FEBRUARY 1997

THE URGE TO CONVERGE

by Roger Feldman  --   Bingham, Dana and Gould, P.C.
(originally published by PMA OnLine Magazine: 04/98)

If the future structure of the power industry clearly had been dictated by the private power industry, its future role, as a provider of new merchant plants to a functionally disaggregated electric industry subject to wholesale and retail open access would be clear. Subject to the concerns of IOUs with stranded costs and munis and rural coops as to their future relevance, that is the direction in which federal initiatives are pushing.

When the premier merger trend in the industry was toward intra-IOU mergers, even that trend could be rationalized with, and subjected to the policy prescriptions of, private power. Tactics to obscure stranded costs and to artificially enlarge service territories, it was thought, must surely ultimately fall to a regime emphasizing true competition and open access.

However, the reality of the marketplace is now "convergence", not mere agglomeration of electric power assets. For private power to both define its niche in the new energy world and stake out its position on the form of coming electric power deregulation, it must come to terms with the fact that the new markets in which it plays are not likely to be simply multiple gencos selling to unregulated transco and discos. They are more likely to reflect one of several types of "convergence":

• Creation of regional "fortress hubs" made up of gas and electric firms, seeking to defend their historic service territories; add retail energy services; and possibly lay a foundation for broader diversification;

• National energy firm construction, focused on future one stop trading and "name brand" sales through pipeline merger with regionally based electric companies, or through registered holding company alliance with local gas companies;

• Regional or national mergers or alliances between local utilities and companies with infotainment technologies or capabilities, intended to focus on the home access characteristics of existing utilities;

• Regional mergers among electric and water and gas utilities designed to focus on economies of system management; and

• Power privateer marketers nailing down their own gas supplies.

Since in the catechism of private power - and to a significant degree in fact - innovative competition is in the public interest, the logical response to "convergence" ought to be in pro-competitive regulation by the gatekeepers: FERC; SEC (under PUHCA), perhaps the Department of Justice under the Anti-trust laws, and perhaps the states under their "little PUHCAs" or even traditional utility regulation. However, this runs into a basic problem: the language and models for industry regulation have not caught up with the explosive change in industry structure which convergence now presents. This may be seen in three facets of the new FERC merger guidelines:

• Definition of business/relevant market;

• Proposed mitigation of anti-competitive impacts of mergers; and

• Jurisdictional issues.

As a consequence, power privateers may be driven back to examining "convergence" in the legislative context - and may find itself with surprising allies and enemies.

• FERC’s adaptation of the merger guidelines was meant to move it from an unsuitable passive review role, focused on savings and absence of demonstrated competitive harm to the standards more traditional in non-regulated industries: impact on market, consumer effects, significance of changing market structure. It should be recognized, however, that the "market" which in the first instance this analysis will be focused on is electricity; firms and non-firm energy and long-term capacity. The perspective of the convergers; Btu competition via tolling arrangements, "spark" swaps or other trading structures is not explicitly recognized.

• Market dominance mitigation is framed in a manner very similar to that under Order No. 888. Noted ratepayer safeguards are creation of an ISO, asset divestiture, regional transmission pricing and related customer protection mechanisms such as an open season to exit existing contracts. In short, the solution is framed to deal with the potential problem defined in a narrow manner, not with the risks of energy market dominance as a consequence of convergence.

• FERC has crafted its own jurisdiction relative to companies joining holding companies - asserting its right to impose its affiliate transaction standards. These will be deferred to state jurisdiction to protect state interests, where state have extant laws to do so. Put differently, the possibility of federal/state disagreements on mergers, particularly when convergence is involved, is a real possibility, and one which may favor the convergers relative to the rest of the market’s players.

• For power privateers, waiting for merchant niches to spring phoenix-like from the husks of old merged firms, therefore, their prospects are more problematic than they may previously have seemed. One solution might be to seek to broaden the 1997 Energy Act to deal with "energy access" and address convergence. But that may well be more than private power can chew or Congress could digest. The other alternative, of which I suspect we will see more, is to follow the energy leaders, and be prepared to join other "genercos" in the newly complicated battle to serve different categories of end use customers.

One way or another, the urge to converge is not one to be ignored by private power. Traditional administrative and current state of the art legislative thinking may not adequately distinguish between the creatively efficient and the ingeniously predatory.

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.