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Electricity Utility Mergers: The Answer or the Question?

Fortnightly Magazine - January 1 1996

and Baltimore Gas and Electric Co. expect to save 2.6 percent of revenues. (Some of these companies also distribute gas.) Unregulated companies do not merge to save such small percentages of income.

Utility projections of merger-related savings are understandably optimistic, and will probably differ from those calculated by opponents. Yesterday's utility could project with more confidence than today's because its income stream, cost recovery, and political situation were all more secure than they are ever likely to be again. Some of today's utilities find themselves in tough situations because past projections of revenue and costs have not come true. Even if a merged utility realizes the savings, investors will not prosper if regulators insist on a passthrough to ratepayers. As for the ratepayers, let's assume that electricity makes up 5 percent of production costs (a very high share) for an industrial customer: A 2-percent post-merger price fall lowers that customer's total costs by only one-tenth of one percent.

LEAN AND MEANINGFUL?

Most savings from electric mergers are to come from sources that seldom motivate mergers elsewhere. In most announcements, two-thirds or more of the savings stem from staff reductions, investment deferrals, and related consolidations. Consider that fact. Utility-owned generation may have lost its natural monopoly, but the workforce of the merged companies has now become one. Any unmerged company that can only eliminate redundant employees by merger is a company with poorly designed job responsibilities. Oddly, merging utilities seldom target specific staff or functions for elimination. Instead, they intend to replace employees who depart voluntarily, and to fill in the vacancies by reassigning those who remain. If downsizing by employee attrition was good competitive strategy, unregulated businesses would use it more often. Ordinary firms, however, will more likely merge to acquire desirable employees rather than to lose them at random.

Only in odd situations will a merger leave the product better "positioned" for competition. In bulk generation, if one party enjoys an excess of low-cost generation while the other does not, regulators might insist on allocating the inexpensive power to native load. If neither partner can compete in the generation market by itself, a company that controls the aggregate of their generation also probably cannot. A merger cannot give a "first-mover" advantage in an industry where the important first moves have already been made. A merger between two utilities might employ their complementary skills for competitive advantage, but merger announcements seldom indicate what those skills might be.

A merger might allow some component of Utility A to function more effectively by embedding it into a combination of Utilities A and B. Utility B, however, might acquire the function more cheaply by contract than by merger, without combining other activities that a merger would disadvantage. If Utility A covets a particular piece of Utility B, it can buy just that piece, contract to share it, hire away the key personnel, or build its own on the same pattern. Electric utilities show a long record of ingenious and productive contracting. They routinely arrange diverse bulk-energy trades with one another, invest jointly in generation and