Abstract

Mergers, Acquisitions, and Market Power in the Electric Power Industry

Joseph Diamond and Jon D. Edwards

Institute for the Study of International Aspects of Competition

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:

1. Accurate definition of the market is needed.
2. Calculation of a merger specific benefit-cost test to the extent possible.
3. An understanding that market power is influenced by market share and elasticity of demand, as well as other factors is crucial.
4. There may be trade-offs between market structures
5. 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
6. 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.
7. Improved research should be done on economies of scale and scope of vertical integration versus other organizational options in order to evaluate M&A.
8. 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.
9. 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.