UNIT COSTS (EXPRESSED AS CENTS PER KILOWATT-HOUR SOLD) OF SOME REPRESENTATIVE PUBLICLY OWNED UTILITY OPERATIONS
THROUGHOUT THE UNITED STATES, 1937

Braintree, Mass.

Chicopee, Mass.

Colorado Springs, Colo.

Concord, Mass.

Danville, Va.

Fort Collins, Colo.

Holland, Mich.

Jamestown, N. Y.

Los Angeles, Calif..

Tacoma, Wash.

Wallingford, Conn.

Watertown, S. Dak.

Winnetka, Ill.

Source: Computed from costs reported in annual reports of these municipalities.

A FURTHER STATEMENT ON ALLOCATION OF COSTS OF TENNESSEE VALLEY AUTHORITY DAMS AND RESERVOIRS BETWEEN NAVIGATION, FLOOD CONTROL, AND POWER

Prepared by Arthur E. Morgan for the Joint Congressional Committee on the Investigation of the Tennessee Valley Authority, December 1938

In his testimony before this committee Mr. Lilienthal admitted that he tried to commit the Tennessee Valley Authority to the theory that power is only a byproduct of Tennessee Valley Authority dam construction and as such should not be required to bear any of the cost of dams and reservoirs. He admitted that as chief counsel for the Tennessee Valley Authority he advised his Board that it was bound to accept that theory. In his testimony before this committee he has endeavored to justify that position.

I hold that in the Tennessee Valley Authority project as it actually has been developed, in a practical sense power is not a byproduct. Everyone knows that in the mind of Senator Norris and those others who were most instrumental in creating the Tennessee Valley Authority, power was the dominant interest, though from the constitutional viewpoint navigation is the use which gives constitutional status to unified river control. But for power, the system of dams as actually designed and built, would not have been built.

In the end, after years of contending for the byproduct theory, when the matter finally was brought into the open, and after this investigating committee was organized, the byproduct theory was reluctantly surrendered, and substantially the allocation I had proposed to the Board in December 1936 was accepted.

Had the byproduct theory been imposed on the Board, as for years Mr. Lilienthal endeavored to do, it would have resulted in a charge against power in the three-dam system of Wilson, Wheeler, and Norris, of less than $24,000,000 as against the amount finally allocated, more than $49,000,000. Both these figures are taken from the official Tennessee Valley Authority allocation report. In interest and depreciation charges alone such an allocation of capital investment would have reduced the apparent annual expense by more than $1,300,000.

The fair cost of power investment, as shown by the allocation finally adopted by the Tennessee Valley Authority in June 1938, is about twice as great as would be shown by an allocation on the byproduct theory. That is a very great difference in the cost of power. That difference is a measure of the fair cost of power investment which would have been a concealed subsidy if the Tennessee Valley Authority had been committed to the byproduct theory. As Mr. Lilienthal quoted in the letter to Senator McNary, "All are agreed that the conclusions (on the allocation) are of particular importance as it is expected that the principles employed will be used in the cost allocation of all dams constructed by the Tennessee Valley Authority and may affect dams constructed outside the Valley" (p. 1204). This issue was of real importance. The policy of entering on a great dam-building program primarily because of a dominant interest in power and then in cost accounting of treating power as only a byproduct, charging against power only the cost of powerhouses and generators, and none of the cost of dams and reservoirs, would destroy any prospect of fair and honest accounting of the cost of power and would be misleading the public.

If the work of this committee should have no other result than to prevent the adoption of this false and unfair byproduct theory of allocation and if accurate power accounting should result, the efforts and expenditures of this committee will have been justified. A national power policy is at issue. Mr. Lilienthal has repeatedly stated that byproduct pricing of power would not necessarily set the price at which power would be sold, but only the minimum price. That statement does not disclose the real issue of byproduct pricing. The actual situation is this:

Everyone recognizes that the Tennessee Valley Authority power program can be successful only if it can sell large amounts of industrial power. The industrial power market is highly competitive and sales are made on a narrow margin of profit. The Tennessee Valley Authority is receiving only about a quarter of a cent (21⁄2 mills) per kilowatt-hour for the industrial power it sells. Its contracts with four industrial customers are for the greater part of the output of the Wilson-Wheeler-Norris system. Under these conditions a difference of even three one-hundredths of a cent (three-tenths of a mill)

per kilowatt-hour may be the difference between getting or losing a contract. Under byproduct pricing the cost allocated to power in the three-dam system according to the figures in the allocation report adopted by the Tennessee Valley Authority, would be $23,967,000, as against a total of $49,360,000 finally allocated to the power by the Tennessee Valley Authority. Under byproduct pricing the Tennessee Valley Authority power project would have escaped 52 percent of the capital cost of power in the unified system. It then could undersell any competitor, could tolerate wasteful administration, and still could appear to show a profit on its books. That is what byproduct pricing would

mean.

The public has a right to know whether in selling industrial power the Tennessee Valley Authority actually is making money on its investment, or whether, in its apparently successful competition with private companies, the public actually is making up the loss and is making contributions to the Aluminum Co. and to the Arkansas Power Co. and to other Tennessee Valley Authority industrial customers.

Tennessee Valley Authority power would continue to be sold, even if the competitive rate were too low to meet all the fixed and operating expenses, but the public has a right to know the facts. Also, if all the fair costs are known there will be a greater tendency to eliminate extravagance and waste in operation.

Mr. Lilienthal testified that the byproduct power theory of allocating costs of Federal dams was prescribed in the McNary bill, introduced on July 29, 1935, and in the later Bonneville bill, introduced on May 26, 1936. I do not believe that this is the case. I do not know what was in the minds of those who drafted those bills, but the bills themselves do not prescribe allocation by the byproduct_theory.

In the Bonneville bill the only wording which hints at byproduct allocation is the phrase that the rates shall be determined "with due regard to the fact that such electric energy is developed from the water power created as an incident to the construction of Federal projects" (p. 1036). Also, the power conferred upon the Federal Power Commission to set rates shall be exercised "with due regard to (1) the cost of construction, operation, maintenance, and replacement of power facilities properly chargeable to development, transmis sion, and sale of power; (2) available markets; (3) the interest of the ultimate consumers; (4) the general public welfare; and (5) the interests of irrigation in connection with projects being developed by Federal agencies" (p. 1037). This legislation does not prescribe or require allocation of power costs on the byproduct principle. The only suggestion in the bill that power shall be treated as a byproduct is in the phrase "from the water power created as an incident in the construction of Federal projects." The same might be said of irrigation or flood control or navigation or power. The word "incident" has more than one meaning. It may mean "related to" or "a subordinate part of."

As against the idea that water power should be treated as a byproduct is the expression in the bill that rates shall be set "with due regard to (1) the cost of construction, operation, maintenance, and replacement of power facilities properly chargeable to development, transmission, and sale of power," and also with regard to "the general public welfare."

Where the chief actual incentive to building dams is the power they would develop, then to omit all or part of the cost of dams and reservoirs from the cost of power is to omit costs "properly chargeable" to power I repeat-for the Tennessee Valley Authority to omit such costs in estimating the cost of power is to mislead the public mind and to create a hidden subsidy for power. It is not in "the general public interest."

The letter from Mr. Manly which Mr. Lilienthal quotes in his testimony (p. 1042), insofar as it goes, conforms to my understanding of the conversation referred to, but it barely touches on one very important element of our discussion; that is, his letter does not define the particular conditions under which the incremental rate should be "the minimum at which such power should be sold." Mr. Manly's quotation from his memorandum concerning our conference reads:

"The conversation then turned to the general questions of rate determinations and allocations of cost. Dr. Morgan showed that he had misunderstood a statement which I had made at one of the conferences with the President. He thought I had expressed the view that power at Government dams might be sold at its bare increment cost. I pointed out that this was a misunder

standing that I had referred to the increment cost of establishing the minimum at which such power should be sold and the total cost of all the works as establishing a maximum at which such power should be sold. Some time was spent on this point. I gave it as my view that between these upper and lower limits, rates for power should be determined with due consideration for several other factors, such as existing wholesale rates, the cost of alternative sources of power, cost of steam power at load centers, etc." (p. 1043–1044).

Mr. Manley and I were discussing a general national power policy. The point was made that unless the income from power would pay charges on at least the cost of the powerhouse, generators, transmission lines, etc., then power installation would not be profitable under any possible allocation, and should not be built. We wholly agreed on that. The same would be true as to navigation, flood control, or as to any other use. For instance, in building Norris Dam the Tennessee Valley Authority very properly omitted the proposed barge lift or locks because we believed that the extra value for navigation would not be worth the extra cost; but that did not mean that navigation is a byproduct.

It was only in this sense of determining what construction would be practical in the first place that the incremental cost should be the minimum cost. Mr. Manley, in his memorandum of our conversation, goes on to say that in setting rates other factors should be considered, including "the cost of alternative sources of power." It was just on this point that I differed from Mr. Lilienthal. In contrast to his byproduct theory, the allocation I proposed to the Board, and also the allocation finally adopted by the Board in June 1938 used "the alternative cost of power" as a measure of what the power is really worth as a basis for allocating costs. We did just what Mr. Manley's mem

orandum proposes.

"In December 1935" according to Mr. Lilienthal's testimony (p. 1147), "Professor Bonbright replied at length, stating that he regarded the problem of allocating joint costs on any rational principle as impossible, and suggesting that only the incremental power costs be charged directly to power." The allocation finally adopted by the Tennessee Valley Authority in June 1938 is a clear refutation of Professor Bonbright's position, though Mr. Lilienthal says, "Professor Bonbright is I think by common consent the outstanding authority in the United States on the economics of valuation" (p. 1148). Mr. Lilienthal quoted me as follows:

"In his capacity as an attorney and as chief counsel for the Tennessee Valley Authority, he instructs his Board that it is bound to use his byproduct theory. He says, "That doctrine we must accept.' I believe that such advice was wholly unsound and was a misuse of his position as chief counsel" (p. 1027). He then goes on to testify:

"It was no abuse of my then position as general counsel to state that we were obliged to accept a doctrine clearly stated by the Supreme Court of the United States. Before presenting my memorandum to the Board, I submitted my interpretation of the decision in the Ashwander case to Mr. James Lawrence Fly, then the Authority's general solicitor (and now its general counsel), who had conducted the case for Tennessee Valley Authority and who was in active charge of our legal division. He approved the particular interpretation of the court's ruling, as the initialed copy of a draft of the memorandum shows. I do not agree that it was any lack of soundness to recommend that that doctrine should be applied specifically as a method of establishing a floor below which Tennessee Valley Authority rates could not be fixed" (p. 1027-28).

Yet the allocation actually approved by the Tennessee Valley Authority after the appointment of your committee completely abandons that theory.

Mr. Lilienthal in his testimony confuses cost allocation with rate-making. This tends to confuse the committee.

Except as a guide for determining whether power plants will be sufficiently productive to justify their being installed in the first place, there is not and ought not to be any "floor below which Tennessee Valley Authority rates could not be fixed." For instance, should scientific developments reduce the cost of generating power, Tennessee Valley Authority rates would have to go down in competition, even though all capital costs were not covered. The reason for allocating costs after the dams are built is to enable the public to know whether Tennessee Valley Authority power is being sold at a profit or at a loss. Since capital charges are the principal cost of hydroelectric power, after the generating plants have been built and that cost incurred, that power 115943-39-pt. 11- -30