ITEM 1.  BUSINESS

The Corporation

The Tennessee Valley Authority ("TVA") is a corporate agency and instrumentality of the United States ("U.S.") that was created in 1933 by legislation enacted by the U.S. Congress in response to a request by President Franklin D. Roosevelt.  TVA was created to, among other things, improve navigation on the Tennessee River, reduce the damage from destructive flood waters within the Tennessee River system and downstream on the lower Ohio and Mississippi Rivers, further the economic development of TVA’s service area in the southeastern United States, and sell the electricity generated at the facilities TVA operates.

Today, TVA operates the nation’s largest public power system and supplies power in most of Tennessee, northern Alabama, northeastern Mississippi, and southwestern Kentucky and in portions of northern Georgia, western North Carolina, and southwestern Virginia to a population of over nine million people.  In 2013 , the revenues generated from TVA’s electricity sales were $10.8 billion and accounted for virtually all of TVA’s revenues.

TVA manages the Tennessee River, its tributaries, and certain shorelines to provide, among other things, year-round navigation, flood damage reduction, and affordable and reliable electricity.  Consistent with these primary purposes, TVA also manages the river system to provide recreational opportunities, adequate water supply, improved water quality, natural resource protection, and economic development.  TVA performs these management duties in cooperation with other federal and state agencies which have jurisdiction and authority over certain aspects of the river system.   In addition, the TVA Board of Directors (the "TVA Board") established two councils--the Regional Resource Stewardship Council ("RRSC") and the Regional Energy Resource Council--under the Federal Advisory Council Act to advise TVA on its energy resource activities and its stewardship activities in the Tennessee Valley.

Initially, all TVA operations were funded by federal appropriations.  Direct appropriations for the TVA power program ended in 1959, and appropriations for TVA’s stewardship, economic development, and multipurpose activities ended in 1999.  Since 1999, TVA has funded all of its operations almost entirely from the sale of electricity and power system financings. TVA’s power system financings consist primarily of the sale of debt securities and secondarily of alternative forms of financing such as lease arrangements.  As a wholly-owned government corporation, TVA is not authorized to issue equity securities.

Service Area

The area in which TVA sells power, its service area, is defined by the TVA Act.  Under the TVA Act, subject to certain minor exceptions, TVA may not, without specific authorization from the U.S. Congress, enter into contracts that would have the effect of making it, or the local power company customer of TVA ("LPC") which distribute its power, a source of power supply outside the area for which TVA or its LPCs were the primary source of power supply on July 1, 1957.  This provision is referred to as the “fence” because it bounds TVA’s sales activities, essentially limiting TVA to power sales within a defined service area.

In addition, an amendment to the Federal Power Act ("FPA") includes a provision that helps protect TVA’s ability to sell power within its service area.  This provision, called the "anti-cherrypicking" provision, prevents the Federal Energy Regulatory Commission ("FERC") from ordering TVA to provide access to its transmission lines to others for the purpose of using TVA’s transmission lines to deliver power to customers within TVA’s defined service area.  As a result, the anti-cherrypicking provision reduces TVA’s exposure to loss of customers.

TVA’s revenues by state for each of the last three years are detailed in the table below.

 

Note

See Power Supply — Coal-Fired for a discussion of idled coal-fired units .     

Customers

TVA is primarily a wholesaler of power.  It sells power to LPCs which then resell power to their customers at retail rates.  TVA’s LPCs consist of (1) municipalities and other local government entities ("municipalities") and (2) customer-owned

entities ("cooperatives") .  These municipalities and cooperatives operate public power electric systems that are not doing business for profit but are operated primarily for the purpose of supplying electricity to the general public or members.  TVA also sells power to directly served customers, consisting primarily of federal agencies and customers with large or unusual loads.  In addition, power that exceeds the needs of the TVA system may, where consistent with the provisions of the TVA Act, be sold under exchange power arrangements with other electric systems.

Local Power Company Customers

Revenues from LPCs accounted for 86 percent of TVA’s total operating revenues in 2013 .  At September 30, 2013 , TVA had wholesale power contracts with 155 LPCs.  Each of these contracts requires the LPCs to purchase from TVA all of its electric power and energy consumed within the TVA service area.

All LPCs purchase power under one of three basic termination notice arrangements:

The number of LPCs with the contract arrangements described above, the revenues derived from such arrangements in 2013 , and the percentage of TVA’s 2013 total operating revenues represented by these revenues are summarized in the table below.

Note

(1)  Ordinarily the LPC and TVA have the same termination notice period; however, in contracts with eight of the LPCs with five-year termination notices, TVA has a 10-year termination notice (which becomes a five-year termination notice if TVA loses its discretionary wholesale rate-setting authority). Also, under TVA’s contract with Bristol Virginia Utilities, a five-year termination notice may not be given by the LPC until January 2018.

TVA’s two largest LPCs — Memphis Light, Gas and Water Division ("MLGW") and Nashville Electric Service ("NES") — have contracts with five-year and 10-year termination notice periods, respectively.  Although no single customer accounted for 10 percent or more of TVA’s total operating revenues in 2013 , sales to MLGW and NES accounted for nine percent and eight percent, respectively.

The power contracts between TVA and the LPC provide for purchase of power by the LPC at the wholesale rates established by the TVA Board.  Under section 10 of the TVA Act, the TVA Board is authorized to regulate the LPC to carry out the purposes of the TVA Act through contract terms and conditions as well as through rules and regulations.  TVA regulates LPCs primarily through the provisions of TVA’s wholesale power contracts.  All of the power contracts between TVA and the LPCs require that power purchased from TVA be sold and distributed to the ultimate consumer without discrimination among consumers of the same class, and prohibit direct or indirect discriminatory rates, rebates, or other special concessions.  In addition, there are a number of wholesale power contract provisions through which TVA seeks to ensure that the electric system revenues of the LPCs are used only for electric system purposes.  Furthermore, almost all of these contracts specify the specific resale rates and charges at which the LPC must resell TVA power to their customers.  These rates are revised from time to time,

subject to TVA approval, to reflect changes in costs, including changes in the wholesale cost of power.  The regulatory provisions in TVA’s wholesale power contracts are designed to carry out the objectives of the TVA Act, including the objective of providing for an adequate supply of power at the lowest feasible rates. See Rates — Rate Methodology below.

Other Customers

Revenues from directly served industrial customers accounted for 11 percent of TVA’s total operating revenues in 2013 .  Contracts with these customers are subject to termination by the customer or TVA upon a minimum notice period that varies according to the customer’s contract demand and the period of time service has been provided.

The United States Enrichment Corporation ("USEC"), a subsidiary of USEC, Inc. , was TVA’s largest directly served industrial customer.  On May 24, 2013, USEC announced the cessation of enrichment activities at its Paducah, Kentucky site. TVA and USEC have subsequently completed agreements to extend power sales to facilitate the cessation of enrichment activities and to support non-enrichment activities at the site at a greatly reduced level. These sales arrangements may continue to be extended. Power sales to USEC represented three percent and five percent of TVA's total operating revenues for the years ended September 30, 2013, and 2012, respectively. 

Rates

Rate Authority

The TVA Act gives the TVA Board sole responsibility for establishing the rates TVA charges for power.  These rates are not subject to judicial review or to review or approval by any state or federal regulatory body.

Under the TVA Act, TVA is required to charge rates for power which will produce gross revenues sufficient to provide funds for:

In setting TVA’s rates, the TVA Board is charged by the TVA Act to have due regard for the primary objectives of the TVA Act, including the objective that power shall be sold at rates as low as are feasible.

Rate Methodology

In view of demand for electricity, the level of competition, and other relevant factors, it is reasonable to assume that rates, set at levels that will recover TVA's costs, can be charged and collected from customers. Further, the TVA Board has the discretion to determine when costs will be recovered in rates. As a result of these factors, TVA records certain assets and liabilities that result from the self-regulated ratemaking process that could not otherwise be so recorded under accounting principles generally accepted in the United States. See Note 1 — Cost-Based Regulation and Note 7 .

In setting rates to cover the costs set out in the TVA Act, TVA uses a wholesale rate structure that is comprised of a base rate and a fuel rate that is automatically determined by the operation of the fuel cost adjustment formula each month. In setting the base rates, TVA uses a debt-service coverage ("DSC") methodology to derive annual revenue requirements in a manner similar to that used by other public power entities that also use the DSC rate methodology. Under the DSC methodology, rates are calculated so that an entity will be able to cover its operating costs and to satisfy its obligations to pay principal and interest on debt. This ratemaking approach is particularly suitable for use by entities financed primarily, if not entirely, by debt capital, such as TVA.

TVA's revenue requirements for costs or projected costs (other than the fuel, purchased power, and related costs covered by the fuel rate) are calculated under the DSC methodology as the sum of the following components:

This methodology reflects the cause-and-effect relationship between TVA's costs and the corresponding rates it charges for its regulated products and services. Once the revenue requirements (or projected costs) are determined, they are compared to the projected revenues for the year in question, at existing rates, to arrive at the shortfall or surplus of revenues as compared to the projected costs. Power rates are adjusted by the TVA Board to a level deemed to be sufficient to produce revenues approximately equal to projected costs (exclusive of the costs collected through the fuel rate).

TVA's wholesale and retail rate structures include time-of-use ("TOU") and seasonal demand and energy ("SDE") rate structures. These rate structures provide price signals intended to incentivize LPCs and end-use customers to shift energy usage from high-cost generation periods to less expensive generation periods. The rates are intended to more closely align TVA's revenues with its costs.

For LPCs, the default wholesale rate structure is seasonal TOU. The wholesale rate provisions originally specified that the SDE option expired in September 2012. In April 2012, the TVA Board approved optional enhanced TOU and SDE structures which became effective in October 2012. TVA allowed LPCs to elect one of these wholesale rate structures and make retail adjustments consistent with their wholesale elections. LPC elections as of October 1, 2013, are as follows: 144 are served under the enhanced TOU structure, five remain served under the default seasonal TOU structure, and six are served under the enhanced SDE structure.

TVA's rates also include a fuel cost recovery mechanism that automatically adjusts its rates each month to recover its fuel costs, which include the costs of natural gas, fuel oil, purchased power, coal, emission allowances, nuclear fuel and other fuel-related commodities; realized gains and losses on derivatives purchased to hedge the costs of such commodities; and tax equivalents associated with the fuel cost adjustments.

On August 22, 2013, the TVA Board approved a five-year extension of the environmental adjustment (which commenced in 2004), which reflects the need to collect revenue for environmental expenditures to further TVA's environmental performance, as well as comply with new, more stringent air, water, and waste regulations. The environmental adjustment currently recovers approximately $415 million per year. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations — Key Initiatives and Challenges — Ratemaking . In addition, the TVA Board approved a non-fuel base rate increase of 2.63 percent on wholesale rates. It is anticipated this will increase base revenues by approximately $190 million for 2014.

Power Supply

General

Power generating facilities operated by TVA at September 30, 2013 , included 29 conventional hydroelectric sites, one pumped-storage hydroelectric site, 10 coal-fired sites, three nuclear sites, 14 natural gas and/or oil-fired sites, one diesel generator site, 16 solar energy sites, digester gas cofiring capacity at one coal-fired site, biomass cofiring potential (located at coal-fired sites), and one wind energy site, although certain of these facilities were out of service as of September 30, 2013. See Net Capability for a discussion of these out-of-service facilities.  TVA also acquires power under power purchase agreements of varying durations as well as short-term contracts of less than 24-hours in duration.

The following table summarizes TVA’s net generation in millions of kilowatt hours ("kWh") by generating source and the percentage of all electric power generated by TVA for the years indicated:

Note

(1)  Operation and maintenance issues reduced the available renewable generation during 2013, 2012, and 2011 from several facilities, including those utilizing methane, solar, and wind.

Net Capability

The following table summarizes TVA's summer net capability in megawatts ("MW") at September 30, 2013 :

Notes

(1) Net capability is defined as the ability of an electric system, generating unit, or other system component to carry or generate power for a specified time period and

does not include operational limitations such as derates.

(2) John Sevier Units 1 and 2 were retired on December 31, 2012, and Units 3 and 4 were mothballed on December 31, 2012.

(3) Eight MW of cofired methane at Allen and seven MW of cofired biomass at Colbert are accounted for as coal

generation as opposed to TVA Renewable Resources.

(4) Colbert Unit 5 was idled on October 1, 2013.

(5) Includes only active units. See Power Supply — Coal-Fired for a discussion of TVA's idling plans for units.

(6) Widows Creek Units 3 and 5 were retired on July 31, 2013.

(7) All four units at Raccoon Mountain Pumped-Storage Plant were temporarily out of service at September 30, 2013. All units are expected to return to service in 2014.

(8) See Item 2, Properties for a discussion of TVA-operated natural gas and/or oil-fired facilities subject to leaseback and long-term lease arrangements.

(9) Peak firing of simple-cycle combustion turbine units accounts for an additional 257 MW of short-term capability.

(10) The Allen Simple-Cycle Facility had four units (64 MW) out of service pending maintenance at September 30, 2013.

(11) The units at the Gleason Simple-Cycle Facility were derated to 360 MW as of September 30, 2013, pending maintenance.

(12) Caledonia is currently a leased facility operated by TVA.

(13) John Sevier Combined Cycle Facility is a single steam cycle unit driven by three gas turbines (3x1 configuration).

(14) Lagoon Creek Combined Cycle Facility is a single steam cycle unit driven by two gas turbines (2x1 configuration).

(15) In February 2013, TVA sold its diesel generators located in Albertville, Alabama.

(16) TVA's three wind turbines (2 MW nameplate capacity) at its Buffalo Mountain Site in Tennessee were not operational as of September 30, 2013, and do not appear to be economical for returning to operation. TVA owns 0.4 MW of solar installations at 16 sites.

(17) Contract Renewable Resources include Generation Partners, Renewable Standard Offer, and 15 wind turbine generators located on Buffalo Mountain. See Power Supply — Purchased Power and Other Agreements for information on renewable energy power purchase contracts.

Coal-Fired

TVA began its coal-fired plant construction program in the 1940s, and its coal-fired units were placed in service between 1951 and 1973. Coal-fired units are either active or inactive. TVA considers units to be in an active state when the unit is generating, available for service, or is temporarily unavailable due to equipment failures, inspections, or repairs.  As of September 30, 2013 , TVA had 10 coal-fired plants consisting of 46 active units, accounting for 12,901 MW of summer net capability. As of September 30, 2013 , TVA had 14 inactive units. Inactive units may be in three categories: retired, mothballed, or inactive reserve. Retired units are unavailable for service and are not expected to return to service in the future. TVA currently has four retired units: John Sevier Fossil Plant ("John Sevier") Units 1 and 2 and Widows Creek Fossil Plant ("Widows Creek") Units 3 and 5. Mothballed units are unavailable for service but can be brought back into service after some maintenance with an appropriate amount of notification, typically weeks or months.  As of September 30, 2013 , TVA had nine mothballed units: Shawnee Fossil Plant ("Shawnee") Unit 10, Johnsonville Fossil Plant ("Johnsonville") Units 7 and 8, Widows Creek Units 1, 2, 4, and 6, and John Sevier Units 3 and 4.  Inactive reserve units are unavailable for service but can be brought back into service after some repairs in a relatively short duration of time, typically measured in days. As of September 30, 2013 , TVA had one unit in inactive reserve: Colbert Fossil Plant ("Colbert") Unit 5.  On October 1, 2013, four additional units were mothballed — Johnsonville Units 5, 6, 9, and 10 — and the status of Colbert Unit 5 was changed from inactive reserve to mothballed. TVA refers to units which are in inactive reserve or mothballed status as idled.

Coal-fired plants have been subject to increasingly stringent regulatory requirements over the last few decades, including those of the Clean Air Act ("CAA") and subsequent laws and regulations. Increasing regulatory costs require consideration of whether to make the required capital investments to continue operating, or to decommission these facilities. In April 2011, TVA entered into two agreements (collectively, the "Environmental Agreements") .  The first agreement is a Federal Facilities Compliance Agreement with the Environmental Protection Agency ("EPA") .  The second agreement is with Alabama, Kentucky, North Carolina, Tennessee, and three environmental advocacy groups: the Sierra Club, National Parks Conservation Association, and Our Children’s Earth Foundation.  Under the Environmental Agreements, TVA agreed to retire 18 of its 59 coal-fired units by the end of 2017 and was generally absolved from any liability, subject to certain limitations and exceptions, under the New Source Review ("NSR") requirements of the CAA for maintenance, repair, and component replacement projects that were commenced at TVA's coal-fired units prior to the execution of the agreements. Failure to comply with the terms of the Environmental Agreements would subject TVA to penalties stipulated in the agreements. TVA is taking the actions necessary to comply with the Environmental Agreements. TVA is confident that it has adequate capacity to meet the needs of its customers after these units are retired.

The following table summarizes the retirement actions TVA is required to take under the Environmental Agreements, and the status of those actions.

Notes

(1) If TVA decides to add emission controls to these units, TVA must continuously operate the emission controls once they are installed.

(2) Convert to renewable biomass.

As of September 30, 2010, TVA had 14,573 MW (Summer Net Capability) of coal-fired generation. After these planned actions TVA will have 9,098 MW (Summer Net Capability) of coal-fired generation.

TVA is planning to balance its coal-fired generation with lower-cost and cleaner energy generation technologies. TVA’s long-range plans will continue to attempt to balance the costs and benefits of significant environmental investments at its remaining coal-fired plants that do not have scrubbers and/or SCRs. TVA expects to decide whether to control, convert, or retire its remaining coal-fired capacity on a unit-by-unit schedule.

Transmission upgrades may be required to maintain reliability when some coal-fired units become inactive. TVA invested $130 million in such upgrades between 2011 and 2013, and estimates future expenditures for transmission upgrades to accommodate inactive coal-fired units to be approximately $350 million for 2014 to 2020. Upgrades may include enhancements to existing lines and substations or new installations as necessary to provide adequate power transmission capacity, maintain voltage support, and ensure generating plant and transmission system stability.

* An extension request has been submitted to the Nuclear Regulatory Commission. See Sequoyah License Renewal and Nuclear Reactor Licensing below.

Nuclear Regulatory Commission Safety Improvements Orders and Other Guidance . In March 2012, the Nuclear Regulatory Commission ("NRC") issued three new safety orders stemming from lessons learned from the events that occurred in 2011 at the Fukushima Daiichi Nuclear Power Plant ("Fukushima events") . The orders require (1) the development of strategies for responding to an interruption of off-site power, (2) the addition of more reliable instruments to measure water levels in cooling pools where spent nuclear fuel is stored, and (3) the installation of more robust containment venting systems to prevent containment failure due to overpressurization. The first two orders apply to every nuclear reactor in the U.S., including Watts Bar Unit 2, which will be required to comply prior to issuance of its operating license. The third order applies only to certain U.S. boiling water reactors, including Browns Ferry. These reactors are required to improve their containment venting systems to prevent over-pressurization due to the buildup of non-condensable gases such as hydrogen. TVA plans to fully implement the requirements of these three orders which were submitted to the NRC on February 28, 2013. TVA expects to complete the implementation of these orders by 2019, and the cost to comply with these orders is not expected to exceed $220 million.

In addition to these orders, the NRC issued requests for information from U.S. nuclear operators regarding earthquake and flood risks and emergency planning. Based on the information provided in response to these requests, the NRC will determine if additional regulatory requirements are needed for these subjects. At this time, TVA is not able to predict the final outcome of these potential requirements or the associated costs; however, these amounts could be significant.

Since the Fukushima events, the NRC has also issued and adopted additional detailed guidance on the expected response capability to be developed by each nuclear plant site. TVA has developed plans and schedules for the development and implementation of strategies and physical plant modifications to address the actions outlined in this guidance for all of its plants, including Watts Bar Unit 2. The initial studies, including the required plant walkdowns, are expected to be complete in the first quarter of 2014. Flooding and seismic re-evaluations to determine any further plant modifications are scheduled for completion in mid 2015. In addition to the actions described above, TVA may be required to take further actions to comply with any additional regulatory action that the NRC takes in response to the Fukushima events.

Sequoyah License Renewal. TVA submitted the license renewal applications for both Sequoyah units to the NRC on January 7, 2013. If approved, the licenses for both units would be extended by an additional 20 years to 2040 for Unit 1 and