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Gas-Electric Mergers: Money Well Spent?

Fortnightly Magazine - March 1 2000

electric company and kept a gas company and put them under one corporate umbrella," Priory says.

Flinn explains that at some merged companies, "gas people are on one floor and power is on another floor. They never talk. They have these predetermined transfer prices and everybody manages their blue or green widget, but no one is looking [at the big picture]."

And Flinn makes no claim that his own company is among the 1 percent of those fully integrated.

In its convergence merger in January 1997, PG&E Corp. paid approximately $1.5 billion for Valero Natural Gas Co. Valero operated a 7,500-mile gas pipeline system and eight natural gas processing plants in Texas, as part of the parent company Valero Energy Corp. At the time, the Valero acquisition was one of three conducted by PG&E Corp. in the natural gas sector.

Flinn says that his company still remains about halfway from full integration. PG&E's integration effort was delayed because of its recent focus on perfecting the company's infrastructure, he says. Nevertheless, Flinn adds, a big distinction remains between PG&E's integration approach and others.

For example, he says, if employees on the gas and electric sides simply exchange information about how much gas was burned, or if the power plant operator tells a power trader how many megawatts to sell, that is not true integration.

"They are just managing input and output from a volume perspective and are not managing their spark-spread risk," he says.

(The spark spread marks the difference between the input price of the natural gas fuel and the output price of the electricity generated, with each expressed in an equivalent form to reflect the heat content of the gas and the heat-rate efficiency of the plant. Spark spread is commonly expressed in terms of cost per Btu, or cost per megawatt-hour. It can help operators decide whether to generate power or toll the plant and sell the fuel as a commodity.)

Flinn discusses the value of tolling strategies. He also explains how a combined gas-power company can use a hot power market to escape a profit-denting price cap on the gas commodity side, or vice versa:

"As we combine our gas and power businesses ¼ we are going to ¼ do things on the power grid side combined with pipeline assets. In the wintertime that allows us to replicate [such things as] market area peaking storage."

Flinn wants access to pipeline capacity and supply both to meet the needs of its power plants "and the lucrative opportunities around the power side of the equation in the summer time."

A key component in PG&E's convergence strategy is replicating market area peaking storage in a virtual way, he says. That means using new combined-cycle power units during the winter.

"If we load in gas supply to run [the power plant] for the entire winter, and if we have markets that peak and need gas, we can buy power off the grid. [We] shut down the power plant, keep our power cells whole and go sell the natural gas to a gas distributor,"