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Electric M&A: A Regulators Guide

Fortnightly Magazine - January 1 1996

others have proposed rate freezes, some have proposed one-time refunds, and still others have proposed rate ceilings or caps. Despite the popularity of such proposals, regulators must ensure that any promised rate changes are consistent with the circumstances of the merger. In particular, are the rate proposals and projected cost savings consistent? And are proposed rate changes caused by the merger or an external condition like emerging competition?

Regulators should also look closely at the motivation behind rate design changes. Overall revenue-neutral rate design changes should be distinguished from interclass revenue-neutral changes. Rate changes should reflect the costs of the merger and not be used for other purposes, such as a preemptive strike against potential retail wheeling threats. Lower rates for industrial customers, at residential ratepayers' expense, will offer a tempting strategy for those merging companies that can afford to employ such devices. Because of the complexities, uncertainty, and opportunities for subterfuge, regulators should consider restricting their investigation of a proposed merger to the merits of the merger alone, deferring rate design changes to a future rate investigation or a later annual merger savings review.

Savings and Synergies

The biggest selling point in any proposed merger is the anticipated cost savings. All merger proposals loosely throw about claims of "synergies," "economies," and "efficiencies." Regulators should require some accountability for such claims.

Savings, however, beg the question "Compared to what?" PUCs should establish a baseline before authorizing a merger. Cost reductions attributable to the preparation for competition would exist absent a merger and should be included in the baseline.

Properly defined, a baseline can be used as part of a tracking mechanism to compare forecasted (pre-merger, stand-alone) and actual (post-merger) expenses. The baseline, however, should be adjusted annually to account for changes in inflation, using the difference between actual expenses and those established in the inflation-adjusted baseline to approximate merger-related savings.

Historically, PUCs have taken different approaches to ensure that ratepayers receive the cost savings projected from a merger. For example, the Connecticut Department of Public Utility Control, in approving the merger between Northeast Utilities and Public Service Co. of New Hampshire, required that in each future rate proceeding the merged companies pass through either 1) 50 percent of the projected administrative and general savings projected, or 2) the actual amount of the savings incurred during that period (em whichever is greater. The Kansas State Corporation Commission, on the other hand, ruled in its review of the Kansas Gas & Electric Co. and Kansas Power and Light Co. merger that savings beyond than the acquisition premium should be shared between ratepayers and stockholders on a 50/50 basis.

Establishing an appropriate sharing mechanism for cost savings will ensure accountability and create positive incentives for the merged companies. To maximize savings incentives for the merged company, PUCs should consider sharing mechanisms between ratepayers and shareholders that employ an increasing scale. That is, merged companies that meet or exceed projected savings could be allowed to keep a gradually larger share of such savings. The greater the savings, the greater the proportion reserved for the company and