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Electricity Utility Mergers: The Answer or the Question?

Fortnightly Magazine - January 1 1996

Differences of opinion make for good horse races and bad jokes about economists, and those who are studying the recent wave of electric utility merger announcements have not let us down. Some of these economists optimistically believe that the mergers act as forces for competition, since they will combine corporate assets and staffs to bolster operating efficiency and market acumen at the merged companies. Other economists, who see transmission as the root of monopoly power, are more pessimistic. They expect that a merged system controlling more transmission will end up better able to deny competitive access and thereby harm competition. Most likely, both of these views will turn out to be incorrect or incomplete.

Optimists should note that the announced savings from utility mergers are small, speculative, and often obtainable by less drastic means. Regulation makes it unlikely that a merged system will create a more formidable rival to independent generators, marketers, or telecommunications purveyors. Pessimists should note that the Energy Policy Act of 1992 (EPAct) put important limits on transmission monopoly by empowering the Federal Energy Regulatory Commission (FERC) to issue wheeling orders. Those limits will become more stringent as the FERC gears up to compel utilities of all sizes to file open-access transmission rates.

Neither monopoly nor competition seems to explain the recent merger rush. Combining two large utilities can prove costly, time-consuming, and disruptive. At a time when management should prepare for market developments, a merger diverts its attention to a transaction of little apparent value. In ordinary markets, mergers, acquisitions, and takeovers can be productive, but here they seem otherwise. Utilities that merge may be preparing for politics rather than competition.

HOW HIGH THE SAVINGS?

The substantial savings projected for recent mergers largely reflect the size of the merging systems, which often announce their newfound efficiency in ways that encourage a sense of wonderment in lay onlookers. Merger announcements never discount expected savings to a present value so that the returns to a merger can be compared with returns on other investments. The announcements give only one figure, rather than a range that might account more accurately for the greater risks that will come with increased competition. They also omit any explicit accounting for regulatory risk. If recent experiences are typical, most mergers will require about two years to obtain the necessary regulatory and antitrust approvals. If any one agency disapproves, the merger may never take place. If an agency imposes unexpected conditions on the merger, some of the anticipated savings might also vanish.

Even without these qualifications, the claimed savings are never very substantial. The annualized $770-million, 10-year savings for Southwestern Public Service Co. and Public Service Co. of Colorado amount to 2.6 percent of current electric revenues and 1.2 percent of the book value of their assets. Since the two companies do not abut, they must link themselves with a 300-mile line costing several hundred thousand dollars a mile. Northern States Power Co. and Wisconsin Energy Co. expect $2 billion in savings over the next 10 years (3.3 percent of annual revenue); Potomac Electric Power Co.

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