Public Comments and Response of the United States; United States v. Enova Corporation

DEPARTMENT OF JUSTICE

Antitrust Division

Public Comments and Response of the United States; United States

v. Enova Corporation

Notice is hereby given pursuant to the Antitrust Procedures and

Penalties Act, 15 U.S.C. 16(b)-(h), that public comments and the

response of the United States thereto have been filed with the United

States District Court for the District of Columbia in United States v.

Enova Corporation, Civil No. 98-CV-583 (RWR).

On March 9, 1998, the United States filed a Complaint seeking to

enjoin a transaction in which Pacific Enterprises (``Pacific'') would

merge with Enova Corporation (``Enova''). Pacific is a California gas

utility company and Enova is a California electric utility company.

Enova sells electricity from plants that use coal, gas, nuclear power,

and hydropower. Pacific is virtually the sole provider of natural gas

transportation and storage services to plants in southern California

that use natural gas to produce electricity. The proposed merger would

have created a company with both the incentive and the ability to

lessen competition in the market for electricity in California. The

[[Page 3552]]

Complaint alleged that the proposed merger would substantially lessen

competition in the market for electricity in California, in violation

of Section 7 of the Clayton Act, 15 U.S.C. 18.

Public comment was invited within the statutory sixty-day comment

period. The two comments received, and the responses thereto, are

hereby published in the Federal Register and filed with the Court.

Copies of the Complaint, Stipulation and Order, Proposed Final

Judgment, Competitive Impact Statement, Public Comments, and

Plaintiff's Response to Public Comments are available for inspection in

Room 215 of the U.S. Department of Justice, Antitrust Division, 325

Seventh Street, NW., Washington, DC 20530 (telephone: (202) 514-2481)

and at the office of the Clerk of the United States District Court for

the District of Columbia, 333 Constitution Avenue, NW., Washington, DC

20001. Copies of these materials may be obtained on request and payment

of a copying fee.

Constance K. Robinson,

Director of Operations, Antitrust Division.

United States of America, U.S. Department of Justice, Antitrust

Division, 325 Seventh Street, NW., Suite 500, Washington, DC 20530,

Plaintiff, v. Enova Corporation, 101 Ash Street, San Diego, CA

92101, Defendant.

[Case Number: 98-CV-583 (RWR); Judge Richard W. Roberts]

Plaintiff's Response to Public Comments

Pursuant to the requirements of the Antitrust Procedures and

Penalties Act (``APPA''), 15 U.S.C. 16(b)-(h) (``Tunney Act''), the

United States hereby responds to the two public comments received

regarding the proposed Final Judgment in this case.

I. The Complaint and Proposed Judgment

The United States filed a civil antitrust Complaint on March 9,

1998, alleging that the proposed merger of Pacific Enterprises

(``Pacific''), a California natural gas utility, and Enova Corporation

(``Enova''), a California electric utility, would violate Section 7 of

the Clayton Act, 15 U.S.C. 18. The Complaint alleges that as a result

of the merger, the combined company (``PE/Enova'') would have both the

incentive and the ability to lessen competition in the market for

electricity in California and that consumers would be likely to pay

higher prices for electricity.

The Complaint further alleges that prior to the merger, Pacific's

wholly owned subsidiary, Southern California Gas Company, was virtually

the sole provider of natural gas transmission and storage to natural

gas-fueled electric generating plants in Southern California (``gas-

fired plants''). As a consequence and without regard to the merger, it

had the ability to use that market power to control the supply and thus

the price of natural gas available to the gas-fired plants. Prior to

the merger, however, Pacific did not own any electric generation

plants, so it did not have the incentive to limit its gas

transportation, sales or storage or to raise the price of gas to

electric utilities in order to increase the price of electricity.

The Complaint alleges that in early 1998, the California electric

market experienced significant changes as the result of a legislatively

mandated restructuring. In this new competitive electric market, gas-

fired plants, which are the most costly electric generating plants to

operate, set the price that all sellers receive for electricity in

California in peak demand periods. Thus, if a firm could increase the

cost of the gas-fired plants by raising their fuel prices, it could

raise the price all sellers of electricity in California receive, and

increase the profits of owners of lower cost sources of electricity.

Based on these facts, the Complaint alleges that the merger

violated Section 7 of the Clayton Act because the acquisition of

Enova's low-cost electric generating plants gave Pacific a means to

benefit from any increase in electric prices. The Complaint challenges

the acquisition of these specific plants:

Once Pacific's pipeline is combined with Enova's low cost

electricity generation facilities, PE/Enova would have the ability

to raise the pool price of electricity either by (a) limiting the

availability of natural gas to competing gas-fired plants that

supply the most expensive units of electricity into the pool, or (b)

by limiting gas or gas transportation to gas-fired plants that are

more efficient and would otherwise have kept the pool price for

electricity down. PE/Enova would have the incentive to raise the

pool price after the merger because, through its ownerships of low

cost generation facilities, it could profit substantially from any

increase in the pool price of electricity and its incremental

profits would more than offset any losses of gas transportation

sales that would result from withholding gas from competing gas-

fired plants. PE/Enova thus will have the incentive and ability to

lessen competition substantially and increase the price of

electricity in California during periods of high demand.

(Compl. para.24 (emphasis added).)

The proposed Final Judgment directly remedies this harm by

requiring Enova to divest its low-cost generating units to a purchaser

or purchasers acceptable to the United States in its sole discretion.

These divestiture assets are the Encina and South Bay electricity

generation facilities owned by Enova and located at Carlsbad and Chula

Vista, California, and include all rights, titles and interests related

to the facilities.\1\ By requiring this divestiture, the incentive that

was created by the merger for PE/Enova to raise electricity prices is

removed, providing a full remedy to the harm alleged in the

Complaint.\2\

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\1\ The Final Judgment provides that the approvals by the United

States required by this decree for sale of these assets are in

addition to the necessary approvals by the California Public

Utilities Commission (``CPUC'') or any other governmental

authorities for the sale of such assets. Enova must submit required

applications to divest the assets no later than ninety days after

entry of the Final Judgment, and complete the divestiture as soon as

practicable after receipt of all necessary government approvals, in

accordance with the proposed Final Judgment.

\2\ As explained in the Competitive Impact Statement (``CIS''),

the decree does not require the divestiture of the merged company's

nuclear assets, as the price of electricity from those assets will

be regulated during the cirtical first years of the decree, which

means that ownership of those assets will not give the merged firm

an incentive to raise prices. In 2001, if the nuclear power prices

become deregulated, the decree provides for safeguards to ensure

that any incentive to use these assets to raise price is minimized

or eliminated.

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As part of the settlement, the United States also obtained the

Defendant's agreement to protection that are beyond those needed to

remedy directly the harm created by the acquisition. The proposed

decree includes limitations on PE/Enova's ability in the future to

acquire other low cost gas-fired generating assets that could give the

merged firm the same incentive and opportunity to raise electricity

prices that the acquisition of the divested Enova assets would have

presented. Recognizing that PE/Enova would have numerous acquisition

opportunities over the next few years as a consequence of the State of

California's orders that many generating assets be divested (see CIS at

13), the proposed decree requires PE/Enova to seek prior approval from

the United States before acquiring ownership or ownership-like rights

to other low-cost, California generating assets. The United States can,

at its sole discretion, disallow any acquisition of such assets,

without incurring the costs and risks of litigation.\3\ The types of

transactions

[[Page 3553]]

subject to this prior approval process include outright acquisition of

any existing California Generating Assets (Final Jmt. Sec. V.A.1); any

contract that allows PE/Enova to control such assets (Final Jmt.

Sec. V.A.2); any contract for the operation and sale of the output from

generating facilities owned by the Los Angeles Department of Water and

Power (``LADWP''), the second largest generator of electricity in

California and an entity owning more generation than Enova even prior

to the divestiture (Final Jmt. Secs. V.A.2, II.B); power management

contracts of California Generating Facilities with the LADWP (Final

Jmt. Secs. V.C.4,II.C); and future tolling arrangements of the type

that would most clearly mimic true ownership of the tolled facilities

(Final Jmt. Secs. V.A.2, V.C.3).

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\3\ The Final Judgment does not prevent PE/Enova from building

new capacity in California, or from acquiring capacity built in

California after January 1, 1998. New capacity will only be built in

California if the output is inexpensive enough to be sold in many

hours. By increasing the amount of less expensive power available to

meet demand, new, low-cost capacity will reduce the number of hours

in which the most costly gas-fired capacity is needed. This in turn

will limit PE/Enova's ability to raise the pool price since it is

more costly and difficult for PE/Enova to restrict gas to more

numerous low-cost plants. For the same reasons, the Final Judgment

allows the merged company to acquire or gain control of plants that

are rebuilt, repowered, or activated out of dormancy after January

1, 1998. Output from such plants is the equivalent of output from

new-build capacity. CIS at 13-14.

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In addition, the United States has the ability to monitor PE/

Enova's entry into many power management contracts not subject to prior

approval (Final Jmt. Sec. V.C.5). The United States thus has the

opportunity to review these contracts, which are relatively new in the

deregulated California market, and determine whether they would give

PE/Enova the same incentive to raise electricity prices that ownership

of the divested Enova assets would have created. The United States can

then challenge any contracts that would do so.

In sum, the decree provides two types of relief for the United

States. First, it achieves a direct remedy for the harm caused by

Pacific's acquisition of Enova's low-cost generating assets by ordering

divestiture of those specific assets. Second, it provides the

additional benefits of the prior approval and contract monitoring

provisions. These additional provisions are not meant to (nor can they)

prevent PE/Enova from entering any transaction or acquiring any asset

that could give it the incentive to exploit Pacific's pipeline market

power in the electricity market. Instead they provide the United States

with a check on potentially anticompetitive transactions, where the

acquisition of such assets would again create incentives similar to

these created by the assets acquired (and divested) in the transaction

before this Court.

The United States and Enova have stipulated that the proposed Final

Judgment may be entered after compliance with the APPA.

II. Response to Public Comments

On June 8, 1998, the United States filed the CIS in this docket and

on June 18, 1998, the Complaint, Final Judgment and CIS were published

in the Federal Register. The Federal Register notice explained that

interested parties could provide comments to the Department for a

period of 60 days. Two parties filed comments with the Department:

Edison International (``Edison'') and the City of Vernon.

A. Edison's Comments

Edison's primary comment is that the decree does not strip PE/Enova

of the ability or incentive to increase electricity prices, but only

eliminates one opportunity to do so. Despite the decree, Edison argues,

PE/Enova still can use Pacific's market power over natural gas

transmission and still can enter into transactions that will give it

the incentive to exercise that power and raise electricity prices.

Edison enumerates and discusses particular transactions that would give

Pacific that incentive:

1. Building or acquiring new or repowered generating facilities;

2. Entering into tolling agreements;

3. Entering into power generation management contracts; and

4. Entering into financial contracts (derivatives) tied to prices

in the California Electric market.

But Edison's criticism misses the mark, because each of the

potential transaction it lists is a transaction that Pacific could

engage in whether or not it merges with Enova. Thus, Edison's comments

do not focus on the harm caused by the merger, but rather on the harm

to competition that might result from Pacific's premerger ownership of

a monopoly gas pipeline. In contrast, the United States' Complaint is

focused only on the effects that flow from the merger.

Edison's assertion (Edison Comments at 13) that Pacific had no

premerger incentive to manipulate electricity prices is simply wrong.

As soon as California deregulated retail electricity prices, Pacific

had the incentive, among other things, to build or acquire new and/or

repower other existing generating assets, purchase derivatives, and

make gas tolling agreements in order to exploit its pipeline's market

power over gas-fired generators. The ability and incentive of Pacific

to exercise its natural gas transmission market power for gain in the

electric market in any of these manners does not require acquisition of

any of Enova's generating assets or its ``electricity expertise.'' \4\

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\4\ Edison's comments, which mention Enova's ``electricity

expertise'' in one sentence, do not define this term, identify where

in Enova it resides, or assert that pacific, the pipeline's parent

company, did not already have such expertise prior to the merger or

have the ability to obtain it by a number of means, including hiring

employees with electric experience.

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Nevertheless, Edison argues that the Final Judgment is defective

because the United States did not also ``understand[ ], anticipat[e],

and then prohibit[ ] all the various means by which the merged company

could seek to retain or create incentives to earn profits through

electricity price manipulations.'' (Edison Comments at 20.) To the

extent that Edison means to suggest that, once any merger transaction

is found to violate the Clayton Act, a merger decree should enjoin any

and all other means by which the defendant might violate the antitrust

laws in the future, the suggestion plainly is incorrect.\5\ Contrary to

Edison's suggestions, enforcement of the merger laws, Section 7 of the

Clayton Act, is aimed at remedying the competitively harmful changes in

market structure or other conditions that result from the merger. Here,

the merger takes Pacific's ability to profitably raise electric prices

and adds the incentive provided by Enova's low cost generating assets.

The proposed decree severs those assets from the merged company,

remedying the change in incentive and ability from the status quo ante.

The Final Judgment requires these assets to be sold to a party that

will not own the monopoly pipeline and removes the new incentive

provided by the acquired Enova assets for PE/Enova to use the

pipeline's already existent market power.\6\

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\5\ See Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S.

100, 133 (1969) (explaining that a court may not enjoin ``all future

violations of the antitrust laws, however unrelated to the violation

found by the court''); Hartford-Empire Co. v. United States, 323

U.S. 386, 409-10 & n.7 (1945) (citing NLRB v. Express Publ'g Co.,

312 U.S. 426, 433, 435-36 (1941)).

\6\ Edison also makes the same argument from the opposite

perspective--that competition is separately harmed because Enova has

gained an ability via the merger to raise price. (Edison Comments at

5.) Again, there is no additional pipeline monopoly power created by

the merger. The proposed remedy is effective against the harm caused

by the combination (the pipeline and Enova's low cost generating

assets), whether the Southern California Gas Company pipeline's

monopoly power is wielded by Enova or by Pacific.

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Just as Edison's critical comments do not address the merger-

related harms alleged in the Complaint, its comments do not address

whether the parties' proposed decree is adequate to remedy the harms

alleged in that Complaint. Instead, Edison proposes its own alternative

remedies that either do not

[[Page 3554]]

address the harm caused by the merger, or are not as effective as the

decree. Edison suggests that: (1) The merger be rescinded, (2) the

pipeline be divested, (3) the pipeline be controlled by an independent

system operator, or (4) the merged company be barred from trading in

financial instruments for Southern California electricity markets

(Edison Comments at 6).\7\

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\7\ Edison compares its preferred options with the proposed

Final Judgment, calling the remedy in the proposed Final Judgment

``the least attractive option'' from Edison's perspective. (Edison

Comments at 3 (``The last but least attractive option is to try to

lessen the merged firm's incentive to exercise its monopoly power in

order to profit from higher electric prices.'').) Edison finds this

course less attractive because ``it requires a complex latticework

of provisions * * * [that is] difficult to write and even harder to

administer.'' Id. The alternative it suggests, creating an

independent system operator for the pipeline system, has never been

done anywhere in the United States and, while possible, cannot be

assumed to be easy to write and easier to adminster.

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Two of Edison's proposed remedies--the independent system operator

and the bar on trading--are aimed at controlling the preexisting market

power of the gas pipeline rather than remedying any harm created by the

merger. And, ironically, the Edison remedies aimed most closely at the

merger--rescission or divestiture of the pipeline--would not place any

limits on the pipeline's new owner's ability to raise the price of

electricity or limit the pipeline owner from acquiring assets or

contracts that would give it the incentive to do so, even though this

incentive and ability is purportedly the gravamen of Edison's concern.

The Proposed Final Judgment, in contrast, gives this emerging electric

market more protection than Edison's suggested remedies through prior

notice and market monitoring provisions.\8\

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\8\ For example, Edison argues that the FTC's consent decree in

PacificCorp (PacifiCorp/The EnergyGroup, FTC File No. 9710091)

provides a superior remedy. It mischaracterizes the FTC decree as

equivalent to the divestiture of Pacific's gas pipeline assets that

constitute virtually all of the assets Pacific contributed to the

merger with Enova. Unlike this case, however, the divesture of coal

assets in PacifiCorp was not the equivalent of rescission of the

merger. PacifiCorp is a large integrated electric utility with coal

holdings in the western United States. It was acquiring the Energy

Group, an international electric company, the second largest

electric distribution company in the United Kingdom, which also held

coal reserves in both eastern and western United States. The FTC

decree did not requirement the Energy Group to divest its coal

business, much less its primary utility business, as Edison would

have the decree in the instant case require divestiture of Pacific's

utility pipeline business. Instead, the FTC decree required a

specific subset of the Energy Group's western coal mines to be

divested. The FTC's PacifiCorp decree stopped with divesture of

those specific assets and, unlike the Final Judgment proposed here,

did not go further to limit the merged company's reacquisition of

assets that would create the same vertical problem as the divested

assets.

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In the end, Edison's preference for a different remedy is not

relevant to the Court's inquiry. Under the Tunney Act, the Court may

not choose or fashion a remedy that is ``better'' in someone's opinion

than the one negotiated and agreed to by the parties. To the contrary,

``a proposed decree must be approved even if it falls short of the

remedy the court would impose on its own, as long as it falls within

the range of acceptability or is `within the reaches of the public

interest.' '' \9\ The proposed Final Judgment meets and exceeds this

legal standard.

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\9\ United States v. American Tel. & Tel. Co., 552 F. Supp. 131,

153 n.95 (D.D.C. 1982), aff'd sub nom. Maryland v. United States,

460 U.S. 1001 (1983)(mem.).

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B. City of Vernon's Comments

The City of Vernon recognizes in its comments that the Proposed

Final Judgment focuses entirely on the potential of PE/Enova to reduce

competition in the electricity market in Southern California. It

comments that the proposed judgment ``ignores'' the effect of the

merger on the natural gas transmission market in Southern California.

The case brought by the Department, however, involved the electricity

market in Southern California, and the relief addressed in the Proposed

Final Judgment remedies the competitive harm posed by the proposed

acquisition to that market. The Complaint does not allege violations in

the natural gas transmission market, and the City of Vernon's proposed

relief is thus not relevant to this proceeding.

III. The Legal Standard Governing the Court's Public Interest

Determination

Once the United States moves for entry of the proposed Final

Judgment, the Tunney Act directs the Court to determine whether entry

of the proposed Final Judgment ``is in the public interest.'' 15 U.S.C.

Sec. 16(e). In making that determination, ``the court's function is not

to determine whether the resulting array of rights and liabilities is

one that will best serve society, but only to confirm that the

resulting settlement is within the reaches of the public interest.''

United States v. Western Elec. Co., 993 F.2d 1572, 1576 (D.C. Cir.)

(emphasis added, internal quotation and citation omitted), cert.

denied, 114 S. Ct. 487 (1993).

The Court is not ``to make de novo determination of facts and

issues.'' Western Elec., 993 F.2d at 1577. Rather, ``[t]he balancing of

competing social and political interests affected by a proposed

antitrust decree must be left, in the first instance, to the discretion

of the Attorney General.'' Id. (internal quotation and citation

omitted). In particular, the Court must defer to the Department's

assessment of likely competitive consequences, which it may reject

``only if it has exceptional confidence that adverse antitrust

consequences will result--perhaps akin to the confidence that would

justify a court in overturning the predictive judgments of an

administrative agency.'' Id. \10\ The Court may reject a decree simply

``because a third party claims it could be better treated,'' United

States v. Microsoft, 56 F.3d 1448, 1459 (D.C. Cir. 1995), or based on

the belief that ``other remedies were preferable,'' id. at 1460.

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\10\ The Tunney Act does not give a court authority to impose

different terms on the parties. See e.g., American Tel. & Tel., 552

F. Supp. at 153 n. 95; accord H.R. Rep. No. 93-1463, at 8 (1974). A

court, of course, can condition entry of a decree on the parties'

agreement to a different bargain, see e.g., American Tel. & Tel.,

552 F. Supp. at 225, but if the parties do not agree to such terms,

the court's only choices are to enter the decree the parties

proposed or to leave the parties to litigate.

United States v. Thomson Corp., 949 F. Supp. 907 (D.D.C. 1996),

cited by Edison (Edison Comments at 9-10), does not support Edison's

argument to reject the Proposed Final Judgment. That case involved

the Tunney Act review of a proposed final judgment that required one

of the merging companies to license a copyright that it claimed but

had not licensed prior to the merger. While there was some

controversy as to whether the decree's license provisions could have

been extracted as the result of a trial, see Thomson, 949 F. Supp.

at 927, the Court nevertheless considered comments on the specific

terms of the license proposal because of the potential

anticompetitive harm that could result from ``the merger of these

two publishing giants in conjunction with'' the asserted copyright

claim. Id. at 928. The Thomson Court addressed comments on the

license provision on that ground, and not because the decree would

remedy preexisting wrongs; nor did the court add or alter any

provisions to the Final Judgment that had not been agreed to by the

parties. Here, in contrast, Edison is not commenting on a specific

remedy agreed to by the parties as a means of addressing the harms

related to a merger. Instead, Edison is asking this Court to insert

an entirely new mechanism for relief into the decree, in order to

address Pacific's preexisting pipeline market power as it could be

exercised in relation to the acquisition of any electricity assets,

regardless of Pacific's merger with Enova. Edison's proposed

approach is completely at odds with Judge Friedman's actions in the

Thomson case. Judge Friedman, as Edison concedes, was careful not to

substitute his judgment for the government's and, further, did not

adopt proposed remedies that were unrelated to the merger. (See

Edison Comments at 10).

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Further, the Tunney Act does not contemplate judicial reevaluation

of the wisdom of the government's determination of which violations to

allege in the Complaint. The government's decision not to bring a

particular case on the facts and law before it, like any other decision

not to prosecute, ``involves a complicated balancing of a number of

factors which are peculiarly within [the government's expertise.''

Heckler v. Chaney, 470 U.S. 821, 831 (1985). Thus, the Court may

[[Page 3555]]

not look beyond the Complaint ``to evaluate claims that the government

did not make and to inquire as to why they were not made.'' Microsoft,

56 F.3d at 1459; see also United States v. Associated Milk Producers,

Inc.. 534 F.2d 113, 117-18 (8th Cir. 1976).

The government has wide discretion within the reaches of the public

interest to resolve potential litigation. See e.g., Western Elec. Co.,

993 F.2d 1572; American Tel & Tel., 552 F. Supp. at 151. The Supreme

Court has recognized that a government antitrust consent decree is a

contract between the parties to settle their disputes and differences,

United States v. ITT Continental Baking Co.. 420 U.S. 223, 235-38

(1975); United States v. Armour & Co., 402 U.S. 673, 681-82 (1971), and

``normally embodies a compromise; in exchange for the saving of cost

and elimination of risk, the parties each give up something they might

have won had they proceeded with the litigation.'' Armour, 402 U.S. at

681. As Judge Greene has observed:

If courts acting under the Tunney Act disapproved proposed

consent decrees merely because they did not contain the exact relief

which the court would have imposed after a finding of liability,

defendants would have no incentive to consent to judgment and this

element of compromise would be destroyed. The consent decree would

thus as a practical matter be eliminated as an antitrust enforcement

tool, despite Congress' directive that it be preserved.

American Tel. & Tel., 552 F. Supp. at 151. This Judgment has the virtue

of bringing the public certain benefits and protection without the

uncertainty and expense of protracted litigation. See Armour, 402 U.S.

at 681; Microsoft, 56 F. 3d at 1459.

Finally, the entry of a governmental antitrust decree forecloses no

private party from seeking and obtaining appropriate antitrust

remedies. Defendants will remain liable for any illegal acts, and any

private party may challenge such conduct if and when appropriate.

IV. Conclusion

After careful consideration of the public comments, the United

States concludes that entry of the proposed Final Judgment will provide

an effective and appropriate remedy for the antitrust violation alleged

in the Complaint and is in the public interest. The United States will

therefore ask the Court to enter the proposed Final Judgment after the

public comments and this Response have been published in the Federal

Register, as 15 U.S.C. 16(d) requires.

Dated: January 11, 1999.

Respectfully submitted,

Jade Alice Eaton

D.C. Bar #939629, Trial Attorney, U.S. Department of Justice, Antitrust

Division, 325 Seventh Street, N.W., Washington, DC 20530. Phone: (202)

307-6316.

Certificate of Service

I hereby certify that I have caused a copy of the foregoing

Plaintiff's Response to Public Comments, as well as attached copies of

the public comments received from the City of Vernon, California, and

from Southern California Edison Company, to be served on counsel for

defendant and for public commentators in this matter in the manner set

forth below:

By first class mail, postage prepaid:

Steven C. Sunshine,

Shearman & Sterling, 801 Pennsylvania Avenue, N.W., Washington, DC

2004.

John W. Jimison,

Brady & Berliner, 1225 Nineteenth Street, N.W., Suite 800, Washington,

DC.

J.A. Bouknight, Jr.,

David R. Roll,

James B. Moorhead,

Steptoe & Johnson LLP, 1330 Connecticut Ave., N.W., Washington, DC

20036.

Dated: January 11, 1999.

Jade Alice Eaton,

D.C. Bar # 939629. Antitrust Division, U.S. Department of Justice, 325

Seventh Street, N.W., Suite 500, Washington, DC 20530, (202) 307-6456,

(202) 616-2441 (Fax).

Brady & Berliner

1225 Nineteenth Street. N.W., Suite 800, Washington, DC 20036

August 17, 1998.

Mr. Roger W. Fones,

Chief Transportation Energy & Agriculture Section Antitrust

Division, U.S. Department of Justice, 325 Seventh Street, N.W.,

Suite 500, Washington, DC 20530.

Re: Comments of the City of Vernon, California, on the Proposed

Final Judgement, Stipulation in the Competitive Impact Statement in

U.S. v. Enova Corporation, Civil No. 98-CV-583

Dear Mr. Fones: Pursuant to the legal notice issued by the

Antitrust Division on June 18, 1998 the City of Vernon, California,

(``Vernon'') hereby provides these comments in opposition to the

approval of the Proposed Final Judgement Stipulation in the

Competitive Impact Statement in U.S. v. Enova Corporation, Civil No.

98-CV-583 (``Proposed Judgement'').

Vernon submits that the Proposed Judgement would permit a merger

to be consummated that will alter and damage the potential for

competition in the California natural gas market. The Proposed

Judgement focuses entirely on the potential of the merged entity to

reduce competition in the electricity market in southern California,

and orders as a remedy the divestiture of certain electricity

generating stations owned by the San Diego Gas & Electric Company

(``SDG&E''). The Proposed Judgement ignores the fact that the merger

will combine the two largest natural gad transmission and

distribution companies in southern California. The merger will thus

eliminate the potential for competition between them, or for support

by either of them for new natural gas transmission pipeline which

would compete with the other.

Vernon operates a municipal electricity utility including its

own gas-fired power plant and will complete this year a municipal

natural gas utility. Vernon and other natural gas distributing

entities in southern California have lacked any meaningful

alternative to the monopoly natural gas transmission service from

the Southern California Gas Company (``SoCalGas''), the parent of

which, Pacific Enterprises, is merging with Enova. Although two

interstate pipelines were built into California in the first years

of this decade, their systems terminate in the Bakersfield,

California, region and do not compete with SoCalGas in its service

territory in the large Los Angeles metropolitan region, including

Vernon.

In order for a competing pipeline to be constructed into Los

Angeles, the sponsor must overcome significant hurdles and expenses

of locating and obtaining an environmentally suitable right-of-way,

and must have agreements with shippers for an adequate volume of

natural gas to support the expensive project. Having large

prospective shippers under contract to use a new pipeline is a

prerequisite to constructing one. Despite these obstacles, there

have been a number of potential pipelines discussed and considered

that would have competed with SoCalGas' gas transmission service

into the Los Angeles area. However, to date, SoCalGas' actions to

frustrate and oppose any such competition have been successful.

These efforts have included special discounted contracts offered to

the most likely customers of a new pipeline and adopting a penalty

tariff that effectively forbids any customer of a new pipeline from

taking any service at all from SoCalGas--even at different

locations--without paying the full SoCalGas system tariff for

transmission in addition to the cost of the competing pipeline.

The single largest potential ``anchor'' customer of a new

pipeline to compete with SoCalGas was SDG&E. The merger that would

be approved by the Proposed Judgement would eliminate SDG&E's

potential role as an anchor shipper on a new pipeline, and cement a

permanent alliance between SDG&E and SoCalGas to sustain their joint

monopoly on gas transmission services in southern California.

While the divestiture of SDG&E's power plant may have reduced

the potential that the merged entity would use that monopoly to

favor its own gas-fired generators in a competitive electricity

market, that limited divestiture does nothing to reduce the damage

to competition created by this merger in the natural gas market.

Across the United States, competition among natural gas

transportation companies has benefitted consumers with improved

[[Page 3556]]

service at lower tariffs. With the exception of those customers in

the Bakersfield area, and those selectively receiving discounts to

ensure they will not support competing pipelines, the customers in

southern California have not had any benefits of competition among

gas transmission providers. The approval of the Proposed Judgement

and consummation of the merger it approves will reduce their chances

of such benefits.

Vernon submits that approval of the merger should have been

conditioned not only on actions to reduce the potential risks to

competition in the electricity market, but also to reduce the injury

to competition in the natural gas market. Such action could have

included a requirement that SoCalGas sell to independent entities a

volume of transportation capacity equivalent to that which it had

traditionally used to serve SDG&E, or a requirement that SoCalGas

offer transportation rights on its system which can be released and

brokered to others, creating the potential for a competitive third-

party market among gas shippers with defined rights. No such action

was taken in the Proposed Judgement.

For this reason, Vernon opposes the approval of the Proposed

Judgement.

Respectfully submitted,

John W. Jimison, Esq.,

Attorney for The City of Vernon.

Comments of Amicus Curiae Southern California Edison Company on the

Proposed Final Judgment

Kevin J. Lipson,

Mary Anne Mason,

Hogan & Hartson LLP, Columbia Square, 555-Thirteenth Street, NW,

Washington, DC 20004-1109, (202) 637-5600.

Stephen E. Pickett,

Douglas Kent Porter, Southern California Edison Company, P.O. Box 800,

2244 Walnut Grove Avenue, Rosemead, California 91770, (626) 302-1903.

J.A. Bouknight, Jr.,

David R. Roll,

Steptoe & Johnson LLP, 1330 Connecticut Avenue, NW, Washington, DC

20036, (202) 429-3000.

Dated: August 17, 1998.

Comments of Amicus Curiae Southern California Edison Company on the

Proposed Final Judgment

Southern California Edison Company (``SCE'') respectfully submits

the following comments on the proposed Final Judgment in the above

referenced matter.\1\

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\1\ As a part of these Comments, SCE is attaching the Affidavit

of Paul R. Carpenter, an economist who has extensive experience in

analyzing energy markets.

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Introduction and Summary

This is a case about an electric utility. Like any company in our

capitalistic system, this utility would like to raise its prices in

order to increase profits for its shareholders. Finding that

competition constrains its ability to increase electricity prices, the

utility decides to buy the only company in the world that will give it

that ability to raise electricity prices in the area where the utility

competes. Not surprisingly, the Department of Justice (``DOJ'') finds

the merge to be an obvious violation of the antitrust laws. DOJ then

files a complaint and proposes a Final Judgment that permits the merger

without eliminating the competitive problem identified in the

complaint.

The violation alleged in DOJ's complaint is straight-forward. Enova

Corporation (``Enova''), the owner of one of California's three major

electric utilities, has acquired Pacific Enterprises (``Pacific''),

which owns and operates the intrastate gas pipeline system that

provides virtually all of the natural gas consumed in southern

California. As DOJ's complaint alleges, control of this pipeline system

will provide Enova with monopoly control of natural gas in the southern

California market. This in turn will permit Enova to control the price

of electricity in southern California much of the time, because natural

gas is used to generate electricity ``on the margin'' during most hours

of the year in southern California.

In competitive markets, the cost characteristics of a producer on

the margin are likely to set the market-clearing price. In southern

California, as of April 1, 1998, this is necessarily true, because

California has created a power exchange (``PX'')--the first such market

in the United States--in which generators of electric power bids for

each hour and all successful bidders are paid a price determined by the

highest bid that is accepted. Thus, where gas-fueled generation is on

the margin, as it is most of the time, an increase in the price of

natural gas leads directly to an increase in the price for every

kilowatt hour of electricity consumed in southern California.

Prior to the merger, Enova had every incentive to raise electricity

prices but it lacked the ability to do so because it has no control

over natural gas prices. On the other hand, before the merger, Pacific

had the ability to control natural gas prices but had not succeeded in

entering the electricity marketing business.\2\ Thus, Enova has the

incentive but not the ability to manipulate electricity prices; Pacific

had the ability but lacked the incentive.

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\2\ Before the merger, Pacific had established a subsidiary for

gas and electricity marketing and tried to enter the electricity

marketing business. However, as Enova explained to the Federal

Energy Regulatory Commission (``FERC''), this subsidiary had not

succeeded in securing any contracts to sell electricity at the time

of the proposed merger. See Ensource, 78 FERC para. 61,064, at

61.231 (1997) (``Since Ensource never has engaged in marketing

activity* * *'').

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DOJ correctly concluded that a merger of these two firms, which

combines the ability and incentive to raise electricity prices in the

southern California market, violates the antitrust laws. In the face of

this violation, what is the remedy? The most obvious remedy, of course,

is to stop the merger from happening. Short of that, the next most

effective and logical remedy is to remove the source of the merged

firm's monopoly power, either by requiring divestiture of the natural

gas pipeline system or by creating an independent system operator

(``ISO'') to operate that system. The last but least attractive option

is to try to lessen the merged firm's incentive to exercise its

monopoly power in order to profit from higher electricity prices. This

is the least attractive option because curbing incentives to profit

from higher electricity prices requires a complex latticework of

provisions designed to prevent the merged firm from retaining and

acquiring contractual rights and other types of economic interests in

electric power. Such a remedy is difficult to write and even harder to

administer.

Rather than stopping the merger in its tracks or adopting a

structural remedy to remove the source of the monopoly power. DOJ asks

this Court to approve a remedy that will have little or no impact on

the merged company's incentive to raise electricity prices. The

proposed Final Judgment should be rejected because the merged entity

still has the unfettered ability to enter into a variety of electric

power transactions, which will enable it to profit from higher

electricity prices. Specifically:

While the proposed Final Judgment requires Enova to

divest two of its gas-fueled electric generating plants, totaling

some 1650 megawatts, it allows the merged company to acquire an

unlimited amount of generating facilities built after January 1,

1998, or any repowered/rebuilt facilities, whatever the fuel-type.

Thus, the 1650 MW divestiture requirement can be undone with a

single purchase of a large new facility.

There is no prohibition on the merged company

contracting, the day after divestiture, to purchase the electrical

output of those same divested generating facilities (or other

facilities).

The proposed Final Judgment explicitly permits the

merged firm to enter into ``tolling'' arrangements by which it can

in essence rent electric generating plants to convert gas into

electricity.

There is no prohibition on the merged company entering

into financial contracts (derivatives such as options and futures)

that

[[Page 3557]]

would enable it to prohibit from changes in southern California

electricity prices.

Under the proposed decree, the merged firm can acquire both new and

repowered/rebuilt electric generation assets. It can acquire by

contract the economic attributes of ownership of electric generation.

It can rent generating units to produce electric power. And it can

trade in electricity financial contracts for the southern California

market. If it can do all this, then it obviously can benefit from

increases in the price of electricity just as it could if it still

owned the divested electric generating facilities. Consequently, the

proposed Final Judgment does not eliminate the merged firm's incentive

to exercise market power in order to increase electricity prices. And

it does not even purport to address market power. Therefore, the

proposed Final Judgment does not even come close to solving the

fundamental competitive problem articulated in DOJ's complaint.

One rationale that DOJ has put forward for having accepted the

ineffective remedial measures in the proposed Final Judgment is that

more effective remedies would involve relief that extends beyond the

effect of the merger, as Pacific could theoretically have engaged in

theses activities without a merger. But this is an unlawful merger.

Without the acquisition, Enova's incentive to raise electricity prices

is not backed by any ability to do so. The merger dramatically and

unlawfully changes the landscape by immediately coupling Enova's

incentive and electricity-expertise with Pacific's natural gas muscle.

The argument that a substantial link between the gas pipeline system

and electricity markets could easily have been established without the

merger ignores the fact that this merger creates that substantial link.

If, for whatever reason, DOJ prefers not to stop the merger and not

to address the upstream source of the market power, but instead chooses

to focus on the incentives to exercise its market power in the

downstream electricity market, then the public interest requires that

it craft remedies designed to curb the incentives that are sufficiently

effective to cure the antitrust violation. Because DOJ failed in that

task, this Court is faced with a proposed Final Judgment that falls far

short of being within the reaches of the public interest.\3\

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\3\ As a diversionary tactic, Enova can be expected to urge the

Court to disregard SCE's comments, no matter how persuasive they may

otherwise be, because SCE is merely a self-interested competitor of

the merged firm. While it is true that SCE is a competitor for

electricity sales, SCE's principal interest in this matter is at the

largest purchaser of electricity in the southern California market,

one that will be directly and significantly harmed by electricity

price increases resulting from this merger. Under the California

restructuring legislation, the legislature ``froze'' electricity

rates at levels in effect as of June 1996. See Cal. Pub. Util. Code

Sec. 368(a). During the rate freeze period which will end December

31, 2001, SCE must purchase all the energy that it sells to its

utility service customers from the PX. SCE's rates include separate

components for transmission, distribution, etc. The sum of these

separate components is less than the frozen rate levels, with that

residual difference being used by SCE to recover costs associated

with generation-related assets that would not otherwise be recouped

if cost recovery were determined solely by selling energy purchased

from these assets at the prevailing market price. As a consequence,

SCE's shareholders are at risk and will be directly harmed if PX

electricity prices rise to a level that would cause SCE's costs to

exceed the frozen rate levels.

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In summary, SCE urges that the proposed Final Judgment be rejected.

If DOJ nevertheless concludes that a salvage effort is appropriate, DOJ

and Enova can be sent back to the bargaining table to produce a Final

Judgment that remedies the competitive problem described in the

complaint. Such remedies would include one of the following:

(1) Rescission of the merger;

(2) Divestiture of the gas pipeline system or, alternatively,

establishment of an independent system operator to operate it

independently of the merged company; or

(3) Adoption of measures that will eliminate the merged company's

incentive to participate directly, and indirectly through financial

instruments, in the southern California electricity market in any

manner that would allow it to profit from increased electricity prices.

Argument

I. The Tunney Act Standard of Review Requires This Court To Determine

Whether the Proposed Final Judgment Is in the Public Interest

On March 9, 1998, the Antitrust Division of DOJ filed a complaint

against Enova alleging that the merger of Enova and Pacific will

violate Section 7 of the Clayton Act. Along with the complaint, DOJ

filed a Stipulation and Order pursuant to which the parties consented

to entry of a proposed Final Judgment and Enova agreed to abide by its

terms pending its entry by the court.

The filing of the proposed Final Judgment triggered a proceeding

under the Antitrust Procedures and Penalties Act, commonly known as the

Tunney Act.\4\ The purpose of the Tunney Act is to provide notice to

the public, an opportunity to comment, and judicial scrutiny of consent

decrees in antitrust cases to determine whether they are in the

``public interest.'' The Tunney Act requires DOJ to publish the

proposed Final Judgment and to file and publish a competitive impact

statement (``CIS'') explaining the case, the anti-competitive conduct

involved, the proposed remedy, and any alternative remedies considered

by it. DOJ must also furnish to the Court any comments that it receives

from the public during a 60-day period commencing with the noticing of

the CIS, its response to these comments, and any documents it

``considered determinative in formulating'' the decree.

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\4\ 15 U.S.C. Sec. 16(b)-(h).

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Before a court may approve a proposed Final Judgment, the Tunney

Act requires the court to ``determine that the entry of such judgment

is in the public interest''.\5\ The Act provides that in making its

public interest determination, the court may consider:

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\5\ 15 U.S.C. Sec. 16(e).

(1) the competitive impact of such judgment, including

termination of alleged violations, provisions for enforcement and

modification, duration or relief sought, anticipated effects of

alternative remedies actually considered, and any other

considerations bearing upon the adequacy of such judgment;

(2) the impact of entry of such judgment upon the pubic

generally and individuals alleging specific injury from the

violations set forth in the complaint including consideration of the

public benefit, if any, to be derived from a determination of the

issues at trial.\6\

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\6\ Id.

The scope of Tunney Act review was articulated in a 1995 decision

of the Court of Appeals for the D.C. Circuit in Microsoft.\7\ In that

case, District Judge Sporkin had declined to enter a proposed consent

decree settling an action by DOJ alleging monopolization and various

exclusionary practices. Although the Court of Appeals reversed and

ordered entry of the proposed decree without revision, it set forth

certain guidelines, among others, that are relevant to the Court's

public interest determination in this case:

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\7\ United States v. Microsoft, 56 F.3d 1448 (D.C. Cir. 1995).

``[T]he court's function is not to determine whether

the resulting array of rights and liabilities is the one that will

best serve society, but only to confirm that the resulting

settlement is within the reaches of the public interest.'' \8\

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\8\ Id. at 1460 (emphasis in original, internal citations and

quotation marks omitted).

``[I]f third parties contend that they would be

positively injured by the decree, a district judge might well

hesitate before assuming that the decree is appropriate.'' \9\

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\9\ Id. at 1462.

[[Page 3558]]

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``A district judge * * * would and should pay special

attention to the decree's clarity [and may] insist on that degree of

precision concerning the resolution of known issues as to make this

task, in resolving subsequent disputes, reasonably manageable * * *

. If the decree is ambiguous, or the district judge can foresee

difficulties in implementation, we would expect the court to insist

that these matters be attended to.'' \10\

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\10\ Id. at 1461-62.

Under Microsoft, it is now clear that a court may not reject a

remedy simply because it is not the ``best'' remedy that could have

been selected. On the other hand, it is equally clear under Microsoft

that a court has discretion to reject a negotiated remedy which is

ineffective because it does not seek to address and resolve the core

competitive problem identified in DOJ's complaint.

Following Microsoft, courts have continued to scrutinize proposed

consent decrees to determine whether they effectively address and

resolve the fundamental competitive problems articulated by DOJ. For

instance, in Thomson, District Judge Friedman examined concerns about

several aspects of a proposed consent decree as expressed in briefs

submitted amicus curiae by two competitors of the merging parties, in

public comments submitted to DOJ, and at an extended public

hearing.\11\ Judge Friedman carefully examined arguments concerning

each of the four separate areas of concern, noting proposed

supplemental commitments \12\ and modifications to the initially filed

proposed consent decree to resolve some of these concerns.\13\ He was

careful not to substitute his own judgment for DOJ's as to what could

be the best remedy \14\ and he declined to suggest relief for conduct

unrelated to the merger.\15\ Nonetheless, Judge Friedman refused to

enter even the revised decree, because neither the original nor the

proposed revision resolved substantial concerns that the decree would

maintain, by court order, a dubious copyright claim that DOJ's

complaint and commentators had identified as a substantial barrier for

new competitors seeking to enter the relevant market.\16\ Only after

the parties submitted a further amendment addressing these concerns did

Judge Friedman order entry of the consent decree.\17\

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\11\ United States v. The Thomson Corp., 949 F. Supp. 907, 909,

912 (D.D.C. 1996), aff'd per curiam 1998 U.S. App. LEXIS 12921 (May

29, 1998).

\12\ See, e.g., id. at 916 (noting that ``Thomson confirmed in

writing that it will continue'' a practice that commentators and

amicus curiae thought might cease after the merger).

\13\ See, e.g., id. at 916 (noting adoption of new consent

decree provision barring Thomson from taking certain actions to

undermine viability of products to be divested under the decree);

id. at 924 (noting proposal to add language to proposed decree to

ensure that licenses to one of the products to be divested may be

sublicensed); id. at 925 (noting further change to proposed consent

decree after Tunney Act hearing to ensure that divestiture will not

affect pre-existing rights under a particular contract). See also

id. at 926 nn. 19-20 (noting changes to initial proposed decree in

response to concerns expressed in comments and at the hearing).

\14\ See id. at 919.

\15\ See, e.g., id. at 920 (refusing to consider requests to

reopen bidding on past contracts, because not related to competition

among the parties to the merger).

\16\ See id. at 927-930 (discussing complaint's allegations and

decree's proposed remedy regarding copyright claim).

\17\ See United States v. The Thomson Corp., 1997-1 Trade Cas.

(CCH) para. 71,735, 1997 U.S. Dist. LEXIS 1893 (Feb. 27, 1997).

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II. The Proposed Final Judgment is Not in the Public Interest

Under standards laid down in Microsoft and implemented in Thomson,

the proposed Final Judgment is not within the ``reaches of the public

interest'' because it does not remedy the core competitive problem

identified in DOJ's complaint--namely, that the merged entity will have

the ability and incentive to increase electricity prices. Unless and

until DOJ and Enova agree to a remedy which addresses and resolves this

problem, the Court must reject the proposed decree.

A. The Complaint Correctly Identifies the Root of the Competitive

Problem: Pacific's Control of Natural Gas Transportation and Storage in

California

As a result of its monopoly over intrastate transmission and

storage of natural gas, Pacific (via its subsidiary, SoCal Gas), has

the power and ability to increase the price of natural gas to gas-fired

electric generators which in turn will increase the price of

electricity in California. In its complaint, DOJ found that,

notwithstanding regulatory oversight, Pacific has the ability to use

its control over those assets to manipulate the price of gas to

consumers, including gas-fueled electric generators:

Pacific has ``a monopoly of transportation of natural

gas within southern California [and] a monopoly of all natural gas

storage services throughout California.'' \1\\8\

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\1\\8\ Complaint para.15.96 percent of gas-fueled generators in

southern California buy gas transportation services from Pacific.

Proposed Final Judgment and Competitive Impact Statement; United

States v. Enova Corp. (``CIS''), 63 FR 33393, at 33403 (June 18,

1998).

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``[A]lthough regulated by the California Public

Utilities Commission (`CPUC'), Pacific has the ability to restrict

the availability of gas transportation and storage to consumers, by

limiting their supply or cutting them off entirely, which has the

effect of raising the price they pay for natural gas.'' \19\

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\19\ Complaint para.16; see also Complaint para.20.

The attached Affidavit of Dr. Paul Carpenter describes the numerous

means by which Pacific (via SoCalGas) can exercise its monopoly power,

as charged by DOJ, to restrict the availability of gas transportation

and gas storage capacity in southern California. These means include

SoCalGas' ability to (a) control and deny access to its intrastate

transmission and storage assets, (b) manipulate the price of intrastate

services, such as short-term balancing or emergency supply services,

(c) withhold the quantity of interstate capacity it makes available in

secondary markets in order to raise price, (d) determine the volume of

flowing supplies on a day-to-day basis through its core-related storage

injection and withdrawal decisions, and (e) manipulate prices and

access through its possession of valuable operational

information.\2\\0\

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\2\\0\ Aff. at para.8.

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The ability of Pacific to restrict the availability of gas

transportation and storage to consumers, including gas-fueled

generators, is the key to its power to increase electricity prices in

southern California for two related reasons. First, as explained by

DOJ, most electricity generated in California is bought and sold

through the California PX, which is a computerized bidding system that

matches electricity supply and demand every hour.\21\ The price of

electricity for all units sold is determined by the most expensive unit

sold in that hour, regardless of the cost or bidding price of less

expensive units.\22\ Stated differently, all sellers receive the PX's

marginal price, regardless of their bid, and all buyers pay the

marginal price.\23\

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\21\ CIS at 33403. The CIS states that the matches occur every

half-hour; in fact, the matches are hourly.

\22\ CIS at 33403.

\23\ Aff. at para.9. This is true with one exception involving

nuclear-powered generators, which are covered by a different pricing

scheme.

Second, ``gas-fired plants are in general the most costly to

operate.'' \24\ In other words, gas-fueled plants are usually on the

margin. Because of the California PX, an increase in the price of

natural gas to these gas-fired plants will translate in an increase in

the price of all electricity sold in California through the PX. DOJ

made this point in its CIS as follows:

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\24\ CIS at 33403.

[d]uring these periods [of high electricity demand], the gas-

fired plants, as the most costly to operate and thus the highest

bidders

[[Page 3559]]

into the [PX], are able to set the price for all electricity sold

through the [PX].\25\

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\25\ Id. DOJ is certainly correct in this critical finding.

Attachment B to Dr. Carpenter's affidavit depicts the electricity

supply curve for all generating resources in the western United

States. As shown, actual demand for electricity (which varies by

time of day and by season) falls within a certain band (70,500

megawatts to 93,500 megawatts) about two-thirds of the time. Within

that band, 90 percent of the megawatts that can be generated come

from gas-fired generators. And, 69 percent of those megawatts come

from California gas-fired generators. Aff. at Attach. B.

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In short, what this all means is that as a consequence of its

monopoly over gas transportation and storage, Pacific has the

unquestioned ability to directly and materially affect the price of

electricity in southern California. As summarized by DOJ:

By virtue of its monopoly over natural gas transportation and

storage, Pacific currently has the ability to increase the price of

electricity, when during high demand periods, electricity from

California gas-fired generators is needed to supplement less costly

electricity. Pacific can restrict gas-fired generators' access to

gas, which has the effect of raising the cost of gas-filed

generators in general. Alternatively, Pacific can cut off or impede

the more efficient gas generators' access to gas, leaving the

higher-cost generators to meet consumer demand for electricity. In

either case, Pacific is able to increase the cost of electricity

from gas-fired plants, thereby increasing the prices they bid into

the [PX] and ultimately the price of electricity sold through the

[PX].\26\

\26\ CIS at 33404 (emphasis added).

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To be sure, Pacific's ability to increase electricity prices

existed absent the merger. Without the merger, however, Pacific had no

incentive to use its market power because it was not in the electricity

business, and it had no economic interest in electricity sales.\27\ It

is surely no coincidence that Enova--one of California's ``big three''

electric utilities and one which every incentive to raise electricity

prices--sought out Pacific, the one company in the world that could

raise prices in the soon-to-be deregulated California electricity

market (the PX). It is also no coincidence that the timing of the

merger was to coincide almost precisely with the commencement of

operation of that deregulated market.

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\27\ A Pacific affiliate did have paper authority from the

FERC--the federal overseer of wholesale electricity sales--to make

electricity sales but it never made any such sales and, in fact,

voluntarily terminated its marketing certificate once the Enova-

Pacific merger was announced. See Ensource, 78 FERC para. 61,064

(1997).

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To take the position, as apparently DOJ does, that Pacific's

ability to raise gas prices and hence, electricity prices is not merger

related, and therefore should not be subject to any merger-related

remedy is to ignore reality. But for this merger, Enova would not be

able to affect electricity prices. It is the merger that transforms

Pacific's previously benign ability to affect electricity prices into a

serious, immediate threat to stifle competition in a nascent but

vitally important market.

B. The Competitive Problem Attendant to This Merger Calls for a

Structural Remedy Directed at the Natural Gas Transportation and

Storage Assets

Having identified the source of the competitive problem, and having

concluded that the merger was unlawful, DOJ then had to fashion an

appropriate remedy. Logic, traditional antitrust policy and precedent,

and one of the very terms of the proposed Final Judgment, all point to

a structural remedy aimed directly at the source of the market power--

Pacific's natural gas transportation and storage assets.\28\ Such a

remedy would separate Pacific's gas transportation and storage assets

from the merged company's other assets, either by divestiture or by

creation of an ISO to operate those assets. But, for unexplained

reasons, the proposed Final Judgment does no such thing; indeed, this

remedy apparently was not even seriously considered. In a section of

the CIS entitled ``Alternatives to the Proposed Final Judgment'', the

only alternative DOJ stated that it considered was a full trial on the

merits.\29\ The remedies that the DOJ did adopt are all aimed at

curtailing the incentive of the merged company to carry out it proven

ability to manipulate gas and, hence, electricity prices. The

ineffectiveness of these remedies is discussed in the following

section.

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\28\ Of course the most obvious and most effective remedy--

preventing this unlawful merger from being consummated--was

apparently rejected by DOJ. No explanation was given for eschewing

this proven, simple method of remedying the effects of this unlawful

merger.

\29\ See CIS at 33407.

Ironically, a provision in the proposed Final Judgment itself makes

clear that the only completely effective remedy is a structural remedy

aimed at the source of the market power; the same provision undermines

the effectiveness of the remedies actually proposed by DOJ and Enova,

which focus only on incentives. Article XIII. A of the proposed Final

Judgment provides that all of the complex provisions of the decree will

abruptly terminate in the event ``an Independent System Operator has

assumed control of Pacific's gas pipelines within California in a

manner satisfactory to the United States.\30\ Termination under these

circumstances would be appropriate in DOJ's view, because

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\30\ Proposed Final Judgment at 33402.

[i]n that event, PE/Enova will lose the ability to control access to

gas transportation and storage. Without these tools, the merged

company will not be able to raise the price for electricity sold

through the [PX] by reducing its gas sales, and the basis for the

Final Judgment would be removed.\31\

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\31\ CIS at 33406 (emphasis added).

Thus, DOJ's own reasoning supports the position that the only way to

completely eliminate the merged company's ability to increase

electricity prices is to eliminate Pacific's control over its gas

transportation and storage assets. This structural remedy serves the

public interest because it addresses the core competitive problem and

is certain to be effective over the long term. No policing is

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necessary.

The staff of the Bureau of Economics of the Federal Trade

Commission (``FTC'') recently expressed its view that structural

remedies aimed directly at the source of market power are the most

effective remedies because such structural remedies alter incentives

(by eliminating the ability to exercise market power) while behavioral

remedies do not:

As a general proposition, we have found that structural

remedies, such as divestiture in merger cases, are the most

effective and require the least amount of subsequent monitoring by

government agencies. The effectiveness of structural remedies lies

in the fact that they directly alter incentives. Behavioral

remedies, in contrast, leave incentives for discriminatory behavior

in place and impose a substantial burden on government agencies to

monitor subsequent conduct.

In 1995, with regard to competition in electric generation and

transmission, we suggested that FERC [the Federal Energy Regulatory

Commission] promote independent system operators (ISOs) to control

the regional electric transmission grids, as an alternative to

ordering divestiture of transmission lines or relying solely on open

access rules to promote competition in electric generation

markets.\32\

\32\ Comments of the Staff of the Bureau of Economics of the

Federal Trade Commission Before the Public Utilities Commission of

Texas, at 2 (June 19, 1998). See Aff. at para. 13. Adoption of a

structural remedy aimed at the source of the market power would be

consistent with traditional antitrust policy and precedent. See,

e.g., California v. American Stores Cos., 495 U.S. 271, 294 n.28

(1990) (citing 2 P. Areeda & D. Turner, Antitrust Law Sec. 328b

(1978) (``[D]ivestiture is the normal and usual remedy against an

unlawful merger''.); United States v. American Cyanamid Co., 719

F.2d 558, 565 (2d Cir. 1983) (citing Ford Motor Co. v. US, 405 U.S.

562,573 (1972) (``[D]ivestiture is not uncommonly the appropriate

relief when a Section 7 violation is proven''). See also United

States v. Merc & Co., Inc., Proposed Final Judgment and Competitive

Impact Statement, 45 F.R. 60044 (1980) (ordering divestiture of

assets that would give the defendant the ability to exercise market

power in violation of Section 7 of the Clayton Act and Sections 1

and 2 of the Sherman Act).

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[[Page 3560]]

Thus, as explained by Dr. Carpenter, in a merger of electricity

transmission and generation companies, the FTC would focus its relief

on the source of the market power--the transmission facilities--rather

than the generation facilities that provide the incentive to engage in

the anti-competitive activity.\33\

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\33\ Aff. at para. 13.

Earlier this year in an analogous situation, the FTC entered into a

consent order settling a challenge to a proposed acquisition by an

electric power company of a coal supplier.\34\ Like the merger in the

present case involving electricity and natural gas pipelines, the FTC

found that a merger involving electricity and coal posed a direct

threat to competition in western U.S. electricity markets. In so

concluding, the FTC made findings remarkably similar to DOJ's findings

in this case:

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\34\ PacifiCorp/The Energy Group, File No. 971 0091. PacifiCorp,

headquartered in Portland, Oregon, makes electricity sales

throughout the western United States. The Energy Group PLC

(``TEG''), headquartered in London, England, is a diversified energy

company that owns, among other things, Peabody Coal Company, which

produces roughly 15 percent of the coal mined in the United States.

See FTC Restructures Electric/Coal Combination to Ensure that All

Consumers Reap Low Prices From Electricity Deregulation, FTC News

Release, Feb. 18, 1998.

``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 concerns.'' \35\

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\35\ Analysis of Proposed Consent Order to Aid Public Comment

(``Analysis'') at 4.

During off-peak periods in the western United States,

``coal-fired plants frequently are the price-setting, marginal

plants.'' \36\

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\36\ Analysis at 3.

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PacifiCorp's acquisition ``would give PacifiCorp the

power to raise the price (or otherwise diminish the availability) of

coal, a necessary input for any firm seeking to compete with

PacifiCorp in electricity generation.'' \37\

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\37\ Statement of The Federal Trade Commission Upon Withdrawal

From Consent Agreement, In the Matter of PacifiCorp, File No. 971

0091, (``Statement'') at 1 (emphasis added).

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``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.'' \38\

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\38\ Analysis at 4 (emphasis added).

Prior to the acquisition, the coal supplier (Peabody) had the ability

to raise coal prices to competing electric generators, but it had no

incentive to do so. On the other hand, before the acquisition, the

electricity company (PacifiCorp.) had the incentive to increase

electricity prices but lacked the ability. It was the merger of the

two, bringing together that ability and that incentive, that gave rise

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to the FTC's concerns.

In stark contrast to DOJ's remedy in the present proceeding, the

FTC in PacifiCorp/The Energy Group did not hesitate to adopt a remedy

which went to the heart of the market power problem identified in the

FTC's complaint. The FTC proposed a remedy that required PacifiCorp to

divest Peabody Western Coal Company--the owner of the coal mines that

conferred market power on the merged firm and enabled it to increase

fuel prices at competing generating facilities (Navajo and Mohave).

And, the FTC directly addressed and rejected the proposals of several

commenters who had recommended conduct/behavioral remedies to resolve

the antitrust problem:

``Public comments on the consent agreement recommended

that we substitute conduct provisions for the order's divestiture

requirement, but we were not persuaded that the suggested course of

action would be preferable.'' \39\

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\39\ Statement at 1 n.1.

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``The divestiture remedy is 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.'' \40\

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\40\ Analysis at 8. The merger never was consummated because

PacifiCorp subsequently withdrew its bid in the face of a competing

offer. In closing the investigation, the FTC stated: ``Absent this

turn of events, the Commission would have been inclined to issue the

final order against PacifiCorp without modification.'' Statement at

1.

In both PacifiCorp and this case, the fuel supply assets are the

source of the competitive problem identified by the federal enforcement

authorities. The simple, direct way to remedy that problem is to cut

out and divest those assets or require that they be controlled by an

independent system operator.

C. The Remedies Adopted in the Proposed Final Judgment Fail To

Effectively Curb the Merged Company's Incentive To Manipulate

Electricity Prices

As explained above, DOJ made no pretext of selecting a remedy

designed to address the gas market power problem. Rather, DOJ focused

all of its attention on the electricity side of the merged company's

business and proposed a complicated set of conditions that are supposed

to curb the incentive of the merged company to manipulate electricity

prices. DOJ's theory is that if there is no financial gain to be made

from electricity price manipulations, then the merged company likely

would not engage in such conduct even if it possessed the power and

ability to do so. There is nothing wrong with this theory from an

analytical point of view. But having chosen this least attractive

remedial approach, DOJ needed to `'get it right'' by understanding,

anticipating, and then prohibiting all the various means by which the

merged company could seek to retain or create incentives to earn

profits through electricity price manipulations. DOJ, however, did not

do so.

The proposed Final Judgment requires and allows the following:

Enova is required to sell its Encina and South Bay

electricity generation facilities, totaling some 1650 megawatts, to

a purchaser acceptable to DOJ.\41\

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\41\ Proposed Final Judgment art. IV(A) at 33398 (requiring

divestiture) & (D)(3) at 33398 (specifying DOJ's right to prior

approval of purchaser) & (I) at 33399 (specifying the criteria for

DOJ approval). The divestiture is to occur within eighteen months,

subject to extension by DOJ, or a trustee will be appointed.

Proposed Final Judgment art. IV(E) at 33399.

Enova is enjoined from acquiring ``California

Generation Facilities'' without prior notice and approval of DOJ.

\42\

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\42\ Proposed Final Judgment art. V(A)(1). The term ``California

Generation Facilities'' is defined to mean electricity generation

facilities in California in existence on January 1, 1998, and any

contract to operate and sell output from generating assets of the

Los Angeles Department of Water and Power (``LADWP''). Proposed

Final Judgment art. II(B) at 33397. ``Acquire'' is defined to mean

``obtaining any interest in any electricity generating facilities or

capacity, including but not limited to, all real property * * *

capital equipment * * * or contracts related to the generation

facility, and including all generation, tolling, reverse tolling,

and other contractual rights.'' Proposed Final Judgment art II(A).

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Enova is enjoined from entering any contracts that

allow it to ``control any California Generation Facilities'' without

prior notice and approval of DOJ.\43\

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\43\ Proposed Final Judgment art. V(A)(2) at 33399. ``Control''

means to have the ability to set the level of output of an

electricity generation facility.'' Proposed Final Judgment art.

II(E) at 33398.

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In general, Enova is allowed to acquire or control up

to 500 MW of capacity of California Generation Facilities without

prior DOJ approval.\44\

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\44\ Proposed Final Judgment art. V(B)(1) at 33399. The cap may

be increased to 800 MW upon Enova's sale of all of its existing

nuclear generating capacity, but only up to 10% of its total retail

electricity sales. Proposed Final Judgment art. XIII(D) at 33402.

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Enova is allowed to ``own, operate, control, or acquire

any electricity generation facilities other than California

Generation Facilities [and] any cogeneration or renewable generation

facilities in California.'' \45\

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\45\ Proposed Final Judgment art. V(C)(1) and (2) at 33399.

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Enova is also allowed to ``enter into tolling and

reverse tolling agreements with any electricity generation

facilities in

[[Page 3561]]

California,'' provided it does not ``control'' them.\46\

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\46\ Proposed Final Judgment art. (V)(C)(3) at 33399.

As explained by Dr. Carpenter, these remedies are ineffective

because they are incomplete.\47\ While their aim is to curb the merged

company's incentives to harm competition by restricting its

participation in certain activities, they also allow other activities

that can completely undo what DOJ seeks to achieve. It is as if DOJ

closed one door to anti-competitive activity but left wide open several

other doors.

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\47\ Aff. at Paras. 19, 21.

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The rationale underlying DOJ's required divestiture of the 1650 of

the 1650 MW of Enova generating facilities is that infra-marginal

assets (assets that are low-cost relative to the market price of

electricity) create incentives through the price-clearing mechanism in

the PX for the merged company to manipulate gas prices. As stated by

DOJ:

The Final Judgment requires Defendant to sell all generation

assets that would likely give PE/Enova the inventive to raise

electricity prices. [footnote excluded] To that end, the Final

Judgment requires Defendant to divest all of its low-cost gas

generators * * *. Because these generators operate in almost all

hours of the year and are relatively low-cost, if PE/Enova were to

own them, it could earn substantial profits (revenues exceeding its

costs) by restricting the supply of natural gas which, as explained

above, would increase the overall price for electricity in the pool

and thus the prive PE/Enova would receive for electricity.\48\

\48\ CIS at 33404.

But, what DOJ overlooked is that many other arrangements and

transactions that are not prohibited by the proposed Final Judgment

will allow the merged entity to directly, or indirectly through

financial instruments, collect the earnings from infra-marginal

generating facilities. Specifically, the proposed Final Judgmebnt has

left in place significant anti-competitive incentives by permitting the

merged company to:

Build or acquire new or repowered generating facilities;

Enter into tolling agreements;

Enter into power generation management contracts;

Enter into financial contracts tied to prices in the

California electricity market

1. Acquisition of New or Repowered Generating Facilities

While the merged company would generally be prohibited from owning

or controlling existing California generating facilities over and above

the 500 MW cap, the proposed Final Judgment allows it to build or

acquire new generating facilities and to acquire plants that are

rebuilt, repowered or activated out of dormancy after January 1, 1998.

While adding new facilities is generally procompetitive, here that is

not the case. Acquisition of new (or rebuilt/repowered/reactivated)

generating facilities will create incentives to manipulate gas prices

that the merged company does not have, easily undoing via vertical

market power the otherwise positive horizontal effect of adding new

generation facilities.\49\ DOJ required the divestiture of Enova's two

generation plants because, as low-cost facilities, they could ``earn

substantial profits'' under the PX pricing mechanism (see supra at p.

22). That same rationale holds equally true for the types of generating

facilities that the proposed Final Judgment permits the merged company

to acquire.

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\49\ Aff. at para. 22.

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By way of example, consider two scenarios. In scenario one, the

merged company divests 1650 MW of Enova's generating facilities, and

then builds a 1650 MW facility to replace the lost output. Because of

technology improvements, the new facility can be brought on-line with

costs roughly equal to those of the old facilities. In scenario two,

the merged company retains its 1650 MW of existing facilities and a

disinterested third party builds a 1650 MW facility. In both scenarios,

the market has the same amount of megawatts available for consumption

and the merged company has roughly the same incentive to raise gas

prices.\50\ The proposed Final Judgment permits scenario one but

prohibits scenario two. A provision such as that can hardly be said to

be within the reaches of the public interest.

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\50\ See Aff. at para. 23.

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2. Tolling Agreements

The proposed Final Judgment permits the merged company to enter

into tolling or reverse tolling agreements so long as it does not

control the level of the plant's output. Under a tolling agreement, a

party who owns natural gas enters into a contract with the owner of the

generating facility to use (``rent'') that facility, thereby allowing

the gas-owning party to produce electricity for a set fee. The gas-

owning party can then sell the electricity at the market price, which

may be higher or lower than the set fee.\51\

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\51\ Aff at para. 24.

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The problem is that tolling agreements are akin to virtual

ownership because they provide the merged company with the same

incentive to increase electricity prices as does physical ownership.

And, the agreement need not provide for control of the plant's output

for that incentive to exist. For example, the merged company could

enter into tolling agreements with the two Enova generating facilities

that it has agreed to divest. The facilities' operator, whoever that

is, would bid into the PX at the facilities' marginal cost and the

facilities would operate whenever the bids are successful. To the

extent that the agreement provides the merged company with electricity

at a fixed price, the company has an incentive to increase the PX price

by increasing gas prices--it will simply pocket the additional

revenue.\52\

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\52\ Aff. at para. 25.

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The failure of the proposed Final Judgment to close this gap is

another reason to find it not in the public interest.

3. Power Generation Management Contracts

A further reason to reject the proposed Final Judgment is due to

its failure to prohibit the merged company from entering into

management contracts under which it would operate a generation facility

owned by a third party. Such arrangements are similar to tolling

agreements in that they permit a sharing in a facility's profits.\53\

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\53\ Aff. at para. 26. A management contract may be structured

to be more complex than a tolling agreement (e.g., clauses with

operating cost incentives) but, in essence, both arrangements have a

built-in incentive to make the facility as profitable as possible.

Id.

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Importantly, the proposed Final Judgment recognizes the potential

harm to competition that such contracts can cause. It requires the

merged company to notify and/or obtain approval from DOJ for management

contracts entered into with the Los Angeles Department of Water and

Power and with the California Public Power Providers. These

restrictions go part way to reducing incentives but apparently they do

not apply to contracts relating to all other California generating

facilities.\54\ Permitting such contracts for certain but not all

California generating facilities is inconsistent and not in the public

interest.

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\54\ There is some ambiguity due to the definition of

``acquisition'' in the proposed Final Judgment. ``Acquire'' could be

interpreted to prohibit any financial interest, or it could be

interpreted to prohibit any ownership interest. The latter

interpretation leaves open the possibility of entering into

management contracts. See proposed Final Judgment at art. II(A); see

also Aff. at para. 28.

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[[Page 3562]]

4. Financial Market Contracts

Finally, the proposed Final Judgment fails to place any

restrictions whatsoever on the merged company's ability to enter into

financial contracts (e.g., forwards, futures, options and other

derivatives) that provide the same incentive to increase electricity

prices.\55\ Financial contracts can be used to approximate the same

financial position the merged company would have by virtue of owning

generation facilities.\56\ The merged company, for example, could

contract for a one-year call option for 1000 MW of output at a certain

``strike price.'' The higher the electricity market price is above the

strike price, the greater the profit when the option is exercised.\57\

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\55\ A forward contract is a non-standardized bilateral contract

for future delivery of electricity at a pre-specified price. A

futures contracts is a standardized forward contract that is traded

on an organized exchange. California-Oregon border and Palo Verde

electricity futures contracts, both of which are traded on the New

York Mercantile Exchange, are accessible to the California market.

Option contracts, which can be either traded on an exchange or done

bilaterally, include additional flexibility for the buyer or the

seller. For example, a call option gives the buyer the right but not

the obligation to purchase electricity in the future at a specified

price. Aff. at para.29 fn.9.

\56\ Aff. at para.29.

\57\ Aff. at para.29.

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As explained by Dr. Carpenter, financial contracts have the

potential to foster more anti-competitive creativity than ownership of

generation facilities because they are more flexible. While it is

difficult to change ownership, it is simple to contract for electricity

in varying amounts over differing time horizons and to change positions

quickly and frequently. This flexibility allows the merged company to

tailor its electricity market position to most advantage itself.\58\

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\58\ Aff. at para.29.

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Both individually and collectively, the shortcomings of the

proposed Final Judgment are significant because they completely

undermine DOJ's effort to curb the merged entity's incentive to

increase electricity prices. DOJ's failure to eliminate this incentive

renders the proposed Final Judgment ineffective and thus outside the

reaches of the public interest. This Court should reject it as

presently written.

Respectfully submitted,

Kevin J. Lipson,

Mary Anne Mason,

Hogan & Hartson LLP, Columbia Square, 555--Thirteenth Street, NW,

Washington, DC 20004-1109. (202) 637-5600.

Stephen E. Pickett,

Douglas Kent Porter,

Southern California Edison Company, P.O. Box 800, 2244 Walnut Grove

Avenue, Rosemead, California 91770. (626) 302-1903.

J.A. Bouknight, Jr.,

David R. Roll,

Steptoe & Johnson LLP, 1330 Connecticut Avenue, NW, Washington, DC

20036. (202) 429-3000.

Affidavit of Paul R. Carpenter

Kevin J. Lipson,

Mary Anne Mason,

Hogan & Hartson LLP, Columbia Square, 555--Thirteenth Street, NW,

Washington, DC 20004-1109. (202) 637-5600.

Stephen E. Pickett,

Douglas Kent Porter,

Southern California Edison Company, P.O. Box 800, 2244 Walnut Grove

Avenue, Rosemead, California 91770. (626) 302-1903.

J.A. Bouknight, Jr.,

David R. Roll,

Steptoe & Johnson LLP, 1330 Connecticut Avenue, NW, Washington, DC

20036. (202) 429-3000.

Dated: August 17, 1998.

1. My name is Paul Carpenter. I am a Principal of The Brattle

Group, an economic and management consulting firm with offices at 44

Brattle Street, Cambridge, Massachusetts 02138, in Washington D.C., and

London, England.

2. I am an economist specializing in the fields of industrial

organization, finance, and regulatory economics. I received a Ph.D. in

Applied Economics and an M.S. in Management from the Massachusetts

Institute of Technology, and a B.A. in Economics from Stanford

University. Since the early 1980s, I have been involved in research and

consulting regarding the economics and regulation of the natural gas,

oil, and electric power industries in North America, the United

Kingdom, and Australia. I have testified frequently before the Federal

Energy Regulatory Commission (``FERC''), the Public Utilities

Commission of the State of California (``CPUC''), other state and

Canadian regulatory commissions, federal courts, the U.S. Congress, the

British Monopolies and Mergers Commission, and the Australian

Competition Tribunal on issues of pricing, competition and regulatory

policy in the natural gas and electric power industries. For at least

ten years I have been extensively involved in the evaluation of the

economics and structure of the natural gas industry in California,

including the interstate pipelines that serve the state, appearing as

an expert witness in many CPUC, FERC and Canadian regulatory

proceedings regarding the certification and pricing of interstate

pipeline capacity to California. Further details of my professional and

educational background and a listing of my publications are provided in

my curriculum vitae appended as Attachment A.

Introduction and Summary of Opinion

3. I have been asked by Southern California Edison Company

(``Edison'') to prepare this affidavit. Its purpose is to evaluate

whether the U.S. Department of Justice (``DOJ'') Final Judgment in this

proceeding (as further explained in its accompanying Competitive Impact

Statement (``CIS'')) remedies the competitive problem identified in

DOJ's Complaint--namely, that as a result of their merger, Pacific

Enterprises (``Pacific'') and Enova Corporation (``Enova'') will have

the incentive and ability to lessen competition in the market for

electricity in California.

4. The DOJ observed correctly in its Complaint and CIS that the

merger will give the combined company (``the Merged Entity'') both the

incentive and the ability to harm competition in the California

electricity market by limiting the supply and/or raising the price of

natural gas supplied to gas-fired electric generating plants in

southern California.

5. In my opinion, the Proposed Final Judgment does not remedy the

serious competitive problem identified by the DOJ in its complaint. The

bases for my opinion are summarized here and elaborated upon in the

remainder of this affidavit:

The DOJ correctly concluded that the merger will give the

Merged Entity both the ability and incentive to raise electricity

prices in southern California.

The DOJ could have remedied this competitive problem by

eliminating the ability of the Merged Entity to exercise market power

by requiring either:

The divestiture of Pacific's intrastate natural gas and

storage assets to a third party; or

The creation of an Independent System Operator to hold and

operate Pacific's natural gas assets.

This type of structural remedy is favored by antitrust

authorities because it is aimed directly at the source of the

competitive problem--market power--and it is clean and easy to enforce,

requiring no ongoing administrative involvement in reviewing the

conduct and performance of the suspect market.

[[Page 3563]]

The remedy chosen by the DOJ is to leave the Merged

Entity's market power intact, and instead to try to curb the Merged

Entity's incentives to harm competition by requiring the sale of two

generating plants and by restricting its participation in certain

activities. This remedy is ineffective. Not only does it leave market

power intact, it fails to eliminate significant anticompetitive

incentives that are equivalent financially to the ownership of the two

power plants.

The Proposed Final Judgment has left in place significant

anti-competitive incentives by permitting the Merged Entity to:

Build or acquire new or repowered generating capacity.

Enter into tolling agreements or management contracts.

Enter into financial contracts (e.g., forwards, futures,

options and other derivatives) for electricity.

These overlooked capabilities are a very real part of the

incentives of the Merged Entity, are a standard part of the package of

services of any major energy marketer, and they are consistent with the

avowed strategic business plans of the Merged Entity.

The Competitive Problem Associated With the Merger

6. Pacific, through its wholly owned subsidiary Southern California

Gas Company (``SoCalGas''), is effectively the sole provider of

intrastate natural gas transmission and storage services to almost all

of the gas-fired electric generating plants in southern California. As

a consequence of this market power, SoCalGas has the ability to limit

the supply and/or raise the price of natural gas to gas-fired plants.

Prior to the merger, however, it had no strong incentive to do so

because it had no position in or control over electricity markets.

7. The DOJ has recognized Pacific's ability to restrict the

availability of gas transportation and storage to gas-fired generators,

and to raise the price of delivered gas to such generators:

Gas-fired power plants cannot and do not switch to other fuels in

response to price increases in natural gas transportation or storage

services, and in California Pacific controls almost all gas-fired

generators' access to gas supply because the state of California has

granted Pacific a monopoly on transportation of natural gas within

southern California. Consequently, 96% of gas-fired generators in

southern California buy gas transportation services from it. Pacific

also has a monopoly on all natural gas storage services throughout

California. Although regulated by the California Public Utilities

Commission (``CPUC''), Pacific has the ability to restrict the

availability of gas transportation and storage to consumers, including

gas-fired generators, by limiting their supply or cutting them off

entirely. Limiting or cutting off gas supply raises the price gas-fired

plants pay for delivered natural gas and in turn raises the cost of

electricity they produce.\1\

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\1\ Competitive Impact Statement (Case 98-CV-583), at 5-7. See

also Complaint, at 6.

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8. The Merged Entity has numerous means to raise prices or limit

supply to gas-fired generators in the southern California market. These

means are derived primarily from SoCalGas' control of the intrastate

transmission, distribution and storage system in southern California,

its role as gas buyer for ``core'' residential and small commercial

customers, and its holding of excess interstate pipeline capacity under

long-term contract.

Intrastate transmission and storage access. As operator of

the intrastate transmission, distribution and storage system. SoCalGas

has considerable authority and autonomy to determine which gas will

flow and under what conditions. It decides on the amount of intrastate

capacity available at each interstate pipeline interconnect, based on

subjective procedures that are not articulated in any tariff or

internal procedural manual. It also has discretion in determining

storage availability.

Pricing of intrastate services. As the provider of hub and

storage services, SoCalGas is allowed under California regulation to

exercise pricing discretion with regard to certain negotiated services.

These services include short-term balancing or emergency supply

services.

Interstate access and pricing. SoCalGas has discretion in

determining the price and quantity of capacity it makes available in

secondary (``capacity release'') markets. This discretion presents the

Merged Entity with one more means by which to influence the delivered

price of gas to its electricity market rivals.

Core procurement behavior. SoCalGas has substantial

flexibility in its core-related storage injection and withdrawal

decisions that allows it to determine the volume of flowing supplies on

a day-to-day basis, notwithstanding customer demand.

Use of operational information. As the operator of the

intrastate natural gas transportation and storage system. SoCalGas

possesses considerable operational information that is extremely

valuable in the restructured natural gas and electricity markets. For

example, as system operator. SoCalGas will receive regular nomination

information from all of its shippers. Because SoCalGas has considerable

discretion in operating its system, it can do so in a manner that can

result in the manipulation of prices and access, and thus the cost of

rivals of using its system. Such manipulations would be almost

impossible to detect, difficult to prove, and not readily subject to

cure.

Each one of these advantages is sufficiently potent to enable to

the Merged Entity to manipulate the price of gas and/or the quality of

service to electricity generators.

9. As of March 31, 1998, California launched the Power Exchange

(PX), through which much of the electricity is now bought and sold in

California. The PX's price per unit of electricity for any given hour

is determined by the bid of the marginal generator--the most expensive

generator required to meet load in that hour. All sellers receive the

marginal price, regardless of their bid, and all buyers pay the

marginal price. As DOJ has acknowledged, because of California's mix of

generating capacity, gas-fired generators usually are the marginal

suppliers, and the marginal-cost pricing instituted by the PX means

that the price bid by gas-fired generators will set electricity prices

in the California market the majority of the time.\2\ The marginal bid

price setting mechanism of the PX means that California gas-fired

capacity will have a dominant effect on electricity prices.\3\

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\2\ To illustrate, Attachment B to this affidavit depicts the

electricity supply curve for both utility and non-utility generating

resources for the entire Western Systems Coordinating Council

(WSCC). This supply curve distinguishes gas-fired capacity and

California gas-fired capacity from other generation capacity. As

illustrated, actual load (which varies by time of day and

seasonally) falls within a band of 70,500 MW to 93,500 MW

approximately two-thirds of the time. Within this same band of the

supply curve, 90% of the capacity is gas-fired capacity, and 69% is

California gas-fired capacity.

\3\ While not all California gas-fired capacity is served by

SoCalGas, the majority of it is, and it has been found that the

prices paid in northern California for gas delivered by Pacific Gas

& Electric Co. (PG&E) are determined by the gas supply alternatives

available at the southern California border. See CPUC Decision 97-

08-055. August 1, 1997, at p.10.

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10. Enova, through its wholly owned subsidiary, San Diego Gas &

Electric (SDG&E), owns gas-fired electric generating stations and

controls over 2,600 MW of electric generating capacity. DOJ recognized

that SDG&E's control of substantial quantities of electricity sold into

the PX gives SDG&E and incentive to raise the PX's electricity price,

making sales of its own

[[Page 3564]]

electricity more profitable. To this existing incentive, the merger

with Pacific adds the ability to increase the price of electricity. The

Merged Entity can accomplish this by increasing the price of natural

gas to gas-fired generating plants in southern California, which in

turn will raise their cost of producing electricity. Because California

gas-fired capacity dominates the electric margin, this will increase

the PX's price per unit of electricity to all sellers.\4\

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\4\ Much of the gas-fired generating capacity in California is

currently under temporary ``must-run'' contracts for reliability,

which when invoked will prevent these units from setting, or

profiting from, the PX price. However, this will have no effect when

must-run conditions are not declared, and the arrangement is

scheduled to expire in three years.

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Failure of the Proposed Final Judgment To Impose a Structural Remedy

Aimed at Market Power

11. The proposed Final Judgment fails to eliminate the competitive

harm caused by the PE/Enova merger because: (1) it does not contain any

provisions designed to curb the Merged Entity's ability to harm

competition through its monopoly over natural gas transportation and

supply, and (2) while it requires SDG&E to divest ownership of two gas-

fired electric generating plants, it permits the Merged Entity to

replicate ownership by entering into contractual arrangements which

offer the same incentives to engage in anti-competitive activity.

12. The proposed Final Judgment fails to impose the obvious,

traditional, and assuredly effective remedy to a market power problem

in a merger proceeding. It could have eliminated the ability of the

Merged Entity to harm competition by eliminating its ability to

exercise market power. It could have done this by requiring the

divestiture of Pacific's intrastate natural gas transmission and

storage assets, or by requiring the creation of an Independent System

Operator (``ISO'') for those assets.

13. The staff of the Bureau of Economics of the Federal Trade

Commission has recently expressed its view that structural remedies

(such as ISOs) aimed directly at the source of market power are the

most effective remedies because such structural remedies alter

incentives (by eliminating the ability to exercise market power) while

behavioral remedies do not:

As a general proposition, we have found that structural

remedies, such as divestiture in merger cases, are the most

effective and require the least amount of subsequent monitoring by

government agencies. The effectiveness of structural remedies lies

in the fact that they directly alter incentives. Behavioral

remedies, in contrast, leave incentives for discriminatory behavior

in place and impose a substantial burden on government agencies to

monitor subsequent conduct.

* * * In 1995, with regard to competition in electric generation

and transmission, we suggested that FERC [the Federal Energy

Regulatory Commission] promote independent system operators (ISOs)

to control the regional electric transmission grids, as an

alternative to ordering divestiture of transmission lines or relying

solely on open access rules to promote competition in electric

generation markets.\5\

---------------------------------------------------------------------------

\5\ Comments of the Staff of the Bureau of Economics of the

Federal Trade Commission Before the Public Utilities Commission of

Texas, at 2 (June 19, 1998).

I agree with this view. Thus, for example, in a merger of

electricity transmission and generation companies, the FTC would focus

its relief on the source of the market power--the transmission

facilities--rather than the generation facilities that provide the

incentive to engage in anti-competitive activity. As stated above, the

FTC would place the transmission facilities in the hands of an

independent entity, an ISO, and would prevent those facilities, which

confer market power, from being controlled by the merged entity.

14. In remedying the anti-competitive effects of vertical mergers

like the present one, the antitrust authorities have opted, and should

continue to opt, for structural remedies that eliminate the source of

the market power. Recently, in addressing the anti-competitive effects

of a proposed merger between an electric utility and a coal company,

the FTC insisted on divestiture of the coal supply assets that were the

source of the market power which in turn led to anti-competitive

control over electricity prices. I agree with this approach and this

remedy. A copy of the FTC's reasoning in that case is appended as

Attachment C.

15. A structural remedy in this case, requiring intrastate gas

transmission and storage divestiture or the creation of an ISO, would

eliminate cleanly the Merged Entity's ability to control the price of

electricity in California, and it would eliminate the enforcement

difficulties associated with behavioral remedies that attempt to

control anti-competitive incentives after the fact.\6\

---------------------------------------------------------------------------

\6\ Nowhere in its CIS does DOJ explain why it has failed to

impose a remedy that eliminates the ability of the merged entity to

raise prices.

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The Proposed Final Judgment Does Not Remedy the Competitive Problem

Identified by DOJ

16. The proposed Final Judgment does not attempt to eliminate the

Merged Entity's market power over natural gas transportation and

storage which gives it the ability to harm competition and raise prices

in electricity markets. Instead, DOJ has chosen to attempt to curb the

Merged Entity's incentive to harm competition by requiring Enova to

divest itself of 1,644 MW of generation assets, namely, the Encina and

South Bay gas-fired electricity generating plants. In addition, the

Final Judgment caps the Merged Entity's ownership of California

electricity generation assets at 500 MW.\7\ The Final Judgment also

enjoins the Merged Entity from acquiring electricity generation

facilities in California which were in existence on January 1, 1998

(except facilities that are rebuilt, repowered, or activated out of

dormancy after January 1, 1998) and/or entering into any contract for

operation and sale of output from generating assets of Los Angeles

Department of Water and Power (``LADWP''), without prior notice to, and

approval of, the United States. Finally, the Final Judgment enjoins the

Merged Entity from entering into any contracts that allow it to control

the output of electricity generation facilities in California in

existence on January 1, 1998 without prior notice to and approval of

the United States.

---------------------------------------------------------------------------

\7\ Since nuclear plants in California will remain price

regulated (i.e., will not receive the PX price) until 2001, Enova's

20% (430 MW) interest in the San Onofre Nuclear Generating Station

(``SONGS'') will not be included in the 500 MW cap. If nuclear power

prices become deregulated after 2001, SONGS capacity will be

included in the cap and the period of the final judgment will be

extended from five to ten years. A 75 MW contract with Portland

General Electric will be included in the cap, unless the contract is

terminated or divested. Finally, the capacity of the Encina and

South Bay generation facilities will be included in the cap for as

long as Enova owns these assets.

---------------------------------------------------------------------------

17. Importantly, this merger involves much more than an effort to

combine SDG&E's electricity generation assets with SoCalGas' natural

gas transmission and distribution assets. The problem with the merger

is that it combines SDG&E's expertise in profiting through the

acquisition and sale of electric power with SoCalGas' ability to

control the price of natural gas in California through its monopoly

over natural gas transportation and storage services in California.\8\

As explained further below, this combination of electricity expertise

and natural gas control creates a serious competitive problem that is

not remedied by the divestiture of assets and other conditions set

forth in the Final Judgment. Specifically, such

[[Page 3565]]

electricity expertise could be used to enter into tolling agreements,

management contracts and forward and futures contracts that perpetuate

the Merged Entity's incentive to manipulate gas prices for anti-

competitive ends, notwithstanding the Final Judgment's generation

ownership restrictions.

---------------------------------------------------------------------------

\8\ The California Commission noted in its merger decision that

``* * * each company sees unregulated energy services (particularly

electricity marketing) as a way to increase earnings. But each feels

that it lacks critical skills and physical assets.'' See D. 98-03-

073, at 24.

---------------------------------------------------------------------------

18. As a general matter, it is extremely difficult to eliminate all

of the anti-competitive incentives facing a utility in a restructured,

partially deregulated wholesale electricity market. Those incentives

manifest themselves in many different ways--only one of which is

through ownership of existing gas-fired plants. Yet to be confident

that the harm is competition is eliminated (when the ability to

exercise market power remains), the antitrust authority or regulator

must identify all of the potential incentives to profit from market

manipulation and then design remedies that will curb each and every

incentive. As explained below, the Final Judgment fails to curb very

significant incentives.

19. The Competitive Impact Statement (CIS) correctly defines the

Merged Entity's incentive but misconstrues the relationship between the

kinds of transactions the Merged Entity might pursue and the incentives

that would be created. As a result, the behavioral remedies put forward

in the Final Judgment eliminate only part of the Merged Entity's

incentives to raise prices.

20. The CIS recognizes that infra-marginal assets (assets that are

low-cost relative to the market price of electricity) create incentives

through the price-clearing mechanism in the California PX for the

Merged Entity to manipulate gas prices. For example, the CIS states (at

page 9):

The Final Judgment requires Defendant to sell all generation

assets that would likely give PE/Enova the incentive to raise

electricity prices [footnote excluded] To that end, the Final

Judgment requires Defendant to divest all of its low-cost gas

generators * * *. Because these generators operate in almost all

hours of the year and are relatively low-cost, if PE/Enova were to

own them, it could earn substantial profits (revenues exceedings its

costs) by restricting the supply of natural gas which, as explained

above, would increase the overall price for electricity in the pool

[PX] and thus the price PE/Enova would receive for electricity.

21. In making this finding, the DOJ overlooks the fact that many

other arrangements and transactions that are not prohibited by the

proposed Final Judgment create financial positions equivalent to, and

potentially even more profitable than, the physical ownership of an

infra-marginal generating unit. Any arrangement that allows the Merged

Entity to collect or share in the earnings of an infra-marginal

generator will give it the incentive to manipulate the spot price of

power by increasing gas prices. The Final Judgment does not prohibit,

and in fact explicitly allows, several such arrangements. Under the

Final Judgment, the Merged Entity is allowed to (1) acquire new,

rebuilt or repowered generation, (2) enter into tolling agreements with

third-party generation owners, (3) enter into power generation

management contracts, and (4) take forward contractual positions in the

electricity market. All of these permitted transactions allow the

Merged Entity to profit by manipulating the price of electric power,

and will risk the abuse of market power as long as the Merged Entity

has the continuing ability to influence gas prices that the CIS has

acknowledged. As I explain below, in each of these situations the Final

Judgment's restrictions simply do not eliminate the Merged Entity's

incentives to exercise market power.

New or Repowered Generation Capacity

22. Under the proposed Final Judgment, the Merged Entity would be

prohibited from owning or controlling existing generating facilities,

but it is permitted to built or acquire new generating capacity and to

gain control of plants that are rebuilt, repowered or activated out of

dormancy after January 1, 1998. However, the addition of new generation

by the Merged Entity is not necessarily benign. All else equal, adding

generating capacity is usually procompetitive. However, in this case,

all else is decidedly unequal. Allowing the Merged Entity to acquire

new generation (or to rebuild, repower or reactivate generation) will

give it incentives to manipulate gas prices which it would not

otherwise have, easily undoing via vertical market power the otherwise

positive horizontal effect of adding capacity. By giving the Merged

Entity an incentive to raise gas prices, ownership of new or repowered

generation could lead to an across-the-board increase in the cost of

most of the margin-setting capacity in the market. Thus, the Final

Judgment should prohibit the acquisition of new generating capacity for

the same reason it requires divestiture of existing capacity. Holding

any sort of interest in generating capacity eligible for the PX price

gives the Merged Entity an incentive to exercise its market power in

the gas market, to the detriment of the electricity market.

23. Another way to view this is by considering two scenarios: (A)

the Merged Entity divests its existing generation to a third party, and

builds a new generator, or (B) the Merged Entity keeps its existing

generation and a disinterested third party builds the new generator. In

both scenarios, the market has the same amount of generation, and the

Merged Entity has essentially the same incentive to raise gas prices.

However, while the CIS correctly recognizes (B) as problematic, the

Final Judgment explicitly (though incorrectly) allows (A), the

acquisition of new or repowered capacity.

Tolling Agreements

24. In a ``tolling'' agreement, one party contracts for the use of

another party's generating capacity, allowing the first party to

convert its own gas into electricity for a set fee. The first party can

then sell the electricity at the market price, and will be able to

collect the associated profit (or loss) as if it owned the generator.

The proposed Final Judgment explicitly allows the Merged Entity to

enter into tolling agreements, so long as it does not control the

plant's output level in the process.

25. Tolling agreements create virtual ownership positions in power

plants, and provide the Merged Entity with the same incentives to

increase electricity prices as does physical plant ownership. A tolling

agreement would allow the Merged Entity to receive all or most of the

generator's infra-marginal net revenues, whether or not it controls the

plant's output level. The proposed Final Judgment's restriction against

controlling plant output displays a misconception of how the Merged

Entity could exercise market power. It is not by withholding generating

capacity from the market that the Merged Entity would manipulate

electricity prices. Withholding capacity is an issue in horizontal

market power, but not in the vertical market power that is of concern

in this instance. Vertical market power arises here because the Merged

Entity has the ability to raise the price of electricity by raising the

price of gas--the dominant margin-setting fuel, and a vertical input to

electricity. The Merged Entity can profit from gas market manipulation

if it holds a claim on the net revenues of any infra-marginal plant

that is operating when gas-fired generation is setting the PX price,

regardless of whether it controls the plant's output. The plant

operator, whoever it is, would simply bid into the PX at the plant's

marginal cost, so that the plant would dispatch when economical. Thus,

for example, if the Merged Entity enters into a tolling agreement with

the owners of the two plants it has agreed to divest, its

[[Page 3566]]

financial stake will be essentially identical to what it would have

been under direct ownership. While physical plant ownership is rightly

prohibited, the Final Judgment fails to curb the Merged Entity's

incentives because it allows tolling agreements that give the Merged

Entity the same profit-making potential.

Management Contracts

26. The same issues arise with ``management contracts,'' under

which the Merged Entity would operate a plant owned by a third party,

typically for a share of the plant's profits. Such arrangements are

similar to tolling agreements in that they allow the Merged Entity to

share in a plant's net revenues.

27. The problem with the proposed Final Judgment is that it does

not clearly prohibit the Merged Entity from entering into management

contracts with existing California generating facilities (e.g. its own

divested generators or those of others). Thus, the Merged Entity could

sign a management contract for one or more of the plants divested by

itself or others and enjoy essentially the same financial incentives it

could have had by retaining its own plants. Moreover, these units under

management contract need not be gas-fired for them to create price

manipulation incentives. To perpetuate such incentives, all that is

required is that the plant(s) under contract be infra-marginal (i.e.,

lower cost than the marginal gas-fired plant that is setting the PX

price.) To eliminate the anti-competitive incentives associated with

management contracts, the Merged Entity would have to be explicitly

prevented from entering into a management contract with any entity

owning or building generation in California.

28. The proposed Final Judgement recognizes the problems with

management contracts when it requires that the Merged Entity notify

and/or obtain approval from DOJ for management contracts with assets

owned by California Public Power Providers (``CPPP'') and the Los

Angeles Department of Water and Power (``LADWP''). These restrictions

go part way in reducing the Merged Entity's incentives. But since

similar restrictions are not applied to management contracts involving

other assets, the Final Judgment gives the appearance of endorsing such

contracts. Relatedly, the Final Judgment prohibits the ``acquisition''

of California Generation Facilities without prior approval. However, by

carving out exceptions for management contracts, the meaning of

``acquire'' becomes ambiguous, despite being defined as ``obtaining any

interest in any electricity generating facilities or capacity''.

``Acquire'' could be interpreted to prohibit any financial interest

(which it must do to be effective), or could it be interpreted more

narrowly to prohibit only ownership interest--which leaves open the

possibility of management contracts. By explicitly restricting

management contracts with respect to LADWP and CPPP assets only, the

proposed Final Judgment appears to endorse a narrow interpretation of

``acquire'', and threatens to leave the Merged Entity with significant

incentives to exercise its market power. Such debates concerning

interpretation mean that at a minimum, in order to enforce the Final

Judgment the DOJ will have to put itself in a significant oversight

position to ensure consistency of interpretation and compliance. The

need for such continuing regulatory activity by the antitrust authority

would have been eliminated had the Final Judgment imposed a structural

solution to the market power problem.

Financial Markets

29. It is apparent from the proposed Final Judgement that the DOJ

fails to recognize that financial market contracts (derivatives such as

forwards, futures, and options) which the Merged Entity may acquire

could also provide it with incentives to act anti-competitively.\9\ In

fact, financial contracts can be used to essentially recreate the same

financial position one would have by virtue of power plant ownership.

For example, holding a one-year call option for 1,000 MW is financially

akin to a year's ownership of a 1,000 MW power plant with variable cost

equal to the ``strike price'' of the call (the contract price paid for

power if the option is exercised. Such financial market contracts are,

in effect, ``virtual generation assets.'' \10\ The equivalence between

financial and physical assets is such that it is now common for

electric industry planners to treat power plant ownership as equivalent

to holding a series of call options and/or forward contracts to serve

future spot markets for power.

---------------------------------------------------------------------------

\9\ A forward contract for power is simply a non-stardized

bilateral contact for future delivery at a pre-specified price.

Futures are standardized forward contracts traded on an organized

exchange, such as the California-Oregon Border (COB) and Palo Verde

(PV) electricity futures contracts which are traded on the New York

Mercantile Exchange (NYMEX) and which are accessible to the

California market. Options contracts are also derivatives that

include additional flexibility for either the buyer or seller. For

example, a call option, a common type of derivative, gives the buyer

the right but not he obligation to purchase power in the future at a

specified price.

\10\ Financial contracts can foster even more anti-competitive

creativity than power plant ownership, because they are far more

flexible. For instance, while it is difficult to change one's

ownership of generating capacity, it is simple to contract for power

in varying amounts over differing time horizons (a year, a month, a

week, a day), and to change one's position quickly and frequently.

This would allow the Merged Entity to tailor its electricity market

position to make it most advantageous.

---------------------------------------------------------------------------

30. Consequently, to the extent power plant ownership creates anti-

competitive incentives, so would an equivalent bundle of forward or

derivative contracts. While the Final Judgment does attempt to restrict

the future acquisition of existing generating capacity in order to

prevent anti-competitive behavior, it fails to restrict financial

market participation, which creates the same incentives to abuse market

power.

Conclusion

31. In its Complaint in this matter, the DOJ found that the

proposed merger of Pacific Enterprises and Enova results in the

creation of an entity that has the ability and incentive to harm

competition in the market for wholesale electric power in California.

The proposed Final Judgment, however, fails to rectify the problem

because it preserves the ability of the Merged Entity to harm

competition while imposing remedies that fail to eliminate the

incentives. In particular, the Final Judgment fails entirely to deal

with the incentives which the Merged Entity could create through

ownership of new or repowered generation or contracting for power via

tolling agreements, management contracts or financial contracts. The

CIS provides no justification for distinguishing between the

acquisition of physical assets and financial assets in creating anti-

competitive incentives. The limited restrictions that the proposed

Final Judgment does place on the future activities of the Merged Entity

in the areas of new capacity, tolling and energy management contracts

will not eliminate or even substantially curb the Merged Entity's

incentives to harm competition.

32. The proposed Final Judgment does not remedy the serious

competitive problem identified by the DOJ in its Complaint.

Attachment A--Paul R. Carpenter, Principal

Dr. Carpenter holds a Ph.D. in applied economics and an M.S. in

management from the Massachusetts Institute of Technology, and a

B.A. in economics from Stanford University. He specializes in the

economics of the natural gas, oil and electric utility

[[Page 3567]]

industries. Dr. Carpenter was a co-founder of Incentives Research,

Inc. in 1983. Prior to that he was employed by the NASA/Caltech Jet

Propulsion Laboratory and Putnam, Hayes & Bartlett, and he was a

post-doctoral fellow at the MIT Center for Energy Policy Research.

He is currently a Principal of The Brattle Group.

Areas of Expertise

Dr. Carpenter's areas of expertise include the fields of energy

economics, regulation, corporate planning, pricing policy, and

antitrust. His recent engagements have involved:

Natural Gas and Electric Utility Industries: consulting

and testimony on nearly all of the economic and regulatory issues

surrounding the transition of the natural gas and electric power

industries from strict regulation to greater competition. These

issues have included stranded investments and contracts, design and

pricing of unbundled and ancillary services, evaluation of supply,

demand and price forecasting models, the competitive effects of

pipeline expansions and performance-based ratemaking. He has

consulted on the regulatory and competitive structures of the gas

and electric power industries in the U.S., Canada, the United

Kingdom, Australia and New Zealand.

Antiturst: expert testimony in several of the seminal

cases involving the alleged denial of access to regulated

facilities; analysis of relevant market and market power issues,

business justification defenses, and damages.

Regulation: studies and consultation on alternative

rate making methodologies for oil and gas pipelines, on ``bypass''

of regulated facilities before the U.S. Congress; advice and

testimony before several state utility commissions and the National

Energy Board of Canada on new facility certification policy.

Finance: research on business and financial risks in

the regulated industries and testimony on risk, cost of capital, and

capital structure for natural gas pipeline companies in the U.S. and

Canada.

Professional Affiliations

International Association of Energy Economists

American Bar Association (Antitrust Section)

American Economic Association.

Academic Honors and Fellowships

Stewart Fellowship, 1983

MIT Fellowships, 1981, 1982, 1983

Brooks Master's Thesis Prize (Runner-up), MIT, 1978.

Publications

``Pipeline Pricing to Encourage Efficient Capacity Editions,'' (with

Frank C. Graves and Matthew P. O'Loughlin), prepared for Columbia

Gas Transmission Corporation and Columbia Gulf Transmission Company,

February 1998.

``The Outlook for Imported Natural Gas,'' (with Matthew P.

O'Loughlin and Gao-Wen Shao), prepared for The INGAA Foundation,

Inc., July 1997.

``Basic and Enhanced Services for Recourse and Negotiated Rates in

the Natural Gas Pipeline Industry'' (with Frank C. Graves, Carlos

Lapuerta, and Matthew P. O'Loughlin), May 29, 1996, prepared for

Columbia Gas Transmission Corporation, Columbia Gulf Transmission

Company.

``Estimating the Social Costs of PUHCA Regulation'' (with Frank C.

Graves), submitted on behalf of Central and South West Corp. to the

U.S. Securities and Exchange Commission in its Request for Comments

on the Modernization of Regulation of Public Utility Holding

Companies, File No. S7-32-94, February 6, 1995.

``Review of the Model Developer's Report, Natural Gas Transmission

and Distribution Model (NGTDM) of the National Energy Modeling

System'', December 1994, prepared for U.S. Department of Energy,

Energy Information Administration and Oak Ridge National Laboratory

under Subcontract No. 80X-SL220V.

``Pricing of Electricity Network Services to Preserve Network

Security and Quality of Frequency Under Transmission Access'' (with

Frank C. Graves, Marija Ilic, and Asef Zobian), response to the

Federal Energy Regulatory Commission's Request for Comments in its

Notice of Technical Conference Docket No. RM93-19-000, November

1993.

``Creating a Secondary Market in Natural Gas Pipeline Capacity

Rights Under FERC Order No. 636'' (with Frank C. Graves), draft

December 1992, Incentives Research, Inc.

``Review of the Component Design Report, Natural Gas Annual Flow

Module, National Energy Modeling System,'' August 1992, prepared for

the U.S. Department of Energy, Energy Information Administration.

``Unbundling, Pricing, and Comparability of Service on Natural Gas

Pipeline Networks'' (with Frank C. Graves), November 1991, prepared

for the Interstate Natural Gas Association of America.

``Review of the Gas Analysis Modeling System (GAMS): Final Report of

Findings and Recommendations,'' August, 1991, prepared for the U.S.

Dept. of Energy, Energy Information Administration.

``Estimating the Cost of Switching Rights on Natural Gas Pipelines''

(with F.C. Graves and J.A. Read), The Energy Journal, October 1989.

``Demand-Charge GICs Differ from Deficiency-Charge GICs'' (with F.C.

Graves), Natural Gas, Vol. 6, No. 1, August 1989.

``What Price Unbundling?'' (with F.C. Graves), Natural Gas, Vol. 5

No. 10, May 1989.

Book Review of Drawing the line on Natural Gas Regulation: The

Harvard Study on the Future of Natural Gas, Joseph Kalt and Frank

Schuller eds., in The Energy Journal, April 1988.

``Adapting to Change in Natural Gas Markets'' (with Henry D. Jacoby

and Arthur W. Wright), in Energy, Markets and Regulation: What Have

We Learned?, Cambridge: MIT Press, 1987.

Evaluation of the Commercial Potential in Earth and Ocean

Observation Missions from the Space Station Polar Platform, Prepared

by Incentives Research for the NASA Jet Propulsion Laboratory under

Contract No. 957324, May 1986.

An Economic Comparison of Alternative Methods of Regulating Oil

Pipelines (with Gerald A. Taylor), Prepared by Incentives Research

for the U.S. Department of Energy, Office of Competition, July 1985.

``The Natural Gas Policy Drama: A Tragedy in Three Acts'' (with

Arthur W. Wright), MIT Center for Energy Policy Research Working

Paper No. 84-012WP, October 1984.

Oil Pipeline Rates and Profitability under Williams Opinion 154

(with Gerald A. Taylor), Prepared by Incentives Research for the

U.S. Department of Energy, Office of Competition, September 1984.

Natural Gas Pipelines After Field Price Decontrol: A Study of Risk,

Return and Regulation, Ph.D. Dissertation, Massachusetts Institute

of Technology, March 1984. Published as a Report to the U.S.

Department of Energy, Office of Oil and Gas Policy, MIT Center for

Energy Policy Research Technical Report No. 84-004.

The Competitive Origins and Economic Benefits of Kern River Gas

Transmission, Prepared by Incentives Research, Inc., for Kern River

Gas Transmission Company, February 1994.

``Field Price Decontrol of Natural Gas, Pipeline Risk and Regulatory

Policy,'' in Government and Energy Policy Richard L. Itteilag, ed.,

Washington, D.C., June 1983.

``Risk Allocation and Institutional Arrangements in Natural Gas''

(with Arthur W. Wright), invited paper presented to the American

Economic Association Meetings, San Francisco, December 1983.

``Vertical Market Arrangements, Risk-shifting and Natural Gas

Pipeline Regulations,'' Sloan School of Management Working Paper no.

1369-82, September 1982 (Revised April 1983).

Natural Gas Pipeline Regulation After Field Price Decontrol (with

Henry Dr. Jacoby and Arthur W. Wright), prepared for U.S. Department

of Energy, Office of Oil and Gas Policy, MIT Energy Lab Report No.

83-013, March 1983.

Book Review of An Economic Analysis of World Energy Problems, by

Richard L. Gordon, Sloan Management Review, Spring 1982.

``Perspectives on the Government Role in New Technology Development

and Diffusion'' (with Drew Bottaro), MIT Energy Lab Report No. 81-

041, November 1981.

[[Page 3568]]

International Plan for Photovoltaic Power Systems (co-author), Solar

Energy Research Institute with the Jet Propulsion Laboratory

Prepared for the U.S. Department of Energy, August 1979.

Federal Policies for the Widespread Use of Photovoltaic Power

Systems (contributor), Jet Propulsion Laboratory Report to the U.S.

Congress DOE/CS-0114, March 24, 1980.

``An Economic Analysis of Residential, Grid-connected Solar

Photovoltaic Power Systems'' (with Gerald A. Taylor), MIT Energy

Laboratory Technical Report No. 78-007, May 1978.

Speeches/Presentations

``Opening Remarks from the Chair: Rates, Regulations and Operational

Realities in the Capacity Market of the Future,'' AIC conference on

``Gas Pipeline Capacity `97,'' Houston, Texas June 17, 1997.

``Lessons from North America for the British Gas TransCo Pricing

Regime,'' prepared for AIC conference on: Gas Transportation and

Transmission Pricing, London, England, October 17, 1996.

``GICs and the Pricing of Gas Supply Reliability,'' California

Energy Commission Conference on Emerging Competition in California

Gas Markets, San Diego, Ca. November 9, 1990.

``The New Effects of Regulation and Natural Gas Field Markets: Spot

Markets, Contracting and Reliability,'' American Economic

Association Annual Meeting, New York City, December 29, 1988.

``Appropriate Regulation in the Local Marketplace,'' Interregional

Natural Gas Symposium, Center for Public Policy, University of

Houston, November 30, 1988.

``Market Forces, Antitrust, and the Future of Regulation of the Gas

Industry,'' Symposium of the Future of Natural Gas Regulation,

American Bar Association, Washington D.C., April 21, 1988.

``Valuation of Standby Tariffs for Natural Gas Pipelines,'' Workshop

on New Methods for Project and Contract Evaluation, MIT Center for

Energy Policy Research, Cambridge, March 3, 1988.

``Long-term Structure of the Natural Gas Industry,'' National

Association of Regulatory Utility Commissioners Meeting, Washington

D.C., March 1, 1988.

``How the U.S. Gas Market Works--or Doesn't Work,'' Ontario Ministry

of Energy Symposium on Understanding the United States Natural Gas

Market, Toronto, March 18, 1986.

``The New U.S. Natural Gas Policy: Implications for the Pipeline

Industry,'' Conference on Mergers and Acquisitions in the Gas

Pipeline Industry, Executive Enterprises, Houston, February 26-27,

1986.

Various lectures and seminars on U.S. natural gas industry and

regulation for graduate energy economics courses at Massachusetts

Institute of Technology, 1984-96.

Panelist in University of Colorado Law School workshop on state

regulations of natural gas production, June 1985. (Transcript

published in University of Colorado Law Review.) ``Oil Pipeline

Rates after the Williams 154 Decision,'' Executive Enterprises,

Conference on Oil Pipeline Ratemaking, Houston, June 19-20, 1984.

``Issues in the Regulation of Natural Gas Pipelines,'' California

Public Utilities Commission Hearings on Natural Gas, San Francisco,

May 21, 1984.

``The Natural Gas Pipelines in Transition: Evidence From Capital

Markets'', Pittsburgh Conference on Modeling and Simulation,

Pittsburgh, April 20, 1984.

``Financial Aspects of Gas Pipeline Regulation,'' Pittsburgh

Conference on Modeling and Simulation, Pittsburgh, April 19-20,

1984.

``Natural Gas Pipelines After Field Price Decontrol,'' Presentations

before Conferences of the International Association of Energy

Economists, Washington D.C., June 1983, and Denver, November 1982.

``Spot Markets for Natural Gas,'' MIT Center for Energy Policy

Research Semi-annual Associates Conference, March 1983.

``Pricing Solar Energy Using a System of Planning and Assessment

Models,'' Presentations to the XXIV International Conference, The

Institute of Management Science, Honolulu, June 20, 1979.

Testimonial Experience

Antitrust/Federal Court/Arbitration

In the matter of the Arbitration between Western Power Corp. and

Woodside Petroleum Corp., et al., Perth, Western Australia, May-July

1998.

In the United States District Court for the District of Montana,

Butte Division, Paladin Associates, Inc. v. Montana Power Company,

November-December 1997.

In the United States District Court for the District of Colorado,

Atlantic Richfield Co. v. Darwin H. Smallwood, Sr., et al., July

1997.

In the Australian Competition Tribunal, Review of the Trade

Practices Act Authorizations for the AGL Cooper Basin Natural Gas

Supply Arrangements, on behalf of the Australian Competition and

Consumer Commission, February 1997.

In the Southwest Queensland Gas Price Review Arbitration, Adelaide,

South Australia, May 1996.

In the matter of the Arbitration between Amerada Hess Corp. v.

Pacific Gas & Electric Co., May 1995.

In re Columbia Gas Transmission Corp., Claims Quantification

Proceeding in the U.S. Bankruptcy Court for the District of

Delaware, Before the Claims Mediator, July and November 1993.

Deposition Testimony in Fina Oil & Gas v. Northwest Pipeline Corp.

and Williams Gas Supply (New Mexico) 1992.

Testimony by Affidavit in James River Corp. v. Northwest Pipeline

Corp. (Fed. Ct. for Oregon) 1989.

Deposition and Testimony by Affidavit in Merrion Oil and Gas Col, et

al., v. Northwest Pipeline Corp. (Fed. Ct. for New Mexico) 1989.

Deposition Testimony in Martin Exploration Management Co., et al. v.

Panhandle Eastern Pipeline Co. (Fed. Ct. for Colorado) 1988 and

1992.

Trial Testimony in City of Chanute, et al. v. Williams Natural Gas

(Fed. Ct. for Kansas) 1988.

Deposition Testimony in Sinclair Oil Co. v. Northwest Pipeline Co.

(Fed. Ct. for Wyoming) 1987.

Deposition and Trial Testimony in State of Illinois v. Panhandle

Eastern Pipeline Co. (Fed. Ct. for C.D. Ill) 1984-87.

Economic/Regulatory Testimony

Before the National Energy Board of Canada, Application of Alliance

Pipeline Ltd., Hearing Order GH-3-97, December 1997, April 1998.

Before the California Public Utilities Commission, Pacific

Enterprises, Enova Corporation, et al. Merger Proceedings, Docket

A.96-10-038, on behalf of Southern California Edison, August 1997.

In the Superior Court of the State of California for the County of

Los Angeles, Pacific Pipeline System Inc. v. City of Los Angeles, on

behalf of Pacific Pipeline System Inc., January 1997.

Before the U.K. Monopolies and Mergers Commission, British Gas

Transportation and Storage Price Control Review, on behalf of Enron

Capital and Trade Resources Limited, January 1997.

Northern Border Pipeline Company, Federal Energy Regulatory

Commission (FERC) Docket No. RP96-45-000, July 1996.

Wisconsin Electric Power Co., Northern States Power Co. Merger

Proceedings. FERC Docket No. EC 95-16-000, on behalf of Madison Gas

& Electric Co., Wisconsin Citizens Utility Board and the Wisconsin

Electric Cooperative Association, May 1996.

Before the California Public Utilities Commission, Application of

PG&E for Amortization of Interstate Transition Cost Surcharge,

Application 94-06-044, on behalf of El Paso Natural Gas, December

1995.

Tennessee Gas Pipeline Company, FERC Docket No. RP95-112-000, on

behalf of JMC Power Projects, September 1995.

Before the National Energy Board of Canada, Drawdown of Balance of

Deferred Income Taxes Proceeding, RH-1-95, on behalf of Foothills

Pipe Lines Ltd., September 1995.

Pacific Gas Transmission, FERC Docket No. RP94-149-000, on behalf of

El Paso Natural Gas, May 1995.

Before the California Public Utilities Commission, Application of

Pacific Pipeline System, Inc., A.91-10-013, on behalf of PPSI, April

1995.

Before the National Energy Board of Canada, Multipipeline Cost of

Capital Proceeding, RH-2-94, on behalf of Foothills Pipe Lines Ltd.,

November 1994.

[[Page 3569]]

Before the California Public Utilities Commission, Pacific Gas &

Electric 1992 Operations Reasonableness Review, Application 93-04-

011, on behalf of El Paso Natural Gas, November 1994.

Before the National Energy Board of Canada, Foothills Pipe Lines

(Alta.) Ltd., Wild Horse Pipeline Project, Order No. GH-4-94,

October 1994.

Iroquois Gas Transmission System, L.P., FERC Docket No. RP94-72-000,

on behalf of Masspower and Selkirk Cogen Partners, September 1994.

Tennessee Gas Pipeline Co., FERC Docket No. RP91-203-000, on behalf

of JMC Power Projects and New England Power Company, February, May

1994.

Before the California Public Utilities Commission, on the

Application of Pacific Gas & Electric Company to Establish Interim

Rates for the PG&E Expansion Project, July 1993.

Before the Florida Public Service Commission, Petition of Florida

Power Corporation for Order Authorizing A Return on Equity for

Florida Power's Investment in the SunShine Intrastate and the

SunShine Interstate Pipelines, FPSC Docket No. 930281-EI, June 4,

1993.

Before the Florida Public Service Commission, Application for

Determination of Need for an Intrastate Natural Gas Pipeline by

SunShine Pipeline Partners, FPSC Docket No. 920807-GP, April-May

1993.

Northwest Pipeline Corp., et al., FERC Docket No. IN90-1-001,

February 1993.

City of Long Beach, Calif., vs. Unocal California Pipeline Co.,

before the California Public Utilities Commission, Case No. 91-12-

028, February 1993.

Alberta Energy Resources Conservation Board, on Applications of NOVA

Corporation of Canada to Construct Facilities, January 1993.

Before the California Public Utilities Commission, on the

Application of Pacific Gas & Electric Co. to guarantee certain

financing arrangements of Pacific Gas Transmission Co. not to exceed

$751 million, 1992.

Mississippi River Transmission Co., FERC Docket No. RP93-4-000,

October 1992, September 1993.

Unocal California Pipeline Co., FERC Docket No. IS92-18-000, August

1992.

Before the California Public Utilities Commission, in the Rulemaking

into natural gas procurement and system reliability issues, R.88-08-

018, June 1992.

Alberta Energy Resources Conservation Board, Altamont & PGT Pipeline

Projects, Proceeding 911586, March 1992.

Before the California Utilities Commission, on the Application of

Southern California Gas Company for approval of capital investment

in facilities to permit interconnection with the Kern River/Mojave

pipeline, A.90-11-035, May 1992.

Northern Natural Gas, FERC Docket No. RP92-1-000, October 1991.

Florida Gas Transmission, FERC Docket No. RP91-1-187-000 and CP91-

2448-000, July 1991.

Tarpon Transmission, FERC Docket No. RP84-82-004, January 1991.

Before the California Public Utilities Commission, on the

Application of Pacific Gas & Electric Co. to Expand its Natural Gas

Pipeline System, A. 89-04-033, May 1990 and October 1991.

CNG Transmission, FERC Docket No. RP88-211, March 1990.

Panhandle Eastern Pipeline, FERC Docket No. RP88-262, March 1990.

Mississippi River Transmission, FERC Docket No. RP89-249, October

1989, September 1990.

Tennessee Gas Pipeline, FERC Docket No. CP89-470, June 1989.

Empire State Pipeline, Case No. 88-T-132 before the New York Public

Service Commission, May 1989.

Before the U.S. Congress, House of Representatives, Committee on

Energy and Commerce, Subcommittee on Energy and Power, Hearings on

``Bypass'' Legislation, May 1988.

Tennessee Gas Pipeline, FERC Docket No. RP86-119, 1986-87.

Mojave Pipeline Co., FERC Docket No. CP85-437, 1987-88.

Consolidated Gas Transmission Corp., FERC Docket No. RP88-10, 1988.

Panhandle Eastern, FERC Docket No. RP85-194, 1985.

On behalf of the Natural Gas Supply Association in FERC Rulemaking

Docket No. RM85-1, 1985-86.

On behalf of the Panhandle Eastern Pipeline Co. in FERC Rulemaking

Docket No. RM85-1, 1985.

BILLING CODE 7515-01--P

[[Page 3570]]

[GRAPHIC] [TIFF OMITTED] TN22JA99.002

BILLING CODE 4410-11-C

[[Page 3571]]

Attachment B--1996 WSCC Electric Supply Curve (Notes and Sources)

Sources

Electric Supply and Demand Database (NERC); RDI 1996 Fuel Price

Forecast.

Notes

For graphical clarity, units with dispatch cost above $60/MWh

are excluded (30 oil-fired turbines, 740 MW total capacity).

Nameplate capacity has been derated to reflect approximate average

annual availability; hydro derated to reflect available energy.

The WSCC is the electric reliability council consisting of 11

western states and portions of Canada and Mexico; it contains

162,000 MW of generating capacity from over 1,400 generating units.

The annual average WSCC load is approximately 82,000 MW, and one

standard deviation of coincident load is approximately 11,500 MW, so

a one-standard deviation band around average load encompasses the

range from 70,500 MW to 93,500 MW. Actual values fall within one

standard-deviation of the average approximately two-thirds of the

time.

Note that this is an ``average annual'' supply curve, in that

nameplace capacity of units has been derated to reflect average

annual availability (annual energy limits for hydro). Some care must

be taken in interpreting this curve, because at any particular point

in time, the actual supply curve will differ somewhat, depending on

which particular units are actually available at that time. However,

it clearly demonstrates that gas, and particularly California gas,

is the dominant fuel of the price-setting marginal units in the

entire WSCC. Of course, the effect of California gas-fired capacity

on just the California market is even greater.

Affidavit of Paul R. Carpenter, Ph.D.

Commonwealth of Massachusetts, County of Middlesex

ss

I, Paul R. Carpenter, being first duly sworn on oath depose and

say as follows:

I make this affidavit for the purpose of adopting as my sworn

testimony in this proceeding the attached material entitled

``Affidavit of Paul R. Carpenter, Ph.D.'' The statements contained

therein were prepared by me or under my direction and are true and

correct to the best of my knowledge, information, and belief.

Further affiant saith not.

Paul R. Carpenter

Subscribed and sworn to before me, a notary public in and for

the Commonwealth of Massachusetts, County of Middlesex, this 4th day

of August, 1998.

[SIGNATURE ILLEGIBLE].

[FR Doc. 99-1393 Filed 1-21-99; 8:45 am]

BILLING CODE 4410-11-M