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Financial News

Fortnightly Magazine - June 15 1996

shareholders appreciably.

Earnings from generation will depend on the structure of the unregulated generation industry and the particular generating capabilities of the merging utilities. Assuming a deep, liquid, competitive wholesale power market, small producers could easily sell their power at the prevailing market price. Size would not impact ability to sell power; a company's generating efficiency would be the critical determinant of profitability. Thus, a merger's generating benefits would depend on how much it increased generating efficiency.

If the wholesale market is thin and illiquid, or if a utility intends to participate in the bulk-power market, critical mass will be a factor. While a merger may significantly contribute to critical mass, the fuel and geographical mix of generation may prove a key determinant of the regional or national competitive strength of an unregulated generating company. Unfortunately, the future industry structure is not yet clear enough to indicate how helpful a particular merger might be in this respect.

Equally unclear are merger effects on earnings in energy services, still in an embryonic stage. The one-size-fits-all nature of the present monopoly franchise system essentially precludes marketing; little is known about what the energy services business will be like. Apart from bulk-power marketing, size will not likely prove an important factor in this area, at least initially. Thus, merger benefits for energy services would probably derive from obtaining critical expertise, not increasing size. However, no one has much, if any, expertise at this time.

When viewed in terms of the future structure of the industry, utility mergers at this juncture do not appear to hold out much benefit to shareholders. If T&D becomes a common carrier, mergers will not enhance the profitability of T&D. Apart from bulk-power marketing, energy services has not yet developed to the point where a merger can provide any identifiable benefits. The principal merger benefits, if any, lie with generation. However, since the nature of the future generating business remains a fairly unknown quantity, any potential benefits also remain speculative.

Competition as an Add-On

With shareholder merger benefits in doubt, why has there been so much utility merger activity during the last year? The answer: Utilities feel a need to do something and are confused about how the new industry structure will work. Many utilities envision the future structure as a modified version of the current structure, an environment in which success is granted to super-utilities.

To put it another way, many utilities consider competition something that can be appended to the current system. This expectation is evident in a recent comment by Commissioner Gregory Conlon of the California Public Utilities Commission: "If we're going to get competition there's a price to pay, which is the [competitive transition charge]." What he and these utilities both fail to appreciate is that competition, not regulation, provides the norm in the American economy. Viewing competition as a regulatory add-on that can be purchased implies that regulation can control competition, a dangerous assumption.

Current merger activity is premature and increases the risk that managements will make grievous mistakes in preparing for competition. Zealous expansion will