About four months ago, at a conference at Stanford University’s Center for International Development, the economist and utility industry expert Frank Wolak turned heads with a not-so-new but very...
Why Applicants Should Use Computer Stimulation Models to Comply With the FERC's New Merger Policy
Models can overcome a key oversight (em
that both supply and demand affect competition.
This past December, the Federal Energy Regulatory Commission (FERC) issued a policy statement describing important changes in how it will evaluate proposed mergers under the Federal Power Act's public interest standard. These changes should lead to significant improvements (em not only in the evaluation of mergers, but also for other matters that affect market power, %n1%n including industry restructuring and market-based pricing.
It comes as no surprise that the policy statement identifies "effects on competition" as the central issue raised by a merger application. Of greater interest, the statement takes positions on how such effects should be analyzed, of which three stand out.
First, FERC formally adopts the Horizontal Merger Guidelines developed by the Department of Justice (DOJ) and the Federal Trade Commission (FTC) as a framework to analyze competitive effects, bringing its evaluation of market power into the mainstream of antitrust. Combined with heightened interest in the electric industry at the federal antitrust agencies, this action should mean no lack of work for experienced antitrust attorneys and economists.
Second, FERC specifies a "competitive analysis screen" as a first test to discriminate between mergers that raise competitive issues warranting further investigation, and those that do not. This screen describes procedures for several tasks, such as 1) defining relevant product and geographic markets in which market power might be enhanced, 2) identifying potential suppliers in such markets, and 3) computing market shares and concentration indexes for comparison with the Guidelines standards. To satisfy the policy statement, applicants typically must apply the screen and show results under various system conditions and price levels for those groups of customers that might suffer antitrust injury.
Third, as a component of the analytic screen, the FERC adopts a "delivered price test" to determine the geographic scope of competition (see sidebar). Together with information on transmission constraints, this test identifies which generating units to include in computing market shares and concentration for energy delivered to various groups of customers.
This new delivered price test is grounded in sound economic principles. It represents a substantial improvement over the Tier 1/ Tier 2 method that it replaces. Unlike the latter, the delivered price test takes into account the effects of generating costs, transmission losses and tariffs, and other ancillary service costs (em all of which affect the ability of each generating unit to compete in supplying energy to a particular group of customers at a price that would constrain the exercise of market power by owners of other generators.
Nevertheless, the test fails to take account of all factors that affect the geographic scope of competition in energy markets. Competition depends on demand as well as supply conditions. Thus, despite its merits, the FERC's proposed method ignores the role played by the geographic pattern of loads in determining the geographic scope of competition in the supply of energy to any particular group of customers.
Measuring Market Power:
The Role of Opportunity Costs
How should applicants and intervenors go about complying with FERC's required method for determining