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Maryland PSC Staff Says FirstEnergy-Allegheny Merger Will Reduce Retail Competition

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October 5, 2010

The FirstEnergy Corp.-Allegheny Energy merger, "will reduce retail competition, not enhance it, and may lead to higher competitive prices for electricity, directly harming PEC [Potomac Edison] ratepayers," Maryland PSC Staff said in testimony in the FirstEnergy-Allegheny merger proceeding (Case 9233).

Staff presented testimony from Dr. Jonathan Lesser, President of Continental Economics and former partner at Bates White, LLC.  Unlike in Pennsylvania, there is no standard in Maryland that a merger must result in a workably competitive retail market.  However, mergers must be consistent with the public interest, convenience, and necessity, including resulting in benefits and no harm to consumers.

Lesser noted that FirstEnergy and Allegheny have argued that the merger will enhance retail competition, citing the commitment made by FirstEnergy Solutions to serve the Maryland residential market.

"In the abstract, more retail competition will benefit Maryland ratepayers.  However, the Applicants have not provided any evidence that that the merger will improve retail competition.  In fact, since both FirstEnergy Solutions and Alleghehy [sic] Energy Supply both currently compete for Maryland commercial and industrial customers, the proposed merger will reduce retail competition for those customers, who comprise the vast majority of all retail electric sales in the state," Lesser testified.

"Moreover, increased ownership concentration in the wholesale generation market will reduce wholesale market competition, potentially negating any purported benefits of enhanced retail competition for residential customers," Lesser added.

Staff also offered testimony stating that, "[t]he Applicants' own market impact analysis raises significant questions regarding the impact of the proposed merger on market power concentration."

Lesser noted that, "[a]t this point, the only tangible benefit to Maryland ratepayers is the $2.5 million in rate relief promised by over the first two years after the merger is approved and finalized.  If even a slight increase in market power results in an increase in wholesale and retail electric costs, then Maryland ratepayers will be even worse off overall."

The applicants have argued that a wholesale market power analysis prepared in their FERC application shows that the companies' Herfindahl-Hirschman Index exceeds the threshold of 1,000 in only three off-peak periods, at which time applicants said that there is ample excess supply from competitors to mitigate any potential market power.  However, Lesser noted that the HHI value for the Summer Peak period is just 20 points below the 1,000 HHI threshold value, and the Winter peak is just 31 points below the threshold value.  The Spring/Fall peak is just 10 points below the threshold value.

While the companies' FERC market power analysis focuses only on a single year, 2011, "the Maryland Commission must concern itself with the long-run implications of the proposed merger on Maryland ratepayers," Lesser said.

"For example, a key issue for the Commission will be to ensure the merged entity does not use its regulated entities to subsidize the competitive retail operations of FirstEnergy Solutions.  Cross-subsidization and its distorting impacts on competitive retail markets are not considered in market power analyses such as those performed by Dr. Hieronymous [sic] [in the FERC application]," Lesser added.

Lesser concluded that, "[t]he aggregate costs of the proposed merger outweigh the benefits when viewed from the perspective of PEC ratepayers."  While Staff offered several conditions which could be placed on the merger to result in the required ratepayer benefits (such as credits to customers), none of the conditions directly address the potential harm to the retail market cited by Staff.

The Office of People's Counsel testified that, prior to the merger, the regulated Allegheny and FirstEnergy utilities are, in effect, "cross-subsidizing the debt costs of the non-regulated entities."

The cross-subsidization results from the higher bond rating that higher risk non-regulated operations enjoy from being part of a holding company that also has lower risk regulated utility operations, OPC said.  "On a stand-alone basis, the bond rating of an independent power producer is typically less than the bond rating of regulated utility company," OPC noted.

"The regulated utility operating company effectively subsidizes the non-regulated independent power producer affiliate by sharing its combined financial and business strength through the holding company relationship," OPC added.

OPC testified that ratepayers are harmed by this subsidization since their borrowing and interest costs are higher than they otherwise would be, and these costs are reflected in utility rates.  Additionally, "the utility company is not being compensated by its non-regulated affiliate for the support the utility company provides in obtaining a higher bond rating for the non-regulated affiliate.  The compensation from the non-regulated affiliate would be used to lower the utility's retail rates," OPC added.

The total annual value of these costs is $6.0 million, including $1 million in higher interest costs and $5 million in lost compensation for providing the overall risk reduction needed to the lower interest rates for the non-regulated operations, OPC said.

OPC concluded that the merger application is not consistent with the public interest, convenience, and necessity, including benefits and no harm to consumers, and said that it thus should be rejected, though OPC offered several conditions which could make the merger beneficial to customers (rate credits, ring fencing, etc.)

Direct Energy Auction Proposal
Similar to its recommendation in Pennsylvania, Direct Energy filed testimony arguing that changes are required to Maryland's default service structure to mitigate anti-competitive effects of the merger.  Direct proposed an auction mechanism for retail customers at Potomac Edison substantially similar to its Pennsylvania proposal, with certain changes to reflect the unique statutes in each state.  For example, Maryland does not specifically provide for an alternative to the utility provision of SOS, though Direct noted that Maryland statute does distinguish between SOS (to be provided by the utility) and "default service," a term which has yet to be defined by the Commission.

Direct recommended auctioning off non-shopping Potomac Edison retail customers to competitive suppliers, with the auctioned customers placed into two categories: residential, and commercial (which would combine Type I and Type II customers).  Customers with demand of at least 600 kW which currently default to hourly service would not be included in the auction.

Similar to Pennsylvania, pricing for customers in the auction would be determined by the PSC based on various market indices.  Winning suppliers would serve customers at the administratively determined price for 12 months (under two six-month periods of a fixed price).  After the initial 12 months, winning retail suppliers would serve any customers they have retained during the year at a price determined at the supplier's discretion, which would be kept in check by competitive market forces.

For Maryland, Direct recommended that the residential auction include varying size tranches of between 20,000 and 50,000 customers, and the commercial auction include tranches of between 1000 and 4,000 customers.

Using the expected value of $150-500 per customer, Direct estimated that the retail auction could generate between $35 million and $119 million in revenue, which would be rebated to customers.

A spot market-based SOS option would be available for customers electing not to participate in the auction or for various other backstop requirements, with prices adjusted quarterly.

Testifying on behalf of Direct, Dr. Mathew Morey, a senior consultant at Christensen Associates, addressed the proffered benefit of the merger: that FirstEnergy Solutions would enter the Maryland residential market.  Morey noted that FirstEnergy Solutions is not currently serving this market.

"I believe there are two reasons why FES does not currently provide retail electric supply service to residential and small commercial customers in Potomac Edison's service territory.  First, providing retail service to large commercial and industrial customers is more lucrative.  Second, because FirstEnergy does not have distribution or generation services in the service territory, FES cannot leverage its relationship with the incumbent distribution company or sell the generation services of its affiliate in the way its business plan calls for to maximize revenues," Morey said.

   
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