April 14, 1997
Ms. Lois Cashell
Secretary
Federal Energy Regulatory Commission
888 First Street, NE
Washington, DC 20426
Re: Proposed BG&E/PEPCO Merger
Dear Ms. Cashell:
The Office of Advocacy of the Small Business Administration was established by Congress under Pub. L. No. 94-305 to represent the interests of small business before federal agencies and Congress. In the past, Advocacy has submitted comments on FERC's proposal dealing with open access transmission and stranded cost recovery. Advocacy is on record in support of the deregulatory process but only with built-in safeguards to avoid erecting regulatory barriers to new entrants or imposing excessive costs on small business customers. Ergo, Advocacy supports limited recovery of stranded costs. Deregulation has the potential for offering business opportunities for small businesses interested in entering the electric utility industry, as well as providing lower rates for small business retail customers.
The Issue
Currently, Potomac Electric Power Company (PEPCO) and Baltimore Gas and Electric Company (BG&E) have a merger application pending before the Federal Energy Regulatory Commission. Given the magnitude/size of the proposed merger, Advocacy is concerned about the potential effects that a merged utility could have on the marketplace and that the merger is conceivably being proposed in anticipation of de-regulation of the entire industry in order to solidify the merged company's market position post deregulation.
The Proposed Merger Will Create the 9th Largest Utility
In January 1996, PEPCO and BG&E filed an application to seek FERC's approval for merger of the two utilities.
PEPCO generates, transmits, distributes, and sells electric energy in the District of Columbia and adjoining parts of Maryland. With a customer base of 679,000, PEPCO generates 6,723 megawatts of power and has $7.0 billion in assets. PEPCO' s revenues total $2.0 billion per year; it's annual income is approximately $243.93 million.
BG&E generates, buys, and sells electricity within Maryland. It generates 6.741 megawatts of power and has a customer base of 1.1 million. BG&E has $8.1 billion worth of assets, revenues totaling $2.82 billion, and an annual income of $333 million.
If merged, the two entities will form the ninth largest utility company in the nation, with $15 billion in assets and control of the Baltimore/Washington region. PEPCO & BG&E have pledged not to increase rates until the year 2000. That commitment, in addition to the additional concentration of the market, is at the heart of the policy issue.
FERC's Criteria for Evaluating Mergers
On December 18, 1996, FERC issued a policy statement establishing factors that will be relied on to determine whether a merger is in the best interest of the public. In presenting its policy, the Commission stated that it recognized that the electric utility industry is in the midst of enormous technological, regulatory, and economic change. It further stated that, in accordance with the goals of the Energy Policy Act of 1992 (EPA) and FERC's own Order 888, mergers should be consistent with the public interest, take into account the changing marketplace, and pay close attention to both the possible effects that the merger may have on competitive bulk power markets and the subsequent effects on ratepayers.
In evaluating mergers, the Commission stated that it would consider three factors:
For the merger to be approved, the Commission must be satisfied that the impact on all three factors are positive rather than negative. Advocacy asserts that if the Commission carefully considers the three factors, the proposed merger must fail.
The Proposed Merger Will Have a Negative Effect on Competition
Advocacy contends that the negative effects on competition alone are sufficient to warrant rejection of the proposed merger. In order to determine the effect on competition, FERC adopted the Department of Justice/Federal Trade Commission's five-step guidelines for analyzing the effect on competition. The five considerations are:
Given the magnitude of the proposed merger, the application of the five step guidelines can only result in a finding that the merger will have a negative effect on competition.
The Proposed Merger Will Significantly Increase Market Concentration
The obvious answer to whether the merger would increase concentration and result in a more concentrated market is "yes". The proposed merger is between the only two players in the Baltimore/Washington region. The only two electric utility companies in the area will unite to become one company. Moreover, under the current perimeters of the marketplace, a merger between BG&E and PEPCO will erect barriers to entry that will prevent the formation of a diverse marketplace.
In addition to
concentrating the market, merging the two companies will combine
market dominance, assets, personnel, technologies, advertising
budgets, marketing structures, billing, etc. developed during
years of regulation. New competitors will have to contend with
entry barriers such as accessibility to capital, research and
development, etc. New entrants will also have to contend with the
costs of marketing/advertising that contributes nothing to the
production of energy but which will be necessary costs to meet
the competition from established companies and to re-educate
customers accustomed to monopoly markets. Under more concentrated
markets, these difficulties will be compounded by the sheer
strength of the combined entity. If one of the purposes of
deregulation is to promote diversity in the marketplace and avoid
undue market power to promote competition, the proposed merger
should be rejected.
The Merger Raises Concerns About Possible Adverse
Effects
Needless to say, Advocacy is concerned about the possible adverse effects that such a merger will have on the marketplace and small entities. On a wholesale level, the merger may effect a small entity's ability to obtain transmission and distribution services at a reasonable rate. On a retail level, the merger may limit a small entity' s ability to shop and bargain for competitive rates.
Moreover, in general, mergers present concerns about the possible adverse effects on stranded costs recovery. The Office of Advocacy has consistently argued for equitable allocation of partial stranded costs recovery. At this juncture, Advocacy is particularly concerned about the shifting and allocation of stranded costs.
Shifting of stranded costs from one entity to another can be a problem in mergers. In the BG&E/PEPCO merger, Advocacy is particularly concerned about the possibility of significantly shifting stranded costs from one customer base to another due to BG&E's significant investment in plants and equipment and the possible implications that it may have on local small businesses. Currently, BG&E has nuclear plants that may result in stranded costs. PEPCO does not have a similar investment problem. If the merger is approved without provisions to address the stranded costs issue, the costs will be shifted to PEPCO for absorption by PEPCO's customers.
While it is inequitable for PEPCO's customers to have to absorb the stranded costs of BG&E's nuclear plants, the absorption may be particularly burdensome to PEPCO's small business customers. Historically, when large industries or consumers have been able to receive benefits, small businesses have had to absorb excess costs through higher rates. If BG&E's stranded costs are shifted to PEPCO's customer base, the entity's small business customers may inevitably have to "pick up the tab" for BG&E's nuclear power plants. Advocacy contends that it would be fundamentally unfair to expect PEPCO' s small business customers to be burdened with costs from which they did not receive any benefits.
Similarly, Advocacy is also concerned about the shifting costs in determining the equitable allocation of stranded costs. If BG&E/PEPCO allow large industries to leave without absorbing their portion of stranded costs, the excess will be shifted to the remaining customers. As such, small businesses will be forced to absorb the differential left by the large industries in addition to their fair share of the stranded costs.
Furthermore, a monopolist can maximize long term profits by allocating stranded costs in an anti-competitive manner, i.e., if stranded costs are levied heavily on departing customers, then a customer has less incentive to leave its current provider and purchase energy from a new entrant. If customers are reluctant to leave because of high stranded costs, then the new utility providers will be unable to obtain a customer base.
The current merger could produce an entity with a potential for holding several customers hostage if stranded costs are not allocated in an equitable manner. Such practices would be harmful to a small business customer that wishes to leave to obtain a more competitive rate as well as to the small business trying to enter the energy field.
The Entry of the Merged Entity Will Not Deter or Counteract Any Such Concerns
The proposed merger is occurring at the genesis of deregulation. As stated previously, the new entity will be the ninth largest utility company in the country. The company will control all of the District of Columbia and most of the State of Maryland. Individually each company has significant market power in the region to create barriers to entry. To allow a merger that increases market power at this juncture exacerbates concerns about the lack of a new entrant's ability to compete.
Could Efficiency Gains Be Obtained Through Some Other Means?
The answer to this question is unknown. The one thing that is clear is that the merging companies stand to gain efficiencies. The new company can expect to decrease the amount of personnel needed to operate the merged entity as well as reduce the costs of providing electricity service. They can also combine technological advances. Whether the companies could gain the efficiencies through some other mechanisms is a question only FERC can answer. Even if the answer is "No", Advocacy asserts that the reaping of efficiency gains is not enough to mitigate the potential damage to competition-especially in anticipation of deregulation.
Without the Merger, Neither Party Will Fail
The marketplace need not worry whether it will lose the assets of BG&E or PEPCO. Both BG&E and PEPCO have healthy balance sheets acquired through years of regulatory protection. As stated previously, both companies have well developed marketing competencies, technology, corporate strategy, and accounting systems. Individually, they will be competing against start-up companies that do not have the same advantages. It would be ludicrous to suggest that but for the merger, either of these companies would fail.
The Effect of the Proposed Merger on Rates Will Be Incompatible with the Public Interest
The merging companies have pledged to maintain rates at their current level until the year 2000. This proposal has a pleasant ring but it is important to note that the merged company will nevertheless be maximizing profits while reducing costs through merged staffs, facilities, marketing/advertising budgets, etc. Moreover, because of technological advances and competition, the company will experience a reduction in costs. If BG&E/PEPCO maintains its current rates rather than lowering them, its customers may not be able to reap the full benefits of competition and advances in technology. Thus, maintaining rates is not a clear benefit to the customer base or to competition.
Furthermore, the maintenance of rates at a time when new entrants must tackle the problem of rising costs may have a negative effect on competition. If PEPCO and BG&E maintain rates at a level which may be less than a competitive market rate, the new entrants may have difficulty obtaining and maintaining a customer base to create a competitive environment. The long term effect on the lack of a competitive environment will be an increase in customer rates once the customers no longer have appropriate alternatives for a power provider.
The Proposed Merger Will Usurp the Regulatory Process
Historically, deregulation has resulted in an increase in competition through new entrants into the market. To illustrate, in August 1982, the United States District Court for the District of Columbia entered a Modification of Final Judgment to deregulate the telecommunications industry. At the time of the order, there were thirteen companies with assigned carrier identification codes. Within two years, there were 123 companies with assigned carrier identification codes. By 1992, there were 692 companies with carrier identification codes. This represents a 530 per cent growth within the first ten years following deregulation in the telecommunications industry. It is not unreasonable to assume that similar competitive results will occur in electric utility industry following deregulation as occurred in the long distance telephone industry. Both industries are capital intensive- both are regulated monopolies.
Under the proposed merger, however, Advocacy doubts that the benefits of deregulation will occur as quickly as we witnessed in the telephone industry. Advocacy asserts that the proposed merger is a defensive mechanism by BG&E and PEPCO to protect their assets during the deregulatory process. The net result of the merger will be an entity that will be large enough to exert monopolistic power, thereby limiting the benefits reasonably to be expected from deregulating what had been regulated monopolies.
The question FERC has to answer is whether the market concentration that will result from the merger will increase the barriers to the competition that is intended to result from subsequent industry deregulation. If FERC has any concern that it will, then the merger should not be allowed.
Conclusion
The proposed merger application of PEPCO and BG&E is only one of many FERC will have to consider. FERC's merger policy is, if nothing else, copious. What merger is in the "public interest" is not readily determined by easy black and white calculations. With deregulation of the industry on the horizon, Advocacy urges FERC to take a conservative approach to merger approvals so that the benefits to be derived from deregulation will be maximized and that public policy decisions made now will not make it more difficult for new entrants and customers once deregulation is a reality. In this instance, Advocacy is not sanguine that the proposed merger is in the best interests of the public, in that the merger will have a negative effect on competition, rates, and deregulation.
If you would like to discuss this matter or if this office can be of any further assistance, please contact Jennifer A. Smith. She may be reached either by mail at the above address or by telephone at (202) 205-6943.
Thank you.
Sincerely,
Jere W. Glover
Chief Counsel for Advocacy
Jennifer Smith
Assistant Chief Counsel for Economic
Regulation and International Trade