Inquiry Concerning the Commission's Merger Policy Under the Federal Power Act; Policy Statememt

DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 2

[Docket No. RM96-6-000; Order No. 592]

Inquiry Concerning the Commission's Merger Policy Under the

Federal Power Act; Policy Statememt

Issued December 18, 1996.

AGENCY: Federal Energy Regulatory Commission.

ACTION: Policy statement.

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SUMMARY: The Federal Energy Regulatory Commission (Commission) is

amending its regulations to update and clarify the Commission's

procedures, criteria and policies concerning public utility mergers in

light of dramatic and continuing changes in the electric power industry

and the regulation of that industry. The purpose of this Policy

Statement is to ensure that mergers are consistent with the public

interest and to provide greater certainty and expedition in the

Commission's analysis of merger applications.

EFFECTIVE DATE: December 18, 1996.

FOR FURTHER INFORMATION CONTACT:

Jan Macpherson (Legal Matters), Kimberly D. Bose (Legal Matters),

Office of the General Counsel, Federal Energy Regulatory Commission,

888 First Street, N.E., Washington, D.C. 20426; Telephone: (202) 208-

0921, (202) 208-2284.

Wilbur C. Earley (Technical Matters), Office of Economic Policy,

Federal Energy Regulatory Commission, 888 First Street, N.E.,

Washington, D.C. 20426; Telephone: (202) 208-0023.

Michael A. Coleman (Technical Matters), Office of Electric Power

Regulation, Federal Energy Regulatory Commission, 888 First Street,

N.E., Washington, D.C. 20426; Telephone: (202) 208-1236.

SUPPLEMENTARY INFORMATION: In addition to publishing the full text of

this document in the Federal Register, the Commission also provides all

interested persons an opportunity to inspect or copy the contents of

this document during normal business hours in the Commission's Public

Reference Room, Room 2A, 888 First Street, N.E., Washington, D.C.

20426.

The Commission Issuance Posting System (CIPS), an electronic

bulletin board service, provides access to the texts of formal

documents issued by the Commission. CIPS is available at no charge to

the user and may be accessed using a personal computer with a modem by

dialing (202) 208-1397 if dialing locally or 1-800-856-3920 if dialing

long distance. CIPS is also available through the Fed World System (by

Modem or Internet). To access CIPS, set your communications software to

19200, 14400, 12000, 9600, 7200, 4800, 2400 or 1200bps full duplex, no

parity, 8 data bits, and 1 stop bit. The full text of this final rule

will be available on CIPS in ASCII indefinitely and WordPerfect 5.1

format for one year. The complete text on diskette in Wordperfect

format may also be purchased from the Commission's copy contractor,

LaDorn Systems Corporation, also located in Room 2A, 888 First Street,

N.E., Washington, D.C. 20426.

The Commission's bulletin board system also can be accessed through

the FedWorld system directly by modem or through the Internet. To

access the FedWorld system by modem:

Dial (703) 321-3339 and logon to the FedWorld system

After logging on, type: /go FERC

To access the FedWorld system through the Internet, a telnet

application must be used either as a stand-alone or linked to a Web

browser:

Telnet to: fedworld.gov

Select the option: [1] FedWorld

Logon to the FedWorld system

Type: /go FERC

or

Point your Web Browser to: http://www.fedworld.gov

Scroll down the page to select FedWorld Telnet Site

Select the option: [1] FedWorld

Logon to the FedWorld system

Type: /go FERC

Policy Statement Establishing Factors the Commission Will Consider in

Evaluating Whether a Proposed Merger Is Consistent With the Public

Interest

Issued December 18, 1996.

I. Introduction

This Policy Statement updates and clarifies the Federal Energy

Regulatory Commission's (Commission) procedures, criteria and policies

concerning public utility mergers in light of dramatic and continuing

changes in the electric power industry and corresponding changes in the

regulation of that industry. The Commission believes it is particularly

important to refine and modify its merger policy at this critical

juncture for the electric industry. The Commission recognizes that the

electric industry now is in the midst of enormous technological,

regulatory and economic

[[Page 68596]]

changes. At the heart of these changes is the transition to competitive

power supply markets, prompted in part by this Commission's open access

transmission policies. These changes are fundamental, and mergers and

consolidations are among the strategic options available for companies

seeking to reposition themselves in response to the emerging

competitive business landscape.

In this Policy Statement, the Commission has two broad goals.

First, we intend to ensure that future mergers are consistent with the

competitive goals of the Energy Policy Act of 1992 (EPAct) 1 and

the Commission's recent Open Access Rule.2 This means that the

Commission, in applying the Federal Power Act standard that mergers

must be consistent with the public interest, must account for changing

market structures and pay close attention to the possible effect of a

merger on competitive bulk power markets and the consequent effects on

ratepayers. Second, the Commission believes that as the pace of

industry change increases, market participants require greater

regulatory certainty and expedition of regulatory action in order to

respond quickly to rapidly changing market conditions. Accordingly,

this Policy Statement offers procedural innovations and more specific

information that we would expect applicants to file to facilitate the

Commission acting more quickly on merger requests. 3

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\1\ Energy Policy Act of 1992, Pub. L. No. 102-486, 106 Stat.

2776, 2905 (1992).

\2\ See Promoting Wholesale Competition Through Open Access Non-

Discriminatory Transmission Services by Public Utilities and

Recovery of Stranded Costs by Public Utilities and Transmitting

Utilities, Order No. 888, (Open Access Rule) 61 FR 21540 (May 10,

1996), III FERC Stats. & Regs. para. 31,036 (1996), reh'g pending.

\3\ In the near future, the Commission will also issue a notice

of proposed rulemaking to set forth more specific filing

requirements consistent with this Policy Statement and additional

procedures for improving the merger hearing process.

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We will generally take into account three factors in analyzing

proposed mergers: the effect on competition, the effect on rates, and

the effect on regulation. First, our analysis of the effect on

competition will more precisely identify geographic and product markets

and will adopt the Department of Justice/Federal Trade Commission

Merger Guidelines (Guidelines) as the analytical framework for

analyzing the effect on competition. The Guidelines adopt a five-step

procedure for analyzing mergers

First, the Agency assesses whether the merger would significantly

increase concentration and result in a concentrated market, properly

defined and measured. Second, the Agency assesses whether the merger,

in light of market concentration and other factors that characterize

the market, raises concern about potential adverse competitive effects.

Third, the Agency assesses whether entry would be timely, likely and

sufficient either to deter or to counteract the competitive effects of

concern. Fourth, the Agency assesses any efficiency gains that

reasonably cannot be achieved by the parties through other means.

Finally, the Agency assesses whether, but for the merger, either party

to the transaction would be likely to fail, causing its assets to exit

the market.4

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\4\ U.S. Department of Justice and Federal Trade Commission,

Horizontal Merger Guidelines, issued April 2, 1992, 57 FR 41552

(1992).

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By applying an analytic ``screen'' based on the Guidelines early in

the merger review process, the Commission will be able to identify

proposed mergers that clearly will not harm competition.

Second, in assessing the effect of a proposed merger on rates, we

will no longer require applicants and intervenors to estimate the

future costs and benefits of a merger and then litigate the validity of

those estimates. Instead, we will require applicants to propose

appropriate rate protection for customers. The most promising and

expeditious means of addressing this issue is for parties to engage in

a pre-filing consensus-building effort that will result in a filing

that includes appropriate rate protection. If merger applicants and

their affected wholesale customers are able to agree on appropriate

ratepayer safeguards, it should not be necessary to set this aspect of

the merger for hearing.5 Even where the parties have been unable

to come to an agreement before the merger is filed, they should

continue to attempt to negotiate a settlement. While there are several

potential mechanisms available, which we discuss herein, adequate

ratepayer protection will necessarily depend on the particular

circumstances of the merging utilities and their ratepayers. There is

no one-size-fits-all approach, and the Commission strongly encourages

parties to resolve this issue without a formal hearing. However, we

also recognize the possibility that parties may not be able to reach an

agreement on appropriate ratepayer protection and that there may be

situations in which the Commission nevertheless would be able to

approve a merger. This could occur either after a hearing or on the

basis of parties' filings if we determine that the applicants' proposal

sufficiently insulates the ratepayers from harm.

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\5\ Parties may choose to use alternative dispute resolution or

other settlement processes to reach mutually agreeable ratepayer

protection resolutions.

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Finally, with regard to the effect of the merger on regulation, we

will adopt the approach we have used in recent cases. With respect to

shifts of regulatory authority to the Securities and Exchange

Commission (SEC) where the applicants will be part of a registered

public utility holding company, they may either commit themselves to

abide by this Commission's policies with regard to affiliate

transactions, or we will set the issue for hearing. With respect to the

merger's effect on state regulation, where the state commissions have

authority to act on the merger, we intend to rely on the state

commissions to exercise their authority to protect state interests.

In order to provide more certainty and expedition in our handling

of merger applications, this Policy Statement explains how merger

applicants should address each of the three factors as part of their

case-in-chief in support of their application. For the effect on

competition factor, applicants who demonstrate that their merger passes

the market power screen established in this Policy Statement will

establish a presumption that the merger raises no market power

concerns. In that event, a trial-type hearing on this factor should not

be necessary. We are also setting forth guidance on the other two

factors and ways to resolve any concerns about these factors without a

trial-type hearing.

For mergers that do not pass the market power screen, we will

engage in a more detailed analysis, which may include a trial-type

hearing. As discussed below, if we find that a merger will have an

adverse effect on competition, and if the additional factors examined

do not mitigate or counterbalance the adverse competitive effects of

the merger, we may impose various remedies where necessary to make a

merger consistent with the public interest.

In this Policy Statement, we also provide guidance on what kind of

evidence is needed for each factor. Thus, applicants will be able to

provide the necessary information at the outset. This should provide

more certainty and help focus our review on specific issues that

require more scrutiny. We believe that the additional information that

we would expect parties to file will expedite the merger review process

and enable the Commission to act on section 203 applications more

quickly. We intend to process most merger applications within 12-15

months after

[[Page 68597]]

the applications are completed, as discussed below under

``Procedures.''

In general, we expect that a merger approved by the Commission will

satisfy each of the three factors that form the basis of our merger

review, i.e., post-merger market power must be within acceptable

thresholds or be satisfactorily mitigated, acceptable customer

protections must be in place, and any adverse effect on regulation must

be addressed. However, we recognize that there may be unusual

circumstances in which, for example, a merger that raises competitive

concerns may nevertheless be in the public interest because customer

benefits (such as the need to ensure reliable electricity service from

a utility in severe financial distress) may clearly compel approval.

Consistent with the Guidelines, the Commission would continue to

account for such circumstances and could, in a particular case,

conclude that on balance the merger is consistent with the public

interest.

Finally, the Commission recognizes that, as the industry evolves to

meet the challenges of a more competitive marketplace, new types of

mergers and consolidations will be proposed. For example, in addition

to mergers between public utilities, market participants already are

considering restructuring options that include mergers between public

utilities and natural gas distributors and pipelines, consolidations of

electric power marketer businesses with other electric or gas marketer

businesses, and combinations of jurisdictional electric operations with

other energy services.6 As a consequence, our merger policy must

be sufficiently flexible to accommodate the review of these new and

innovative business combinations that are subject to our jurisdiction

under section 203 and to determine their implications on competitive

markets. We believe that the analytical framework articulated in this

Policy Statement provides a suitable methodology for determining

whether such mergers will be consistent with the public interest.7

However, it will not be necessary for the merger applicants to perform

the screen analysis or file the data needed for the screen analysis in

cases where the merging firms do not have facilities or sell relevant

products in common geographic markets. In these cases, the proposed

merger will not have an adverse competitive impact (i.e., there can be

no increase in the applicants' market power unless they are selling

relevant products in the same geographic markets) so there is no need

for a detailed data analysis. If the Commission is unable to conclude

that the applicants meet this standard, the Commission will require the

applicants to supply the competitive analysis screen data described in

Appendix A.

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\6\ See, for example, among others, the proposed merger of Enron

Corporation with Portland General Corporation (Docket No. ER96-36-

000) and the proposed acquisition of PanEnergy Corporation by Duke

Power Company, announced November 25, 1996.

\7\ We recognize that, as some energy products possibly become

more suitable alternatives to others, or as the combination of

complementary energy services possibly affects barriers to entry,

the focus of our analysis may have to be adjusted to encompass those

products, markets, and factors that are relevant to analyzing the

exercise of market power in the future business environment.

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II. Background

Section 203(a) of the Federal Power Act (FPA) provides that no

public utility shall sell, lease, or otherwise dispose of the whole of

its facilities that are subject to the Commission's jurisdiction, or

any part thereof with a value in excess of $50,000, or by any means

whatsoever, directly or indirectly, merge or consolidate such

facilities with those of any other person, or purchase, acquire, or

take any security of another public utility without first securing the

Commission's approval.8 Section 203(a) also says that ``if the

Commission finds that the proposed * * * [merger] will be consistent

with the public interest, it shall approve the same.'' 9 Under

section 203(b), the Commission may approve a proposed merger ``in whole

or in part and upon such terms and conditions as it finds necessary or

appropriate. * * *'' This power is to be exercised ``to secure the

maintenance of adequate service and the coordination in the public

interest of facilities subject to the jurisdiction of the Commission.''

10

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\8\ While many types of transactions, including relatively minor

ones, may require section 203 authorization, this Policy Statement

focuses on mergers.

\9\ 16 U.S.C. 824b(a) (1994).

\10\ 16 U.S.C. 824b(b) (1994).

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Thirty years ago, in the Commonwealth case,11 the Commission

set forth six non-exclusive factors for evaluating mergers:

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\11\ See Commonwealth Edison Company (Commonwealth), Opinion No.

507, 36 F.P.C. 927, 936-42 (1966), aff'd sub nom. Utility Users

League v. FPC, 394 F.2d 16 (7th Cir. 1968), cert. denied, 393 U.S.

953 (1969).

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(1) the effect of the proposed merger on competition;

(2) the effect of the proposed merger on the applicants' operating

costs and rate levels;

(3) the reasonableness of the purchase price;

(4) whether the acquiring utility has coerced the to-be-acquired

utility into acceptance of the merger;

(5) the impact of the merger on the effectiveness of state and

federal regulation; and

(6) the contemplated accounting treatment. Of these factors, the

first two--the effect on competition and the effect on costs and

rates--have presented the most significant issues in recent merger

cases.

Since Commonwealth, however, both the electric utility industry and

utility regulation have changed dramatically. The Commission's Open

Access Rule 12 describes these changes at length. Advances in

technology now allow scale economies to be exploited by smaller-size

units, thereby allowing smaller new plants to be brought on line at

costs below those of the large plants of the 1970s and earlier.13

Technological advances in transmission have made possible the economic

transmission of electric power over long distances at higher

voltages.14 State public utility commissions have been relying

more on competitive contracting as the primary vehicle for adding new

generating capacity.15 This Commission has authorized market-based

rates for wholesale electricity sales when it has found that the public

utilities lack market power.

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\12\ See Open Access Rule, 61 FR at 21540.

\13\ See Id. at 21544.

\14\ See Id. at 21544-45.

\15\ See Paul L. Joskow, Regulatory Failure, Regulatory Reform,

and Structural Change in the Electrical Power Industry, in Brookings

Papers on Econ. Activity, Microeconomics 125 (1989).

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In 1992, a landmark change occurred when Congress enacted the

EPAct. That statute permitted new power suppliers, called exempt

wholesale generators, to enter wholesale power markets, and expanded

the Commission's authority to require transmitting utilities to provide

eligible third parties with transmission access. In 1996, consistent

with the competitive goals of EPAct, the Commission adopted a sweeping

regulatory policy change with the promulgation of the Open Access Rule.

That rule requires each public utility that owns, operates or controls

interstate transmission facilities to file an open access transmission

tariff that offers both network and point-to-point service. The rule is

designed to remedy the undue discrimination that is inherent when a

utility does not offer truly comparable transmission service to others,

and to promote competitive bulk power markets. Thus, EPAct and the

Commission's Open Access Rule have fundamentally changed federal

regulation of the electric utility industry. In addition, many states

are contemplating retail access, which may

[[Page 68598]]

prompt even more significant changes in the industry.

Because these changes have implications for the Commission's

regulation of mergers, 16 we issued a Notice of Inquiry (NOI)

17 soliciting comments on whether our thirty-year-old criteria for

evaluating mergers should be revised. While most commenters agree that

we should revise our merger policies, there are differences of opinions

on the general direction of the change needed. The comments are

summarized in Appendix D.18

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\16\ Many of the commenters in the Open Access Rule proceeding

suggested that the Commission reevaluate its merger policy in

concert with the open access rulemaking. See Open Access Rule at 61

FR 21555.

\17\ See Inquiry Concerning the Commission's Merger Policy Under

the Federal Power Act, Docket No. RM96-6-000, 61 FR 4596 (February

7, 1996), FERC Stats. & Regs. para. 35,531.

\18\ Appendix C sets forth the full names and acronyms of the

commenters.

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III. Discussion

A. General Comments on Revising Merger Policy

1. Direction of Change

As noted above, under section 203, the Commission evaluates mergers

to determine whether they are ``consistent with the public interest.''

Congress did not intend the Commission to be hostile to mergers.

19 We have found that the transaction taken as a whole must be

consistent with the public interest. 20 Thus, even if certain

aspects of a proposed merger are detrimental, the merger can still be

consistent with the public interest if there are countervailing

benefits that derive from the merger. 21

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\19\ Pacific Power & Light Co. v. FPC, 111 F.2d 1014, 1016 (9th

Cir. 1940) (PP&L); also see Northeast Utilities Service Co. v. FERC

(NU), 993 F.2d 937 (1st Cir. 1993).

\20\ Entergy Services Inc. and Gulf States Utilities Company

(Entergy), Opinion No. 385, 65 FERC para. 61,332 at 62,473 (1993),

order on reh'g, Opinion No. 385-A, 67 FERC para. 61,192 (1994),

appeal pending.

\21\ See NU, 993 F.2d at 945.

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Almost all commenters argue that we need to revise our merger

policies and standards in light of the changes in the industry.22

On one side, many commenters argue that mergers may prevent markets

from becoming truly competitive.23 On the other side, some

commenters suggest that the Commission should approve a merger unless

harm to the public interest is demonstrated.24 These commenters

claim that most mergers are procompetitive and should be approved

unless a problem is identified.

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\22\ See Appendix D, Section IA.

\23\ For example, APPA, NRECA at 7-8; ELCON at 12-13.

\24\ For example, Utilicorp United at 2, 7, 10.

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We do not agree either with commenters who argue that we should

actively encourage mergers or those who argue that we should discourage

them. The statutory standard is that a merger must be ``consistent

with'' the public interest. While we believe that the Commission has

broad flexibility in determining what is in the public interest,

particularly in light of changing conditions in the industry, we do not

read the statutory language as creating a presumption against

mergers.25 Nor are we prepared to presume that all mergers are

beneficial. It is the applicants' responsibility to demonstrate that

the merger is consistent with the public interest.

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\25\ In NU, 993 F.2d at 947, the court pointed out that the FPA

differs from the Bank Merger Act in that the latter contains an

``implicit presumption that mergers are to be disapproved.''

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We believe that if the Commission is to fulfill its statutory

responsibilities, it must determine what is consistent with the public

interest in light of conditions in the electric industry in general as

well as the specific circumstances presented by a proposed merger. In

an era of traditional, cost-of-service based regulation, the Commission

defined its public interest responsibilities consistent with that

structure. Today, we believe that the public interest requires policies

that do not impede the development of vibrant, fully competitive

generation markets. We are refining our analysis of the effects of

proposed mergers on competition in order to protect the public interest

in the development of such highly competitive markets, as discussed

below.

The Commission's interpretation of the public interest standard has

never been static. In the El Paso case, 26 we explained that our

view of what it takes to mitigate market power sufficiently to allow

approval of a merger had evolved over time. We pointed out that as the

industry had become more competitive, we began examining market power

in transmission more closely, and that comparable access was now

required. Moreover, we explained in El Paso that while in the past we

had focused only on increases in market power, we no longer believed

that we could find any merger to be consistent with the public

interest, whether or not the merger created increased market power,

unless the merging utilities provided open access. We adopted this

revised view of the public interest in light of EPAct's goal of

encouraging greater wholesale competition and the significant increase

in actual competition.

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\26\ El Paso Electric Company and Central and Southwest Services

Inc., 68 FERC para. 61,181 61,914-15 (1994), dismissed, 72 FERC

para. 61,292 (1995).

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2. How to Implement New Policies

We are adopting our new policies through this Policy Statement

rather than through other means, such as acting on a case-by-case basis

or through a rulemaking. While some commenters suggested other means,

27 we believe that a Policy Statement is needed. Proceeding on a

case-by-case basis would not give applicants and intervenors the

guidance needed to facilitate the presentation of the kinds of well-

focused evidence and arguments that will improve and expedite the

merger review process. On the other hand, a binding rule would be too

rigid at this time. Because the industry continues to change rapidly,

we must maintain flexibility in fulfilling our statutory

responsibilities.

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\27\ See Appendix D at Section IB.

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Commenters disagree on whether we should apply the new policy to

pending merger proposals. 28 Those proposing mergers have been on

notice since we issued the NOI that the Commission is considering

revising its criteria for evaluating proposed mergers. In several

recent merger hearing orders, we have discussed the NOI and have

indicated that we intend to evaluate pending proposals in light of any

new criteria we might adopt. 29 We do not believe that any

applicants will be seriously disadvantaged by application of this

policy to pending cases. Our analysis of the effect of a proposed

merger on competition has been evolving for some time, particularly

since the enactment of EPAct and the issuance of the Open Access Rule.

Thus, we are not applying radically new analyses or standards. The same

is true of the other two remaining factors, the effects on regulation

and on rates. We will address the specific application of the policy to

pending cases on a case-by-case basis. If necessary, we will require

the parties to supplement the record in any pending case, and we do not

expect that this will cause any substantial delay. In fact, if

anything, we expect this Policy Statement will make it easier to

resolve any remaining issues, because of our clarification of our

policies.

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\28\ Id.

\29\ Union Electric Company and Central Illinois Public Service

Company (Union Electric), 77 FERC para. 61,026 (1996), reh'g

pending; Public Service Company of Colorado and Southwestern Public

Service Company (PS Colorado), 75 FERC para. 61,325 (1996), reh'g

pending; Baltimore Gas & Electric and Potomac Electric Power

Company, 76 FERC para. 61,111 (1996).

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[[Page 68599]]

B. Effect on Competition and Remedies

1. Background

In response to the NOI, we received many comments on our market

power analysis. Commenters generally divide into two groups, one

recommending stricter scrutiny of the effect of mergers on competition,

while the other argues that less concern is warranted in today's more

competitive environment.

Those in the first group support more stringent scrutiny because

they believe that mergers can cause competitive harm, particularly in a

transitional era. Many commenters 30 argue that mergers increase

generation market power, increase monopsony buying power, encourage

self-dealing, discourage alternative suppliers under retail access, and

tend to preserve certain competitive advantages associated with

vertical integration. These commenters criticize the analysis the

Commission has been using to evaluate mergers. They argue that the

Commission has not given enough consideration to important factors,

including generation dominance, the effect of transmission constraints

on competition, the merged company's ability to exercise market power

in localized areas and in short-term energy sales, the effects on

markets in which little or no effective competition exists, and the

significant anticompetitive advantages that vertically integrated

utilities possess as a result of the long-existing statutory and

regulatory system.

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\30\ These include, for example, CA Com, Joint Consumer Advoc.,

APPA, NRECA, Environmental Action et al., RUS, Salt River, Lubbock,

Wisconsin Customers, and TAPS.

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The second broad group of commenters 31 argues that mergers

are procompetitive. These commenters maintain that mergers lower costs,

create economies of scale and geographic scope, create large strong

competitors, allow rapid movement into new markets, allow

diversification to minimize shareholder exposure to business

fluctuation, and let the most efficient companies operate facilities,

among other reasons.

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\31\ Such as UtiliCorp, Southern, PanEnergy, and Southwestern.

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2. Discussion

a. The role of competition. The electric industry's rapid

restructuring, and the Commission's regulatory response to it, have

made the effect of mergers on competition, and the way the Commission

evaluates that effect, critically important.

The Open Access Rule was a watershed for electric industry

regulation. In the Rule, we recognized that, where it exists,

competition has become the best way to protect the public interest and

to ensure that electricity consumers pay the lowest possible price for

reliable service. Before the Open Access Rule, the Commission took the

approach that traditional regulation could cure many market power

problems. The size of the company, the territory it covered, and the

assets it held did not matter greatly because regulatory oversight

could hold market power in check. Indeed, the creation of larger

utilities allowed some utilities to take advantage of scale economies

and pass the cost savings on to consumers under regulatory supervision.

With the open transmission access resulting from the Open Access

Rule and the continuing evolution of competitive wholesale power

markets, we believe that competition is now the best tool to discipline

wholesale electric markets and thereby protect the public interest. But

the competition needed to protect the public interest will not be

efficient and deliver lower prices in poorly structured markets. For

example, a concentration of generation assets that allows a company to

dominate a market will dampen or preclude the benefits of competition.

In sum, as customer protection is increasingly dependent upon vibrant

competition, it is critically important that mergers be evaluated on

the basis of their effect on market structure and performance.

This means that the Commission must find ways to assess more

accurately the competitive impact of merger proposals. In doing so,

however, we must be sensitive to another pressing concern: the

industry's need for more analytic and procedural certainty from the

Commission. The increased pace of merger proposals has tested our

ability to respond in a timely way. We recognize that merger proposals

are business decisions made in response to market pressures and

opportunities. Some merger proposals may strengthen weak firms and

create stronger competitors. Some, however, may result in firms that

will dominate or manipulate electricity markets and thwart competition.

In either case, applicants are entitled to timely decisions from this

Commission. The policies and procedures adopted in this Policy

Statement are intended to promote that goal.

b. Definition of markets. An accurate assessment of the effect on

markets depends on an accurate definition of the markets at issue. The

Commission's current analytic approach defines geographic markets in a

manner that does not always reflect accurately the economic and

physical ability of potential suppliers to access buyers in the market.

This approach uses what has come to be known as a hub-and-spoke method.

It identifies affected customers as those that are directly

interconnected with the merging parties. It then identifies potential

suppliers as: (1) those suppliers that are directly interconnected with

the customer (the ``first-tier'' suppliers); and (2) those suppliers

that are directly interconnected with the merging parties and that the

customer thus can reach through the merging parties' open access

transmission tariff (the ``second-tier'' suppliers).

A drawback of this method of defining geographic markets is that it

does not account for the range of parameters that affect the scope of

trade: relative generation prices, transmission prices, losses, and

transmission constraints. Taking these factors into account, markets

could be broader or narrower than the first- or second-tier entities

identified under the hub-and-spoke analysis. For example, a supplier

that is directly interconnected with a buyer may not be an economic

supplier to that buyer if transmission capability across that

interconnection is severely constrained or if the transmission charges

are greater than the difference between the decremental cost of the

buyer and the price at which the supplier is willing to sell. In

contrast, a supplier that is three or four ``wheels'' away from the

same buyer may be an economic supplier if the sum of the wheeling

charges and the effect of losses is less than the difference between

the decremental cost of the buyer and the price at which the supplier

is willing to sell. In other words, mere proximity is not always

indicative of whether a supplier is an economic alternative.

Another concern with the approach we have used in the past is its

analytic inconsistency. It defines the scope of the market to include

the directly interconnected utilities that are accessible due to the

applicants' open access tariff, but does not expand the market to

recognize the access afforded by other utilities' tariffs. This was

acceptable before open access was established as an industry-wide

requirement for public utilities. Now that virtually all public

utilities have open access transmission tariffs on file, it is no

longer appropriate to recognize only the effect of certain entities'

tariffs on the size of the market.

In modifying our competitive analysis, we are adopting the

Guidelines as the basic framework for evaluating the competitive

effects of merger proposals. The Guidelines are a well-

[[Page 68600]]

accepted standard approach for evaluating the competitive effects of

mergers, and they received substantial support from commenters.

c. Use of the Guidelines. The Guidelines set out five steps for

merger analysis: (1) define markets likely to be affected by the merger

and measure the concentration and the increase in concentration in

those markets; (2) evaluate whether the extent of concentration and

other factors that characterize the market raise concerns about

potential adverse competitive effects; (3) assess whether entry would

be timely, likely, and sufficient to deter or counteract any such

concern; (4) assess any efficiency gains that reasonably cannot be

achieved by other means; and (5) assess whether either party to the

merger would be likely to fail without the merger, causing its assets

to exit the market. We note, however, that the Guidelines are just

that--guidelines. They provide analytical guidance but do not provide a

specific recipe to follow. Indeed, applying the Guidelines to the

electric power industry is one of our biggest analytic challenges, both

because the industry is evolving very rapidly and because the industry

has some unique features, such as very limited opportunities for

storage (hence the importance of time-differentiated markets). An

analysis that follows the Guidelines still requires many assumptions

and judgments to fit specific fact situations.

While this Policy Statement provides guidance on how the Commission

intends to more sharply focus its analysis of a merger's effect on

competition, we cannot reduce this analysis to a purely mechanized

computation of the same data inputs for all merger applications.

Rather, the Commission will need to evaluate the relevant product and

geographic markets affected by each merger proposal; these markets, in

turn, depend on the specific characteristics of the merger applicants

and the products and markets in which they potentially trade.

Consequently, mergers may require analysis of different product and

geographic markets due to factors (such as the existence of constrained

transmission paths) that affect the size of a particular market or the

hours in which trade of the product is critical to determine whether

merger applicants possess market power. Such distinguishing factors

will need to be identified and analyzed on a case-by-case basis. Thus,

the analytical process explained in this Policy Statement is a

framework under which appropriate adjustments may be required to be

incorporated to take account of factors unique to a merger.

Furthermore, as noted above, this Policy Statement also is intended to

be sufficiently flexible to accommodate the kinds of new merger

proposals that will be presented to the Commission as the energy

industry evolves to meet the challenges of a more competitive

marketplace.

We note that the Guidelines contemplate using remedies to mitigate

any harm to competition. There will be mergers where, at the end of an

analysis, market power concerns persist but that could be made

acceptable with measures to mitigate potential market power problems.

We encourage applicants to identify market power problems and to

propose remedies for such problems in their merger proposals. In many

cases, such a remedy could avoid the need for a formal hearing on

competition issues and thus result in a quicker decision. As discussed

further in Section III B (2)(e), if a proposed long-term remedy is not

capable of being effectuated at the time the merger is consummated,

applicants may propose effective interim remedial measures.

d. Analytic screen. It is important to give applicants some

certainty about how filings will be analyzed and what will be an

adequate showing that the merger would not significantly increase

market power. This will allow applicants to avoid or minimize a hearing

on this issue. Consequently, we will to use an analytic screen

(described in Appendix A) that is consistent with the Guidelines. If

applicants satisfy this analytic screen in their filings, they

typically would be able to avoid a hearing on competition. We would

expect applicants to perform the screen analysis as part of their

application and to supply the Commission and the public with electronic

files of all data used in the analysis as well as other related

specified data. The Commission will need this information in order to

perform its competitive analysis. If an adequately supported screen

analysis shows that the merger would not significantly increase

concentration, and there are no interventions raising genuine issues of

material fact that cannot be resolved on the basis of the written

record, the Commission will not set this issue for hearing. Applicants

may, of course, submit an alternative competitive analysis in addition

to the screen.

The Commission believes that the screen will be a valuable

analytical tool in all cases. It is conservative enough so that parties

and the Commission can be confident that an application that clears the

screen would have no adverse effect on competition. The screen also

will be valuable in identifying potential competitive problems early in

the process. The result will be more narrowly focused issues at

hearings when they are necessary. We also note that the screen is

intended to be somewhat flexible. It sets out a general method, but we

will consider other methods and factors where applicants properly

support them.

We believe that the analytic screen will produce a reliable,

conservative analysis of the competitive effects of proposed mergers.

However, it is not infallible. In some cases, the screen may not detect

certain market power problems. There also may be disputes over the data

used by applicants or over the way applicants have conducted the screen

analysis. These claims may be raised through interventions and by the

Commission staff. However, such claims must be substantial and

specific. In other words, they should focus on errors in or other

factual challenges to the data or assumptions used in the analysis, or

whether the analysis has overlooked certain effects of the merger.

Unsupported, general claims of harm are insufficient grounds to warrant

further investigation of an otherwise comprehensive analysis developed

by the applicants. Intervenors may also file an alternative competitive

analysis, accompanied by appropriate data, to support their arguments.

The Commission realizes that the need for more rigor in intervention

showings could require additional efforts by potential intervenors. We

will therefore routinely allow 60 days from filing for intervenors and

others to comment on a merger filing.32

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\32\ Merger applicants that wish to facilitate the merger review

process should serve potential intervenors with copies of their

filing (via overnight delivery), including electronic versions, when

they file their applications with the Commission. Cf. Open Access

Rule, 61 FR 21618 n.510.

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A detailed illustrative description of the analytic screen that we

will use is in Appendix A. The following is a brief summary of the

screen. There are four steps the applicant must complete and the

Commission will follow:

(1) Identify the relevant products. Relevant products are those

electricity products or substitutes for such products sold by the

merging entities.

(2) Geographic markets: identify customers who may be affected by

the merger. Generally, these would include, at a minimum, all entities

directly interconnected to a merging party and those that historical

transaction data indicate have traded with a merging party.

[[Page 68601]]

(3) Geographic markets: identify potential suppliers that can

compete to serve a given market or customer. Suppliers must be able to

reach the market both physically and economically. There are two parts

to this analysis. One is determining the economic capability of a

supplier to reach a market. This is accomplished by a delivered price

test, which accounts for the supplier's relative generation costs and

the price of transmission service to the customer, including ancillary

services and losses. The second part evaluates the physical capability

of a supplier to reach the customer, that is, the amount of electric

energy a supplier can deliver to a market based on transmission system

capability.

(4) Analyze concentration. Concentration statistics must be

calculated and compared with the market concentration thresholds set

forth in the Guidelines.33

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\33\ The Guidelines address three ranges of market

concentration: (1) an unconcentrated post-merger market--if the

post-merger Herfindahl-Hirschman Index (HHI) is below 1000,

regardless of the change in HHI the merger is unlikely to have

adverse competitive effects; (2) a moderately concentrated post-

merger market--if the post merger HHI ranges from 1000 to 1800 and

the change in HHI is greater than 100, the merger potentially raises

significant competitive concerns; and (3) a highly concentrated

post-merger market--if the post-merger HHI exceeds 1800 and the

change in the HHI exceeds 50, the merger potentially raises

significant competitive concerns; if the change in HHI exceeds 100,

it is presumed that the merger is likely to create or enhance market

power.

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The usefulness of the screen analysis depends critically on the

data that are supplied with the application. These data are described

in Appendix A. Applicants should file in electronic format the data

specified as well as any other data used in their analysis.

If the Guidelines' thresholds are not exceeded, no further analysis

need be provided in the application. As stated earlier, if an

adequately supported screen analysis shows that the merger would not

significantly increase concentration, and there are no interventions

raising genuine issues of material fact that cannot be resolved on the

basis of the written record, the Commission will not set this issue for

hearing. If the thresholds are exceeded, then the application should

present further analysis consistent with the Guidelines. The Commission

will also consider any applicant-proposed remedies at this stage. If

none is presented, or if the analysis does not adequately deal with the

issues, we will need to examine the merger further.

The Commission will set for hearing the competitive effects of

merger proposals if they fail the above screen analysis, if there are

problems concerning the assumptions or data used in the screen

analysis, or if there are factors external to the screen which put the

screen analysis in doubt. We may also set for hearing applications that

have used an alternative analytic method the results of which are not

adequately supported. As discussed in Section III F, the Commission

will attempt to summarily address issues where possible and may use

procedural mechanisms that permit us to dispose of issues without

having a trial-type hearing.

e. Mitigation. Although a competitive analysis pursuant to the

Guidelines may show that a proposed merger would have anticompetitive

effects, the Commission may be able to approve the merger as consistent

with the public interest if appropriate mitigation measures can be

formulated. In the past, in some cases the Commission has conditionally

approved a merger if applicants agreed to conditions necessary to

mitigate anticompetitive effects. In some instances, applicants

themselves have voluntarily offered commitments to address various

concerns.34 Commenters suggested a variety of conditions that we

could impose (or remedies that applicants could adopt voluntarily) to

solve competitive problems with a merger. These include, for example,

the formation of an Independent System Operator (ISO), divestiture of

assets, elimination of transmission constraints, efficient regional

transmission pricing, and offering an open season to allow the merging

utilities' customers to escape from their contracts. Other commenters

oppose some or all of these remedies. Some commenters also argue that

we should monitor the situation after a merger and impose any new

remedies that are needed; other commenters oppose such post-merger

review.35

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\34\ E.g., Northeast Utilities Services Company/Re Public

Service Company of New Hampshire, 50 FERC para. 61,266, reh'g

denied, 51 FERC para. 61,177, clarification, 52 FERC para. 61,046

(1990), order on reh'g, 58 FERC para. 61,070 (1992), order on reh'g,

59 FERC para. 61,042 (1992), aff'd in part sub nom. Northeast

Utilities Services Company v. FERC, 993 F.2d 937 (1st Cir. 1993);

Midwest Power Systems, Inc. and Iowa-Illinois Gas & Electric

Company, 71 FERC para. 61,386 (committed to offer wholesale

requirements customers an open season).

\35\ The comments on remedies are summarized in more detail in

Appendix D, Section VI D.

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As noted, the Commission's review of merger applications has

frequently resulted in the development of particular conditions that

are designed to remedy problems associated with the merger. These

conditions are imposed as part of our approval of the merger

application. We expect that practice to continue. For example, we

expect the competition analysis to focus extensively on generation

market power and on whether a proposed merger exacerbates market power

problems. We also expect applicants to propose remedies for market

power problems identified in their analysis. It is our hope that as our

market power analysis becomes more refined to cope with changing

circumstances in the industry, applicant-proposed remedies or

mitigation strategies will also become more refined or tailored to

address the identified harm. Of course, one remedy that an applicant

could consider is to propose to divest a portion of its generating

capacity so that its market share falls below the share that poses

anticompetitive concerns under the Guidelines. This remedy is discussed

in the Appendix A section entitled ``Competitive Analysis Screen.''

Similarly, an applicant's ability to exercise generation market

power may be affected by transmission constraints and transmission

pricing. In particular, the scope of the geographic market may be

limited both by transmission constraints and by the need to pay

cumulative transmission rates in order to transmit power across the

systems of the merging utilities and neighboring utilities. It is

likely that both market concentration and the applicant's market share

would be greater within such a circumscribed geographic market. Hence,

the opportunity to exercise market power also would be greater.

Potential remedies for such market power could include the following.

First, a proposal by the applicants to turn over control of their

transmission assets to an ISO might mitigate market power. In

particular, an ISO might facilitate the implementation of efficient

transmission pricing and thereby expand the effective scope of the

geographic market. Second, an up-front, enforceable commitment to

upgrade or expand transmission facilities might mitigate market power,

because the constraint relieved by such an upgrade or expansion no

longer would limit the scope of the relevant geographic market. These

and other remedies also are discussed in Appendix A. We intend to

tailor conditions and remedies to address the particular concerns posed

by a merger on a case-by-case basis.

If an applicant does not propose appropriate remedies to mitigate

the anticompetitive impact of a merger, the Commission intends to

fashion such remedies during the course of its consideration of an

application.

We do not intend to rely on post-merger review or on new remedies

[[Page 68602]]

imposed after a merger is approved. We must find that a merger is

consistent with the public interest before we approve a merger.36

Moreover, heavy reliance on post-merger review would expose the merging

entities to too much uncertainty. However, as the Commission has noted

in past merger cases, the Commission does retain authority under

section 203(b) to issue supplemental orders for good cause shown as it

may find necessary or appropriate.37

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\36\ For example, an expansion or upgrade of facilities to

alleviate a transmission constraint would not be an acceptable

mitigation measure unless uncertainties about the utilities' ability

to complete the upgrade or expansion are resolved prior to

consummation of the merger.

\37\ See FPA section 203(b), 16 U.S.C. Sec. 824b(b) (1994).

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The Commission acknowledges that many of the solutions that would

mitigate market power or anticompetitive effects cannot be implemented

quickly and, in fact, could take an extended period to accomplish

(e.g., siting and constructing new transmission lines to alleviate a

transmission constraint, divestiture of generation assets, formation of

an ISO). While long-term remedies may be necessary to allow the

Commission to determine that a merger is consistent with the public

interest, a requirement to satisfy such conditions prior to

consummating a merger may jeopardize the ability of parties to merge.

In turn, customers will experience unnecessary delays in receiving

benefits accruing from the merger. Therefore, we will entertain

proposals by merger applicants to implement interim mitigation measures

that would eliminate market power concerns during the period that it

takes to put in place the long-term remedies necessary to address the

anticompetitive effects of their proposed merger.38 Such interim

measures must fully and effectively address the specific market power

problems identified for the merger but should not be viewed as

substitutes for the long-term remedies required by the Commission.

Applicants should implement long-term remedies as quickly as practical.

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\38\ For example, an applicant could sell its transmission

rights on congested transmission paths to third parties or not trade

in markets where it has market power until long-term remedies are

implemented.

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C. Effect on Rates

1. Background

In determining whether a merger is consistent with the public

interest, one of the factors we have considered is the effect the

proposed merger will have on costs and rates. In the past we have

considered whether the elimination of the independence of the companies

and resulting combination of the facilities of the separate entities

would be likely to lead to unnecessary rate increases or inhibit rate

reductions.39 We have also been concerned with whether the merged

companies would be able to operate economically and efficiently as a

single entity.40 In connection with these concerns, the Commission

has investigated applicants' claims about the potential costs and

benefits of their proposed mergers and weighed that information to

determine whether the costs are likely to exceed the benefits. Our

investigations have frequently required trial-type hearings. Although

we have considered the applicants' burden of proof to be met by a

generalized showing of likely costs and benefits,41 these hearings

have often been time-consuming, and there has been considerable

controversy over whether the estimates of future costs and benefits are

truly meaningful. Moreover, there has been controversy over the

position we have taken that benefits are to be ``counted'' even if they

could reasonably be obtained by means other than the merger. There also

has been controversy over the allocation of the projected merger

benefits.42

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\39\ Commonwealth, 36 FPC at 938.

\40\ Edison, 47 FERC para. 61,196 at 61,672 (1989).

\41\ Entergy Services Inc. (Entergy), 65 FERC para. 61,332, at

62,473 (1993), order on reh'g, 67 FERC para. 61,192 (1994), appeal

pending.

\42\ These benefits have included items such as fuel cost

savings; bankruptcy resolution; reducing administrative and general

costs; lowering net production costs; and eliminating or deferring

construction of new generating units.

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In more recent cases, the Commission has focused on ratepayer

protection. We have either accepted a hold harmless commitment (a

commitment from the applicant that any net merger-related costs will

not raise rates) or have set for hearing the issue of whether the

applicants' hold harmless commitment or some other proposed ratepayer

protection was adequate. For example, in Primergy, the Commission held

that wholesale ratepayers would be adequately protected if the

applicants were to commit that, for a period of four years after the

merger is consummated, the merging companies would not seek to increase

rates to wholesale requirements customers.

In PS Colorado,43 the applicants submitted evidence on costs

and benefits, but also proposed a hold harmless commitment. We noted

several concerns with the hold harmless commitment, pointing out that

it did not cover most of the merger-related costs.44 We set for

hearing the issue of whether the applicants' hold harmless commitment

provided adequate protection for ratepayers (those who receive

unbundled generation and transmission services as well as those who

receive bundled service) and, if not, what ratepayer protection

mechanisms would be sufficient. We did not set for hearing the effect

on rates as such; that is, we did not instruct the administrative law

judge to conduct a factual investigation into the alleged costs and

benefits of the merger. In Cincinnati Gas & Electric Company and PSI

Energy, Inc., the Commission modified the hold harmless provision,

stating that the applicants would have the burden of convincingly

demonstrating in future section 205 filings that their wholesale

customers had, in fact, been held harmless; that is, they would have to

show any rate increase was not related to the merger.45 The

applicants would be required to make an affirmative showing in their

initial case-in-chief that their proposed rates did not reflect merger-

related costs unless such costs were offset by merger-related

benefits.46

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\43\ 75 FERC at 62,043-44.

\44\ The commitment was not to seek an increase in base rates

for five years after the merger. We found, however, that this

provided little protection, since the five years would be over

before most of the claimed merger savings were projected to be

realized. Moreover, the applicants proposed to amortize merger-

related costs over five years, but their hold harmless commitment

covered only costs that would be ``booked to the merger'' through

the first two years.

\45\ See Cincinnati Gas & Electric Company and PSI Energy, Inc.,

64 FERC para. 61,237 at 62,714 (1993), order withdrawing

authorization of merger and instituting settlement procedures, 66

FERC para. 61.028, order denying rehearing and approving settlements

and unilateral offers as conditioned and modified, 69 FERC para.

61,005 (1994), order granting clarification, 69 FERC para. 61,088

(1994).

\46\ Id. at 62,714.

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In Union Electric,47 the applicants proposed an open season

guarantee for the first five years after the merger was consummated.

The open season guaranteed that existing wholesale customers could

terminate their contracts by giving notice on the day the applicants

filed for a rate increase affecting that customer. The Commission was

concerned that the open season commitment might not provide adequate

protection for wholesale ratepayers (those that receive bundled

generation and transmission service as well as those that receive

unbundled generation or transmission service) and set that issue for

hearing. We stated that if at hearing it was determined that the open

season

[[Page 68603]]

commitment was not adequate protection, a determination should be made

as to what ratepayer protection mechanisms might be suitable for the

proposed merger.

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\47\ 77 FERC para. 61,026 at 61,107-08 (1996), reh'g pending.

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In response to the NOI, only a few commenters suggest that we

dispose of the effect on rates factor altogether.48 Most

commenters consider this factor to be essential in deciding whether to

approve a merger.49 However, commenters differ on how this factor

should be assessed.

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\48\ See Appendix D, section III(A).

\49\ Id.

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2. Discussion

We disagree with the argument presented by a few commenters that we

need not be concerned about the effect of a merger on rates in this

competitive environment because prices will be set by market forces and

customers can choose their suppliers accordingly. Also, while it may be

true that most of the rate issues in connection with the typical merger

affect retail ratepayers and are subject to state jurisdiction, the

Commission in order to ensure that a merger is consistent with the

public interest still must protect the merging utilities' wholesale

ratepayers and transmission customers from the possible adverse effects

of the merger. As mentioned in our discussion above on the effect on

competition and in our discussion in the Open Access Rule, we recognize

that even in an open access environment, markets may not work perfectly

or even well.50 This is particularly the case during the

transition from a monopoly cost-of-service market structure to a

competitive market-based industry. For instance, during the transition

some customers may be unable to take immediate advantage of competition

because of contractual commitments or because of stranded costs

obligations. Furthermore, because transmission remains effectively a

natural monopoly and will continue to be regulated on a cost-of-service

basis, the Commission has reason to be concerned that mergers do not

affect transmission rates adversely. For these reasons, we will not

abandon the effect on rates factor.51

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\50\ See Open Access Rule, 61 FR at 21553.

\51\ In the past, we have referred to this factor as the

``effect on costs and rates.'' However, the basic concern is with

the effect on rates. Accordingly, we will refer to it as the

``effect on rates.''

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Rather than requiring estimates of somewhat amorphous net merger

benefits and addressing whether the applicant has adequately

substantiated those benefits, we will focus on ratepayer protection.

Merger applicants should propose ratepayer protection mechanisms to

assure that customers are protected if the expected benefits do not

materialize. The applicant bears the burden of proof to demonstrate

that the customer will be protected. This puts the risk that the

benefits will not materialize where it belongs--on the applicants.

Furthermore, we believe that the most promising and expeditious

means of addressing ratepayer protection is for the parties to

negotiate an agreement on ratepayer protection mechanisms. The

applicants should attempt to resolve the issue with customers even

before filing, and should propose a mechanism as part of their filing.

Even if these negotiations have not succeeded by the time of filing,

the parties should continue to try to reach a settlement. What

constitutes adequate ratepayer protection necessarily will depend on

the particular circumstances of the merging utilities and their

ratepayers, and we strongly encourage parties to minimize contentious

issues and to resolve them without the time and expense of a formal

hearing. Parties may not be able to reach an agreement on an

appropriate ratepayer protection and the Commission may still be able

to approve the merger. As mentioned earlier, this could occur either

after a hearing or on the basis of parties' filings if we determine

that the applicants' proposal sufficiently insulates the ratepayers

from harm.

As described above, the Commission has accepted a variety of hold

harmless provisions, and parties may consider these as well as other

mechanisms if they appropriately address ratepayer concerns. Among the

types of protection that could be proposed are:

Open season for wholesale customers--applicants agree to

allow existing wholesale customers a reasonable opportunity to

terminate their contracts (after notice) and switch suppliers. This

allows customers to protect themselves from merger-related harm.

General hold harmless provision--a commitment from the

applicant that it will protect wholesale customers from any adverse

rate effects resulting from the merger for a significant period of time

following the merger. Such a provision must be enforceable and

administratively manageable.

Moratorium on increases in base rates (rate freeze)--

applicants commit to freezing their rates for wholesale customers under

certain tariffs for a significant period of time.\52\

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\52\ A rate freeze, however, does not insulate the merged

utility from a rate reduction if the Commission, pursuant to section

206, determines that the utility's rates are no longer just and

reasonable. Also, in circumstances in which ratepayers clearly would

be entitled to a rate reduction in the absence of the merger, e.g.,

expiration of a current surcharge or some other clearly defined

circumstance, a simple rate freeze may not provide adequate

ratepayer protection.

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Rate reduction--applicants make a commitment to file a

rate decrease for their wholesale customers to cover a significant

period of time.53

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\53\ Whether these types of proposals are appropriate in a

particular case will depend on the circumstances of the merging

companies and the customers and the details of the proposals.

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Although each mechanism provides some benefit to ratepayers, we

believe that in the majority of circumstances the most meaningful (and

the most likely to give wholesale customers the earliest opportunity to

take advantage of emerging competitive wholesale markets) is an open

season provision. We urge merger applicants to negotiate with customers

before filing and to offer an adequate open season proposal or other

appropriate ratepayer protection mechanism in their merger

applications. If intervenors raise a substantial question as to the

adequacy of the proposal, parties should continue to pursue a

settlement. If no agreement can be reached, we may decide the issue on

the written record or set the issue for hearing.

D. Effect on Regulation

When the Commission in Commonwealth referred to impairment of

effective regulation by this Commission and appropriate state

regulatory authorities, its concern was with ensuring that there is no

regulatory gap.\54\ The potential for impairment of effective

regulation at the Federal level has been increased by the Ohio Power

decisions.\55\ That case holds that if the SEC approves a contract for

sales of non-power goods or services between affiliates in a registered

holding company, this Commission in its rate review may not disallow

any part of the payment under the contract in order to protect

ratepayers against affiliate abuse.\56\

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\54\ Cinergy, 64 FERC at 61,710 n. 278; Commonwealth, 36 FPC at

931.

\55\ Ohio Power Company v. FERC, 954 F.2d, 779, 782-86 (D.C.

Cir. 1992), cert. denied, 498 U.S. 73 (1992) (Ohio Power).

\56\ Cf. AEP Power Marketing, Inc., 76 FERC para. 61,307 at

62,515 (1996).

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In recent cases, the Commission has developed its policy regarding

the effect of proposed mergers on both state and Federal regulation.

For instance, PS Colorado involved the creation of a new multistate

registered holding company. On the question of a shift of regulation

from the state commissions to this Commission, we declined to order a

[[Page 68604]]

hearing, noting that the state commissions had authority to disapprove

the merger and that they did not argue that their regulation would be

impaired. On the question of a shift of authority from this Commission

to the SEC, we pointed out that pre-merger, we had authority to review

for rate purposes all the costs the companies incurred, but if the

merger were approved, under Ohio Power we would lose that authority if

the SEC approved an inter-affiliate transaction. Thus, the costs could

be flowed through to ratepayers, even if the goods or services were

obtained at an above-market price or the costs were imprudently

incurred. To guard against this possibility, we gave the applicants two

options.\57\ They could either choose to have the issue set for

hearing, or they could agree to abide by our policies on intra-system

transactions.\58\

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\57\ 75 FERC at 62,045-46.

\58\ Accord, Union Electric, 77 FERC at 61,108-09 (state

expressed concern over shift of regulatory authority from itself and

this Commission to SEC; Commission noted that state had authority to

disapprove merger).

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In response to the NOI, commenters generally argue that it is

important for the Commission to continue to look at the effect of a

merger on the effectiveness of state and Federal regulation.59

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\59\ Appendix B at Section IV.

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2. Discussion

We will continue to examine the effect on regulation as a factor in

our analysis of proposed mergers and will use the approach adopted in

PS Colorado and subsequent cases. Thus, in situations involving

registered public utility holding companies, we will require the

applicants to choose between two options and to make that choice clear

in their filing. They may commit themselves to abide by this

Commission's policies with respect to intra-system transactions within

the newly-formed holding company structure, or they may go to hearing

on the issue of the effect of the proposed registered holding company

structure on effective regulation by this Commission. If applicants

choose the first option, we will set the issue for hearing only if

intervenors raise credible arguments that because of special factual

circumstances, the commitment will not provide sufficient protection.

With respect to the effect of a merger on state regulatory

authority, where a state has authority to act on a merger, as in

PSColorado, we ordinarily will not set this issue for a trial-type

hearing. The application should tell us whether the states have this

authority. If the state lacks this authority and raises concerns about

the effect on regulation, we may set the issue for hearing; we will

address these circumstances on a case-by-case basis.

E. Other Commonwealth Factors

The other Commonwealth factors are evidence of coercion, the

proposed accounting treatment, and the reasonableness of the purchase

price.

These three factors elicited very little comment. As to evidence of

coercion, a few commenters suggest that this should be evaluated by the

marketplace rather than by the regulatory process.60 Several

commenters say that this factor should be considered only if someone

demonstrates that it is relevant.61 OK Com is among the few

commenters who favor retaining this factor. It suggests that coercion

is a means by which some companies will try to gain oligopolistic

control of the market in the coming competitive environment.

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\60\ East Texas Coop., EEI, PaineWebber, and Southern Company.

\61\ Florida and Montaup.

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As to accounting treatment, some commenters support elimination of

accounting concerns as a factor.62 PaineWebber notes that most

recent mergers were mergers of equals, involving minimal premiums over

current market prices. It suggests that a similar market discipline

would likely cause shareholders to reject merger transactions involving

large merger premiums and excessive amortization. Florida and Montaup

argue that the accounting treatment of a merger should not be an issue

for hearing unless an applicant seeks treatment different from the

Commission's standards. Southern Company contends that the Commission's

analysis of this factor should be subsumed within the analysis of the

merger's impact on costs and rates.

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\62\ East Texas Coop, EEI, and PaineWebber. Although they do not

support keeping this factor, EEI and PaineWebber suggest that in

light of broad industry changes, this may be the right time for a

generic re-examination of accounting concerns, of which accounting

for mergers could be a part.

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NY Com and OK Com are concerned about the accounting consequences

of mergers. OK Com favors keeping the historical cost approach to

accounting for plant acquisitions during mergers and business

combinations until competitive market structures are achieved at the

national, regional, and state levels. NY Com also urges the Commission

to continue to require unrestricted access to all books and records of

newly merged entities.

We also received a few comments on looking at the reasonableness of

the purchase price as a factor. A number of commenters 63 urge

that the Commission not substitute its judgment for the workings of

market forces, which will determine the reasonableness of the purchase

price. Others 64 believe that this issue should be examined only

if its relevance is raised. However, OK Com argues that purchase price

still has some relevance in this era of diversification. It is

concerned that the purchase price may be based on expected returns on

non-regulated investments, which, if they fail to materialize, may

dilute the value of utility stock.

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\63\ CINergy, East Texas Coop, EEI, PaineWebber, and Southern.

\64\ Florida and Montaup.

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We will no longer consider these three matters as separate factors.

Any evidence of coercion will be considered as part of our analysis of

the effect of the merger on competition. We have treated the

reasonableness of the purchase price as an issue only insofar as it

affects rates, so this issue is subsumed in the effect on rates factor.

As for the proposed accounting treatment, this is not really a factor

to be balanced along with other factors; proper accounting treatment is

simply a requirement for all mergers.65

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\65\ See, e.g., Public Service Company of Colorado and

Southwestern Public Service Company, 75 FERC para. 61,325 (1996);

Entergy Services, Inc. and Gulf States Utilities Company, Opinion

No. 385, 65 FERC para. 61,332 (1993), order on reh'g, 67 FERC para.

61,192 (1994).

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If a merger application seeks to recover acquisition premiums

through wholesale rates, we will address the issue in post-merger rate

applications. However, the Commission historically has not permitted

rate recovery of acquisition premiums.

F. Procedures for Handling Merger Cases

We received many suggestions as to how to improve our procedures

for handling merger cases. The commenters focused particularly on the

need for certainty and the need to expedite the process, at least for

some mergers. They suggested various screens or hold harmless

provisions. Some suggested that we set forth filing requirements. There

were also many comments on coordination with other agencies that are

reviewing the merger.66

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\66\ Appendix D, Section VI.

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Although we plan to issue a Notice of Proposed Rulemaking in the

near future to set forth more specific filing requirements consistent

with this Policy Statement and additional procedures for improving the

merger hearing process, we have determined that the best way to improve

the Commission's handling

[[Page 68605]]

of merger proposals is to update our merger review policy. As outlined

in this Policy Statement, we will generally limit the number of factors

we examine in order to determine whether a merger is in the public

interest.

The principal area that will require a fact-based review is the

effect of a proposed merger on competition. By using the Guidelines as

a screen and by informing applicants of the type of information we

expect them to file with us when they apply, we hope to expedite our

review of applications considerably.

As discussed above under ``Effect on Competition,'' ``Effect on

Rates,'' and ``Effect on Regulation,'' we are setting forth for each

factor guidance to enable merger applicants ordinarily to avoid a

trial-type hearing or to have a hearing focused on limited issues.

Moreover, we have set forth above under ``Effect on Competition'' and

in Appendix A the information that we think we need at this point to

determine whether a merger would impair competition. We have also

discussed ways to mitigate anticompetitive effects. Our consideration

of the other two factors, the effect on rates and the effect on

regulation, should not require a lot of data or analysis, since we will

be relying primarily on the applicants' commitments. This should make

it possible for applicants to make filings that can be processed more

quickly. The Commission intends to propose a rule to set forth detailed

filing requirements.

Another step that can make our processing of merger applications

more efficient is to discourage redundant or irrelevant pleadings. We

agree with commenters who argue that we should not consider extraneous

issues, and we will not consider interventions that raise matters

unrelated to the merger. Moreover, in the past, the process has been

bogged down by repetitive filings such as answers to answers. We will

not consider such filings, nor will we consider ``new'' information

unless it is genuinely new and relevant.

With all the streamlining changes discussed above, we believe that

we will be able to act on mergers more quickly after a complete

application is filed. A complete application is one that adequately and

accurately describes the merger being proposed and that contains all

the information necessary to explain how the merger is consistent with

the public interest, including an evaluation of the merger's effect on

competition, rates, and regulation.67 We expect applicants to be

able to provide all the necessary information, given the guidance in

this Policy Statement. We also emphasize that applicants should not

expect speedy action if their merger proposals change, as has

frequently happened in the past. The Commission cannot be expected to

act quickly on a moving target. If applicants change the mechanism or

terms under which they intend to merge or supplement the supporting

information in their application, the Commission's review process will

restart.

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\67\ The information would include all applicable exhibits and

accompanying testimony and other data that will constitute

applicants' showing that the merger is consistent with the public

interest. In addition, a copy of all applications or other

information filed with other regulatory bodies regarding the merger

must be provided to the Commission to initiate our review process.

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Once we have a complete application, we will make every reasonable

effort to issue an initial order 60-90 days after the comment period

closes. An initial order could take any of several actions, including:

requesting additional information from the applicants or intervenors;

setting some or all issues for a trial-type or paper hearing; approving

the merger; or rejecting the merger. If we determine in the initial

order that further procedures are necessary, we will choose among the

available procedural options based on the completeness of the record

before us, the types of issues that need to be resolved (factual,

policy or legal), and the need to give parties adequate due process.

However, we are hopeful that the guidance in this Policy Statement will

result in more complete applications and more focused and detailed

interventions and that we will be able to act summarily on many (or in

some cases all) issues in the initial order.

If the Commission determines in an initial order that trial-type or

paper hearing procedures are necessary, we believe that we will be able

to issue a final order on most applications within 12-15 months from

the date that the completed application was filed. We emphasize that

this assumes no significant changes in the proposal; any such changes

will start the process over and will require that a new notice be

issued. Of course, some applications will take more time than others.

For example, if a merger raises extraordinarily complex factual

disputes, or if the development of competitive remedies or hold

harmless agreements is entirely deferred to the hearing, case

processing may take longer. On the other hand, if a merger falls below

the HHI screen, the applicants propose adequate ratepayer protection

mechanisms, and the applicants make the commitments necessary to

assuage our concerns about the effect on regulation, we should be able

to act much more quickly.

The Commission believes that in order to meet routinely the target

dates we have set forth in this Policy Statement, it is appropriate to

reexamine whether our procedures for processing merger applications,

including hearing procedures, can be tailored better to meet the

specific needs of participants in merger proceedings. To that end, in

the proposed rulemaking on information filing requirements (see note

3), we will also request public comment on merger processing

procedures.

We will not delay our processing of merger applications to allow

the states to complete their review, as some commenters suggest.

However, we will be willing to consider late interventions by state

commissions where it is practicable to do so. In cases where a state

commission asks us to address the merger's effect on retail markets

because it lacks adequate authority under state law, we will do so.

In response to commenters who are concerned that our decisions be

consistent with those of other agencies, we note that since we are

adopting the Guidelines as a framework for our analysis of the effect

on competition, our analysis should be generally consistent with the

DOJ's and the FTC's analyses.

G. Other Issues

According to FERC Policy Project, recent changes in the industry

may make mergers financially unattractive without planning and

operational changes; these changes can harm the environment. FERC

Policy Project argues that we should revise our rule that provides that

merger applications will not generally require preparation of an EIS or

EA. The rule ``categorically excludes'' mergers unless circumstances

indicate that the action may be a major Federal action significantly

affecting the qualify of the human environment.68 FERC Policy

Project also argues that the effect on the environment should be

considered as a factor in deciding whether to approve a merger.

Moreover, it believes we should require applicants to provide with

their applications information on the environmental effects of the

merger and that we should require mitigation of environmental effects

through various means.

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\68\ 18 CFR 380.4 (a)(16) and (b).

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The Commission has recognized that a particular merger can have

environmental effects and has been willing to study the issue in an

[[Page 68606]]

individual case where it is justified.69 We do not see the need to

change our regulation, which explicitly addresses the possibility that

an EA or EIS may, on rare occasions, be needed. However, both our

categorical exclusion rule and the absence of environmental concerns

from the list of three factors in this Policy Statement reflect the

simple fact that most mergers do not present environmental concerns.

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\69\ See Southern California Edison Company, 47 FERC para.

61,196 (1989), order on reh'g, 49 FERC 61,091 (1989).

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Low-Income Representatives argues that the ``public interest''

standard requires us to consider matters such as the need for service

to all households, the need for consumer input into the decisions made

by utilities, and other matters. We clarify that the three factors

discussed in this Policy Statement are not necessarily the only factors

that make up the public interest, and, if appropriate, we will consider

other matters that are under our jurisdiction. However, we believe such

matters as the need for service to all households are more

appropriately the concern of the states.

IV. Administrative Effective Date and Congressional Notification

Under the terms of 5 U.S.C. 553 (d)(2), this Policy Statement is

effective immediately. The Commission has determined, with the

concurrence of the Administrator of the Office of Information and

Regulatory Affairs of the Office of Management and Budget, that this

Policy Statement is not a major rule within the meaning of section 351

of the Small Business Regulatory Enforcement Act of 1996.70 The

Commission is submitting the Merger Policy Statement to both Houses of

Congress and to the Comptroller General.

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\70\ 5 U.S.C. 804 (2).

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List of Subjects in 18 CFR Part 2

Administrative Practice and Procedure, Electric power, Natural gas,

Pipelines, Reporting and recordkeeping requirements.

By the Commission.

Lois D. Cashell,

Secretary.

In consideration of the foregoing, the Commission amends Part 2,

Chapter I, Title 18 of the Code of Federal Regulations as set forth

below.

PART 2--GENERAL POLICY AND INTERPRETATIONS

1. The authority citation for Part 2 continues to read as follows:

Authority: 15 U.S.C. 717-717w, 3301-3432; 16 U.S.C. 792-825r,

2601-2645; 42 U.S.C. 4321-4361, 7101-7352.

2. Part 2 is amended by adding Sec. 2.26, to read as follows:

Sec. 2.26 Policies concerning review of applications under section

203.

(a) The Commission has adopted a Policy Statement on its policies

for reviewing transactions subject to section 203. That Policy

Statement can be found at 77 FERC para. 61,263 (1996). The Policy

Statement is a complete description of the relevant guidelines.

Paragraphs (b)-(e) of this section are only a brief summary of the

Policy Statement.

(b) Factors Commission will generally consider. In determining

whether a proposed transaction subject to section 203 is consistent

with the public interest, the Commission will generally consider the

following factors; it may also consider other factors:

(1) The effect on competition;

(2) The effect on rates; and

(3) The effect on regulation.

(c) Effect on competition. Applicants should provide data adequate

to allow analysis under the Department of Justice/Federal Trade

Commission Merger Guidelines, as described in the Policy Statement and

Appendix A to the Policy Statement.

(d) Effect on rates. Applicants should propose mechanisms to

protect customers from costs due to the merger. If the proposal raises

substantial issues of relevant fact, the Commission may set this issue

for hearing.

(e) Effect on regulation. (1) Where the merged entity would be part

of a registered public utility holding company, if applicants do not

commit in their application to abide by this Commission's policies with

regard to affiliate transactions, the Commission will set the issue for

a trial-type hearing.

(2) Where the affected state commissions have authority to act on

the transaction, the Commission will not set for hearing whether the

transaction would impair effective regulation by the state commission.

The application should state whether the state commissions have this

authority.

(3) Where the affected state commissions do not have authority to

act on the transaction, the Commission may set for hearing the issue of

whether the transaction would impair effective state regulation.

Note: These Appendices will not appear in the Code of Federal

Regulations.

Appendix A--Competitive Analysis Screen

The analytic screen provides applicants with a standard analytic

method and data specification to allow the Commission to quickly

determine whether a proposed merger presents market power concerns.

Some past merger cases were delayed or set for hearing because an

adequate analysis was not part of the application or because

sufficient data that would allow the Commission to corroborate or

independently check applicants' conclusions was not provided in the

application. This is especially true regarding the effect that

transmission prices and capability may have on the scope of the

geographic market. The chances for hearings and delays will be

reduced if the screen analysis and data described below are filed

with the application.

A. Consistency With DOJ Guidelines

In this policy statement, the Commission has adopted the DOJ

Merger Guidelines (the Guidelines) 1 as the basic framework for

evaluating the competitive effects of proposed mergers. The analytic

screen applies the Guidelines. Before describing the screen, the

Guidelines are briefly summarized so that the screen's consistency

with them is clear.

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\1\ U.S. Department of Justice and Federal Trade Commission,

Horizontal Merger Guidelines, 57 FR 41552 (1992).

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In general, the Guidelines set out five steps for merger

analysis: (1) assess whether the merger would significantly increase

concentration; (2) assess whether the merger could result in adverse

competitive effects; (3) assess whether entry could mitigate the

adverse effects of the merger; (4) assess whether the merger results

in efficiency gains not achievable by other means; and (5) assess

whether, absent the merger, either party would likely fail, causing

its assets to exit the market.

The analytic screen focuses primarily on the Guidelines first

step. This step can be broken down into two components:

Defining product and geographic markets that are likely to be

affected by a proposed merger and measuring concentration in those

markets. The products to consider are those sold by the merging

parties. The Guidelines suggest a way of defining geographic markets

based on identifying the suppliers that are feasible alternative

suppliers to the merged firm from a buyer's perspective: the

hypothetical monopolist test. Essentially, if a hypothetical and

unregulated monopoly that owned all the supplies inside the

geographic market being tested could profitably sustain a small but

significant price increase (i.e., suppliers external to the market

are not, by definition, sufficiently good substitutes for the buyers

in the market), then the limit of the geographic market has been

reached.2 The sustainability of a price increase depends on

both sellers entering the market and the response of buyers to the

increase. The concentration of suppliers included in the market is

then measured (by summary statistics such as the Herfindahl-

Hirschman Index, or HHI, and single seller market share)

[[Page 68607]]

and used as an indicator of the potential for market power.

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\2\ The Guidelines suggest that a 5% price increase be used for

the test, but allow that larger or smaller price increases may also

be appropriate. DOJ Guidelines at 41555.

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Evaluating the change in concentration using the Guidelines'

thresholds to indicate problematic mergers. The Guidelines address

three ranges of market concentration: (1) an unconcentrated post-

merger market--if the post-merger HHI is below 1000, regardless of

the change in HHI the merger is unlikely to have adverse competitive

effects; (2) a moderately concentrated post-merger market--if the

post merger HHI ranges from 1000 to 1800 and the change in HHI is

greater than 100, the merger potentially raises significant

competitive concerns; and (3) a highly concentrated post-merger

market--if the post-merger HHI exceeds 1800 and the change in the

HHI exceeds 50, the merger potentially raises significant

competitive concerns; if the change in HHI exceeds 100, it is

presumed that the merger is likely to create or enhance market

power.3

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\3\ DOJ Guidelines at 41558.

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If the concentration analysis indicates that a proposed merger

may significantly increase concentration in any of the relevant

markets, the Guidelines suggest examination of other factors that

either address the potential for adverse competitive effect or that

could mitigate or counterbalance the potential competitive harm.

Such factors include the ease of entry in the market and any

efficiencies stemming from the merger.4 If the additional

factors examined do not mitigate or counterbalance the adverse

competitive effects of the merger, remedial conditions would be

explored at this stage.

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\4\ In assessing market concentration, the Guidelines state ``*

* * market share and concentration data provide only the starting

point for analyzing the competitive impact of a merger.'' DOJ

Guidelines at 41558 .

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B. Analytic Screen Components

There are four steps to the screen analysis.

1. Identify the Relevant Products

The first step is to identify one or more products sold by the

merging entities. Products may be grouped together when they are

good substitutes for each other from the buyer's perspective. If two

products are not good substitutes, an entity with market power can

raise the price of one product and buyers would have a limited

ability to shift their purchases to other products. In the past, the

Commission has analyzed three products: non-firm energy, short-term

capacity (firm energy), and long-term capacity.5 These remain

reasonable products under the prevailing institutional arrangements,

and applicants should recognize such products in their analysis.

Other product definitions may also be acceptable. For example, the

lack of on-site buyer storage creates products differentiated by

time. Thus, peak and off-peak energy (seasonal and daily) may be

distinct products.

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\5\ See Baltimore Gas & Electric and Potomac Electric Power

Company, 76 FERC para. 61,111 (1996) at 61,572. The factor that is

considered in evaluating long term capacity markets is the effect of

a merger on barriers to entry into those markets.

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The Commission encourages parties to propose even more precise

definitions of relevant products where appropriate. Indeed, we would

expect to see greater precision in product differentiation as market

institutions develop.

2. Geographic Markets: Identify Customers Who May Be Affected by the

Merger

This is the first of a two-step process of determining the

geographic size of the market. To identify customers potentially

affected by a merger, at a minimum, applicants should include all

entities directly interconnected to either of the merging parties.

Additional entities should be included in the analysis if historical

transaction data indicates such entities have been trading partners

with a merging party. Applicants and others may argue either that

there are other customers to be included as relevant buyers or that

identified customers are not relevant buyers. Intervenors also may

argue that other customers not identified by the applicants will be

affected by the merger.

3. Geographic Markets: Identify Potential Suppliers to Each Identified

Customer

This second, and key, step in determining the size of the

geographic market is to identify those suppliers that can compete to

serve a given market or customer and how much of a competitive

presence they are in the market. Alternative suppliers must be able

to reach the market both economically and physically. There are two

parts to this analysis. One is determining the economic capability

of a supplier to reach a market. This is accomplished by a delivered

price test. The second part evaluates the physical capability of a

supplier to reach a market, i.e., the amount of the defined product

a supplier can deliver to a market based on transmission capacity

availability.

Supply and demand conditions in electricity markets vary

substantially over time, and the market analysis must take those

varying conditions into account. Applicants should present separate

analyses for each of the major periods when supply and demand

conditions are similar. One way to do this is to group together the

hours when supply and demand conditions are similar; for example,

peak, shoulder and off-peak hours. There may even be smaller

groupings to reflect periods of significantly constrained

transmission capability available for suppliers to reach a market.

The screen analysis also examines historical trade data as a

check on which suppliers should be included in the relevant markets.

a. Delivered price test. The screen analysis should first

identify those suppliers with the potential to economically supply

power to the destination market or customer. The merging companies

as well as non-traditional suppliers should be included in this test

to identify potential suppliers. Basically, suppliers should be

included in a market if they could deliver the product to a customer

at a cost no greater than 5% above the competitive price to that

customer.6 The delivered cost of the product to the relevant

market for each potential supplier is found by adding the potential

supplier's variable generation costs and all transmission and

ancillary service charges that would be incurred to make the

delivery.7 Thus, the farther away a supplier, the more

transmission and ancillary service prices that must be added to its

power costs. Suppliers that would have to traverse a non-open access

system can be included as potential suppliers only to the extent

they have firm access rights. The analysis should also take into

account the effect of line losses on the economics of trade with a

distant supplier.

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\6\ The Guidelines suggest a 5% price threshold but acknowledge

that others may be appropriate. Applicants have the burden of

justifying a different price threshold.

\7\ This would include the unbundled transmission rates of a

seller that is a vertically integrated public utility.

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If a supplier can deliver the product to the market at a cost no

more than 5% above the market price,that supplier should be included

in the geographic market. Applicants are expected to provide

product-specific delivered price estimates for each destination

market or customer.

The delivered price test uses the following data. Applicants

should provide in electronic format these data and any other data

relied upon in their analysis.

Transmission prices. Applicants should use the ceiling

prices in utilities' open access tariffs on file with the

Commission. Where a non-jurisdictional entity's transmission system

is involved, the ceiling price in its ``NJ'' tariff should be used.

If the entity has not filed an ``NJ'' tariff, applicants should use

their best efforts to secure or estimate transmission ceiling

prices. Prices that are not found in a tariff on file with the

Commission should be adequately supported. While we are aware that

ceiling prices are frequently discounted, this screen analysis is to

be conservative. Applicants may present an additional alternative

analysis using discounted prices if they can support it with

evidence that discounting is and will be available.

Potential suppliers' generation costs. The Commission

will consider various measures of costs. Applicants are free to use

any appropriate cost data as long as it is verifiable and supported

with reasoned analysis. Possibilities include generating plant cost

data from the FERC Form 1 annual reports or unit specific data.

Another is system lambda data. Either of these data can be used to

calculate a potential supplier's costs at various time periods.

Other measures or data sources may also be appropriate. The

Commission has not reached a firm conclusion on a specific cost

measure.

Competitive market price. Electricity markets have not

sufficiently matured yet to exhibit single market clearing prices

for various products. In addition, price discovery is difficult

because the reporting of actual transaction prices is still in its

formative stage. Until market institutions mature enough to reveal

single market clearing prices, applicants may use surrogate measures

as long as they are properly supported. For example, a buyer's

system lambda may be used because a buyer is not likely to purchase

from a supplier that is more costly than its own costs of production

[[Page 68608]]

at specific times.8 Another possibility might be the price at

which the affected customer has been purchasing power.

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\8\ System lambda data are usually reported by control area. For

smaller entities that are within a control area, the area's system

lambda may be a reasonable proxy for the cost of energy from the

marginal resource.

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For each supplier, the screen analysis should then show the

amount of each product the supplier could supply to the market.

Generation capacity measures are appropriate for this showing.9

Different capacity measures should be used, as appropriate, for

different products. It is also appropriate, even desirable, to use

several measures for one product. Given that competitive analysis is

an inexact science and that electricity markets are changing

rapidly, using several measures for a particular product will

corroborate the result of the analysis. While the Commission has not

firmly decided on specific measures for analyzing products, the

following discussion of capacity measures is intended to offer

guidance on this matter. These are some ways to measure a supplier's

ability to supply a particular product to a market. They are not

product definitions.

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\9\ The DOJ Guidelines support using capacity measures in

industries with homogenous products, such as electricity. DOJ

Guidelines, at 41557. We note that energy measures (MWH) may also be

appropriate.

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Economic capacity. This is the most important of the

measures because it determines which suppliers may be included in

the geographic market. Economic capacity is that from generating

units whose variable costs are such that they could deliver energy

to a relevant market, after paying all necessary transmission and

ancillary service costs, at a price close to the competitive price

in the relevant market. For example, if the average competitive

price in the wholesale market is 2.2 cents/kWh during a particular

period, all capacity that can sell into the market at 2.3 cents/kWh

(5% above the competitive price) should be included in the market.

If a seller has no economic capacity, it should not be considered in

the market at this stage of the analysis. The economic capacity

measure provides a sense of which suppliers own or control the

largest shares of low cost generating capacity that has a pronounced

competitive advantage over higher cost capacity in the

market.10

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\10\ Economic capacity and similar measures were recommended by

the DOJ and FTC. See FTC comments at 10 and DOJ comments, Appendix

at 8.

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Available economic capacity. This measure indicates how

much economic capacity a supplier identified in the previous step

might actually have available to sell into a market. It includes

capacity from generating units that are not used to serve native

load (or are contractually committed) and whose variable costs are

such that they could deliver energy to a market at a price close to

the competitive price in the market. The presumption underlying this

measure is that the lowest running cost units are used to serve

native load and other firm contractual obligations and would not be

available for other sales. As competition develops, this presumption

may not be valid.11 Because of its focus on variable costs,

available economic capacity is useful for evaluating energy (in

contrast to capacity) markets.

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\11\ For example, in a market with full retail access and a bid-

based power exchange, all generation units would be in the market.

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Uncommitted capacity. This traditional measure is

useful for evaluating intermediate-capacity markets. For each

supplier included in the relevant market, this measure is computed

by subtracting native load and firm contractual obligations from

total capacity.

Total capacity. Total capacity has traditionally been

used by the Commission and others to analyze markets. While this

measure does not account for native load obligations and does not

capture the availability or cost of generation, and thus is not

useful for a delivered price analysis, it does provide a sense of

the overall size of a supplier that is included in the relevant

market.

b. Accounting for transmission capability. Once the suppliers

that might economically supply the product to a market or customer

are identified, and the relevant capacity measures are calculated,

each supplier's capacity measures should be adjusted to account for

how much of the product that seller can physically deliver to that

market. The extent of transmission capability determines the extent

of a supplier's ability to physically reach a market.

The flows on a transmission system can be very different under

different supply and demand conditions (e.g. peak vs. off-peak).

Consequently, the amount and price of transmission available for

suppliers to reach wholesale buyers at different locations

throughout the network can vary substantially over time. If this is

the case, the analysis should treat these narrower periods

separately and separate geographic markets should be defined for

each period.

It is important to assess accurately the amount of transmission

capability available for each supplier's use. The key to

incorporating transmission limitations into the merger analysis is

to include each supplier in the relevant market only to the extent

of the transmission capability available to them. This would be

calculated as the combination of the available transmission

capability (ATC) 12 and any firm transmission rights held by

the supplier that are not committed to long-term transactions.

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\12\ As used by the industry, ATC is a measure of the transfer

capability remaining in the physical transmission network for

further commercial activity over and above already committed uses.

See for example, NERC, Available Transfer Capability Definitions and

Determination, June 1996 at page 2. In hours when ATC is zero, a

transmission constraint is said to be binding. This prevents the

dispatcher from scheduling any additional transactions between the

two points in the constrained direction.

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In many cases, multiple suppliers could be subject to the same

transmission path limitation to reach the same destination market

and the sum of their economic generation capacity could exceed the

transmission capability available to them. In these cases, the ATC

must be allocated among the potential suppliers for analytic

purposes. There are various methods for accomplishing this

allocation. Applicants should support the method used.

Applicants should also present evidence regarding how

transmission capability will be affected by the merger. Transmission

line loadings are likely to change as a result of the merging

parties'' combined operations. These changes are likely to result in

transmission availability that is different from historical

experience. Applicants should include in their application the

following data: hourly TTC 13 and hourly firm and non-firm ATC,

and firm transactions between relevant control areas. The ATC and

TTC data should come directly from the OASIS systems once they are

implemented. Until then, applicants should file estimates of TTC and

ATC with data or other background material that will allow the

Commission to verify that the estimates are reasonable. Given these

data, the Commission will be able to assess independently the amount

of generation capacity that may be available to the market by each

supplier.

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\13\ As used by the industry, total transmission capability

(TTC) is the amount of electric power that can be transferred over

the interconnected network in a reliable manner while meeting all of

a specific set of defined pre- and post-contingency conditions.

NERC, id. at page 2.

---------------------------------------------------------------------------

c. Trade data check. It would be expected that there be some

correlation between the suppliers included in the market by the

delivered price test and those actually trading in the market. As a

check, actual trade data should be used to compare actual trade

patterns with the results of the delivered price test. For example,

it may be appropriate to include current trading partners in the

relevant market even if the above analysis indicates otherwise.

Alternatively, if there has been little or no trade between a

customer and a specific supplier, it may be appropriate to exclude

that supplier from the market, unless the applicants can show why it

should be included prospectively. The lack of open access in the

past may have prevented trade between the entities but trade may be

more likely in an open access environment. Applicants should file

historical trade data showing transactions between potential

suppliers identified in the steps discussed above and the customers

in question. The trade data filed should identify the supplier,

customer, and characteristics of the transactions (duration,

firmness, etc.). Any adjustments to the suppliers included in the

market under the delivered price test must be fully supported.

4. Analyze concentration. The final step in the screen analysis

is to analyze the effect of the proposed merger on market

concentration and competition. To do so, concentration statistics

should be calculated using the capacity measures discussed above for

each relevant market identified. In cases where limited transmission

capability during certain time periods results in a number of time

differentiated markets, concentration statistics should be

calculated for each. Both HHIs and single firm market share

statistics should be presented for both pre- and post-

[[Page 68609]]

merger conditions.14 In calculating HHIs and market shares, the

relevant generation capacity of the customers in each market should

be included in the denominator of the ratio statistics. For example,

if the economic capacity measure is being used, then the customer's

economic capacity should be included. Such capacity would be

available and turned to as a response to a significant price

increase by external suppliers.

---------------------------------------------------------------------------

\14\ Post-merger geographic markets could include more or fewer

suppliers than the pre-merger markets due to the effect of combining

transmission rates. In cases where the merged company will charge a

single system wide transmission rate, the merger will result in just

one transmission rate where there were two before the merger. Thus,

after the merger, some suppliers that were excluded from some

destination markets could be included if the elimination of one of

the transmission charges allows them to economically reach the

market. While a stable geographic market would be preferable for

analytic reasons, the effect described here reflects the reality of

current transmission pricing policy and market organization. A buyer

inside the transmission area of one of the merging companies could

see higher transmission rates as a result of a single system rate

for the merged company thereby decreasing the competitive options

available to it. We also note that a decrease in transmission prices

paid could result in increased demand, congestion, and no increase

of suppliers in some markets.

---------------------------------------------------------------------------

The HHI measures should be compared with the thresholds given in

the DOJ Merger Guidelines. The Guidelines address three ranges of

market concentration: (1) an unconcentrated post-merger market--if

the post-merger HHI is below 1000, the merger is unlikely to have

adverse competitive effects regardless of the change in HHI; (2)

moderately concentrated post-merger market--if the post merger HHI

ranges from 1000 to 1800 and the change in HHI is greater than 100,

the merger potentially raises significant competitive concerns; and

(3) highly concentrated post-merger market--if the post-merger HHI

exceeds 1800 and the change in the HHI exceeds 50, the merger

potentially raises significant competitive concerns; if the change

in HHI exceeds 100, it is presumed that the merger is likely to

create or enhance market power.15

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\15\ DOJ Guidelines, at 41558.

---------------------------------------------------------------------------

If the Guidelines' thresholds are not exceeded, no further

analysis need be provided in the application. We emphasize, however,

that the Guidelines are just that: guidelines. There will

undoubtedly be instances where concentration statistics may fall

just above or just below the thresholds for concern and some

additional analysis or judgement is needed.16 For example, if a

proposed merger's effect on concentration falls just below a

threshold, the Commission might still want to see further analysis

if intervenors have raised significant concerns regarding the

proposed merger. It is reasoned analysis, not blind faith in the

thresholds, that must carry the day.

---------------------------------------------------------------------------

\16\ The Guidelines state that the HHI statistics provide a

useful framework for merger analysis but they suggest ``greater

precision than is possible with the available economic tools and

information. Other things being equal, cases falling just above and

just below a threshold present comparable competitive issues.''

Guidelines, at 41558.

---------------------------------------------------------------------------

Instances where high concentration is indicated in markets that

are defined by fairly short-lived periods of low transmission

capability will require additional analysis. The concern with high

concentration in a market is that firms will be able to raise prices

substantially and adversely impact the market. Relatively short

periods of high concentration could be significant if the

concentration is high enough. The factors that affect whether such a

situation is problematic are the degree of concentration, as

measured by HHI statistics, and how long that concentration lasts.

High concentration is an indicator for how easy it would be for

firms to behave strategically (e.g., collude, or if concentration is

high enough, act unilaterally) to raise prices. It is a proxy

measure for the degree to which prices could be raised. This,

together with the length of time the concentration lasts, gives some

idea of the potential severity of anticompetitive impact.

The Commission has insufficient experience to adopt at this time

specific thresholds for the various possible combinations of HHI and

length of time at which the constrained periods would be

problematic. Applicants and other parties are strongly encouraged to

analyze short-lived periods of high concentration using the

framework discussed above and to support the conclusions drawn from

it. There may be cases in which the applicant may be able to show

that the anticompetitive effect of constrained transmission

availability is de minimis. While the Commission has insufficient

experience to establish a specific de minimis test in this policy

statement, applicants may argue in a specific case that the

anticompetitive effect of a constraint is de minimis. We offer the

following general guidance to applicants that seek to make such a

showing regarding short-lived transmission constraints. First, peak

periods may be more problematic than other periods, because the

opportunity to exercise market power likely would lead to

significantly higher prices during those hours. Second, some level

of market concentration above the DOJ threshold may be acceptable if

the applicant can show that there are multiple sellers in the

constrained area and/or that there are multiple holders of capacity

into the constrained area. And finally, our concern with short-lived

periods of high concentration is greater if the merged firm will

have market-based pricing authority. Without such authority, the

firm may not be able to substantially raise prices.

If the DOJ Guideline concentration thresholds are exceeded,

including instances where short-lived periods of high concentration

are indicated to be problematic, then the application should present

further analysis consistent with steps 2 to 5 in the Guidelines. The

additional analysis could address the potential for adverse

competitive effects, the potential for entry in the market and the

role entry could play in mitigating the increased market power, any

efficiency gains that reasonably could not be achieved by other

means, and whether, but for the merger, either party would likely

fail causing its assets to exit the market.

If entry is considered as a potential mitigating factor,

applicants should address entry barriers, such as the time needed to

install any necessary transmission capacity. All entry barriers

should be addressed, even if they are not controlled by the

applicants. Good market structure can be stymied by entry barriers,

regardless of the source, e.g., transmission constraints on a

neighboring utility's system.

C. Data

The usefulness of this screen depends on the quality and

comprehensiveness of the data filed with the application. The data

needed for the screen generally are publicly available. It is

important for applicants to file electronically all data used for

the screen analysis, including supporting data, and the data

specified in this policy statement.17 The Commission must be

able to check on the applicants' analysis independently. To do so,

the Commission must have ready access to the data. Otherwise, data

requests could result in delay. If there are problems in obtaining

or understanding the data, the Commission is interested in

developing informal means, such as technical conferences, to gather

additional needed data or resolve questions or misunderstandings

concerning the screen analysis, before the Commission addresses the

merger. This approach could reduce the time needed to get useable

data and perhaps reduce the need to set a merger for evidentiary

hearing.

---------------------------------------------------------------------------

\17\ The data that should be electronically filed in an

application is listed in Appendix B.

---------------------------------------------------------------------------

D. Other Considerations

We note that the above description of the analytic screen

focuses only on monopoly (seller) power. This is not intended to

exclude monopsony (buyer) power as a relevant consideration. An

analysis of monopsony power should be developed if appropriate.

Long-term purchases and sales data for interconnected entities are

already collected and could be used to assess buyer concentration in

the same way that seller concentration is calculated. In any event,

intervenors may raise this issue if it is a concern.

The Commission understands that the screen analysis described in

this policy statement will evolve with industry restructuring and

market maturation. For example, as unbundling occurs, companies may

have market power for sales from individual generating units (e.g.,

``must-run units''). In addition, markets are developing in response

to competition and are spawning new products and increasingly short

term exchanges. Markets will probably be differentiated by product

(e.g., firm and non-firm energy and reactive power), by time (e.g.,

peak, off-peak) or by geography (e.g., markets separated by

transmission constraints). The definition of relevant geographic and

product markets must account for these new realities. Further,

methods for trading and information availability are changing. As

regional institutions, such as ISOs, and regional markets develop,

transmission services may no longer be a series of transactions

based on utility-by-utility corporate boundaries, but rather single

regional transactions. This will

[[Page 68610]]

have important implications for entry, customer response to price

changes, and the number of suppliers that have competitive delivered

prices.

The means of our analysis may also change. For example, flow

based network models that include constraints on transmission

networks are likely to be needed for the screen analysis. In the

future, the Commission will have to rely less on methods that use

costs to assess markets. Generation cost data will become

increasingly sensitive, market participants will be less willing to

report them, and accounting costs will be increasingly irrelevant to

market behavior. The Commission will rely more on actual transaction

prices because they will be more available as market institutions

such as ISOs and power exchanges produce this information and

because they are a better measure of market boundaries. New market

institutions will change the ability to exercise market power. High

transactions costs of trading tend to exclude competitors.

Transactions costs include the costs of obtaining information,

searching for trading partners, and completing a transaction.

Further, the improved ability of buyers to respond quickly to price

changes can significantly reduce market power. ISOs provide one

vehicle for reducing transactions costs and making information

available to traders via such means as the OASIS. Real-time pricing

provides buyers with an improved ability to respond quickly to price

changes.

We note that we intend to apply the analytic screen to mergers

between firms that are not solely engaged in electricity markets,

e.g., electric-gas mergers. However, it will not be necessary for

the merger applicants to perform the screen analysis or file the

data needed for the screen analysis in cases where the merging firms

do not have facilities or sell relevant products in common

geographic markets. In these cases, the proposed merger will not

have an adverse competitive impact (i.e., there can be no increase

in the applicants' market power unless they are selling relevant

products in the same geographic markets) so there is no need for a

detailed data analysis. If the Commission is unable to conclude that

the applicants meet this standard, the Commission will require the

applicants to supply the competitive analysis screen data described

in Appendix A.

D. Remedy

A problematic merger may be made acceptable if certain remedial

actions are taken. In some cases, the Commission may recommend them

if we determine that a proposed merger will cause significant

adverse effects on competition without a remedy. In other cases, the

applicants may propose certain actions to be taken if the Commission

approves the proposed merger. We offer the following guidance

concerning standards for remedies and specific remedial options.

1. Standards

Any remedies proposed by the applicants or relied upon by the

Commission to mitigate the anticompetitive effect of a proposed

merger should meet the following standards.

Nexus. Remedies should be clearly designed to mitigate the

specific competitive problems identified in the analysis.

Approval of other authorities. Full and effective mitigation

must be in place at the time the merger is consummated. Some, and

maybe all, of the possible remedies to market power require the

approval of other Federal, state and local authorities. For example,

local authorities must approve many aspects of transmission line

siting and construction and state commissions would surely have to

approve any divestiture of generating plants also used to provide

retail service. Promises to the Commission that such actions will be

taken in exchange for merger approval are empty if not accompanied

by all approvals necessary. We recognize, however, that final

approvals may require quite some time to secure. In such cases, we

will consider interim mitigation measures that can be implemented

more quickly so as not to unduly delay a merger's consummation. We

will require, however, that any interim measure must be fully

effective in mitigating the identified market power problems.

Specificity. Remedial commitments must specify exactly which

facilities are affected by the commitment, e.g., which generating

unit(s) will be divested.

2. Remedial options

The remedies discussed in this section are intended to mitigate

the market concentration problem caused by the merger. We stress

that the options discussion is meant only as guidance and not as an

exhaustive list of potentially acceptable remedies.

(a) Require transmission expansion. Limitations on available

transmission capability that prevent competitors from participating

in a market can give substantial market power to incumbents in the

market. Conditioning merger approval on eliminating a known

constraint could help to mitigate this type of market power. Where

constraints on other systems are a problem, the applicants would

also be required to seek transmission expansion on those systems. As

with relieving constraints on their own system, applicants should

show that all necessary approvals have been secured before the

Commission could approve the merger. This process does not need to

wait for the Commission to identify a problem. Applicants wanting

fast approval could include this as part of the application.

(b) No trade over constrained paths. If constrained paths are

responsible for market concentration problems and they cannot be

relieved for any reason, the company could agree to not use those

paths for its own off-system trade when other transmission service

requests are pending. This condition would keep the merged company

from exercising market power in trade in the constrained areas.

(c) Generation plant divestiture. In concentrated markets,

including those subject to severe and long lasting transmission

limitations, splitting up different generating units into

independent and separately owned companies could reduce horizontal

market power. Where there are only a few generating units in the

market area, divesting those units to just a few owners may not

mitigate the market power problem. In such a case, one alternative

might be to divest the ownership rights to each unit's energy and

capacity to a number of owners. The unit could then be operated as a

competitive joint venture and parts of its output could be bid or

sold independently.

(d) Defer to an ISO's analysis and mitigation efforts. Although

ISOs are just now in their formative changes, they hold some promise

of playing a part in mitigating certain sources of market power.

Applicants' membership in, or commitment to join, an ISO with the

authority necessary to mitigate market power could allow the

Commission to rely on the ISO to identify and remedy market power

problems. The ISO would have access to more information than does

the Commission and would possess greater technical expertise to

assess problems. More importantly, the ISO would have the proper

incentives to mitigate the problems if the ISO's governing body is

broadly comprised of market participants. This potential role for

ISOs highlights the critical importance of balanced ISO governance.

An ISO would also be a mitigating influence on market power to

the extent that it attracts new entrants into a market. An ISO

assures comparable and independent access to all customers. These

institutional guarantees will serve both to attract new entrants and

to encourage continued participation in markets that would otherwise

be dominated by vertically integrated utilities.

ISOs are generally thought to be the proper vehicle for dealing

with vertical market power, e.g., ensuring transmission expansion or

preventing the strategic manipulation of generation dispatch. An ISO

would be able to deal with horizontal market power issues to the

extent it has the ability to control the dispatch or prices paid to

generators. For example, an ISO could identify units with market

power (such as must-run units) and those units could be subject to

contracts that mitigate those units' ability to raise prices

excessively. To take advantage of this option, applicants would be

expected to show that: (1) the ISO meets the Commission's standard

for independence; (2) already exists or will come into existence

before the merger is completed; (3) has a mandate to identify both

vertical and horizontal market power issues; and (4) has the

authority to either remedy any problems it finds or bring those that

it cannot remedy to the Commission.

(e) Real-time pricing. Real-time pricing, when combined with

other mitigation measures, could help constrain the ability of a

firm to raise prices excessively. Buyers who can see the higher

prices in real time can respond by conserving. This makes demand

more elastic, thereby making it more difficult to exercise market

power.

[[Page 68611]]

Appendix B.--Data Used for Competitive Analysis Screen

------------------------------------------------------------------------

Analysis and data element Sources\1\

------------------------------------------------------------------------

Delivered Price Test:

Hourly System Lambda............... FERC Form No. 714.

Plant Generation Costs/Capability.. FERC Form No. 1.

Unit Generation Costs:

Heat Rates..................... EIA Form 860.

Fuel Costs..................... FERC Form 423.

Transmission Rates................. Filed tariffs, Applicants'

filing.

Transmission Capability Test:

Hourly Capability (ATC)............ OASIS, Applicants' filing.

Total Capability................... OASIS, NERC Reports.

Developing Capacity Measures:

Hourly System Lambda............... FERC Form No. 714.

Plant Generation Costs/Capability.. FERC Form No. 1.

Unit Generation Costs:

Heat Rates..................... EIA Form 860.

Fuel Costs..................... FERC Form 423.

Transmission Rates................. Filed tariffs, Applicants''

filing.

Adjusting for LT Sales, Purchases, and

NUGS:

Trade Data (Firm Capacity ales).... FERC Form No. 1, OE-411, NERC

Reports, Applicants' filing.

Adjusting for Tx Capability:

Hourly/Total Capability (ATC, TTC). OASIS, NERC Reports Applicants'

filing.

------------------------------------------------------------------------

\1\ Most of the data listed is publicly available, however the

Applicants should assemble the data and file it electronically with

their merger application.

Appendix C.--Commenters on Merger Notice of Inquiry

------------------------------------------------------------------------

Short name Commenter

------------------------------------------------------------------------

APPA.............................. American Public Power Association.

Attorneys General et al........... Attorneys General of the States of

Iowa, Maine, Maryland, Minnesota,

Oklahoma and Wisconsin.

CA Com............................ California Public Utilities

Commission.

Carolina Association.............. Carolina Utility Customers

Association, Incorporated.

Centerior......................... Centerior Energy Corporation.

Central and South West............ Central and South West Corporation.

CINergy........................... CINergy Corporation.

Colorado Municipals............... Colorado Association of Municipal

Utilities.

Com Ed............................ Commonwealth Edison Company.

Competitive Coalition............. Coalition for a Competitive Electric

Market.

Diamond and Edwards............... Diamond, Joseph and Edwards, Jon D.

DOE............................... U.S. Department of Energy.

DOJ............................... U.S. Department of Justice.

East Texas Coop................... East Texas Electric Cooperative,

Incorporated.

Economists........................ Economists Incorporated (Mark W.

Frankena).

EEI............................... Edison Electric Institute.

EGA............................... Electric Generation Association.

Environmental Action et al........ Environmental Action Foundation and

Consumer Federation of America.

FERC Policy Project............... Project for Sustainable FERC Energy

Policy.

Florida and Montaup............... Florida Power Corporation and

Montaup Electric Company.

FTC............................... Bureau of Economics of the Federal

Trade Commission.

Georgia Municipal................. Municipal Electric Authority of

Georgia.

Hawes and Behrends................ Hawes, Douglas W. and Behrends, Sam

(IV).

Illinois Industrials.............. Illinois Industrial Energy

Consumers.

IN Com............................ Indiana Utility Regulatory

Commission.

Industrial Consumers.............. Electricity Consumers Resource

Council, American Iron and Steel

Institute, and Chemical

Manufacturers Association.

International Brotherhood......... International Brotherhood of

Electrical Workers.

Joint Consumer Advoc.............. Joint Consumer Advocates of Maryland

People's Counsel.

KS Com............................ Kansas Corporation Commission.

Low-Income Representatives........ Consolidated Low-Income

Representatives.

Lubbock........................... Lubbock Power & Light.

Madison G&E....................... Madison Gas and Electric Company.

MidAmerican....................... MidAmerican Energy Company.

Missouri Basin.................... Missouri Basin Municipal Power

Agency.

MN Public Service................. Minnesota Department of Public

Service.

MO Com............................ Missouri Public Service Commission.

NARUC............................. National Association of Regulatory

Utility Commissioners.

NIEP.............................. National Independent Energy

Producers.

NM Industrials.................... New Mexico Industrial Energy

Consumers.

NRECA............................. National Rural Electric Cooperative

Association.

NRRI.............................. National Regulatory Research

Institute.

[[Page 68612]]

NV Com............................ Public Service Commission of Nevada.

NY Com............................ Public Service Commission of the

State of New York.

OH Com............................ Public Utilities Commission of Ohio.

OK Com............................ Oklahoma Corporation Commission.

OK Industrials.................... Oklahoma Industrial Energy

Consumers.

Otter Tail........................ Otter Tail Power Company.

PA Com............................ Pennsylvania Public Utility

Commission.

PaineWebber....................... PaineWebber Incorporated.

PanEnergy......................... PanEnergy Corporation.

PP&L.............................. Pennsylvania Power & Light Company.

PS Colorado....................... Public Service Company of Colorado.

RUS............................... Rural Utilities Service.

Salt River........................ Salt River Project.

Sierra Pacific.................... Sierra Pacific Power Company.

Southern Company.................. Southern Company Services,

Incorporated.

Southwestern Electric............. Southwestern Electric Cooperative,

Incorporated.

Southwestern PS................... Southwestern Public Service Company.

TAPS.............................. Transmission Access Policy Study

Group.

TDU Systems....................... Transmission Dependent Utility

Systems.

Texas Industrials................. Texas Industrial Energy Consumers.

Texas Utilities................... Texas Utilities Electric Company.

TX Com............................ Public Utility Commission of Texas.

UtiliCorp......................... UtiliCorp United Incorporated.

WI Com............................ Public Service Commission of

Wisconsin.

Wisconsin Customers............... Wisconsin Wholesale Customers.

Wisconsin PS...................... Wisconsin Public Service

Corporation.

------------------------------------------------------------------------

Appendix D--Summary of Comments on Merger Policies

I. General Comments on Revising the Commission's Merger Policy

A. Direction of Change

Almost all commenters argue that we need to revise our merger

policies and standards in light of the changes in the industry.

However, they do not agree on the direction of the change. On one

side, many commenters argue that mergers may prevent markets from

becoming truly competitive. 1 On the other side, some

commenters suggest that the Commission should approve a merger

unless harm to the public interest is demonstrated.2 These

commenters claim that most mergers are procompetitive and should be

approved unless a problem is identified.

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\1\ For example, APPA, NRECA at 7-8; ELCON at 12-13.

\2\ For example, Utilicorp at 2, 7, 10.

---------------------------------------------------------------------------

Commenters 3 who argue that moving to a more competitive

market warrants stricter merger approval criteria are concerned that

the recent wave of mergers threatens the development of competitive

markets. For example, Industrial Consumers and TAPS believe that the

Commission's current policy is too lax. These commenters offer

numerous reasons for opposing mergers, including the detrimental

effects of large ``mega-utilities'' and diversion of management's

attention from cost minimization. RUS fears that mega-utilities

could have market power in generation and political power at the

state and federal levels that could suppress competition in

transmission and distribution. Madison G&E is also concerned about

the challenge mega-utilities pose to effective state regulation.

UtiliCorp notes that the need for efficient dispositions and

transfers of capital, which are critical to the transition from a

regulated to a competitive industry, warrant a revised merger

policy.

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\3\ Among others, APPA, NRECA, EEI, Texas Utilities, Southern,

East Texas Coop (endorsing the joint petition of APPA/NRECA and

comments of NRECA), NIEP, Colorado Municipals (endorsing the views

of APPA), IN Com, DOJ, Joint Consumer Advoc., TAPS, TX Com, and NY

Com.

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Many of these commenters criticize the ``consistent with''

standard as we have interpreted it--that is, as a ``do no harm''

standard. They argue that this approach, which was developed in an

era of tight regulation, is inconsistent with the public interest in

the transition to a competitive environment.4 Joint Consumer

Advoc. suggests that a merger is not consistent with the public

interest unless dollars invested in a merger could not have been

used otherwise to lower costs more.

---------------------------------------------------------------------------

\4\ East Texas Coop, Joint Consumer Advoc., and TAPS.

---------------------------------------------------------------------------

Numerous commenters 5 argue that we should revise our

merger criteria because of general industry restructuring due to

open access or new state and federal laws and policies that provide

incentives to merge.

---------------------------------------------------------------------------

\5\ These commenters include Texas Utilities, Southern, DOJ,

TAPS, TX Com, NARUC, and APPA.

---------------------------------------------------------------------------

On the other hand, commenters who support more relaxed merger

criteria argue that the marketplace can best decide the future path

of the industry. They argue that the Commission's current policy is

simply too stringent; 6 we should recognize that the

transformation to a competitive industry requires a certain amount

of industry reshuffling, best accomplished without the Commission's

intervention.

---------------------------------------------------------------------------

\6\ UtiliCorp, PaineWebber, Texas Utilities, Southwestern, and

Southern.

---------------------------------------------------------------------------

For example, CINergy believes that consolidation may be a

necessary step toward industry rationalization and disaggregation as

companies seek critical mass to spin off generation. This suggests

that we should monitor the merger process closely, but not try to

predict or dictate the path of industry restructuring. Similarly,

Central and South West says that the nearly 150 control areas and

the utilities that operate them will not survive competitive

restructuring and that mergers may allow market forces to bring

about a competitive and workable market structure. UtiliCorp notes

that mergers and acquisitions are likely to increase as utilities

act to improve their ability to compete in increasingly competitive

markets. Some of these commenters argue for automatic approval of a

merger if no harm to the public interest is demonstrated. PanEnergy

and Hawes and Behrends believe that certain types of mergers are

either procompetitive or have no effect on competition and warrant a

streamlined approval process.

The Commission also received comments from parties that neither

favor nor oppose mergers but suggest a revised approach, for a

variety of reasons. For example, NIEP and Diamond and Edwards

believe that as markets become more competitive and the Commission

reduces some aspects of its regulatory scrutiny, merger standards

should be adjusted so that they more closely track traditional

antitrust principles. On the other hand, PA Com and KS Com support a

``wait and see'' approach. PA Com comments that reevaluating merger

policy may be premature at this time because the Open Access Rule is

being reviewed by the industry and power pools do not have to file

their open access tariffs until December 31, 1996. KS Com believes

that the public interest and state and federal review processes will

benefit if a

[[Page 68613]]

consistent view of the appropriate markets and regulatory framework,

designed to achieve an efficient and sustainable generation market,

is developed before merger evaluation standards.

Project argues that our merger policies must ensure that the

market functions under rules that promote environmental quality and

economic efficiency; specifically, a policy of sustainability.

B. How to Implement New Policies

We received a few comments on whether to adopt our new policies

on a case-by-case basis, through a policy statement, or through a

rulemaking.7

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\7\ For example, DOJ, East Texas Coop, OH Com, NRECA, and

Southwestern Electric suggest a rulemaking as the vehicle to

implement the Commission's new merger policy; CINergy advocates a

case-by-case approach; APPA suggests a combination of various

methods; DOJ suggests that we convene a technical conference

immediately to delineate the relevant geographic markets for the

electric utility industry for the entire U.S. DOJ says that this

would greatly facilitate the Commission's (and DOJ's) review of

merger applications and enable the Commission quickly to establish

safe harbors or screens for any merger application based upon

changes in market concentration for a known geographic market.

---------------------------------------------------------------------------

Commenters also expressed differing views on whether our new

policies should be applied to pending mergers. Lubbock urges the

Commission evaluate all pending mergers under the new merger

standards. Wisconsin Customers recommend, however, that the new

merger policy be applied only to mergers filed after the date of

issuance of the NOI.

Enviromental Action et al. recommends that mergers be prohibited

until the Commission's new merger policy is established through a

NOPR process. However, if mergers are not prohibited during this

period, there should be a moratorium on unconditional approvals; any

mergers approval should be conditional and required to conform to

the merger final rule.

The Pennsylvania Commission urges the Commission to let

competitive wholesale restructuring develop before approving mergers

among the members of power pools.

On the other side, Florida and Montaup argue that any new rule

resulting from this proceeding should apply only to merger

applications filed after the effective date of a final rule. Merger

applications filed before that date should be considered under the

filing requirements and standards in effect at the time of their

filing. EEI and UtiliCorp request that the Commission move quickly

to review those merger applications already before it without

waiting to develop a new merger policy.

II. Comments Concerning Effect on Competition

A. Defining the Relevant Markets

1. Defining Product Markets

Some commenters emphasize that relevant product markets should

be established from the buyer's perspective, that is, in terms of

the delivered product.8 Such an approach would examine

generation and transmission in combination, since neither is of use

to a customer by itself. They add that in an open access

environment, where transmission rates will remain regulated,

transmission should be viewed as a substitute for local generation,

rather than as a separate market.9

---------------------------------------------------------------------------

\8\ For example, EEI, UtiliCorp, and Centerior.

\9\ These include, for instance, EGA, Low-Income

Representatives, NIEP, and TAPS.

---------------------------------------------------------------------------

Commenters suggest that the Commission examine two or more

product markets. However, there is little consensus on which markets

to consider. For example, Environmental Action, et al. suggests

existing generation, new generation, transmission, retail

aggregation and sales, physical distribution, demand side management

services, ancillary services associated with generation transmission

and distribution, and fuels. Industrial Consumers suggests firm and

non-firm bulk power, short-term capacity, short-term energy, long-

term capacity, and energy and transmission services. To minimize

opportunities for affiliate abuse, RUS recommends examining at least

markets for generation, transmission, and ancillary services. For

applying the Guidelines to the electric power industry, DOJ and FTC

suggest that we look at four product markets: short-term energy,

intermediate-term energy, long-term capacity, and ancillary

services. FTC notes that sales to differently situated customers may

constitute separate markets if differential pricing is feasible.

APPA proposes similar markets, but suggests considering short-term

energy or capacity. EEI proposes a short-term energy and capacity

market (up to about two years) and a medium-term (two- to five-year)

capacity contract market involving capacity and associated energy

sales from excess capacity from existing facilities. MO Com suggests

focusing on the commodities market (hourly energy from existing

generation facilities) and the contracts market (capacity and energy

from existing and new generation). NIEP proposes two broad product

markets, generation sales and retail sales. Several commenters

suggest that the Commission consider ancillary services as a product

market.10

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\10\ These include, for example, Industrial Consumers, DOJ,

Enviromental Action et al., CA Com, CINergy, and UtiliCorp.

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Other commenters argue that long-term product markets should not

be subject to market power analysis. For example, EEI says that the

long-term capacity market where sales from new capacity compete with

long-term contracts for sales from existing capacity should not be

subject to the analysis. APPA makes the same argument for long-run

sales from new capacity, since such capacity represents potential

entry. Similarly, UtiliCorp argues that we should disregard the

long-run generation product market because of our finding in the

Open Access Rule that long-run markets are generally competitive.

CINergy believes that open access, the absence of artificial

impediments to expansion of generation capacity by existing

suppliers, and the prospect of entry into the generation business by

new suppliers preclude market power in the long run. However, DOJ

questions the presumption that utilities do not have market power

over long-run energy and capacity.

Com Ed argues that the Commission should disregard short-term

energy markets because these markets involve buyers who are able to

make purchases to replace energy otherwise available at a higher

cost, such as from the buyer's own installed capacity. The cost of

energy from such otherwise available capacity effectively limits the

price at which short-term energy is offered.

Several commenters cite the need to consider the temporal

characteristics of product markets. For example, Florida and Montaup

suggest dividing them into short-term and medium-term markets and

further dividing these into various product markets as appropriate

to the area. Others 11 suggest that delivered capacity and

energy be analyzed under market conditions during peak and off-peak

hours and summer and winter conditions.

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\11\ E.g, Madison G&E and CINergy.

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As to whether the Commission should examine only the wholesale

market, leaving concerns over retail competition to the states,

Southern says yes. Several commenters believe that we should also

examine the impact on retail competition.12 They suggest that

the Commission has both the authority 13 and the responsibility

to examine the impact of mergers on actual or potential retail

competition.

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\12\ These include PP&L, DOJ, and TAPS.

\13\ Citing FPC v. Conway, 426 U.S. 271 (1976).

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2. Defining Geographic Markets

We received a significant response from commenters on various

aspects of defining relevant geographic markets. Most of these

comments relate to the approaches (such as generic versus case-by-

case) to defining markets, factors that are important to consider in

defining markets, and the use of modeling.

DOJ and others 14 define the relevant geographic market as

the area in which the seller operates and to which the purchaser can

turn for supplies. They suggest that the best way to determine which

suppliers are in the relevant market is to look at the physical

location of the generating unit (as opposed to disposition of power

from the unit). DOJ suggest that we could determine the geographic

markets immediately for the electric utility industry for the United

States through a rulemaking or technical conference.

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\14\ E.g., EEI, Wisconsin Customers, APPA, and TX Com.

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Some commenters urge the Commission to recognize the effects of

open access on the extent of geographic markets.15 For example,

the Commission should revise its current two-tier analysis because

open access will broaden the relevant geographic market beyond two

tiers. EEI suggests that the Commission first define the smallest

geographic area (under the trading patterns existing before open

access) and then broaden the market as choices available to the

purchasers increase under open access.

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\15\ E.g., Industrial Consumers, RUS, UtiliCorp, EEI, Wi

This text is long and has been trimmed here. Open the source document for the complete record.