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Utility Industry Consolidation Moves Ahead
June 2006
Mergers and acquisitions in the utility industry are becoming larger and more common, driven in part by recent changes in law. What does this mean for customers? The answer depends on who you talk to.
Until recently, the Public Utility Holding Company Act (“PUHCA”) limited the ability of utilities to merge and grow. Some say this act was a relic of the 1930s and was no longer applicable to the industry of today. Others would argue that point. Congress, after many years of debate and discussion, finally repealed PUHCA in 2005 and industry consolidation has been progressing more quickly than ever as a result. Recently announced mergers include Duke/Cinergy (now completed), Constellation/FPL, Keyspan/National Grid, and the largest of all, Exelon/PSEG. We’re not here to pass judgment on whether these consolidations are good or bad (where you stand, in part, depends on where you sit) but we would like to point out the issues that many are grappling with as these mergers move through the regulatory process.
Issues of Perception
From a state regulatory point of view, the acquisition of an in-state utility by an out-of-state holding company presents a perception, at the very least, of the loss of control and influence. Although the acquiring company will say that the local utility will still be managed locally by senior management, the reality is that the “real” decision making power moves out of state to the holding company and the state regulatory body loses at least some of its control. Intra-company transactions become regulated at the Federal rather than state level, and state commissioners and staff now often deal with senior managements that are several states away and less concerned with in-state issues.
From the point of view of both state regulators and customers, customer service becomes an issue as, again, decisions and control moves to a new and larger corporate entity further removed from where the decisions have their ultimate impact. Customer call-centers may be located far away from the “action” and the person a customer reaches by phone may have no knowledge of the local area. Dispatch, in the event of an emergency, may take longer as “duplicate” staffs are reduced.
These two issues are often issues of perception rather than fact, and regulators and customers may or may not see a direct impact from those management related changes. Regulators will learn to deal with new people and new decision making processes, and they still retain ultimate authority, including the ability to set rates, require appropriate levels of service, and levy penalties for lack of compliance.
Issues of Fact
The two key issues in any merger, however, are not driven by perception but come down to cold, hard dollars and cents. Companies merge for a reason, and that reason is money – money to be saved and money to be earned. How those dollars are estimated and divided up, and how the new, larger company can exert market influence are the major issues that have to be decided in the merger approval process.
Read any merger announcement and you will read about synergies and savings to be generated through the merger. Companies, whether they discuss this in detail or not, are planning on eliminating duplicate staff, including accounting, finance, customer service and more, and may talk about savings from more efficient dispatch of power plants, pipeline capacity, etc. These savings run into the tens of millions of dollars per year in many cases, and these savings must be shared with customers. Regulators are, or should be, charged with defining these savings, ordering a sharing of these savings and, most importantly, guaranteeing that these savings materialize in customer rates. This is the traditional approach we have seen from state regulators, and one we expect to see in all future merger cases.
The most important issue, however, is relatively new to the utility industry and is driven by industry deregulation – this is the issue of market power. With market prices being set by competitive market conditions, i.e., supply and demand, a merged entity can now exert undue influence and control over price by how it manages its supply. This is true in both gas and electric industry mergers and is most obvious in the proposed merger of Exelon and PSEG in the PJM service territory. The companies readily acknowledged potential market power when they proposed certain asset divestitures, but the reality of market power and the potential for undue influence and control appears far greater than the companies initially indicated. The New Jersey BPU and the US Department of Justice are currently grappling with the merger issue and their ultimate decisions are not due until later this year but, from what we understand, the companies’ proposed solution is far less than what is needed to mitigate market power.
So What Do We Conclude?
In the end, mergers and acquisitions in the utility industry are not necessarily a bad thing. Clearly, there are efficiencies to be gained and savings to be had. Customers and regulators, however, must be keenly aware of the pitfalls and deal with them realistically. They also must take the long view and not, as has often happened in the past, be satisfied with short term benefits at the expense of longer term costs. Most importantly, regulators and customers must make sure that merged companies do not gain undue influence over price and markets, and that competition is not effectively derailed under the guise of improved efficiency.
Compass Energy Services encourages its customers to be aware of and, especially in the case of larger customers, participate in the regulatory process through industrial groups. These groups exist in each state and at the national level as well. Contact Compass for more information.
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