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Gas-Electric Mergers: Money Well Spent?

Fortnightly Magazine - March 1 2000

says Flinn.

"Historically, to meet that peak-day need, someone would have to go out and either pay and develop market area storage, or pay and develop production area storage combined with long-haul capacity," Flinn notes.

But in the future the gas industry won't have that built-in redundancy in pipeline capacity.

"As you don't fund this kind of built-in redundancy over time, you need to look for more efficient ways to do it," he says. In other words, people who rely on buying delivered gas from the market during winter to run their power plants probably just will not run them, he says.

"[In another strategy], if you have a rate cap on the pipe and vertically integrate it with your generation business, [you can] capture the value on the power side, where you have an uncapped value proposition. [You are] raising the rate of return capability for a pipe even though it is being recorded over on the power side," he explains.

Other strategies abound for integrating gas and power assets. That may explain why over 50 percent of investor-owned electric utilities own or have a significant ownership interest or alliance with a gas company, according to the Edison Electric Institute. In addition, EEI data reveal that 26 percent of revenues from electric IOUs in 1998 came from a combination of natural gas distribution, processing, pipeline and trading operations.

Back-Office Savings? Not the Key Factor

In a merger between natural gas and electric concerns, the most immediate and easily calculable savings come from consolidating duplicated business units, says Hugh Holman, senior equity analyst at investment bank Robertson Stephens, part of Fleet Financial Services. Investors and company managers usually expect immediate gains from cost reductions, he explains.

"It may be accounting functions, human resources functions and management functions that are duplicative. Taking an organization from $5 billion to $10 billion doesn't mean that you have to have twice as many people in that task," Holman says. For example, Duke's Priory describes going "viciously" after duplicative businesses after his company's electric and gas merger.

"We [were] going to save X million dollars in insurance and we [were] going to reduce the accounting department by X percentage," Priory recalls.

In 1997, as part of its first convergence merger, Duke Power paid $7.7 billion for the Houston-based PanEnergy gas pipeline, and created Duke Energy.

Priory admits that in regions where the company would sell gas product to electric customers, growth is more difficult to track because of organizational changes.

In fact, the No. 1 revenue earner and the main reason for these mergers is to provide gas to power conversion facilities, he says.

"The electrons - that is where the bulk of the [financial] revenue will be coming from," Priory expounds. "You can deliver an electron in Connecticut but make it from a molecule in the Gulf Coast, Western Canada or at Sable Island."

"A real converged capability is that you can pick the molecule of least cost and deliver it to that machine and convert it into the electron that may be desired in Connecticut.