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Pa. PUC Approves FirstEnergy-Allegheny Merger Without Additional Retail Market Conditions, Orders Investigation into Default Service

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February 25, 2011  

The Pennsylvania PUC approved, without additional retail market-related conditions, a non-unanimous stipulation authorizing the merger of FirstEnergy Corp. and Allegheny Energy (A-2010-2176520 et. al.).

The PUC did order a generic proceeding related to various retail market issues, including default service, due to concerns raised by retail suppliers in the merger proceeding, but there is no guarantee that the process will result in any change in market structure.

"There will be no retail electric choice in most of Pennsylvania as a result of this merger," PUC Chairman James Cawley said in a lengthy dissent, stating that the combined FirstEnergy-Allegheny company will be, "in a position to dominate the Pennsylvania market."

The PUC approved 3-2 a motion from Commissioners Robert Powelson and John Coleman, Jr. to approve the non-unanimous stipulation and deny the exceptions from Direct Energy and the Retail Energy Supply Association. Direct Energy, in particular, had sought to require the combined FirstEnergy distribution companies to cease serving as the default service provider, and to introduce an auction mechanism to assign non-shopping customers (see 8/18).

Powelson and Coleman's motion was supported by Commissioner Wayne Gardner.

Powelson and Coleman called the concerns raised by Direct and RESA, "largely speculative," and declined to adopt any of their recommendations. Furthermore, Powelson and Coleman said it would be more appropriate to address any issues related to the structure of the retail electricity market in Pennsylvania on a statewide level rather than on a "piecemeal" basis as a result of a litigated proceeding.

In that vein, the adopted motion from Powelson and Coleman requires the PUC to institute statewide investigation into Pennsylvania’s retail electricity market, "including an analysis of the current default service model and whether, as currently structured, that model is hindering competition."

"Additionally, the investigation will include a process to identify interested alternative suppliers of electric generation services qualified to provide default service throughout the state and should result in recommendations for legislative changes, as well as changes the Commission can initiate on its own, to improve competition in Pennsylvania’s retail markets," the motion states.

Furthermore, Powelson and Coleman's adopted motion requires several provisions to be added to the Code of Conduct Rulemaking currently underway at Docket No. L-2010-2160942, specifically: (1) protections so that Electric Generation Suppliers (EGS) affiliated with Electric Distribution Companies (EDCs) do not inappropriately benefit from the use of resources shared with their affiliated EDC; (2) prohibitions on joint EDC/EGS marketing, sales, and promotional activities; (3) provisions to prevent direct or indirect cross-subsidies, such as the use of the affiliate EDC for credit support for affiliated EGS sales; and (4) an examination of [emphasis added] whether the Commission should require EDC-affiliated EGSs to change their trade names so as to be dissimilar from both the EDC affiliate and corporate parent.

Finally, Powelson and Coleman's adopted motion directed the FirstEnergy distribution companies to meet with suppliers to address operational issues including (1) not implying a right of rescission in customer enrollment confirmation letters; (2) implementing an EDI Advance Notice of Drop; (3) providing PLC factors; (4) developing procedures for seamless moves; and (5) addressing account attribute changes for shopping customers by eliminating any operational or other rules that provide a disincentive for customers to either switch to a competitive electricity provider, or once switched, to remain a customer of an EGS, when a person initiates service or when a customer moves or his or her customer information changes (this "should" include prohibitions against any rule that requires an applicant to take default service for any period of time before being able to obtain service from an EGS).

Again, however, the motion only requires that the FirstEnergy distribution companies and suppliers "reach mutually satisfactory resolutions" to the above issues, rather than directing any specific action.

Vice Chairman Tyrone Christy dissented from the Powelson and Coleman motion, stating that he was "particularly troubled" by the majority's decision to open an investigation of the potential removal of the EDC as the default service provider.

Separately, the Commission also adopted a motion from Gardner to impose additional credit-related conditions on the merger, including a requirement that regulated and unregulated functions must remain organized as separate corporate structures.

As more fully reported in October (see 10/26), the non-unanimous stipulation requires implementation of POR at West Penn Power (since implemented), the offering of both rate ready and bill ready billing, improvements in availability of customer eligibility lists and supplier-specific sync lists, and that West Penn Power shall mail a letter to residential and small commercial customers listing offers from competitive electric suppliers twice during the period after merger consummation and prior to June 1, 2013. Administrative costs of the letter shall be recovered from participating suppliers.

Cawley Dissent

Cawley said that the conditions did not go far enough in ensuring the merger results in a workably competitive market as required by statute. The combination of FirstEnergy's existing generation with Allegheny's generation, each's role as default service provider, and FirstEnergy Solutions' marketing strategy for such generation, "will result in the stifling of competition throughout the FirstEnergy service territory," Cawley said.

"In consequence, no real competition will exist and result in customers paying higher prices than if real competition were able to develop," Cawley stated.

Citing Energy Choice Matters' recent report on FirstEnergy Solutions' over 81% market share of retail generation sales in its affiliated Ohio territories (see 2/17), Cawley warned that approval of the merger without additional conditions would result in, "Ohio All Over Again," or a market in which the majority of migration is simply to a competitive affiliate of the utility, and not an open market with numerous competitors.

Cawley criticized the approval of the merger by FERC in a perfunctory process. In particular, Cawley noted that FERC shifted the burden of evidence onto intervenors such as the Pennsylvania Office of Consumer Advocate. Matters is unaware of any merger rejected by FERC.

"FERC was content to rely on the IMM [independent market monitor] to ensure that economic withholding does not incur [due to the merger], rather than on a truly competitive generation market to force competitive outcomes in the marketplace," Cawley said.

Regarding OCA's contention that PJM West should be treated as a separate market for the merger's market power analysis, "FERC shifted the burden of proof to OCA and refused to hold an evidentiary hearing on this important issue of fact," Cawley noted.

"If FERC had taken the time to address product markets associated with default service bidding, market power screens for such markets would have consistently failed. In fact, all default service markets are highly concentrated. In the case of Penelec, the calculated HHI (Herfindahl-Hirschman) index for the residential and small commercial default service market, combined, would have been approximately 2800 pre-merger and over 4600 post merger, an HHI increase of over 1800 [a market with an HHI in excess of 1,800 is considered highly concentrated]. In the case of West Penn Power, individual default service class HHI indices were all approximately 4000 or higher, the combined residential and small commercial (rate class C-20) HHI index increased from approximately 3400 to 4200, and, combining all rate class procurement markets, the HHI index increased from approximately 2400 to 3000," Cawley said.

"These statistics clearly indicate that, if this merger is approved without the conditions proposed herein, it will be necessary for this Commission to significantly modify the provision of default service in the FirstEnergy companies’ service territories," Cawley warned.

"To put this in perspective, while there are approximately 1,340 generation plants in PJM, there were only 8 winning bidders in Penelec’s auctions, with 3 bidders accounting for over 77% of the supply. Similarly, there were approximately a dozen bidders in all of Allegheny’s default service auctions, but only 4 winning bidders. Without revealing too much detail because of the potential confidential nature of these requests for proposals and auctions, FirstEnergy and Allegheny Energy Services were substantive competitors – competition that will be lost in this merger to the detriment of Penelec and Allegheny default service customers," Cawley reported.

Cawley further questioned the so-called competitive nature of the PJM market which FERC is relying on to mitigate pricing. "Evidence provided in this proceeding clearly indicates that consumers must rely on the IMM and PJM’s tariff to mitigate market prices, instead of relying on real competition. For example, the IMM has already noted that capacity markets are highly concentrated, leading the IMM to impose bid caps in all zones. This merger will only increase the concentration of generating capacity in the PJM market, and worsen the potential market power problems in the capacity market," Cawley said.

Cawley would have required the FirstEnergy merged companies to exit the default service provider role, and also would have required the combined company to divest generation assets, "in such a fashion as to mitigate any increase in the HHI in PJM markets."

FirstEnergy should have been required to participate in the efforts of PPL Electric Utilities to design and implement an EGS consolidated billing process, Cawley added.

"The Partial Settlement provides quantitative benefits of slightly less than $22 million. In contrast to this, Allegheny Power shareholders would receive a $1.2 billion premium on their investment if they cash out today, Allegheny Power senior executives will be paid $43 million in change-of-control payments, and lawyers, investment bankers, and consultants will be paid $58 million," Cawley noted.

"As to the potential for higher default service premiums being imposed on consumers due to the highly concentrated nature of default service supplier markets, a mere $1 per MWH increase in default service costs translates into roughly $68 million and $86 million when net present valued over a 15 year period for the Penelec and West Penn Power service territories, respectively. If, on the other hand, FirstEnergy uses its expanded generation fleet to increase overall wholesale market prices only $1 per MWH in its four Pennsylvania service territories, the net present value cost to consumers over a 15-year period explodes to roughly $465 million ... It should come as no shock that these costs are in line with the premium paid and the costs incurred by FirstEnergy to gain approval of this merger," Cawley said.

Reacting to the decision, Steven Murray, president of Direct Energy’s residential business, said that the result is "disappointing" for the 2 million residential and small business electricity customers, "who will now face limited choice for their energy needs" and would have received an estimated credit of up to $500 under Direct Energy's auction proposal (as customers would have been paid revenue from suppliers bidding to serve the customers).

“Direct Energy welcomes the Public Utility Commission’s announcement of an investigation of regulatory and legislative initiatives needed to foster competition in Pennsylvania and we are hopeful that this review will be concluded and recommendations implemented via an expedited process," said Murray.

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