You've heard talk lately about the convergence of electricity and natural gas. That idea has grown as commodity markets have matured for gas and emerged for bulk power.
But some economists take a different view. They see the real convergence occurring between electricity and telecommunications. I'm not talking about the "smart house" or fiber-to-the-whatever. Instead, how is the product is created? Electric utilities and telephone carriers share some common attributes (em a product you can't control, inventory you can't store, and a nonlinear transmission network tying it all together (and probably underpriced) that creates economies and value. The Internet provides the classic example: All network and no product.
Scott Neitzel, a member of the Wisconsin PSC, puts it this way: "The obligation to serve will convert to an obligation to connect. Utilities will simply energize the wires."
Read the Tea Leaves
Early last month, at EXNET's Ninth Annual Utility Mergers and Acquisitions (M&A) Symposium, held as usual at the Plaza Hotel in New York City, I grabbed a seat at lunch and listened to Commissioner William L. Massey's thoughts on merger policy at the FERC. Just one day earlier, on January 31, the FERC had released its order denying immediate approval of the Primergy merger between Wisconsin Electric Power Co. and Northern States Power Co. (Docket No. EC95-16-000).
Massey hinted that anyone curious about the FERC's future direction should study the Primergy order. "Read the tea leaves," he advised. Massey repeated his well-known concern about antitrust analysis and market concentration in the electric generation sector. But he also showed particular interest in transmission bottlenecks. He brought up the not-uncommon practice of merger partners offering an "open season" on bulk-power procurement to allay fears of any possible future price manipulation by the merged company. Massey, however, suggested that such open-season offers might prove hollow: "Suppose many of the competitors of a merging company are on the other side of a transmission constraint controlled by that company. . . . FERC may have to discount the availability of the competitors' power in its generation dominance analysis."
It was that last point (em generation dominance (em that provoked the most interesting question after lunch. That question came from Michael M. Schnitzer, now managing director at The NorthBridge Group, a Harvard-educated chemist who formerly worked as managing director at Putnam, Hayes & Bartlett.
Schnitzer asked whether generation is too concentrated or whether electric transmission rates are simply too high. "When transmission prices are set too high," says Schnitzer, it discourages certain long-range power transfers and "shrinks the apparent geographic market." With a smaller market, he explains, "The problem of generation concentration arises sooner than it would otherwise."
Neitzel echoed that view. "The key is market size," he said. "If the market is the Eastern Interconnection, then you will probably be OK. But if the market is Wisconsin, then it will be pretty easy to get your HHI (Herfindahl-Hirshman Index) above 1,800. And the key to market size is transmission policy." Neitzel continued: "So in a sense, merger activity is a response to the market getting larger."
But the problem, of course, is that everything is a moving target. The Mega-NOPR promised to create a competitive market by unbundling transmission from generation. Now, with competitive power pools emerging (the California Power Exchange, plus proposals at PJM, NEPOOL, and American Electric Power Co.), the utilities themselves appear to be rebundling generation with transmission. Can the system operator stay independent?
Lawyer Lon Bouknight, a principal in the ill-fated merger between San Diego Gas & Electric Co. and Southern California Edison, summed up the problem: "When you operate the transmission network, what you are really doing is dispatching generating plants. So how can you separate the two?"
Let 'er Rip
A month earlier, at the annual meeting of the American Economic Association in San Francisco, professor William Shepherd (University of Massachusetts) delivered a paper to the association's Transportation and Public Utilities Group, entitled "Mergers, Consolidations, and Antitrust Policies in Network-based Markets." Shepherd argued (five weeks before the President signed the new telecommunications act) that deregulation and antitrust oversight have failed to produce telephone competition, and will likely fail in the electric arena: "[T]elecommunications has since the 1950s been something of a strange cuckooland, full of illusions and pie-in-the-sky hype; and electricity now seems to be catching that disease, too."
Shepherd continues: "Antitrust has become a weak cure . . . for complex mergers of the types now arising in telecommunications and electricity. [These two sectors] call for much deeper changes toward competition than now seem to be in prospect. . . . [P]remature deregulation may entrench dominance further, blocking the chances for genuinely effective competition."
When the American Public Power Association and the National Rural Electric Cooperative Association filed their joint petition asking the FERC to revise its merger approval standards under Federal Power Act section 103 (Docket No. RM96-8-000, filed Jan. 17, 1996), they attached a 32-page appendix by none other than the same professor Shepherd, entitled "Applying Antitrust to Mergers in the Electric Industry," which advanced many of the same arguments as the San Francisco paper.
In the joint APPA-NRECA filing, Shepherd counsels against too much reliance on antitrust oversight: "The antitrust agencies, on their part, should not be counted on to see and avoid the dangers. They are thinly staffed, lacking in electricity expertise, and scantily informed about the dramatically changing terrain in the electric industry."
The urge to merge can be irresistible. Del Hock (chairman and CEO, Public Service Co. of Colorado), admitted as much at the EXNET M&A conference in New York. "If your monopoly business becomes competitive, one result is certain," says Hock. "You will lose market share. Thus growth is critical."
Professor Shepherd needs more convincing. "Beware loose talk and smooth assurances," he warns. "If you just open up dominated markets and 'let 'er rip,' the ripping will probably hit consumers and small rivals."
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