With respect to the claim against TVA, the court held that the alleged violations of federal law failed as a matter of law because Congress had specifically authorized TVA to set the rates charged by distributor customers through TVA’s contracts with distributor customers. The plaintiffs appealed to the United States Court of Appeals for the Sixth Circuit (“Sixth Circuit”), and on October 17, 2006, the Sixth Circuit affirmed the district court’s decision, holding, among other things, that TVA’s rates were not subject to judicial reviewsignificant additional claims and that TVA is not subject to antitrust liability when doing so would interfere withliabilities. If actual liabilities significantly exceed the amounts accrued, TVA’s purposes.results of operations, liquidity, and financial condition could be materially adversely affected.
Global Warming Cases
. On July 21, 2004, two lawsuits were filed against TVA in the United States District Court for the Southern District of New York alleging that global warming is a public nuisance and that carbon dioxide (“CO2”) emissions from fossil-fuel electric generating facilities should be ordered abated because they contribute to causing the nuisance. The first case was filed by various states (California, Connecticut, Iowa, New Jersey, New York, Rhode Island, Vermont, and Wisconsin) and the City of New York against TVA and other power companies. The second case, which alleges both public and private nuisance, was filed against the same defendants by Open Space Institute, Inc., Open Space Conservancy, Inc., and the Audubon Society of New Hampshire. The plaintiffs do not seek monetary damages, but instead seek a court order requiring each defendant to cap its carbon dioxideCO2 emissions and then reduce these emissions by an unspecified percentage each year for at least a decade. In September 2005, the district court dismissed both lawsuits because they raised political questions that should not be decided by the courts.
The plaintiffs appealed to the U.S.United States Court of Appeals for the Second Circuit (“Second Circuit”). Oral argument was held before the Second Circuit on June 7, 2006, and2006. On June 21, 2007, the Second Circuit directed the parties are awaiting a decision.to submit letter briefs by July 6, 2007, addressing the impact of the Supreme Court’s decision in Massachusetts v. EPA, 127 S.Ct. 1438 (2007), on the issues raised by the parties. On July 6, 2007, the defendants jointly submitted their letter brief.
Case Involving Alleged Modifications to the Colbert Fossil Plant
. The National Parks Conservation Association, Inc. (“NPCA”), and Sierra Club, Inc. (“Sierra Club”), filed suit on February 13, 2001, in the United States District Court for the Northern District of Alabama, alleging that TVA violated the Clean Air Act (“CAA”) and implementing regulations at TVA’s Colbert, Fossil Plant, a coal-fired electric generating facility located in Tuscumbia, Alabama. The plaintiffs allege that TVA made major modifications to one of the power generating units, specifically Colbert Unit 5 without obtaining preconstruction permits (in alleged violation of the Prevention of Significant Deterioration (“PSD”) program and the Nonattainment New Source Review (“NNSR”) program) and without complying with emission standards (in alleged violation of the New Source Performance Standards (“NSPS”) program). The plaintiffs seek injunctive relief; civil penalties of $25,000 per day for each violation on or before January 30, 1997, and $27,500 per day for each violation after that date; an order that TVA pay up to $100,000 for beneficial mitigation projects; and costs of litigation, including attorney and expert witness fees. On November 29, 2005, the district court held that sovereign immunity precluded the plaintiffs from recovering civil penalties against TVA. On January 17, 2006, the district court dismissed the action, on the basis that the plaintiffs failed to provide adequate notice of NSPS claims and that the statute of limitations curtailed the PSD and NNSR claims. The plaintiffs appealed to the U.S.United States Court of Appeals for the Eleventh Circuit (“Eleventh Circuit”) on January 25, 2006. Briefing of the appeal toIn an October 4, 2007 decision, the Eleventh Circuit was completed in July 2006. Oral argumentaffirmed dismissal of the lawsuit. In January 2008, the plaintiffs filed a petition for a writ of certiorari, asking the United States Supreme Court to hear an appeal was held on January 11, 2007. Ifof the decision is reversed on appeal, there is a reasonable possibility that TVA will be ordered to install additional controls on Colbert Unit 5.Eleventh Circuit’s decision.
Case Involving Alleged Modifications to Bull Run Fossil Plant
. The NPCA and the Sierra Club filed suit against TVA on February 13, 2001, in the United States District Court for the Eastern District of Tennessee, alleging that TVA did not comply with the new source reviewNew Source Review (“NSR”) requirements of the CAA when TVA repaired its Bull Run Fossil Plant (“Bull Run”), a coal-fired electric generating facility located in Anderson County, Tennessee. In March 2005, the district court granted TVA’s motion to dismiss the lawsuit on statute of limitation grounds. The plaintiffs’ motion for reconsideration was denied, and they appealed to the United States Court of Appeals for the Sixth Circuit. Amicus curiaeCircuit (“Sixth Circuit”). Friend of the court briefs supporting the plaintiffs’ appeal have been filed by New York, Connecticut, Illinois, Iowa, Maryland, New Hampshire, New Jersey, New Mexico, Rhode Island, Kentucky, Massachusetts, and Pennsylvania. Several Ohio utilities filed an amicus curiaea friend of the court brief supporting TVA. Briefing of the appeal to the Sixth Circuit was completed in May 2006. Oral argument was held on September 18, 2006, and a panel of three judges issued a decision reversing the dismissal on March 2, 2007. TVA requested that the full Sixth Circuit rehear the appeal. However,appeal, but the Sixth Circuit denied this request. A scheduling order has been entered by the district court on remand, setting the case for trial on August 11, 2008. TVA is already installing or has installed the control equipment that the plaintiffs seek to require of TVA to install in this case, and it is unlikely that an adverse decision will result in substantial additional costs to TVA at Bull Run. An adverse decision, however, could lead to additional litigation and could cause TVA to install additional emission control systems, such as scrubbers and selective catalytic reduction systems, on units where they are not currently installed, under construction, or planned to be installed. It is uncertain whether there would be significant increased costs to TVA.
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Case Involving Opacity at Colbert
. On September 16, 2002, the Sierra Club and the Alabama Environmental Council filed a lawsuit in the United States District Court for the Northern District of Alabama alleging that TVA violated CAA opacity limits applicable to Colbert between July 1, 1997, and June 30, 2002. The plaintiffs seek a court order that could require TVA to incur substantial additional costs for environmental controls and pay civil penalties of up to approximately $250 million. After the court dismissed the complaint (finding that the challenged emissions were within Alabama’s two percent de minimis rule, which provided a safe harbor if nonexempt opacity monitor readings over 20 percent did not occur more than two percent of the time each quarter), the plaintiffs appealed the district court’s decision to the Eleventh Circuit. On November 22, 2005, the Eleventh Circuit affirmed the district court’s dismissal of the claims for civil penalties but held that the Alabama de minimis rule was not applicable because Alabama had not yet obtained Environmental Protection Agency (“EPA”) approval of that rule. The case was remanded to the district court for further proceedings, and the plaintiffs filed a motion for summary judgment. On May 23, 2006, the district court issued orders staying the matter until a decision is issued in a CAA case accepted by the United States Supreme Court (the “Supreme Court”),United States v. Duke Energy; referring the action to mediation to be completed before the close of business on December 15, 2006, unless the district court extends the deadline; and denying as moot the plaintiffs’ motions to hold TVA liable (with leave to file again, if necessary, after the stay is lifted). On May 26, 2006, the plaintiffs asked the district court to reconsider its orders and in the alternative to allow an interlocutory appeal, and on July 5, 2006, the district court denied plaintiffs’ motion. Mediation was unsuccessful. On January 22, 2007, the district court partially lifted the stay on the issue of liability, and on March 5, 2007, the district court fully lifted the stay.proceedings. On April 5, 2007, the plaintiffs moved for summary judgment. No trial dateTVA opposed the motion and moved to stay the proceedings. On April 12, 2007, EPA proposed to approve Alabama’s de minimis rule subject to certain changes. This rulemaking proceeding is ongoing. On July 16, 2007, the district court denied TVA’s motion to stay the proceedings pending approval of Alabama’s de minimis rule. On August 27, 2007, the district court granted the plaintiffs’ motion for summary judgment, finding that TVA had violated the CAA at Colbert. The district court held that, while TVA had achieved 99 percent compliance on Colbert Units 1-4
and 99.5 percent compliance at Colbert Unit 5, TVA had exceeded the 20 percent opacity limit (measured in six-minute intervals) more than 3,350 times between January 3, 2000, and September 30, 2002. The district court ordered TVA to submit a proposed remediation plan, which TVA did on October 26, 2007. The plaintiffs have responded, and TVA’s expects the district court to decide whether or not to conduct a hearing on the matter. If EPA approves Alabama’s de minimis rule, the lawsuit will become moot.
In addition to Colbert, TVA has been set.another coal-fired power plant in Alabama, Widows Creek Fossil Plant (“Widows Creek”), which has a winter net dependable generating capacity of 1,628 megawatts. Since the operation of Widows Creek must meet the same opacity requirements as Colbert, this plant may be affected by the decision in this case. The proposed de minimis rule change would help reduce or eliminate the chances of an adverse effect on Widows Creek from the district court decision.
Case Brought by North Carolina Alleging Public Nuisance
. On January 30, 2006, North Carolina’s Attorney GeneralCarolina filed suit against TVA in the United States District Court for the Western District of North Carolina alleging that TVA’s operation of its coal-fired power plants in Tennessee, Alabama, and Kentucky constitute public nuisances. North Carolina is asking the court to impose caps on emissions of certain pollutants from TVA’s coal-fired plants that North Carolina considers to be equivalent to caps on emissions imposed by North Carolina law on North Carolina’s two largest electric utilities. The imposition of such caps could require TVA to install more pollution controls on a faster schedule than required by federal law. On April 3, 2006, TVA moved to dismiss the suit on grounds that the case is not suitable for judicial resolution because of separation of powers principles, including the fact that these matters are based on policy decisions left to TVA’s discretion in its capacity as a government agency and thus are not subject to tort liability (the “discretionary function doctrine”), as well as the Supremacy Clause. In July 2006, the court denied TVA’s motion and set the trial for the term of court beginning October 2007. On August 4, 2006, TVA filed a motion requesting permission to file an interlocutory appeal with the United States Court of Appeals for the Fourth Circuit (the “Fourth Circuit”), which the district court granted on September 7, 2006. On September 21, 2006, TVA petitioned the Fourth Circuit to allow the interlocutory appeal. The Fourth Circuit granted the petition, but the district court did not stay the case during the appeal. Briefing of the interlocutory appeal to the Fourth Circuit was completed in January 2007, and the case is set for oral argument was held on October 31, 2007. On July 2, 2007, North Carolina filed with the district court a motion for partial summary judgment addressing certain of TVA’s defenses. On July 31, 2007, and August 20, 2007, TVA filed two separate motions for summary judgment, seeking dismissal of the lawsuit. The trial before the Fourth Circuit duringdistrict court previously scheduled for the term of court beginning in September 2007. Trial remains scheduled inOctober 2007 has been canceled and has not yet been rescheduled. On January 31, 2008, the district court forFourth Circuit affirmed the termdenial of TVA’s motion to dismiss. TVA has not yet decided whether to seek a rehearing before the court which begins in October 2007.full Fourth Circuit.
Case Involving North Carolina’s Petition to the EPA
. In 2005, the State of North Carolina petitioned the EPA under Section 126 of the CAA to impose additional emission reduction requirements for sulfur dioxide (“SO2”) and nitrogen oxides (“NOx”) emitted by coal-fired power plants in 13 states, including states where TVA’s coal-fired power plants are located. In March 2006, the EPA denied the North Carolina petition primarily on the basis that the Clean Air Interstate Rule remedies the problem. In June 2006, North Carolina filed a petition for review of EPA’s decision with the United States Court of Appeals for the District of Columbia Circuit. On October 1, 2007, TVA filed a friend of the court brief in support of EPA’s decision to deny North Carolina’s Section 126 petition.
Case Arising out of Hurricane Katrina
. In April 2006, TVA was added as a defendant to a class action lawsuit brought in the United States District Court for the Southern District of Mississippi by 14 residents of Mississippi allegedly injured by Hurricane Katrina. The plaintiffs sued seven large oil companies and an oil company trade association, three large chemical companies and a chemical trade association, and 31 large companies involved in the mining and/or burning of coal, including TVA and other utilities. The plaintiffs allege that the defendants’ greenhouse gas emissions contributed to global warming and were a proximate and direct cause of Hurricane Katrina’s increased destructive force. The plaintiffs are seeking monetary damages among other relief. TVA has moved to dismiss the complaint on grounds that TVA’s operation of its coal-fired plants is not subject to tort liability due to the discretionary function doctrine.
Page 21 On August 30, 2007, the district court heard oral arguments on whether the issue of 47
greenhouse gas emissions is a political matter which should not be decided by the court. The district court then dismissed the case on the grounds that the plaintiffs lacked standing. The dismissal has been appealed to the United States Court of Appeals for the Fifth Circuit.
East Kentucky Power Cooperative Transmission Case
. In April 2003, Warren Rural Electric Cooperative Corporation (“Warren”) notified TVA that it was terminating its TVA power contract. Warren then entered into an arrangement with East Kentucky Power Cooperative, Inc. (“East Kentucky”) under which Warren would become a member of East Kentucky, and East Kentucky would supply power to Warren after its power contract with TVA
expires in 2009. After agreeing to become Warren’s power supplier, East Kentucky then asked TVA to provide transmission service to East Kentucky for its service to Warren. TVA denied the request on the basis that, under the anti-cherrypicking provision, it was not required to provide the requested transmission service. (With the exception of wheeling power to Bristol, Virginia, the anti-cherrypicking provision precludes TVA from being ordered to wheel another supplier’s power to a customer if the power would be consumed within TVA’s defined service territory.) East Kentucky then asked to interconnect its transmission system with the TVA transmission system in three places that are currently delivery points through which TVA supplies power to Warren. TVA did not agree to provide the interconnections, and East Kentucky asked the Federal Energy Regulatory Commission (“FERC”) to order TVA to provide the interconnections. In January 2006, FERC issued a final order directing TVA to interconnect its transmission facilities with East Kentucky’s system at three locations on the TVA transmission system. On August 11, 2006, TVA filed an appeal in the U.S. Court of Appeals for the District of Columbia Circuit seeking review of this order on the grounds that this order violated the anti-cherrypicking provision. On December 7, 2006, Warren announced its intention to withdraw its notice to terminate its existing power contract. On January 10, 2007, TVA and Warren executed an agreement under which Warren rescinded its notice of termination and the parties extended the term of the TVA power contract through June 11, 2016. Given this agreement,termination. On May 3, 2007, East Kentucky no longer needsfiled a motion with FERC to establish interconnections to TVA’s transmission system. Accordingly, it is likely thatterminate the FERC proceeding andon grounds of mootness. TVA has also filed a motion with FERC to vacate all orders issued in the resulting litigation will eventually be dismissed and not proceedproceeding. On December 12, 2007, FERC granted the motion to a conclusion.terminate the proceeding, but denied the motion to vacate its previous orders.
Claim
Case Involving Areva Fuel Fabrication
. On November 9, 2005, TVA received two invoices totaling $76 million from Framatome ANP Inc., which subsequently changed its name to AREVA NP Inc. (“AREVA”). AREVA asserted that it was the successor to the contract between TVA and Babcock and Wilcox Company (“B&W”) under which B&W providedwould provide fuel fabrication services for TVA’s Bellefonte Nuclear Plant. AREVA’s invoices were based upon the premise that the contract required TVA to buy more fuel fabrication services from B&W than TVA actually purchased. In September 2006, TVA received a formal claim from AREVA which requested a Contracting Officer’s decision pursuant to the Contract Disputes Act of 1978 and reduced the amount sought to approximately $25.8 million. On April 13, 2007, the Contracting Officer issued a final decision denying the claim. On April 19, 2007, AREVA filed suit in the United States District Court for the Eastern District of Tennessee, reasserting the $25.8 million claim and alleging that the contract required TVA to purchase certain amounts of fuel and/or to pay a cancellation fee. TVA is reviewingfiled its answer to the complaint and preparingon June 15, 2007. AREVA subsequently raised its response.claim to $47.9 million. Trial is scheduled to begin September 29, 2008.
Notification of Potential Liability for Ward Transformer Site
. EPA and a working group of potentially responsible parties (“PRPs”) have provided documentation showing that TVA has been notified by one of the parties involved with clean-up ofsent electrical equipment containing PCBs to the Ward Transformer (“Ward”) Superfund Site, a facility locatedsite in Raleigh, North Carolina, that it considers TVA a potentially responsible party and intends to pursue a claim against TVA. The Ward site is one of two non-TVA areas identified in TVA’s Annual Report for which TVA was unable to estimate its potential liability.Carolina. Under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), any entity which arranges for disposal of a CERCLA hazardous substance at a site may bear liability for the cost of cleaning up the site. ThereThe working group is evidence thatcleaning up on-site contamination in the summer of 1974 TVA sent transformers to Ward that contained PCBs. Several responsible parties have entered into a settlementaccordance with an agreement with EPA and plans to clean up on-site contamination at the site, and thesue non-participating PRPs for contribution. The estimated cost of the on-site cleanup is currently estimated to be $20 million. In addition, EPA is also investigating off-site contamination from Ward operations, which may extend to the Neuse River and includes water bodieslikely has incurred several million dollars in a county and state park. The State of North Carolina has issued fish consumption advisories due to PCBs in areas up to 20 miles downstream of the Ward site. The expansion of the area believed to have been contaminated offsiteresponse costs, and the potentialworking group has reimbursed EPA approximately $725,000 of those costs. EPA has also proposed a cleanup plan for assessments ofoff-site contamination. The present worth cost estimate for performing the proposed plan is about $5 million. In addition, there may be natural resource damages liability related to liable partiesthis site, but TVA is not aware of any estimated amount for any such damages.
Completion of Browns Ferry Unit 1, Team Incentive Fee Pool Claims. Under the contracts for the restart of TVA’s Browns Ferry Unit 1, the engineering and construction contractors, Bechtel Power Corporation and Stone & Webster Construction, Inc., respectively, are to share in a team incentive fee pool funded from cost savings for the respective workscopes. The contracts provide that each contractor’s maximum payment from this pool will be as much as $38 million, for a maximum total payout under both contracts of $76 million. The contractors have taken the position that they should each receive the maximum payment. Currently, TVA has calculated each contractor’s share at $12,371,405, for a total payout under both contracts of $24,742,810. TVA and the contractors have agreed to nonbinding mediation of the matter. It is reasonably possible that TVA could substantially raiseincur some potential liability in excess of the cleanup costs. As yet thereamount previously calculated, but TVA is no formalunable to estimate any such amount at this time.
Notice of Violation at Widows Creek Unit 7. On July 16, 2007, TVA received a Notice of Violation (“NOV”) from EPA as a result of TVA’s failure to properly maintain ductwork at Widows Creek Unit 7. From 2002 to 2005, the unit’s ducts allowed SO2 and NOx to escape into the air. TVA repaired the ductwork in 2005, and the problem has been resolved. TVA is reviewing the NOV. While the NOV does not set out an administrative penalty, it is likely that TVA will face a monetary sanction through giving up emission allowances, paying an administrative penalty, or both. TVA's estimate of potential monetary sanctions is included in the costs associatedaccrued amount listed above.
Paradise Fossil Plant Clean Air Act Permit. On December 21, 2007, the Sierra Club, the Center for Biological Diversity, Kentucky Heartwood, and Hilary Lambert filed a petition with this site or any potential damages.the EPA raising objections to the conditions of TVA’s current Clean Air Act permit at the Paradise Fossil Plant (“Paradise”). Among other things, the petitioners allege that activities at Paradise triggered the NSR requirements for NOx and that the monitoring of opacity at Units 1 and 2 of the plant is deficient. The current permit continues to remain in effect. It is unknown atunclear whether or how the plant’s permit might be modified as a result of this time what levelproceeding.
Employment Proceedings. TVA is engaged in various administrative and legal proceedings arising from employment disputes. These matters are governed by federal law and involve issues typical of those encountered in the ordinary course of business of a utility. They may include allegations of discrimination or retaliation (including retaliation for raising nuclear safety or environmental concerns), wrongful termination, and failure to pay overtime.overtime under the Fair Labor Standards Act. Adverse outcomes in these proceedings would not normally be material to TVA’s results of operations, liquidity, and financial condition, although it is possible that some outcomes could require TVA to change how it handles certain personnel matters or operates its plants.
In accordance with SFAS No. 5, “Accounting for Contingencies,”TVA had accrued approximately $21 million with respect to the proceedings described above as of March 31, 2007, as well as approximately $12 million with respect to other proceedings that have arisen in the normal course of TVA’s business. No assurance can be given that TVA will not be subject to significant additional claims and liabilities. If actual liabilities significantly exceed the estimates made, TVA’s results of operations, liquidity, and financial condition could be materially adversely affected.
8. Subsequent Events
Significant Litigation to Which TVA Is Not a Party
On April 2, 2007, inMassachusetts v. EPA, a case concerning whether EPA has the authority and duty to regulate carbon dioxide emissions under the CAA, the Supreme Court found that greenhouse gases, including carbon dioxide, are pollutants under the CAA and thus EPA does have the authority to regulate these gases. The Supreme Court also concluded that EPA’s refusal to regulate these pollutants was based on impermissible reasons, and remanded the case to EPA to “ground its reasons for action or inaction in the statute.” While this case focused on carbon dioxide emissions from motor vehicles, it sets a precedent for regulation in other industrial sectors, such as the electric utility industry.
. On April 2, 2007, the Supreme Court also issued an opinion in the case ofUnitesUnited States v. Duke Energy,, vacating the ruling of the Fourth Circuit in favor of Duke Energy and against EPA in EPA’s NSR enforcement case against Duke Energy. The NSR regulations apply primarily to the construction of new plants but can apply to existing plants if a maintenance project (1) is “non-routine” and (2) increases emissions. The Supreme Court held that the test for emission increases under the NSR program does not have to be the same as the test under EPA’s New Source Performance Standard program. In light of the decision it appears that under EPA’s PSD regulations, increases in annual emissions should be used for the test, not hourly emissions as utilities, including TVA, have argued should be the standard. Annual emissions can increase when a project improves the reliability of plant operations and, depending on the time period over which emission changes are calculated, it is possible to argue that almost all reliability projects significantly increase annual emissions. Neither the Supreme Court nor the Fourth Circuit addressed what the “routine” project test should be. The United States District Court for the Middle District of North Carolina had ruled for Duke on this issue, holding that “routine” must take into account what is routine in the industry and not just what is routine at a particular plant or unit as EPA has argued. EPA did not appeal this ruling. On October 5, 2007, EPA filed a motion with the United States District Court for the Middle District of North Carolina asking that court to vacate its entire prior ruling, including the portion relating to the test for “routine” projects.
TVA is currently involved in two NSR cases (one involving Bull Run, the dismissal of which was recently reversed on appeal) and another at Colbert)Colbert (the dismissal of which was recently affirmed on appeal but may be reviewed by the U.S. Supreme Court). See Note 7These cases are discussed in this Quarterly Report for a discussion of these cases.more detail above. The Supreme Court’s rejection of the hourly standard for emissions testingholding could undermine one of TVA’s defenses in these cases, although TVA has other available defenses. Environmental groups and North Carolina have given TVA notice in the past that they may sue TVA for alleged NSR violations at a number of TVA units. The Supreme Court’s decision could encourage such suits, which are likely to involve units where emission control systems such as scrubbers and selective catalytic reduction (“SCR”) systems are not installed, under construction, or planned to be installed in the relatively near term.
At this point, no estimate can be made regarding the impact of any such suits on TVA.
Debt Securities
8. Subsequent Events
Debt
In April 2007,January 2008, TVA issued a total of $500 million in power bonds with a coupon of 4.875 percent. The bonds have a final maturity of January 2048.
In January 2008, TVA announced it will redeem three of its electronotes® issues on February 15, 2008. TVA will redeem all $25 million outstanding of its 2001 six percent electronotes® due December 15, 2021, all $28 million outstanding of its 2002 5.5 percent electronotes® due August 15, 2022, and all $4 million outstanding of its 2006 5.625 percent electronotes® due August 15, 2016. Each of these issues will be redeemed at 100 percent of par value.
In January 2008, TVA issued $36 million of electronotes® with an interest rate of five4.75 percent which mature in 20142028 and are callable beginning in 2012.
In February 2008, TVA announced it will redeem two of its electronotes® issues on March 11, 2008. TVA will redeem all $28 million outstanding of its 2002 6.125 percent electronotes® due January 15, 2022, and all $13 million outstanding of its 2002 6.125 percent electronotes® due April 15, 2022. Each of the issues of electronotes® will be redeemed at 100 percent of par value.
TVA monetized the call options on two public bond issues by entering into two swaption transactions (see Note 9, Risk Management Activities and Derivative Transactions in Part II of the 2007 Form 10-K). In February 2008, the counterparty to the swaption transactions exercised its options to enter into swaps with TVA, effective March 11, 2008, where TVA will be required to make fixed rate payments to the counterparty of 6.125 percent and the counterparty will be required to make floating payments to TVA based on London Interbank Offered Rate (“LIBOR”). These payments will be based on a combined notional amount of $41.7 million and will begin on April 15, 2008.
Properties
On December 14, 2007, TVA entered into an agreement to purchase the Office of Power Complex (the portion of TVA's Chattanooga Office Complex in Chattanooga, Tennessee, leased from Chattanooga Valley Associates) upon the expiration of the existing lease on January 1, 2011. The purchase price is $22 million, payable on January 3, 2011.
Regulation of Mercury
On February 8, 2008, the United States Circuit Court for the District of Columbia (the “D.C. Circuit”) vacated EPA’s Clean Air Mercury Rule (“CAMR”). CAMR established caps for overall mercury emissions in two phases, with the first phase becoming effective in 2010 and the second in 2018. It allowed the states to regulate mercury emissions through a market-based cap-and-trade program. All of the states in which TVA operates potentially affected sources adopted CAMR without significant change. TVA is currently evaluating the potential impact of the D.C. Circuit’s decision on its operations. It is possible that TVA may incur higher costs in the future should a replacement of, or significant modification to, CAMR impose increased regulatory restrictions and the need for additional environmental controls or a change in the way TVA operates its facilities. See Item 1, Business — Environmental Matters in the Annual Report.
(Dollars in millions except where noted)
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) explains the results of operations and general financial condition of the Tennessee Valley Authority (“TVA”).TVA. The MD&A should be read in conjunction with the accompanying financial statements and TVA’s Annual Report on Form 10-K, as amended by Form 10-K/A, for the fiscal year ended September 30, 20062007 (the “Annual Report”).
Financial Outlook
As of March
Net loss for the three months ended December 31, 2007, TVA’swas $17 million compared to net income for 2007 is forecasted to be about $60of $51 million or 13.9 percent, less than budgeted, primarily because of mild winter weather and dry conditions in the Tennessee Valley during the first half of 2007. Power sales are 2.8 percent below budgeted amounts for the six months ended March 31, 2007, as a resultsame period of decreased demand2006. This change was primarily due to unseasonable weather. Hydro generation, TVA’s cheapest sourcechanges in ratemaking methodology related to capitalized interest on construction projects (“AFUDC”) resulting in additional expense of power, is 27.8 percent below budget$46 million. Additionally, TVA changed its ratemaking methodology for the six months ended March 31, 2007, primarily due to the dry conditions. The three-month period of January through March was the driestgains and losses on recordcertain derivative instruments used in call monetization transactions which increased income by $15 million in the eastern Tennessee Valley in 118 years. Rainfall was 67 percentfirst quarter of normal2007. See Results of Operations.
TVA still faces challenges related to fuel, purchased power, hydroelectric generation, and runoff was 62 percent of normal for the eastern Tennessee Valley. It is assumed that the dry conditions will continue throughoutcapacity during the remainder of the year. Because ofLong-term demand projections indicate upward pressure on capacity and the lack of rainfall and runoff,need for additional capacity to be built or purchased over TVA's planning horizon. TVA is operating its reservoir system to help ensure therediscussing the possibility of a rate increase with the Tennessee Valley Public Power Association, Inc. (“TVPPA”), a group that represents most of TVA’s distributor customers, and with other groups. The increase could be between six and nine percent and is sufficient water for navigation, industrial process cooling, and other purposes.
The effects of the weather on sales, additional purchased power due to more outage days, and lower rated electrical capabilities of generating equipment (deratings), along with higher fuel prices have increased TVA’s delivered cost of power in 2007. Additionally, these factors contributed to a lower balance of cash and cash equivalents on hand as of March 31, 2007. In response, management has identified cost reductions in operating and maintenance activitiesexpected to be implemented over the remainder of the year.
Strategic Plan
On March 30, 2007, President and Chief Executive Officer (“CEO”) Tom Kilgore presented a report toin April 2008 if approved by the TVA Board of Directors (the “TVA(“TVA Board”) on. In addition to funding additional capacity and other capital projects, the development of the 2007 Strategic Plan whichadjustment would provide strategic direction for TVA in light of the significant changes in the electric utility industry landscape during the past several years. Retail competition in the country has stalled and wholesale competition is evolving slowly. Several new issues have emerged including escalating fuel prices, a growing need to learn how to use energy more efficiently, and an increasing desire for a cleaner environment. The Strategic Plan will focus on leveraging TVA’s strengths and addressing customer, financial, operational, and organizational actions necessary for TVA to support the region’s future growth and success in a rapidly changing business environment. The proposed policy-level plan would provide strategic direction for the next ten years. The plan is out for public comment. The TVA Board will consider adoption of the plan thereafter. See Item 7,Management’s Discussion and Analysis of Financial Condition and Results of Operations — Business Overviewin TVA’s Annual Report for more information regarding TVA’s strategy and the challengeshelp ensure that TVA may face.
New Generation
In ordercollects revenues needed to help balance the use of purchased power and its own generation to meet growing power supply needs in its service area, TVA purchased two additional combustion turbine facilities in December 2006. The Gleason facility was available for service in January 2007, and the Marshall County facility is scheduled to be available for service during the third quarter of 2007.
TVA expects that Browns Ferry Nuclear Plant Unit 1 (“Browns Ferry Unit 1”) will return to service in the spring of 2007. A major project milestone in achieving that goal was realized when fuel loading was completed in December 2006. The cost of the project may be slightly more than TVA’s original estimate because of steam dryer modifications, the selection of Browns Ferry Unit 1 as the lead plant for extended power up-rate, and schedule adjustments that optimize timing with the Browns Ferry Nuclear Plant Unit 2 refueling outage. Even with the possible increase over the project’s budget, restart costs are still projected to be about $1.8 billion (exclusive of allowance for funds used during construction (“AFUDC”) and asset retirement obligation costs). Browns Ferry Unit 1 is expected initially to provide additional generating capacity of approximately 1,150 megawatts and eventually to provide
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1,280 megawatts of capacity. At March 31, 2007, the restart work at Browns Ferry Unit 1 was approximately 99.5 percent complete. The cost of the project as of March 31, 2007, was $1,785 million excluding AFUDC of $233 million.
Another option being evaluated by TVA for additional generating capacity is the completion of Watts Bar Nuclear Plant Unit 2 (“Watts Bar Unit 2”) upon which construction was halted in 1985. TVA continues to consider whether to complete the Watts Bar Unit 2 reactor and is in the process of conducting a detailed scoping, estimating and planning study to determine the project’s cost and scheduling. Separately, TVA has prepared a draft report evaluating potential environmental impacts under the requirements of the National Environmental Policy Act. The draft environmental report states that completing constructionTVA Act and the tests and provisions of its bond resolutions, and do so in accordance with the unit is TVA’s preferred course of action, although TVA will make no decision on whether to complete Watts Bar Unit 2 untilfinancial objectives set forth in the scoping study is complete.
During the second quarter of 2007,Strategic Plan adopted by the TVA Board authorizedon May 31, 2007 (the “Strategic Plan”). It is anticipated that the purchaserate increase will generate an additional $265 million to $400 million of the Tenaska Brownsville site in southwest Tennessee. The Tenaska site formerly housed three combustion turbines. Although the combustion turbines are no longerrevenue during 2008 depending on the site, some of the plant equipment and buildings remain, and the site can be converted to a natural gas combined-cycle facility capable of generating about 600 to 900 megawatts of electricity in the summer. TVA is currently evaluating alternatives for the completion of the site.
In addition, during the second quarter of 2007,percentage increase approved by the TVA Board approved leasing the Caledonia combined-cycle facility located near Columbus, Mississippi, subject to the negotiationBoard.
Fuel-Cost Adjustment
As of a lease agreement. The Caledonia combined-cycle facility consists of three combined-cycle units with a nominal capacity of 813 megawatts and a capacity of 750 megawatts in the summer. Although TVA is still negotiating the lease for the Caledonia facility, TVA has already begun receiving power from the facility under a conversion services agreement.
TVA is also working with distributor customers to explore distributor ownership and development opportunities that may exist related to new power generation facilities. Such agreements may potentially provide new sources of power for use in meeting power demand in the areas served by TVA and distributors of TVA power in addition to the actions reported above.
Service Reliability
On JanuaryDecember 31, 2007, TVA met an all-time winter peakhad recognized a regulatory asset of 30,320 megawatts with no connection point interruptions on TVA’s system.
Continuing dry conditions may have further impact on TVA’s operations for the remainder of the fiscal year in several areas. There may be a loss of hydro generation due to balancing water for generation with potential summer reliability thermal issues related to the temperature of cooling water discharged from fossil plants. To a lesser degree, low water levels may result in disruption of fuel delivery by barge. TVA management is currently reviewing these issues and expects to have plans in place before the anticipated increased electricity demand during the summer months.
In addition, TVA has participated in meetings to address deficiencies in hydro production on the Cumberland River due to safety issues resulting from increased seepage rates at the U.S. Army Corps of Engineers’ Wolf Creek Dam. In light of these safety issues, the Southeastern Power Administration (“SEPA”) has not been able to provide TVA and other customers with all of the power that it is required to provide under its contractual arrangements with these parties. SEPA’s performance under these arrangements will continue to be monitored to assess how the deficiencies in hydro production will affect TVA and other customers with an interest in the output of the Cumberland River system.
The scheduled outage of Unit 3 at TVA’s Paradise Fossil Plant (which began on March 17, 2007, and was to end on April 29, 2007) has been extended through May 30, 2007, to correct an issue with a turbine rotor. During this additional period, TVA expects that the plant’s output will be reduced by 1,026 megawatts. TVA is using other generating assets to replace the lost power, and it is not yet known if TVA will have to purchase additional power to replace the output from Paradise Unit 3 or what the ultimate financial impact of the extended outage will be.
The Federal Energy Policy Act of 2005 authorized the establishment of an Electric Reliability Organization (“ERO”) with oversight powers granted by the Federal Energy Regulatory Commission (“FERC”). This legislation makes compliance with ERO reliability standards mandatory and enforceable. All users, owners, and operators of the bulk electric system, including TVA, are subject to these standards. Effective July 2006, FERC selected the North American Electric Reliability Corporation to serve as the ERO. Beginning June 4, 2007, fines may be imposed for non-compliance with ERO reliability standards.
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Increased Fuel and Purchased Power Costs
In July 2006, the TVA Board approved the implementation of a fuel cost adjustment (“FCA”) to be applied quarterly, beginning on October 1, 2006, as a mechanism to adjust TVA’s rates to reflect changing$151 million representing deferred fuel and purchased power costs to be recovered through the fuel cost adjustments (“FCA”) in future periods. Under TVA’s FCA methodology, adjustments to rates are based on the difference between forecasted and baseline (budgeted) costs for the upcoming quarter. Because the FCA adjustments are forward-looking, there is typically a difference between what is collected in rates and what actual expense is realized over the course of the quarter. This difference is added to or deducted from certain accounts on TVA’s balance sheet. The higher or lower costs added to or taken away from the amounts includedbalance sheet accounts are then amortized to expense in TVA’s base rates. Duethe periods in which they are to be collected in revenues. This methodology allows better matching of the revised forecasts for the second quarter of 2007, the adjustmentrevenues with associated expenses. The FCA amount to be implemented on AprilJanuary 1, 2007, was an increase of 0.842008, is 0.267 cents per kilowatt-hour and is expected to produce an estimated $29$105 million in revenue during the thirdsecond quarter of 2008. See Note 1 — Accounts Receivables and Cost-Based Regulation.
Weather Conditions
The amount of electricity that TVA is able to generate from its hydroelectric plants depends on a number of factors outside TVA's control, including the amount of precipitation, runoff, initial water levels, the need for water for competing water-management objectives, and the availability of its hydroelectric generation plants. When these factors are unfavorable, TVA must increase its reliance on more expensive generation plants and purchased power. TVA continued to be impacted by drought conditions during the first quarter of 2008. Although rainfall totals from October 1, 2007, through January 31, 2008, were 72 percent of normal, runoff totals were far less at 33 percent of normal. Reduced hydroelectric generation has driven up purchased-power costs, which were about $40 million higher than projected for the first quarter of 2008.
Performance of TVA Assets
Unscheduled Outage. Browns Ferry Nuclear Plant Unit 3 had an automatic shutdown of its nuclear reactor on December 31, 2007. The FCA had no effectshutdown was determined to be caused when the main turbine generator received a load reject signal. A load reject signal causes the system to “think” that the generator has lost the attached load. All safety systems responded properly to the signal. The unit was returned to service on rates priorJanuary 21, 2008. The net cost of the repair is estimated to January 1, 2007.be less than $3 million and the cost of replacement power during this period was $33 million. The FCA was initially set to zero and had its first impact on rates beginning January 1, 2007, at which time rates increased 0.01 cents per kilowatt-hour. Ascost of March 31, 2007, TVA had recognized a regulatory asset of $36 million representing deferredthis replacement power costs towill be recovered through the FCA adjustmentsFCA.
Extended Outage. The duration of a planned outage scheduled from October 3, 2007, to November 2, 2007, at Sequoyah Nuclear Plant Unit 1 was extended 16 days due to the identification of damage in the main generator during the outage work. The cost of additional work related to the generator was $7 million and the net cost of replacement power during this extended period was $22 million. The cost of this replacement power will be recovered through the FCA.
Challenges Related to Water Supply and Water Temperature
TVA faces challenges related to water supply and water temperature on the Cumberland River where the U. S. Army Corps of Engineers (“Corps”) operates hydroelectric facilities and TVA operates fossil plants and on the Tennessee River System where TVA operates hydroelectric facilities, fossil plants, and nuclear plants.
Cumberland River Challenges. The Corps operates eight hydroelectric facilities on the Cumberland River. Of these facilities, Wolf Creek Dam and Center Hill Dam are in need of emergency repairs. The need to repair the dams and the drought in the southeast has resulted in less water flow and high water temperature. There have been two effects on TVA.
The first is a reduction in the amount of power TVA receives from the Southeastern Power Administration (“SEPA”). TVA, along with others, has contracted with SEPA for the power produced from the Corps’s Cumberland River hydroelectric facilities. Under the contract, SEPA was to provide TVA an annual minimum of 1,500 hours of power for each megawatt of TVA's 405 megawatt allocation, and all surplus power from the Corps’s hydroelectric facilities on the Cumberland River. As a result of the need the repair to Wolf Creek and Center Hill dams and as a result of the drought, SEPA has instituted an emergency operation plan that:
| • | Eliminates its obligation to provide TVA (and any affected customer) with a minimum amount of power; |
| • | Provides for all affected customers (except TVA) to receive a specified share of a portion of the gross hourly generation from the eight Cumberland River hydroelectric facilities, with TVA receiving the remainder; |
| • | Eliminates the payment of demand charges by customers (including TVA) since there is significantly reduced dependable capacity on the Cumberland River system; and |
| • | Increases the rate charged per kilowatt-hour of energy received by SEPA's customers (including TVA). |
It is likely that the end of the drought will not eliminate the need for the emergency operating plan. It is unclear how long it will take the Corps to repair these facilities and how long the emergency operating plan will remain in effect.
The second is the likelihood that TVA will have to reduce power output (“derate”) its Cumberland and Gallatin Fossil Plants at times during the summer. During the summer of 2007, the temperature of the Cumberland River reached the point where TVA had to derate these plants in order not to exceed thermal limits. Future summer derates remain a possibility until the Wolf Creek and Center Hill dams are repaired and normal water flow is restored on the Cumberland River.
Tennessee River System Challenges. The drought in the southeast has resulted in less rainfall in the area drained by the Tennessee River and its tributaries and less runoff into the system. This results in there being less water available for cooling purposes and the available water having a higher temperature. In order not to exceed thermal limits, during the summer of 2007 TVA derated two fossil plants and at Browns Ferry Nuclear Plant, temporarily took one unit offline and reduced the output at the other two units. Additionally, TVA used its cooling towers at Browns Ferry and Sequoyah Nuclear Plants. Using the cooling towers takes a substantial amount of power that TVA would have otherwise sold. If the drought continues, TVA may have to take similar actions in the summer of 2008.
Meeting the Power Needs in TVA’s Service Area
Combined Cycle Facility. TVA completed the acquisition of a combined cycle facility located in southwest Tennessee in October 2007. Now known as Lagoon Creek 3, the unfinished site contains turbine foundations and substantial ancillary equipment. With an anticipated commercial operation date of June 2010, the facility is expected to have a planned winter net dependable capacity of approximately 600 megawatts.
New Nuclear Generation. TVA submitted its combined license application to the Nuclear Regulatory Commission ("NRC") for Bellefonte Nuclear Plant Units 3 and 4 in October 2007. If approved, the license to build and operate the plant would be issued to TVA. Obtaining the necessary license would give TVA more certainty about the cost and schedule of a nuclear option for future periods.decisions. The combined license application for two AP1000 reactors at Bellefonte was officially docketed by the NRC on January 18, 2008, indicating the NRC found it complete and technically sufficient to support their more detailed reviews. The TVA Board has not made a decision to construct a new plant at the Bellefonte site, and TVA continues to evaluate all nuclear generation options at the site.
Preliminary project activities began at Watts Bar Nuclear Plant Unit 2 in October 2007. TVA began to engage in unrestricted construction activities at the end of December 2007, having previously notified the NRC that such activities may begin after December 3, 2007. When completed, Watts Bar Unit 2 is expected to provide 1,180 megawatts of capacity.
Purchased Power. Purchasing power from others will likely remain a part of how TVA meets the power needs of its service area. The Strategic Plan establishes a goal of balancing production capabilities with power supply requirements within five percent. Achieving this goal will allow TVA to reduce its reliance on purchased power, which constituted over 14 percent of the power that TVA sold to its customers in the first quarter of 2008. The purchases during the first quarter of 2008 represent a 41 percent increase over the amount of power purchased during the first quarter of 2007. However, TVA forecasts that purchased power volume as a percentage of total system requirements will likely be less in 2008 than 2007. See Performance of TVA Assets.
TVA intends to consider other opportunities to add new generation from time to time. Market conditions, like the volatility of the price of construction materials and the potential shortage of skilled craft labor, may add uncertainties to the cost and schedule of new construction.
Customers
On January 1, 2008, Bristol Virginia Utilities (“BVU”) became the 159th municipal supplier or electric cooperative to connect with TVA’s power grid. The new contract has a minimum 15-year term, and a five-year termination notice may not be given until January 2018. The rates under this contract are intended to recover the cost of reintegrating BVU into TVA’s power-supply plan and serving its customer load. BVU is a 16,000-customer distributor that was previously served by TVA from 1945 to 1997, and sales to BVU accounted for approximately 0.4 percent of TVA’s annual operating revenues in 1997. Sales to BVU are forecasted to remain approximately 0.4 percent of TVA’s total sales.
Service Reliability
TVA met a monthly peak demand record on October 8, 2007, of 28,601 megawatts, which was 12.3 percent higher than the prior record set in October 2006. A record peak was also set for the month of November 2007 with 25,280 megawatts, exceeding the 25,169 megawatt record set in November 2006. This was the fourth consecutive monthly record peak load.
On January 25, 2008, TVA met a record winter demand of 32,027 megawatts without any customer interruptions. During the hour of peak supply, purchased power constituted approximately 12 percent of TVA's load.
TVA hosted a formative meeting of regional transmission planning stakeholders for the Central Region Public Power Partners, which includes Associated Electric Cooperative, Inc., Big Rivers EC, East Kentucky Power Cooperative, and TVA. Stakeholders participating included TVPPA, as well as representatives of independent power producers, utility marketing organizations, peer transmission planners, and the Kentucky Public Service Commission. This new planning and stakeholder process is another step in TVA's efforts to better coordinate TVA transmission operations with neighboring systems and to involve stakeholder groups in the planning of TVA's bulk transmission facilities. The stakeholder process is being voluntarily implemented by TVA as part of TVA's effort to comply with Federal Energy Regulatory Commission's (“FERC”) Order 890, which revises the FERC pro-forma tariff applicable to jurisdictional public utilities.
Sources of Liquidity
TVA’s current liabilities exceed current assets because of the continued use of short-term debt as a funding source to fund cash needs as well as scheduled maturities of long-term debt. To meet short-term cash needs and contingencies, TVA depends on various sources of liquidity. TVA’s primary sources of liquidity are cash on hand and cash from operations, proceeds from the issuance of short-term and long-term debt, and proceeds from borrowings under TVA’s $150 million note with the U.S. Treasury. Other sources of liquidity include two $1.25 billion credit facilities with a national bank as well asand occasional proceeds from other financing arrangements including call monetization transactions and sales of receivables and loans.
The majority of TVA’s balance of cash on hand is typically invested in short-term investments. During 2007, TVA’s average daily balance of cash and cash equivalents on hand was $389 million. The daily balance of cash and cash equivalents maintained is based on near-term expectations for cash expenditures and funding needs. TVA’s cash and cash equivalents at December 31, 2007, was $158 million, a decrease of $7 million from the cash balance at September 30, 2007.
Summary Cash Flows.A major source of TVA’s liquidity is operating cash flows resulting from the generation and sales of electricity. A summary of cash flow components for the six monthsquarters ended MarchDecember 31, 2007, and 2006, follows:
Summary Cash Flows
For the Six Months Ended March 31
| | | | | | | | | | |
| | | 2007 | | 2006 | | |
Summary Cash Flows For the Three Months Ended December 31 | | Summary Cash Flows For the Three Months Ended December 31 | |
| | | | | 2007 | | | 2006 | |
| Cash provided by (used in) | | | | | | | |
| Operating activities | | $ | 945 | | $ | 793 | | | $ | 218 | | | $ | 324 | |
| Investing activities | | | (880 | ) | | | (797 | ) | | (398 | ) | | (469 | ) |
| Financing activities | | | (219 | ) | | | (33 | ) | | | 173 | | | | 111 | |
| | | | | | | |
| Net decrease in cash and cash equivalents | | $ | (154 | ) | | $ | (37 | ) | | $ | (7 | ) | | $ | (34 | ) |
| | | | | | | |
Issuance of Debt.TVA issued $41 million of power bonds of $28 million during the sixthree months ended MarchDecember 31, 2007, while redeeming power bonds of $464 million. In April2007. Subsequent to December 31, 2007, TVA issued $4$500 million of electronotes® with an interest ratepower bonds and $36 million of five percent which mature in 2014 and are callable beginning in 2008.electronotes®. No long-term debt was retired or redeemed during this period. For more information regarding TVA’sabout TVA's debt activities, see Notes 3 and 8.
Credit Facilities.Facilities. In the event of shortfalls in cash resources, TVA has short-term funding available in the form of two $1.25 billion short-term revolving credit facilities. Infacilities, one of which matures on May 14, 2008, and the other of which matures on November 2006, TVA renewed the credit facility with the November 12, 2006, maturity date. The new maturity date for this credit facility is November 11, 2007. In May 2006, TVA renewed the credit facility with the May 16, 2007, maturity date. The new maturity date for this credit facility is May 14,10, 2008. The interest rate on any borrowing under either of these facilities is variable and based on market factors and the rating of TVA’s senior unsecured long-term non-credit enhanced debt. TVA is required to pay an unused facility fee on the portion of the total $2.5 billion against which TVA has not borrowed. The fee may fluctuate depending on the non-enhanced credit ratings on TVA’s senior unsecured long-term debt. There were no outstanding borrowings under the facilities at MarchDecember 31, 2007. TVA anticipates renewing each credit facility from time to time.
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Comparative Cash Flow Analysis
2007
2008 Compared to 20062007
Net cash provided by operating activities increased $152decreased $106 million from $793$324 million to $945$218 million for the sixthree months ended MarchDecember 31, 2006, and 2007, respectively. This increasedecrease resulted from:
| • | | An increase in cash provided by operating revenues of $261 million resulting primarily from higher average rates and increased demand for industries directly served in the first six months of 2007; |
|
| • | | Less cash paid for interest of $27 million in the first six months of 2007; and |
|
| • | | Proceeds from customers of $34 million in the first six months of 2007 related to a future generation reserve. |
These items wereAn increase in cash used by changes in working capital of $140 million resulting primarily from a larger increase in inventories and other of $25 million and a $164 million greater reduction in accounts payable and accrued liabilities, partially offset by:by a $42 million greater decrease in accounts receivable and a $7 million smaller reduction in interest payable;
| • | | An increase in cash paid for fuel and purchased power of $145 million due to higher volume of fuel and purchased power as well as increased market prices for fuel; |
|
| • | | An increase in tax equivalent payments of $30 million; and |
|
| • | | An increase in expenditures for nuclear refueling outages of $43 million due to two planned outages in the first six months of the current year compared to one planned outage in the prior year. |
Page 27
Changes
An increase in componentscash paid for fuel and purchased power of working capital resulted$118 million due to higher volume and increased market prices for purchased power;
An increase in a $12 million sourcecash paid for interest of cash for the first six months of 2007 compared to a $61 million use of cash for the same period in 2006. This change resulted primarily from:$39 million;
| • | | A smaller increase in inventories and other of $53 million in the first six months of 2007 due to higher beginning fuel inventories in the current year resulting in decreased purchases of coal; and |
|
| • | | A smaller decrease in accounts payable and accrued liabilities of $34 million in the first six months of 2007 due to timing of accruals and an increase in distributor revenues collected in advance. |
These items were partially offset by:
| • | | An $8 million reduction in accounts receivable collections; and |
|
| • | | A smaller increase in accrued interest of $6 million. |
An increase in cash outlays for routine and recurring operating costs of $35 million; and
Cash used
An increase in investing activities increased $83 million from the first six monthstax equivalent payments of 2006 to the first six months of 2007. The increase was primarily due to:$13 million.
| • | | An increase in expenditures for capital projects of $85 million primarily due to increased expenditures of $84 million related to the Watts Bar Steam Generator Replacement project and a corresponding increase in AFUDC of $20 million, partially offset by a decrease in expenditures for the Browns Ferry Unit 1 restart of $30 million; and |
|
| • | | An increase in expenditures of $98 million to acquire the Gleason and Marshall County combustion turbine facilities. |
These items were partially offset by:
| • | | A decrease in expenditures for the enrichment and fabrication of nuclear fuel of $64 million related to the restart of Browns Ferry Unit 1; and |
|
| • | | A larger source from collateral deposits in the first six months of 2007 of $35 million as compared to the first six months of 2006. See Note 1 —Summary of Significant Accounting Policies — Restricted Cash and Investments. |
Page 27 of 47
Net cash used in financing activities increased $186 million from the first six months of 2006 to the first six months of 2007 primarily due to:
| • | | A decrease of $40 million in long-term debt issues; and |
|
| • | | An increase in redemptions and repurchases of long-term debt of $309 million. |
These items were partially offset by an increase in operating revenues of $245 million resulting primarily from increases in revenue from municipalities and cooperatives and industries directly served, in both cases, from higher average rates and the FCA and, in the case of industries directly served, higher volume.
Cash used in investing activities decreased $71 million from the first quarter of 2007 to the first quarter of 2008. The decrease is primarily due to:
The inclusion in the first quarter of 2007 of a $98 million use of funds to acquire two combustion turbine facilities;
A $23 million reduction in the amount of restricted cash and investments held by TVA during the first quarter of 2008 compared to an $8 million increase in the amount of restricted cash and investments held by TVA during the same period of 2007; and
A decrease in expenditures for capital projects of $9 million.
These items were partially offset by an increase in expenditures for the enrichment and fabrication of nuclear fuel of $61 million related to a buildup of fuel for strategic inventory, fuel for identified upcoming Browns Ferry Nuclear Unit 3 and Watts Bar Nuclear Unit 1 outages, and blended low enriched uranium fuel and uranium purchases that are not identified to a specific outage. The effect of these increases was somewhat offset by reductions of fuel inventory for fuel loaded into the reactor at Browns Ferry.
Net cash provided by financing activities was $62 million higher for the three months ended December 31, 2007, compared to the same quarter of the prior year. The increase was primarily due to:
A decrease in redemptions and repurchases of long-term debt of $77 million, with no long-term debt retired in the first quarter of 2008; and
An increase in long-term debt issues of $32 million as a result of the issuance of $41 million of long-term debt.
These items were partially offset by a decrease in net issuances of short-term debt of $165$47 million in the first six monthsquarter of 20072008 compared to the same period inquarter of the prior year.
Cash Requirements and Contractual Obligations
The estimated cash requirements and contractual obligations for TVA as of MarchDecember 31, 2007, are detailed in the following table.
Commitments & Contingencies
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Total | | | 2007(1) | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | Thereafter | |
| | | |
Debt(2) | | $ | 22,711 | | | $ | 2,638 | | | $ | 90 | | | $ | 2,030 | | | $ | 63 | | | $ | 1,015 | | | $ | 16,875 | |
| Interest payments relating to debt | | | 21,099 | | | | 600 | | | | 1,173 | | | | 1,117 | | | | 1,063 | | | | 1,032 | | | | 16,114 | |
| Leases | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-cancelable operating | | | 114 | | | | 22 | | | | 40 | | | | 26 | | | | 13 | | | | 5 | | | | 8 | |
| Capital | | | 240 | | | | 31 | | | | 59 | | | | 58 | | | | 57 | | | | 29 | | | | 6 | |
| Power purchase obligations | | | 4,596 | | | | 117 | | | | 162 | | | | 171 | | | | 173 | | | | 174 | | | | 3,799 | |
| Purchase obligations | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fuel purchase obligations | | | 3,342 | | | | 1,029 | | | | 543 | | | | 504 | | | | 482 | | | | 223 | | | | 561 | |
| Other obligations | | | 454 | | | | 107 | | | | 205 | | | | 125 | | | | 8 | | | | 2 | | | | 7 | |
| Payments on other financings | | | 1,507 | | | | 35 | | | | 89 | | | | 85 | | | | 89 | | | | 95 | | | | 1,114 | |
Payment to the U.S. Treasury(3) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Return of appropriation investment | | | 150 | | | | 20 | | | | 20 | | | | 20 | | | | 20 | | | | 20 | | | | 50 | |
| Return on appropriation investment | | | 282 | | | | 20 | | | | 23 | | | | 22 | | | | 21 | | | | 20 | | | | 176 | |
| Retirement plans | | | 44 | | | | 44 | | | | — | | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 54,539 | | | $ | 4,663 | | | $ | 2,404 | | | $ | 4,158 | | | $ | 1,989 | | | $ | 2,615 | | | $ | 38,710 | |
| | | | | | | | | | | | | | | | | | | | | | |
Commitments and Contingencies |
| | | Total | | | 2008 (1) | | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | Thereafter | |
| | | | | | | | | | | | | | | | | | | | | | |
| Debt | | $ | 22,685 | (2) | | $ | 1,655 | | | $ | 2,031 | | | $ | 62 | | | $ | 1,015 | | | $ | 1,525 | | | $ | 16,397 | |
| Interest payments relating to debt | | | 20,724 | | | | 838 | | | | 1,228 | | | | 1,120 | | | | 1,089 | | | | 1,060 | | | | 15,389 | |
| Lease obligations | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Capital | | | 180 | | | | 30 | | | | 58 | | | | 57 | | | | 29 | | | | 3 | | | | 3 | |
| Non-cancelable operating | | | 411 | | | | 47 | | | | 50 | | | | 39 | | | | 29 | | | | 27 | | | | 219 | |
| Purchase obligations | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Power | | | 5,929 | | | | 175 | | | | 221 | | | | 237 | | | | 242 | | | | 248 | | | | 4,806 | |
| Fuel | | | 3,136 | | | | 982 | | | | 557 | | | | 528 | | | | 220 | | | | 258 | | | | 591 | |
| Other | | | 658 | | | | 239 | | | | 212 | | | | 32 | | | | 28 | | | | 27 | | | | 120 | |
| Payments on other financings | | | 1,467 | | | | 83 | | | | 85 | | | | 89 | | | | 95 | | | | 97 | | | | 1,018 | |
Payment to U.S. Treasury (3) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Return of Power Facilities Appropriation Investment | | | 130 | | | | 20 | | | | 20 | | | | 20 | | | | 20 | | | | 20 | | | | 30 | |
Return on Power Facilities Appropriation Investment | | | 258 | | | | 19 | | | | 22 | | | | 21 | | | | 20 | | | | 18 | | | | 158 | |
Retirement plans (4) | | | 81 | | | | 81 | | | | – | | | | – | | | | – | | | | – | | | | – | |
| Total | | $ | 55,659 | | | $ | 4,169 | | | $ | 4,484 | | | $ | 2,205 | | | $ | 2,787 | | | $ | 3,283 | | | $ | 38,731 | |
Notes
| | |
Notes: |
| |
| (1) | | Period AprilJanuary 1 —- September 30, 2007.2008. |
| |
| (2) | | Does not include noncash items of foreign currency valuation loss of $252$264 million and unamortizednet discount on sale of $178Bonds of $189 million. |
| |
| (3) | | TVA has access to financing arrangements with the U.S. Treasury whereby the U.S. Treasury is authorized to accept from TVA a short-term note with the maturity of one year or less in an amount not to exceed $150 million. TVA may draw any portion of the authorized $150 million during the year. Interest is accrued daily at a rate determined by the United States Secretary of the Treasury each month based on the average rate on outstanding marketable obligations of the United States with maturities of one year or less. During 2006, the daily average outstanding balance was $131 million. TVA’s practice is to repay on a quarterly basis the outstanding balance of the note and related interest. Because of this practice, there was no outstanding balance on the note as of MarchDecember 31, 2007. Accordingly, the Commitments and Contingencies table does not include any outstanding payment obligations to the U.S. Treasury for this note at MarchDecember 31, 2007. |
| (4) | TVA’s Board plans to evaluate the need for future funding on an annual basis through the ratemaking process. |
In addition to the cash requirements above, TVA has contractual obligations to provide powerin the form of revenue discounts related to energy prepayments. See Note 1 —Energy Prepayment Obligations.
Energy Prepayment Obligations.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Total | | | 2007* | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | Thereafter | |
| | | |
| Energy prepayment obligations | | $ | 1,191 | | | $ | 53 | | | $ | 106 | | | $ | 105 | | | $ | 105 | | | $ | 105 | | | $ | 717 | |
| | | | | | | | | | | | | | | | | | | | | | |
| | | Total | | | 2008 (1) | | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | Thereafter | |
| | | | | | | | | | | | | | | | | | | | | | |
| Energy Prepayment Obligations | | $ | 1,112 | | | $ | 79 | | | $ | 105 | | | $ | 105 | | | $ | 105 | | | $ | 105 | | | $ | 613 | |
Note
| (1) | Period January 1 - September 30, 2008. |
During the first quarter of 2008, TVA executed certain contracts related to the resumption of construction activities at Watts Bar Nuclear Plant Unit 2. As of December 31, 2007, expenditures against these contracts are forecasted to be approximately $1.2 billion.
| | |
Note: |
|
* | | Period April 1 — September 30, 2007. |
Bear Creek Dam is experiencing foundation problems as evidenced by seepage through the foundationPage 29
Financial Results
The following table compares operating results and selected statistics for the three and six months ended MarchDecember 31, 2007, and 2006.2006:
Summary Statements of Income
| | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | | Six Months Ended | |
| | | March 31 | | | March 31 | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | |
| Operating revenues | | $ | 2,277 | | | $ | 2,048 | | | $ | 4,381 | | | $ | 4,100 | |
| Operating expenses | | | (1,891 | ) | | | (1,766 | ) | | | (3,679 | ) | | | (3,593 | ) |
| | | | | | | | | | | | | |
| Operating income | | | 386 | | | | 282 | | | | 702 | | | | 507 | |
| Other income | | | 18 | | | | 16 | | | | 30 | | | | 28 | |
| Unrealized gain on derivative contracts, net | | | 16 | | | | 21 | | | | 31 | | | | 35 | |
| Interest expense, net | | | (294 | ) | | | (305 | ) | | | (586 | ) | | | (609 | ) |
| | | | | | | | | | | | | |
| Net income (loss) | | $ | 126 | | | $ | 14 | | | $ | 177 | | | $ | (39 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Sales (millions of kWh) | | | 43,760 | | | | 41,585 | | | | 83,275 | | | | 83,060 | |
| | | | | | | | | | | | | | | | | |
| Heating degree days (normal 1,874 and 3,194, respectively) | | | 1,632 | | | | 1,609 | | | | 2,859 | | | | 2,962 | |
| Cooling degree days (normal 9 and 68, respectively) | | | 63 | | | | 20 | | | | 126 | | | | 139 | |
| | | | | | | | | | | | | |
| Combined degree days (normal 1,883 and 3,262, respectively) | | | 1,695 | | | | 1,629 | | | | 2,985 | | | | 3,101 | |
| | | | | | | | | | | | | |
| | | 2007 | | | 2006 | |
| | | | | | | |
| Operating revenues | | $ | 2,350 | | | $ | 2,104 | |
| Operating expenses | | | (2,038 | ) | | | (1,788 | ) |
| Operating income | | | 312 | | | | 316 | |
| Other income | | | 2 | | | | 12 | |
| Unrealized gain on derivative contracts, net | | | – | | | | 15 | |
| Interest expense, net | | | (331 | ) | | | (292 | ) |
| Net (loss) income | | $ | (17 | ) | | $ | 51 | |
| | | | | | | | | |
| Sales (millions of kWh) | | | 40,441 | | | | 39,515 | |
| | | | | | | | | |
| Heating degree days (normal 1,311) | | | 1,058 | | | | 1,227 | |
| Cooling degree days (normal 64) | | | 150 | | | | 63 | |
| Combined degree days (normal 1,375) | | | 1,208 | | | | 1,290 | |
| | | | | | | | | |
Net incomeloss for the second quarter ofthree months ended December 31, 2007, was $126$17 million compared to net income of $14$51 million for the same period in 2006. Significant items contributing to the $112The $68 million increasechange in net income for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, included a $229 million increase in operating revenues, an $11 million decrease in net interest expense, and a $2 million increase in other income. was primarily attributable to:
| • | A $250 million increase in operating expenses; |
| • | A $39 million increase in net interest expense resulting primarily from a change in ratemaking methodology relating to AFUDC; |
| • | A $15 million decrease in net unrealized gain on derivative contracts resulting primarily from a change in ratemaking methodology for gains and losses on certain derivative instruments used in call monetization transactions; and |
| • | A $10 million decrease in other income. |
These items were partially offset by a $125$246 million increase in operating expensesrevenues.
Operating Revenues. Operating revenues and a $5 million decrease in unrealized gain on derivative contracts, net.
Net income through the first two quarterssales of 2007 was $177 million compared to a net loss of $39 millionelectricity for the same period in 2006. three months ended December 31, 2007, and 2006, consisted of the following:
Operating Revenues and Sales of Electricity For the Three Months Ended December 31 | |
| | |
| | | Operating Revenues | | | Sales of Electricity | |
| | | (millions of dollars) | | | (millions of kWh) | |
| | | 2007 | | | 2006 | | | Percent Change | | | 2007 | | | 2006 | | | Percent Change | |
| | | | | | | | | | | | | | | | | | | |
| Sales of Electricity | | | | | | | | | | | | | | | | | | |
| Municipalities and cooperatives | | $ | 1,905 | | | $ | 1,742 | | | | 9.4 | % | | | 30,182 | | | | 30,907 | | | | (2.3 | %) |
| Industries directly served | | | 392 | | | | 302 | | | | 29.8 | % | | | 9,818 | | | | 8,108 | | | | 21.1 | % |
| Federal agencies and other | | | 25 | | | | 25 | | | | 0.0 | % | | | 441 | | | | 500 | | | | (11.8 | %) |
| Other revenue | | | 28 | | | | 35 | | | | (20.0 | %) | | | – | | | | – | | | | – | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 2,350 | | | $ | 2,104 | | | | 11.7 | % | | | 40,441 | | | | 39,515 | | | | 2.3 | % |
Significant items contributing to the $216 million change in net income for the six months ended March 31, 2007, as compared to the six months ended March 31, 2006, included a $281$246 million increase in operating revenues a $23 million decrease in net interest expense, and a $2 million increase in other income. These items were partially offset by an $86 million increase in operating expenses and a $4 million decrease in unrealized gain on derivative contracts, net.included:
Operating Revenues.Below is a detailed table of operating revenues for the three and six months ended March 31, 2007, and 2006.
Operating Revenues
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | | Six Months Ended | |
| | | March 31 | | March 31 |
| | | | | | | | | | | Percent | | | | | | | | | | | Percent | |
| | | 2007 | | | 2006 | | | Change | | | 2007 | | | 2006 | | | Change | |
| | | | | |
| Sales of Electricity | | | | | | | | | | | | | | | | | | | | | | | | |
| Municipalities and cooperatives | | $ | 1,922 | | | $ | 1,745 | | | | 10.1 | % | | $ | 3,664 | | | $ | 3,508 | | | | 4.4 | % |
| Industries directly served | | | 301 | | | | 245 | | | | 22.9 | % | | | 603 | | | | 475 | | | | 26.9 | % |
| Federal agencies and other | | | 26 | | | | 32 | | | | (18.8 | %) | | | 51 | | | | 58 | | | | (12.1 | %) |
| Other revenue | | | 28 | | | | 26 | | | | 7.7 | % | | | 63 | | | | 59 | | | | 6.8 | % |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total operating revenues | | $ | 2,277 | | | $ | 2,048 | | | | 11.2 | % | | $ | 4,381 | | | $ | 4,100 | | | | 6.9 | % |
| | | | | | | | | | | | | | | | | | | |
Page 29 of 47
Significant items contributing to the $229 million increase in operating revenues for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, include:
| | • | | A $177$163 million increase in revenuesrevenue from municipalities and cooperatives primarily due to the FCA. The FCA provided $140 million in additional revenues with another $64 million primarily provided by fluctuations in rates related to certain types of energy programs and credits. This increase was partially offset by decreased sales of 2.3 percent, which reduced revenue by $41 million; and |
| • | A $90 million increase in revenue from industries directly served primarily attributable to increased sales of 6.921.1 percent, the FCA and an increasefluctuations in average rates related to certain types of 4.1 percent;energy programs and |
|
| • | | A $56 credits. Increased sales, the FCA, and fluctuations in rates related to certain types of energy programs and credits yielded $61 million, increase$18 million, and $11 million, respectively, in revenues from industries directly served attributable to increased sales of 0.1 percent and an increase in average rates of 23.4 percent.additional revenue. |
Average rates increased primarily due to the 10.0 percent increase in firm wholesale electric rates effective April 1, 2006, partially offset by the 4.5 percent decrease in firm wholesale electric rates effective October 1, 2006.
These items were partially offset by a $5 million decrease in revenues from off-system sales (included inFederal Agencies and Other) due to decreased sales of 58.4 percent and a decrease in average rates of 20.8 percent, reflecting unfavorable market conditions.
Significant items contributing to the $281 million increase in operating revenues for the six months ended March 31, 2007, as compared to the six months ended March 31, 2006, include:
| • | | A $156 million increase in revenues from municipalities and cooperatives attributable to increased sales of 0.1 percent and an increase in average rates of 5.2 percent; and |
|
| • | | A $128 million increase in revenues from industries directly served attributable to increased sales of 1.3 percent and an increase in average rates of 26.0 percent. |
Average rates increased mainly due to the 10.0 percent increase in firm wholesale electric rates effective April 1, 2006, partially offset by the 4.5 percent decrease in firm wholesale electric rates effective October 1, 2006.
These items were partially offset by a $5 million decrease in revenues from federal agencies directly served (included inFederal Agencies and Other) reflecting a decrease in average rates of 2.0 percent and decreased sales of 8.1 percent, primarily as a result of a decrease in demand by one of TVA’s largest directly served federal agencies due to a change in the nature and scope of its test programs.
A detailed table of electricity sales for the three and six months ended March 31, 2007, and 2006 is below.
Electricity Sales
(Millions of kWh)
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | | Six Months Ended | |
| | | March 31 | | March 31 |
| | | | | | | | | | | Percent | | | | | | | | | | | Percent | |
| | | 2007 | | | 2006 | | | Change | | | 2007 | | | 2006 | | | Change | |
| | | | | |
| Sales of electricity | | | | | | | | | | | | | | | | | | | | | | | | |
| Municipalities and cooperatives | | | 35,102 | | | | 32,828 | | | | 6.9 | % | | | 66,009 | | | | 65,932 | | | | 0.1 | % |
| Industries directly served | | | 8,175 | | | | 8,166 | | | | 0.1 | % | | | 16,283 | | | | 16,078 | | | | 1.3 | % |
| Federal agencies and other | | | 483 | | | | 591 | | | | (18.3 | %) | | | 983 | | | | 1,050 | | | | (6.4 | %) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total sales of electricity | | | 43,760 | | | | 41,585 | | | | 5.2 | % | | | 83,275 | | | | 83,060 | | | | 0.3 | % |
| | | | | | | | | | | | | | | | | | | |
Page 30 of 47
A significant item contributing to the 2,175 million kilowatt-hour increase in electricity sales for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, was the 2,274 million kilowatt-hour increase in sales to municipalities and cooperatives. The primary reason for the increase in sales was an increase in combined degree days of 4.1 percent. Sales to municipalities and cooperatives react more to weather than other categories of sales because residential power demand is more weather sensitive. During the three months ended March 31, 2007, there were 23, or 1.4 percent, more heating degree days and 43, or 215.0 percent, more cooling degree days than during the three months ended March 31, 2006.
Note:
TVA uses weather degree days to measure the impact of weather on TVA’s power operations. TVA calculates weather degree days for each of the five largest cities in TVA’s service area. If the average temperature for a given day in one of these cities exceeds 65 degrees Fahrenheit, that city will have cooling degree days for that day equal to the amount by which the average temperature for that day exceeds 65 degrees Fahrenheit. Similarly, if the average temperature for a given day in one of these cities is lower than 65 degrees Fahrenheit, that city will have heating degree days for that day equal to the amount by which 65 degrees Fahrenheit exceeds the average temperature for that day.
This increase was partially offset by:
| • | | A 28 million kilowatt-hour decrease in sales to federal agencies directly served (included inFederal Agencies and Other) primarily as a result of a decrease in demand by one of TVA’s largest directly served federal agencies due to a change in the nature and scope of its test programs; and |
|
| • | | An 80 million kilowatt-hour decrease in off-system sales (included inFederal Agencies and Other) attributable to decreased generation available for sale primarily as a result of the record-setting dry period. |
Significant items contributing to the 215 million kilowatt-hour increase in electricity sales for the six months ended March 31, 2007, as compared to the six months ended March 31, 2006, include:
| • | | A 77 million kilowatt-hour increase in sales to municipalities and cooperatives due to favorable economic growth in the service area, partially offset by a decrease in combined weather degree days of 3.7 percent; and |
|
| • | | A 205 million kilowatt-hour increase in sales to industries directly served mainly as a result of increased sales to TVA’s largest directly served industrial customer to accommodate higher production levels at its facility, partially offset by decreased sales to other large directly served industrial customers reflecting reduced demand due to more unplanned outages at those facilities compared to the prior period. |
These items were partially offset by a 72 million kilowatt-hour decrease in sales to federal agencies directly served (included inFederal Agencies and Other) primarily as a result of a decrease in demand by one of TVA’s largest directly served federal agencies due to a change in the nature and scope of its test programs.
Operating Expenses.Below is a detailed table of operating expenses for the three and six months ended March 31, 2007, and 2006.
Operating Expenses
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | | Six Months Ended | |
| | | March 31 | | | March 31 | |
| | | | | | | | | | | Percent | | | | | | | | | | | Percent | |
| | | 2007 | | | 2006 | | | Change | | | 2007 | | | 2006 | | | Change | |
| Operating expenses | | | | | | | | | | | | | | | | | | | | | | | | |
| Fuel and purchased power | | $ | 824 | | | $ | 717 | | | | 14.9 | % | | $ | 1,563 | | | $ | 1,462 | | | | 6.9 | % |
| Operating and maintenance | | | 576 | | | | 567 | | | | 1.6 | % | | | 1,161 | | | | 1,167 | | | | (0.5 | %) |
| Depreciation, amortization, and accretion | | | 382 | | | | 389 | | | | (1.8 | %) | | | 738 | | | | 777 | | | | (5.0 | %) |
| Tax equivalents | | | 109 | | | | 93 | | | | 17.2 | % | | | 217 | | | | 187 | | | | 16.0 | % |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | $ | 1,891 | | | $ | 1,766 | | | | 7.1 | % | | $ | 3,679 | | | $ | 3,593 | | | | 2.4 | % |
| | | | | | | | | | | | | | | | | | | |
Page 31 of 47
Significant drivers contributing to the $125 million increase in operating expenses for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, include:
| • | | A $10 million increase in fuel expense reflecting higher aggregate fuel cost per kilowatt-hour net thermal generation of 0.2 percent, increased generation of 1.1 percent and 159.1 percent at the coal-fired and combustion turbine plants, respectively, in part because of lower hydroelectric generation, and a FCA deferral for fuel expense of $6 million. In accordance with the FCA methodology, TVA has deferred the amount of fuel costs that were lower than the amount included in power rates for the first quarter of 2007. This $6 million deferred amount will be refunded to customers in future FCA adjustments; |
|
| • | | A $97 million increase in purchased power expense due to higher volume acquired of 66.2 percent to accommodate for decreased total generation of 1.4 percent, partially offset by a decreased average purchase price of 6.2 percent and a FCA deferral for purchased power expense of $30 million. In accordance with the FCA methodology, TVA has deferred the amount of purchased power costs that were higher than the amount included in power rates for the first quarter of 2007. This $30 million deferred amount will be charged to customers in future FCA adjustments; |
|
| • | | A $9 million increase in operating and maintenance expense mainly as a result of increased outage and routine operating and maintenance costs at fossil-fired plants of $32 million due to more planned outages during the second quarter of 2007 and the significant planned recovery work on the three Paradise coal-fired units, partially offset by decreased pension financing costs of $22 million attributable to a 0.52 percent higher discount rate and a 0.50 percent higher than expected long-term rate of return on pension plan assets; and |
|
| • | | A $16 million increase in tax equivalent payments reflecting increased gross revenues from the sale of power during 2006 as compared to 2005. |
These items were partially offset by a $7 million decrease in depreciation, amortization, and accretion expense largelyother revenue primarily due to decreased revenue from salvage sales and a $9gain on the sale of sulfur dioxide (“SO2”) emission allowances during the first quarter of 2007 not present in the first quarter of 2008.
A significant item contributing to the 926 million decreasekilowatt-hour increase in depreciation expense primarilyelectricity sales included a 1,710 million kilowatt-hour increase in sales to industries directly served. This was mainly attributable to the depreciation rate reduction for Browns Ferry Nuclear Plant reflecting the 20-year license extension approved on May 4, 2006,increased demand from TVA’s largest and second largest directly served industrial customers of 24.2 percent and 82.2 percent, respectively, to accommodate higher production levels at their facilities. In addition, aggregate demand from a few other large directly served industrial customers increased 26.0 percent as a result of changes in product mix and higher production levels at their facilities.
This increase in sales to industries directly served was partially offset by a $2 million increase in accretion expenseby:
| • | A 725 million kilowatt-hour decrease in sales to municipalities and cooperatives largely due to a significant decrease in unbilled sales, which consist primarily of residential sales, firm sales, and distribution losses. Sales to municipalities and cooperatives react more to weather than other categories of sales because residential demand is more weather sensitive. For the first quarter of 2008, there was a decrease in combined degree days of 82 days, or 6.4 percent. |
| • | A 59 million kilowatt-hour decrease in sales to Federal agencies and other. |
| ° | This decrease was due to an 86 million kilowatt-hour decrease in off-system sales mainly reflecting decreased generation available for sale. |
| ° | The decrease in off-system sales was partially offset by a 27 million kilowatt-hour increase in sales to directly served federal agencies largely attributable to an increase in demand by several directly served federal agencies as a result of a change in the nature and scope of their loads. |
Operating Expenses. Operating expenses for the adoptionthree months ended December 31, 2007, and 2006, consisted of FASB Interpretation (“FIN”) No. 47 and the updated incremental accretion for Statementfollowing:
Operating Expenses For the Three Months Ended December 31 | |
| | |
| | | 2007 | | | 2006 | | | Percent Change | |
| | | | | | | | | | |
| Fuel and purchased power | | $ | 935 | | | $ | 739 | | | | 26.5 | % |
| Operating and maintenance | | | 592 | | | | 563 | | | | 5.2 | % |
| Depreciation, amortization, and accretion | | | 390 | | | | 356 | | | | 9.6 | % |
| Tax equivalents | | | 121 | | | | 108 | | | | 12.0 | % |
| Loss on asset impairment | | | – | | | | 22 | | | | (100.0 | %) |
| Total operating expenses | | $ | 2,038 | | | $ | 1,788 | | | | 14.0 | % |
Significant drivers contributing to the $86$250 million increase in total operating expenses for the six months ended March 31, 2007, as compared to the six months ended March 31, 2006, include:included:
A $196 million increase in Fuel and purchased power expense.
| | •° | | A $36This increase was due to a $153 million increase in purchased power expense and a $43 million increase in fuel expense. |
| – | The increase in purchased power expense asresulted from: |
| • | An increase in the average purchase price of 20.4 percent, which resulted in $77 million in additional expense; |
| • | An increase in the volume of purchased power of 40.7 percent, which resulted in $55 million in additional expense; and |
| • | An increase in the FCA net deferral and amortization for purchased power expense of $21 million. |
| – | The increase in fuel expense resulted from: |
| • | An increase in the net commercial generation of 7.7 percent, which resulted in $43 million in additional expense; and |
| • | An increase in the FCA net deferral and amortization for fuel expense of $43 million. |
| – | The increase in fuel expense was partially offset by a result of higher7.0 percent lower aggregate fuel cost per kilowatt-hour net thermal generation, of 9.2 percent and increased generation of 2.6 percent and 42.0 percent at the coal-fired and combustion turbine plants, respectively, partially offset by a FCA deferral forwhich reduced fuel expense of $33by $43 million. In accordance with the FCA methodology, TVA has deferred the amount of fuel costs that were higher than the amount included in power rates for the first two quarters of 2007. This $33 million deferred amount will be charged to customers in future FCA adjustments; |
| |
| • | | A $65$34 million increase in purchased power expense attributable to higher volume acquired of 38.2 percent to accommodate for decreased total generation of 2.1 percent, partially offset by a decreased average purchase price of 16.5 percentDepreciation, amortization, and a FCA deferral for purchased power expense of $7 million. In accordance with the FCA methodology, TVA has deferred the amount of purchased power costs that were higher than the amount included in power rates for the first two quarters of 2007. This $7 million deferred amount will be charged to customers in future FCA adjustments; and |
|
| • | | A $30 million increase in tax equivalent payments reflecting increased gross revenues from the sale of power during 2006 as compared to 2005.accretion expense. |
Page 32 of 47
These items were partially offset by:
| | •° | | A $6 million decrease in operating and maintenance expense primarily due to decreased pension financing costs of $45 million asThis increase was a result of a 0.52 percent higher discount rate$34 million increase in depreciation expense. |
| – | An increase in depreciation rates at several of TVA’s facilities; and |
| – | An increase in completed plant accounts due to net plant additions. |
A $29 million increase in Operating and maintenance expense.
| ° | This increase was mainly a 0.50 percent higher than expected long-term rate of return on pension plan assets, partially offset by increasedresult of: |
| – | Increased outage and routine operating and maintenance costs at fossil-firedcoal-fired plants of $15$36 million largely due toto: |
| • | An increase in outage days of 173 days as a result of one more planned outage and a change in the nature and scope of the outages during the first six monthsquarter of 2008, |
| • | Significant repair work on Unit 3 at Paradise Fossil Plant not present in the first quarter of 2007, and the significant planned recovery work on the three Paradise Fossil Plant coal-fired units, a $17 million write-down of a scrubber project at TVA’s Colbert Fossil Plant (“Colbert”), and write-downs of $5 million relating to other construction work-in-progress; and |
|
| • | | A $39 million decrease in depreciation, amortization, and accretion expense largely due to a $45 million decrease in depreciation expense primarily attributable to the depreciation rate reduction for Browns Ferry Nuclear Plant reflecting the 20-year license extension approved on May 4, 2006, partially offset by a $6 million increase in accretion expense mainly reflecting the adoption of FIN No. 47 and the updated incremental accretion for SFAS No. 143. |
| • | The operation of two additional combustion turbine units not operated during the first quarter of 2007; and |
| – | Increased routine operating and maintenance costs at nuclear plants of $19 million primarily attributable to: |
| • | The operation of an additional nuclear unit not operated in the first quarter of 2007, |
| • | Timing of contractor work and materials purchased, and |
| • | Timing of mid-cycle and forced outages. |
| ° | These items were partially offset by: |
| – | Decreased pension costs of $15 million mainly as a result of a 0.35 percent higher discount rate used during the first quarter of 2008; and |
| – | A decrease in the FCA net deferral and amortization for operating and maintenance expense of $3 million. |
A $13 million increase in Tax equivalent payments reflecting increased gross revenues from the sale of power (excluding sales or deliveries to other federal agencies and off-system sales with other utilities) during 2007 compared to 2006.
The increases in Fuel and purchased power expense, Depreciation, amortization, and accretion expense, Operating and maintenance expense, and Tax equivalent payments were partially offset by a $22 million decrease in Loss on asset impairment. There was no Loss on asset impairment during the first quarter of 2008. During the first quarter of 2007, a $22 million Loss on asset impairment was recorded as a result of a $17 million write-down of a scrubber project at TVA’s Colbert Fossil Plant (“Colbert”) and write-downs of $5 million related to other Construction in progress assets. See Note 6.
Other Income.Income. The $10 million decrease in Other income was $2 million higher for the threelargely due to decreased interest income from short-term investments and six months ended March 31, 2007, as compared to the same periods in 2006, reflecting increaseddecreased interest earnings on the collateral deposit funds held by TVA. See note 1 —Restricted Cash and Investments.
Unrealized Gain on Derivative Contracts, Net.Significant items contributing to the $5 million decrease in net unrealized gain on derivative contracts for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, include:
| • | | A $42 million smaller gain related to the mark-to-market valuation of swaption contracts, from a $59 million gain in the second quarter of 2006 to a $17 million gain in the second quarter of 2007; and |
|
| • | | A $30 million net change related to the mark-to-market valuation adjustment of an interest rate swap contract, from a $30 million gain in the second quarter of 2006 to no gain or loss in the second quarter of 2007. |
These items were partially offset by a $67 million smaller loss related to the mark-to-market valuation adjustment of an embedded call option, frompayment received by TVA in connection with a $68 million loss in the second quarter of 2006 to a $1 million loss in the second quarter of 2007.False Claims Act suit.
Significant items contributing to the $4
Unrealized Gain on Derivative Contracts, Net. The $15 million decrease in net unrealizedUnrealized gain on derivative contracts, net was attributable to a change in ratemaking methodology. Beginning in 2008, TVA began using regulatory accounting treatment for swaps and swaptions related to call monetization transactions to better match the income statement recognition of gain and loss with the economic reality of when these transactions actually settle. This treatment removes the non-cash impacts to TVA’s earnings that result from marking the value of these instruments to market each quarter. The values of the swaps and swaptions for the six months ended March 31, 2007,first quarter of 2008 were recorded on TVA’s balance sheet and no income was recognized. However, TVA recognized $15 million as compared to the same period in 2006 include:
A $29 million smallerUnrealized gain related to the mark-to-market valuation of swaptionon derivative contracts, from a $51 million gain innet for the first two quartersquarter of 2006 to a $22 million gain in the first two quarters of 2007; and
2007.A $33 million smaller gain related to the mark-to-market valuation adjustment of an interest rate swap contract, from a $43 million gain in the first two quarters of 2006 to a $10 million gain in the first two quarters of 2007.
These items were partially offset by a $58 million smaller loss related to the mark-to-market valuation adjustment of an embedded call option, from a $60 million loss in the first two quarters of 2006 to a $2 million loss in the first two quarters of 2007.
Page 33 of 47
Interest Expense. A detailed table of interestInterest expense, outstanding debt, and interest rates for the three and six months ended MarchDecember 31, 2007, and 2006, is below.consisted of the following:
Interest Expense
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | | Six Months Ended | |
| | | March 31 | | | March 31 | |
| | | | | | | | | | | Percent | | | | | | | | | | | Percent | |
| | | 2007 | | | 2006 | | | Change | | | 2007 | | | 2006 | | | Change | |
| Interest expense | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest on debt | | $ | 339 | | | $ | 339 | | | | 0.0 | % | | $ | 675 | | | $ | 674 | | | | 0.1 | % |
| Amortization of debt discount, issue, and reacquisition costs, net | | | 5 | | | | 5 | | | | 0.0 | % | | | 10 | | | | 10 | | | | 0.0 | % |
| AFUDC and nuclear fuel expenditures | | | (50 | ) | | | (39 | ) | | | 28.2 | % | | | (99 | ) | | | (75 | ) | | | 32.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest expense | | $ | 294 | | | $ | 305 | | | | (3.6 | %) | | $ | 586 | | | $ | 609 | | | | (3.8 | %) |
| | | | | | | | | | | | | | | | | | | | | |
Interest Expense For the Three Months Ended December 31 | | Interest Expense For the Three Months Ended December 31 | |
| | | | 2007 | | | 2006 | | | Percent Change | |
| | | | | | | | | | | |
| Interest on debt | | | $ | 329 | | | $ | 336 | | | (2.1 | %) |
| Amortization of debt discount, issue, and reacquisition costs, net | | | 5 | | | 5 | | | 0.0 | % |
| Allowance for funds used during construction and nuclear fuel expenditures | | | | (3 | ) | | | (49 | ) | | | (93.9 | %) |
| Net interest expense | | | $ | 331 | | | $ | 292 | | | | 13.4 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Percent | | Percent | | (percent) | |
| | | 2007 | | 2006 | | Change | | 2007 | | 2006 | | Change | | 2007 | | | 2006 | | | Percent Change | |
| Interest rates (average) | | | | | | | | | | | | | |
| Long-term | | 5.98 | | 6.07 | | | (1.5 | %) | | 6.02 | | 6.06 | | | (0.7 | %) | | 5.96 | | | 5.94 | | | 0.3 | % |
| Discount notes | | 5.16 | | 4.33 | | | 19.2 | % | | 5.20 | | 4.13 | | | 25.9 | % | | 4.59 | | | 5.25 | | | (12.6 | %) |
| Blended | | 5.89 | | 5.88 | | | 0.2 | % | | 5.93 | | 5.85 | | | 1.4 | % | | 5.87 | | | 5.87 | | | 0.0 | % |
Significant items contributing to the $11$39 million decreaseincrease in net interest expense for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, include:included:
| | • | | A $46 million decrease in AFUDC and nuclear fuel expenditures primarily due to a change in ratemaking methodology. TVA continues to capitalize a portion of current interest costs associated with funds invested in most nuclear fuel inventories, but beginning in 2008, interest on funds invested in construction projects will be capitalized only if (1) the expected total cost of a project is $1 billion or more and (2) the estimated construction period is at least three years. Capitalized interest continues to be a component of the asset cost and will be recovered in future periods through depreciation expense. In addition, AFUDC continues to be a reduction to interest expense as costs are incurred. The interest costs associated with funds invested in construction projects that do not satisfy the $1 billion and three-year criteria are no longer capitalized as AFUDC, remain in the Statement of Income, and will be recovered in current year rates as a component of interest expense; |
| • | An increase in the average long-term interest rate from 6.075.94 percent during the first quarter of 2007 to 5.98 percent;5.96 percent during the same period in 2008; and |
| |
| • | • | | A decreaseAn increase of $151$499 million in the average balance of long-term outstanding debt; and |
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| • | | An $11 million increasedebt in AFUDC due to a 24.4 percent increase in the construction work in progress base.2008. |
These items were partially offset by:
| • | • | | An increaseA decrease in the average discount notes interest rate from 4.335.25 percent during the first quarter of 2007 to 5.16 percent;4.59 percent during the same period in 2008; and |
| |
| • | • | | An increaseA decrease of $88$852 million in the average balance of discount notes outstanding.outstanding in 2008. |
Significant items contributing to the $23 million decrease in interest expense for the six months ended March 31, 2007, as compared to the six months ended March 31, 2006, include:
| • | | A decrease in the average long-term interest rate from 6.06 percent to 6.02 percent; |
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| • | | A decrease of $286 million in the average balance of long-term outstanding debt; |
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| • | | A decrease of $99 million in the average balance of discount notes outstanding; and |
|
| • | | A $24 million increase in AFUDC due to a 26.0 percent increase in the construction work in progress base. |
These items were partially offset by an increase in the average discount notes interest rate from 4.13 percent to 5.20 percent.
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Off-Balance Sheet Arrangements
TVA has entered into one transaction that mightcould constitute an off-balance sheet arrangement. In February 1997, TVA entered into a purchase power agreement with Choctaw Generation, Inc. (subsequently assigned to Choctaw Generation Limited Partnership) to purchase all the power generated from its facility located in Choctaw County, Mississippi. The facility hashad a committed capacity of 440 megawatts and the term of the agreement iswas 30 years. Under the accounting guidance provided by Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,”as revisedamended by FINFASB Interpretation No. 46R (“(as amended, “FIN 46R”), TVA may be deemed to be the primary beneficiary under the contract; however, TVA does not have access to the financial records of Choctaw Generation Limited Partnership. As a result, TVA was unable to determine whether FIN 46R would require TVA to consolidate Choctaw Generation Limited Partnership’s balance sheet, results of operations, and cash flows for the yearquarter ended September 30, 2006.December 31, 2007. Power purchases for the three and six months ended March 31, 2007,first quarter of 2008 under the agreement amounted to $27 million, and $60 million, respectively, and the remaining financial commitment under this agreement is $4$5.2 billion. TVA has no additional financial commitments beyond the purchase power agreement with respect to the facility.
The preparation of financial statements requires TVA to estimate the effects of various matters that are inherently uncertain as of the date of the financial statements. Although the financial statements are prepared in conformity with generally accepted accounting principles, (“GAAP”), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the amounts of revenues and expenses reported during the reporting period. Each of these estimates varies in regardsregard to the level of judgment involved and its potential impact on TVA’s financial results. Estimates are deemed critical either when a different estimate could have reasonably been used, or where changes in the estimate are reasonably likely to occur from period to period, and such use or change would materially impact TVA’s financial condition, changes in financial position, or results of operations. TVA’s critical accounting policies are discussed inSee Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations —Critical Accounting Policies and Estimatesand Note 1 —Summary of Significant Accounting Policiesin the Annual Report.Report for a discussion of TVA’s critical accounting policies. TVA’s critical accounting policies are also discussed in Note 1 of the Notes to the Annual Report and in Note 1 of the Notes to this Quarterly Report.
TVA’s power rates are not subject to regulation through a public service commission or other similar entity. The TVATVA’s Board is authorized by the TVA Act to set rates for power sold to its customers. This rate-setting authority meets the “self-regulated” provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” and TVA meets the remaining criteria of SFAS No. 71 because (1) TVA’s regulated rates are designed to recover its costs of providing electricity and (2) in view of demand for electricity and the level of competition it is reasonable to assume that the rates, set at levels that will recover TVA’s costs, can be charged and collected. Accordingly, TVA records certain assets and liabilities that result from the regulated ratemaking process that would not be recorded under GAAPgenerally accepted accounting principles for non-regulated entities. Regulatory assets generally represent incurred costs that have been deferred because such costs are probable of future recoverylikely to be recovered in customer rates. Regulatory liabilities generally represent obligations to make refunds to customers for previous collections for costs that are not likely to be incurred. Management assesses whether the regulatory assets are probable of future recoverylikely to be recovered by considering factors such as applicable regulatory changes, potential legislation, and changes in technology. Based on this assessment,these assessments, management believes the existing regulatory assets are probable of recovery.likely to be recovered. This determination reflects the current regulatory, commercial, and political environment and is subject to change in the future. If future recovery of regulatory assets ceases to be probable, TVA couldwould be required to write-off the cost of these assetscosts under the provisions of SFAS No. 101, “Regulated Enterprises–Accounting for the Discontinuation of Application of FASB Statement No. 71.” Any asset write-offs would be required to be recognized in earnings in the period in which future recoveries cease to be probable.
TVA continues to capitalize a portion of current interest costs associated with funds invested in most nuclear fuel inventories, but beginning on October 1, 2007, interest on funds invested in construction projects will be capitalized only if (1) the expected total cost of a project is $1 billion or more and (2) the estimated construction period is at least three years. Capitalized interest continues to be a component of the asset cost and will be recovered in future periods through depreciation expense. In addition, AFUDC continues to be a reduction to interest expense as costs are incurred. The interest cost associated with funds invested in construction projects that do not satisfy the $1 billion and three-year criteria is no longer capitalized as AFUDC, remains in the Statement of Income, and will be recovered in current year rates as a component of interest expense. As a result of the new policy, TVA recorded a total of $3 million in AFUDC in the first quarter of 2008 compared to $49 million for the first quarter of 2007.
The TVA Board approved, beginning in 2008, using regulatory accounting under SFAS No. 71 ceasedtreatment for swaps and swaptions related to apply.call monetization transactions to better match the income statement recognition of gain and loss with the economic reality of when these transactions actually settle. This treatment removes the non-cash impacts to TVA’s earnings that result from marking the value of these instruments to market each quarter. The value of the swaps and swaptions will still be recorded on TVA’s balance sheet, and any interest expense impacts will continue to be reflected in TVA’s income statement. Had TVA not adopted this new accounting treatment, its net loss for the first quarter of 2008 would have decreased by $99 million.
New Accounting Standards and Interpretations
Accounting Changesfor Defined Benefit Pension and Error CorrectionsOther Postretirement Plans. In May 2005,On September 30, 2007, TVA adopted the FASB issuedprovisions contained within SFAS No. 154,158, “Employers’ Accounting Changesfor Defined Benefit Pension and Error Corrections —Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R).” This standard requires employers to fully recognize within their financial statements the obligations associated with single-employer defined benefit pension, retiree healthcare, and other postretirement plans. Specifically, the new standard requires an employer to recognize in its statement of financial position an asset for a replacementplan’s overfunded status or a liability for a plan’s underfunded status; measure a plan’s assets and its obligations that determine its funded status as of APB Opinion No. 20the end of the employer’s fiscal year (with limited exceptions); and FASB Statement No. 3,”recognize changes in the funded status of a defined benefit postretirement plan in the year in which replaces Accounting Principles Board (“APB”) Opinion No. 20,“Accounting Changes,” andthe changes occur. Such changes are to be reported within comprehensive income of a business entity (except that regulated entities may report such changes as regulatory assets and/or liabilities in accordance with the provisions of SFAS No. 3,“Reporting Accounting Changes in Interim Financial Statements.”This statement applies to all voluntary71), and within changes in accounting principles and also applies to changes required by an accounting pronouncementnet assets of a not-for-profit organization.
TVA’s 2007 adoption of SFAS No. 158 resulted in the unusual instance thatrecognition of the pronouncement does not include specific transition provisions. This statement requires, unless impracticable, retrospective application tofollowing amounts on its Balance Sheet at September 30, 2007: additional regulatory assets of $475 million (including the reclassification of $246 million in unamortized prior periods’ financial statementsservice cost previously classified as intangible assets) resulting in post-SFAS No. 158 benefit regulatory assets of changes$973 million; and additional pension and postretirement obligations of $330 million and $143 million, and $2 million classified as accumulated other comprehensive gain, resulting in accounting principles. If it is impracticable to determine the period-specific effectspost-SFAS No. 158 benefit obligations of an accounting change on one or more individual prior periods
Page 35$1,128 million. The net amount of 47
presented, this statement requires that the new accounting principle be applied to the balances ofrecognizing such amounts increased total assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. This statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This statement became effective for TVA beginning in$475 million at September 30, 2007.
Fair Value Measurements. In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” This standard provides guidance for using fair value to measure assets and liabilities that currently require fair value measurement. The standard also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. SFAS No. 157 establishes a fair value hierarchy that prioritizes the information used to develop measurement assumptions. The provisions of SFAS No. 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007,2008, and interim periods within those fiscal years. At this time, TVA is evaluating the requirements of this statementstandard and has not yet determined the impact of its implementation, which may or may not be material to TVA’s results of operations or financial position.
Accounting for Defined Benefit Pension and Other Postretirement Plans. On September 29, 2006, FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendmentPage 35
The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective for TVA as of the end of the fiscal year ending after June 15, 2007. TVA plans to apply the new standard for its 2007 year-end financial statements and recognize on its 2007 Balance Sheet the funded status of its pension and other postretirement benefit plans. However, had TVA been required to adopt the standard as of its last actuarial valuation date (September 30, 2006), TVA would have recorded the following amounts on its Balance Sheet for the year then ended: a regulatory asset of $795 million, additional pension and postretirement obligations of $368 million and $152 million, respectively, and the reclassification to regulatory assets of an intangible asset with a balance of $275 million, representing unamortized prior service cost. The net effect of recognizing such amounts would have been to increase total assets and liabilities by $520 million at that date.
Fair Value Option. In February 2007, FASB issued SFAS No. 159,“TheThe Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option established by SFAS No.159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions in this statement are elective. The provisions of SFAS No. 159 are effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157,“Fair Value Measurements.”At this time, TVA is evaluating the requirements of this statementstandard and has not yet determined the potential impact of its implementation, which may or may not be material to TVA’s results of operations or financial position.
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Offsetting Amounts. On April 30, 2007, FASB issued FASB Staff Position (“FSP”) FIN No. 39-1,, “Amendment of FASB Interpretation No. 39,”which addresses certain modifications to FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts.”This FSP replaces the termsconditional contracts “conditional contracts” andexchange contracts “exchange contracts” with the termderivative instruments “derivative instruments” as defined in SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities,Activities.”and The FSP also permits a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. The guidance in the FSP is effective for fiscal years beginning after November 15, 2007, with early application permitted. At this time, TVA is evaluating the requirements of this guidance and has not yet determined the potential impact of its implementation, which may or may not be material to TVA’s financial position.
Accounting for Misstatements.On September 13, 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108,“Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.”This bulletin provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Application of the guidance will become effective for TVA with its annual report for the year ending September 30, 2007. TVA is not aware of any potential misstatements at this time.
Legislative
TVA was created by the TVA Act, and legislation is introduced from time to time that if enacted would directly or indirectly affect TVA’s operations. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations— Legislative and Regulatory Matters in the Annual Report for a discussion of legislative initiatives that may affect TVA.
President’s Budget
On February 5, 2007,4, 2008, the Office of Management and Budget (“OMB”) transmitted the President’s proposed 20082009 federal budget to Congress. In the portions specifically relating to TVA, theThe proposed budget recommends:recommends allowing Congress to establish the amount of TVA’s Office of Inspector General’s budget and directing TVA to fund the amount with power revenues beginning in 2009. Funding for TVA’s Office of the Inspector General is currently established by TVA.
| • | | Expanding the types of financial arrangements that count towards TVA’s $30 billion debt ceiling; |
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| • | | Requiring TVA to register its debt securities with the Securities and Exchange Commission; and |
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| • | | Allowing Congress to establish the amount of TVA’s Office of Inspector General’s budget and directing TVA to fund the amount with power revenues beginning in 2008. Funding for TVA’s Office of the Inspector General is currently paid directly by TVA. |
The first recommendation has been included in a draft bill prepared by OMB, but it has not yet been introduced in Congress. The other recommendations have not been introduced in any legislation or included in any draft bill.Proposed Legislation
Draft Legislation
On March 13, 2007, Senators Jim Bunning and Mitch McConnell both Republicans fromof Kentucky introduced the Access to Competitive Power Act of 2007 (the “Bill”) in the Senate. The Bill would provide as follows:
FERC Jurisdiction –Under this bill, TVA and federal power marketing agencies would be subject to greater FERC jurisdiction with respect to transmission, including rates, terms, and conditions of service.
Anti-Cherrypicking Provision –The anti-cherrypicking provision would not apply with respect to any distributor which provided a termination notice With regard to TVA, before December 31, 2006, regardless of whether the notice was later withdrawn or rescinded. (With the exception of wheeling power to Bristol, Virginia, the anti-cherrypicking provision precludes TVA from being ordered to wheel another supplier’s power to a customer if the powerbill would be consumed within TVA’s defined service territory.)generally provide, among other things, that:
Stranded Costs –If TVA provides transmission service to any distributor pursuant to a FERC wheeling order, TVA may not recover any stranded cost from that distributor.
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Noticing Distributors –Distributors that have given termination notices to TVA on or before December 31, 2006, would have express authority under federal law to:
| (1) | (1)The anti-cherrypicking provision would not apply with respect to any distributor which provided a termination notice to TVA before December 31, 2006, regardless of whether the notice was later withdrawn or rescinded; |
| (2) | | Construct, own, and operate any generation facility, individuallyDistributors that have given termination notices to TVA on or jointly with other distributors; |
|
| (2) | | Receivebefore December 31, 2006, would have express authority under federal law to receive partial requirements services from TVA; |
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| (3) | | Receive transmission services from TVA that are sufficient to meet all electric energy requirements of the distributors; and |
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| (4) | | Elect, elect, not later than 180 days after enactment, to rescind the termination notice “without the imposition of a reintegration fee or any similar fee.fee;” |
Non-Noticing Distributors – Distributors that have not given termination notices to TVA on or before December 31, 2006, would have express authority under federal law to:
| (3) | (1) | | Construct, own, and operate any generation facility, individuallyDistributors that have not given termination notices to TVA on or jointly with another distributor; and |
|
| (2) | | Receivebefore December 31, 2006, would have express authority under federal law to receive partial requirements from TVA within a ratable limit, which cumulatively stays within a three-percentthree percent compounded annual growth rate on the TVA system.system; and |
SEPA Power – Any distributor which
| (4) | Any distributor that terminates its power supply contract with TVA in whole or in part would have the federal statutory right to directly receive its share of SEPA power that is otherwise being delivered to TVA for the benefit of all distributors. | (1) | | TVA would have to provide transmission to enable such distributor to receive its share of SEPA power at one or more of the distributor’s delivery points specified by that distributor; and | | | (2) | | The price that such distributor would pay for its SEPA power would be the same rate thatis otherwise being delivered to TVA pays for the SEPA power that it receives for the remainingbenefit of all distributors. |
Privatization – Within 180 days
In May 2007, the Government Accountability Office (“GAO”) would be requiredTVA Board approved a Strategic Plan which addresses the changing business environment and sets a new direction for TVA to conductremain economically viable and fulfill its stated mission. This Strategic Plan focuses on TVA’s performance in five broad areas and establishes general guidelines for each area. Due to the increasing environmental requirements and expectations coupled with challenges and opportunities related to natural resources, TVA is re-evaluating its high-level environmental policy to align with and execute the direction in the 2007 TVA Strategic Plan. TVA has contracted the services of a study of the “costs, benefits,consulting firm to assist TVA in updating its environmental policy and other effects of privatizing” TVA and report the results to Congress.developing TVA’s renewable strategy. TVA Debt – Within 180 days of enactment, GAO would be required to conduct a study of the financial structure of, and the amount of debt held by, TVA.
The status of this bill is unclear and the likelihood of the bill’s requirements becoming law remains unknown.
Environmental
As is the case across the utility industry and in other sectors, TVA’s activities are subject to certain federal, state, and local environmental statutes and regulations. Major areas of regulation affecting TVA’s activities include air quality control, water quality control, and management and disposal of solid and hazardous wastes. These activities are described in further detail under Item 1, Business —Environmental Mattersand Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations —Environmental Mattersin the Annual Report. TVA has incurred and continues to incur substantial capital and operating and maintenance costs in order to comply with evolving environmental requirements. Many of these costs are associated with the operation of TVA’s 59 coal-fired generating units. While it is not possible to predict with any precision how these evolving requirements will impact the operation of existing and new coal-fired and other fossil-fuel generating units, it is virtually certain that environmental requirements placed on the operation of these generating units will continue to become more restrictive. Litigation over emissions from coal-fired generating units is also occurring, including litigation against TVA. See Item 3, Legal Proceedings in the Annual Report.
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Several existing regulatory programs have been and are being made more stringent in their application to fossil-fuel units and additional regulatory programs affecting fossil-fuel units were promulgated in 2005, including the Clean Air Interstate Rule (“CAIR”), which requires significant utility reductions of emissions of sulfur dioxide and nitrogen oxides in the eastern half of the United States (including all of TVA’s operating areas), and the Clean Air Mercury Rule (“CAMR”). TVA had previously estimated its total capital cost for reducing emissions from its power plants from 1977 through 2010 to reach $5.8 billion, $4.6 billion of which had already been spent as of September 30, 2006. TVA estimates that compliance with CAIR and CAMR could lead to additional costs of $3.0 billion to $3.5 billion in the next decade if TVA should continue to operate all of its present coal plants. There could be additional material costs if reductions of carbon dioxide are mandated, or if future legislative, regulatory, or judicial actions lead to more stringent emission reduction requirements, but these costs cannot be predicted at this time. TVA will continue to monitor these developments and will assess any potential financial impacts as information becomes available.
In October 2006, TVA began operating its seventh flue gas desulphurization system (“scrubber”) on Unit 3 at its Paradise Fossil Plant (“Paradise Unit 3”) in Drakesboro, Kentucky. A scrubber removes sulfur dioxide emissions by routing gases produced from burning coal through a limestone and water mixture, which removes the sulfur dioxide and allows cleaner gases to be released through the plant stack. The Paradise Unit 3 scrubber is the largest single module in the United States. It is removing more than 95 percent of the sulfur dioxide from Paradise Unit 3. All three units at Paradise are now equipped with scrubbers. Paradise is one of TVA’s largest generating plants and provides approximately 14 billion kilowatt-hours of electricity a year.
In February 2007 TVA announced plans to install additional emissions control equipment at the John Sevier Fossil Plant located near Rogersville, Tennessee. TVA plans to add selective non-catalytic reduction (“SNCR”) systems to reduce nitrogen oxide emissions and a scrubber to reduce sulfur dioxide emissions from the four unit 712-megawatt plant. The first SNCR on Unit 1 is expected to begin operation in the summer of 2007, with similar equipment installed on the other three units by 2010. Construction of the planned scrubber is scheduled to begin in 2008 with completion scheduled for 2012.
As a part of the 2006 tri-ennial review of State Water Quality Standards in Tennessee, the Tennessee Department of Environment and Conservation (“TDEC”) has placed a portion of Barkley Reservoir downstream of TVA's Cumberland Fossil Plant on its draft 2008 list of impaired streams. This list is adoptingknown as the Environmental Protection Agency (“EPA”) recommended threshold of 0.3 parts per million (“ppm”) of mercury303d List after the section in fish as its criterion for issuing a “Precautionary Fish Consumption Advisory” (“Precautionary Advisory”). The previously used thresholds were 0.5 ppm for a Precautionary Advisory and 1.0 ppm for a “Do Not Consume Advisory.” In Tennessee a Precautionary Advisory recommendsthe Clean Water Act that sensitive populations such as children and women of child-bearing age should not consume the fish species named, and that all other persons should limit consumptionestablished these requirements. Section 303d of the named speciesClean Water Act requires states to one meal per month. A “Do Not Consume Advisory” recommendsdevelop and report to the EPA on a two-year cycle a list of waters that certain fish species shouldare "water quality limited" or are expected to not be consumed by anyone in any amount.
As a result of lowering the threshold, Precautionary Advisories have been recommended for several additional stream and reservoir segments within the State of Tennessee, including some streams and reservoir segmentsmeet water quality standards in the Tennessee Valley Watershed. TDEC’s announcement of additional Precautionary Advisories for several Tennessee water bodies does not mean that mercury levels in fish are increasing. TVA has been monitoring mercury levels in fish and sediments in TVA reservoirs for the last 35next two years and TVA’s data was provided to TDEC as a partneed additional pollution controls. This section of its review process. TVA’s data show significant reductions in mercury concentrations in fish from the reservoirs with known industrial discharges that have now ceased operation. Other than those areas historically impacted by industrial discharges, mercury concentrations in fish have tended to fluctuate through time with no discernable trend in fish from most reservoirs. Despite greatly increased burning of coal for electricity generation, current and historic data records indicate that mercury concentrations in reservoir sediments have remained stable or declined.
In November 2006, TVA received a letter from the attorneys for one of the parties conducting the removal action at the Ward Transformer Superfund Site in North Carolina that put TVA on notice that it was identified as a Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) liable party, and that one or more of the parties intends to pursue a contribution claim against TVA. The Ward Transformer site was one of two non-TVA areas identified in TVA’s Annual Report for which TVA was unable to estimate its potential liability. At TVA’s request, the attorneys provided information showing that TVA sent additional equipment thatBarkley Reservoir had not been previously identified by TVA,listed previously. The reservoir conditions in 2007, especially for temperature and dissolved oxygen, changed significantly due primarily to reduced flows in one or more transactionsthe Cumberland River resulting from emergency dam repairs on the U. S. Army Corps of Engineers' (“Corps”) Wolf Creek and Center Hill dams coupled with Ward, transformers containing PCBs which were sentthe most severe drought on record in the region. The prospect of continued reduced flows through the Cumberland River system during the period required to complete the Ward Transformer site were either repaired, rebuiltnecessary repairs to Wolf Creek and sold, or scrapped. For a further discussionCenter Hill dams may impact the generation of the Ward Transformer contamination claim, seeLegal Proceedings — Notification of Potential Liability for Ward Transformer Sitein Note 7 of this Quarterly Report.
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In addition to the on-site cleanup activities, off-site contamination has been discovered which is believed to extend to the Neuse Riverelectricity from TVA's Cumberland and includes water bodies in a county and state park. The State of North Carolina has issued fish consumption advisories due to PCBs in areas up to 20 miles downstream of the Ward Transformer site. The expansion of the area believed to have been contaminated offsite and the potential for assessments of natural resource damages to liable parties could substantially raise the cleanup costs. As yet there is no formal estimate of the costs associated with cleanup or resource damages, nor has TVA’s potential share of those costs been determined.
Legal
Legal Proceedings to Which TVA Is a Party
As discussed in Note 7,Gallatin fossil plants. TVA is involvedworking with the Corps and TDEC to minimize the impacts to TVA's generating plants and improve the conditions observed in a number of lawsuitsthe river in 2007.
TVA is subject to various legal proceedings and claims relating to a varietythat have arisen in the ordinary course of issues.business. These proceedings and claims include the matters discussed below. In accordance with SFAS No. 5, “Accounting “Accounting for Contingencies,”TVA had accrued approximately $33$27 million with respect to the proceedings described below as of MarchDecember 31, 2007, relatedas well as approximately $8 million with respect to pending litigationother proceedings that have arisen in the normal course of TVA’s business. No assurance can be given that TVA will not be subject to significant additional claims and other claims.liabilities. If actual liabilities significantly exceed this estimate,the amounts accrued, TVA’s results of operations, liquidity, and financial condition could be materially adversely affected. See Note 7. Legal Proceedings to Which
Global Warming Cases. On July 21, 2004, two lawsuits were filed against TVA Is Not a Party Thein the United States SupremeDistrict Court (the “Supreme Court”) recently issued decisions which (1) classifyfor the Southern District of New York alleging that global warming is a public nuisance and that carbon dioxide as(“CO2”) emissions from fossil-fuel electric generating facilities should be ordered abated because they contribute to causing the nuisance. The first case was filed by various states (California, Connecticut, Iowa, New Jersey, New York, Rhode Island, Vermont, and Wisconsin) and the City of New York against TVA and other power companies. The second case, which alleges both public and private nuisance, was filed against the same defendants by Open Space Institute, Inc., Open Space Conservancy, Inc., and the Audubon Society of New Hampshire. The plaintiffs do not seek monetary damages, but instead seek a pollutantcourt order requiring each defendant to cap its CO2 emissions and then reduce these emissions by an unspecified percentage each year for purposesat least a decade. In September 2005, the district court dismissed both lawsuits because they raised political questions that should not be decided by the courts. The plaintiffs appealed to the United States Court of Appeals for the Second Circuit (“Second Circuit”). Oral argument was held before the Second Circuit on June 7, 2006. On June 21, 2007, the Second Circuit directed the parties to submit letter briefs by July 6, 2007, addressing the impact of the Supreme Court’s decision in Massachusetts v. EPA, 127 S.Ct. 1438 (2007), on the issues raised by the parties. On July 6, 2007, the defendants jointly submitted their letter brief.
Case Involving Alleged Modifications to the Colbert Fossil Plant. The National Parks Conservation Association, Inc. (“NPCA”), and Sierra Club, Inc. (“Sierra Club”), filed suit on February 13, 2001, in the United States District Court for the Northern District of Alabama, alleging that TVA violated the Clean Air Act (“CAA”) and (2)implementing regulations at TVA’s Colbert Fossil Plant (“Colbert”), a coal-fired electric generating facility located in Tuscumbia, Alabama. The plaintiffs allege that TVA made major modifications to Colbert Unit 5 without obtaining preconstruction permits (in alleged violation of the Prevention of Significant Deterioration (“PSD”) program and the Nonattainment New Source Review (“NNSR”) program) and without complying with emission standards (in alleged violation of the New Source Performance Standards (“NSPS”) program). The plaintiffs seek injunctive relief; civil penalties of $25,000 per day for each violation on or before January 30, 1997, and $27,500 per day for each violation after that date; an order that TVA pay up to $100,000 for beneficial mitigation projects; and costs of litigation, including attorney and expert witness fees. On November 29, 2005, the district court held that sovereign immunity precluded the plaintiffs from recovering civil penalties against TVA. On January 17, 2006, the district court dismissed the action, on the basis that the plaintiffs failed to provide adequate notice of NSPS claims and that the statute of limitations curtailed the PSD and NNSR claims. The plaintiffs appealed to the United States Court of Appeals for the Eleventh Circuit (“Eleventh Circuit”) on January 25, 2006. In an October 4, 2007 decision, the Eleventh Circuit affirmed dismissal of the lawsuit. In January 2008, the plaintiffs filed a petition for a writ of certiorari, asking the United States Supreme Court to hear an appeal of the Eleventh Circuit’s decision.
Case Involving Alleged Modifications to Bull Run Fossil Plant. The NPCA and the Sierra Club filed suit against TVA on February 13, 2001, in the United States District Court for the Eastern District of Tennessee, alleging that TVA did not comply with the New Source Review (“NSR”) requirements of the CAA when TVA repaired its Bull Run Fossil Plant (“Bull Run”), a coal-fired electric generating facility located in Anderson County, Tennessee. In March 2005, the district court granted TVA’s motion to dismiss the lawsuit on statute of limitation grounds. The plaintiffs’ motion for reconsideration was denied, and they appealed to the United States Court of Appeals for the Sixth Circuit (“Sixth Circuit”). Friend of the court briefs supporting the plaintiffs’ appeal have been filed by New York, Connecticut, Illinois, Iowa, Maryland, New Hampshire, New Jersey, New Mexico, Rhode Island, Kentucky, Massachusetts, and Pennsylvania. Several Ohio utilities filed a friend of the court brief supporting TVA. Briefing of the appeal to the Sixth Circuit was completed in May 2006. Oral argument was held on September 18, 2006, and a panel of three judges issued a decision reversing the dismissal on March 2, 2007. TVA requested that the full Sixth Circuit rehear the appeal, but the Sixth Circuit denied this request. A scheduling order has been entered by the district court on remand, setting the case for trial on August 11, 2008. TVA is already installing or has installed the control equipment that the plaintiffs seek to require annual testingTVA to install in this case, and it is unlikely that an adverse decision will result in substantial additional costs to TVA at Bull Run. An adverse decision, however, could lead to additional litigation and could cause TVA to install additional emission control systems, such as scrubbers and selective catalytic reduction systems, on units where they are not currently installed, under construction, or planned to be installed. It is uncertain whether there would be significant increased costs to TVA.
Case Involving Opacity at Colbert. On September 16, 2002, the Sierra Club and the Alabama Environmental Council filed a lawsuit in the United States District Court for the Northern District of Alabama alleging that TVA violated CAA opacity limits applicable to Colbert between July 1, 1997, and June 30, 2002. The plaintiffs seek a court order that could require TVA to incur substantial additional costs for environmental controls and pay civil penalties of up to approximately $250 million. After the court dismissed the complaint (finding that the challenged emissions were within Alabama’s two percent de minimis rule, which provided a safe harbor if nonexempt opacity monitor readings over 20 percent did not occur more than two percent of the time each quarter), the plaintiffs appealed the district court’s decision to the Eleventh Circuit. On November 22, 2005, the Eleventh Circuit affirmed the district court’s dismissal of the claims for civil penalties but held that the Alabama de minimis rule was not applicable because Alabama had not yet obtained Environmental Protection Agency (“EPA”) approval of that rule. The case was remanded to the district court for further proceedings. On April 5, 2007, the plaintiffs moved for summary judgment. TVA opposed the motion and moved to stay the proceedings. On April 12, 2007, EPA proposed to approve Alabama’s de minimis rule subject to certain changes. This rulemaking proceeding is ongoing. On July 16, 2007, the district court denied TVA’s motion to stay the proceedings pending approval of Alabama’s de minimis rule. On August 27, 2007, the district court granted the plaintiffs’ motion for summary judgment, finding that TVA had violated the CAA at Colbert. The district court held that, while TVA had achieved 99 percent compliance on Colbert Units 1-4 and 99.5 percent compliance at Colbert Unit 5, TVA had exceeded the 20 percent opacity limit (measured in six-minute intervals) more than 3,350 times between January 3, 2000, and September 30, 2002. The district court ordered TVA to submit a proposed remediation plan, which TVA did on October 26, 2007. The plaintiffs have responded, and TVA’s expects the district court to decide whether or not to conduct a hearing on the matter. If EPA approves Alabama’s de minimis rule, the lawsuit will become moot.
In addition to Colbert, TVA has another coal-fired power plant in Alabama, Widows Creek Fossil Plant (“Widows Creek”), which has a winter net dependable generating capacity of 1,628 megawatts. Since the operation of Widows Creek must meet the same opacity requirements as Colbert, this plant may be affected by the decision in this case. The proposed de minimis rule change would help reduce or eliminate the chances of an adverse effect on Widows Creek from the district court decision.
Case Brought by North Carolina Alleging Public Nuisance. On January 30, 2006, North Carolina filed suit against TVA in the United States District Court for the Western District of North Carolina alleging that TVA’s operation of its coal-fired power plants in Tennessee, Alabama, and Kentucky constitute public nuisances. North Carolina is asking the court to impose caps on emissions underof certain pollutants from TVA’s coal-fired plants that North Carolina considers to be equivalent to caps on emissions imposed by North Carolina law on North Carolina’s two largest electric utilities. The imposition of such caps could require TVA to install more pollution controls on a faster schedule than required by federal law. On April 3, 2006, TVA moved to dismiss the new source review (“NSR”) regulations. Although TVAsuit on grounds that the case is not suitable for judicial resolution because of separation of powers principles, including the fact that these matters are based on policy decisions left to TVA’s discretion in its capacity as a party to these cases, the decisions may impact TVA operations in the future. Clean Air Developments. On April 2, 2007, inMassachusetts v. EPA, a case concerning whether EPA has the authority and duty to regulate carbon dioxide emissions under the CAA, the Supreme Court found that greenhouse gases, including carbon dioxide, are pollutants under the CAAgovernment agency and thus EPA does have the authorityare not subject to regulate these gases. The Supreme Court also concluded that EPA’s refusal to regulate these pollutants was based on impermissible reasons and remanded the case to EPA to “ground its reasons for action or inaction in the statute.” While this case focused on carbon dioxide emissions from motor vehicles, it sets a precedent for regulation in other industrial sectors, suchtort liability (the “discretionary function doctrine”), as well as the electric utility industry.
New Source Review.Supremacy Clause. In July 2006, the court denied TVA’s motion and set the trial for the term of court beginning October 2007. On April 2, 2007, the Supreme Court also issuedAugust 4, 2006, TVA filed a motion requesting permission to file an opinion in the case ofUnited States v. Duke Energy, vacating the ruling ofinterlocutory appeal with the United States Court of Appeals for the Fourth Circuit (the “Fourth Circuit”), which the district court granted on September 7, 2006. On September 21, 2006, TVA petitioned the Fourth Circuit to allow the interlocutory appeal. The Fourth Circuit granted the petition, but the district court did not stay the case during the appeal. Briefing of the interlocutory appeal to the Fourth Circuit was completed in January 2007, and oral argument was held on October 31, 2007. On July 2, 2007, North Carolina filed with the district court a motion for partial summary judgment addressing certain of TVA’s defenses. On July 31, 2007, and August 20, 2007, TVA filed two separate motions for summary judgment, seeking dismissal of the lawsuit. The trial before the district court previously scheduled for the term of court beginning October 2007 has been canceled and has not yet been rescheduled. On January 31, 2008, the Fourth Circuit affirmed the denial of TVA’s motion to dismiss. TVA has not yet decided whether to seek a rehearing before the full Fourth Circuit.
Case Involving North Carolina’s Petition to the EPA. In 2005, the State of North Carolina petitioned the EPA under Section 126 of the CAA to impose additional emission reduction requirements for sulfur dioxide (“SO2”) and nitrogen oxides (“NOx”) emitted by coal-fired power plants in 13 states, including states where TVA’s coal-fired power plants are located. In March 2006, the EPA denied the North Carolina petition primarily on the basis that the Clean Air Interstate Rule remedies the problem. In June 2006, North Carolina filed a petition for review of EPA’s decision with the United States Court of Appeals for the District of Columbia Circuit. On October 1, 2007, TVA filed a friend of the court brief in support of EPA’s decision to deny North Carolina’s Section 126 petition.
Case Arising out of Hurricane Katrina. In April 2006, TVA was added as a defendant to a class action lawsuit brought in the United States District Court for the Southern District of Mississippi by 14 residents of Mississippi allegedly injured by Hurricane Katrina. The plaintiffs sued seven large oil companies and an oil company trade association, three large chemical companies and a chemical trade association, and 31 large companies involved in the mining and/or burning of coal, including TVA and other utilities. The plaintiffs allege that the defendants’ greenhouse gas emissions contributed to global warming and were a proximate and direct cause of Hurricane Katrina’s increased destructive force. The plaintiffs are seeking monetary damages among other relief. TVA has moved to dismiss the complaint on grounds that TVA’s operation of its coal-fired plants is not subject to tort liability due to the discretionary function doctrine. On August 30, 2007, the district court heard oral arguments on whether the issue of greenhouse gas emissions is a political matter which should not be decided by the court. The district court then dismissed the case on the grounds that the plaintiffs lacked standing. The dismissal has been appealed to the United States Court of Appeals for the Fifth Circuit.
East Kentucky Power Cooperative Transmission Case. In April 2003, Warren Rural Electric Cooperative Corporation (“Warren”) notified TVA that it was terminating its TVA power contract. Warren then entered into an arrangement with East Kentucky Power Cooperative, Inc. (“East Kentucky”) under which Warren would become a member of East Kentucky, and East Kentucky would supply power to Warren after its power contract with TVA expires in 2009. East Kentucky then asked TVA to provide transmission service to East Kentucky for its service to Warren. TVA denied the request on the basis that, under the anti-cherrypicking provision, it was not required to provide the requested transmission service. East Kentucky then asked to interconnect its transmission system with the TVA transmission system in three places that are currently delivery points through which TVA supplies power to Warren. TVA did not agree and East Kentucky asked the Federal Energy Regulatory Commission (“FERC”) to order TVA to provide the interconnections. In January 2006, FERC issued a final order directing TVA to interconnect its transmission facilities with East Kentucky’s system at three locations on the TVA transmission system. On August 11, 2006, TVA filed an appeal in the U.S. Court of Appeals for the District of Columbia Circuit seeking review of this order on the grounds that this order violated the anti-cherrypicking provision. On January 10, 2007, TVA and Warren executed an agreement under which Warren rescinded its notice of termination. On May 3, 2007, East Kentucky filed a motion with FERC to terminate the FERC proceeding on grounds of mootness. TVA has also filed a motion with FERC to vacate all orders issued in the proceeding. On December 12, 2007, FERC granted the motion to terminate the proceeding, but denied the motion to vacate its previous orders.
Case Involving Areva Fuel Fabrication. On November 9, 2005, TVA received two invoices totaling $76 million from Framatome ANP Inc., which subsequently changed its name to AREVA NP Inc. (“AREVA”). AREVA asserted that it was the successor to the contract between TVA and Babcock and Wilcox Company (“B&W”) under which B&W would provide fuel fabrication services for TVA’s Bellefonte Nuclear Plant. AREVA’s invoices were based upon the premise that the contract required TVA to buy more fuel fabrication services from B&W than TVA actually purchased. In September 2006, TVA received a formal claim from AREVA which requested a Contracting Officer’s decision pursuant to the Contract Disputes Act of 1978 and reduced the amount sought to approximately $25.8 million. On April 13, 2007, the Contracting Officer issued a final decision denying the claim. On April 19, 2007, AREVA filed suit in the United States District Court for the Eastern District of Tennessee, reasserting the $25.8 million claim and alleging that the contract required TVA to purchase certain amounts of fuel and/or to pay a cancellation fee. TVA filed its answer to the complaint on June 15, 2007. AREVA subsequently raised its claim to $47.9 million. Trial is scheduled to begin September 29, 2008.
Notification of Potential Liability for Ward Transformer Site. EPA and a working group of potentially responsible parties (“PRPs”) have provided documentation showing that TVA sent electrical equipment containing polychlorinated biphenyls (“PCBs”) to the Ward Transformer site in Raleigh, North Carolina. Under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), any entity which arranges for disposal of a CERCLA hazardous substance at a site may bear liability for the cost of cleaning up the site. The working group is cleaning up on-site contamination in accordance with an agreement with EPA and plans to sue non-participating PRPs for contribution. The estimated cost of the cleanup is $20 million. In addition, EPA likely has incurred several million dollars in response costs, and the working group has reimbursed EPA approximately $725,000 of those costs. EPA has also proposed a cleanup plan for off-site contamination. The present worth cost estimate for performing the proposed plan is about $5 million. In addition, there may be natural resource damages liability related to this site, but TVA is not aware of any estimated amount for any such damages.
Completion of Browns Ferry Unit 1, Team Incentive Fee Pool Claims. Under the contracts for the restart of TVA’s Browns Ferry Unit 1, the engineering and construction contractors, Bechtel Power Corporation and Stone & Webster Construction, Inc., respectively, are to share in a team incentive fee pool funded from cost savings for the respective workscopes. The contracts provide that each contractor’s maximum payment from this pool will be as much as $38 million, for a maximum total payout under both contracts of $76 million. The contractors have taken the position that they should each receive the maximum payment. Currently, TVA has calculated each contractor’s share at $12,371,405, for a total payout under both contracts of $24,742,810. TVA and the contractors have agreed to nonbinding mediation of the matter. It is reasonably possible that TVA could incur some potential liability in excess of the amount previously calculated, but TVA is unable to estimate any such amount at this time.
Notice of Violation at Widows Creek Unit 7. On July 16, 2007, TVA received a Notice of Violation (“NOV”) from EPA as a result of TVA’s failure to properly maintain ductwork at Widows Creek Unit 7. From 2002 to 2005, the unit’s ducts allowed SO2 and NOx to escape into the air. TVA repaired the ductwork in 2005, and the problem has been resolved. TVA is reviewing the NOV. While the NOV does not set out an administrative penalty, it is likely that TVA will face a monetary sanction through giving up emission allowances, paying an administrative penalty, or both. TVA's estimate of potential monetary sanctions is included in the accrued amount listed above.
Paradise Fossil Plant Clean Air Act Permit. On December 21, 2007, the Sierra Club, the Center for Biological Diversity, Kentucky Heartwood, and Hilary Lambert filed a petition with the EPA raising objections to the conditions of TVA’s current Clean Air Act permit at the Paradise Fossil Plant (“Paradise”). Among other things, the petitioners allege that activities at Paradise triggered the NSR requirements for NOx and that the monitoring of opacity at Units 1 and 2 of the plant is deficient. The current permit continues to remain in effect. It is unclear whether or how the plant’s permit might be modified as a result of this proceeding.
Employment Proceedings. TVA is engaged in various administrative and legal proceedings arising from employment disputes. These matters are governed by federal law and involve issues typical of those encountered in the ordinary course of business of a utility. They may include allegations of discrimination or retaliation (including retaliation for raising nuclear safety or environmental concerns), wrongful termination, and failure to pay overtime under the Fair Labor Standards Act. Adverse outcomes in these proceedings would not normally be material to TVA’s results of operations, liquidity, and financial condition, although it is possible that some outcomes could require TVA to change how it handles certain personnel matters or operates its plants.
Significant Litigation to Which TVA Is Not a Party. On April 2, 2007, the Supreme Court issued an opinion in the case of United States v. Duke Energy, vacating the ruling of the Fourth Circuit in favor of Duke Energy and against EPA in EPA’s NSR enforcement case against Duke Energy. The NSR regulations apply primarily to the construction of new plants but can apply to existing plants if a maintenance project (1) is “non-routine” and (2) increases emissions. The Supreme Court held that the test for emission increases under the NSR program does not have to be the same as the test under EPA’s PreventionNew Source Performance Standard program. In light of Significant Deterioration (“PSD”)the decision it appears that under EPA’s PSD regulations, increases in annual emissions should be used for the test, not hourly emissions as utilities, including TVA, have argued should be the standard. Annual emissions can increase when a project improves the reliability of plant operations and, depending on the time period over which emission changes are calculated, it is possible to argue that almost all reliability projects significantly increase annual emissions. Neither the Supreme Court nor the Fourth Circuit addressed what the “routine” project test should be. The United States District Court for the Middle District of North Carolina had ruled for Duke on this issue, holding that “routine” must take into account what is routine in the industry and not just what is routine at a particular plant or unit as EPA has argued. EPA did not appeal this ruling. On October 5, 2007, EPA filed a motion with the United States District Court for the Middle District of North Carolina asking that court to vacate its entire prior ruling, including the portion relating to the test for “routine” projects.
TVA is currently involved in two NSR cases (one involving Bull Run, Fossil Plantthe dismissal of which was recently reversed on appeal) and another at Colbert Fossil Plant)(the dismissal of which was recently affirmed on appeal but may be reviewed by the U.S. Supreme Court). See Note 7These cases are discussed in this Quarterly Report for a discussion of these cases.more detail above. The Supreme Court’s rejection of the hourly standard for emissions testingholding could undermine one of TVA’s defenses in these cases, although TVA has other available defenses. Environmental groups and North Carolina have given TVA notice in the past that they may sue TVA for alleged NSR violations at a number of TVA units. The Supreme Court’s decision could encourage such suits, which are likely to involve units where emission control systems such as scrubbers and selective catalytic reduction (“SCR”) systems are not installed, under construction, or planned to be installed in the relatively near term. At this point,
TVA Board Nominations
On December 31, 2007, Congress adjourned without the Senate having voted upon President George W. Bush’s nominations of Susan Richardson Williams, Thomas C. Gilliland, and Bishop William Graves to the TVA Board. Because Congress adjourned and their nominations were not approved, Ms. Williams and Bishop Graves are no estimate can be made regarding the impactlonger directors of any such suits on TVA. Page 40 As a result of 47
Clean Water Developments
In the second phase ofthese vacancies and a three-part rulemakingprevious vacancy which Mr. Gilliland had been nominated to minimize the adverse impacts from cooling water intake structures on fish and shellfish, as required under Section 316(b) of the Clean Water Act, the EPA promulgated a final rule for existing power producing facilities that became effective on September 7, 2004. The new rule required existing facilities to select among several different compliance options for reducing the number of organisms pinned against and/or drawn into the cooling systems. These included development of a site-specific compliance option based on application of cost/cost or cost/benefit tests. The site specific tests were designed to ensure that a facility’s costsfill, there are not significantly greater than cost projections in the rule or the benefits derived from taking mitigation actions. Actions taken to compensate for any impacts by restoring habitat, or pursuing other options such as building hatcheries for fish/shellfish production, would have counted towards compliance.
On January 25, 2007, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) issued a decision in a proceeding brought by environmental groups, industry groups, and certain northeastern states challenging the EPA’s final rule. The Second Circuit held that costs cannot be compared to benefits in picking the best technology available (“BTA”) to minimize the adverse environmental impacts of intake structures. Instead, the court held that the EPA is allowed to consider costs in two ways: (1) to determine what technology can reasonably be borne by industry, and (2) to engage in cost-effectiveness analysis in determining BTA. Finding the rulemaking record to be unclear on whether the EPA had relied on a cost-benefit analysis or a cost-effectiveness analysis, the Second Circuit remanded the EPA’s BTA determination, giving the EPA the option to provide a reasonable explanation of its determination or make a new determination basedcurrently six directors on the permissible cost considerations set out inBoard. Under the Second Circuit opinion. The Second Circuit also remanded provisions ofTVA Act, while the EPA rule that allowed the use ofTVA Board may have up to nine directors, a site-specific cost-benefit testquorum for transacting business is five directors.
New Vice President and restoration measures (such as building hatcheries) to demonstrate compliance, holding that these rule provisions were based on an impermissible construction of the statute. Several other provisions of the rule such as the one that sets the performance standards as a range rather than one national standard were also remanded.Controller Named All of the intakes at TVA’s existing coal-fired and nuclear generating facilities are subject to the EPA’s rule and, potentially, to the Second Circuit’s decision. TVA had been in the process of determining what was needed to comply with the EPA rule, and had believed that some expenditures might have been required. TVA is currently assessing the Second Circuit’s decision and its potential impacts on TVA. Given the uncertainty over whether the EPA will appeal this decision and what the changes in the final rule as ultimately issued and applied will be, TVA cannot assess what the potential impacts are at this time. EPA’s official responses to the remand have been to (1) petition the Second Circuit Court for more time to consider an appeal, and (2) issue a guidance letter to the EPA Regions announcing its intention to suspend the rule and instructing regulators to develop permit conditions on a “Best Professional Judgment” basis.
Management Changes
New Chief Operating Officer Named
On March 12,December 4, 2007, TVA announced the appointment of William R. (Bill) McCollum, Jr.,John M. Thomas III as Vice President and Controller and its Chief Accounting Officer, effective January 7, 2008. He succeeded Randall P. Trusley, who has more than 30 years of experience in the energy services industry, as chief operating officer ofretired from TVA effective May 1, 2007. As TVA’s chief operating officer, January 4, 2008.
Mr. McCollumThomas is responsible for directingthe development and managingmaintenance of TVA accounting policies and practices, compliance with SEC reporting requirements including disclosures, internal controls, and financial reports, development of policy and methods for business planning, budgeting and financial management, and ensuring consistency with TVA financial policy. In addition, he provides oversight and analysis of financial and performance reporting and serves as the operationsprimary management point of contact for the FossilAudit and Ethics Committee.
Executive Vice President, Power Group,System Operations Retirement
W. Terry Boston, TVA’s Executive Vice President, Power System Operations, retired from TVA Nuclear, River Operations, and Commercial Operations and Fuels. Later, he will also assume responsibilityon February 1, 2008. Mr. Boston had worked at TVA for Power Systems Operations. Mr. McCollum reportsalmost 36 years. He left TVA to TVA’sbecome the president and chief executive officer. Mr. McCollum came to TVA from Duke Energy Corp., where he most recently was the group executive and chief regulated generation officer. He has heldofficer of PJM Interconnection, which operates a variety of positions in engineering, nuclear and fossil operations, safety, and project management. He served as vice president of Catawba and Oconee nuclear stations and managed nuclear support functions for all three nuclear plants at Duke, including nuclear fuels management, nuclear supply chain services, regulatory/self-assessment functions, and engineering and scientific services.
Mr. McCollum graduated from the Georgia Institute of Technology with a Bachelor of Electrical Engineering degree and a Master of Science degree in nuclear engineering. He also received a Master of Business Administration degree from the University of North Carolina at Charlotte.
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Retirement of Chief Nuclear Officer Announced
On March 30, 2007, TVA announced the pending retirement of Karl W. Singer, chief nuclear officer and executive vice president, TVA Nuclear. Mr. Singer will remain with TVA until September 30, 2007, and will assistlarge centrally dispatched electric grid in the transition as TVA’s new chief nuclear officer assumes his position.eastern United States.
New Chief Nuclear Officer Named
On April 10, 2007, TVA announced the appointmentPage 41
Mr. Campbell’s experience in the commercial nuclear power industry has been with several highly regarded utility companies including Entergy Nuclear Generation Company, where he served as the chief operating officer for Entergy Nuclear’s South Region, Duke Energy, Carolina Power and Light, and Union Electric Company. In his most recent position at Entergy, he was responsible for the operating results of the company’s regulated nuclear assets in Mississippi, Texas, Louisiana, and Arkansas.
Mr. Campbell graduated from North Carolina State University with a Bachelor of Science degree in nuclear engineering. He also has a Master of Science degree in mechanical engineering from Clemson University.
New Senior Vice President of TVA Nuclear Generation and Development Appointed
On April 30, 2007, Ashok Bhatnagar became the senior vice president of TVA’s Nuclear Generation and Development organization. Mr. Bhatnagar is responsible for TVA Nuclear plant-licensing functions, the Watts Bar Nuclear Plant Unit 2 completion studies, and all NuStart Development LLC (“NuStart”) activities at the Bellefonte site. See Note 2 in the Annual Report for more information on TVA’s nuclear licensing activities and NuStart. Mr. Bhatnagar reports to TVA’s chief operating officer, William McCollum.
New Vice President of Watts Bar Unit 2 Named
On April 30, 2007, Masoud Bajestani became the new vice president of Watts Bar Unit 2. In that capacity, Mr. Bajestani reports to Ashok Bhatnagar, senior vice president of Nuclear Generation and Development, and is responsible for overseeing the Watts Bar Nuclear Plant Unit 2 completion studies and potential construction activities.
Restructuring of River System Operations & Environment Organization
On May 10, 2007, TVA announced that effective immediately, the River System Operations & Environment (“RSO&E”) organization was being restructured into two separate organizations. The River Operations group, under Janet Herrin, senior vice president, will remain within the Chief Operating Officer organization with Ms. Herrin reporting directly to the chief operating officer. All other organizations formerly within RSO&E will become the new Office of Environment & Research, headed by Bridgette Ellis, senior vice president. Ms. Ellis will report directly to the chief executive officer.
New Officer for Energy Efficiency, Load-Shaping, and Renewable Resources
On May 10, 2007, TVA announced that Kate Jackson, formerly executive vice president of RSO&E, was being given responsibility for TVA’s plans to effectively address energy efficiency, load-shaping, and renewable resources, areas identified within the draft Strategic Plan as key programs for TVA going forward. Ms. Jackson will report directly to the chief executive officer.
There are no material changes related to market risksrisk from the market risks disclosed under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations —Risk Management Activitiesin the Annual Report. Page 42 of 47
Disclosure Controls and Procedures
An evaluation has been performed under the supervision of TVA maintainsmanagement (including the president and chief executive officer) and members of the disclosure control committee (including the chief financial officer and the vice president and controller) of the effectiveness and the design of TVA’s disclosure controls and procedures as of December 31, 2007. Based on that are designedevaluation, the president and chief executive officer and members of the disclosure control committee (including the chief financial officer and the vice president and controller) concluded that TVA’s disclosure controls and procedures were effective as of December 31, 2007 to ensure that information required to be disclosed in reports itTVA files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. This includes controls and procedures designed to ensure that such information is accumulated and communicated to TVA management, including the president and chief executive officer, the Disclosure Control Committee,disclosure control committee, and the chief financial officer, as appropriate, to allow timely decisions regardingabout required disclosure. An evaluation has been performed under the supervision of TVA management (including the president and chief executive officer) and members of the Disclosure Control Committee (including the interim chief financial officer and the vice president and controller) of the effectiveness of TVA’s disclosure controls and procedures as of March 31, 2007. Based on that evaluation, the president and chief executive officer and members of the Disclosure Control Committee (including the interim chief financial officer and the vice president and controller) concluded that, as a result of two material weaknesses identified (described below), TVA’s disclosure controls and procedures were not effective as of March 31, 2007. However, to assess the financial statement impact of these internal control deficiencies, TVA performed additional analyses, interim supplemental procedures, and monitoring activities subsequent to quarter end. As a result of these supplemental procedures, the president and chief executive officer, the interim chief financial officer, and the vice president and controller have determined that there is reasonable assurance that the financial statements included in this Quarterly Report fairly present, in all material respects, TVA’s financial condition, results of operations, and cash flows as of, and for, the periods presented.
TVA management has identified a material weakness in internal controls related to TVA’s end use billing arrangements with wholesale power customers. Under these arrangements, TVA relies on the distributor customers to calculate major components of their own power bills. In fiscal year 2006, TVA requested annual Statement on Auditing Standards (“SAS”) 70 Type II internal control reports on 12 specific control objectives from distributor customers and their third party billing processors. Based on the evaluation of these SAS 70 Type II reports, TVA determined that distributor customers who represent a material amount of TVA’s 2007 revenue either had qualified opinions and/or internal control test results that negatively impact their ability to meet TVA’s control objectives. However, subsequent to quarter end TVA has also performed additional revenue analysis by comparing various metrics from billing data for distributor customers with similar characteristics and benchmarking those with control weaknesses against those with strong controls. As a result of this analysis, TVA has determined that reported revenues are not materially misstated.
TVA management has also identified a material weakness related to controls over the completeness, accuracy, and authorization of TVA’s property, plant, and equipment transactions and balances; the calculation of AFUDC; and the review of construction work in progress accounts for proper closure to completed plant. To remediate this control weakness, TVA has developed a new process for project approval to include the determination of proper project cost classification and has made changes in staffing for fixed asset accounting. TVA is also formalizing the accounting review of account balances and transactions and improving the documentation of management review and approval. Additional analysis has been performed to ensure that property, plant, and equipment is not materially misstated.
During the most recent fiscal quarter, there were no changes in TVA’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, TVA’s internal control over financial reporting. TVA is continuing to take steps to address the identified material weaknesses in internal controls as described in the preceding two paragraphs
TVA management believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and that no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company can be detected.
TVA’s controls and procedures are designed to provide reasonable, but not absolute, assurance that the objectives will be met. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and thereevents. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Changes in Internal Control over Financial Reporting
During the most recent fiscal quarter, there were no changes in TVA’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, TVA’s internal control over financial reporting.
See Note 7 in this Quarterly Report for a discussion of legal proceedings affecting TVA.
ITEM 1A. RISK FACTORS The discussion below supplements
There are no material changes related to risk factors from the disclosure contained inrisk factors disclosed under Item 1A Risk Factors in the Annual Report. The factors described in Item 1A, Risk Factors in the Annual Report, together with the risk factors discussed below and the other information contained in the Quarterly Report, could materially affect TVA’s business, financial condition, and operating results and should be carefully considered. Further, the risks described in this Quarterly Report and in the Annual Report are not the only risks facing TVA. Additional risks and uncertainties not currently known to TVA management or that TVA management currently deems to be immaterial also may materially adversely affect TVA’s business, financial condition, and operating results. Events at non-TVA facilities which affect the supply of water to TVA’s generation facilities could interfere with TVA’s ability to generate power.
TVA’s fossil and nuclear generation facilities depend on water from the river systems upon which they are located for cooling water and for water to convert into steam to drive turbines. While TVA manages the Tennessee River and large portions of its tributary system in order to provide much of this necessary water, entities such as the U.S. Army Corps of Engineers operate and manage other bodies of water upon which some TVA facilities rely. If events at these non-TVA bodies of water or their associated hydroelectric facilities were to interfere with the flow of water, TVA might have insufficient water to meet the needs of its plants. TVA might thus be required to reduce generation at its affected facilities to levels compatible with the available supply of water.
Purchased power prices may be highly volatile, and providers of purchased power may fail to perform under their contracts with TVA.
TVA acquires a portion of its electricity needs through purchased power arrangements. The price for purchased power has been quite volatile in recent years, so the price that TVA pays for purchased power may increase significantly in the future. In addition, if one of TVA’s purchased power suppliers fails to perform under the terms of its contract with TVA, TVA might have to purchase replacement power on the spot market, perhaps at a significantly higher price than TVA was entitled to pay under the contract. In some circumstances, TVA may not be able to recover this difference from the supplier. Moreover, if TVA is unable to acquire replacement power on the spot market and does not have enough reserve generation capacity available to offset the loss of power from the purchased power supplier, TVA might be unable to satisfy its own obligations to deliver power. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations —Business Overview — Challenges During 2006 — Increased Fuel and Purchased Power Costs andRisk Management Activities — Credit Risk — Credit of Other Counterpartiesin the Annual Report.
Payment of principal and interest on TVA securities is not guaranteed by the United States.
Although TVA is a corporate agency and instrumentality of the United States government, TVA securities are not backed by the full faith and credit of the United States. Principal and interest on TVA securities is payable solely from TVA’s net power proceeds. Net power proceeds are defined as the remainder of TVA’s gross power revenues after deducting the costs of operating, maintaining, and administering its power properties and tax equivalent payments to states and counties, but before deducting depreciation accruals or other charges representing the amortization of capital expenditures, plus the net proceeds from the sale or other disposition of any power facility or interest therein.
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The trading market for TVA securities might be limited.
All of TVA’s Bonds are listed on the New York Stock Exchange except for TVA’s discount notes, which have maturities of less than one year, and power bonds issued under TVA’s electronotes® program, which is a medium-term note program. In addition, some of TVA’s Bonds are listed on foreign stock exchanges. Although many of TVA’s Bonds are listed on stock exchanges, there can be no assurances that any market that will develop or continue to exist for any Bonds. Additionally, no assurances can be made as to the ability of holders to sell their Bonds or as to the price at which holders will be able to sell their Bonds. Future trading prices of Bonds will depend on many factors, including prevailing interest rates, the then-current ratings assigned to the Bonds, the amount of Bonds outstanding, the time remaining until the maturity of the Bonds, the redemption features of the Bonds, the market for similar securities, and the level, direction, and volatility of interest rates generally.
If a particular offering of Bonds is sold to or through underwriters, the underwriters may attempt to make a market in the Bonds. The underwriters would not be obligated to do so, however, and could terminate any market-making activity at any time without notice.
In addition, legal limitations may affect the ability of banks and others to invest in Bonds. For example, national banks may purchase TVA Bonds for their own accounts in an amount not to exceed ten percent of unimpaired capital and surplus. Also, TVA Bonds are “obligations of a corporation which is an instrumentality of the United States’’ within the meaning of Section 7701(a)(19)(C)(ii) of the Internal Revenue Code for purposes of the 60 percent of assets limitation applicable to U.S. building and loan associations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None.
ITEM 5. OTHER INFORMATION None.
In accordance with the Board’s September 27, 2007 approval of its Audit and Ethics Committee’s recommendation, Ernst & Young LLP became TVA’s independent registered public accounting firm beginning December 12, 2007.
| | | | | | Exhibit No. | | Description | | | | | | 3.1 | | Tennessee Valley Authority Act of 1933, as amended, 16 U.S.C. §§ 831-831ee | | 31.110.1 | | TVA Discount Notes Selling Group Agreement | | 31.1 | | Rule 13a-14(a)/15d-14(a) Certification Executed by the Chief Executive Officer | | | | | | | 31.2 | | | Rule 13a-14(a)/15d-14(a) Certification Executed by the Chief Financial Officer | | | | | | | 32.1 | | | Section 1350 Certification Executed by the Chief Executive Officer | | | | | | | 32.2 | | | Section 1350 Certification Executed by the Chief Financial Officer |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 15, 2007February 12, 2008 | | | | | | TENNESSEE VALLEY AUTHORITY
(Registrant)
| | | By: | /s/ Tom D. Kilgore | | | | Tom D. Kilgore | | | | President and Chief Executive Officer
(Principal Executive Officer) | | | | | | | By: | /s/ John M. Hoskins | | | | John M. Hoskins | | | |
TENNESSEE VALLEY AUTHORITY (Registrant)
By: /s/ Tom D. Kilgore Tom D. Kilgore President and Chief Executive Officer (Principal Executive Officer)
By: /s/ Kimberly S. Greene Kimberly S. Greene Chief Financial Officer and Executive Vice President, Financial Services (Principal Financial Officer)
Interim Chief Financial Officer and Executive
Vice President, Financial Services
(Principal Financial Officer) | |
Page 4645
| | | | | | Exhibit No. | | Description | | | | | | | | | 31.13.1 | | Tennessee Valley Authority Act of 1933, as amended, 16 U.S.C. §§ 831-831ee | | 10.1 | | TVA Discount Notes Selling Group Agreement | | 31.1 | | Rule 13a-14(a)/15d-14(a) Certification Executed by the Chief Executive Officer | | | | | | | 31.2 | | | Rule 13a-14(a)/15d-14(a) Certification Executed by the Chief Financial Officer | | | | | | | 32.1 | | | Section 1350 Certification Executed by the Chief Executive Officer | | | | | | | 32.2 | | | Section 1350 Certification Executed by the Chief Financial Officer |
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