Mergers, Acquisitions, Divestitures, and Applications for Market-Based Rates in a Deregulating Electric Utility Industry

May 1999

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Mergers, Acquisitions, Divestitures, and Applications for Market-Based Rates in a Deregulating Electric Utility Industry

The adoption of Appendix A to Order 592 represents an attempt by the Federal Energy Regulatory Commission (FERC) to bring its competitive analysis in the electric utility industry more in line with the approach of other agencies and other industries, as well as of the courts.

Alan J. Cox

I. Introduction

he establishment of deregu-lated electricity markets will

generally result in a large number of transactions, many of which will come under antitrust review. Divestitures by incumbent electric utilities of generation assets will come under scrutiny to determine whether the divestiture is exten-sive enough, to ensure that assets are being sold to a competitively adequate number of firms, and to ensure that there are no lingering

vertical issues.

1

Mergers, joint ven-tures, and other forms of restruc-turing may be planned in order for firms to adapt to the new environ-ment and become more effective competitors. The establishment of power exchanges and independent system operators will require anti-trust review to ensure that they allow appropriate opportunities for entry. Other antitrust issues that may arise as deregulated mar-kets are being established include the appropriate degree and pricing of access to transmission facilities,

Alan J. Cox

is a vice president in theSan Francisco office of NationalEconomic Research Associates.

Dr. Cox, who holds a Ph.D. in AppliedEconomics from the Haas School of

Business at the University of Californiain Berkeley, CA, has served as a

Visiting Economist at M.I.T.’s EnergyLaboratory, where he undertook

research on the economics of non-utilityelectricity generation, and contributedto early work on the economics of real-

time pricing of electricity. He hastestified frequently on antitrust issues

in the oil and electricity industries,and advised on competitive

consequences of proposals torestructure the electric utility

industry in New Zealand.

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the extent to which must-run plants should participate in the competitive market, the evaluation of standards of conduct for affili-ates, the method of recovery of stranded costs, and the establish-ment of competitive markets for ancillary services.

any of these restructuring-related activities will

receive antitrust review by the Federal Energy Regulatory Com-mission (FERC).

2

Indeed, mergers of electric utilities generally must be approved by FERC,

3

though the Antitrust Division of the Department of Justice has the power to challenge a merger that FERC approves.

4

Mergers and other reconfigurations may also be reviewed by state public utility commissions (PUCs).

Given the changing circum-stances, it seems appropriate to ask whether the current policies result in appropriately defined markets and correct analysis of competitive issues in the future. FERC and the PUCs’ antitrust principles were developed under the assumption of continued reg-ulation of vertically integrated utilities in a market that consists of transactions among utilities, whose prices are regulated and whose customers are located in exclusive franchises of sometimes extensive geographic areas. Such principles may not be appropriate when analyzing the competitive consequences of proposed trans-actions in a state where prices are set by market forces, where cus-tomers can freely contract with or terminate service from a local generator, and where distribution

system operators may change from town to town.

In this article, I review FERC’s current procedures for undertak-ing competitive analysis. The cur-rent procedure for evaluating the competitive impact of trans-actions in the electric utility indus-try is described in Order 592, in particular Appendix A.

5

These procedures effectively revised cri-teria that had been laid out in

Commonwealth Edison

6

and

upon the

Horizontal Merger Guide-lines

issued jointly by the Federal Trade Commission and the Anti-trust Division of the Department of Justice (

FTC/DOJ Merger Guide-lines

).

9

While it borrows much of the language and basic concepts of the

Merger Guidelines

, FERC’s procedures have been criticized as not following the methodology closely enough, leaving open the possibility of mistakes in market definition.

A. Basic Methodology for Undertaking Competitive Analysis

The

FTC/DOJ Merger Guidelines

elucidate a method for defining the relevant product and geographic markets. FERC’s interpretation of the


methodology involves the follow-ing four-step process:

1.

Product Market Definition:

Identify relevant products affected by the merger or other transaction. A relevant product includes all products or services (hereinafter products) which are economic sub-stitutes for the products manufac-tured by the applicant company or companies. Markets defined too expansively will appear unlikely to create competitive problem when, in fact, there is such a prob-lem. Conversely, markets may be defined too narrowly, making it appear that they create a competi-tion problem when, in fact, they do not.

2.

Geographic Market Definition (Customers):

Identify the whole-sale electricity customers who would be affected by the merger.

3.

Geographic Market Definition

FERC’s procedureshave been criticized

for straying frommethodology, leaving achance for mistakes in

market definition.

brought its merger policy in line with the EPAct and the provisions of Order 888. Order 592 was an attempt to provide “more cer-tainty and expedition” in han-dling mergers.

7

It established three criteria that had to be satis-fied for a merger to be approved: “Post-merger market power must be within acceptable thresholds or be satisfactorily mitigated, accept-able customer protections must be in place [to ensure that rates will not go up as a result of increased costs] and any adverse effect on regulation must be addressed.”

8

FERC states that its Order 592 Merger Policy Statement is based

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(Suppliers):

Identify the partici-pants of the supply side of the geo-graphic market by identifying wholesale electricity suppliers who would be able to provide elec-tricity competitively to the pur-chasers affected by the merger. Again, failure to correctly define the geographic scope of a market may result in markets in which it appears to be easier or more diffi-cult to exercise market power than is actually the case.

4. Measure the degree of con-centration (or market power) before and after the proposed merger using the Herfindahl-Hirschman Index (HHI). If the merger does not violate the Com-mission’s criteria, no further analy-sis is required. If it does, conditions of entry and other indicators of the competitiveness of the market are considered.

t is important to emphasize that the index of concentration

is merely used as an initial screen. If the index of concentration is below a certain level, no further analysis is necessary. The merger is deemed to not create a market power concern and will generally be approved. High indexes of concentration, however, are not sufficient to block a merger. In that case, further inquiry is needed to determine whether there are other competitive con-siderations that are not captured in the concentration index. For instance, if it can be shown that entry into the industry is easy, then a merger may be approved even if the market in which the companies operate are concentrated.

II. Defining Relevant Product Markets

The initial step in determining whether a proposed transaction will result in the creation of market power or in its increase is to define the relevant antitrust product mar-ket. Under the


, a product market in which merging companies partici-pate is defined by determining whether a hypothetical monopolist

small but significant increase in price above competitive levels such that the price increase is unprofitable, then those products are also included in the relevant antitrust product market. The pro-cedure is repeated until consumers switch in such small amounts that the monopolist could sustain the price increase above competitive levels.

his procedure is consistent with FERC’s suggested proce-

dure in earlier decisions in electric-ity and other industries, among them oil product pipelines (“. . . if a threshold increase in the product price encourages enough custom-ers to switch to substitute products, then the group of products are all included in the product market”).

10

Without describing the process by which it arrived at this conclu-sion, the Commission held in Order 592 that there are at least three wholesale electricity prod-ucts: non-firm energy, short-term capacity, and long-term capacity.

11

Presumably it has determined, for instance, that a purchaser of power under long-term power contracts will not or cannot purchase power under short-term firm contracts in an attempt to evade an exercise of market power in the provision of long-term power. It has also required market studies for at least one other product, ancillary ser-vices.

12

Furthermore, FERC notes that demand and supply condi-tions can change with the time of day, requiring analysis of market power in the sale of the relevant products for each of the major periods of the day, that is, off-peak, shoulder, and peak periods.

It is important to emphasize that the Herfindahl-Hirschman Index of concentration is merely used as an

initial screen.

(controlling the production of the relevant antitrust product made by the two firms) could increase prices above competitive levels by a small but significant amount for a non-transitory period of time and earn higher profits. Any alter-native product to which pur-chasers would turn in significant numbers must be included in the relevant product market. The anal-ysis is then repeated under the assumption that the hypothetical monopolist produces all the prod-ucts that were identified in the pre-vious step. If a sufficient number of consumers would likely switch to other products in response to a

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The Commission leaves open the possibility that there will be other relevant product markets as the deregulated electric industry evolves.

13

This is clearly one area which may change with increased experience in deregulated markets. Absent the restrictions and the deadening effect on innovation imposed by regulation, new prod-ucts are likely to be developed. These will include a variety of con-tractual forms, forward and deriv-ative markets, and energy sources of interest to certain customer seg-ments such as green power. Whether these will be separate markets in an antitrust sense will depend upon the ease with which they are substituted by combina-tions of other products.

In

Entergy

the Commission stated that transmission service is a relevant product market separate from generation because it can be sold separately, and because it has no substitute for many buyers and all sellers. Transmission is also relevant as the means for a buyer to reach generation other than its own.

14

uch an assertion appears to be inconsistent with the manner

in which the Commission has approached the transportation of other forms of energy, for instance, oil product pipelines. The Com-mission has generally found that oil product pipelines compete in destination markets with other pipelines, with other modes of delivery (such as barges and truck-ing), and with refineries located in those destination markets. It has consequently defined the destina-tion market in which oil pipelines

compete as the market for deliv-ered refined petroleum products. Similarly, to the extent that “local” production of electricity is an eco-nomical substitute for transmitted electricity, they should be consid-ered in the same market, providing delivered electric power.

III. The Geographic Market

Determining the geographic extent of a market is a crucial and

determining relevant markets, a point that has resulted in some criticism.

15

It may be in geo-graphic market definition that the differences between merger policy in a regulated electric industry versus an unregulated one are the most pronounced.

A. Purchasers in Destination Markets

In Step 2 of the procedure de-scribed in Appendix A of the Merger Policy Statement, the Commission identifies the de-mand side of the geographic markets in which the utilities operate by identifying all parties potentially affected by the merger. This will include all entities directly interconnected to either of the merging parties. Additional entities should be included in the market if historical transaction data indicates that the potentially included entity has been a “trad-ing partner” from either of the merging parties.

B. Sellers in Destination Markets

Step 3 of the procedure described in Appendix A of Order 592 is to determine the geographic distribution of the suppliers of electricity who can deliver power. More specifically, the geographic market includes all locations of generation entities that are eco-nomically capable of supplying electricity to one of the purchasers of electricity affected by the merger. A generator is economi-cally capable of providing electric-ity to an affected utility if all of its incremental costs of delivering

Determining thegeographic extent

of a marketis a crucial

and often

complex task.

often complex task. It is crucial because the size of the geographic area will determine the number of utilities that participate in the market. It is complex because the geographic scope of the market will be determined to some extent by the availability of transmission capacity, which can vary by time of day and by season. The Com-mission has revised its procedures for determining the geographic scope of electricity markets in its Merger Policy Statement in a manner that is more in keeping with the

Merger Guidelines.

It does not, however, formally apply the hypothetical monopolist test in

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power do not exceed, by more than 5 percent, the competitive price of delivered power to a possibly affected utility.

16

The total cost should include its costs of genera-tion and the explicit cost of trans-mission in the case of purchased transmission, and the implicit cost of transmission in the case of trans-mission provided by the buyer or the seller. This is the “delivered price test.”

17

istorical trading data should be used as a check to com-

pare the set of utilities identified as being in the market with those that actually supplied power to the cus-tomers of one of the merging com-panies.

18

If supply and demand conditions vary significantly over time, separate analyses should be undertaken for different time peri-ods within which supply and demand conditions are similar.

19

Once utilities in the geographic market have been identified, it is necessary to determine the capac-ity they have available to supply the different relevant products to that market. The Commission will consider various measures of capacity, including total capacity, uncommitted capacity (total capacity less native load and con-tractual commitments), economic capacity (all capacity whose vari-able cost is not significantly

20

higher than the competitive level), and available economic capacity (economic capacity less native load and contractual com-mitments).

21

Any of the capacity available to supply the needs of the utilities affected by the merger must be adjusted to reflect the availability and cost of trans-

mission capacity.

22

In determin-ing the amount of transmission capacity available, FERC has looked to “dispatchers opera-tions limits” rather than rated capacities.

23

They should also be forward-looking, assessing the impact of imminent changes in capacity, industry structure, and regulation.

24

There appear to be some com-plicating issues in estimating market shares arising from trans-

termined its geographic extent, the Merger Policy Statement requires the calculation of the Herfindahl-Hirschman Index. The HHI deter-mines the extent to which market share is held by a limited number of firms. The economic rationale for measuring the degree of con-centration is stated in the

Horizon-tal Merger Guidelines.

“Other things being equal, market concentration affects the likelihood that one firm, or a small group of firms, could successfully exercise market power.”

26

A large number of simi-larly sized suppliers of a product will complicate an attempt to orga-nize and maintain a cartel or any coordinated attempt by suppliers to raise prices above competitive levels. It is likely to be more diffi-cult to organize a large number of firms than a small number of firms to raise prices either explicitly or implicitly. The likelihood that a collusive agreement can be main-tained is lower when there are many firms in a market since there are incentives to break explicit or implicit attempts to raise prices above competitive levels. Firms participating in such an arrange-ment will have an incentive to lower prices in the hope of captur-ing a large amount of market share.

1. Calculating Market Shares.

In this step, market shares are esti-mated and used to estimate HHIs for the various products or prod-uct markets before and after the merger.

27

A generating firm’s mar-ket share is simply its capacity (total capacity, uncommitted capacity, economic capacity, or available economic capacity)

The capacity figure must be adjusted to reflect the availability and cost of transmission

capacity.

mission ownership and control, even if open access tariffs have been filed. In the

Primergy

merger decision, the Commission found it “appropriate to adjust the mar-ket shares to attribute to Primergy that portion of [a particular trans-mission line] that can reasonably be ascribed to Primergy as a result of the merger.”

25

It ascribed some control over this interface despite the open access tariff that had been filed by the merg-ing entities.

C. Analyzing Concentration

Having described the relevant antitrust product market and de-

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divided by the total similarly defined capacity in the relevant geographic market. In determining the market power held by a com-pany, the Commission has excluded from its analysis genera-tion assets that are committed under long-term contracts.

here is an important variation on the calculation of market

shares that focuses on those gener-ating plants that are likely to be “on the margin.” To describe this mea-sure of concentration, one can think of an electric system as being divided into two types of power plant. One type consists of plants that are always left on because they are the cheapest to run, cannot eas-ily adjust their levels of production, and/or are required to be left on for system reliability. Such plants are referred to as base-load or infra-marginal plants. In general, total system demand does not fall below the total capacity of base load plants. Other plants are turned on and off, or provide varying levels of output depending upon demand conditions. These plants can be described as being “on the margin.” Concentration of ownership in on-the-margin plants is estimated using the share of the on-the mar-

gin plants that are held by each firm that owns on-the-margin plants.

28

A version of this method of mea-suring concentration is that put for-ward in a recent report of the Mar-keting Monitoring Committee of the California Power Exchange (PX).

29

In that report, the committee measured the share of the incre-mental energy that was supplied as bid prices increase. If one or a few firms provided a disproportional part of the increased energy that was bid between any two prices, then that firm or firms were found to have an effective ability to determine the prices within that range.

30

This sort of analysis was also described approvingly by FERC in its decision approving the proposed merger between Baltimore Gas and Electric and Potomac Electric.

31

2. Calculating the Herfindahl-Hirschman Index.

The Herfindahl-Hirschman Index (HHI) is calcu-lated by taking the square of each market share (expressed as a per-centage) and then summing those squares. For example, in a market with two utilities with 25 percent market share and five utilities each holding 10 percent market shares, the pre-merger HHI would be

1,750 (i.e., 25

2

1

25

2

1

10

2

1

10

2

1

10

2

1

10

2

1

10

2

). If a utility in this market with a 25 percent market share merged with a utility with a 10 percent market share, the post merger HHI would be 2,250 (i.e., 35

2

1

25

2

1

10

2

1

10

2

1

10

2

1

10

2

).nder the procedure outlined in Order 592, the Commis-

sion evaluates industry concentra-tion ratios and the changes in those concentration ratios in the same manner as described in the

DOJ/FTC Guidelines.

The critical HHI ranges and changes in HHI are described in

Table 1

. Specifically, a merger that results in an HHI for a relevant antitrust product market below 1,000 is found to be unlikely to adversely affect competition. A merger resulting in a post-merger HHI of between 1,000 and 1,800, and in which the increase in the HHI as a result of the merger is greater than 100, potentially raises significant competitive concerns. Finally, a merger that results in a post-merger HHI in the relevant antitrust market above 1,800, and in which the increase in the HHI due to the merger is greater than 50, potentially also raises signifi-cant competitive concerns. If the merger raises the HHI by more

Table 1:

HHI Ranges Defined in Order 592

Estimated Post-Merger Concentration FERC Market Description

Increase in HHI as a Consequence of Proposed Merger FERC Action

Less than 1,000 Unconcentrated NA No further competitive analysis required

Between 1,000 and 1,800 Moderately concentrated Less than 100 No further competitive analysis required

Greater than 100 Further competitive analysis required

Greater than 1,800 Highly concentrated Less than 50 No further competitive analysis required

Greater than 50

Further competitive analysis required

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than 100, and the post-merger HHI is above 1,800, it is presumed that the merger is likely to create or enhance market power. Merger applicants who fail to provide complete testimony on market shares and HHI calculations risk having their application found deficient by the Commission.

32

The Commission frequently is sat-isfied to determine lack of market power on the basis of the applicant’s market share alone. For example, it has found an applicant’s market share of 25 percent as adequate to demonstrate lack of market power.33 In keeping with a large number of decisions by the Federal Trade Commission (FTC), the Department of Justice (DOJ), FERC, state regula-tory commissions, and the courts, the ranges described above in regard to mergers provide only an initial screen. If a proposed merger fails the HHI “safe harbor” tests found in Table 1, it may still succeed if one or more of several other miti-gating factors are present. Factors that may mitigate or counteract the ability of a firm to exercise market power should be considered if a mechanical application of the HHI suggests that a merger might do competitive harm.34 FERC’s Merger Policy Statement (Order 592) quotes the DOJ/FTC Merger Guidelines “. . . market share and concentration data provide only the starting point for analyzing the competitive impact of a merger.”35

IV. Other Considerations in Determining Market Power

Other factors to be considered are ease of entry and whether the

merger results in efficiencies that will presumably result in the cre-ation of a more effective competi-tor. On ease of entry, FERC found in Entergy that “the potential for entry by other suppliers into Entergy’s relevant markets is an important dynamic consideration in assessing long-run market power. Such entry would include the ability of buyers to negotiate with existing suppliers in

and demand, and of firm behavior in determining whether there is any potential to exercise market power.37 FERC recently solicited comments on its intention of developing a standard computer model of utility operations with which to evaluate mergers.38 Modeling has also been used in merger applications submitted before state PUCs.39 Computer-based models can permit the anal-ysis and modeling of the complex physics that govern the networks in which electricity is generated and transmitted. They better repre-sent the dynamic interactions among generators, loads, and transmission networks than a static summary of data based upon yearly or seasonal averages. They may thus provide a more accurate implementation of the “delivered price test” to determine which firms to include in the market.40

The Appendix A methodology has been criticized as not taking into account the full range of out-comes that may arise from an effort to exercise market power by raising prices above the competi-tive level. For instance, an electric generating company may appear to have a price that is too high to restrain an exercise of market power and therefore be excluded from the market. A correctly speci-fied model would describe the full extent of the responses to an attempt to exercise market power.

dditionally, computer models can make forecasts on the

basis of behavior other than cost-minimizing behavior. Some com-mentators have pointed out that strictly cost-minimizing models of

Entergy’s relevant markets for existing or new capacity, as well as with potential entrants [such as independent power producers], for new capacity.” It went on to examine evidence as to whether Entergy controls entry or can erect barriers to entry, including sites suitable for the construction of new generators, key inputs to gen-eration, and transportation of key inputs to generation.36

A. Modeling Market Behavior to Measure Market Power

Antitrust analysis in the electric-ity industry may be incorporating more explicit modeling of supply

A

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this sort may not accurately pre-dict the actual outcomes since they exclude other sorts of behavior that take advantage of opportuni-ties to exercise market power.41

V. Applications for Market-based Rates

In order to minimize regulatory burdens and intrusive monitor-ing of a firm’s operations, FERC has provided opportunities in many energy industries for firms to apply for market-based rates. Currently, regulated firms who can show that their behavior would be adequately constrained by market pressures can receive permission to set whatever rates the market will bear.42 Applica-tions to sell at market-based rates are also required for utilities to bid into a competitive market managed by a PX.43 In electricity, to apply for market-based rates for existing generation, a utility or other applicant must show that it does not dominate the market, that it cannot control access to markets through its control of transmission systems, and that it or its affiliates could not erect other barriers to entry. The Com-mission has also said that it would note whether there may be prob-lems due to affiliate abuse or reciprocal dealing.44 Electric utili-ties must also file an open access transmission tariff for the provi-sion of transmission services com-parable to those that it would pro-vide itself.45 Consistent with the concept of the relevant market consisting of delivered power, the Commission sought to determine

whether the applicant had market power in generation and in transmission.46

The Commission has used market-based rates in situations in which (1) “changing characteristics of the industry justify a new approach; (2) deviations are not unreasonable or inconsistent with statutory responsibilities; and (3) the regulatory scheme acts as a monitor to determine whether com-

For each energy industry, market definition for the purposes of analyzing a request for market-based rates generally uses the same methodology as is applied in evaluating mergers.

VI. Conclusion

Order 592 represents an attempt to bring the manner in which FERC undertakes its competitive analysis in the electric utility industry more in line with the approach adopted by other agen-cies and increasingly in use by the courts. In fact, the adoption of the Appendix A procedure brings the analysis of electricity mergers more in line with its own competi-tive analysis in other industries. Success in applying the Appendix A procedure over the next few years will depend upon the ability of the Commission and applicants to apply it to a changing industry. j

Endnotes:

1. For a recent example of a decision on such a matter, see New York State Elec-tric & Gas Corporation, NGE Genera-tion, Inc., Pennsylvania Electric Com-pany Mission Energy Westside, Inc., Docket No. EC98-64-000 Order Autho-rizing Disposition Of Jurisdictional Facilities Issued Jan. 13, 1999.

2. For a description of the history of the Commission’s policies in assessing mar-ket power in the electric utility industry, see Walter Surratt The Analytic Approach to Measuring Horizontal Market Power in Electric Utility Markets: A Historical Per-spective, Elec. J., July 1998 at 22–33.

3. 16 U.S.C. § 824b(a) (1994) Cited in Richard J. Pierce, Jr., Antitrust Policy in the New Electricity Industry, Energy Law J. (1996) at 30, f.n. 8.

4. 15 U.S.C. § 18a (1994), Cited in Pierce, supra note 3 at 30, f.n. 8.

petition will drive prices to a zone of reasonableness.”47 For electricity generation, FERC has said that it will allow market-based rates if:

1. The applicant does not have generation market power;

2. The applicant does not have transmission market power. This may be mitigated with an open access tariff, which an applicant is required to have filed with the FERC;

3. There are no other barriers to entry, in particular no reciprocal dealing arrangements that may be anti-competitive; and

4. There is no evidence of abuse of affiliate relationships.48

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5. 18 CFR Part 2 [Docket No. RM96-6-000; Order No. 592] 61 FERC 68,595, Dec. 30, 1996. Inquiry Concerning the Com-mission’s Merger Policy Under the Federal Power Act; Policy Statement. This can be found on the Internet by searching “GPO Access” at http://www.access.gpo.gov/su_docs/aces/aces140.html.

6. Commonwealth Edison Co. (Common-wealth), 36 FPC 927, 931 (1966), aff’d sub nom. Utility Users League v. FPC, 394 F.2d 16 (7th Cir. 1968), cert. denied, 393 U.S. 953 (1968).

7. It is FERC’s objective to complete the review of a merger within five months of the filing of a completed application. See FERC Merger and Acquisition Policy, Speech by Commissioner William Massey, July 16, 1998. Available at http://www.ferc.fed.us/intro/oea/mass7–16.pdf.

8. 61 FERC ¶ 68,595 at 68,596

9. The Guidelines can be viewed on the Internet at the Federal Trade Commis-sion’s Web page at www.ftc.gov/bc/docs/horizmer.htm and can be down-loaded from the Department of Justice’s Web page at www.usdoj.gov/atr/guidelin.htm. The Guidelines are being increasingly invoked by the courts and by several state utility commissions. For instance, the decision of the California Public Utilities Commission on the pro-posed merger between Southern Califor-nia Edison and San Diego Gas and Elec-tric cited to the then-current version of the Guidelines extensively (Decision 91-05-028. App. 88-12-035, 1991.) See also State Regulatory Agency Refers Probe to ALJ on Legality of Utility Merger, 73 Anti-trust & Trade Reg. Rep. (BNA) 264 (Sept. 11, 1997) referring to Pennsylvania PUC’s Decision to evaluate the proposed merger on the basis of the DOJ/FTC Merger Guidelines. Cited in 1998 Annual Report of the Section of Public Utility, Communications and Transportation Law, at 46.

10. 53 FERC ¶ 61,473 (Dec. 31, 1990) at 62,664.

11. The Commission has made it clear that it will not address retail issues in reviewing mergers unless state commis-

sions request that they do so. See Balti-more Gas and Electric Company and Potomac Electric Power Company Docket Nos. EC96-10-000 and ER96-784-000 Opinion and Order Authorizing Proposed Merger (Opinion No. 412), at 16, citing the Merger Policy Statement.

12. 77 FERC 61,265 (1996) at 62,085 citing 77 FERC ¶ 61,204 at 84–86.

13. For example, it may be possible to bundle different products from varying sources in order to provide a substitute for long-term capacity, as was found in assessing an application by Public Ser-

of Proposed Rulemaking, Revised Filing Requirements, issued April 16, 1998.

16. FERC has also indicated that three “wheels” are enough to exclude a utility from consideration as a participant in a relevant destination market for short-term energy. Three wheels refers to the number of third-party transmission sys-tems to be used. See for instance, Inquiry Concerning the Commission’s Policy on the Use of Computer Models in Merger Analysis; Notice of Request for Written Comments and Intent To Convene a Technical Conference, FR Vol. 63, No. 79, April 24, 1998, at 20,401.

17. Order 592, Merger Policy Statement, Appendix A, Section B. 3.a.

18. Order 592, Merger Policy Statement, Appendix A, Section B.3.c.

19. Some of the data requirements and data sources to undertake this test are described in Staff’s Framework for a Delivered Price Test Without a Model in Inquiry Concerning the Commission’s Policy on the Use of Computer Models in Merger Analysis; Notice of Request for Written Comments and Intent To Convene a Technical Conference, FR Vol. 63, No. 79 April 24, 1998, at 20,401.

20. Significantly within the meaning of the Horizontal Merger Guidelines.

21. Appendix A, Section B.3.a.

22. Appendix A, Section B.3.b.

23. 77 FERC ¶ 61,265 (1996) at 62,084.

24. Id.

25. Opinion No. 413, Docket No. EC95-16-000, issued May 14, 1997. See Section IX.A.3.

26. Section 2, Merger Guidelines.

27. The step is described in Section B.4 of Appendix A.

28. They are “the ‘mid-merit order’ gen-erating units which are likely to be the units providing the final increment in the supply portfolio. The concentration of ownership of this group of assets might be more important than overall generation concentration. In both cases, the powerful entity may control the final increment in the market-clearing supply

vice of Indiana (PSI) to sell 450 MW of firm power at market-based rates and a commitment to file open access trans-mission tariffs. FERC defined the rele-vant market as the market for long-term firm delivered power. “PSI’s product market will include all products that can be substituted for PSI’s product, includ-ing components of long-term firm deliv-ered base-load power that can be bun-dled with complementary products from other sources.” Public Service Co. of Indiana, Inc., Docket Nos. ER89-672-000 and ER89-672-001, 51 FERC (CCH) ¶ 61,367 (1990) at 62,193, June 28, 1990.

14. Entergy 58 FERC (CCH) ¶ 61,234 (1992) at 61,755.

15. See, for instance, the comments of the Edison Electric Institute on Federal Energy Regulatory Commission, 18 CFR Part 33, Docket No. RM98-4-000, Notice

36 © 1999, Elsevier Science Inc., 1040-6190/99/$–see front matter PII S1040-6190(99)00024-X The Electricity Journal

portfolio and thus control the marginal price for generation.” CPUC, D.95-12-063, Dec. 20, 1995, as corrected by CPUC D.96-01-009, Jan 10, 1996, Chapter 4 available at http://www.cpuc.ca.gov/restur.dec/toc.html. See also the descrip-tion of PG&E’s suggested methodology in Federal Energy Regulatory Commis-sion, Pacific Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison Company 77 FERC ¶ 61,265 Docket No. ER96-1663-000, Order Providing Guidance And Convening A Technical Conference (Dec. 18, 1996), at 62,081.

29. Report on Market Issues in the Cali-fornia Power Exchange Energy Markets, Aug. 17, 1998.

30. The report offers no citation to previ-ous regulatory or legal findings or the economic literature to support such a finding.

31. Baltimore Gas and Electric Company and Potomac Electric Power Company (Docket Nos. EC96-10-000) and ER96-784-000 Opinion and Order Authorizing Proposed Merger (Opinion No. 412), at 25. Footnote 79 shows HHI changes resulting from the merger for prices of $19–20/MWh, $20–21/MWh, and so on. This analysis is based upon an attempt by the trial staff to determine the impact of the merger on concentration of “eco-nomic capacity” (which includes mar-ginal capacity and capacity whose incre-mental costs are lower than those of marginal capacity). According to trial staff, marginal capacity is that capacity with costs in the range of $15 to $25/MWh. Trial staff further argues that eco-nomic capacity is all capacity with costs at or below $25/MWh.” (See p. 19.)

32. For instance, the Commission found that the proposed decision in the Primergy merger application, which had found the merger was consistent with the public interest, was incorrect. Among other points the Commission made was that the applicants’ “market power anal-ysis, which does not include any HHI analyses, falls short of what the Merger Guidelines require.”

33. Southwestern Public Service Com-pany, 72 FERC ¶ 61,208 at 61,966–67 (1995), reh’g pending; Louisville Gas &

Electric Company, 62 FERC ¶ 61,016 at 61,146 (1993).

34. Appendix A, Sections A and B.4.

35. This quotation is taken from Section 2.0 of the Merger Guidelines.

36. Supra note 14 at 61,759.

37. A more complete description of some of the issues raised in modeling is pro-vided in Edward P. Kahn, Numerical Techniques for Analyzing Market Power in Electricity, Elec. J., July 1998, at 34–43.

38. Notice of Request for Written Com-ments and Intent to Convene a Technical Conference, Concerning the Commis-sion’s Policy on the Use of Computer Models in Merger Analysis, April 16, 1998, Docket No. PL98-6-000.

39. Re DQE Inc.,186 P.U.R.4th 39 1998 WL 406768_(Pa.P.U.C.)

40. For a description of the use of these models, see H. Stoll, Least Cost Elec-tric Utility Planning, (Wiley Press, 1989) and Edward P. Kahn, Electric Utility Planning and Regulation (American Coun-cil for an Energy Efficient Economy, Sec-ond Ed., 1991) and Edward P. Kahn, Regu-lation by Simulation: The Use of Production Cost Models in Electricity Pricing and Plan-ning, Operations Res., 43(3) 1995.

41. See, for instance, Severin Borenstein, James Bushnell, and Christopher Knittel, Comments of the University of Califor-nia Energy Institute on the Use of Com-

puter Models for Merger Analysis in the Electric Utility Industry, June 15, 1998. “There is, however, another class of models that do attempt to explicitly model strategic behavior. Indeed it is often far more important to represent the strategies of producers than to model their physical production characteristics in minute detail.” The Department of Justice suggests that an appropriate model should simulate the profit-maximizing behavior of the hypo-thetical monopolist.

42. These rates, once set, are subject to the non-discrimination and other restric-tions that are part of tariff setting.

43. Pacific Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison Company, Docket No. ER96-1663-000, Order Pro-viding Guidance and Convening a Tech-nical Conference, Dec. 18, 1996. 77 FERC ¶ 61,265

44. Rule 888, at 7. This language copies that found in Enron Power Enterprises, in which a successful bidder in a competi-tive auction applied for a finding that its rates were just and reasonable. 52 FERC (CCH) ¶ 61,193 (1990) at 61,708, and 85 FERC ¶ 61,379 Federal Energy Regula-tory New England Power Pool Order Con-ditionally Accepting Market Rules, And Conditionally Approving Market-Based Rates, Dec. 17, 1998.

45. As stated in 77 FERC ¶ 61,265 (1996).

46. Enron had 4 percent of the generation capacity in the relevant market and no transmission facilities.

47. Supra note 14 at 61,752.

48. See for example, AES Huntington Beach, L.L.C 83 FERC ¶ 61,100. et al. Docket No. ER98-2184-”Order Accepting For Filing Proposed Market-Based Rates And Denying Request For Waiver Of Fil-ing Requirement” (April 30, 1998). See also Pennsylvania Power & Light Com-pany “Order Conditionally Accepting For Filing Proposed Market-Based Rates” 80 FERC ¶ 61,053, July 17, 1997, finding, under item 3, that if the appli-cant abused its ownership of oil and gas pipelines by denying access or imposing unreasonable terms on competitors, those competitors could complain to the Commission.

Documents

Mergers, Acquisitions, Divestitures, and Applications for Market-Based Rates in a Deregulating Electric Utility Industry