PacifiCorp, et al.; Analysis to Aid Public Comment

FEDERAL TRADE COMMISSION

[File No. 971-0091]

PacifiCorp, et al.; Analysis to Aid Public Comment

AGENCY: Federal Trade Commission.

ACTION: Proposed consent agreement.

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SUMMARY: The consent agreement in this matter settles alleged

violations of federal law prohibiting unfair or deceptive acts or

practices or unfair methods of competition. The attached Analysis to

Aid Public Comment describes both the allegations in the draft

complaint that accompanies the consent agreement and the terms of the

consent order--embodied in the consent agreement--that would settle

these allegations.

DATES: Comments must be received on or before April 27, 1998.

ADDRESSES: Comments should be directed to: FTC/Office of the Secretary,

Room 159, 6th St. and Pa. Ave., N.W., Washington, D.C. 20580.

FOR FURTHER INFORMATION CONTACT: Joseph Krauss, FTC/S-3627, Washington,

D.C. 20580. (202) 326-2713.

SUPPLEMENTARY INFORMATION: Pursuant to Section 6(f) of the Federal

Trade Commission Act, 38 Stat. 721, 15 U.S.C. 46 and Section 2.34 of

the Commission's rules of Practice (16 CFR 2.34), notice is hereby

given that the above-captioned consent agreement containing a consent

order to cease and desist, having been filed with and accepted, subject

to final approval, by the Commission, has been placed on the public

record for a period of sixty (60) days. The following Analysis to Aid

Public Comment describes the terms of the consent agreement, and the

allegations in the complaint. An electronic copy of the full text of

the consent agreement package can be obtained from the FTC Home Page

(for February 18, 1998), on the World Wide Web, at ``http://

[[Page 9552]]

www.ftc.gov/os/actions/htm.'' A paper copy can be obtained from the

FTC Public Reference Room, Room H-130, Sixth Street and Pennsylvania

Avenue, N.W., Washington, D.C. 20580, either in person or by calling

(202) 326-3627. Public comment is invited. Such comments or views will

be considered by the Commission and will be available for inspection

and copying at its principal office in accordance with Section

4.9(b)(6)(ii) of the Commission's Rules of Practice (16 CFR

4.9(b)(6)(ii)).

Analysis of Proposed Consent Order to Aid Public Comment

I. Introduction

The Federal Trade Commission has accepted from PacifiCorp and The

Energy Group PLC (TEG), for public comment, an Agreement Containing

Consent Order (Proposed Consent Order). The Commission has also entered

into a Hold Separate Agreement that requires Proposed Respondents to

hold separate and maintain certain assets until they are divested. The

purpose of the Proposed Consent Order is to remedy the likely

anticompetitive effects of PacifiCorp's acquisition of TEG.

II. Description of the Parties and the Transaction

PacifiCorp, which is headquartered in Portland, Oregon, provides

retail electric utility service in seven western states: Oregon,

Washington, California, Utah, Idaho, Wyoming, and Montana. PacifiCorp's

1996 retail electricity sales totaled 2.1 billion dollars. PacifiCorp

also makes wholesale electricity sales to other utilities in the

western United States. PacifiCorp's 1996 wholesale electricity sales

totaled 739 million dollars. Finally, PacifiCorp also operates five

coal mines in the northwestern United States and owns a power marketer

that trades electric power throughout the United States.

TEG is a diversified energy company headquartered in London,

England. TEG owns Peabody Coal Company (Peabody), which produces

roughly 15 percent of the coal mined in the United States. TEG also

owns a power marketer, which trades electric power throughout the

United States and owns both electric power plants and an electric power

transmission system in England. TEG's total revenue for the fiscal year

ending September 30, 1996 was roughly 6 billion dollars.

PacifiCorp seeks to acquire 100 percent of the voting securities of

TEG.

III. Industry Background

The generation and marketing of electricity is moving from a

regulated environment to a competitive environment.\1\ Currently,

utilities in most states own both generating facilities and

transmission facilities. State public utility commissions regulate

rates charged by these utilities. In this regulated environment,

utilities trade electricity to some extent in a wholesale market. To

meet its electricity needs, a utility can purchase electricity from

another utility or from an independent producer. The Federal Energy

Regulatory Commission (``FERC'') regulates interstate wholesale

electricity sales and transmission. FERC permits wholesale electricity

sales to be made at market rates if a power generator can show that it

does not possess market power in the region in which it operates.

Consequently, wholesale electricity rates are determined by the balance

of supply and demand.

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\1\ See Timothy Brennan, A shock to the System: Restructuring

America's Electricity Industry (1996); Joskow, Restructuring,

Competition and Regulatory Reform in the U.S. Electricity Sector,

11(3) Journal of Economic Perspectives 119-138 (1997); and Comment

of the Staff of the Bureau of Economics of the Federal Trade

Commission before the Federal Energy Regulatory Commission (August

7, 1995).

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Many states are in the process of deregulating their electric

utility industries. As this process progresses, the vertical

integration that has historically characterized the industry is likely

to diminish, and transmission and generation functions will be

separated. In the deregulatd environment, electricity transmission

would remain a regulated monopoly in which the operator of the

transmission system is prohibited by FERC Orders 888 and 889 from

discriminating against particular users. Electric power generator,

however, would become competitive, allowing customers to choose their

supplier of electricity. The end result of this deregulation process

will be a market in which retail rates are no longer regulated by state

utility commissions, but are determined by the balancing of supply and

demand in a competitive market. The differences between wholesale and

retail electricity rates, which are largely a product of their

different regulatory environments, will disappear or will be

significantly reduced.

In the current wholesale electricity market, short periods of time

(e.g., hour or one-half hour periods) often represent distinct product

markets because electricity demand cannot easily be shifted from one

time period to another and because electricity cannot easily be stored

in large quantities. As retail electricity sales are deregulated,

retail rates will also likely be priced on an hour-by-hour basis.

Constraints on transmission capacity typically delimit geographic

markets as regional areas comprised of several states. One such

geographic market is the area included within the Western Systems

Coordinating Council (``WSCC''). The WSCC coordinates interchange of

electricity among power plants and transmission systems located within

the eleven western states of Arizona, California, Colorado, Idaho,

Montana, Nevada, New Mexico, Oregon, Utah, Washington, and Wyoming, and

parts of southwestern Canada and northwestern Mexico.

While transmission constraints limit the geographic area within

which electricity is generated and consumed, trading among buyers and

sellers in the wholesale electricity market links electricity markets

into larger trading areas, one of the largest being the United States

as a whole.

Electricity demand in a particular region at a particular time is

met by utilizing or ``dispatching'' power plants in an order that is

likely to be based substantially on plants' variable cost of generating

electricity. Given current technology and fuel prices, nuclear power

plants have low variable costs and are dispatched first. Hydroelectric

plants operating on a run-of-stream basis also have very low variable

costs and are usually dispatched as long as they are operating on that

basis.\2\ Coal-fired power plants have higher variable costs, and

natural gas plants generally have even higher variable costs.

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\2\ Although hydroelectric power plants have low variable costs,

river flow is often insufficient to dispatch these plants at full

capacity 24 hours a day. When river flow is low, some hydroelectric

capacity is held back during off-peak periods and dispatched at

periods of peak electricity demand.

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As a consequence of the dispatch order discredited above,

competition between a small number of plants can be critical in setting

price. In the WSCC, during periods of lower or off-peak demand, gas-

fired plants generally are not utilized because of their high variable

costs.\3\ Consequently, for off-peak periods in the WSCC, coal-fired

power plants frequently are the price-setting, marginal plants.

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\3\ Off-peak hours in the western U.S. are generally recognized

by the industry to consist of the eight hours between 11:00 PM and

7:00 AM Monday through Saturday, and all day Sunday. Peak hours are

recognized by the industry to consist of consist of the sixteen

hours between 7:00 AM and 11:00 PM Monday through Saturday.

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California is one of the first states that has started to

deregulate its retail electricity sales. California is currently in the

process of establishing a power exchange (``PX''), modeled on the

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system used in the United Kingdom, which will run a centralized auction

for the purchase of electricity. Under the California reforms, each

generating plant will bid to supply power to the state's PX. The PX

will then rank generators' bids from lowest to highest prices, and

choose the lowest-cost bids necessary to meet projected demand. All

suppliers will receive the price of the last increment of supply

necessary to fulfill demand, even if they bid a lower price.

Consequently, in the system anticipated to be used in California, the

marginal supplier will set the price for the entire system.

Entry into an electricity market can occur through the construction

of a new power plant or the construction of new transmission capacity,

which would enable distant electricity producers to compete more

effectively. However, the time required for obtaining regulatory

approval and for construction prevents either type of entry from

quickly correcting anticompetitive behavior.

IV. Threat to Competition

A. Raising Rivals' Costs

Navajo Generating Station (Navajo) is a 2,250-megawatt coal-fired

power plant located in the north-central section of Arizona. Navajo is

supplied exclusively from Peabody's Kayenta mine via an 80-mile

dedicated rail line. Mohave Generating Station (Mohave) is a 1,580-

megawatt coal-fired power plant located in southern Nevada. Mohave is

supplied exclusively from Peabody's Black Mesa Mine through a 275-mile

coal slurry pipeline. Long-term contracts govern the terms on which

Peabody supplies Navajo and Mohave.

Navajo and Mohave are absolutely dependent upon the Kayenta and

Black Mesa coal mines for their fuel supply because of their extreme

isolation relative to rail lines and other coal mines. There are no

other economic sources of fuel, coal or otherwise, for these two large

power plants.

PacifiCorp owns roughly 9,000 megawatts capacity in the Western

Systems Coordinating Council (WSCC), an organization of electric

utilities and power marketers organized to improve the reliability of

power transmission and delivery in the western United States and parts

of southwestern Canada and northwestern Mexico. The WSCC represents a

geographic market since transmission constraints severely limit

imports. The WSCC represents a geographic market since transmission

constraints severely limit imports. Sub-regions within the WSCC may

also represent geographic markets, at certain times, given that the

transmission capacity connecting subregions is limited and may be

inadequate to balance supply and demand across the subregions.

A firm can sell its product at a higher price if its rivals charge

higher prices. Thus, a firm can profitably increase its own price if it

can take actions at low cost to itself that raise the costs, and

subsequently the price, of its rivals. By vertically integrating with

suppliers of a large share of some key input, a firm may be able to

increase its rivals' costs. Given this, PacifiCorp's acquisition of

Peabody, which is the exclusive supplier of coal to certain power

plants that compete with PacifiCorp's own power plants, raises

antitrust concern. Specifically, PacifiCorp would have an incentive to

increase fuel costs at Navajo and Mohave in order to drive up the

market price of electricity in the western United States. In the near

term, PacifiCorp would be able to realize this higher price on its net

wholesale electricity sales. In the long-term, assuming deregulation,

PacifiCorp might also be able to realize this higher price on some of

its retail electricity sales.

The extent of the anticompetitive harm caused by PacifiCorp's

acquisition of Peabody depends on two factors: First, how much

discretion does the mine owner have to affect the fuel costs at Navajo

and Mohave given the long-term contracts between Peabody and the plan

owners? Second, over what periods, if any, and to what extent will

changing the costs of Navajo and Mohave affect the market price of

electricity?

The long-term contracts that govern the supply of coal to Navajo

and Mohave have a modified cost-plus format that makes them vulnerable

to cost manipulation. A long history of cost disputes between the

parties underlines the supplier's discretion to determine cost levels

at the power plants. Consequently, post-merger, PacifiCorp could

increase Navajo and Mohave's costs. Alternatively, an independent,

profit-maximizing Peabody might find it in its interests to grant the

power plants a discount on coal pricing. A merged PacifiCorp/Peabody,

however, might decline to grant such discounts because increased output

at Navajo and Mohave might decrease wholesale electricity prices in the

WSCC and cause PacifiCorp/Peabody to earn less on its electricity

sales. In this context, failure to grant a price concession amounts to

a price increase.

Peabody documents reveal that price concessions in the near future

for both Navajo and Mohave are a real possibility. Peabody documents

show that the company has considered granting Navajo price discounts,

because the plant has been underutilized during off-peak hours in the

recent past. Moreover, Peabody documents also reveal that it expects

the coming deregulation of the electricity industry will intensify

competitive pressures on both coal-fired power plants and their coal

suppliers. Peabody documents also reveal that Mohave will face a costly

decision in the next several years on whether to install scrubbers to

comply with environmental regulations and will implicitly be looking to

its coal supplier for cost relief.

PacifiCorp's roughly 9,000 megawatts of generating capacity,

Navajo's 2,250 megawatts of generating capacity, and Mohave's 1,580

megawatts of generating capacity represent a comparatively small share

of the 138,000 megawatts of generating capacity in the WSCC. In a

market with numerous competitors such as electricity generation in the

WSCC, one might assume if coal costs at two plants such as Navajo and

Mohave were to increase and their generation consequently declined,

other plants would simply increase output and there would be no effect

on the market-clearing price. However, there is substantial evidence

that manipulating fuel cost at Navajo could have a significant effect

on the market price for wholesale electricity.\4\ A Peabody document

recognizes that if Navajo were to go to full capacity utilization

during off-peak hours, it would produce 1,200 megawatts of additional

power, depressing electricity prices. Also, computer modeling using

programs well-accepted in the industry shows that manipulating prices

at Navajo would have an effect on wholesale electricity prices in the

WSCC.

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\4\ At current electricity prices, Mohave operates at full

capacity. Hence Mohave is currently an infra-marginal producer and

unlikely to be a price setter. However, as California deregulates

its electricity market, prices are likely to fall and Mohave could

then be in a position to be a marginal, price-setting plant.

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How can participation of suppliers comprising only a small fraction

of capacity affect the market price for electric power? The answer lies

in the way in which power plants are dispatched. Power plants tend to

have very flat cost functions until they reach their capacity.

Thus, power plants tend to operate at maximum capacity if they can

economically do so at the prevailing price. Otherwise, they tend to be

idled.\5\

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Consequently, most of the power plants generating electricity, at any

particular time period, have almost no ability to expand output and

offset anticompetitive behavior. Given these circumstances, the power

plants that could defeat anticompetitive behavior here would be those

power plants with excess capacity that could produce and deliver to the

areas served by Navajo and Mohave electricity at the same cost (or

slightly above) Navajo's or Mohave's. The evidence indicates that there

are no such power plants here.

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\5\ Because coal-fired plants require a start-up period of

several days, their output would be cut back to some minimal level

(e.g., 40 percent of capacity) when they are uneconomic for short

periods of time (e.g., nighttime).

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During periods of low electricity demand in the WSCC (e.g.,

nighttime hours during the spring), electricity demand is met using

some hydroelectric capacity, nuclear power plants, and some coal-fired

power plants. Gas-fired power plants tend to be idled during these

periods. Since coal-fired power plants are the last plants to be

dispatched during these time periods, the market price of electricity

during these periods is determined by the price at which the last-

dispatched coal-fired power plant supplies electricity. Since periods

of low electricity demand represent a substantial portion of the year

and since fuel costs at Navajo and Mohave affect market price during

these times, higher fuel prices at Navajo and Mohave can cause

significant harm to consumers. Indeed, to give a rough sense of how

this acquisition could increase concentration in markets for wholesale

electricity during off-peak hours, a hypothetical merger of

PacifiCorp's electric plants with Mohave and Navajo would make the

market for coal-fired electricity in the WSCC highly concentrated and

give PacifiCorp a 35% share, a level at which, under the Merger

Guidelines, could lead to unilateral anticompetitive effect.

Cost manipulation at Navajo and Mohave could affect electricity

prices in the WSCC not only during those off-peak hours when Navajo and

Mohave are the marginal, price-setting plants, but also during a

broader period of time. As noted above, power plants are dispatched in

large part based on their variable cost, which in turn is largely

determined by their fuel costs. This dispatch order can be thought of

as a supply curve for electricity. Given this supply curve, if the fuel

price at one power plant increases, then this power plant is removed

from its current position in the supply curve and placed in a position

further along the supply curve. This reorders the supply curve as

higher priced plants are dispatched earlier along the affected section

of the supply curve. This leads to higher prices every time electricity

demand in a particular period intersects the affected section of the

supply curve. Higher fuel prices at Navajo and Mohave could have a

significant effect on price along a significant portion of the supply

curve. If either plant were forced to close down, its removal would

affect prices at all points above the plant on the supply curve.

B. Abuse of Proprietary Information

Power plant operators currently compete to supply electricity in

informal wholesale markets characterized by bilateral contracts. In

some states (e.g., California), power plant operators will soon compete

in formal auctions to supply electricity. In all of these situations,

power plant operators buy and sell both directly and through ``power

marketing'' affiliates that have been expressly created to compete in

the deregulating wholesale market for electric power.

Competition in the wholesale electricity market could be adversely

affected by this acquisition throughout the United Stats because

PacifiCorp may gain access, through Peabody's coal contracts and coal

supply relationships, to highly sensitive data on competitors' costs

and to real-time information relating to operating conditions of

competing generators of electrical power.

A coal supplier is able to obtain competitively-sensitive

information about the day-to-day operation of the power plant it

supplies, including when the plant is experiencing downtime and when it

is facing transmission bottlenecks. In addition, because coal costs

comprise 90% of a coal-fired power plant's variable cost of generating

electricity, a coal supplier will know cost information sufficient to

predict the price the power plant will likely bid.

Peabody is a significant supplier of coal to coal-fired plants,

supplying 27% of the coal that goes to such plants in the WSCC and 15%

of the coal going to such plants in the United States. Many of

Peabody's coal supply contracts have no protection against the transfer

of such competitively-sensitive information, since they were executed

prior to regulatory reform and before purchasers under these contracts

had reason to be concerned about the competitive sensitivity of the

information that could be revealed to competitors through such

contracts or through the day-to-day relationship between the coal

supplier and customer. Consequently, by acquiring Peabody, PacifiCorp

will gain an invaluable window on real-time information relating to

operating conditions and production plans at many of the approximately

150 power plants supplied by Peabody. By enabling PacifiCorp to predict

supply shifts and consequent price movements in the market, this

information gives PacifiCorp a significant competitive advantage in

power marketing.

PacifiCorp will be able to trade on that information at the expense

of other traders of wholesale electricity. Expected profits for both

incumbents and prospective entrants will be lower if PacifiCorp

possesses inside information regarding competitors' costs, supply

conditions, and future operating plans. Consequently, as a result of

PacifiCorp's perceived information advantage regarding electricity

supply and costs, competitive entry in power marketing will be

discouraged, and existing power marketing companies may defer greater

investments in such enterprises and perhaps even exit, making the

market for wholesale electricity operate less efficiently.

V. The Proposed Complaint and Consent Order

The Federal Trade Commission has accepted for public comment an

Agreement Containing Consent Order with PacifiCorp and TEG in

settlement of the charges in the proposed complaint. The proposed

complaint alleges that PacifiCorp's acquisition of TEG violates Section

5 of the Federal Trade Commission Act, 15 U.S.C. 45, and Section 7 of

the Clayton Act, as amended, 15 U.S.C. 18. The proposed complaint

alleges that the Acquisition will lessen competition in the supply of

electricity in the WSCC and in various geographic markets in the United

States as a whole.

To remedy the alleged harm to competition from raising rivals

costs, the proposed Consent Order would require PacifiCorp to divest

Peabody Western Coal Company (PWCC), the Peabody subsidiary that owns

the Black Mesa and Kayenta mines, to an acquirer approved by the

Commission. The required divestiture solves the competitive concerns

raised in this acquisition in the WSCC by assuring the PacifiCorp would

not have an anticompetitive incentive to raise fuel prices at Navajo

and Mohave in order to raise the price of electricity in the WSCC.\6\

The divestiture remedy is

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consistent with longstanding Commission policy which favors the

structural approach to remedies, rather than the behavioral approach

which seeks to govern conduct through the use of rules.\7\

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\6\ Disvestiture is unnecessary elsewhere because there is no

evidence that other captive coal-fired power plants are marginal

price-setters in their geographic market as Navajo and Mohave are.

\7\ See William J. Baer, FTC Perspectives on Competition Policy

and enforcement Initiatives in Electric Power, before the Conference

on the New Rules of the Game for Electric Power: Antitrust &

Anticompetitive Behavior (Washington D.C., Dec. 4, 1997) at 12-13

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The fuel supply contracts between PWCC and Navajo and Mohave give

the Navajo owners a right of first refusal to buy the Kayenta mine and

Mohave owners a right of first refusal to buy the Black Mesa mine.

Because these rights of first refusal could delay the divestiture

process, the proposed Consent Order affords PacifiCorp a period of nine

months following the Acquisition to complete the required divesture,

and under certain circumstances, extends the time for divestiture to as

late as March 1, 2000. Under the circumstances of this case, the

Commission believes that the unusually long time afforded Respondents

to complete the divestiture and possible extension of that time under

the terms of the proposed Consent Order are likely to lead to

substantial economic harm. PacifiCorp's incentive to increase the fuel

price at Navajo and Mohave depends on PacifiCorp's sales of electricity

at the market price. In the near-term, most of PacifiCorps electricity

sales are at regulated rates or a prices specified by long-term

contracts. Thus, in the near-term, PacifiCorp will not have a strong

incentive the increase fuel prices at Navajo and Mohave because

PacifiCorp has limited net sales of electricty at the market price.

However, as PacifiCorp's wholesale contracts are renegotiated and as

PacifiCorp's retail sales are deregulated, PacifiCorp gains an ever

greater incentive to increase electricity prices by raising the fuel

price at Navajo and Mohave.

To remedy the alleged threat to competition from abuse of

confidential customer information, the proposed consent order forbids

Peabody from transferring PacifiCorp non-public information regarding

Peabody customers who object to such disclosure and who either purchase

coal from Peabody under contracts with a term of one-year or longer or

who purchased in excess of one million tons of coal from Peabody during

the preceding year. By preventing the transfer of this information, the

Proposed Consent Order prevents PacifiCorp from trading on proprietary

information in a way that is likely to retard development of a fully

competitive market in the wholesaling of electric power.

VI. Opportunity for Public Comment

The proposed Consent Order has been placed on the public record for

sixty (60) days for receipt of comments by interested person. Comments

received during this period will become part of the public record.

After sixty days, the Commission will again review the proposed Consent

Order and the comments received and will decide whether it should

withdraw from the Agreement Containing Consent Order, make final the

Consent Order, or take such other action as the Commission may

determine to be in the public interest.

The Commission anticipated that the proposed Consent Order will

cure the anticompetitive effects of the Acquisition as alleged in the

proposed complaint. The purpose of this analysis is to invite public

comment on the proposed Consent Order, including the proposed

divestitures, to aid the Commission in its determination of whether to

make final the proposed Consent Order. This analysis is not intend to

constitute an official interpretation of the proposed Consent Order,

nor is it intended to modify the term of the proposed Consent Order in

any way.

Donald S. Clark,

Secretary.

[FR Doc. 98-4755 Filed 2-24-98; 8:45 am]

BILLING CODE 6750-01-M