Constellation-Exelon Commit to Build New Generation in Amount Cited by Staff as Easing Market Power Concerns

Additional mitigation of the Exelon-Constellation merger remains necessary beyond the initially offered divestitures, Maryland PSC Staff said in a post-hearing brief, while Exelon-Constellation simultaneously announced a commitment to build new generation in an amount which Staff suggested could potentially alleviate Staff's remaining concerns.

Specifically, Exelon and Constellation, in order to, "eliminate any questions regarding the effectiveness of their proposed mitigation," are committing to construct 175 MW of new generation in Maryland. Of this total, at least 150 MW will be east of the 5004/5005 transmission constraint and 55 MW will consist of Tier 1 renewable resources.

"It is expected that of the 150 MW east of the 5004/5005 transmission constraint, 120 MW will be gas-fired combustion turbines and 30 MW will be solar," Constellation and Exelon said. Due to superior wind conditions in Western Maryland, the remaining 25 MW of renewable generation is more likely to be west of the constraint.

The commitment requires Exelon to develop, or assist in the development (such as through financing or PPA) of the generation, either directly or through a subsidiary other than Baltimore Gas & Electric.

This additional commitment is meant to address concerns about the retirement of the to-be divested Crane and Wagner units. While additional generation would increase the applicants' market share, the addition of generation is seen as also reducing capacity and energy prices.

While not Staff's preferred solution to mitigation concerns, Staff said in an initial brief that one alternative to relieve Staff's concerns would be to, "increase the amount of new generating capacity [applicants] have proposed to build as part of their application."

Staff witness Dr. David DeRamus stated, "New entry is always better for competition. And new renewable entry probably has double benefits. It benefits competition and it benefits ratepayers by substituting cleaner sources of energy for dirtier sources."

Staff noted that, "Dr. DeRamus recognized that a 150 MW increase in the amount of generation owned by the Applicants would increase their market share; however, he was 'comfortable that that additional capacity in the market is going to have benefits to consumers more broadly, have a depressing influence on prices, both capacity prices and energy prices, and provide some environmental benefits that would be real tangible.'"

Constellation's new commitment was made yesterday in its initial brief, meaning Staff had no opportunity to address the new commitments in its concurrently filed brief.

Addressing the mitigation offered by the applicants as it stood at the close of the hearings, Staff said, "it is not just the quantity of mitigation that is at issue, but also the quality of that mitigation, i.e., its actual effectiveness in addressing the market power concerns raised by the Applicants' merger, and this is dependent on whether the divested Crane and Wagner units are retired in the reasonably foreseeable future, as well as on who purchases the divested units, 500 MW sale of energy, and any other energy sales proposed by the Applicants."

Staff remains concerned that divesting the Crane and Wagner plants will not provide meaningful mitigation because the plants will likely be uneconomic under new environmental rules, and not likely candidates for needed retrofits. If these plants are ultimately retired, reducing the total installed capacity in PJM, the divestiture will not reduce the applicants' market position.

"Staff also stated that both plants, which began operations in the 1950s and 1960s, must burn significantly more coal to generate the same amount of electricity, and each plant's capacity factor has been steadily decreasing over the past five (5) years, further demonstrating 'their declining competitive position in the market.' All of these factors further support Staff's concern of the retirement risk for both plants, as 'generating plants that run less frequently will tend to have lower gross margins, and are at greater risk of being retired,'" Staff said.

"Since the Applicants' counter-proposal would not fully address the market power concerns raised by the Staff in the event of the retirement of the units at issue, it is not a viable option for the Commission's consideration," Staff said.

Staff noted that as part of Exelon's Third Quarter 2011 Earning's Conference Call, Exelon created a power point presentation, dated October 26, 2011, which indicated that PJM had announced 10,000 MW of coal retirements beginning in 2012, and that Exelon estimated as much as 15,000 MW of coal retirements in PJM through 2015.

"The retirement of this much coal generation will increase the Applicants' ability to exercise market power since the Applicants do not have any other significant coal plants in the relevant market other than the coal units being proposed for divestiture," Staff said.

"Such significant additional retirements by other market participants will necessarily further increase the Applicants' market shares. Exelon indicated that when coal plants in its markets are retired, there is a potential for price increases which could be positive for Exelon," Staff added.

Since the final decision on whether the divested plants will remain in operation will not be in the hands of either Exelon or Constellation, "the Commission cannot rely entirely on the Applicants' assertions regarding the future viability of the plants," Staff said.

Accordingly, Staff continues to maintain that a compliance filing, after the buyers of the plants are identified, is the most efficient option to ensure that the divestiture is effective, "as that will provide the perspective of whichever entity ultimately purchases the plants and what they intend to do with the plants."

The compliance filing would show the effect on market concentration given the actual divestitures, and presumably allow the Commission to pursue further mitigation at that time, if warranted.

Other alternatives suggested by Staff include swapping out Crane and Wagner in favor of divesting other units that are not at risk of being retired, or an additional divestiture now to compensate for the risk of the plants' early retirement. Adding 200 MW of additional divestiture to the applicants' current proposed mitigation, i.e., on a non-contingent basis, could be sufficient to compensate for the risk of Crane and Wagner retiring in the near future, Staff said.