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Exelon's Epic End Game

Electric M&A: The merger with PSE&G may herald a new industry structure, squarely at odds with regional markets.

Fortnightly Magazine - May 2005

comprehensive discussion of the 100-plus-page affidavit of William H. Heironymus,
a vice president of Charles River Associates Inc., and the key technical witness for the merger parties, and his evidence on products, markets, and compliance with FERC’s merger guidelines. Nor does it permit a full retelling of the
many in-depth critiques of that evidence, such as offered by Harvard University Professor Joseph Kalt, or Charles J. Cicchetti of the Pacific Economics Group, who have testified as opposing witnesses for the PP&L Cos., and PEPCO Holdings, respectively.

Much of this testimony involves disagreements over which geographic portions of the overall PJM regional grid should be considered pivotal in analyzing the effects of the merger.  Instead, consider just one of the many issues involved: the price of  natural gas.

In its protest to the merger, and by testimony presented by its key witness, Julia Frayer, a partner and managing director of London Economics International, FirstEnergy contends that Heironymus seriously has underestimated the scope of likely increases in natural gas prices. Frayer and FirstEnergy argue that this alleged shortcoming has caused the merging parties to offer a faulty analysis of which power plants should be considered as infra-marginal ( i.e., able to compete on price) in various PJM zones.

According to Frayer and FirstEnergy, Hieronymus estimated future natural gas prices by applying standard escalator factors to historical prices taken from 2004. By contrast, Frayer has employed power prices plus historic spot gas prices from 2004 to derive an implied competitive heat rate. (The rate at which a gas-fired plant must be able to convert the heat content of its fuel into electric output to compete at the prevailing market price for energy.) She then applied that implied heat rate to actual forward natural gas prices at the Henry Hub for 2006, as listed on the New York Mercantile Exchange. That analysis led Frayer to calculate destination market prices for energy some 47 to 57 percent higher, on average (with the exception of prices for the extreme annual super peak), than power market prices estimated by Hieronymus, representing the merging parties.

It is in such details that the Exelon merger fight may be won or lost.

Practical Effects

Beyond the theoretical arguments over arcane points of antitrust law and regulatory merger analysis, the EEG deal could have real, concrete, dollar-and-cents effects on power-market players across a wide area.

In New Jersey, for example, where PSE&G is a key player, the state’s Board of Public Utilities has asserted that the merger could pose “a serious threat”
to the very viability of the state’s BGS auction for basic generation service.

From Indiana, NISOURCE notes that with Exelon’s ComEd subsidiary having recently joined PJM, its electric subsidiary, Northern Indiana Public Service Co., has seen significant changes in grid loading patterns. Loopflows, it says, have forced closure of transmission lines or reductions in power-plant output. The company worries that the merger only will make things worse.

NIPSCO Vice President Frank Venhuizen states that ComEd’s joining of PJM has increased the west-to-east bias in power flows across his company’s lines (from 4,000 to 5,000