False constellation impression

r is used to determine the level of stranded costs by netting those costs above the PX price, on an ongoing basis, as “justifiable“ stranded costs. With greater competition, PX prices decrease and stranded costs increase, giving still more money to IOUs and their affiliates to beat back competitors and gain market share. Two other points make California’s competitive picture look especially grim. First, the IOUs seem able to keep the PX price low for several reasons. Because of what many view as disc~~atory

PX protocols, few

seem willing to sell power through the PX. California’s large IOUs are selling off most all their thermal plants, but must sell remaining generation-nuclear

and hydro genera-

tion, both with low operating costsinto the PX. This keeps PX prices low and creates lots of cash to cross-subsidize IOU affiliates. Second, small consumers pay by far the most stranded cost under the adopted approach to customer class cost allocation. As default customers they have the least chance to benefit from competitive direct access. They are unattractive to marketers, so they will be price takers of PX purchases. Thus the market is segmented: Small customers will bear the bulk of stranded costs, and IOU affiliates can use this cash to “out-compete” competitors for large customers. Theory is becoming reality. Witness I’G&E Energy Services ~derbidd~g Washington Water Power’s Avista Energy. Without subsidy, PG&E’s cost structure could never rival that of WWP’s hydro-based Avista. When will those states which allow high levels of stranded recovery actually benefit from competition? Not until all the “funny money” is spent. Eric C. Woychik Presi~e~f, Sfrafegy ~~fegr~fio~

January/February

1998

False Constellation

-.

Impression

fact that no retail electric competition is currently allowed in Maryiand. In

I

wish to address several misleading allegations made by Richard Pierce

(“Merger Policy and Federalism,”

Aug. /Sept. ‘97, at 49) concerning the Maryland Public Service Commission’s (MdPSC) evaluation of the competitive effects of the proposed merger of Baltimore Gas & Electric Co. (BGE) and Potomac Electric Power Co. (Pepto) to form Constellation Energy Corp. (Case No. 8725). Mr. Pierce inaccurately depicted the MdI’SC’s treatment of the market power issue in the merger proceeding. Moreover, his discussion of the impact of the merger on electricity markets is based on flawed economic analysis and assumptions. Mr. Pierce’s article gives the false impression that the MdPSC did not comprehensively

evaluate market

power effects of the merger. In the course of the merger proceeding, six witnesses presented written and oral testimony concerning market power. The issue also was explored at length in parties’ initial and reply briefs. Only two parties (Maryland Office of People’s Counsel and the International Bro~erh~

of Electrical Work-

ers) claimed that the merger should not be approved because of market power concerns. On the issue of wholesale market power the Commission found that neither Pepto nor BGE possessed excess generating capacity. In fact, both companies are relying on long-term and mid-term capacity purchase agreements to meet native load obligations. Despite Mr. Pierce’s allegations of negligence, any discussion of retail market shares by the Federal Energy Regulatory Commission, the MdESC or the parties to the federal and state merger proceedings had to face the

Case No. 8738 (commenced before our merger order issued), the MdPSC is investigating whether retail competition for electric consumers is in the public interest. The MdPSC determined that its electric restructuring proceeding would be the appropriate forum to explore any issues concerning the competitive effects of a combined BGE-Pepto. It would have been irresponsible for the MdPSC to either reject the merger because of competition concerns or to require market power mitigation conditions for an entity that would continue to be regulated as a monopoly. Indeed, the FERC only voiced concerns about Constellation’s generation dominance in retail markets “if retail access becomes available.” (Docket Nos. EC 96 10-000 and ER96-784-000, mimeo at 16.) The MdPSC would not make retail access available unless it believed it had (or could obtain, with the assistance of the Ma~land

General As-

sembly) authority to mitigate market power held by Maryland utilities. Mr. Pierce also makes several cavalier economic pronouncements.

He

cites several studies for the proposition that “[cfompetitive electricity markets perform poorly when they are highly concentrated” (at 49). However, it must be remembered that the impact of concentration on a future competitive retail electric market can be mitigated by “rules of engagement” imposed by regulators, including open-access conditions, statemandated capacity assignment, and affiliate standards of conduct. All these conditions are currently under evaluation by the MdPSC. As a consequence, Mr. Pierce engages in speculation when he states, “thus, a merger between utilities with large shares of the same regional market is likely to

3

harm consumers.” (I&) Also unsub-

market power effects of the merger;

capital assets that can be used as the

stantiated is his notion that FERC’s

(2) I engaged in “simple speculation”

basis for sales in the market.

deferring the retail competition issue

when I predicted that the merger

to the MdPSC “will have significant

would have an unacceptable effect on

tempts to reassure the citizens of

adverse effects on the performance of

market power in the retail market;

Maryland that the MdPSC will make

the wholesale market throughout the

and, (3) the “MdPSC [will] not make

retail access available to Maryland

middle Atlantic region and on con-

retail access available unless it be-

consumers only with “rules of en-

sumers in Pennsylvania, New Jersey,

lieve[sJ it ha[s] . . authority to miti-

gagement” that mitigate the potential

and Delaware, as well as Ma~lan~

gate market power held by Ma~land

effects of market concentration. He re-

(at 53). Even if one ignored the

utilities.”

fers to three potential mitigating

FERC’s finding that the merger posed

1. If the MdPSC “comprehen-

3. Finally, Chairman Frisby at-

measures: “open-access conditions,

sively evaluated” the market power

state-mandated

is simply no economic basis for these

effects of the merger, it certainly did

ments, and affiliate standards of con-

assertions.

not share its evaluation with the

duct.” Open-access conditions and af-

no harm to wholesale markets, there

capacity assign-

In sum, Mr. Pierce’s article is a

public by including any description

filiate standards of conduct are

paean to federal intrusion into mat-

of its evaluation in its order approv-

important mechanisms to mitigate

ters of state concern, which he at-

ing the merger. If there is some se-

the potential effects of ~~erfic~~ market

tempts to justify on unfounded con-

cret appendix to the order that in-

power, but neither they nor state-

cerns about market power. The

cludes the MdPSC’s evaluation, I

mandated capacity assignments can

states do have a role in determining

would be very interested in seeing

mitigate the effects of the massive

how retail customers will be im-

it. Any such evaluation would have

horizontal market power created by

pacted by utility mergers. Appropri-

to be unusually creative in order to

the merger.

ate measures to protect customers

support a finding that a merger that

from retail market power should be

creates an entity with an 80 to 100

mitigating market power when a single

crafted by the state commissions

percent share of the retail market

firm controls assets that account for 80

will not have market power in the

to 100 percent of sales in a market. The

retail market.

MdPSC will have to order the new firm

which are responsible

for retail con-

sumers’ welfare. In the case of the BCE-Pepto

merger, the MdPSC per-

2. I am mystified by Chairman

There is only one effective method of

created by the merger to divest a sig-

Frisby’s assertion that I engaged in

nificant proportion of its generating as-

instituted measures consistent with

“simple speculation”

sets. In other words, the MdESC can

the market realities that exit within

dicted that the merger would create

make available to Maryland consum-

Maryland.

undue market power. There is

ers the substantial benefits of retail ac-

much we don’t yet know about the

cess only be undoing much of what it

formed its analysis thoroughly

and

H. Rllssell Frishj, jr., C~zair~an Mlrrylarzd Pddic Service Commission

Professor Pierce responds:

relationships

when I pre-

of the myriad charac-

teristics of an electricity market to the performance

of such a market.

did in its order approving the BG&E/Pepco merger. If the MdPSC had actually engaged

We do know a few basic properties

in “comprehensive

hairman Frisby’s attempt to de-

of those relationships,

competitive effects of the proposed

fend the Maryland ESC’s treat-

FERC found that the merger would

merger, it would have discovered

ment of retail market power in con-

produce a single firm that “would

that reality, and it would have taken

nection with its approval of the

control 100 percent of the market

the oniy sensible action consistent

BGE/I’epco merger reinforces my

for firm energy and between 80 to

with effective retail competition. It

concern that some state commissions

88 percent of the market for non-

would have conditioned its approval

lack either the willingness or the abil-

firm energy if retail access became

of the proposed merger on the appli-

ity to evaluate the potential competi-

available in applicants’ service terri-

cants’ willingness to implement a

tive consequences of proposed utility

tories.” It does not require “specula-

plan of partial divestiture of generat-

mergers. Chairman Frisby makes

tion” to predict that a market will

ing capacity sufficient to create a

three basic arguments: (1) the MdPSC

perform poorly when a single firm

structurally competitive retail electric-

did “comprehensively

controls 80 to 200 percent of the

ity market. n

C

4

evaluate” the

however. The

evaluation” of the