How Colorado's settlement in the Xcel merger builds a case for treating needy ratepayers as a separate class entitled to merger benefits.

Low-income consumer interests frequently get lost in the shuffle when utilities merge. Believing that the needs of low-income consumers are neither caused nor exacerbated by the merger itself, the companies and the regulators who oversee them instead focus on traditional merger-related issues such as market power, the ratemaking implications of acquisition costs, and the extent to which merger-related efficiencies should be shared between investors and ratepayers.

Not so in Colorado's recent consideration of the proposed Xcel Energy merger that would combine New Century Energies - and its operating subsidiary Public Service Company of Colorado (PSCO) - with Northern States Power Co. (NSP). In February, the Colorado Public Utilities Commission (PUC) approved a groundbreaking settlement between PSCO and a low-income advocacy alliance of Catholic Charities of Metropolitan Denver (CC) and the Colorado Energy Assistance Foundation (CEAF). The settlement addressed a host of low-income issues.

• Energy Assistance. PSCO agreed to contribute $4.75 million to CEAF during a seven-year period. CEAF provides energy assistance and energy efficiency assistance to low-income Colorado residents.
• Funding for Social Agencies. PSCO agreed to provide 20 computers and Internet access to energy assistance agencies designated by CEAF over a two-year period. PSCO will train the agencies to use this equipment to access the PSCO home page to review a client's account, determine an appropriate assistance amount, and communicate financial commitments to PSCO customer services staff.
• Set Aside of Default Credits as Relief. PSCO agreed to pay CEAF 8 percent of any bill credits the energy company might be required to pay for failing to maintain designated service quality standards. Such funds will be applied to energy assistance for low-income customers of PSCO.
• Energy Efficiency Funding. PSCO agreed to fund a low-income energy efficiency program at $2.6 million per year through 2006. Funds can be used for any purpose allowed by the U.S. Department of Energy's low-income Weatherization Assistance Program.
• Project for Testing Relief Delivery. PSCO agreed to design and implement a pilot rate-affordability project by fall 2000 for testing cost-effective means of delivering rate assistance to low-income consumers.
• Reports on Payment Problems. Finally, PSCO agreed to make annual reports on low-income payment troubles through 2009, even though its regulatory obligation to make such reports was to expire at the end of 2001. These reports include information on termination of service, payment agreements, households in arrears, PUC complaints, impacts of energy efficiency and rate-affordability programs, and related matters.

The Xcel case offers a legal framework for PUCs in addressing several key questions: (1) How do utility mergers generate cost savings? (2) Are local consumers likely to see any of those benefits? (3) If not, should regulators make a special effort to capture those savings for low-income customers? (4) If yes, then how can advocates develop a legal argument within the framework of utility regulation to justify that needy ratepayers should represent a separate class deserving of a special allocation of merger savings?

Traditional legal and economic analysis requires that a company seeking approval of a proposed merger not only demonstrate that efficiency savings will arise, but that those savings will be "passed on" to consumers. Part of the "passing on" analysis is to consider the potential adverse impacts of the proposed merger that might offset or eliminate the benefits of the merger to particular markets.

 

Are Mergers a Raw Deal for Consumers?

The Consumer Federation is the latest group blaming industry consolidation and market power abuses for the failures of deregulation. Excessive consolidation among participants in the deregulating electricity markets is part of the reason competition hasn't delivered on its promises, according to an April 18 report from the Consumer Federation of America. The CFA's report urges the Federal Energy Regulatory Commission to take a "very cautious approach to mergers," and follows a petition filed in December at the FERC that asked for a two-year moratorium on utility mergers. In that earlier petition, the American Public Power Association and the National Rural Electric Cooperative Association argued, "There is not yet evidence that the market can sustain the impact of large-scale utility mega-mergers." The CFA cites the conflicting goals of market participants, market manipulation, and ineffective policy responses by regulators for threatening system reliability and hindering consumer savings. The non-profit association of 260 consumer groups recommends that the FERC deny requests for merger approval or market-based rates to utilities that don't participate in an approved RTO. It also urges that FERC review the existing market-based rates of any utility that is not part of an RTO, and revoke market-based rates for any vertically integrated utility deemed capable of exercising market power. "With little experience in a competitive market, institutions undeveloped, and rules ill-defined, it is extremely dangerous to allow large numbers of competitors to be eliminated. ... Policymakers run the risk of establishing a competitive structure without competitors. After the fact fixes are extremely difficult and onerous." CFA concludes, "An ounce of prevention is worth a pound of cure." The CFA's report, "Mergers and Open Access to Transmission in the Restructuring Electric Industry" can be found at www.consumerfed.org/electmkt.pdf. - R.R.J.

In the proposed merger pending before the Colorado PUC, CEAF/CC identified distinct adverse impacts of the merger for the low-income market. In addition, CEAF/CC conveyed to the PUC how these adverse impacts would more than offset any savings passed on to low-income consumers. Thus, from the vantage point of the low-income market, the merger, as proposed, did not comply with the passing-on requirement.

In merger situations where the potential for such adverse impacts has been found, programmatic responses to mitigate these impacts have proven an appropriate condition of the mergers. PSCO likewise agreed to implement programmatic responses to redress potential harms created by the merger. The merger settlement reached between CEAF/CC and PSCO ensures that benefits of the merger will be passed on to the low-income market just as they are with other markets, without being offset by merger-induced problems. Here we examine the legal and policy basis for PSCO's commitments.

Poor Ratepayers: Justifying A Separate Class

The first inquiry in analyzing merger impacts involves a market definition. A delineation of markets is important to determine whether, and to what extent, impacts (positive or negative) will arise from a merger. The PUC must have a frame of reference within which to isolate and examine the anticipated effects of the proposed merger.

A market, simply defined, is an area within which sellers compete for the patronage of a common group of buyers. As this definition points out, the first two fundamental characteristics of "a market" thus require (1) a rivalry for the purchase decisions of buyers, and (2) a commonality amongst the sought-after buyers. CEAF/CC's presentation of facts in the PSCO case focused on the second element of the market definition.

"Ratepayers" do not represent a market. Instead, "ratepayers" consist of multiple markets. In the PSCO merger proceeding, CEAF/CC argued that low-income customers represent a distinct market for purposes of merger analysis, and identified factors that distinguished low-income residential customers as a separate market. In particular, the elasticity of demand distinguished low-income consumers. The definition of a market is frequently predicated upon the elasticity of consumer demand for the product in question.

The elasticity of demand measures the extent to which consumers can and will turn to substitutes if the price of a product increases. It considers the price sensitivity of the product in question as well. There can be no serious dispute that residential customers generally, and low-income customers in particular, have fewer alternatives, and lower price sensitivity, than large customers in the commercial and industrial (C&I) classes.

The elasticity of demand helps to define a market even within the monopoly situation of a distribution electric and natural gas utility. Low-income customers are less likely to switch fuels, because they are less likely to have dual fuel capabilities. They are less likely to reduce consumption. As a result, higher rates and lower levels of service can be imposed with less likelihood to the monopoly utility that consumers will respond by reducing their usage or moving to alternative fuels or fuel suppliers.

The "Passing On" Test: Rethinking Cost Allocation

Traditional merger analysis holds that efficiencies expected to result from a merger should be reviewed to determine the extent to which they are (1) merger-specific, and (2) likely to be passed on to consumers in the form of lower prices. CEAF/CC addressed the second half of this inquiry with respect to the proposed PSCO merger.

The passing-on requirement was first described formally by the Federal Trade Commission's 1984 decision in American Medical International (104 F.T.C. 1, 213-20 (1984)). The FTC found that "it is unlikely that market forces will oblige [AMI] to pass [cost-saving efficiencies] on to consumers." The passing-on requirement has been articulated time and again since.

In the PSCO proceeding, CEAF/CC identified two ways in which the passing-on requirement was not met. First, the merger itself created adverse impacts for the low-income market that more than offset benefits that were passed on. Second, the mechanism for distributing the merger-created benefits resulted in a disproportionately small share of benefits being provided to the low-income market.

Keeping a Local Focus. Cost savings resulting from consolidation are among the PSCO-NSP merger's economic benefits for investors, and, in fact, are a primary goal of the merger. Consolidation refers to the process of combining functions and offices so that a larger geographic area can be served with a smaller staff in fewer offices.

CEAF/CC argued, however, that consolidation likely would harm low-income consumers. The charity groups contended that mergers result in a degradation of service offerings tailored to low-income customers in local areas because the customer base to which the merged company is accountable increases.

As any company - whether in health care, financial services, or energy - expands its geographic service territory, the customer and institutional base to which it is accountable also becomes bigger. The largeness of the customer base typically forces the company to pay more attention to financial returns than to local community needs. Responding to local needs in rural Colorado, CEAF/CC said, would become less compelling to a company serving not only Colorado, but Texas, Wyoming, New Mexico, Oklahoma, Minnesota, North Dakota, Wisconsin, South Dakota, and Michigan as well.

The health care industry is an example cited by CEAF/CC. The merger and consolidation of health care plans has proven to result in plans favoring standardization, which in turn reduces the plans' responsiveness to the particular health needs and conditions of local communities. In fact, a 1993 survey of managed care organizations shows how market size can affect groups that evaluate the utilization of health care plans. The survey found that when such groups serve national markets, they tend to place considerably less value on local norms of clinical practices and local participation in studying health plan utilization than do similar groups that serve smaller state or regional markets.

The same problem arises in the case of bank mergers. In one article for the Federal Reserve Board of Kansas City, researchers emphasized the special knowledge that local bankers bring to community development. Noting that "deregulation has raised the specter of larger banks entering rural markets," the Federal Reserve writers expressed concern that this special knowledge pool would dry up. This report and others emphasize the importance of local community bankers in local leadership and in addressing community problems.

CEAF/CC found that the same results likely would obtain for PSCO. An increase in the geographic scope of the markets served by PSCO, CEAF/CC said, would lead to a reduced focus on the needs of particular states and localities and the local norms of treating payment-troubled customers. The experience of local energy service providers serving low-income customers nationwide bears out these findings in areas such as negotiating payment plan terms, establishing creditworthiness, and responding to inability to pay.

In addition, increased consolidation has decreased utility attention on the needs of particular local populations and how those needs affect the interface between the company and its customers. These local needs include such things as the closing of a major employer (thus putting substantial numbers of customers out of work), the significant presence of substandard low-income housing, and the prevalence of fixed-income older customers in a community. Local communities can have needs that go into the calculus of how a utility best interacts with the community, and it is precisely these needs that are less well-served by a merged company.

In sum, CEAF/CC identified adverse impacts of the proposed PSCO merger that would more than offset any benefits passed on to low-income consumers via a proposed rate freeze. CEAF/CC argued that specific merger conditions were needed to remedy these adverse impacts, thus assuring that net benefits were passed on to the low-income consumers.

Fixing Ratemaking Bias. In addition to the adverse impacts created by the merger, CEAF/CC assessed the extent to which merger savings would inure to low-income PSCO consumers. CEAF/CC argued to the Colorado PUC that, due to their unique attributes, low-income consumers would receive a disproportionately small share of the savings unless actions were taken to capture and distribute the benefits.

In Colorado, PSCO proposed to share the savings generated by the merger with customers through a rate freeze. This mechanism, in effect, allocates merger savings back to individual customers on a per-unit-of-energy basis (kilowatt-hour or therm). In this way, the more energy a customer uses, the higher the proportion of merger savings will be returned to him in the form of a bill that is lower than it would have been without the merger.

CEAF/CC objected to this plan. According to PSCO's merger application and pre-filed testimony, $96.6 million in merger savings could be attributed to the customer service function. Nearly $29 million in PSCO labor savings came in the area of "customer service." PSCO would realize an additional $67.6 million in savings in customer-service-related capital and expenditures for operations and maintenance.

CEAF/CC argued that a distribution of this $96.6 million in savings on a per-unit-of-energy basis would provide a disproportionately small benefit to low-income consumers. PSCO acknowledged that customer service costs are incurred as a function of numbers of customers. Indeed, the allocation of customer service costs on the basis of both usage (in units of energy) and sales (in dollars of revenue) were found to be inappropriate as cost allocators for customer service costs. In addition, PSCO conceded, the proper cost allocation for savings on information systems (IS) retail projects and customer information systems involves the number of customer bills. Finally, PSCO said, the proper allocation of IS savings involving distribution and delivery is the number of electric/gas customers.

If benefits are produced based on numbers of customers or customer bills, CEAF/CC said, but distributed according to energy usage, then customers (or classes of customers) with higher consumption will receive a disproportionately high share of the benefits and customers with lower consumption will receive a disproportionately low share.

In making these calculations, it does not matter whether one is addressing inter- or intra-class distribution of benefits. According to CEAF/CC, if you have a certain sum of benefits that are causally related to numbers of customers and you distribute those benefits between customer classes (e.g., industrial, commercial) on the basis of units of energy, then some "residential" benefits will be distributed to the high-use C&I customers.

The same is true within a ratepayer class as well. If residential savings (such as customer service savings) are produced on the basis of numbers of customers, and those savings are distributed on the basis of units of energy consumption, then there will be a disproportionate distribution of benefits to high-use residential customers and away from low-use residential customers. That will disproportionately harm low-income consumers, according to CEAF/CC.

CEAF/CC cited the Residential Energy Consumption Survey (RECS) prepared by the DOE's Energy Information Administration in support of its conclusion that low-income customers use less energy on a per household basis than do average residential customers. The RECS reports that for the Mountain Census Division of the Western Census Region - this is, the census division of which Colorado is a part - energy consumption by low-income households is less than that for the average household. Though the average annual energy consumption for all households in the Mountain Census Division is 98.1 million British thermal units, the consumption for households with incomes at or below 150 percent of the federal poverty level is only 78.6 mmBtu.

Using this data, CEAF/CC found that if merger-generated benefits are distributed on the basis of usage rather than number of customers, low-income customers will "lose" roughly $90 of every $1,000 in savings. At this rate of misallocation, roughly $8.7 million of merger savings that should have accrued to PSCO's low-income customers instead would accrue to other customers.

The Settlement: Borrowing from Telecom Deals

In response to the merger-induced harms to low-income consumers it had identified, CEAF/CC recommended that PSCO enter into a Community Energy Partnership. CEAF/CC emphasized that funding for the Partnership would not come out of ratepayer pockets, but instead would be taken out of projected merger savings. The Partnership was proposed as a mechanism for distributing projected merger savings to low-income consumers who otherwise would be denied their fair share. But the Partnership was more than a sharing mechanism for merger savings, however. It also had been structured to redress the affirmative harms that were projected to arise as a direct result of the merger. A variant of the CEP ultimately resulted in the PSCO settlement agreement.

The settlement between PSCO and CEAF/CC was not an unprecedented response to the types of merger-induced problems CEAF/CC identified with respect to low-income consumers. Programmatic remedies are common responses to adverse impacts for particular markets as a result of a merger. CEAF/CC cited the recent merger of Butterworth Health Corp. with Blodgett Memorial Medical Center in Michigan as a similar situation. In that proposed merger, the principal claim of "efficiency savings" involved claims of "capital avoidance." Concerns were raised, however, that the capital avoidance really involved excluding the offer of products and services that consumers otherwise would demand from an unmerged hospital.

In response to these concerns, the federal court hearing the case required the hospitals to implement a "Community Commitment" plan as a condition of the merger. The Community Commitment included, amongst other things (1) a freeze on prices and charges, (2) a freeze on prices to managed care plans to pre-merger levels, and (3) a commitment to the medically underserved and needy. In particular, the merged hospitals agreed to provide a minimum of $6 million each fiscal year to assist the underserved and general community, to be distributed through 30 programs addressing locally identified needs. The federal court required the merging hospitals to enter into a consent decree to ensure that they complied with the commitment to pass along benefits to consumers.

In a similar case, the merger of two corporate parents of three hospitals in central Pennsylvania recently was allowed by the Pennsylvania attorney general's office on the condition that the merged entity pass on at least 80 percent of net savings to consumers through reduced prices (or limited price increases for existing services), and low-cost or no-cost health care programs for the indigent. In another case involving adverse effects of a merger for particular customers, Massachusetts settled its objections to the merger of two of that state's largest HMOs after those HMOs agreed, among other things, to freeze group rates for one year, double enrollment in the Medicare risk program, and spend $4 million on services placed at risk by the merger. Services determined to be at risk included health care for the homeless, violence prevention, and AIDS prevention.

So, too, has this type of programmatic response been adopted by utility regulators as a condition of proposed telecom mergers. In California, for example, the SBC-Pacific Bell merger was conditioned on implementation of a Community Partnership Commitment, under which PacBell promised to fund more than $80 million in education and community technology projects during the next 10 years. Similarly, in Ohio, an agreement approving the proposed SBC-Ameritech merger was conditioned on Ameritech's funding more than $12 million for consumer education, technology diffusion, and community computer centers.

As with PSCO's settlement in its NSP merger proceeding, these telecommunication merger agreements responded to specific adverse impacts that would have been caused or substantially exacerbated by the proposed mergers. The mergers were proposed to facilitate the development and distribution of high-tech telecommunications, but information presented in the merger proceedings demonstrated the widening technology gap for low-income consumers. As a result, the benefits of the merger were found to be largely denied to low-income consumers. The Community Partnership Agreement, as well as the Ameritech-Ohio programmatic commitments, were mechanisms for assuring that the beneficial effects of each merger were passed on to low-income consumers.

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