50120-310.indd

21st century basics:
finance
Dan Watkiss, contributing editor
this merger with the New Deal-era statute. MidAmerican nor its majority-owner Moreover, Congress could intervene: Both Berkshire Hathaway lays claim to syner- hen last I penned this column, houses of the 109th Congress continue gistic business drivers. Nor do they foresee I addressed “back to basics,” or to play their now familiar roles in passing significant cost savings through workforce B2B. Many investor-owned PUHCA repeal bil s, which, if enacted, reductions or other cost cutting. Rather, electric utilities retrenched to B2B to re- could rescue the AEP acquisition of CSW the driver of this acquisition appears to build from the rubble of the 2000/2001 and pave the way for Exelon, Duke and Western energy debacles and the col apses MidAmerican.
that column I asked how those B2B utili- savings appear to be the drivers ties would achieve sufficient earnings of both the Exelon and Duke growth now that long-dormant interest combinations. For its part, rates have begun a steady ascent. One an- the Exelon-PSEG merger swer was through mergers or acquisitions. combines known strengths Exelon’s stock acquisition of PSEG that overcome perceived D
had only then become a case in point. But weaknesses in each company. an
quick on its heels came other big plays: On the positive side of the led- W
Duke and Cinergy have committed to ger, the new company would marry their fortunes in another exchange of stock; MidAmerican stands poised to of low-cost nuclear operations with buy PacifiCorp from ScottishPower. While PSEG’s strong performance in transmis- opposed to earnings growth through spe- providing an avenue for earnings growth, sion and distribution operations. Exelon cific scale economies and targeted cost re- wil these combinations concentrate mar- projects that this marriage wil reduce op- ductions. ket power to an extent inconsistent with erating costs through workforce cuts and evolving forms of market-based regulation? scale economies. And if these proposed consolidations suc- Similarly, the expanded Duke wil tions, eliminate competition between the cessful y navigate a sea of chal enges, wil try to capitalize on combining Duke’s merging firms. This is of little consequence they then presage a uniquely 21st century Midwestern natural gas-fired merchant where the merging firms are smal or are pursuit of earnings growth through scale generation with Cinergy’s older and pre- in businesses characterized by easy entry economies or a return to the vilified power dominantly coal-fired regulated and mer- and exit. But natural gas and electric public chant fleets, providing both supply and utilities are neither smal nor susceptible to Concurrently with the announce- demand flexibility and an opportunity for particularly easy entry or exit. Competition ments of these consolidations, a Securities Cinergy to modernize its generation base eliminated through mergers and acquisi- and Exchange Commission judge cast into and reduce greenhouse gas emissions. tions between utilities typical y is contro- doubt the viability of growth strategies an- These combined operations wil al ow the versial because the combined utilities have chored in utility mergers and acquisitions. expanded Duke to pursue earnings growth the potential to concentrate market power In a May 3 order, the judge ruled that the through savings, trimming the combined and, in the case of holding company utili- Commission was mistaken six years ear- work force by an estimated 1,500 employ- ties, induce affiliate and reciprocal dealings lier when it condoned another consolida- ees.
at inflated prices harmful to ratepayers. tion, American Electric Power’s acquisition through merger of Central & Southwest, as carries with it a B2B commitment. At both enforcement officers, consumer advocates satisfying the “integrated public-utility sys- utilities, management has suggested that and competitors are scrutinizing the Ex- tem” demand of the Public Utility Holding the Cinergy acquisition may be the first elon, Duke and MidAmerican transactions Company Act of 1935 (PUHCA). Like an step in a transition that ultimately wil see to ascertain whether, under the antitrust appeals court before him, the judge con- the natural gas operations of the combined laws, these consolidations lessen compe- cluded that, notwithstanding AEP’s pur- companies separated and spun off from tition or tend to create a monopoly. They chase of transmission interconnecting with electric power operations. The end product wil also be reviewed for consistency with CSW over several hundred miles of sepa- would be one large, yet very basic, power the public interest—whether the anticipat- ration, the two systems were not in a single company and a separate and equal y basic ed benefits and savings of a combination MidAmerican’s PacifiCorp purchase wel as consistency with the applicants’ sion to the SEC, which may yet reconcile appears to blaze a different trail. Neither authority to continue making wholesale Reprinted with revisions to format, from the July/August 2005 edition of ELECTRIC LIGHT & POWER
power sales at market (rather than cost-of- sale power markets or control areas, their in an independent operator or to surrender service) prices. Any one of the announced combinations wil increase the combined any transmission system control.
deals could also run aground on the shoals company’s share of the wholesale power of PUHCA’s “single public-utility system” market and potential y increase the extent announced combinations beg the ques- requirement as interpreted in the May 3 or- to which it serves as a pivotal supplier. Ei- tion, what if the merger or acquisition fails der, provided that legislation repealing the ther eventuality would require that market in the near term? How wil earnings growth power be mitigated—probably in the form be achieved? For some utilities, that growth Exelon has placed a premium on ex- of generation divestiture or long-term con- wil default to more B2B investments in pediting its PSEG acquisition. That wil tracting out generation à la Exelon-PSEG— an expanded rate base of big-ticket hard- turn on averting an evidentiary hearing be- as a prerequisite to the new company being ware: new transmission, IGCC generation fore FERC to determine whether the trans- al owed to retain market-pricing authority. technologies and possibly a nuclear devel- action is consistent with the public interest. If the merger partners are not geographical- opment renaissance. Alternatively, some To pacify regulators and other opponents, ly proximate, then, within their respective may suspend M&A growth strategies and the merging companies have proposed in- markets or control areas, their combination return to diversification into non-regulated creasing their initial proposal to divest out- would neither concentrate market share and possibly even foreign operations.
right 2,900 megawatts of fossil generation nor magnify the combined company’s role by an additional 1,100 megawatts and con- as a pivotal supplier.
succeed and usher in others, with or with- tracting out an additional 2,600 megawatts While this eventuality would not raise out PUHCA repeal, what wil that portend? of mostly nuclear capacity on a long-term concerns of concentrated market power, Wil market power become so concentrat- it ironical y could make it more likely that ed that regulators are forced to reconsider This gambit appears to have succeed- the merger would run afoul of PUHCA’s their stil young affair with market pricing? ed, at least thus far. Over the opposition of “single public-utility system” requirement The answer to that question wil turn on the fel ow PJM Interconnection members, the as that requirement was interpreted by the mitigation conditions imposed on com- American Antitrust Institute, and a num- SEC administrative judge in the AEP case. bining firms. Additional y, we need to ask ber of ratepayer advocates, on July 1 FERC According to that judge, PUHCA requires whether a rash of consolidations wil herald approved the PSEG acquisition, without that the combined public utility system be the return of power trusts, as some fear. convening a hearing. As a consequence, confined to a single “geographic” area or While that should be a concern, a return of Exelon remains on track to close its acqui- region. In light of that construction, several the power trusts is unlikely. Proposed con- sition in the first quarter of 2006. In contrast industry observers have surmised that both solidations wil expand the size and reduce to Exelon, Duke and MidAmerican appear the Duke and MidAmerican acquisitions the number of utilities. Quite possibly they to be reconciled to the likelihood that hear- are, in reality, craps table come bets that the also wil increase market power and reduce ings wil be convened to explore the consis- 109th Congress wil , unlike so many of its competition in certain utility services. tency of their acquisitions with competition predecessors, final y repeal PUHCA.
Yet one more hurdle may confront cial structures of the 1920s’ power trusts Mergers and acquisitions that survive those pursuing earnings growth through should be prevented by enforcement of antitrust review and a FERC public-inter- a merger or acquisition. In the AEP case, PUHCA’s financial simplification require- est hearing wil stil need to address mar- FERC conditioned its public interest au- ments, as wel as the financial disclosure ket-power concerns. If not obviated, those thorization of the merger on the combined and verification requirements of the 1933 concerns could jeopardize the applicants’ utility’s surrendering operational control of and 1934 securities laws and Sarbanes- FERC-conferred market pricing author- its transmission systems to an independent Oxley. Even in the increasingly likely event ity, which is widely perceived as essential regional transmission organization. This that PUHCA is repealed, then under the for competing in today’s wholesale power was necessary, in FERC’s view, to mitigate most-tenable scenario of the comprehen- markets. In 2004, FERC adopted two the transmission market power of the com- sive energy bil to emerge from a Senate- “screens”—a measure of wholesale market bined utilities. FERC should be expected House conference committee, new FERC- share and a test to determine whether a sup- to attach a similar condition to the merger enforced transparency and disclosure plier is “pivotal”—through which it filters applicants currently before it. That did not rules wil be enacted, which (together with indicators of market power. As confirmed prevent FERC from authorizing Exelon’s the securities and Sarbanes-Oxley laws) in recent analyses applying these screens, acquisition of PSEG since both are mem- should be sufficient to protect against the many if not most of the six merging utili- bers of the PJM Interconnection. Nor holding company shel games of the 1920s ties own or control percentages of available should such a condition deter MidAmeri- as wel as the accounting shams of certain generating capacity within their control ar- can, which itself is a member of the Mid- 1990s energy merchants. eas that raise market power concerns under west ISO and has endorsed membership one or both screens, even before they are in a similar independent operation for the combined with their merger partners. Be- Western markets in which PacifiCorp owns cause of its failure to pass the screen that transmission. But for Duke, surrender of Bracewel & Giuliani in Washington, measures wholesale market share within its transmission system operating control may D.C. Focusing on litigation and arbitra- control area, Duke was recently ordered to prove a poison pil ; the North Carolina tion, his clients include utilities, banks discontinue market pricing of its wholesales utility—together with other Southeastern and other lenders and energy project developers. You can contact Dan at To the extent that their merger part- tors—has steadfastly refused to participate ners operate in the same or adjacent whole- Dan.Watkiss@bracewel giuliani.com.

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