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Electricity Utility Mergers: The Answer or the Question?

Fortnightly Magazine - January 1 1996

transmission, share short-term capacity, and make contracts for a variety of wheeling and coordination services. Why should two utilities merge if they can arrange almost any efficient transaction by contract? If merging really saves hundreds of millions, why did utilities rely on contracts for so long, and why were managements and regulators so slow to notice the savings?

CAN A MERGER MONOPOLIZE?

Some commentators fear (and some utilities may hope) that a merged system will exert greater monopoly power over transmission. If a utility cannot profitably exploit its transmission before merging, however, it probably cannot do so afterwards. A monopoly can only overcharge if it restricts product availability, a difficult feat for a utility with obligations to serve at cost-based rates. Under open access, the withholding of transmission is unlikely, particularly if wheeling customers can reassign their rights and utilities must offer interruptible service on unused capacity. Whether or not mergers occur, utilities may soon have to surrender some of their control to regional transmission groups and wholesale pools.

Open access might alleviate transmission restrictions, but a larger post-merger utility could wield more monopoly power in energy than a smaller one. In bulk power, the FERC increasingly assumes that wholesale generation markets are competitive. A merger only harms competition in those markets if it somehow forecloses transmission-dependent systems from transacting beyond the merged territory. If there are such impediments, a fine-tuning of open-access policy may be in order. At retail, regulation will continue, and antitrust action remains possible. Mergers will not affect state regulations that restrict retail direct access or otherwise require final users to pay above-market prices. Larger utilities will only be able to exercise monopoly power at retail if state regulators let it happen.

ARE MERGERS LIKE TAKEOVERS?

An economically efficient business produces at low cost. It encompasses the right scope of activities and sells its product competitively. Efficiency grows more likely if investors actively compete for control of the business, since those who can better operate it will outbid others.

Investors can choose from numerous methods to compete for corporate control. A proxy fight may vote out an inept management, a well-run existing firm may acquire an ineptly run firm, or a merger may combine one firm's executives with another's. Most graphically, a takeover specialist can acquire stock and install management of its choice. This new leadership often changes the firm's financial structure and reshapes its scope by divesting inappropriate activities. In theory and practice, takeovers usually improve efficiency and make corporations more valuable. The financial restructuring puts investment decisions under closer scrutiny by the capital markets.

Today's mergers between adjacent utilities hardly serve as efficient takeovers. No recent announcement even hints that one partner has less than superb management, although it seems odd that so many good matches have only arisen so recently. No merging parties have announced corporate restructurings beyond such easy steps as the formation of a holding company. Merging utilities may often be unable to propose more radical changes. Regulation often restricts their corporate structures and imposes service obligations they cannot abandon. Bond indentures can