January 2006

Monitoring the Urge to Merge

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2006/04/01)
 

In the age when Sam Scalito has refocused national attention on the “original intent” of the Founding Fathers, FERC has essentially chosen a similar approach to the primal utility corporate urge to merge. In doing so, FERC is to an extent subordinating policy concerns about the health and functioning of the national power system – and incidentally relegating those who bet on a future merchant power model - to a backseat.

There is obviously no question that the central reality of the electric power industry in the coming year (and probably those to come) will be the consolidation of utilities. Mergers do not, of course deal with the inherent vulnerability of utilities in the absence of regulatory relief to recover fuel costs nor assure an up tick in credit ratings simply by reason of agglomeration of assets (see the early returns on the Constellation - FP & L merger). Indeed some utilities such as Sempra, rather than focusing on utility asset aggregation are said to be contemplating offloading the bulk of their generation and focusing on more attractive businesses such as liquefied natural gas and gas storage. No matter, utility mergers are not regulated in terms of their contribution to the health of that industry any more than are those of companies in any other line of business. That is just not our political system.

With the passage of EPACT, as Congressman Barton has thundered, this is more true than ever. The shackles of special prophylactic policing of utility holding companies under PUHCA was essentially cast off - not to be replaced, in his view by a new surrogate FERC – enforced regimen. Overall, the regulatory impedance of the national utility march to consolidation was to be streamlined and brought more into line with the relatively supine standards applicable to the rest of American business life.

Which makes it all the more exceptional that FERC promulgated Order No. 669 to implement the EPACT amendments to Section 203 (the Federal Power Act section dealing with mergers and consolidation) . Issued in late December, Order 669 does not loose sight of the fact that the preponderance of utility operations are still the beneficiary of public rate regulation, that such regulation creates the potential for intercorporate transactions and cross subsidy arrangements which benefit utilities at the expense of those who pay regulated rates. We find three basic facts emerging from evaluation of Order No. 669.

• The FERC flag is still there in the consolidation field and now flies over a broader jurisdiction - for better or worse - in terms of entities regulated. Public power and munis (except inter muni-mergers) are included. So far all FUCOs (acquisitions of overseas utilities), despite Congressman Barton’s protestations.
   

• The market for “institutional investor” trading in smaller utility ownership interests below 10% by parties without interests in other power assets, is thrown open, also, any room for unregulated upstream reorganizations is open a crack.
   

• The basic requirements to consistency with the public interest, i.e., measurement of no harm to competition, rates and regulation under FERC’s Merger Policy Statement of effect essentially is intact. In the case of consumer protection it is in some respects enhanced by an encrustation of PIHCA doctrine.
   

• Through a blanket exemption provisions of the Order, FERC has agreed to stay out of intrastate, i.e., state commission regulated matters.

What does all this mean for “merchant power” – the injection of competition into the electric power industry as a means of controlling prices and stimulating innovation. That’s the merchant power whose prospects appear “dim” to S&P in its recent Report except for IPPs with nuclear and coal base load plants, R.I.P. ____ Calpine. Or even the “merchant power” which represents the assets in play among large acquisition and hedge funds, at present, and which may well gravitate back (read “flip”) to the utility sector in the longer run, like the assets of Orion Power acquired by Madison Dearborn and U.S. Power Generating. How will the regulatory environment affect the future flips?

For this subset population of the power world, the effective operative, the effectively operative principles of Order 669 appear to be these:

• All assets, even “generation only”, are subject to jurisdictional review with the exception of certain QFs.
   

• Industrial organization of QFs (including cogen and renewables) remains immune from the FPA § 203 standards. But acquisitions of QF interests by otherwise FERC jurisdictional entities now are subject to FERC jurisdiction.
   

• The significance of a business entity’s exemption from the PUHCA 2005 requirements is irrelevant to applicability of Section 203. (EWGs also appear to fall within this jurisdictional ambit.)

FERC’s 203 rules matter Non-compliant transactions may be declared null and void by FERC. The statutorily raised dollar threshold for exercise of FERC’s jurisdiction to $10 million, has been in its effect mitigated by its definition of this threshold in terms of “value”, i.e., nondepreciated costs (rather than at asset value as it would be for rate base (ratemaking) purposes. FERC now has significant civil penalty powers.

Order 669 is effectively complemented by FERC’s recently announced determination to fundamentally change its review of market manipulation to broadly follow on SEC type model in future police the trading markets - yet another Congressional mandate under EPAC - relatively broadly construed. Like FERC’s merger regulation rules the market manipulation rules point toward enhancement of a meticulously managed utility - dominated system. Will it be through a sterile new world for merchant powers already reeling from EPACT’s decimation of to PURPA, most recently bolstered by FERC in its NOPR construing EPACT to specify that is mandatory QF buying utilities is not required in RTO areas. We shall see.

So PUHCA is effectively out. Some sustained FERC oversight of mergers is in. Competitive power concepts are an afterthought, except as related to more vigorous transaction police of the last standing players. FERC has chosen a formal legal oversight approach to the urge to merge - “originalist” thinking if you will. The merchant power will navigate the consequences remains to be seen. Merchant power’s place is FERCs Eden, in which it is monitoring the slightly sanitized urge to merge, remains unclear.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.