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FERC Deals with Vertical Market Power in Mergers

Fortnightly Magazine - September 1 1997

Commission explained that for a vertical merger to affect competition adversely in the wholesale electric market it is necessary for the upstream delivered gas and downstream wholesale power markets to be conducive to the exercise of market power after the merger. A vertical merger is unlikely to affect competition unless the merged company has the incentive and ability to affect prices or quantities in the upstream and downstream markets.

Merger Evaluation. To evaluate competitive effects, the FERC used the basic principles laid out in the 1992 Horizontal Merger Guidelines, developed by the U.S. Department of Justice and the Federal Trade Commission (see 57 Fed.Reg. 41,552). Embraced by the FERC in its 1996 Merger Policy Statement, the guidelines were applied to both the upstream delivered gas and downstream wholesale power markets to determine whether those markets are conducive to the exercise of market power after the merger.

Using that evaluation, the FERC was able to define relevant product and geographic markets; examine the competitive circumstances in the upstream market (delivered gas); examine the competitive circumstances in the downstream market (wholesale electricity) and the effect of entry into that market; and consider, based on the circumstances in the upstream delivered gas market and downstream wholesale electric market, whether the net effect of the merger likely would be significantly higher wholesale electric prices. The FERC said its analysis applied equally to a bilateral or PX market arrangement.

The FERC found seven situations in which the merger could impair marketability of competing power from gas-fired generators in interstate wholesale markets if regulatory safeguards are not imposed. The FERC said SoCalGas could:

• Use competitive market information to manipulate costs and services to SDG&E's advantage;

• Offer transportation discounts to SDG&E not made to competing generators;

• Withhold or deny access to pipeline capacity to competing generators;

• Offer service contracts providing SoCalGas with unilateral and arbitrary control over pipeline access and delivery points;

• Manipulate storage injection schedules to withhold pipeline capacity from competing generators;

• Force competing generators to renominate volumes to other delivery points or purchase additional firm capacity; or

• Manipulate terms and conditions of intrastate gas tariffs to SDG&E's advantage by enforcing the letter of SoCalGas' tariff when dealing with competitive generators.

Mitigation Requirements. The Commission implemented specific mitigation requirements to address the potential that SoCalGas will unduly discriminate in favor of downstream affiliates, and thereby put SDG&E's competitors at a disadvantage.

FERC curbed discriminatory conduct by SoCalGas and ensured transparency of transactions involving sales and purchases of gas transportation services. It also required separation of SDG&E's purchases of transportation service from SoCalGas for gas that would be used for its electric generators.

Rival utility Southern California Edison applauded FERC for acknowledging serious concerns over anti-competitive and vertical market power issues. Edison was one of about 12 parties filing protests at FERC, alleging that the merger would give the new entity unfair market power and ability to influence electric costs in the emerging competitive market in California.

"We could support this proposed merger," said Stephen Peckett, Associate General Counsel for Edison, "but only after adequate consumer protections and market