Mergers, Acquisitions, and Market Power in the Electric Power Industry
Joseph Diamond and Jon D. Edwards
Working Paper 97-2
Market power is a subject of concern in a restructured electric power industry. In 1995, the U.S. electric power industry saw high rates of announced mergers and acquisitions (M&A). The objective of this paper is to investigate the interactions and effects of M&A and market power, both within California and throughout the U.S., and make recommendations concerning the FERC’s NOI on merger criteria and policy. M&A can be a result of economic efficiency, defensive motives, diversification, growth and personal aggrandizement, market power, and deregulation and international competition. M&A often do not work due to poor analysis or faulty implementation.
A survey of views on M&A in the electric power industry was done. Perspectives ranged from viewing recent M&A as strategic, designed to hold off competitive threats, leading to efficiency, and moving toward disaggregation as a natural part of the industry restructuring, and the development of “workable competition”. Specific recommendations relevant to the FERC NOI include:
- Accurate definition of the market is needed.
- Calculation of a merger specific benefit-cost test to the extent possible.
- An understanding that market power is influenced by market share and elasticity of demand, as well as other factors is crucial.
- There may be trade-offs between market structures
- In order to scrutinize efficiency claims:
- a. Cost savings need to be discounted
- b. Stand-alone analysis needs to be correctly specified
- c. Claimed benefits from capacity deferral need to recognize that benefits and costs occur beyond a limited period
- d. Savings in customer service and overhead costs tend to be asserted
- e. Rules for cost savings based on efficiency need to be developed
- f. Recognition of relevancy and trade-offs between allocative (competitive) versus technical efficiency is necessary
- Large path dependencies (irreversible situations) with uncertainty and their implications seem to be omitted from the public debate on M&A. If true, it would argue for a stringent merger policy which could be liberalized if conditions warrant.
- Improved research should be done on economies of scale and scope of vertical integration versus other organizational options in order to evaluate M&A.
- Estimates should be made of future M&A and their potential impacts might be included in planning studies as future scenarios that might assist public policy analysis.
- Continued monitoring should occur on the interrelationship of technological change, M&A, and market power.
It is too early to tell whether M&A in the electric power industry will lead to efficient restructuring to obtain economies of scale and/or scope, or will pose a threat to “workable competition” through the exercise of market power. FERC should note and evaluate the following point when revising its merger policy: Deregulation should be supplemented by strict antitrust policy in order to avoid market power abuses that are not in the public interest.
Appendix I provides a brief overview of the filings to FERC on its NOI. Appendix II is a summary of the new FERC policy stemming from its NOI Docket No. RM96-6-000 regarding mergers. We close with Appendix III which are comments on FERC’s new merger policy.