In two separate cases, the Federal Energy Regulatory Commission for the first time has approved an analytical framework for examining vertical market power concerns raised by convergence mergers of gas and electric companies. This new framework applies when market power in one sector (such as natural gas) threatens competition in another (e.g., electricity).
In the first case, the FERC on June 25 conditionally approved the disposition of jurisdictional facilities in the proposed merger of two holding companies, Enova Corp. and Pacific Enterprises, the parent companies of San Diego Gas & Electric and Southern California Gas, respectively (Docket Nos. EC97-12-000 et al.).
On April 30, the FERC had ruled that while it does not have jurisdiction over mergers of public utility holding companies, it does have control over transfers of control - dispositions of public utility facilities that result from such mergers. That jurisdiction includes transfers of control of power marketer paper facilities, such as contracts, and physical facilities like transmission lines.
The second June 25 case involved the merger of two Houston-based companies - independent power developer, Destec Energy Inc., with NGC Corp., which the FERC approved. NGC engages in a wide range of energy-related businesses.
Commissioner William Massey encouraged FERC observers to study the Enova case. Massey observed that comity required the FERC to look to the California Public Utilities Commission to avoid duplicate cases and provide guidance. He said that if the PUC adopts mitigation measures, then "our wholesale concerns will be satisfied." That opinion was echoed by Chair James Hoecker, who pointed out that convergence mergers are vertical, and "this one especially requires cooperation between FERC and states."
Vertical Market Power Concerns. The proposed merger of Enova and Pacific Enterprises will create the nation's 22nd largest electric and gas combination utility holding company. If approved, the intrastate gas operations of SoCalGas would combine with the electric operations of SDG&E. But the FERC raised vertical market power concerns, noting that the potential existed for the merged entity to exercise market power that could adversely affect wholesale power markets. SoCalGas delivers natural gas not only to SDG&E's gas-fired generators, but to most gas-fired generators in Southern California that compete with SDG&E in the wholesale electric market.
The FERC said that while it believes most market power concerns could be eased, the most effective mitigation strategies lie within the jurisdiction of the California PUC. Therefore, FERC conditionally approved the disposition of facilities subject to adoption of certain mitigation remedies by the PUC. If the PUC's remedies do not satisfy the FERC, however, then it could revoke its merger approval.
The FERC noted that it crafted its Merger Policy Statement to apply primarily to horizontal mergers (see Order No. 592, Dec. 18, 1996). Vertical mergers, however, raise three types of competitive concerns that can result in higher prices or reduced output in the downstream output market: 1) denying rival firms access to inputs or raising their input costs; 2) increased anti-competitive coordination; and 3) regulatory evasion. The FERC decided to address the first two concerns, but left the third to the PUC.
The 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 power remedies are imposed."
On June 16, the California PUC delayed a decision to approve the proposed merger until March 1998. The delay is due to the PUC's performance-based rate case for SoCalGas, which was issued July 16.
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