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FERC's Merger Policy: Still Founded on Market Power

But the fly in the ointment is computer modeling, where no one yet agrees on how to mirror the real world.
Fortnightly Magazine - January 1 2001

horizontal mergers (HHI statistics, the CAS, and effects on competition), it also adds some unique requirements for approving vertical deals.

According to FERC, the mischief of a vertical merger-the creation of the opportunity or incentive for the merged firm to exploit its position in the upstream gas supply market in order to charge anticompetitive prices in the downstream electric generation market-can be accomplished in several ways. These include increasing the price of, or withholding the supply of gas, engaging in concerted anticompetitive activity in the upstream markets with other participants in those markets, sharing competitively significant information, or through regulatory evasion raising the price of gas sold internally to a downstream regulated electric utility. In all cases, the end result is anticompetitively high electricity prices.

A vertical merger can create competition issues only where the applicants have both upstream and downstream market power. FERC frequently finds no market power concerns if the applicants lack market power either upstream or downstream or where the merged firm's upstream markets are geographically remote from its downstream markets. 7 Order 642 also specifies that vertical analysis is not needed when the upstream product sold by the merged firm is used to produce no more than a amount of the downstream product.

Assuming there are vertical problems, applicants must determine whether the upstream markets are highly concentrated (i.e., exhibit an HHI statistic of 1,800 or higher). Since a minimum of six suppliers is necessary arithmetically to reduce the HHI statistic below the highly concentrated level, nearly all upstream markets will be found to be highly concentrated. The traditional CAS and the delivered-price test then are used to evaluate concentration in the downstream electric markets. In this analysis, the merged company is treated as owning all the electric applicant's electric generation, plus all the electric generation receiving natural gas service from the gas applicant. 8 In addition, whereas the acceptability of a horizontal merger depends on the merger-related increase in market concentration, a vertical merger would be viewed as creating competition problems simply because the upstream and downstream markets are highly concentrated.

Order 642 does not reverse FERC's policy of accepting "behavioral" mitigation in the form of its pipeline standards to justify vertical mergers raising potential anticompetitive concerns. 9 In the merger, FERC applied the pipeline standards to the relationship between a gas distributor and its electric marketing affiliates. 10 In the merger, FERC applied the pipeline standards to the relationship between an interstate pipeline and each of its affiliated energy companies. 11 In that case, FERC specifically rejected an applicant's objection that "energy" was overly broad and that the standards should be limited to a narrower class of affiliates. FERC's chief objectives in and were to prevent discriminatory service offerings and the competitive misuse of commercially sensitive information. Of course, restrictions on sharing of information and employees also hinder management's ability to obtain merger efficiencies and cost savings. Along another remedial avenue, in the merger of two vertically integrated electric utilities, FERC found transmission vertical market power remedied by membership in an independent system operator/RTO. 12