bonneville funding for conservation "legacy" commitments (conservation contacts already in place prior to the Comprehensive Review) are estimated in the cost baseline based on the maximum contract value. Given historical spending patterns, utilities likely will not spend the maximum contract amounts. Thus, Bonneville should reduce its projections of future expenses associated with the existing conservation contracts. The Committee recommends that Bonneville not extend or modify these existing legacy contracts. Rationale: The legacy program is work done in support of existing conservation acquisition contracts in the region that still are active. Most of Bonneville's incentive-based legacy contracts terminate on or before 2000, but the debt service payment streams continue for up to 20 years. More than 250 active contracts exist in FY 1998. These contracts under legacy are commitments made under Bonneville's earlier resource acquisition program. No new contracts have been signed or funded since 1994, except for low-income weatherization. As contracts close out, active management and oversight will decrease. Associated staffing should be reduced. Normally, Bonneville's budget estimates include the maximum amount of the contracts. Nevertheless, utilities generally under-spend the contracts. Estimates of under-spending are based on Bonneville's past experience. Based on Bonneville's estimates, the Committee expects that approximately $4.5M in savings will accrue from under-spending of these legacy conservation contracts. Risks: The contract estimates are based on the maximum amount of the contract balances. Bonneville has committed to this maximum amount. If utilities wish to spend at a higher level within the terms of the existing contract, Bonneville is committed to pay for the higher level of spending. Recommendation #4: Further reduce staffing/funding for Northwest Power Planning Council Baseline: $6.2 million (2002-06 annual average) (1995: $8.5 million) Recommendation: Further reduce funding to reflect the changes in Bonneville's role in the region, and the Council's altered role in power as recommended by the Comprehensive Review, and the continued importance of fish and wildlife issues. Targeted reductions and an overall streamlining of the Council will be required. The recommended reductions reflect a 27 percent reduction from the 2002-06 baseline and a 47 percent reduction from the 1995 budget. Accomplishing these levels will require: significant reduction in staffing in the Power Division; reductions in Administration, Legal and Public Affairs; reductions in contracting, travel and facilities; probable consolidation of management responsibilities; significant reductions in state staffing; and reduction in the number of Council members per state from two to one. Cuts of this magnitude bear the risk of impairing the effectiveness of the Council. The possibility of additional funding from other sources to support Council activities of regional scope should be investigated. Rationale: The Council was created in 1981 as a consequence of the passage of the Pacific Northwest Electric Power Planning and Conservation Act (the Power Act). The Council is responsible for the development of long-range regional power plans to guide the resource acquisitions of Bonneville, the development of a program to protect, mitigate and enhance the fish and wildlife resources of the Columbia Basin, and provide for the participation and consultation of the states, tribes, interested groups, and the general public within the region. Council staffing and budgets have been developed to fulfill these responsibilities and facilitate their implementation. Looking forward, the continued high importance of fish and wildlife issues argues for maintaining the necessary capability. For example, annually the Council plays a key role in assuring accountability by providing congressionally mandated scientific and policy reviews of proposals for more than $125 million in Bonneville fish and wildlife funding. Congress has also asked the Council to carry out reviews to assist Congress in making decisions on major appropriations decisions. The Council anticipates further assignments of this nature. The Council is also spearheading efforts to establish a strong scientific foundation for fish and wildlife policy in the basin. All three tasks involve significant assistance from the Council's public affairs, power and legal divisions in addition to fish and wildlife staff. Reductions in staffing in these areas must not impair the Council's ability to complete work in these three areas. On the power side, the onset of a competitive generation market and the restricted resource acquisition role for Bonneville means the Council's planning function should be reduced and reoriented. However, the importance of Bonneville to the economies of the Northwest states means that maintaining a capability for continued oversight of Bonneville is required. In addition, the Comprehensive Review recommended that analytic capability be maintained to monitor and evaluate the transition to competitive electricity markets and facilitate the development of conservation and renewables in those markets. Council members can rely to a greater extent on central staff for staff support. Having two Council members per state reflects Congress and the states? desire to have broad representation on the Council. In some states, requirements for geographical representation have been included. This kind of representation would probably have to be sacrificed in order to achieve the greater efficiency required by these budget levels. Cost to Implement: There may be some near-term investment in information/telecommunications technology (e.g. video teleconferencing) to facilitate reduced travel budgets and the need for greater state-central coordination. Implications: Since the Council was created by Congress and actions of the state legislatures, federal and state legislation would be necessary to realign the mission and responsibilities of the Council and, if necessary, change the representation. Risks: Necessary legislation may not be passed. Effectiveness of Council may be impaired. Recommendation #5: Renewable resource projects: no new projects beyond those currently committed Baseline: $23.0 million/year expense (2002-06 annual average)
($10.3 million/yr. Revenues at "green" market prices) Recommendation: $19.7 million/year (2002-06 annual average) Annual savings: $3.3 million/year (2002-06 annual average)
Recommendation: Reduce Bonneville's funding of renewable resources and associated oversight responsibilities by 2002 in order to be consistent with the recommendations of the Comprehensive Review. This will reduce renewable resource research and development and financial support for renewable generation to just the projects already committed. This also will result in staff reductions in the Power Business Line and related support costs, already included in Committee Recommendation #1. Rationale: The underlying assumption is that Bonneville's core business strategy should not include development of new renewable resources or related research. Therefore, costs associated with new renewables costs should not be incurred. Implementation: Bonneville will not make any new commitments for renewable resource projects. Implications: This recommendation could negatively affect the relationship that Bonneville has with several of its historic constituents, as well as prospective resource development partners. Risks: Potential legal challenge to this interpretation of Bonneville's responsibility under the Act, and loss of support by constituent groups. Recommendation #6: Develop/implement a consolidated/integrated capital/asset management strategy for the FCRPS, including transmission Corps of Engineers Baseline: $116.7 million/year (2002-06 annual average) Note: The Management Committee recommends that the Corps of Engineers increase its operating margins by $40 million, of which $30 million is assumed to be obtained from operation and maintenance expense reductions and the remainder from improved revenues as a result of increased project availability. Bureau of Reclamation Baseline: $50.9 million/year (2002-06 annual average) Note: The Management Committee recommends that the Bureau of Reclamation increase its operating margins by $8 million, of which $2 to $3 million is assumed to be obtained from operation and maintenance expense reductions and the remainder from improved revenues as a result of increased project availability. Recommendation: Collaboratively forge and implement a consolidated, integrated capital/asset management strategy directed at maximizing value, including both financial returns and public benefits. The strategy should encompass the operation and maintenance of the FCRPS, including transmission, physical assets, a coordinated investment plan (including new investment, disinvestment, and asset divestiture actions), and the creation of integrated performance measures. Each element would be directed at maximizing the value (financial returns, public benefits) of the physical assets. Performance should be measured explicitly and reported publicly. Accountabilities should be established and incentives created to ensure the asset management success of the FCRPS.
Rationale: As it currently operates, the FCRPS is essentially a single accounting entity composed of three distinct federal agencies: Bonneville in the Department of Energy, the Corps of Engineers in the Department of Defense, and the Bureau of Reclamation in the Department of Interior. Each agency has its own unique set of multiple (and at times, competing) objectives. Prior to the onset of competition in the electric power industry, these multiple objectives were at times inconvenient and possibly awkward, but did not threaten the basic mission of the participating agencies because Bonneville enjoyed a substantial cost advantage over alternative sources of power. The increasingly competitive market for power has changed that equation dramatically. No longer can each agency pursue its own objectives independently without threatening the financial health of the entire FCRPS. The economic margins that once allowed the luxury of some level of strategic misalignment within the FCRPS no longer are possible. This is true especially when considering that the agencies having control over the cost and quality of production are largely separated from the marketing and cost recovery responsibilities. It is essential that the FCRPS adapt the business model to its particular purposes if it is to maximize the value of its assets both for the Pacific Northwest and for the United States? taxpayers. Survival (long-term cost recovery) in a competitive marketplace requires it. This calls for a capital/asset management strategy that is both integrated ? that is, directed toward value maximization; and consolidated ? that is, involving all entities in the FCRPS working together toward that end. Simply adapting the business model to meet the needs of the FCRPS is not sufficient to ensure success. A crucial factor for success is to connect the management of the capital and asset base directly to business strategy. Once this alignment has been made, creating appropriate incentives along with key accountabilities is relatively straight-forward. The participating agencies of the FCRPS must work together to improve margins. To that end the Corps and Bureau must continue their efforts to find additional expense reductions and increase availability. The Bureau is recognized for having undertaken productive efforts to reduce expenses to date. Therefore, only incremental expense reductions are requested. The Corps has not demonstrated to the satisfaction of the Management Committee that it has looked sufficiently for ways to reduce future expenses. Therefore, larger expense reductions are expected from the Corps. In addition to these expense reductions, the Corps and Bureau are expected to provide greater project availability (weighted by generation capacity). Implementation: A key opportunity for achieving a consolidated, integrated capital/asset management strategy for the FCRPS would be the establishment of a Joint Operating Committee. This Committee would develop common objectives for the purpose of guiding power-related planning, budgeting, operational, and investment decisions of the FCRPS. These common objectives, criteria, and controls should take into account constraints imposed by the non-power purposes of the Federal projects. In addition, the Committee would establish common controls (i.e., financial and operational reporting mechanisms) and means of measuring accountability. The FCRPS should investigate areas where savings could be gained by consolidating services that currently are provided in triplicate. Given Bonneville's experience with reductions in the cost of providing shared services, it appears that the greatest areas for consolidation might be accounting and financial systems, human resources, and information technology systems. Such steps should be directed toward eliminating redundancies and reducing overhead costs, while ensuring that planning, control and accountability systems support the objective of maximizing asset value. The FCRPS should participate in industry-wide benchmarking studies to identify "best practices" for both the power and transmission functions. The work accomplished to date is an excellent start, but all agencies within the FCRPS should be participating in these studies. The agencies of the FCRPS should work together in adopting and implementing "best practices". Costs to Implement: Capital investments may be required to produce the expected increases in project availability, although adopting "best practices" and potential benefits from increased coordination should be able to produce improvements. If capital funds are needed, they may be obtained by reprioritizing existing capital investments or possibly increasing capital investments. The expected increases in revenues are stated net of any increase in costs. Also, any change in the capital investment plan should bring additional savings in operation and maintenance expenses. Risks: If long lead times are necessary to obtain these expected savings, they may not be produced by FY 2002. The expected increases in revenues from improved availability may not occur if streamflows are inadequate. Recommendation #7: WNP-2: Aggressive cost management, flexible response to market conditions Baseline: $172.5 million/year operating expenses (2002-06 annual average) $153.8 million/yr. Revenues (878 aMw @ 20 mills/kWh) Recommended Improvement in Annual Net Operating Revenues: About $19 million/year (2002-06 annual average) Recommendation: 1. Subject WNP-2 to a market test: annual reveneus at market price
recover annual operating costs If the plant passes the market test, sell WNP-2 output at market, not subscription, prices, unless legal or other issues prevent doing so. To the extent that plant revenues exceed operating expenses, use the net operating revenues first to build up the decommissioning fund to improve future financial flexibility. Reevaluate plant termination in the event that operating costs are projected to exceed revenues achievable at market prices by more than the termination costs (i.e., terminate if termination is more economic than continued operation). Rationale: WNP-2 should continue to be operated only if it can meet a cost recovery test based on market prices. Currently, projected operating costs (defined as all costs except debt service) exceed projected revenues by about $19 million per year. If costs can be managed so it can meet the market test, the plant should continue to be operated. Separating WNP-2 from the rest of the subscription pool and selling the output at market prices would allow a lower subscription price for the rest of the federal system power. The subscription price would be reduced by about ? mill/kwh for every 2 mills difference between the subscription price and the market price obtained for the plant's output. Implementation: Separate WNP-2 from the federal hydro and sell the output at a higher, market price, either as a "2nd tier" subscription product or outside of the subscription process. As part of an evaluation of termination, if the plant fails to meet the market test, termination costs and effects on reliability of the federal system must be considered, particularly if there are significant additional reductions in capability of the federal hydro system as a result of fish enhancement and mitigation. Implications/Risks: Subtracting the power produced by WNP-2 from a subscription product sold significantly below market would exacerbate potential over-subscription. This could mean that the residential customers of the region's Investor-Owned Utilities will not get all the benefits of federal power that they may expect as a result of the Comprehensive Review recommendation on subscription, unless some alternative allocation scheme is devised. There is some risk that WNP-2 will face significant unplanned costs, either from failure of major pieces of equipment or from increased regulatory requirements. There also is some risk that market prices will be significantly lower than currently assumed. In the event of major unplanned costs, reductions in output or reliability, or a significant reduction in expected market prices, Bonneville and the Supply System should consider terminating WNP-2. A termination analysis should take into account the potential impact on revenues and Bonneville costs during the period, including termination costs not covered by the decommissioning fund and costs of any major equipment failure. While the analysis should focus on implications for federal system reliability, it also must consider effects on the region as a whole due to load/resource or reserve deficits, particularly if John Day or Lower Snake Dams (or both) have been or are expected to be breached or significantly reduced in output for purposes of fish enhancement and mitigation. Recommendation #8 Reduce Corporate Overheads Baseline ? PBL portion of Corporate Overheads: $15.4 million/year (02-06
annual ave.) Note: These figures combine both the direct and indirect reductions to power business line expenses due to corporate overhead savings. The entire corporate overhead reduction goal is $31.7 million. $9.0 million of these reductions directly benefit power through reduced corporate overhead distributions. The remaining $22.7 million reduce transmission expense and capital costs. These transmission savings result in an indirect PBL reduction of $5.5 million through lower transmission rates. Recommendation: Bonneville's goal is to reduce annual corporate expenses by approximately 50 percent from 1996 levels. This goal will be accomplished through several efforts. The first is the "shared services" review Bonneville currently has underway. Upon the completion in 1998 of this effort, corporate expense reductions will be identified as a result of corporate or overhead efficiencies gained through the redesign of financial, information, and human resource management systems, adoption of formalized benchmarking techniques, and implementation of private sector-based "best practices". Implementation of "Shared Services" review recommendations also will identify activities that may be more efficiently provided through outsourcing. In addition to the shared services review, Bonneville also is currently investigating "Enterprise software." While implementation of such software agency-wide will require substantial investments in the near term, it has the promise of yielding great long-term savings, which are integral to the goal of reducing corporate cost by 50 percent. The Committee recommendations call for reductions (essentially 50 percent, in aggregate) of all corporate overhead areas except for fish and wildlife recovery and enhancement overhead costs. In keeping with this recommendation, Bonneville also is reducing other corporate functions not covered in the shared services review, such as corporate communications, regional relations, legal services, pollution abatement, and others. The cost reductions outlined here are shown as reductions to the overheads charged to the business lines. The allocation of these reductions to the business lines is assumed to be proportional to the current overhead distributions. Rationale: Companies redesign their "shared services" are finding that infrastructure costs can be reduced substantially by eliminating services, updating and integrating systems, streamlining processes, and sharing service delivery to business lines. In addition, companies that have implemented enterprise software are finding that they can reduce their information technology costs substantially. Implementation Scheme : After the shared services studies are complete in July 1998, Bonneville will proceed to implement study recommendations as quickly as possible, with a projected one to two years for complete implementation. In addition to shared services recommendations, Bonneville also will be implementing Enterprise software, which will result in additional process changes and subsequent cost reductions. The purchase of Enterprise software should be completed by July 1998 and implemented by July 2000. Cost to Implement: Implementation costs for the recommendations identified via the "Shared Services" review will be identified as a part of each study. These costs could include the costs associated with possible downsizing (severance packages, voluntary separation incentives, lost productivity during implementation). To the extent outsourcing opportunities are identified, the cost of such outsourcing is assumed to be more than offset by anticipated staffing and other savings. On the other hand, Enterprise software will require an up-front investment of up to $90 million over costs currently in the baseline. It will take approximately 3-5 years to recover this investment. Risks:
Recommendation #9 Obtain legislation to improve administrative effectiveness and efficiency Annual savings due to recommendations (FY 2002-2006 annual averages) Note: Cost reductions due to these legislative changes apply to both business lines within Bonneville. As shown, the direct impact on the PBL cost baseline is estimated to be $3.0 million. The direct impact on transmission is estimated to be $7.0 million, of which an estimated $4.0 million will be "passed through" indirectly to PBL through lower transmission rates. Recommendation: If Bonneville is to minimize its costs, it must have the internal administrative flexibilities and efficiencies available to other participants in the electricity industry. In particular, to optimize the size, quality, composition, and use of its workforce, Bonneville must establish flexible, business-like human resource policies and practices ? currently made difficult or prohibited by government-wide civil service laws and requirements.
Rationale: Bonneville's status as a federal agency means that it is encumbered by certain personnel management, procurement, and other administrative regulations and procedural requirements that create unnecessary cost and rate pressures. For example, the agency is subject to government-wide civil service requirements that often are cumbersome, time consuming, and ineffective, thus adding to administrative costs, impeding downsizing and staff redeployment objectives, and hampering the ability to use modern compensation practices. In addition, federal requirements such as appropriations laws, procurement laws and property laws add limitations which are more conducive to truly governmental entities than to a self-financed agency charged with operating on a business-like basis in a competitive environment. Examples of burdensome procurement or property procedures that Bonneville currently must follow include: a prohibition on the joint ownership of federal and non-federal transmission facilities, which Congress has encouraged; and, restrictions on self-representation in litigation and requirements for the resolution of contractual disputes before the DOE Board of Contract Appeals, a very lengthy process. In addition, the current separation of power production and marketing functions between Bonneville, the Corps and the Bureau result in duplicative and inefficient procurement processes. Efficiencies in the procurement of major equipment and maintenance services for federal generation facilities may be obtained if common, flexible and business-oriented procurement procedures are used by all three FCRPS federal agencies. Implications: These recommendations require changes to the statutory authorities of Bonneville, and in some cases, other FCRPS entities. Risks: New legislation requires both Executive and Congressional Branch initiative and approval. The current interest in electrical industry deregulation may make it either easier or more difficult to obtain this attention and approval, depending on the priority given to this legislation. Seeking legislation also may create the opportunity for further changes to Bonneville's statutory authority not anticipated by this committee. Recommendations #10/11: Federal Power Act (FPA) conformance (cost functionalization) and reduce transmission overhead costs Baseline: $236.9 million/year (2002-06 annual average) ? PBL Transmission
Cost Forecast Recommendation: The cost baselines should be consistent with Federal Power Act guidelines and requirements for functionalizing transmission and power costs. This recommendation will not reduce Bonneville's total costs, but will have the effect of reducing the power cost baseline and increasing the transmission cost baseline. Although the $30 million estimate is based on early analysis only, types of costs currently in the power business baseline that would be functionalized to transmission include, for example, Corps and Bureau generation-integration and other transmission costs. In addition, the Management Committee at this point recommends that the TBL seek additional internal expense reductions of $2.5 million per year by reviewing activities such as aircraft, equipment maintenance and transmission sales staff. $1.5 million of this reduction would benefit power through reduced transmission rates. The other $1.0 million would benefit other transmission service purchasers. However, the Committee's work on recommendations for the TBL has not been concluded, and the Committee expects to reflect more savings in its final report. Rationale: The objective is to ensure Bonneville's power and transmission cost baselines for FYs 2002-2006 align with industry practices and FERC regulatory guidelines under the Federal Power Act. Adjustments to cost baseline projections are recommended accordingly. Inconsistencies originated with Bonneville's recent reorganization when it functionally unbundled FCRPS transmission and generation activities and costs. Implementation of FERC's open access rule and Bonneville's understanding of FPA requirements have evolved and clarified over the last year. The FCRPS cost baselines generally assumed that certain cost recovery assignments in the 1996 Transmission Settlement Agreement would remain in effect after the agreement expires in 2001, although that Agreement set no precedent. Implementation: Cost functionalization issues are decided through the rates hearing and filing process, and will be addressed with parties to the rate case at that time. Cost to Implement: The cost of this effort is negligible. Implications: This recommendation will effectively reduce the cost of transmission for Bonneville's power customers and could lead to an increase in transmission costs for other wheeling customers. Recommendation #12: Further reduce federal and non-federal debt service Baseline: $963 million/year (2002-06 annual average) Recommendations: Increase variable interest rate debt exposure, refinance debt whenever market interest rates allow prudent savings, and take other debt reduction actions, such as accelerated repayment and revenue financing for new investments, in order to restructure Bonneville's total debt portfolio (federal and non-federal) and reduce long-term debt service expense. These actions will reduce carrying charges and Bonneville's high level of fixed costs. Implementation: Over the next two to four years, Bonneville will work to secure any additional prudent variable interest rate debt exposure. In addition, Bonneville will take action to implement prudent debt reduction strategies which may include actions such as accelerating the repayment of higher interest debt and revenue funding a portion of new capital additions. Bonneville will forge and implement a capital investment strategy that gives rigorous evaluation to new investment proposals, disinvestment, and asset divestiture options. See Capital/Asset Management Strategy for FCRPS. Cost to Implement: Refinancing and financial products transaction costs (included in savings estimate above) as well as Debt/Investment Management staff and advisor costs (already reflected in reduced corporate overhead spending projections). Implications and Risks: Rising Interest Rates: While variable interest rate debt historically carries marginally lower interest rates than Bonneville's fixed rate debt, variable interest rate debt is inherently riskier than fixed rate debt. To the extent the variable interest rate exposure is "capped", then Bonneville's exposure could be limited and estimated savings reduced somewhat. Inasmuch as Bonneville's financial reserves are a key means of mitigating financial risks, any use of cash reserves to accelerate debt or to revenue finance a portion of new capital additions could reduce the probability of making annual Treasury payments on time and in full (the same is true of variable rate interest rate exposure). These recommendations could affect Bonneville's rate-making assumptions, e.g., planned net revenue for risk, in order to ensure adequate rate revenue to meet scheduled Treasury payments. Note: Interest expense projections in this Cost Review do not assume that repayment will be accelerated from current repayment policy and schedules. The Comprehensive Review recommended that Bonneville accelerate repayment when certain pricing conditions occur. |
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