The Larger, the Better
In recent years, increased competition and the threat of deregulation have spurred numerous mergers and acquisitions. Fourteen mergers have been completed by investor-owned utilities (IOUs) over the last five years; seven more have been announced. If all of these mergers receive approval, nearly 20 percent of the IOUs that existed in 1990 will no longer exist.
These mergers have consolidated generation resources into fewer hands, raising the possibility that sellers will be able to keep prices profitably above competitive levels for a significant period of time (em that is, to exert market power. In states where regulators and policymakers are considering deregulation, abuse of market power is a great concern. For example, in its December 20, 1995, order on restructuring, the California Public Utilities Commission ordered Pacific Gas & Electric Co. (PG&E) and Southern California Edison Co. (SCE) to voluntarily divest themselves of 50 percent of their fossil generating assets. As more and more jurisdictions consider restructuring, it becomes increasingly important that proper techniques are used to gauge the degree to which market power may exist.
In a soon to be released study, U.S. Electric Utility Industry Mergers and Acquisitions, Resource Data International (RDI) offers an indepth analysis of the concentration of generation resources in each geographic region of the United States. Although the study used several different analytical techniques to estimate the potential for market-power abuse, this article focuses on the concentration of owned generation assets and the Herfindahl-Hirschman Index (HHI), as applied to California electricity markets. The HHI is the square of each company's market share, commonly used by the U.S. Department of Justice when evaluating mergers under antitrust law. Most economists agree that competitive concerns associated with concentration become significant when the HHI exceeds a value in the range of 1,800 to 2,500.
One difficulty in properly using the HHI lies in defining the geographic size of the market to be considered. Factors affecting the size of the relevant market in electricity include transmission pricing, transmission bottlenecks, time of day and year, and available supply. If the California market is defined to include only utilities in the California/Southern Nevada subregion of the Western Systems Coordinating Council (WSCC), the HHI would be 2,394. At this level, SCE and PG&E may be able to exert market power. Together they would control more than 60 percent of California's generation capability. These estimates of market share include the utilities' long-term purchased-power commitments. If the two
utilities were to divest 50 percent of their fossil generation assets, the HHI would fall to below 1,600. Transmission constraints could justify a market limited to California and Southern Nevada: The two major paths into California are nearly always fully loaded during summer peak hours.
If the market size were expanded to include all WSCC subregions, except for the Rocky Mountain region, the HHI index would fall to 953. In this scenario, SCE and PG&E each represent only 15 percent of the market. While still significant, this share is small enough to prevent market power. If SCE and PG&E were to auction off their purchased-power obligations instead of their generation assets, the HHI would fall to 1,600, also sufficiently eliminating market power.
Over the next several years, as regulators and policymakers resolve uncertainty regarding transmission pricing and restructuring, focus may turn toward transmission and the investment decisions needed to open fully the electric grid. The size of the market created will be important: A larger market will help relieve fears of market power. In the case of California, market power could be diminished in the future by relieving constraints on the transmission paths into the state. t
Christopher D. Seiple and Douglas M. Logan are senior consultants at Resource Data International, Inc., an energy industry consulting and information management firm specializing in market and competitor analysis.
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