In April, Texas Utilities announced that it would buy ENSERCH, Western Resources launched a hostile takeover bid for Kansas City Power & Light, and The Southern Co. initiated its ultimately futile bid for the United Kingdom's National Power. Eight other pending mergers involving major electric utilities have been announced during the last year. Utility managements clearly believe their future success requires merging with other utilities. The benefits for shareholders, however, are less obvious.
Shareholder benefits depend on the extent to which mergers enhance earning power, but restructuring casts a cloak of uncertainty over future earnings. It also requires a new framework for analyzing utility mergers that makes specific assumptions about the new structure of the industry.
Fortunately, the forces driving the restructuring process are obvious enough to allow a reasonably accurate projection of that structure. Technological and economic forces are making competition possible over a broad segment of the electric industry, and regulators and legislators are groping toward policies that will promote competition wherever feasible.
Future Industry Structure
We can assume that competition will be fostered wherever services can be provided by competing suppliers. Where competition is not practicable and strong natural monopoly elements are present, services will be provided by a regulated natural monopoly, much as they are under the current monopoly franchise system. Where competition is promoted, policymakers will ensure that market power is sufficiently constrained to allow competition to flourish. Such constraint will include actions to prevent utilities from using their natural monopoly activities to gain marketing advantages.
Electric generation and the marketing of electric services clearly lend themselves to competitive supply. Transmission and distribution (T&D), the electric power transportation system, has strong natural monopoly elements. Thus, logically, generation and energy services will become unregulated, while T&D remains a regulated monopoly. However, the desire to promote competition as broadly as possible will no doubt strip T&D of everything that is not necessarily a natural monopoly. Most customer services, such as metering and billing, will be severed from T&D and become unregulated energy services.
To constrain market power and create a level playing field for competition, T&D must function as a common carrier. Otherwise, utilities would be able to turn their transmission facilities to advantage in marketing their generation, and their distribution facilities to advantage in selling energy services. T&D will thus probably be completely separated from generation and energy services, possibly through spinoffs.
To analyze the earnings benefit of a merger, we must view a future utility as two parts: a regulated T&D system and unregulated other activities. T&D will earn a regulatory return as in the past, determined either by traditional rate-of-return regulation or some kind of performance-based regulation. Unregulated activities (em generation and energy services (em will earn returns that reflect a company's relative competitive position.
Future Merger Benefits
Under the new industry structure, T&D earnings will be asset-based, and the rate of return on assets will be largely independent of size. Any T&D savings from
a merger would be passed through to customers. Hence, increasing the size of a T&D system through merger would not benefit