Follow-up Audit of TVA's Financial Trading Program

March 28, 2014

2011-14477-01

Audit

During 2012, we completed an audit of TVA's Financial Trading Program (FTP) audit number 2011-14477. The program, which started in 2003, was designed to hedge or otherwise limit economic risk associated with the price of commodities recovered in TVA's fuel cost adjustment (FCA). Since the hedging of natural gas comprised the majority of the hedging program, we generally limited our scope to the gas hedging program. Although our audit determined the overall design of TVA's FTP control structure was appropriate, we also identified several areas where management oversight needed improvement to validate the usefulness and effectiveness of the program, as well as ensure TVA stakeholders' understanding of the program.As a follow-up to audit 2011-14477, we contracted with Mercatus Energy Advisors (Mercatus) to provide a third-party review of the final actions taken by TVA management with regard to the recommendations from our audit and determine if TVA's Financial Gas Hedging program was designed and functioning in a manner to achieve program objectives in the most efficient and effective manner.In summary, Mercatus agreed the overall design of TVA's FTP control structure was appropriate. However, Mercatus identified several additional areas regarding the design and function of the program that required attention. To address these areas, Mercatus recommended TVA>Determine risk tolerance and proper size of the FTP.Analyze volumetric risk on a regular consistent basis and communicate with stakeholders having a vested interest in this aspect of the FTP.Redesign hedging strategies to better match the characteristics of the exposures being hedged.Improve and consolidate performance reports.Cease using "Value at Risk" as a primary risk metric and replace it with at risk type of metric(s) that includes financial natural gas hedges and the physical exposures being hedged.Conduct stress testing on a routine basis.Ensure actions required by governance documents are adhered to or if language in the documents is inaccurate, revise the documents to reflect actual practices.Conduct a proper cost/benefit analysis of the FTP and compare all-in hedged cost of fuel to the cost of fuel without hedging (market price).Properly analyze and manage all of TVA's energy commodity exposure.TVA management generally agreed with the recommendations and provided a plan of action to address the recommendations.

Yes

Yes (agency-wide)

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