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Electric Mergers: Transmission Pricing, Market Size, and Effects on Competition

Fortnightly Magazine - June 1 1996

be effective. Without attempting such a precise analysis, we illustrate the approximate size by examining VACAR and MAIN, two areas in which more than five utilities, albeit of unequal size, now operate. Assuming that as part of the restructuring, the generation assets of the companies will be more evenly distributed and that the FERC will designate each area for a single poolwide transmission rate, effective competition in generation and resulting productive efficiency should be possible. Enlarging this area would increase the inefficiency of single-system pricing without efficiency benefits of corresponding size from greater competition. These areas are thus used as a projection of the approximate size in which single-system rates will prevail and hence the maximum size of the relevant geographic market. A more precise analysis might show that utilities could effectively compete with fewer generating resources and that a smaller area could be used to constitute a power pool. Because this area now supports more than five utilities, it is doubtful, however, that such an analysis could support a larger area as the minimum size necessary for effective competition.

Based on this paradigm of the future industry structure, the effect of mergers between interconnected utilities in VACAR and MAIN can be analyzed to demonstrate the probable effect on competition of mergers of interconnected utilities.

Why Many Mergers of Utilities Operating in the Same Region will be Anticompetitive

To illustrate the effect of transmission cost on market shares, and the impact on competition of mergers of typical size, consider a hypothetical merger of Duke Power Co. with South Carolina Electric & Gas Co. (SCE&G), both of which belong to VACAR. Assume that FERC has established a single-system transmission rate within VACAR and that VACAR is therefore considered the relevant geographic market.8 An analysis of market concentration within VACAR before and after the proposed merger illustrates that such a merger would trigger strict antitrust scrutiny under the Merger Guidelines.

DOJ and FTC evaluate competition using the Hirfindahl-Hirschman Index (HHI), a statistical technique that quantifies concentration of market shares in a given industry. The HHI reflects the idea that possession of large shares of concentrated markets creates opportunities for price leadership and for unilateral reductions in output that boost prices above competitive levels.

Under the Merger Guidelines, an HHI below 1,000 is considered unconcentrated and normally creates no obstacles to mergers. A market with an HHI of 1,000 to 1,800 is considered moderately concentrated; a merger within that market will likely be challenged if the merging companies have a significant share (em depending upon other factors, such as ease of entry. Markets with an HHI over 1,800 are considered highly concentrated; a proposed merger producing an HHI of that level typically raises challenges, particularly where it would significantly increase concentration, and particularly in the presence of the kind of barriers to entry that characterize power generation.

The total annual sales of each utility are used to determine market shares, and it is assumed that there are no long-term contracts removing the capacity for these sales from the market. This reflects a conclusion that the