SPEAKERS CONTENTS INSERTS
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ANTITRUST ASPECTS OF ELECTRICITY DEREGULATION
WEDNESDAY, JUNE 4, 1997
House of Representatives,
Committee on the Judiciary,
Washington, DC.
The committee met, pursuant to notice, at 9:38 a.m., in room 2141, Rayburn House Office Building, Hon. Henry J. Hyde (chairman of the committee) presiding.
Present: Representatives Henry J. Hyde, F. James Sensenbrenner, Jr., George W. Gekas, Howard Coble, Sonny Bono, Ed Bryant, Steve Chabot, William L. Jenkins, Asa Hutchinson, Edward A. Pease, John Conyers, Jr., Howard L. Berman, Robert C. Scott, Melvin L. Watt, Zoe Lofgren, Sheila Jackson Lee, Martin T. Meehan, William D. Delahunt, and Robert Wexler.
Also present: Thomas E. Mooney, chief of staff/general counsel; Joseph Gibson, counsel; Julian Epstein, minority staff director; and Perry H. Apelbaum, minority chief counsel.
OPENING STATEMENT OF CHAIRMAN HYDE
Mr. HYDE. The committee will come to order. This morning, the committee begins hearings on antitrust aspects of electricity deregulation. In some respects, this debate reminds us of last year when we passed the Telecommunications Act of 1996 to bring the benefits of competition in local service to consumers.
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This year, we are discussing efforts to deregulate electricity, to bring the same benefits of retail competition to electricity consumers. The deregulation, or restructuring as some call it, of the electricity industry promises huge benefits to our national economy. Just as in the telecommunications area, everyone can state the promise of competition easily. But also like telecommunications, the details of how we get from here to there are devilishly complicated. As all of you know, they will not be resolved in a day; however, I am hopeful that working them out cooperatively will take us somewhat less than the 12 years that the Telecommunications Act took.
Because this is the Judiciary Committee's first foray into electricity in this Congress, I want to say a few words about my position. I am committed to getting us to full and fair competition in the retail electricity market. Beyond that broad goal, which I believe everybody shares, I have an open mind on how we get there. I am here this morning to learn as much as I can, and I know that the excellent witnesses that we have will help in that task.
Let me also say a word about committee jurisdiction. Our hearing will focus on antitrust, because that is the primary part of this debate over which we have jurisdiction. There are numerous antitrust issues involved, but there are also many issues not involving antitrust. We intend to have our say on the matters over which we have jurisdiction, but just as surely, we do not intend to impinge on the jurisdiction of the Commerce Committee.
We intend to have helpful and cooperative relationships with our colleagues on the Commerce Committee, as this process moves forward. We have already had very positive contacts at the staff level, and I expect to continue to have an excellent working relationship with them. I want to thank my friends, Chairman Tom Bliley, Ranking Member John Dingell, Dan Schaefer and Ralph Hall for the work they have already done in this area, and I look forward to working with them.
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As I said earlier, I have an open mind, as I am sure we all have, and we are here to learn. I look forward to hearing from the witnesses who will help illuminate this very complicated issue for us, and I am pleased to recognize the distinguished ranking member, Mr. Conyers, for an opening statement.
Mr. CONYERS. Good morning, Chairman Hyde and members, I am delighted to be here. And first of all, I would like to commend you for the jurisdictional situation we worked out with Commerce. It is well known in these hallowed halls that Commerce has the longest reach jurisdictionally of any committee known to man in the 20th century, and I do not make any reference to my dear colleague, Chairman Dingell.
But this is a very important area and I am glad that we are there. I am sorry that you mentioned the Telecommunications Act and how it was supposed to have benefited consumers, and we had an antitrust problem there that we worked together on. It just so happens that the Telecommunications Act isn't benefiting consumers, and I have all the speeches of all the Members and the White House and the President that explain to those of us who were not as anxious to believe the tooth fairy, that it was not going to happen, and it happened.
Now here we are again. The most vertically operated industry in America now wants to get more free of the modest restraints that the State holds on them. The most vertically integrated industry in America now wants to be free of the shackles of antitrust—I mean, how they have been held back and prevented from benefiting the consumer. There are lawsuits in Michigan, all over the map, about the utility abuses; and now they want to get free.
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We need—let my people go. It has a ring to it.
Well, anyway, I am happy to know that the president of Detroit Edison, Anthony ''Tony'' Earley, will be here to help ease the fears and apprehensions of some of the members of the Michigan delegation.
So I yield back the balance of my time.
Mr. HYDE. Thank you. I thank you.
Does anyone have an opening statement they wish to make.
Mr. DELAHUNT. I did, but I will waive it.
Mr. HYDE. You are a gentleman. Mr. Delahunt, I want your name with a gold star after it in the record.
Mr. Gekas.
Mr. GEKAS. I thank the chairman. Just a brief comment. My own State of Pennsylvania has recently engaged in the process of deregulating the electric industry, and so the importance of these panels today is higher for me than they normally would be because I have to see what is the play between the Federal and State positions on deregulation and how we—do we impede or foster the States embarking on their own enterprises in this field.
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This is an important issue for me, and I thank the Chair for bringing these hearings to the front.
Mr. HYDE. I thank the gentleman.
The gentleman from North Carolina.
Mr. COBLE. Nothing, Mr. Chairman.
Mr. HYDE. Thank you very much.
Does the gentleman from California have an opening statement?
Mr. BONO. Thank you, Mr. Chairman. Just a brief opening statement.
Our State, as well, is deregulating, and it is a very, very important issue. And how to do it, as you said, is very complicated. Any help we can get on what is the best way to do it—I actually concur with Mr. Gekas, and I hope we can find the best way. I think we have reached that era now where we do need to deregulate. Thank you for your assistance.
Mr. HYDE. Thank you, Mr. Bono.
The gentleman from Tennessee.
Mr. BRYANT. No.
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Mr. HYDE. Thank you.
Our first panel consists of witnesses from both of the Government's antitrust enforcement agencies, the Federal Trade Commission and the Antitrust Division of the Department of Justice. First we have Robert Pitofsky, Chairman of the Federal Trade Commission. Chairman Pitofsky is now serving his third tour of duty at the Commission. He was the Director of the Bureau of Consumer Protection from 1970 through 1973 and was a Commissioner from 1978 through 1981; he became Chairman in April 1995. In between those stints, he has been a professor at Georgetown University Law School and of counsel to the Washington law firm of Arnold & Porter.
Secondly, we have Douglas Melamed, Principal Deputy Assistant Attorney General in the Antitrust Division. Before coming to the Division in October 1996, Mr. Melamed was a partner in the Washington law firm of Wilmer, Cutler & Pickering. He has written numerous articles and taught law school courses in the field of antitrust law.
We are glad to have both of you with us today, and we look forward to your testimony. Which of you prefers to go first or are you indifferent?
STATEMENT OF ROBERT PITOFSKY, CHAIRMAN, FEDERAL TRADE COMMISSION
Mr. PITOFSKY. I will start. Thank you, Mr. Chairman, members of the committee.
I agree with the essential point of the opening statements, that this is an exceptionally important matter, deregulation of electric utilities, but getting the details right is going to make all the difference in whether or not it benefits consumers and the extent to which it benefits consumers. I have a more lengthy statement I would submit, with your permission, for the record.
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As you know, electric power is the latest industry where extensive rate and entry regulation probably has become outmoded by time and changes in technology. We have seen this pattern before with airlines, long distance telecommunications, railroads and trucking; and if history is any guideline, what we will see is deregulation leading to lower consumer prices with rare adverse effects on quality, greater choice for consumers, and new rivalry and progress in the area of technological innovation.
Now we look at another industry and an immense one. Some estimates are that we are talking about $200 billion in revenue, and hopefully we can learn from the past and conduct this deregulation in the most efficient way possible. I would like to make a few general points about deregulation, and then address the issue of deregulation in this industry.
First, some members of almost all deregulated industries, having thrived in a protected environment in which government prevented all-out competition, will seek to continue that quiet life through private arrangements, like cartels and accumulation of monopoly power, and it is essential that antitrust be available to respond to any such private arrangements.
Second, as the committee well knows, the transition from regulation to deregulation is never immediate, never complete, and therefore, there will be some firms in the competitive arena that will still be regulated, others completely deregulated, others partly regulated. Those companies will legitimately say that this difference in approach is unfair and inequitable.
The important thing to remember is that it is unfair in some circumstances. But the important thing when you have unequal regulation of different players in the marketplace is to try to focus on reducing regulation of those that are still regulated, rather than increasing regulation of those that have become deregulated.
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Third—I say this as an antitrust lawyer and teacher—antitrust addresses a narrow range of goals primarily concerned with economic efficiency, but those are not the only legitimate goals in the economy. For example, with respect to electrical utilities, there is the question of environmental protection, and there is the question of universal service. Antitrust doesn't easily accommodate that kind of consideration.
Nevertheless, the Federal Trade Commission has worked in the past, and will continue to work with FERC, hopefully in a cooperative way, in order to recognize and achieve those goals, as well as economic efficiency.
On the basis of the first three points that I have made, the fourth is that antitrust must be flexible, must take into account the special history and special concerns in this industry. I expect that what we will focus upon is price fixing. There will be very complicated questions of access, because there will be bottleneck monopolies that will remain as we move along in the direction of deregulation, and we must be concerned that the players in the industry do not restructure themselves and restore their massive market power, today protected by the government, through mergers or through predatory behavior.
Lastly and briefly, there are a series of consumer protection issues that we must think about as well, and at the Federal level, the Federal Trade Commission is the principal agency concerned with that. Quite soon, consumers are going to be presented with a world of choice they have never seen before, involving very complicated decisions. Advertising will make all sorts of claims about which form and which source of electrical energy is better and which is worse. We must be careful to ensure that there is no deception or unfairness in those claims.
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There may need to be legislation that makes essential information available to consumers so they can protect themselves in the free market. I have come around to the view that case-by-case enforcement sometimes is not the most efficient way to go. The best way to protect consumers is through consumer education, which puts them in a position to protect their own interests.
The FTC has already begun to look at those questions and will continue to do so.
In conclusion, let me simply say that I believe all the more in a deregulated environment. Antitrust is important, and I think these hearings are very welcome in the sense of examining the role antitrust will play.
Thank you.
Mr. HYDE. Thank you very much, Chairman Pitofsky.
[The prepared statement of Mr. Pitofsky follows:]
PREPARED STATEMENT OF ROBERT PITOFSKY, CHAIRMAN, FEDERAL TRADE COMMISSION
I. INTRODUCTION
Mr. Chairman and members of the Committee, I am pleased to appear before you today to present the testimony of the Federal Trade Commission concerning the important topic of deregulation and competition in the electric power industry.(see footnote 1) The staff of the Commission has commented to the Federal Energy Regulatory Commission (''FERC'') on the importance of wholesale competition(see footnote 2) and on the appropriate analytical framework for evaluating mergers,(see footnote 3) and to states on the importance of introducing competition in the electric power industry.(see footnote 4)
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The FTC is a law enforcement agency with statutory authority over a broad spectrum of the American economy, including the electric power industry. The Commission enforces, among other statutes, the FTC Act(see footnote 5) and the Clayton Act,(see footnote 6) sharing with the Department of Justice authority under section 7 of the Clayton Act to prohibit mergers or acquisitions that may ''substantially lessen competition or tend to create a monopoly.''(see footnote 7) Section 5 of the FTC Act prohibits ''unfair methods of competition'' and ''unfair or deceptive acts or practices,'' thus giving the Commission responsibilities in both the antitrust and consumer protection areas.
Electric power is the latest industry in which extensive regulation has been outmoded by time and technology. Regulation has receded in industries such as airlines, telecommunications, railroads, trucking, and banking and financial services. Over the last twenty years, an industry with many structural characteristics similar to electric power, the production and transmission of natural gas, has been largely deregulated. There are lessons to be learned from the successes and difficulties of these deregulatory efforts.
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The Commission's statement will focus on some general principles that apply whenever regulated markets are opened to competition and then will discuss the application of those principles to the electric power industry, keeping in mind several characteristics of this industry that may temper the application of competitive forces.
There are huge resources at stake in the shift to a competitive environment. Total industry revenues are estimated at $200 billion a year. If the levels of cost savings and technological improvements in this industry approach those attained in previously deregulated industries, consumers will be substantially better off in terms of lower prices and increased choices.(see footnote 8) These potential savings and innovations will not appear automatically, however. Ensuring the benefits of competition will require vigorous enforcement of antitrust and consumer protection principles. It is particularly important to establish effective merger enforcement in the early years of deregulation to deal with the reorganization that typically occurs in an industry after regulators lose the power to control terms of entry and consolidation. Many mergers represent a sound response to deregulation; others may be likely to preserve anticompetitive power. If the withdrawal of regulatory power is followed by the accumulation of undesirable private market power, deregulation will fail and consumers will lose.
II. GENERAL PRINCIPLES
Economic theory tells us, and experience confirms, that certain general principles apply whenever a heavily regulated industry is subjected to market forces. We can expect that, to some degree, these same forces will affect the electric power industry as regulatory constraints are peeled away.
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First, because industry participants have become used to a regulatory environment, some may attempt to protect or duplicate many of the comfortable aspects of that environment. Where they are accustomed to coordinated interaction and the use of the regulatory process to bar or disadvantage new entry, industry members may attempt to use monopolistic or cartel behavior to protect their entrenched positions after deregulation. A monopolist will not ordinarily welcome new entry, and issues of access or structural realignment designed to promote access will have to be considered with those incentives in mind.
Second, because the transition from regulation to competition is never instantaneous or complete, market participants may find themselves subject to inconsistent requirements. Some participants may become subject to market forces while others remain regulated, or different participants may be subject to different regulatory rules. It may be inefficient and unfair to have different regulatory rules apply to direct competitors. In the electric power industry, for instance, potential anticompetitive behavior may be monitored by FERC, state public utility commissions, or the federal antitrust agencies, depending on the pace and mix of deregulatory efforts. In a deregulatory environment, it is important to equalize treatment by reducing burdens whenever possible, rather than increasing them.
Third, regulatory bodies may have non-competition policy goals that warrant consideration in the transition to a competitive environment. In some regulated industries, for example, universal lifeline service(see footnote 9) at low cost is an important public policy goal. Another important policy goal in the electric power industry is environmental protection. Antitrust policy does not incorporate these goals. Some continuing regulation or other special provisions may be necessary to be certain that those policy goals are fully taken into account. Antitrust enforcement seeks to prevent coordinated private firm decisions that can lead to anticompetitive behavior while distinguishing behavior that promotes legitimate goals without harming competition.
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The first three principles imply that the antitrust laws will have to be applied flexibly to handle the issues that arise in regulated, or formerly regulated, industries. Regulatory regimes are usually established in response to some market failure, perceived or actual, that makes market forces inadequate to protect consumers and promote efficiency. Even if a consensus exists that the initial decision to regulate an industry was wrong, or technology obviates the need for regulation, the impact of the regulation on the industry structure, incentives, and expectations requires that the antitrust agencies be especially sensitive in applying antitrust rules while market forces regain primacy.
Applying the antitrust rules with special care does not, however, mean a ''hands off'' approach. The consumer and efficiency gains from deregulation may be jeopardized without vigorous antitrust enforcement during and after deregulation. The antitrust agencies must ensure that public regulation is replaced by private competition, not private collusion or dominant firm behavior. Here, the antitrust laws flexibility is a major advantage. Antitrust jurisprudence unfolds on a case-by-case approach, constantly adapting to new learning and new experiences. Where, as here, the deregulated world will be so different from the experience of all industry participants, it is difficult to know in advance what oversight will work best. The difficulty of predicting how the industry will look in the future suggests that fixing government oversight policy in concrete at this stage could be counterproductive. In this type of uncertain environment, flexible antitrust enforcement may be particularly important.
The little first hand experience with deregulation in electric power that is available supports the application of the antitrust laws at each stage of regulatory withdrawal. In Britain, for example, deregulation was accompanied by the sale of the government's monopoly system. The government's conventional (non-nuclear) generating capacity was divided between only two entities, and the resulting duopoly has assertedly been able to raise market prices by withholding capacity.(see footnote 10) This experience counsels in favor of continuous antitrust scrutiny of a deregulated electric power industry.
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III. APPLICATION OF THE ANTITRUST LAWS TO THE ELECTRIC POWER INDUSTRY
Congress designed the antitrust laws as general enforcement principles applicable to all industries. But the application is not mechanical. Thus, in applying these laws, the Commission is always cognizant that the competitive environment is different in each industry. The electric power industry exhibits its own unique characteristics, and antitrust analysis must take account of the industry as we find it.
A. Regulatory and Structural Background
Until recently, the electric power industry was dominated by vertically integrated monopolies. A retail customer bought electric power from a monopoly supplier that owned or controlled one or more generating plants, one set of transmission wires that moved the power from the generating plants to the local distribution grid, and one local distribution grid that moved the power to the customer.(see footnote 11) The economies of scale in power generation were such that no single long term contract would be sufficient to justify entry, which entailed huge sunk costs and a long lead time. In addition, the complexity of the transmission and distribution system was thought to be such that reliability could not be guaranteed if the generating capacity was supplied by an independent source.(see footnote 12)
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This vertically integrated monopoly system was, and continues to be, regulated at both the state and federal levels. In the states, public utility commissions have substantial power over company operations, including the power to set retail prices and rates of return. At the federal level, FERC regulates the interstate transmission of electricity, including the setting of transmission prices. Under the Federal Power Act, FERC is also required to approve mergers of interstate utility companies, using a public interest standard.(see footnote 13) In addition, the antitrust agencies are empowered to enforce the Clayton Act's section 7 prohibition against anticompetitive mergers.(see footnote 14)
In the 1970s and 1980s, a number of factors converged to change the perception of the industry.(see footnote 15) Congress passed the Public Utility Regulatory Policies Act of 1978 (''PURPA''),(see footnote 16) which authorized FERC to require utilities to purchase power from qualifying independent producers. Around the same time, new natural gas generation technology, assisted by a decrease in the price of natural gas relative to other fuels, began to make it economically feasible to generate electricity in much smaller plants. This so reduced the minimum efficient scale of power plants that generation of electricity could no longer be considered a natural monopoly. One unintended effect of PURPA was to provide information showing that independent generators would not disrupt the wholesale power grid. By 1994, approximately 8% of U.S. generating capacity was independently owned. In 1992, Congress passed the Energy Policy Act,(see footnote 17) which authorized FERC to order open access to the wholesale distribution system, which FERC did under Order 888(see footnote 18) on April 24, 1996.
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It is apparent that these changes are only the beginning. A number of states have seized the initiative and moved to increase competition in their local distribution systems, either by requiring open access to the transmission and distribution monopolies within their reach or by establishing independent system operators (''ISOs'') to determine access and pricing.(see footnote 19) Congressional interest also has been sparked. Several options are available for federal legislation. One is to allow the state experiments to continue without federal interference. Some, believing that interstate commerce will be affected by sharpened market forces and that there is the potential for one or more states to impede the introduction of competition, believe that Congress should mandate the boundaries of the deregulatory effort. Bills have been introduced that would limit federal action to repeal of certain federal regulatory schemes such as PURPA and PUHCA, while other bills would mandate comprehensive reform, including open access to the retail grid.
This is a political decision with substantial economic consequences. We do not address the method and scope of regulatory reform, but we believe that strong antitrust oversight of the industry will and should remain vital no matter what course of deregulation is chosen.
B. Competitive Issues—Vertical and Horizontal
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Market power can be accumulated or abused through both vertical and horizontal arrangements. These potential abuses are not unique to the electric power industry, but the structure and history of the industry suggest certain areas will require enhanced scrutiny.
The vertical relationships in this industry are different from those in almost all other industries. The industry has been almost completely integrated for many years. The important issue this industry structure raises is not how to prevent anticompetitive consolidation, but how to ensure that the benefits of new competition occurring in power generation reach the consumer. A key to effective competition is to provide open access(see footnote 20) for independent generators to vertically integrated transmission and distribution systems so that lower prices in generation are passed on to consumers. One possibility, of course, would be through divestiture of the vertically integrated companies. However, large scale forced divestiture could prove costly in terms of complex legal liability issues for existing contracts and the sacrifice of potentially important economies of scope and vertical integration.(see footnote 21) The method chosen by both the states and FERC to assure open access and efficient pricing in the transmission and distribution grids is to unbundle and make transparent the pricing decisions of the vertically integrated firms.(see footnote 22) If correctly done, this unbundling should prevent a monopolist from discriminating against independent power generators and from shifting costs to the regulated portion of its business.(see footnote 23)
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Two methods of unbundling currently are being used by regulators in the electric power industry. For wholesale sales of interstate transmission of electricity, FERC requires ''functional'' unbundling, whereby it orders a transmission monopolist to grant open access and charge the same prices to independent generators that it charges internally to its own generator plants. A number of states, on the other hand, have opted for what the FTC staff has termed ''operational'' unbundling, in which an independent system operator is established to operate the transmission and distribution grids to insure open access and transparent pricing while the monopolist retains ownership of the physical assets.(see footnote 24) The operational unbundling plan may work to preserve economies of vertical integration, internalize loop flow externalities, and assure transparent investment signals for potential investors(see footnote 25) while eliminating the strategic opportunities of the monopolist to favor subtly its own generating capacity.(see footnote 26)
In terms of horizontal antitrust scrutiny of the electric power industry, open access will not eliminate the need to guard against anticompetitive conduct, either through merger or through other means. Bottlenecks in transmission and distribution and loop flow problems could give rise to market power exercised unilaterally or through agreement among competitors. Mergers between generating firms may create market power that could be exercised by withholding capacity in order to drive up rates, as the British experience may indicate. Mergers at the retail level, between electric utilities or between electric utilities and independent retail marketers, could harm existing or potential competition.
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Following deregulation, horizontal mergers are more likely than vertical mergers in the electric power industry, given the current high level of vertical integration. Merger analysis is not industry specific; it is designed to apply across all industries. Nonetheless, this industry, like all industries, has certain unique features that would require that the analysis be applied in a flexible manner. Using the analysis described in the Horizontal Merger Guidelines, jointly developed by the Commission and the Department of Justice,(see footnote 27) the enforcement agencies assess whether the proposed transaction would harm consumers of any relevant product through increased prices or lower product quantity, quality or service levels, or reduced technological innovation.
Defining the relevant product and geographic markets is the first step in determining where any potential anticompetitive effects will be felt. A relevant product market is one in which many consumers of the product would not switch to an alternative product if the price of the first product were increased by a small, but significant amount.(see footnote 28) Similarly, a relevant geographic market comprises the locations of all of the alternative suppliers to which customers would likely turn if prices rose in the relevant product market.
In many industries, the more distinctive and important inquiry concerns the relevant product market, where the consumers substitutes are determined. In the electric power industry, both product and geographic markets may prove difficult to define with absolute precision. Product markets will need to be defined, taking into account time, reliability, and interruptibility. The more difficult issue in this industry may be defining the relevant geographic market. As open access to the transmission and distribution grids becomes the norm, consumers will be able to turn to ever more distant sources of electricity. The geographic market may be national, or perhaps even international if Canadian and Mexican generators become tied into the U.S. grids. But establishing the relevant markets may be more complicated because the elements of defining the product market also change the scope of the geographic market. Electricity cannot be stored in any measurable quantities; it must be generated as it is consumed. Also, demand varies substantially not only seasonally but by time of day. Thus, the substitute sellers of electricity to any given consumer may be a number of firms offering subtly different products. Some consumers may want guaranteed reliability, while others may opt for interruptible power at lower prices. Some consumers may choose to defer power consumption to off-peak hours in return for lower prices. Each of these consumer decisions affects the definition of the relevant product market and may affect the number of potential suppliers in that market.
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Once markets have been determined, the participants and their market shares must be identified. A market that is divided evenly among many participants will rarely have the potential for abuse of market power.(see footnote 29) The Merger Guidelines use a measure of market share distribution called the Herfindahl-Hirschman Index to determine the relative concentration of firms in the industry. In this industry, as in others, antitrust analysis goes significantly beyond the mere calculation of market shares. Certain economic characteristics may make this industry susceptible to cartel behavior at a level of concentration different from the point at which we would otherwise be concerned. A careful and thorough analysis of each transaction must therefore be undertaken once the relevant markets and market shares have been determined. If experience suggests that this industry is particularly subject to cartel behavior, or that mergers indirectly promote cartel behavior, then threshold levels of concern indicated by market shares may need to be adjusted.
Entry and efficiencies are factors that are given considerable emphasis in the Guidelines. If entry into a market is easy, post-merger market participants likely will be unable profitably to increase prices above the pre-merger level. Entry analysis in the electric power industry poses a number of difficulties. The size of an efficient generating plant has decreased significantly but it still may take longer than the Guidelines benchmark of two years to enter at that level. Siting and environmental problems may complicate and delay entry at any level. Excess capacity and the decommissioning costs of nuclear power plants are important factors to consider. The ease of entry in this industry may vary from case to case as relevant markets change. For instance, available sites for new building may be more abundant in some areas than in others, making entry quicker and less costly.
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The potential for anticompetitive effects does not end the inquiry in a typical merger investigation. Where the potential for anticompetitive effects is a close question, the potential efficiencies generated by the merger must be considered. Cognizable efficiencies may include economies of scale, integration of production facilities, plant specialization, and lower transportation costs.
The antitrust agencies have long considered efficiencies as relevant to the exercise of their prosecutorial discretion when deciding whether to challenge a transaction. In a close case, an agency may refrain from challenging a merger if it appears that the merger would generate substantial efficiencies. After a series of Commission hearings on Competition Policy in the New High-Tech, Global Marketplace indicated concern with how the antitrust agencies consider efficiencies in evaluating mergers, the Commission and the Department of Justice recently published a revised efficiency section for the Guidelines.(see footnote 30)
Efficiencies may have particular significance for the electric power industry. In an industry that has been pervasively regulated for many years, efficiencies are likely to play an enhanced role in motivating restructuring after deregulation. Where capital mobility was once circumscribed by regulators, firms will now be able to pursue the most efficient, market-determined structure. For instance, independent generators that have acted as maverick firms may be able to acquire additional capacity quickly, thus enhancing their ability and incentive to lower prices. Firms with an inefficient mix of generating plants for their markets (e.g., more low cost coal fired plants and fewer flexible natural gas fired plants in a market with highly volatile time of day demand peaks) may be able to adjust their capacity to the demand.
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C. Consumer Protection Issues
The Federal Trade Commission is the only agency with statutory mandates in both antitrust and consumer protection enforcement and is the only federal agency with general jurisdiction in the area of consumer protection. Effective consumer protection will be important in the electric power industry after deregulation. Choosing an electricity supplier will be a novel experience for most consumers, who may find it difficult to understand the ramifications of their choice of power supplier. The Commission has substantial experience with consumer information disclosures, in such diverse areas as energy efficiency information for major home appliances, octane ratings for gasoline, gas mileage information for automobiles, price and other information with respect to 900-number telephone lines, and loan interest rate information in the form of annual percentage rates.
The Commission has already begun efforts to protect electric power customers. The Commission is participating in an interagency task force established by the Department of Energy to explore consumer information issues arising from the restructuring of the electric power industry.(see footnote 31) In particular, the task force is addressing issues associated with providing consumers with reliable information on energy sources. One of the principal concerns that has already arisen with respect to consumer information disclosure is the ''green marketing'' of electricity, that is, marketing electricity generated by environmentally friendly methods. Because electricity is purchased by virtually all Americans, it will be important for marketers to convey environmental information in a way that consumers can understand, yet that is not so vague and general as to be deceptive through providing insufficient information. The Commission has issued Guides for the Use of Environmental Marketing Claims(see footnote 32) that will help provide guidance to electricity marketers on how to promote the environmental features of their product without misleading consumers. In addition, the requirement of section 5 of the Federal Trade Commission Act that marketing claims be truthful and substantiated will apply to claims made in the marketing of electricity.
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It may be very difficult to evaluate the types of environmental claims that are likely to be made in promotional materials for electricity. These claims might include such features as the fuel mix of a power seller (e.g., coal, nuclear, renewable resources) and the emissions associated with the generation (e.g., carbon dioxide, nitrous oxides, sulfur dioxide). When even technical experts do not agree on what is more important to the environment, it will be difficult to convey this information to consumers so that they can make a meaningful choice. Thus, effective consumer education and enforcement of the law against unfair or deceptive acts or practices will be important.
IV. CONCLUSION
Deregulation in a number of industries has proven to be beneficial to consumers and the competitive process. The deregulated industries exhibit lower prices, increased quality and quantity of goods and services, and heightened innovation. The electric power industry is on the verge of substantial deregulation. While it is unclear whether that process will be driven by the states or by the federal government, the outcome in either case should be that market forces will have an effect on firms long accustomed to the slower pace of regulated life.
The potential for consumer savings and increased choice is enormous, but it is certainly not guaranteed. Vigilant antitrust enforcement is an essential component of a market economy, especially in the formative years after the regulatory grasp is loosened. In particular, strong merger enforcement is necessary to ensure that the inevitable restructuring does not result in the accumulation and abuse of private market power. The Commission stands ready to provide this enforcement to protect the consumer gains that should follow the introduction of market forces to the electric power industry.
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Mr. HYDE. And now, Douglas Melamed of the Antitrust Division.
STATEMENT OF A. DOUGLAS MELAMED, PRINCIPAL DEPUTY ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION, U.S. DEPARTMENT OF JUSTICE
Mr. MELAMED. Thank you, Mr. Chairman and members of the committee. I appreciate the opportunity to speak to you this morning about some of the competition issues involved in restructuring the electric power industry. I have a longer written statement, which I would submit for the record, but would like to summarize briefly this morning.
It would be hard to overstate the importance of electric power to the American economy and to American families. Sales of electricity in the United States total more than $200 billion a year. All of us have a stake in eliminating obstacles to efficient generation and transmission of electrical power.
The Antitrust Division is actively working with other agencies of the executive branch to develop the administration's position on some key restructuring issues. That process is not complete, but I can highlight a few key issues we think must be dealt with if competitive restructuring is to succeed. Our perspective reflects more than 25 years of active enforcement activity by the Antitrust Division in this industry.
Technology in the electric power industry has evolved to the point where competition is feasible in the generation segment of the industry, but it is not yet feasible in the transmission and distribution segments. The challenge before us is thus to foster vigorously competitive generation markets within the context of regulated transmission and distribution monopolies. The electric power industry has a number of unique characteristics that distinguish it even from other network industries and that will make the restructuring task very challenging. The product, electric energy, cannot be stored and consumer demand for it varies widely from season to season, day to day, and even hour to hour.
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Actual quantities generated thus must continuously and instantaneously adjust to changes in demand for electric power. In addition, the flow of energy over an electric power network cannot today be economically switched to follow a particular path, so energy flows along the path of least resistance. As a result, the actual physical delivery patterns for electricity may not match the contractual arrangements for the sale of electricity, and successful transmission depends on the relative output levels of all the generators on the power grid.
Antitrust enforcement will play a large role as we move to a competitive market. As our experience with deregulation and a variety of industries over the past two decades shows, when we seek to end pervasive government regulation and make room for competitive market forces, the industry responds with a major restructuring of its own in attempting to adapt to the new environment. If history is any guide, we can anticipate a wave of electric utility mergers and acquisitions, and we can also anticipate increased temptation, at the very least, on the part of utilities to resort to anticompetitive schemes, to ease competitive pressures posed by the new market-based environment.
It is critically important to have an active and sound antitrust enforcement policy to help ensure a successful transition to competition. The Antitrust Division intends to remain vigilant and active in this respect.
Let me briefly discuss two of the potential benefits of successful competitive restructuring: open access to transmission and time-of-use pricing. Open access to the transmission system will increase efficiency because purchasers of electric power will gain access to the least costly suppliers, because a vertically integrated utility, one that owns both generation and transmission facilities, ordinarily has the ability and incentive to favor its own generators and to restrict transmission access by other generators. Achieving open access requires that control of transmission be independent from ownership of generation. This might be accomplished through FERC orders 888 and 889 issued last year or through an independent system operator, which is a regional entity that takes operational control of transmission but does not alter ownership of the transmission facilities.
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Time of use pricing will enable end users to obtain reduced rates when they shift their use of power from peak to nonpeak time periods and will thus create incentives for more efficient use of generation capacity. With time-of-use pricing, there will be less need to employ the more costly generating facilities and less need to construct additional generating facilities solely to handle peak load. The result should be reduced total cost for the electric industry as a whole, and reduced average cost to the benefit of consumers.
Congress should consider whether current regulation unnecessarily impedes the incentives for end users to shift their power use to offpeak time periods in order to achieve this desirable result.
Before I conclude my statement, I should touch briefly on two potential impediments to effective competitive restructuring: market power in the generation segment of the industry and the question of stranded costs. Market power issues in the electricity industry are complex and subtle, and they are likely to change as we move from a regulated environment to a competitive one. We think it would be a good idea for FERC to study the market power issues; Federal tools to remedy market power problems may need to be augmented. As to stranded costs: There is, as I am sure the committee knows, great debate about how to measure them and who should pay for them. We take no position on those important questions, but we do believe that however stranded costs are to be measured and allocated, they should be recovered only on a competitively neutral basis, one that minimizes or avoids to the extent possible distortions of competitive choices by wholesale and retail customers.
On a final note, Mr. Chairman, I would like to thank you and the committee for the important role you played in the last Congress in preserving the full applicability of the antitrust laws and the restructuring of the telecommunications industry. That is equally important when it comes to restructuring the electric industry. Any such restructuring is, by its nature, an experiment, even if a carefully considered one. It is important to maintain the backstop of antitrust laws and their 100-year history of preserving and fostering competition.
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Thank you.
[The prepared statement of Mr. Melamed follows:]
PREPARED STATEMENT OF A. DOUGLAS MELAMED, PRINCIPAL DEPUTY ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION, U.S. DEPARTMENT OF JUSTICE
Good morning, Mr. Chairman and Members of the Committee. I appreciate the opportunity to speak to you about some of the competition issues involved in restructuring the electric power industry.
It would be hard to overstate the importance of electric power to the American economy and to American families. Sales of electricity in the U.S. totaled more than $207 billion in 1995, the last year for which final figures are available. All of us have a stake in eliminating obstacles to efficient generation and transmission of electric power.
I believe that bringing competitive market forces more fully to bear in the electric power industry will enable more efficient use of electric power resources, resulting in important benefits for consumers and the economy. Experience has shown that truly competitive markets, when they are achievable, invariably surpass regulation in efficiently allocating resources and maximizing consumer welfare.
Congress has begun looking at what can be done at the federal level to encourage competition in the electric power industry. While I am generally supportive of these efforts, I think it is appropriate to sound a note of caution at the outset. The fact is that there are unique attributes to this industry that will likely make successful competitive restructuring more difficult than might appear at first glance.
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In my remarks today, I do not intend to outline a program or offer definitive answers. At this point, the Antitrust Division is actively working with other interested agencies in the Administration to develop the Administration's position on key restructuring issues. So, today, I will simply highlight what I believe are some important issues that will have to be dealt with if we are to have a successful restructuring effort. After I give a brief overview of our enforcement activity in this industry and the industry's evolution, I will discuss two potential areas for increased competitive benefits: open access transmission and time-of-use pricing. I will also address two potential impediments to effective competitive restructuring: potential market power problems and the matter of stranded costs.
HISTORICAL ROLE OF THE ANTITRUST DIVISION
The Antitrust Division has long played an important role in protecting and promoting free and open markets in the electric power industry. A seminal antitrust case in this industry was an enforcement action brought by the Antitrust Division under the Sherman Act to stop the Otter Tail Power Company from monopolizing the retail distribution of electric power in its service area in Minnesota, North Dakota, and South Dakota. Otter Tail owned the transmission lines in its service area, and one of the means it employed to monopolize the market was to refuse to transmit, or ''wheel,'' power over its lines to municipal utilities competing with it for local distribution. In 1973, the Supreme Court upheld a lower court order requiring Otter Tail to wheel power to the municipal utilities, ruling that the electric power industry was subject to the antitrust laws even though it was also subject to regulation by the Federal Power Commission.
Since that time, now more than two decades ago, we have worked to ensure that the antitrust laws protect consumers of electricity. We have conducted many merger reviews, helped FERC develop its new merger review standards, which now are closely patterned on the joint DOJ–FTC merger guidelines, and been active participants in major FERC rulemaking proceedings involving competition issues. Through these activities, I believe the Division has developed a good understanding of the competitive issues in the electric power industry. As we move to a competitive generation market, antitrust enforcement will play an even larger role. As our experience with deregulation in a variety of industries over the past two decades shows, when we seek to narrow government regulation and make room for competitive market forces, the industry involved typically responds with a major restructuring of its own. If history is any guide, we could see a wave of electric utility mergers and acquisitions. And we would also anticipate increased temptation—at a minimum—on the part of utilities to resort to anticompetitive schemes to ease the competitive pressures of the new market-based environment. It is critically important to have an active and sound antitrust enforcement policy to help ensure a successful transition to competition. The Antitrust Division intends to remain vigilant and active.
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THE ELECTRIC POWER INDUSTRY
The electric power industry developed historically from a patchwork of isolated and vertically integrated electric utilities, each generating and distributing electric energy to consumers in relatively compact service areas. Each service area was regarded as a ''natural monopoly,'' because under the existing technology it did not appear economically justifiable to invest in more than one distribution system in each local service area or to construct more generators than necessary to provide full capacity and reliability to that area. Because of these natural monopoly characteristics, state regulators typically required the local utility to supply all consumers in its area, at regulated rates.
Advances in technology over time made power generation more efficient at a larger scale and made transmission of electric energy possible over long distances. These advances encouraged interconnection among utility transmission networks, initially for enhanced reliability and then for improved economy of service.
More recently, it has become possible, with improved technology, to generate electric power at efficient cost levels with much smaller generating plants. There is now a growing consensus that the generation segment of electric power supply could become more efficient and economical under competitive market forces. The transmission and distribution segments, on the other hand, will likely retain their natural monopoly characteristics for the foreseeable future. The challenge, then, is to foster vigorously competitive generation markets within the context of regulated transmission and distribution monopolies.
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In thinking about restructuring, it is important to remember that the electric power industry has a number of unique characteristics that distinguish it not only from basic manufactured goods markets, but also from other network industries such as telecommunications. The product—electric energy—cannot be stored, and consumer demand for it varies widely from season-to-season, from day-to-day, and from hour-to-hour. Actual quantities generated must continuously and instantaneously match widely varying consumer demand.
In addition, the flow of energy over an electric power network cannot economically be switched to follow a particular path, so in the power grid of today and the immediate future, energy will flow along the path of least resistance. Therefore, the actual physical delivery patterns for electricity may not match the contractual arrangements for sale of electricity, and successful transmission will depend on the relative output levels of all generators on the power grid.
INCREASING WHOLESALE COMPETITION
Much of the discussion about restructuring the electric power industry has centered around introducing retail competition. That is certainly a desirable goal, but it will not be easy to achieve. Indeed, an essential first step toward achieving competitive retail prices for electricity will be to ensure that we have a well-functioning wholesale market. Although considerable progress has been made toward this objective, we are not there yet.
We believe that the wholesale market can be made to function even more efficiently than it is currently functioning. Doing so would benefit both wholesale and retail purchasers of electric power, including households and small businesses that use relatively small amounts of power.
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OPEN ACCESS TO TRANSMISSION
Competition can be most effective to the extent that low-cost generators are able to compete for sales to all potential customers that they can economically serve given available technology. When electric power is supplied by the least costly generators running to full efficient capacity, the overall cost of generating the power is minimized, and prices can be lowered. Such competition by low-cost generators requires open and non-discriminatory access to transmission.
Vertical integration in the same utility of generation and regulated monopoly transmission, however, creates an incentive and ability to impede open access. Because competing generators of electricity will need to use the local utility's transmission facilities in order to supply customers in that utility's service area, the vertically-integrated utility has the ability and incentive to impede competition by favoring its own generators and otherwise restricting competitors access.
Last year, the Federal Energy Regulatory Commission (FERC) issued Orders 888 and 889, designed to prevent such discriminatory practices. FERC ordered utilities to separate their generation and transmission businesses functionally, and to abide by a Code of Conduct. FERC's order, which relies on the integrated utilities to engage in conduct that may be inconsistent with their economic interests, may prove insufficient to ensure open access.
Turning over operation and control of transmission facilities to Independent Systems Operators (''ISOs'') is potentially a more promising solution for preventing anticompetitive, discriminatory behavior by the owners of transmission facilities. ISOs are regional entities that assume operational control of transmission facilities. Although the current utility transmission owners could retain ownership of their transmission facilities, the ISOs, if governed in a manner that renders them truly independent of the parochial interests of the owning utilities, could ensure comparable and non- discriminatory access to the transmission grid by competing power suppliers. Congress should consider whether FERC needs additional regulatory authority to promote the creation of ISOs.
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Open transmission access alone will not guarantee competition in the wholesale market. As long as the transmission segment of the industry remains a monopoly, there will be regulatory issues to deal with regarding transmission rates and rate structures. It is important that transmission prices not be so high as to distort competitive decisions for purchasing power from the most efficient suppliers, and not be so low as to discourage investment in major new transmission projects to eliminate bottlenecks in the transmission system. The industry and regulators will undoubtedly also face other important issues regarding how to promote expansion of transmission systems to sustain and nurture competitive wholesale markets.
TIME-OF-USE PRICING
One obvious benefit of increased competition is that it allows consumers to choose a lower-cost electricity supplier. In addition, increased competition can enable certain purchasers to benefit by adjusting their time of consumption in response to price signals. If these purchasers shift some of their use of electricity from peak to non-peak periods, they will reduce the overall costs of acquiring electricity. Lower total demand during peak periods will require less investment in generating facilities and will lower overall system costs.
Congress may want to consider whether current regulation unnecessarily prevents end-users from purchasing electric power directly from a supplier other than their local utility. If end-users are required to purchase power in the retail market at rates based on averaged costs of providing electricity—which do not fluctuate to reflect the actual cost of producing electricity at different points in time—end-users lose an important economic incentive to make more efficient purchases of power.
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MARKET POWER
It is crucial to address possible market power problems in the generation market. Historically, of course, vertically integrated electric utilities have typically had monopoly power in their distribution area, and we anticipate that significant pockets of market power may remain even after wholesale competition is widely introduced. This market power stems not only from transmission constraints, but also from high levels of concentration in the generation market. If competition is to take hold in this industry, restructuring of the generation market may be necessary.
Because of the complexities I described earlier in the physics of transmitting electric power through a shared network, market power is maintained and exercised in the electric power industry in complex ways, which may change as we move from a regulated environment to a competitive one.
As a first step, we urge Congress to consider giving FERC the authorization and resources to undertake a thorough study of market power in this industry. FERC not only is the agency most familiar with the industry; it also offers a suitable public forum in which all interested parties may present their views. We would, of course, be pleased to participate in any such study.
We also believe that the federal tools to remedy market power problems where they are found may need to be augmented. The antitrust laws do not outlaw the mere possession of monopoly power. The exercise of market power can be addressed only if an entity is attempting to monopolize, or if two or more entities are acting in concert in restraint of trade or are proposing to merge. With an industry emerging from decades of government-sanctioned monopoly, we anticipate that there may well be market power problems that do not fit neatly into these categories but are nonetheless serious impediments to competition. Congress should carefully consider whether regulators have sufficient authority to remedy any market power problems, or if federal legislation should further enhance regulatory tools in this area.
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COMPETITIVELY NEUTRAL RECOVERY OF STRANDED COSTS
Let me now turn to what have been referred to as ''stranded costs.'' As competition lowers prices for electricity, it will become increasingly difficult for utilities to recover all of the capital investments they made under regulation. The historical costs on which utilities will not be able to earn a reasonable return in a competitive market are known as ''stranded costs.''
There may be many billions of dollars of potential stranded costs at stake here. Not surprisingly, the question of what to do about stranded costs has emerged as one of the major points of controversy in the electric power restructuring debate. There are strong differences of opinion, not only about who should absorb these costs—the shareholders, the ratepayers, or some broader segment of society—but also about how to measure them. Should all construction costs incurred during the regulated monopoly era be counted, or only costs that are shown to meet a standard of prudence? How great an effort to mitigate the costs should the utility be required to undertake before the remaining costs are deemed to be truly stranded? These, and probably others, are important questions.
We are not here to give an Administration position on either how stranded costs should be measured or how they should be allocated. But however stranded costs are measured and allocated, we believe it is important that they be assessed on a competitively neutral basis. By this we mean that they should be recovered in a way that minimizes distortions of competitive choices by wholesale and retail customers. Otherwise, customers could be artificially induced to choose less efficient suppliers, or less efficient sources of energy.
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CONCLUSION
On a final note, I would like to thank you, Mr. Chairman, and this Committee for the important role you played during consideration of the Telecommunications Act, in ensuring that the importance of preserving full applicability of the antitrust laws was not overlooked in the dramatic deregulatory restructuring of an industry occasioned by that legislation. It is equally important that the antitrust laws remain fully applicable to the electric power industry. Any restructuring of an industry is by nature an experiment—even when it is a carefully considered one. It is thus important to maintain the backstop of the antitrust laws and their 100-year history of preserving and fostering competition.
Mr. HYDE. Thank you, Mr. Melamed.
I would just like to say parenthetically I think the Government and the country are fortunate to have two antitrust enforcement agencies. Normally, that would create a conflict, but working together as well as you both do, and with our interest in cooperation, I think the end result is a good one for the country.
Mr. Conyers, do you have any questions?
Mr. CONYERS. Well, just one or two.
Mr. Melamed, have you testified here before?
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Mr. MELAMED. No.
Mr. CONYERS. Well, welcome. It is usually a friendlier environment.
Now, don't either of you watchdogs of antitrust have any observations about the unprecedented, historic wave of mergers that are going on as we sit here? No, that is not the subject for today, I know, Bob, I got your statement—but I mean—really, gentlemen, I mean, if you read the Wall Street Journal, it will tell you the story.
If it wasn't for the chairman and me, the phone gang would have taken antitrust totally out of the picture. They said, let the FCC decide, which never held an antitrust case in its collective existence; they said, who needs antitrust, as they were throwing out the biggest antitrust law in our history. My dearest friend, Anne Bingaman, whose bark was certainly worse than her bite, was able to keep some kind of order.
Chairman Pitofsky, I know your sentiments, but do you know how many antitrust busts you have pulled off in the last half of the 20th century? And thank God for the Senator the junior Senator from South Carolina. We are tired of all of this yapping about antitrust and nobody is doing anything about it.
I mean, you can buy it off the newsstands; you don't need a lawyer. Murdoch, now American citizen Murdoch, you can now own as many radio stations, television stations, cable, in one market.
Well, we are deregulating, guys. And talking about the phone industry—in the 16 months after the Government opened the $100 billion local phone market to no-holds-barred competition, a new study has found that fewer than half of 1 percent of Americans receive their residential phone service from a competitor to the monopoly provider.
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Airlines, trucking, you know what it costs me to fly to Washington when I started out? It's 86 bucks. You know what it is now? It's $242 coach, and there is no other way to get here. Thanks, guys, you have done a really remarkable job. I mean, we consumers feel so much more comfortable as we sleep in our beds at night.
Mr. HYDE. Those pilots keep wanting to strike, don't they?
Mr. PITOFSKY. May I say something?
Mr. CONYERS. I wish you would.
Mr. PITOFSKY. In one sense, I share the spirit with which you call our attention to this merger wave that is going on in this country. We set a record 2 years ago, we set another record last year for the number of large mergers, and we are well on our way to setting another record in the current year.
On the other hand, I would like to suggest that we are not doing nothing about it, as you may have implied.
Mr. CONYERS. Well, no, you are approving them, you are doing a lot about it.
Mr. PITOFSKY. Well, we are not approving all of them. The people we are suing wouldn't say we are doing nothing, RiteAid and Revco, Staples, Ciba-Geigy, for example, wouldn't say we are doing nothing.
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We brought more merger cases at the Federal Trade Commission 2 years ago and again last year than in any year since 1979. Are we doing enough? We are, to some extent, overwhelmed by the number of mergers that are going on now, but we are actively enforcing the law. We brought 65 merger cases in just the last 2 years. That is much more, far more, than I suspect were filed in the entire decade of the 1980's. So we are not sitting back passively.
On the other hand, it is certainly true that many industries are restructuring themselves through merger in a way that legitimately raises consumer questions.
Mr. CONYERS. Mr. Chairman, can I have a few more minutes to get a response from the Justice Department?
Mr. HYDE. Without objection.
Mr. MELAMED. Congressman, your question is a very important one because we all share a concern in ensuring that deregulation does not mean unbridled monopoly power and ensuring vigorous and continued enforcement of the antitrust laws and application of the antitrust laws to recently deregulated segments. I think two important points, though, should be borne in mind.
First, it is predictable, as I said in my opening statement, that an industry that has been for decades subject to pervasive regulation would have efforts at restructuring as an immediate response to the lifting of regulation. Regulation often does not reflect or lead to optimal allocation of resources in an industry.
When a regulation is lifted, industry players often respond to their freedom by efforts at restructuring. We find that, as you pointed out, in the telecommunications industry and the transportation industry, and I would predict similar kinds of responses in the electricity industry. That is not a surprising development. I think indeed it may well reflect the healthy and desirable workings of a competitive market.
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The key is to have adequate antitrust enforcement. I can't tell you that every decision made by the agencies is, in hindsight, a perfect or a correct decision, but I think the picture you described of an antitrust agency sitting back and doing nothing is really inaccurate in two respects.
If you look at the communications industry, for example, you find radio mergers were, for all practical purposes, prohibited until the Telecommunications Act. There has been a wave of radio mergers since then, and the Antitrust Division has brought enforcement proceedings in many of those radio mergers in an effort to prevent undue concentrations in the communities where there were competitive problems.
Similarly, on the telephone side, in the AT&T–McCaw transaction, BT–MCI, and others, the Antitrust Division has brought enforcement proceedings. I would expect us to continue to do that in future transactions.
Ironically, in some areas, such as the airlines, I think the record is fairly clear. Where the Antitrust Division did not have authority to enforce merger laws in the early stages of deregulation in the airline industry and was limited to the role of commenting, there were several mergers on which the Antitrust Division recommended that the merger be disapproved, and the Department of Transportation nevertheless approved the merger. So I think history shows that while we can't guarantee that we can do it perfectly, vigorous antitrust enforcement and continued antitrust jurisdiction is the best guarantee against undue market power created by mergers.
Mr. CONYERS. Thank you very much, gentlemen. I appreciate your responses.
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Mr. HYDE. The gentleman from Pennsylvania, Mr. Gekas.
Mr. GEKAS. I thank the Chair.
The chairman of our committee was complimentary of the way that the two entities that you represent work together on antitrust, yet that same concern concerns me.
When two entities in an industry—in the electric industry, for instance—apply for a merger, are both your agencies notified that it is—does the application have to come before both of you, or does it simply go to the FTC and then somehow Justice gets into the act; or how does that work? Will somebody answer that first?
Mr. PITOFSKY. Both agencies are promptly notified that there is a filing in each individual matter.
Mr. GEKAS. But the applicants don't have to apply to the Department of Justice?
Mr. PITOFSKY. They do.
Mr. GEKAS. Or submit their documents to the Department of Justice at the outset; is that correct?
Mr. PITOFSKY. They do.
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Mr. GEKAS. So now the FTC begins its work in analyzing this proposed merger, and then if it decides against the merger, does it engage the Department of Justice, or does it move on its own? How does that work?
Mr. PITOFSKY. Let me say a word about that. Actually, the two agencies never have and do not now ever investigate the same matter at the same time.
What happens is, when the file comes in, both agencies are notified, and then there is a coordination arrangement between the two agencies—probably working better than ever right now—in which we decide on the basis of our experience, our history, our knowledge of the industry, the special abilities that we have to go to court or use an administrative proceeding, which agency should better handle that matter. We work that out, and one agency addresses the question and the other backs off.
Mr. GEKAS. You said, both are notified. Again, back to the original question. Do the applicants notify both entities?
Mr. PITOFSKY. The Federal Trade Commission and the Department of Justice are notified, and we then promptly coordinate with the Department of Justice.
Mr. GEKAS. Well, then, how in the final result does Justice ever enter into the legal process of antitrust in the application that came directly to your entity?
Mr. PITOFSKY. It comes to both, but there is a coordinating committee that looks at the papers, members of the Antitrust Division, members of the FTC. A decision is taken as promptly as possible, often in a matter of several days, which agency will review the file; and if the Department of Justice is the agency that will review the file, the FTC clears the matter to the Department of Justice.
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Mr. GEKAS. It seems unnecessary to me. Maybe I don't see all of the details.
If the FTC has the power to pursue remedies in antitrust fashion, the question comes to my mind, why does the Department of Justice have to come in, or vice versa? If the FTC finds an antitrust issue, why not just have under the law the demand that it go directly to Justice to handle antitrust, like it does in every other field?
Mr. PITOFSKY. The filings take place in both agencies. It seems more efficient to do it this way.
We do enforce a slightly different law, although that is a minor matter; but perhaps more important, we enforce our laws in somewhat different ways on occasion. The Department of Justice always takes its case to court. We may take the case to court, but there are certain kinds of cases that profit from a more extensive administrative procedure, and those cases would go into the Federal Trade Commission's administrative procedure.
So there are virtues to one agency or the other handling a particular case. More important than that, the Department of Justice has decades of experience with respect to certain industries. We have the same with respect to other industries, and we are able to, I hope, be more efficient and more effective in our review as a result of our experience.
Mr. GEKAS. I yield back the balance of my nontime.
Mr. HYDE. I thank the gentleman.
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The gentleman from California.
Mr. Berman.
Mr. BERMAN. Thank you, Mr. Chairman. I am a little unclear on the role of FERC. Do they have jurisdiction over mergers?
Mr. MELAMED. Yes. They have jurisdiction to approve mergers, and it is broader than simply for competition reasons, although their recent statement suggested they are using an analysis very similar to the Justice Department's antitrust analysis.
Mr. BERMAN. So in this new world, where there is, in some cases, State deregulation, perhaps soon to be Federal deregulation, three different agencies of the Federal Government will have jurisdiction to look at proposed mergers from a competition perspective.
Mr. MELAMED. You mean two Federal agencies and a State agency; is that your question?
Mr. BERMAN. Well, FERC, Justice, and who is the guy on your left?
Mr. MELAMED. Oh, well, the Federal Trade Commission and the Antitrust Division don't—as Chairman Pitofsky said a moment ago, don't both look at the same merger, there is an allocation among the agencies as to which one will look at a merger for antitrust reasons.
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Mr. BERMAN. I thought there was an allocation of issues, but there is an allocation of companies. So it will be one or the other and FERC?
Mr. MELAMED. That is correct.
Mr. BERMAN. Mr. Melamed, or either one of you, are there any special problems posed when electric utility companies and natural gas utilities or unregulated gas and electricity marketers propose a merger that would be different than two electric utilities merging? Are any special issues raised by that kind of merger?
Mr. MELAMED. Well, the conceptual issues, the legal issues are the same, the facts may well differ. On the one hand, it may be less likely there is direct competition, horizontal competition, between the merging parties and the situation you posed than there would be if, for example, two generators sought to merge.
On the other hand, it is more likely there would be a vertical relationship if, for example, the electricity utility is using natural gas power. So the particular facts could be different and the analysis could differ, but it would depend on the circumstances.
Mr. BERMAN. In southern California, there is a specific situation raised by the proposed merger of Southern California Gas and San Diego Gas & Electric Co., where apparently Southern California Gas controls the only transmission pipeline for natural gas into the area.
In your testimony, at least in the summary of it, you talk about successful competitive restructuring, with the dual benefits of open access to transmission and time-of-use pricing. The allegation of one of the parties who opposed that merger is that during offpeak seasons, the gas company purchases at below market prices its own natural gas coming through its pipeline for storage purposes. This forces the price of gas at the peak use time to go higher; and that this kind of a merger will pose special problems here in terms of giving them a competitive advantage when they get into the electrical utility business.
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What standards is Justice going to look at in viewing this kind of merger?
Mr. MELAMED. Well, obviously I can't comment on any particular transaction, and I am not familiar with that matter. But I think Justice would analyze the question of whether the control of the pipeline created an opportunity for some kind of strategic anticompetitive behavior, perhaps in terms of the device you are talking about with respect to offpeak load capacity; and if they thought there were a competitive problem, well, then, ask whether the merger exacerbates the problem, and if so, whether some kind of remedy, be it divestiture or a behavioral remedy might be sufficient to ameliorate the problem.
Mr. BERMAN. The ranking member commented earlier about the telephone world and the role of the Justice Department, and I remember the greatest friend of the Justice Department having an antitrust role in the deregulation fight was, at the time, AT&T, as opposed to the local regional Bell Operating Cos.
And now I am reading that there is some talk about AT&T seeking to acquire an already very large, merged regional Bell Operating Co., and I am wondering if you can comment on to what extent Justice is looking at that particular issue.
Mr. MELAMED. Well, we have read the newspaper articles. If there were such a transaction, it would be reported to the agency, it would be referred to the Justice Department, because of our role in the telecommunications industry; and we, of course, would give it a very careful look.
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Mr. HYDE. The gentleman's time has expired and especially since he is drifting off into irrelevancies for our purpose. If you don't mind.
Mr. BERMAN. Well, for your purposes, yes.
Mr. HYDE. Thank you.
The gentleman from North Carolina.
Mr. COBLE. Thank you, Mr. Chairman, good to have you with us this morning. Let me put a general question to each of you.
Do you believe that electricity deregulation calls for any changes in existing antitrust law?
Mr. PITOFSKY. I do not. Antitrust, as you know, is a very flexible discipline. It tries to take into account the special circumstances of industries. I think it is very important we do so here. I see no need to amend the antitrust laws in any way. I think the important thing is simply to recognize that the antitrust laws should apply to this newly deregulated industry.
Mr. COBLE. Let me put a two-part question to each of you.
Do you believe that electricity deregulation calls for any change in the way that mergers in the industry are currently reviewed, A; and B, are there special concerns that arise out of convergence mergers, that is mergers, say, between an electric power company on the one hand, and company or companies that supply other forms of energy, such as natural gas.
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Mr. MELAMED. I think the answer to your first question is no. I think certainly—from the perspective of the Justice Department, I think we have adequate merger tools to analyze mergers in this industry.
Mr. COBLE. As to the review process?
Mr. MELAMED. That is correct. As to the second question, I think I commented a moment earlier, the facts will depend on the particular merger. And if it is what you call a convergence merger, those particular facts will have to be given a great deal of attention to analyze the competitive significance of the merger, but the legal questions and the analytical framework and economic questions the agency should ask are the same.
Mr. PITOFSKY. I agree with that statement.
Mr. COBLE. In my opinion, oftentimes competition in the power generation market does not benefit the consumer unless there is adequate transmission capacity to deliver that power to the ultimate consumer. Competitors, in many instances, I am told, in the generation market, own or control the only transmission lines into an area.
What recommendations would you all have, if any, about how any deregulation legislation should deal with the essential facilities problems raised by transmission bottlenecks, for want of a better way of saying it.
Mr. PITOFSKY. If I may, I think you put your finger on what will turn out to be the most difficult question in this entire area of deregulation.
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You can have competition at generation, you may have competition at retailing, but if the monopoly power persists in the distribution—that is, in the transmission phase—there will be difficulties. I don't really have an answer at this point as to what kind of legislation would be adequate to address that problem, which I have already said is critical.
Antitrust over the years has addressed problems like that, but with great difficulty. The issue is, if you make access absolutely open, then the people who control the essential facility will not invest it in the first place, or they will not maintain the facility as time goes on.
On the other hand, if you don't make access available, then smaller companies who are not party to the transmission monopoly will have no opportunity to get to the market. It is a very, very difficult question; and sitting here at this moment, I am not sure what kind of legislation would make sense in this area.
Mr. COBLE. Gentlemen, if you all could brainstorm about that issue, and if you come up with any ideas—Mr. Chairman, I would like to have the benefit of knowing them, if that would be in order.
Thank you, gentlemen. Thank you, Mr. Chairman.
Mr. HYDE. Thank you.
The gentleman from North Carolina, Mr. Watt.
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Mr. WATT. Thank you, Mr. Chairman. I will try to be brief because I know the chairman wants to move this along.
I take it that the Judiciary Committee is going to have a relatively small role in this whole issue, and that other committees of jurisdiction or another committee of jurisdiction will have the primary role in kind of defining the general parameters. If you were to capsulize—in brief terms, if you could—the role that—the imperatives that we, as a Judiciary Committee, ought to be insisting on being in any legislation insofar as antitrust is concerned, or any other aspect is concerned that might be under our jurisdiction, is there any way for you to give us one, two, three—or just one or whatever number of points there are—that we ought to be under our jurisdiction, as you understand it to be, overly concerned about.
Mr. MELAMED. I can do number one, at least.
I think it is very important that any new legislation continue to ensure the full application of the antitrust laws to mergers and to conduct in the electric power industry.
Mr. WATT. I take it, then, given your reference to earlier airline situations and some of the discussions we had in the telecommunications area that that ought to be clearly defined as an enforcement role, as opposed to a comment role.
Mr. MELAMED. I think that would be our recommendation.
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Mr. WATT. Any others?
Mr. PITOFSKY. I would say exactly the same thing. There should be no exemption from antitrust review in this industry.
Mr. WATT. All right. And that is, I take it, the only imperative you would say this committee ought to absolutely insist on?
Mr. PITOFSKY. Yes, I think that is right.
Mr. WATT. OK. Now the next step beyond that, assume somebody came and said, OK, the natural agency to monitor that issue, the antitrust issue, as well as other regulatory issues, would be the Federal Energy Regulatory Commission, and both of your agencies ought to be left out of this, and that ought to be done by FERC.
What would your response to that be?
Mr. MELAMED. Well, FERC clearly has to have a vital role in overseeing this industry. It has enormous expertise. Our recommendation was a study of market power issues be conducted by FERC because of its industry expertise.
Nevertheless, it has been our experience that the agencies whose expertise is in competition policy and in enforcing the antitrust laws broadly, who are not focused exclusively on a particular industry, do a better job in the long run of enforcing and protecting competition principles and the interest of consumers. So our answer would be, the antitrust jurisdiction and the antitrust enforcement agencies should not be displaced.
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Mr. WATT. I got the impression from an earlier comment you made, though, that the Federal Energy Regulatory Commission was already beginning to apply the same or similar standards as you are applying. Wouldn't it then be redundant to have two agencies doing the same thing, or how would you resolve that?
Mr. MELAMED. Well, FERC's current statute authorizes it to look at a broader range of public interest factors in passing on mergers in the electric power industry. It is not for the Antitrust Division to question the wisdom of that statutory authority, and so long as they have it, it seems to be appropriate for FERC to have a role as well.
But insofar as a role confined solely to competition interests, it seems to me the antitrust agencies are best able to carry it out.
Mr. WATT. So you would say then that the antitrust part of this, to the extent that FERC has taken that into account, the expertise on that aspect ought to come from you all, and then ought to play into their more general evaluation of a particular merger or policy, in that way?
Mr. MELAMED. I would certainly hope there would not be a significant divergence of view between us and FERC about how properly to apply competition principles to this industry.
Mr. HYDE. The gentleman's time has expired.
I want to say parenthetically to my friend, Mr. Berman, I mischaracterized his question. It certainly wasn't irrelevant to the important issue of deregulation and antitrust law, but—it wasn't germane to the issue of electrical deregulation, but the gentleman's question——
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Mr. BERMAN. I knew that is what you meant.
Mr. HYDE. The gentleman's question was indeed relevant. If I knew you knew, I wouldn't have had to say that.
Mr. CONYERS. I think Chairman Pitofsky was going to make a response to Mr. Watt.
Mr. WATT. I would love to have him make a response.
Mr. HYDE. Without objection, the gentleman may have such time.
Mr. PITOFSKY. Very briefly, the fact is that the antitrust agencies are working in a very cooperative fashion with FERC now and you should recognize that aspect of it.
But, secondly, a court, I think, put it rather well. I don't have the citation here, but I can get it for you. It described FERC in this area of anticompetitive review, competitive review as being the first line of defense, but not the exclusive line of defense; and I think that makes sense in an area in which you have agencies with the experience and the special outlook to address competition problems.
Mr. HYDE. Thank you. I might mention, again parenthetically, that the Federal Energy Regulatory Commission was invited to participate in these hearings, but they are having some administrative complexities, which we understand, and so recognizing and out of deference to that, we will hear from them later.
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Mr. CONYERS. Mr. Chairman, those complexities have nothing to do with the Commerce Committee, do they?
Mr. HYDE. Our liaison with them has not covered that subject this morning, so I will check in with them.
Mr. CONYERS. Ah, so.
Mr. HYDE. The gentleman from California, most appropriately, Mr. Bono.
Mr. BONO. Thank you, Mr. Chairman. And, gentlemen, forgive me if I don't ask the questions in the elegant manner of my colleagues. My colleague, Mr. Watt, will attest, God works in strange ways, and He put me on the Judiciary Committee. Antitrust, up until very recently, the most I ever did with that was try to make it rhyme in a lyric, and it was tough.
I would like to get very clear on the assumption here that the goal and purpose is to bring the cost of energy down to the public. Is that our goal and purpose? Is that what all of this dialog is about when we get to the very bottom line?
Mr. PITOFSKY. Yes, but let me put it slightly differently.
The role of antitrust is to protect the free market. We don't regulate prices to force them to be higher or lower or anything like that; we hope we protect the free market. I believe the free market will produce lower prices and more choice for consumers.
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Mr. BONO. I understand what you are saying. They kind of correlate, in a sense.
By protecting a free market, we allow competition, I presume. We allow—we hope that competition will keep costs regulated by themselves, is that correct, is that a correct assumption?
Mr. PITOFSKY. Yes.
Mr. BONO. Thank you. Well, in the case of energy, that is so absolutely necessary at this point.
My next question: Now it sounds like we are talking about, perhaps we are having several different regulatory authorities, is that correct, or a few, not necessarily just the Federal Government? Are we talking about that now in this particular case?
Mr. PITOFSKY. At least two at the Federal level, and we haven't even addressed the complexities of State regulation in this area.
Mr. BONO. So collectively our goal is the objective you just stated, to protect the free market and, subsequently, bring the cost down; is that correct?
Mr. PITOFSKY. I believe that is correct.
Mr. BONO. Because that is what I would consider my role as a Member of Congress: to be, or at least to try to effect this for the public and for the free market.
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Well, then, I can simply ask—where are we? Have we done that, or are we doing that, or are we doing that collectively? Are we just discussing it at this point, or are we all working on putting it together?
I heard Mr. Conyers say that, you know, one of our Members says we have very little or almost nothing to do with that. Are we involved in this?
Mr. PITOFSKY. Well, I guess the way I would put it is that some deregulation has occurred. There are many proposals at the State and Federal level for more.
Mr. BONO. I understand. Are we all collectively now trying to find a method that does it the most efficiently together? Are we just hearing some testimony? Are we all collectively working on this project?
The question I am asking is, how can I contribute? Because I would love to if I could. We desperately need it on the west coast, and if I can contribute to this, this would be a marvelous achievement for me as a Member of Congress.
Mr. HYDE. If the gentleman will yield.
Mr. BONO. Most certainly.
Mr. HYDE. It might be an awkward answer for the witnesses to make, but the purpose of these hearings, from our perspective, is to look at the antitrust aspects of deregulation to determine whether deregulation itself is a good idea; whether we can cut away an overregulatory morass; whether we can advance the delivery of electrical power to people more efficiently, do away with monopolies, which have the threat of increasing or maintaining high prices, and do so to benefit the consumer.
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Mr. BONO. Thank you.
Mr. HYDE. If we can do that, it will be a signal contribution, and if we can get the cooperation and keep this on a bipartisan basis, our chances of success are good.
Mr. BONO. Thank you. That is very—that clarifies it for me, although Mr. Conyers didn't sound like he agreed with that in his opening statement.
Mr. CONYERS. Would the distinguished Member from California yield?
Mr. BONO. Most certainly.
Mr. CONYERS. Thanks, Sonny.
Mr. BONO. Although I have no time left.
Mr. CONYERS. I am sure you will get more time. But this is only a phrase. I agree with what Chairman Hyde said. But just remember this: Deregulating leads to monopoly, and we are all against monopoly.
Mr. BONO. Yes.
Mr. CONYERS. So figure that one out; go figure.
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Mr. BONO. Thank you very much.
Mr. HYDE. That is why we have the antitrust laws.
Mr. SENSENBRENNER. Will the gentleman yield?
Mr. BONO. I will be happy to yield the time I don't have if the chairman will allow me to do so.
Mr. SENSENBRENNER. I ask that the gentlemen get 20 additional seconds.
Mr. HYDE. Without objection, so ordered.
Mr. SENSENBRENNER. I am trying to wade through this. If we get right down to the bottom, gentleman from Michigan, if there is a monopoly, isn't the motto of every monopoly, ''I got you, babe?''
Mr. CONYERS. Yes.
Mr. HYDE. The Chair deplores turning this hearing into a commercial for Mr. Bono.
Mr. BONO. Once a straight man, always a straight man.
With that, Mr. Chairman, I yield back the rest of my time, the time I don't have.
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Mr. HYDE. I view being called straight a compliment.
Anyway, the gentleman—the gentlelady from California, Ms. Lofgren.
Ms. LOFGREN. Thank you, Mr. Chairman. I really just have one set of questions. Every Member of the House from California signed a letter last month, all 52 of us, and I think that is the first time that has ever happened. Basically, to summarize, the two-page letter, says leave us alone. And that request on deregulation really was the product of our delegation meeting with the Governor, Democrats and Republicans in the State senate and assembly, labor and corporate leaders. Everybody agreed that California doesn't want to be involved in the national solution; just leave them alone. They are working through the things they need to do.
So I guess my question to you is: Is there anything in California's process, to the extent you are familiar with it, or anything in H.R. 1230 or H.R. 655, that would preclude adequate enforcement of antitrust laws in California, assuming that we don't draw California into the net, if we in some way come up with a way to agree with what everybody in California wants on a bipartisan basis?
Mr. MELAMED. I don't know.
Ms. LOFGREN. Can you find out and get back to me?
Mr. MELAMED. I will be glad to. We will get back to you.
Mr. PITOFSKY. I have one encouraging note on that, in response to the question. I know that California has a very innovative and creative set of solutions to the kind of problems we are addressing here.
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As far as antitrust is concerned, there is an exemption from the Federal antitrust laws for State action. Your plea to be free from Federal antitrust oversight would follow from the State action exemption. Therefore, your proposal, whatever it is, and I realize it is very complicated and I don't fully understand it, would raise no Federal antitrust problems for California in addressing this in an innovative way.
Mr. CONYERS. Would the gentlelady yield?
Ms. LOFGREN. Yes.
Mr. CONYERS. Could I find out what it was every Federal legislator in the largest State in the Union wanted to be left alone from?
Ms. LOFGREN. Whatever the Federal Government does by energy deregulation, California officials have unanimously asked to be left out of that mix and out of the plan, on a bipartisan basis, including the Governor and the Democratic now controlled assembly and State senate. I mean, the Republicans and the Democrats, the Governor and the legislature, labor and corporations, do not want to be involved in this because they have moved so far ahead of where we are that they feel anything that would be done at a Federal level would be disruptive and counterproductive.
Mr. CONYERS. Thank you very much.
Is that letter available for public review?
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Ms. LOFGREN. Sure. I don't have it on me. I would be happy to provide it to you.
Mr. CONYERS. Thank you very much.
[The letter follows:]
INSERT OFFSET RING FOLIOS 1 TO 7 HERE
Ms. LOFGREN. I yield back the balance of my time, Mr. Chairman.
Mr. HYDE. I thank the gentlelady.
California has already done its deregulation, and that is a remarkable situation.
All right. The gentleman from Texas—from Tennessee, Mr. Bryant.
Mr. BRYANT. Thank you, Mr. Chairman. And I add my welcome to the distinguished panel members.
I have several questions. However, I think my time will be short, and I would like to ask you two questions, and if you could, keep that in mind when you begin to answer the first question.
Being in Tennessee, I obviously am concerned with the Tennessee Valley Authority, TVA, and the talk in Congress about possibly of deregulation. I am concerned about the role of TVA and the deregulation efforts.
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Within the context of this hearing, and antitrust considerations, what changes would you envision concerning TVA consistent with proposed deregulation efforts, again, in the context of antitrust? It is a public entity not subject currently to antitrust law. Have you given any thought to that? If you have, what do you see?
Mr. PITOFSKY. I believe my earlier answer applies here as well. TVA is a special legislative device. It involves State action. I don't think antitrust has any role to play in the way in which TVA operates.
Mr. BRYANT. OK. So I could take from that that TVA would continue to be, in your view, a public government entity?
Mr. PITOFSKY. I am not exactly sure what the legal status of TVA is. Perhaps I could look at that question and get back to you. But my first reaction is that antitrust is unlikely to play any role in dictating the way in which TVA operates.
Mr. BRYANT. OK. In a regulated industry, utilities have an obligation to serve all the customers within the service area, and both of you alluded to this in your opening statements. In a deregulated environment, some customers may be too costly for efficient competitors to supply with electricity. What should be done to ensure that all customers have access to electric power at an affordable rate? And is access a byproduct of competition, or should universal electric service be required or supported in some way?
Mr. MELAMED. Well, that is obviously a very difficult question, and that is a question that suggests it goes beyond antitrust issues, narrowly so-called. I think it is safe to say that in an efficient, competitive market, generally speaking consumers would benefit from lower costs and more efficient generation and delivery of electricity.
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It is possible, however, that some remaining regulatory or legislative requirement would be needed in order to ensure that all customers could have access to electricity at lower affordable rates, and I think that is something that the administration is taking a careful look at.
Mr. BRYANT. That would be something like a universal service requirement, perhaps?
Mr. MELAMED. That kind of question, I think, is something that is being looked at, yes.
Mr. BRYANT. Since I have time, your being very brief as I asked, let me ask you also in a deregulated industry there may be a large number of mergers between competitors which could increase concentration or create monopolies. Examining these mergers on a case-by-case basis could prove very costly. Would competition be promoted if there were clear prohibitions on certain categories of mergers?
Mr. MELAMED. Generally speaking, I think the answer to that question is no, in that generally the broader antitrust principles and the competition analysis that is undertaken in applying them is adequate to separate the anticompetitive from the procompetitive mergers.
Mr. BRYANT. One last question. Are new safeguards needed to prevent larger private utilities from forming collusive alliances or using their existing market power to stifle competition in the future? Are new safeguards needed?
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Mr. MELAMED. If I understand the question, it is whether the antitrust laws are adequate to guard against collaboration by independently-owned generators in the future.
Mr. BRYANT. And I think the chairman has indicated he feels that they are.
Mr. MELAMED. Yes, and I believe they are as well.
Mr. BRYANT. Thank you.
Mr. HYDE. The gentleman's time has expired.
The gentlelady from Texas.
Ms. JACKSON LEE. Mr. Chairman, thank you.
This is a vital hearing and having practiced law for some years before the Federal Energy Regulatory Commission and looked at this issue from both the practical side and as well the consumer side, I am delighted that we are having an opportunity, as a House Judiciary Committee, to protect some of the interests that I hold most dear; that is, the issue of competitiveness and certainly the issues dealing with consumer priorities, if you will.
I happen to be either a victim or a participant in the take or pay curtailment debacle. That is on another side of the issue dealing with natural gas. So it is a wonderment that we begin this process. I hope we do it with diligence and respect, cautiousness and emphasis on the consumer.
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I note that there are four types of utilities: Investor-owned utilities, publicly-owned utilities, rural electric cooperatives, and Federal power companies. However, interestingly enough, the investor-owned utilities have roughly 70 to 75 percent of the retail sales market.
I would ask the Chairman of the FTC to begin, as I begin my questioning, what mechanism is or will you have in place to enforce any new antitrust law? We recognize that you are prepared, as you have said, to enforce any laws. This would be a whole new complex industry. Discussions are already going on in individual States. My State, Texas, has already engendered or encouraged or debated or set up the lines of demarcation. And as I look at the deregulated communications industry, reading just recently the talks of AT&T and SBC going either back or forth, however you want to perceive it, where would you place yourself in the scheme of being able to regulate a new antitrust law that dealt with the utility industry?
Mr. PITOFSKY. It is a new industry for us to address, and there will be unusual problems because of the special economics of that industry. But my answer is that the problems that will arise after deregulation are old-fashioned. It will be cartel behavior, bid-rigging, market division, monopoly abuse, mergers and problems of access. And I think the present set of antitrust laws is adequate to deal with that.
The important thing is in applying these laws to this special industry, with these special background and circumstances, we take the facts into account. But that is the tradition of antitrust law, the facts, the facts, the facts. And I think the law is adequate as it is. No adjustments are necessary.
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Ms. JACKSON LEE. So, in essence, you would have the same structure in place at the FTC that you think would be adequate to address this industry; even with the nuances of the Federal power companies, the rural electrics, those sort of particulars would not cause us to need to look at them uniquely?
Mr. PITOFSKY. I think in both agencies, the structure is adequate to deal with what I accept and I agree with you are the very special factual circumstances of this industry.
Ms. JACKSON LEE. I would like to—well, I guess my argument and hesitation is whether deregulation as we have looked at it has been a boon to the least of those, and that is the average ratepayer, the average consumer. So I will remain apprehensive about deregulation.
But, Mr. Melamed, let me just add my question to you about the Justice Department's both role and position being postured, if you will, to deal with the enforcement of antitrust laws in this very interesting industry and how standard costs of electricity are measured and allocated on a competitively neutral basis. How would you play a role in that?
Mr. MELAMED. In the allocation of costs?
Ms. JACKSON LEE. Yes. And, of course, in the enforcement of antitrust laws.
Mr. MELAMED. All right. Let me take the enforcement of antitrust laws, the general question, first and reiterate really what Chairman Pitofsky said about the suitability of general antitrust principles and the general antitrust expertise of the agencies for this task.
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But I want to reassure you, Congresswoman Lee, on one additional point. This is not a brandnew challenge for the Antitrust Division. One of our existing sections is responsible for, among other things, electricity. We have been actively involved in submitting comments before FERC.
We have brought antitrust cases including the seminal Supreme Court case in the Otter Tail Power matter in 1973 and two more recently—a pending case involving Stillwater, OK. We have reviewed in recent years more than 20 mergers in the electric power industry and issued second requests for substantial investigations in approximately three-quarters of them. So we are not starting from ground zero in terms of expertise and knowledge about the industry.
As to the stranded cost question, that is a very difficult question, as you know, for a variety of reasons. It raises difficult questions of what costs, if any, are properly deemed to be stranded; what incentives ought there to be for mitigation of stranded costs; who, if anyone, ought to bear the burden of those stranded costs; and how the allocation of those burdens ought to be made.
The important principle, from the Antitrust Division's perspective, in terms of competition principles, is that to the extent possible stranded costs not be allocated depending upon future purchases of electric power, because if you allocate it based on future purchases, there is a risk that the person who would by some purchasing pattern have to pay more rather than less of these costs would divert its purchasing in a different direction, and that could distort the efficient allocation of resources and the effective functioning of the competitive market.
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Mr. HYDE. The gentlelady's time has expired.
Thank you.
Ms. JACKSON LEE. Mr. Chairman, thank you very much. I am not sure whether there will be an additional round of questioning, and so as the light goes out, Mr. Chairman, I would certainly like to thank the panelists and would like some response as to the impact of immediate deregulation as opposed to an extended process.
Mr. HYDE. Thank you.
Ms. JACKSON LEE. I thank the chairman.
Mr. HYDE. The gentleman from Ohio, Mr. Chabot.
Mr. CHABOT. I thank the chairman. I have just a couple of questions.
One of the potential problems involved in making the transition from a regulated to a relatively unregulated industry is the potential for cross-subsidization. That is, of course, where a company that is regulated in one of its businesses, where it is guaranteed a rate of return, then takes the profits from that and subsidizes another business in an unregulated market.
Can you give us any examples where this has happened, and what can be done to minimize its occurrence? And either one of the gentlemen I would be happy to have answer the question.
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Mr. PITOFSKY. Cross-subsidization is one of the most difficult issues to deal with in antitrust enforcement, because the books are in the hands of the person who is doing the cross-subsidizing, and the allocation problems are enormously difficult.
In one sense, the best remedy for cross-subsidization is to have divestiture so that one subsidiary can't cross-subsidize the other. Another possibility is to put some third party in charge of running the facility, which has no interest in cross-subsidizing. The problem there is that there are efficiencies to integration that may be lost if you completely divest the facilities. So I don't have a good answer for you.
Antitrust, in the past, has dealt—in fact, the Federal Trade Commission in particular has dealt with cross-subsidization in its examination of price discrimination problems. But they are very, very difficult to address.
Mr. CHABOT. OK. Sir.
Mr. MELAMED. I agree with Chairman Pitofsky.
Mr. CHABOT. OK. Thank you.
In the conclusion to your statement to the committee, Mr. Pitofsky, I was—one of the lines you had in there, you started that conclusion with this statement: Deregulation in a number of industries has proven to be beneficial to consumers and the competitive process.
Now, despite the ranking member's previously stated concerns, I like to think that that will happen. How can the Congress, the FTC or any other agencies, whether they are Federal or State, make sure that this is more likely, that consumers actually will benefit, that prices will come down? What should we be doing, other than just having this hearing today?
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Mr. PITOFSKY. Well, Mr. Melamed and I have emphasized what I think is the most important point I would like to leave with the committee as a result of this hearing. There will almost certainly be serious competitive problems that follow deregulation, and it is exceptionally important that the antitrust agencies, especially in the first years after deregulation, have the resources and the energy to pay attention to the kind of behavior we know that is going to happen: cartel behavior, mergers, monopoly behavior.
Just to take one example from history, we saw that when the NIRA in the 1930's was declared unconstitutional, and all of a sudden companies were turned loose to behave in an essentially deregulated way, and there is a whole literature on the behavior of those companies quite frequently resorting to cartels to restore what they thought was the preferred sheltered existence that they had previously.
So, again, my bottom line, the main message here is antitrust should fully apply to this deregulated industry, if and when it becomes deregulated.
Mr. CHABOT. OK. I thank the witness, and in the interest of time and moving the committee along, I will yield back the balance of my time, Mr. Chairman.
Mr. HYDE. Thank you, Mr. Chabot.
The gentleman from Massachusetts, Mr. Delahunt.
Mr. DELAHUNT. Yes. Thank you, Mr. Chairman.
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I thought your statement, Chairman Pitofsky, in terms of the rationale for antitrust legislation of protecting the free market really does encompass what antitrust ought to be about, and yet I have to acknowledge that I share the concerns that were expressed by the ranking member.
You indicated that we are on the way, it would seem, to breaking all records in terms of mergers and acquisitions. And yet you state that you feel the present antitrust statutory scheme is adequate to deal with both the regulated and unregulated mergers and acquisitions that are ongoing?
Mr. PITOFSKY. Certainly in the unregulated market. When you get into the regulated market, then there are special statutory provisions. But if I understand the thrust of your question, yes, I think section 7 of the Clayton Act is all that we need with a vigorous attitude and energy to enforce the law against anticompetitive mergers.
Mr. DELAHUNT. Let me ask this: Do you feel you have adequate resources now? And I guess I would address that to both of you.
Mr. PITOFSKY. Well, I have been tempted to address that question several times this morning. I think we are stretched very thin. I think the agency is extremely busy, and that while I would not say that we have inadequate resources, if we are given additional assignments, as the Justice Department and we may well be given with respect to deregulation here, it will be difficult with our present resources to handle a review of mergers and other behavior in those industries.
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Mr. DELAHUNT. Mr. Melamed.
Mr. MELAMED. I would agree with that. It may well be that——
Mr. DELAHUNT. You need more resources?
Mr. MELAMED. It may well be.
Mr. DELAHUNT. You are satisfied with the present statutory scheme?
Mr. MELAMED. Yes, definitely.
Mr. DELAHUNT. Why I pose that question is that the Clayton Act, in my memory, I do not go quite that far back, it was the 1930's—was that a 1930's statute?
Mr. PITOFSKY. 1914.
Mr. DELAHUNT. 1914. And yet—and again, I don't have—I don't have any answers to these questions, but in lieu of an opening statement, I intend to submit a communication to the Chair of the committee, because my own sense is that something is different now, in this economy, than when the statutes, the primary antitrust statutes, were enacted.
We are now in a so-called global economy. We have shifted from an industrial economy, to a service economy, to a high-tech economy. And what I see happening, and I think these are the concerns that are being expressed so eloquently by the ranking member, I see happening in terms of the defense industry, in terms of health care, in terms of banking and financial institutions. I see it happening in every sector, and I would urge the Chair, Mr. Hyde, to conduct a series of these kinds of hearings, not just in terms of regulated but also the unregulated industries. And I would ask you for a comment on that statement.
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Mr. PITOFSKY. Well, let me address that, because I actually agree very much with what you are saying. I should have said the statute started, it was enacted, in 1914, but was substantially revised in 1950.
I would like to send you a report of hearings that the Federal Trade Commission held about a year and a half ago on the question of whether or not antitrust requires adjustment as a result of the increased globalization of competition and the increased importance of high-tech competition. But the bottom line on that is the statute doesn't need to be changed, but our interpretation of that statute, including the way in which we treat certain cases that were decided 30, 40 and 50 years ago, does deserve careful review.
So I stick to my answer. The statute is OK, which Congress, in its wisdom, legislated in a very broad and flexible way, but we have to keep paying attention to whether the way we interpret the statute is up to date.
Mr. DELAHUNT. Mr. Melamed.
Mr. MELAMED. If I may, Mr. Chairman, just briefly elaborate on the answer.
The three principal antitrust statutes, Sections 1 and 2 of the Sherman Act and section 7 of the Clayton Act, as I am sure you know, use very broad language that has been adapted to a variety of industries and over a variety of changes. I think in a way it is precisely because of the kinds of changes that you have described in your question, changes in the economy, changes in various industries, changes in the regulatory backdrop, that it is very important that we continue to apply competition principles with such broad and adaptable statutes, rather than try to legislate for today's problems laws that might quickly become obsolete as the economy and various industries change in the future.
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Mr. DELAHUNT. Mr. Chairman, if I may indulge for one more minute, I respect and welcome your answer, but let me assure you that the people whom I represent in their own way are articulating a concern that our antitrust laws are not being effectively enforced. They pick up the paper every day and they read about a new merger or acquisition. They are impacted by downsizing, restructuring.
The day of the corner drugstore is no longer with us when one could walk in and order that raspberry or lime rickey, if you will, and know the proprietor who sponsored the Little League team. That doesn't happen today in this economy with Walgreen's and CVS.
And I would hope that this committee under the leadership of Mr. Hyde would at least conduct similar hearings such as this to educate not just Congress, but also the American people.
Mr. HYDE. Well, if I may interject and advise my friend from Massachusetts that staff is looking at this issue and contemplating a series of hearings on the merger problem. It may well be that we have inadequate laws. It may be that, as Mr. Pitofsky has said, the interpretation of existing laws needs updating. There may be many reasons, and every merger and every downsizing isn't necessarily bad in the grand scheme of things.
But people see the headline and they get concerned, and I guess it is our task to learn about the details of these things and provide reassurance if we can.
But we are going to look at that, and I thank you for having moved us to that point.
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Mr. CONYERS. Mr. Chairman.
Mr. HYDE. The gentleman from Michigan.
Mr. CONYERS. I would like to take the 5 minutes that might be allotted to me in the next panel and consume them on this panel.
Mr. HYDE. Surely.
Mr. CONYERS. Thank you very much.
Mr. HYDE. The gentleman from Tennessee.
Mr. JENKINS. Thank you, Mr. Chairman. First of all, I would like to ask these two gentlemen if after deregulation, whatever happens in the Congress, if we are not going to continue to have regulation of the electric utility industry?
Mr. MELAMED. I think the answer is yes. Certainly in the transmission and distribution function, it will be essential.
Mr. JENKINS. So the term ''deregulation'' is somewhat misleading in that it is not an end to the regulation of the electric utility industry; is that correct?
Mr. MELAMED. That is correct. It is a step in that direction.
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Mr. JENKINS. Now, with respect to the antitrust laws, can either or both of you take—I, like Mr. Bryant, am from Tennessee. Our wholesaler is the Tennessee Valley Authority. Can either of you, either in the TVA area or in any area of the country served by private or public power, give me the particulars of—let's take a residential customer, and then we will take an industrial customer—give me the particulars of how an individual customer is going to be aided by deregulation considering your topic, the antitrust laws?
Mr. MELAMED. Well, obviously who the individual is may affect exactly how this particular effect is realized. In general, if we move——
Mr. JENKINS. Well, let's take an individual that we can relate to. Let's take a homeowner in Greeneville, TN.
Mr. MELAMED. OK. If we move toward deregulation, toward market-based solutions to some of the issues in the distribution and generation of electricity, we would expect to see a more efficient allocation of generation capacity as there is improved access.
Mr. JENKINS. More efficient meaning what, allocation between customers or what form of allocation?
Mr. MELAMED. I meant that we would find potentially two immediate benefits. One, lower cost generation would be used more instead of higher cost generation because customers could shift their purchases to lower cost generators, have access to the transmission network in order to do so. And secondly, to the extent that we increase the use of time-of-use charges, we would create incentives for those large users, who are able to do so, to shift their usage patterns so as to reduce total cost to the system of generating electric power.
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For both of those reasons, one would anticipate the total industry costs of generation will go down and that average costs will go down, and depending on how the regulatory scheme works and how the pricing works, it may well be that the average homeowner to whom you referred would benefit from a reduction in electricity rates resulting from lower costs.
Mr. JENKINS. Now, shouldn't every generator of electricity in this country and every wholesaler and every retailer be employing those devices that you mentioned for the benefit of their customers, whether they are private or public power at the present time? If they are not, they are not doing their job; isn't that correct?
Mr. MELAMED. Well, certainly we would hope to move toward an environment in which there is sufficient open access to the transmission grid that the customers have an opportunity to purchase from the lowest cost generators. There are technical issues that may make it difficult for retail customers in the near future to take advantage of some of the cost-shifting incentives that might be available to larger purchasers, but that is a transitional question, I hope.
Mr. JENKINS. My time is about to expire. Let me ask one question quickly, Mr. Chairman.
In the TVA area, we, being a creature of Congress there, have a statutory fence around us.
Now, in the event that there is a deregulation bill passed in Congress, and in the event that the Justice Department comes on the scene with the antitrust provisions, wouldn't it be fair to everybody concerned if that fence came down? And the fence allows other utilities to come inside the TVA service area; it does not allow TVA to go outside the service area and compete. Now, wouldn't it be fair—wouldn't it be necessary, under the antitrust laws, that that fence be removed so that it would be a two-way street?
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Mr. PITOFSKY. In general, I would say that you want to create consumer choice, and by turning firms loose to compete outside their area or other firms to compete inside the area, that is likely to give consumers choice.
I would like to go back to your earlier question, sir.
Mr. JENKINS. All right, sir.
Mr. PITOFSKY. The name of the game for antitrust is consumer choice. When there is consumer choice, efficiency improves and prices come down. That is the premise of the antitrust laws, and it has been reasserted by the Supreme Court time and time and time again.
You said, well, why can't the monopoly do it just as well? If they are doing their job, why can't they do all the good things? The fact of the matter is, experience demonstrates, that monopolies, while some of them are well run and some of them are badly run, do not operate as efficiently or give the consumer as much choice as competition. And, therefore, the goal of deregulation is competition, free market, consumer choice.
Mr. HYDE. The gentleman's time has expired.
Mr. Conyers has asked to use his 5 minutes on the next panel on this panel, and so without objection, so ordered. And Mr. Conyers is recognized for 5 minutes.
Mr. CONYERS. Thank you, Mr. Chairman.
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I would like to try to get an indication of in California, where everything is going along so great that every Member of Congress, every Senator, has asked you two guys to butt out, was there any review of what was going on there and is going on there that leads them to all ask you to please not come to California?
Mr. MELAMED. Not to my knowledge, and I did not understand the Congresswoman's question—comment about that letter to suggest that it was directed necessarily at the antitrust agencies.
Mr. CONYERS. Oh, it was an invitation to come in?
Mr. MELAMED. Well, I—since I haven't seen the letter, I guess I don't understand what the circumstances were.
Mr. CONYERS. Well, you are not the only one. We are not from California, sir. But you have jurisdiction over California, too, I assume?
Mr. PITOFSKY. Absolutely.
Mr. CONYERS. Are you sure, Mr. Melamed?
Mr. MELAMED. Yes.
Mr. CONYERS. OK. Fine. Just to make sure.
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Mr. MELAMED. We have jurisdiction over the commerce in that State.
Mr. CONYERS. Well, when 52 Congressmen give you a letter and suggest that you—if you say they didn't say butt out, they didn't urge you to come in. That still carries a little weight in a democratic society.
Well, what about it? Are any objections being made? You had to approve or pass on many of those that were multistate operations. We are talking about multibillion-dollar corporations that might have some effect on the subject over which you are tasked, right?
Mr. MELAMED. Congressman, I don't know whether the letter was concerned principally with antitrust or with the prospect of regulatory intervention in California's deregulatory regime. I would be very glad to discuss this matter with you, but I would prefer to know what the letter is about before I attempt to speculate.
Mr. CONYERS. OK. Well, we will get a copy.
If you get a copy of the letter before me, would you send me a copy?
Mr. MELAMED. I would be glad to.
Mr. CONYERS. All right. Good. Thank you for your cooperation.
I want to commend you, Mr. Attorney General, because you come to the bottom line here, of which there has been little or no discussion. See, it is not just the conduct. I mean, once we ratify this business, we are stuck.
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It took 10 years and the rest of one judge's whole career to handle one case. I mean, we don't come back and tinker and amend antitrust decisions very easily, as we all know.
But you did say, vertical integration in the same utility of generation and creates an incentive and ability to impede open access, because competing generators of electricity will need to use the local utility's transmission facilities in order to supply customers in that utility's service area. The vertically integrated utility has the ability and incentive to impede competition by favoring its own generators and otherwise restricting competitor's access.
Now, we go on to talk about divesting and open access.
My concern, like that shared in your statement, is that utility deregulation could mean deregulation not of effective monopolies with exclusive control over the key essential facility, but of the transmission lines. So from an antitrust point of view, shouldn't we require that these transmission lines be open to other competitors so that we don't have a vertically integrated monopoly controlling the essential facility?
Mr. MELAMED. I think it is very important with respect to the vertically integrated transmission lines that some provision be made to ensure that they will not be used as a bottleneck. FERC Order 888 attempts to address this with its comparable access requirement. The administration is, of course, considering this whole question. It may be that something, going a step further, some kind of operational separation with independent systems operators would be required. This is a vital question that I think warrants careful consideration by the administration and by this committee.
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Mr. CONYERS. Well, I thank you for your presence here today.
Now, Mr. Chairman, you approach this with this comment: We do not address the method and scope of regulatory reform, but we believe that strong antitrust oversight of the industry will and should remain vital, no matter what course of deregulation is chosen.
I applaud that statement, but it is after the fact. You know, as well as I, that nobody on this watch will ever go back into the consequences of what is being proposed right now. Mr. Delahunt, who has been a chief prosecutor in his State for almost two decades, the head of it for a decade, has put his finger on this problem. Once the genie is let out of the bottle, we are in big trouble, and that is what bothers me about your statement.
You are talking about what you are going to watch. I am talking about and Melamed is talking about the structure, not the conduct afterward, because if we haven't divested and created open access, it is going to all be history.
Look at the Telecommunications Act. We brought in public interest tests and separate facilities requirements. We required opening up the local loop. We had checklists. And guess what? It is still not working to the satisfaction of the people that forced those provisions into. And you are telling us you are going to watch, you are going to check, for bad conduct. But the structure gives the whole thing away.
Look at where we are on multibillion-dollar mergers and acquisitions and utilities, and look what we have got pending: Baltimore and Potomac Electric right in our own jurisdiction, just $15.4 billion. This is pending. Public Service of Colorado and Southwest Public Service, pending, $6.3 billion; Union Electric and Sepisco, pending; Pico Energy and PP&L, pending; Midwest Resources, Inc., and Iowa, IL, they are already joined, Gas & Electric, pending. One is a $24.5 billion merger. Northern States Power in Wisconsin, $10.8 billion, pending.
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Your comments, please.
Mr. PITOFSKY. Well, first of all, I hope my testimony, my prepared testimony, didn't create a misimpression. Antitrust is not limited to conduct review. It includes structural review. AT&T was broken up as a result of an antitrust case. We review monopolies, we review structure, we review mergers. People can legitimately quarrel about whether or not these pending mergers ought to be challenged or not. I don't know how that is going to turn out.
But antitrust review, its presence in the market, is not limited to conduct.
Mr. CONYERS. What about the transmission lines, how do we handle that?
Mr. PITOFSKY. Well, there are three possibilities. One is that access will be mandated as a result of legislation, a difficult issue. Another is that FERC will continue its own activities with its 888 rule to mandate some form of access. And I think I said earlier that antitrust has mandated access in the past. There are some famous cases in which people obtained control over essential facilities, over bottleneck monopolies, that was challenged under the antitrust laws, and they were required to treat their customers and suppliers in a fair and nondiscriminatory way.
I want to be candid and honest in response to your question. Antitrust is probably not the best way to address access. I think legislation or FERC regulation is a better way of doing it.
Mr. CONYERS. In this Congress?
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Mr. PITOFSKY. I beg your pardon?
Mr. CONYERS. In this Congress?
Mr. PITOFSKY. Oh, in this Congress? Well——
Mr. CONYERS. Well? Yes, the one we are in, yes.
Mr. PITOFSKY. I can only say that I know that Congress will address this question in a serious way. This hearing indicates that they already have begun to do so. These are not easy questions, as you well recognize, and the answers will be difficult as well. And I started off by saying, in my very first sentence, the question is not deregulation; it is how it is done. It is in the details. The devil is in the details, and I respect the fact that these are very, very hard questions that you are raising.
Mr. CONYERS. Well, I want to thank you, Mr. Chairman.
If it is necessary, in your view, might we be able to call our two distinguished witnesses back at some future date?
Mr. HYDE. I am sure they would look forward to that.
Mr. CONYERS. Thank you.
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Mr. HYDE. We can submit questions in writing, which I am sure they would be pleased to answer.
Mr. CONYERS. No, no, no, no.
Mr. HYDE. Mr. Conyers prefers mano a mano. So we will do that.
Mr. Hutchinson.
Mr. HUTCHINSON. Thank you, Mr. Chairman.
Let me ask some questions to Mr. Pitofsky. If electric deregulation occurs, do you anticipate the number of planned mergers to increase?
Mr. PITOFSKY. It is speculation, but, yes, I do.
Mr. HUTCHINSON. That is based upon the history of other industries?
Mr. PITOFSKY. Exactly.
Mr. HUTCHINSON. Is your greatest concern the horizontal or the vertical mergers, as far as open access to consumers and giving them competitive rates?
Mr. PITOFSKY. In the first wave, my concern would be horizontal mergers, because—well, because there will be so many players out there in this newly deregulated environment that it is going to be tempting for firms to merge to restore their previous market power.
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Mr. HUTCHINSON. Do you think the power companies are anticipating deregulation and, therefore, anticipating considering horizontal mergers even as we speak?
Mr. PITOFSKY. They would not be alert if they were not.
Mr. HUTCHINSON. You have already indicated, both of you, that the present statutory authority, in your view, is sufficient to review potential mergers in the future, and we have talked about three different agencies presently that have statutory responsibilities over mergers. It is not clear to me whether any particular agency has lead responsibility. So my question is: Which agency should take the lead in reviewing these mergers after deregulation?
Mr. PITOFSKY. Well, I mean, historically, and I think perhaps with good sense, FERC probably takes the lead in these reviews. As between the Department and the FTC, the Department has reviewed more—by far more of these electric utility mergers. We, on the other hand, have taken the lead in natural gas, in petroleum and other fuels, but on electric utilities, the Department of Justice has taken the lead.
Mr. HUTCHINSON. But is that by accommodation, or is that by design?
Mr. PITOFSKY. Accommodation.
Mr. HUTCHINSON. All right. It just appears to me in the framework of things that agencies might work better if they knew exactly who the lead agency was. It looks to me like it might result in less fingerpointing if something fell through the crack. Would either of you disagree with that?
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Mr. PITOFSKY. No, I agree entirely. And I think that we have worked it out over—in recent years, so that there really is no fingerpointing, and there really is very little uncertainty as to which agency.
Mr. HUTCHINSON. You are to be complimented for that, but I think you indicated that it might be better if there was a lead agency designated?
Mr. PITOFSKY. We haven't done much of that in the past. It is a problem that I don't think needs a solution, but I understand the point you are making and that would be absolutely correct.
Mr. HUTCHINSON. Mr. Melamed, what would your response to that be?
Mr. MELAMED. I would agree with Chairman Pitofsky, particularly the notion that while this is a theoretical problem, I think in practice it is not an immediate problem. It doesn't need a solution.
Mr. HUTCHINSON. But you are saying right now in the power industry, that the Department of Justice is more the lead agency?
Mr. MELAMED. We have done the bulk of the work in the electricity industry.
Mr. HUTCHINSON. All right. Let me ask a question, Mr. Melamed. At the Department of Justice, you indicated that you have reviewed over 20 mergers in the electric power industry. How many of these mergers were disallowed?
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Mr. MELAMED. We have not challenged any of those mergers. In at least one, and I think more than one instance, the merging parties abandoned the transaction during the pendency of the——
Mr. HUTCHINSON. I only have a little bit of time, but you are indicating that you have not challenged any mergers in the electric power industry?
Mr. MELAMED. Yes. The principal reason for that is regulatory barriers means there hasn't been competition anyhow.
Mr. HUTCHINSON. Mr. Pitofsky, you indicated the Federal Trade Commission handled 65 merger cases during the last 2 years. How many of these were in the electric industry?
Mr. PITOFSKY. I would have to get the answer to that. None were purely electric utility mergers. There were some in which natural gas and electric utility were both involved. I could get the answer to that for you.
Mr. HUTCHINSON. Were any of these disallowed?
Mr. PITOFSKY. I don't know the answer to that.
Mr. HUTCHINSON. Of the 65 merger cases, and this is speaking in all the industries that you review, how many of those merger cases were disallowed?
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Mr. PITOFSKY. Oh, I am sorry. In all of those cases. I am only talking about the cases where we challenged—oh, I see your question. I am sorry. Either the mergers were directly challenged and disallowed, or they were adjusted and modified as a result of our case, and I can only think offhand of one case in which we challenged a merger and were not successful in court.
Mr. HYDE. We have eight more witnesses. It is 11:30—11:25. So I just—as a bit of information, does the gentleman have a request?
Mr. HUTCHINSON. I was going to ask permission for one more question.
Mr. HYDE. By all means.
Mr. HUTCHINSON. Thank you, Mr. Chairman.
There is a witness whose testimony I was looking at, that will be subsequent to you, and I wanted to give you a chance to respond. He indicated that in the review of mergers, the Department of Justice would periodically send attorneys to industry conferences to assure audiences that it was indeed looking at mergers and acquisitions, but little else was ever heard from it.
Does that seem to you to be an accurate representation as to the Department of Justice's role in reviewing mergers?
Mr. MELAMED. No. As I think I mentioned, in approximately three-quarters of the mergers in this industry that we have looked at, we issued second requests, which means that we thought this was an important matter that required careful consideration. The effect of doing that was to delay the closing of the merger while we examined the merger. So I think we have been very active in studying this industry and would expect to bring enforcement proceedings in the future if competitive circumstances warranted.
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Mr. HUTCHINSON. Thank you, Mr. Chairman.
Mr. HYDE. I thank the gentleman.
The gentleman from Indiana, Mr. Pease.
Mr. PEASE. Thank you, Mr. Chairman.
One of the frustrations of being at the end of the questioning queue is also one of the liberations. Virtually everything I was going to ask has been addressed by others, and I do listen to the Chair's admonitions.
There is just one area I would like to go into briefly. Do I understand—I think I have heard several times, you both believe that there is sufficient antitrust authority in existing law to address the issues that you anticipate coming, although I thought I heard on a couple of occasions you would like some sort of affirmation of that, either in the record or in the statute. Is that a fair assessment?
Mr. MELAMED. Well, what we, I think, asked for was not so much an affirmation as to make sure that there was an antitrust savings clause that would ensure that the laws continue to apply.
Mr. PEASE. OK. Then the other area, which actually Mr. Delahunt went into, I would like to follow up briefly, and that is your concern that even though you may have the statutory authority, given the statement you just made, there may be some concern about the resources that would make reality the existence of the statutory authority.
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Have either of your offices conducted a study about what you believe the anticipated resource needs would be as a result of this legislation and made internal plans for reallocation of resources, or do you just intend to ask the Congress for more funds?
Mr. MELAMED. We have not gone that far in our thinking yet.
Mr. PITOFSKY. We have, but it doesn't address deregulation of electric utilities. It really addresses the merger wave that has been referred to by several Congressmen earlier. We have reassigned our resources considerably to address this immense merger wave. Two-thirds of our resources devoted to antitrust enforcement are now exclusively devoted to review of mergers.
Mr. PEASE. Thank you.
Can you anticipate, based on what has happened in other industries, that the need for additional resources would increase for a short period of time and then level out or do you anticipate that it will increase and remain high?
Mr. MELAMED. I would imagine it would depend in part on the nature of the new legislation, the nature of the deregulation. There may be a spurt at the outset, but how fast and the duration will depend on the legislation, among other factors.
Mr. PEASE. Thank you very much. Thank you,
Mr. Chairman.
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Mr. HYDE. I thank the gentleman and I thank the panel for very instructive and helpful testimony, and you will be hearing from us again. Thank you.
Our next panel consists of eight witnesses, who represent a broad diversity of views from the public and private sectors. When we have heard from all of them, I believe we will have a good idea of the many ideas in this debate. I am going to ask Mr. Conyers to introduce the first witness, Mr. Anthony Earley, from Detroit, MI.
Mr. CONYERS. Thank you, Mr. Chairman. I am doing this on the basis that Mr. Earley hasn't heard my previous comments and so he won't mind me introducing him.
But he is a friend and it is a pleasure to welcome the chief operating officer of the Detroit Edison Co., where he has been operating as president since 1994. He has a long background in the utility industry, is a former officer in the U.S. Navy, an extremely active person in civic affairs, serves on the Detroit Economic Growth Association, the Cranbrook Institute of Science, the United Way, and many, many others. I am always pleased to see him here, and I look forward to his comments. Thank you.
Mr. HYDE. Thank you.
Next, we have Mr. Roy Thilly, general manager and counsel of Wisconsin Public Power. Mr. Thilly has been with that company since 1992 and before that, he was with the Madison, WI, law firm of Boardman, Suhr, Curry & Field for many years, where he represented the municipal utilities. He appears here today on behalf of the American Public Power Association, a trade association representing publicly owned utilities.
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I will turn to Mr. Hutchinson to introduce the next witness, Mr. Ricky Bittle, from Little Rock, AR.
Mr. HUTCHINSON. Thank you, Mr. Chairman. I appreciate the opportunity to introduce one of our distinguished panelists, Mr. Ricky Bittle, from my home State of Arkansas. Mr. Bittle currently serves as director of planning rates for the Arkansas Electric Cooperative Corp. In this capacity, he is responsible for modeling current and future requirements necessary to ensure delivery of wholesale power in a reliable and effective manner.
He is a registered professional engineer who received his degree in electrical engineering from the University of Arkansas. Mr. Bittle is a member of the National Rural Electronic Cooperative Association and serves on its transmission task force. He is also affiliated with the Southwest Power Pool, the National Electric Reliability Council, and the Integrated Operations Services Working Group.
Mr. Bittle appears here today on behalf of the National Rural Electric Cooperative Association. Let me extend a warm Arkansas welcome to, Mr. Bittle. I appreciate you being here, and thank you, Mr. Chairman, for allowing me to give this personal introduction for Mr. Bittle.
Mr. HYDE. Thank you.
Our next witness is Mr. Steven Burton, senior vice president and general counsel of SITHE—I hope I pronounced that correctly—Energies, Inc., SITHE is an independent power producer, operating 25 power plants on three continents.
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Mr. Burton has been with SITHE since it began doing business in the United States in 1984, and before that, he was general counsel to Winner/Wagner & Associates and chief counsel to the California Air Resources Board. Mr. Burton appears here today on behalf of the Electric Power Supply Association, a trade association representing independent power producers.
From the public sector, we have Mr. John Howe, chairman of the Massachusetts Department of Public Utilities. Mr. Howe became chairman in November 1995, and before that, he worked in government relations for the U.S. Generating Co. and for J. McCousky Associates. He appears here today on behalf of the National Association of Regulatory Utility Commissioners, a trade association representing, as you might imagine, State utility commissioners.
Also, from the public sector, we have Mr. Michael Travieso, the People's Counsel for the State of Maryland. Mr. Travieso became People's Counsel in August 1994. Prior to his appointment, he served as an assistant U.S. attorney in Baltimore and an assistant State attorney general. He also practiced law in Baltimore for 11 years. He appears here today on behalf of the National Association of State Utility Consumer Advocates.
Our next witness is Mr. James Serota, chairman of the Fuel and Energy Industry Committee of the Antitrust Section of the American Bar Association. He is a native of the great city of Chicago. Mr. Serota is a partner in the New York firm of Huber, Lawrence & Abell. Mr. Serota is also a veteran of the antitrust division, having worked several years on the IBM case.
Our final witness is Mr. John O'Brien, chief executive officer and chairman of Wheeled Electric Power Co. Mr. O'Brien began his career as a scientist at the Brook Haven National Laboratory, and in 1985, he formed his own company, Direct Gas Supply Corp. In 1992, he sold that company to British Petroleum. In 1993, he started his current company, Wheeled Electric Power Co.
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The eight of you represent many different perspectives and we look forward to hearing from you all.
Mr. Earley, we will hear from you first, and may I request that you hold your remarks to 5 minutes, with the understanding that the full text will be put in the record. But since we have a lot of you and we are getting late, it would be helpful if you could cooperate. Mr. Earley.
STATEMENT OF ANTHONY F. EARLEY, JR., PRESIDENT AND CEO, DTE ENERGY AND DETROIT EDISON CO., ON BEHALF OF EDISON ELECTRIC INSTITUTE
Mr. EARLEY. Thank you, Mr. Chairman, Mr. Conyers and members of the committee. It is a pleasure to be here to speak on this important subject this morning.
As Mr. Conyers knows, Detroit Edison serves nearly 2 million electric customers in southeastern Michigan. We are over 8,400 men and women, over 3,700 of whom are represented by unions. We are also more than 150,000 shareholders and some 60 percent of which are retirees that depend on dividend income for their retirement.
I am making my presentation this morning on behalf of the Edison Electric Institute, the association of U.S. shareholder-owned electric utilities. EEI's member companies serve 76 percent of all of the retail electric consumers in this country.
The electric utility industry is undergoing a restructuring and deregulation process that is a daunting challenge. We are about to take the most reliable, most efficient, electric system in the whole world and transform it into one giving customers more choice and more competition. That is a laudable goal, but it is risky business. We must ensure that we do this without sacrificing the best attributes of the current system: reliability, affordability and universal service.
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Now as Mr. Jenkins pointed out earlier, deregulation is a misnomer. Transmission and distribution portions of the electric system will continue to be heavily regulated, and thus will not raise any new antitrust issues as we go forward with this process.
Generally, when we are talking about deregulation, we are talking about the generation portion of this industry, where competition has already begun. Without question, as the electric utility industry restructuring proceeds, antitrust laws will have an increasing relevance.
There is no reason to believe, however, as the prior panel stated, that electric industry-specific antitrust legislation is required. There are a number of reasons for this. First, there is already vigorous competition in the wholesale generation markets that has developed. New entrants, independent power producers, marketers, gas companies and others are entering that market every day, and we believe that competition will only increase as retail access develops.
Second, FERC has recently adopted the Department of Justice and FTC merger guidelines, and they will help ensure that market power issues associated with mergers will be addressed. There is no reason to change the standards that have been used successfully elsewhere.
Third, FERC's functional unbundling policy has addressed the concerns about access to the transmission system on a wholesale basis. FERC has required that all utilities open up access to their transmission facilities on an equal basis to those that want to use it. In addition to FERC's move to functionally unbundle the system, it is widely believed that the concept of an independent system operator will further reduce the likelihood that control of the transmission system will affect competition.
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Fourth, States, in their restructuring, are addressing market power issues in the context of their own factual situations, and many of these issues are fact specific, as the prior panel stated, and they are being handled at the State level.
Finally, any residual market power in antitrust concerns can be adequately addressed using the existing Federal and State antitrust laws. In short, we believe while market power and other antitrust issues certainly will be raised as part of this process, no unique industry-specific legislation is necessary.
I want to finish my comments this morning by talking about a constitutional issue that is raised, and that is a takings issue, that can be raised if restructuring does not allow utilities the opportunity to recover stranded costs. Those are investments or other costs that utilities have incurred that regulators have ordered them to recover over a period of time. Many times, these costs are carried on the books as assets. If, now as a result of governmental deregulation action, those investments and other costs can't be recovered, an unconstitutional taking will occur.
Fortunately, FERC, and virtually all States that have been provided the opportunity to look at this issue, do allow recovery of legitimate stranded costs, but there are some pending pieces of legislation in Congress that may not permit this and may raise an interest on the part of this committee.
The restructuring of the electric utility industry raises important public policy questions and EEI appreciates the opportunity to discuss them with you this morning. Thank you.
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Mr. CONYERS. Thank you, Mr. Earley.
[The prepared statement of Mr. Earley follows:]
PREPARED STATEMENT OF ANTHONY F. EARLEY, JR., PRESIDENT AND CEO, DTE ENERGY AND DETROIT EDISON CO., ON BEHALF OF EDISON ELECTRIC INSTITUTE
INTRODUCTION
Mr. Chairman and Members of the Committee, my name is Anthony F. Earley, Jr., and I am president and chief operating officer of DTE Energy and its utility subsidiary the Detroit Edison Company. Detroit Edison Company serves nearly 2 million electric customers in a contiguous territory covering 7600 square miles of Southeastern Michigan.
Detroit Edison is 8,400 men and women who live, work and pay taxes in Michigan. Over 3,735 are represented by unions. Detroit Edison is 150,000 shareholders, some 60% of whom are over 60 years old and depend on dividends for retirement income. Many of our institutional shareholders are pension funds critical to retirees. We own over 10,000 megawatts (MW) of electric generating capacity including the 1,130 MW Enrico Fermi-2 nuclear plant.
In compliance with Rule XI, clause 2(g)(4) of the Rules of the House, we disclose that the Detroit Edison Company, through its operating subsidiaries, provides, pursuant to franchise obligations, electrical service to federal facilities such as military installations, federal courthouses, U.S. Postal Service buildings, Social Security Administration, Internal Revenue Service and other federal service and operation functions. The revenue received by Detroit Edison for such electrical service is based on applicable tariffs approved by the Michigan Public Service Commission.
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I am making my presentation today on behalf of the Edison Electric Institute (EEI), the association of U.S. shareholder-owned electric utilities. EEI's member companies serve 76 percent of all ultimate electricity customers in the nation. A supermajority of EEI's members have established EEI's approach to competition in the electric industry, which my presentation will reflect, although a few members disagree with some elements of that approach.
We welcome this Committee's interest in the antitrust and constitutional issues raised by the competitive restructuring of the electric utility industry and are delighted to appear before you today.
BACKGROUND
As you are aware, this country's electric industry is in the midst of a dramatic restructuring that implicates both the policies and substance of our antitrust laws and the Constitution's Fifth Amendment guarantee against takings.
We all want to get competition right. Under the regulated monopoly structure that has been in place in the U.S. for the better part of this century, we have created the most reliable and efficient electric system in the world. Making the change means making sure that reasonably priced electricity remains available for all consumers at all times. We want to make sure that the electric system continues to operate reliably and safely for all consumers. We want to assure that past regulatory commitments are honored. And we want to ensure that all electricity competitors play by the same rules so that federal exemptions, preferences, subsidies, uneven taxation and different levels of regulation cannot be used as an advantage in competitive markets.
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In order to appreciate where the electric industry is heading, it's important to understand the progress we've already made. First, real electricity prices in this country are 27 percent lower than they were fifteen years ago, and they continue on a downward trend (see graphic ''Real Electricity Prices in the U.S.''). U.S. industrial companies enjoy lower electricity prices than their competitors in other industrialized countries (see graphic ''Worldwide Industrial Electric Prices''). U.S. industrial electricity costs are about half that in Germany and a fourth of Japan's. In fact, industrial electric prices over the past decade have declined in only one country: the United States.
Second, there has already been a tremendous surge in the numbers of competitors in electric markets. (See graphic ''Thousands of Electric Suppliers Compete in Today's Power Markets.'') There are more than 4,000 non-utility generation projects that sell their power to utilities. Between 1990 and 1995, almost 60 percent of new generation came from these non-utility generators. (See graphic ''Cumulative Capacity Additions.'')(see footnote 33) Power marketers and brokers were almost non-existent three years ago, but have experienced explosive growth since then (see chart, ''Power Marketers Sales for Resale''). For example, in the first quarter of 1994, these marketers sold enough electricity to power the equivalent of roughly 430,000 homes; in the first quarter of 1997, they sold enough electricity to power the equivalent of 75 million homes.(see footnote 34) Among suppliers who sell power to ultimate consumers, there are almost 2,000 municipal electric utilities, more than 900 rural electric cooperatives, and roughly 200 shareholder-owned utilities.
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INSERT OFFSET RING FOLIOS 8 TO 12 HERE
Of the 200 shareholder-owned electric utilities, the four largest have just a 17-percent market share.(see footnote 35) By comparison, the four largest long-distance telephone carriers generate roughly 86.5 percent of industry revenues.(see footnote 36) The four biggest airlines, roughly 56 percent.(see footnote 37) In the pulp industry with only 26 mills, the four largest firms account for 44 percent of that industry's revenues.(see footnote 38) The four largest railroads run 69.5 percent of revenue/ton miles.(see footnote 39) And, the four largest investment banking firms recover almost 55 percent of that industry's revenues.(see footnote 40)
The powerful forces of opportunity in this $200 billion industry are attracting myriad new entrants.(see footnote 41) Additionally, electric companies are seeking to merge with each other and increasingly with gas companies. In the near future, there will be a ''BTU market'' where all energy sources—coal, gas, oil and electricity—will be bought and sold interchangeably on a regional and national basis. Other network industries are waiting to form alliances in order to provide what some enterprising marketers are already offering: combined services in telephone, Internet, cable television, home security, electricity or gas. This is a very dynamic period in the most capital intensive industry in the country. These transformations will have a profound impact on every American consumer because energy and information drive our economy.
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Electricity markets are regulated at both the federal and state levels. The federal government traditionally has regulated the wholesale market. Sales of electricity between utilities or between a non-utility generator and a utility, as well as the price charged to move that electricity over transmission lines, are virtually all regulated by FERC. The states have traditionally regulated retail electric distribution and sales.
WHERE WE ARE NOW AT THE FEDERAL LEVEL
FERC implemented Congress' Energy Policy Act of 1992 by opening up all wholesale electricity markets to competition in the open access Order No. 888, issued last spring. FERC's open access order allows any wholesale power supplier to use transmission lines owned by shareholder-owned utilities at the same price, terms and conditions that those utilities charge themselves. Other non-jurisdictional utilities (e.g., cooperatives and municipals) that want such open access service need to provide reciprocal service on their own systems. As a result, electric power can be competitively supplied or procured while transmission continues to be regulated.
FERC's order also expanded market opportunities. Its requirements for the functional unbundling of transmission from generation assured that all parties would have the same access to the transmission network. FERC also required all transmission owners to post—for their own use and that of all competitors—the availability, terms and conditions of transmission service on a computerized Open Access Same-time Information System, or ''OASIS.'' This and other requirements to separate transmission and marketing functions assure that a transmission owner gains no special advantage over other transmission users.
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Wholesale competition is spreading widely among utilities, independent generators and power marketers. Electricity is increasingly sold on a regional, rather than a local, basis. In addition, a vibrant futures market for electricity has emerged in less than a year since the restructuring order. FERC estimates that these competitive changes will result in annual savings of $3.8 billion to $5.4 billion to consumers.(see footnote 42)
In Order No. 888, FERC provided for the opportunity to recover legitimate costs that cannot be recovered in competitive markets—that is ''stranded costs''—that result from the government mandated change from regulation to competition. As FERC said on rehearing in Order No. 888–A, removing the greatest barrier to competitive wholesale power markets by requiring non-discriminatory open access transmission ''carries with it the regulatory public interest responsibility to address the difficult transition issues that arise in moving from a monopoly, cost-based electric utility industry to an industry that is driven by competition among wholesale power suppliers and increasing reliance on market-based generation rates. The most critical transition issue that arises as a result of the Commission's actions ... is how to deal with the uneconomic sunk costs that utilities prudently incurred under an industry regime that rested on a regulatory framework and a set of expectations that are being fundamentally altered.'' Order No. 888–A, at 489.
WHERE WE ARE NOW IN THE STATES
All fifty states and the District of Columbia are actively considering some form of retail competition. (See graphic ''State Activities on Restructuring and Competition.'') Eleven states have adopted retail competition. (See graphic ''Retail Competition Decisions to Date.'') Many of the higher cost states have restructured their retail electricity markets first: Arizona, California, Maine, Massachusetts, New Hampshire, New York, Pennsylvania, Rhode Island and Vermont. (See graphic ''Average Rates per kWh—Total Industry—1995.'') States with average or below average electricity prices have tended to be more cautious than the higher cost states, but two lower cost states—Montana and Oklahoma—have also adopted retail restructuring.
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INSERT OFFSET RING FOLIOS 13 TO 15 HERE
As at the federal level, the states plan to deregulate electric power supply but continue to regulate local distribution wires that carry electricity from suppliers to customers.
The remaining states and the District of Columbia are all actively considering introducing competition into retail power markets. In December 1996, the Michigan Public Service Commission (MPSC staff) filed a framework for restructuring the electric utility industry in Michigan as early as July 1, 1997. The staff report allows for recovery of stranded costs, with the securitization of utility assets as the preferred method of recovery accompanied by a non-by-passable end-user charge.
Six states have active retail access pilot programs: Illinois, Massachusetts, New Hampshire, New York, Washington and Idaho. Three more states are planning pilot programs: Missouri, New Jersey and Pennsylvania. These experiments are helping to gain experience in establishing new competitive retail markets. Detroit Edison anticipates that a phase-in of retail wheeling will begin in Michigan in the second half of 1997.
WHAT ARE THE KEY TRANSITION ISSUES?
Making the transition to competitive electricity markets raises many complex and controversial issues for both the states and the federal government. The challenge is moving from the current fully regulated market to a more deregulated, competitive one without littering the path with unhappy consumers, bankrupt electric companies and poor customer service. The process will have failed if newly competitive markets are structured so that a few large consumers benefit at the expense of smaller ones; if traditionally regulated electricity suppliers are inhibited from participating in evolving electricity markets by regulations that are not applied to new providers; or if the reliability of electric service deteriorates.
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The real question is, how do we increase competition in a way that achieves our goals? Retail electric service has traditionally been a state concern because the needs and priorities of electricity customers are directly affected by state and regional differences such as climate, population, geography and economics. Achieving our goals will require a balanced approach that recognizes the important role that both the federal government and the states play in the nation's electricity supply. Legislators and regulators need to be careful that, as we work together to restructure and open electricity markets, we truly allow competition to work.
It is essential that we get the transition to competition right. EEI supports approaches that produce net benefits to customers and are fair to customers, utility shareholders and suppliers. Moreover, the transition should be consistent with the principles of economic efficiency and customer choice that underlie competition. As part of this transition certain issues must be addressed.
Shared Benefits With All Customers. All customers, both large and small, must benefit, or at least not be harmed, from a cost, service, and reliability perspective. It is critical that the burdens of this transition not be on the backs of small commercial and residential customers. At the same time, the costs of producing special services to disadvantaged customers and meeting other public policy objectives should be shared equitably by all electric users.
Stranded Cost Recovery. Government must honor its past regulatory commitments, as FERC and most of the states adopting customer choice have done, by providing for recovery of legitimate stranded costs. Costs may be stranded when investments in generation and related assets, made under regulation and included in rates, become unrecoverable as a result of the governmentally mandated shift to competition.
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The easiest way to understand the concept of stranded costs is that they are analogous to the mortgage on your house. For example, when utilities made large capital investments, they were not permitted to recover that investment from customers immediately—the sticker shock would have been unbearable. For the same reason most of us don't pay cash for our house but rather take a mortgage to pay over time. In the regulated utility world, customers were permitted to reimburse utilities for their investments over a long period of time because a stable customer base would always be there—they could not switch suppliers unless they moved out of their local utility's franchise service territory. Now, through governmental action to deregulate the industry, that long term mortgage (sometimes called the regulatory compact) is being renegotiated. It only makes business and legal sense that utilities must be given the opportunity to recover their original investment in the same way the original mortgage holder wants to get paid when you sign a new mortgage.
These stranded costs include investments in power plants and long-term supply contracts, above-market prices for power purchases required by the Public Utility Regulatory Policies Act (PURPA) and costs incurred to fulfill other public priorities such as energy conservation, low-income assistance, environmental and other public interest programs. Regulators have approved recovery of these costs, but often have required utilities to stretch out the recovery of some of them over long periods of time, up to 30 years. Utilities and their shareholders incurred these costs with the expectation that they would be recovered. As I discuss in more detail below, changing rules for electric supply must include a mechanism to recover these costs that is workable and fair to all consumers and to shareholders.
Competitive Level Playing Field. Fair competition requires all competitors to play by the same rules. This requires Congress to revise several federal laws, such as PURPA and the Public Utility Holding Company Act, that are roadblocks to competition. Congress must also ensure that federal exemptions, preferences, subsidies, uneven taxation and different levels of regulation cannot be used as an advantage for certain favored participants in evolving competitive markets.
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Open Transmission Access. While privately owned utilities are required to provide open transmission access, it is important to assure that all other transmission owners and operators, including the federal government, public power entities and rural cooperatives, which account for a quarter of all transmission facilities, comply with the same open access requirements in competitive markets. Only the federal government can ensure such truly national open access.
Public Policy Programs. Electricity is a unique product; without electricity modern society grinds to a halt. Because of the vital nature of the product, electric utilities are called upon to carry out important public policy programs and goals such as universal service, low income assistance and environmental and renewable energy programs. In a restructured industry, the government must ensure that such programs are accomplished through an equitable contribution by all users of electricity, regardless of who supplies the electricity.
Corporate Structure. Where markets are competitive, regulators should allow the market to work. Government-imposed divestiture, undue restrictions on the legitimate business activities of utility affiliates and other approaches which would impede the development of efficient markets should be avoided. Specific market power concerns can be resolved through adequate existing regulatory and antitrust mechanisms.
THE ELECTRIC INDUSTRY RESTRUCTURING AND THE ANTITRUST LAWS
The well developed body of U.S. antitrust laws guard our commerce and provide the structure necessary to assure fair, open and robustly competitive markets. It has worked well to define the boundaries of lawful commercial action within which competition can thrive. The electric utility industry is no less subject to these laws than any other industry. Currently, the state action doctrine immunizes utility activity that is carried out pursuant to an affirmative state intent to displace competition with regulation and that is actively supervised by the state. The power supply component of this industry was that type of activity. Now, as power generation moves from a regulated to a competitive industry, the antitrust laws will have increasing relevance. This is because significantly less of the electric industry will be immune from the antitrust laws as a result of the state action doctrine. As the states choose to move from an expressed policy of regulation to one of competition, they will expose more utility business activities to the full force of the antitrust laws.
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Under the current law, the electric industry is subject to the same antitrust treatment as any other tariffed industry, including the interstate shipping and telecommunications industries, with the ''filed rate'' doctrine continuing to provide an important function in balancing the respective roles of competition and regulation. The filed rate doctrine does not provide an unlimited antitrust immunity for the regulated parts of the electric industry. The courts have found antitrust violations by some electric utilities notwithstanding the limited protection of the filed rate doctrine. For example, courts have found that electricity ''price squeezes'' and other suits by competitors are not immunized by the filed rate doctrine. At the same time, as long as significant segments of the industry—particularly transmission and distribution service—remain regulated, there will continue to be an important role for the filed rate doctrine.
During the transition to a competitive power supply industry, a number of major areas of antitrust concern may arise: (1) potential market power issues associated with mergers, (2) vertical market power arising from owning generation, transmission and distribution facilities, (3) horizontal market power in generation, (4) cross-subsidization (5) calls by critics that FERC and possibly other agencies be empowered to intervene in markets to remedy undue market concentration and (6) antitrust laws as applied to certain classes of competitors.
Federal Merger Policy
Mergers involving electric utilities are governed by Section 7 of the Clayton Act and Section 203 of the Federal Power Act (''FPA''). FERC has interpreted the legal standard for merger approval in the FPA, ''consistent with the public interest,'' to incorporate the competition standards of the Clayton Act. The Clayton Act condemns mergers or acquisitions that ''may ... substantially ... lessen competition or ... tend to create a monopoly.'' Thus, both the FPA and the Clayton Act focus review on whether a merger or acquisition will significantly reduce competition in some relevant market. But both also recognize that mergers are an important part of the competitive process that can play a key role in ensuring that markets function efficiently.
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FERC recently revised its merger policy to adopt formally the
Department of Justice (''DOJ'')/Federal Trade Commission (''FTC'') Horizontal Merger Guidelines. FERC also narrowed its review to the effects of a proposed merger on three areas: (1) competition, (2) rates and (3) regulation.
FERC's new policy commits it to an accelerated process with more clearly defined filing requirements. Because of the commercial pressures on companies during the merger process, however, FERC's current, typical 16-month or more review period is far too long. In comparison, the Hart-Scott-Rodino (HSR) review used by the FTC and DOJ to review mergers in all industries is often completed within one month. The HSR process requires that merging parties file a form and provides for a 30-day period for the government either to approve the merger or to issue what is called a second request for more information.
EEI strongly recommended that FERC adopt the DOJ/FTC Merger Guidelines in its comments to FERC. EEI supports FERC's effort to modernize its approach to merger review—especially in light of the industry restructuring it has promulgated—and to streamline the approval process. We hope that as the FERC applies its new merger policies it will emulate the antitrust enforcement agencies not only in substance but in speed as well.
A number of parties are seeking to ''raise the bar'' in FERC's merger review standard to prohibit utility mergers that do not serve to reduce market power. These parties also want Congress to give FERC authority to intervene where the Commission finds ''undue'' market concentration. Both arguments ignore the firm underpinnings of the Clayton Act standards in widely accepted economic principles. Barring mergers unless they reduce market power is based on a presumption that mergers are inherently bad. Market economics and experience teach the opposite: mergers should be seen as a normal part of competition unless they significantly increase market power. Thus, we view these efforts to stifle efficiency-enhancing mergers which reflect natural competitor realignments in response to market forces as misguided. To intervene this way in functioning markets would be unsound policy.
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There is no reason to suppose that the economic consequences of mergers will be any different in the electric industry from those in any other industry. As we have seen in other formerly regulated industries, mergers and other strategic alliances in response to and in anticipation of competition can increase efficiencies in product and service offerings, resulting in lower costs and greater benefits for consumers. Evidence from these other industries, as well as what we have seen so far of the dynamic, fast-paced changes in the electric power industry, confirm the presumption that barring mergers unless they reduce market power is unwarranted and would be bad policy.
The many years of decisions under Section 7 of the Clayton Act and the resulting experiences recognize that the fate of a merger found to, or structured to, not ''substantially lessen competition,'' should be decided by markets, not regulators. It is not the proper role of regulators to pick winners and losers when markets can be left free to decide. We must keep in mind that our energy supply is being deregulated precisely to unleash these competitive forces to produce more benefits for consumers.
Vertical Market Power
FERC's open access Order No. 888 fully addresses vertical market power concerns. FERC's ''functional unbundling'' policy, as set forth in Order No. 888, sufficiently mitigates any potential wholesale vertical market power. Order No. 888 mandates open access to the bulk power transmission grid, thus removing any potential for vertically integrated utilities to use their market power over transmission to gain a competitive advantage in upstream or downstream power markets. In addition, FERC's companion Order No. 889 requires utilities to separate both information flows and personnel between unregulated power marketing and their regulated wires business. Open access to transmission service is now widely available; thus there is no need for structural reforms, such as corporate unbundling or asset divestiture.
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With open access, the energy industry of the future will be a regional if not national business. In the Midwest, utilities and other parties are currently seeking to form an Independent System Operator (''ISO'') that will provide broad regional transmission access and corresponding competitive markets. Similarly, both California and the Pennsylvania-New Jersey-Maryland power pool have filed regional transmission operator proposals at the FERC. New England and the Pacific Northwest are also working on such plans. When approved by FERC, these voluntarily formed, independent transmission system operators that will run the regional transmission grid will help to eliminate or substantially mitigate market power concerns by ensuring that all market participants have an equal opportunity to compete over large territories. Thus, these ISOs will give customers a wide choice of competitively priced electricity suppliers.
Horizontal Market Power
A key issue raised by utility restructuring is whether horizontal market power may arise that will stifle competition and lead to higher prices. For example, limits or constraints on transmission capability may lead to isolated load pockets that can only be reached by limited amounts of generation. If the ownership of this generation is concentrated, market power may be a concern. These operational market power issues tend to be highly fact specific—but they also come well within the existing antitrust principles.
Thus, the antitrust laws are already sufficient to handle these issues. Monopolization and attempted monopolization are illegal under Section 2 of the Sherman Act. The Sherman Act is a powerful weapon against monopolies. For example, the break-up of AT&T by the Justice Department was accomplished through the use of Section 2 of the Sherman Act, and not by any special legislation. Similarly, if any electric company tried to monopolize the electricity industry, the antitrust laws enable the government to prevent any such attempt. FERC has also shown an interest in enforcing mitigation measures for operational market power and has the ability to do so under existing laws. If any electric company tried to monopolize the electric industry, the antitrust laws and the Federal Power Act enable the government to prevent any such attempt.
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Cross-Subsidization Issues
The issue of a regulated utility using profits from its regulated activities to ''cross-subsidize'' non-regulated activities is nothing new to antitrust or the electric power industry. There is a well-developed body of law equipped to deal with such abuses of market power. Asserted subsidization is subject to scrutiny as either attempted monopoly or ''monopoly leveraging.'' In addition, state utility commissions have many years of experience in discovering and preventing regulated utilities from attempting to include the costs of non-regulated activities in the rate base. Moreover, cross-subsidization concerns will, if anything, be reduced in the new competitive environment as the regulated side of the industry is reduced.
Undue Market Concentration
There is no basis in law, economics or sound policy for interfering in a market based solely on a level of concentration. Further, there is no agreed upon standard or measure of what level would constitute ''undue'' concentration. There is no reason to carve out a new and untested antitrust policy for the electric industry. New legislation to single out the electric industry and subject it to stricter standards than have been adopted by the antitrust laws for nearly every other industry would harm consumers and stifle competition, rather than encourage it.
Antitrust Standards Applied to Certain Classes of Competitors
Finally, just as the electric industry should not be held to a special stricter antitrust standard, neither should certain parts of it be given a special lax standard. EEI asks this Committee to guard against any efforts by certain classes of competitors to carve out special antitrust exemptions that would benefit particular players in the industry. There should be a strong presumption against special treatment under the antitrust laws. This is the only U.S. industry where federal and state entities are significant participants. If state and federal entities seek to enter competitive markets, antitrust enforcement may need to be re-examined to prevent these entities from unfairly leveraging the power and advantages that are the result of their governmental status to gain unfair advantage over other market participants.
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The current antitrust laws provide strong protection against abuses of market power and prevent anti-competitive mergers. These laws apply with full force to the electric industry, and no additional industry-specific legislation is necessary.
STATE RESTRUCTURING PROCEEDINGS
States that are moving to restructure retail electric markets are addressing all of the many competitive issues involved in converting retail monopolies into competitive energy suppliers. Some states have adequate legal authority for the public utility commission to undertake the restructuring while other states are adopting—or still studying—new legislation.
These states are developing plans that will allow competition in generation but continue to regulate the distribution business and adopting codes of conduct to segregate the regulated transmission and distribution side from unregulated generation. These states are also providing for stranded cost recovery. At the same time, a number of utilities in these states are already restructuring the retail services business and selling off certain generation assets.
These states are typically working with all stakeholders to create competitive marketplaces. In Michigan the major utilities and the MPSC Staff are supporting the formation of an ISO to ensure that all competitors have fair access to the transmission system. Elsewhere, California has instituted not only an ISO for the transmission system but is establishing a power exchange or short-term energy market into which participants will bid electricity on a half-hourly basis or engage in bilateral deals. Some states have required some divestiture of generating assets while other states, like Michigan, have not seen the need for this.
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Of critical importance from a federal antitrust point of view is that the states are addressing these issues head on. They do not need any additional authority that could be provided through federal legislation to address these particular issues. For our part, electric utility companies are eager to participate in these markets and will work to assure that we have the full opportunity to compete.
CONSTITUTIONAL CONSIDERATIONS
Any restructuring of electric supply markets, whether guided by the federal government or the states, must provide for an equitable transition from the traditional regulatory framework to open access. As recognized by FERC, an equitable transition requires that utilities be given an opportunity to recover stranded costs. Stranded costs arise from investments in generation, the commitments made under long-term contracts and other commitments that were incurred to serve customers under traditional regulatory oversight and approval, with the expectation of future recovery through regulated rates, and that now would not be recovered through market prices because these costs exceed the cost of power in post-open access, competitive markets.
Stranded costs arise as a result of the change in government policy to transition from the traditional regulatory framework to open access. Under the traditional regulatory framework, utilities undertook long-term financial obligations to meet government mandates or approvals. At the retail level, these long-term obligations typically reflected the extensive capital investment and other programs required to satisfy an obligation to serve all present and potential customers. Many state regulatory schemes included comprehensive processes for ensuring that utilities had reserve capacity available with diverse fuel supplies. Some of the financial obligations that were undertaken under the regulatory framework included investments in plant, secure fuel supplies, labor contracts, deferred recovery of certain expenses, and federally mandated power purchases under long-term contracts. Indeed, many of these costs that may now be above market were encouraged, if not mandated, by legislative and regulatory initiatives.
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In exchange for undertaking these often government-imposed, long-term financial obligations, utilities were given the opportunity to recover their associated costs and to earn a limited return on their investments through regulated rates. In contrast, unregulated suppliers voluntarily undertake investments and entirely bear the risk associated with those investments, without being limited in the return they can earn on those investments.
Under both federal and state efforts, the traditional regulatory framework is being replaced with an open access regime to accommodate competitive power supply markets. Under open access, utilities must allow competing suppliers to use their transmission facilities under the same rates, terms and conditions as utilities use those facilities for their own sales to customers. As a result of open access, utilities lose the opportunity to recover, through rates charged to power sales customers, those previously approved generation and associated costs that may exceed market prices. Costs in excess of market prices are ''stranded'' simply because, under open access, any attempt by a utility to charge more than the market price of power would result in the loss of that customer to a competing supplier.
To the extent that utilities are deprived of the opportunity to recover a portion of their approved costs through market-based prices, they must be given an opportunity to recover those costs stranded by the move away from single-supplier, regulated rates to open access. Failure to give utilities this opportunity would violate the government's half of the traditional ''regulatory bargain'' and would amount to an unconstitutional taking. Open access without stranded cost recovery would shift to investors or other customers the risk of investments that utilities reasonably undertook on the basis of the regulatory framework then in effect. Part of the responsibility of changing that framework is to provide an opportunity to recover those stranded costs. This is the essence of the decisions made by FERC in Order No. 888 and by the majority of the states.
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Under the Constitution's Fifth Amendment, the government cannot ''take'' private property without providing just compensation. Because the property of utilities was committed to serve the public, the Constitution's protection against takings without just compensation required regulators to set rates to provide an overall rate of return adequate to operate successfully, maintain financial integrity, attract capital and compensate investors.(see footnote 43) On the faith of these protections, vast sums have been invested in generation and other long-term commitments.
Moreover, open access creates a physical taking not only of the wires used to provide open access but of the entire integrated system of generation, transmission and distribution that utilities put in place to serve customers. That physical taking of the ability to recover costs incurred under the regulatory framework requires just compensation for the reduced value of the associated investment in generation resulting from open access use of the wires. By requiring open access, the owners of the transmission and distribution systems are denied their fundamental rights of ownership with the consequence that their property is damaged, requiring compensation.(see footnote 44)
To meet the Fifth Amendment's requirement of just compensation, utilities must be given an opportunity to recover the stranded costs that will arise as a result of the change in government policies to require open access. Without an opportunity to recover those stranded costs utilities would not be made whole for all costs arising from open access, violating the Fifth Amendment.
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EEI is pleased that the FERC and most states that have initiated restructuring have recognized this obligation and provided an opportunity for recovery of stranded costs. The government must honor its past commitments during the restructuring transition period—or it will face claims, like those now being litigated in New Hampshire, that such government action constitutes an uncompensated taking. This Committee has an important responsibility in assuring that any federal restructuring legislation avoids an uncompensated taking.
CONCLUSION
In conclusion, vigorous competition is coming to electric power markets. Competitive forces are driving both private and governmental restructuring efforts. FERC and the states are acting, each within its ambit, to consult with all stakeholders as they restructure the industry. The antitrust laws apply with full force to the electric industry and play a large role in ensuring that fair, open, and competitive electric power markets develop. We welcome this Committee's interest in the important antitrust and constitutional issues raised by electric industry restructuring.
———
(Opinion by Timothy E. Flanigan, Feb. 29, 1996)
STRANDED COSTS IN THE ELECTRIC UTILITY INDUSTRY
EXECUTIVE SUMMARY
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Historically, the bulk of the nation's electric power needs have been supplied by investor-owned utilities operating under close regulation by government officials. In this regulatory environment, utilities incurred significant costs in fulfilling their statutory and regulatory obligations to supply all present and future demands for power by customers within their exclusive service territories. These costs include, among other things, the costs of constructing generating plants, of entering into long-term power supply contracts with other producers, and of complying with various regulatory directives. All of these costs were incurred in conformity with the ''regulatory compact,'' under which utilities and regulators assumed corresponding obligations to each other. In return for assuming the duty to provide reliable and adequate supplies of power at strictly regulated rates, utilities were promised the opportunity to recover reasonably incurred expenses and earn a fair return on investment. Recognized by the Supreme Court for more than a century, such contracts between states and utilities are today widely acknowledged by regulators themselves. The sanctity of the regulatory compact allowed electric utilities to attract the investment necessary to provide the safe, reliable, and reasonably priced power we have all come to expect.
Recent legislative and regulatory proposals, however, would transform the traditional regulatory environment by mandating that utilities grant access to their transmission systems to any power supplier willing to pay a regulated tariff. This regime of ''mandated open access'' would enable customers to purchase power from any supplier, thereby causing utilities to lose their existing franchises to sell self-generated or purchased power to all customers within their existing service territories. This loss, in turn, would deprive utilities of the revenues needed to recover the costs incurred in upholding their end of the regulatory compact. The proposed breach of the compact on the part of regulators would generate ''stranded costs'' in the staggering amount of $200 billion or more. A failure to allow utilities to recover these costs would be both inefficient and unfair to utility shareholders. More importantly, however, recovery of stranded costs is mandated by the Constitution of the United States.
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First, the Just Compensation (or Takings) Clause requires that utilities be allowed to recover reasonably incurred costs that would be stranded by mandated open access. That proposed regime would constitute a physical taking of utilities' transmission facilities in particular and a regulatory taking and confiscation of their property in general. Although governments may take private property for public use, they must pay just compensation in return. In this situation, just compensation for utilities necessarily includes the opportunity to recover the costs of generation facilities, long-term supply contracts, and other assets that would be stranded by mandated open access, plus a reasonable return on investment.
Second, because the regulatory compact is an enforceable contract between states and utilities, a breach of the compact by adopting mandated open access would constitute an impairment by states of their own contractual obligations. Such uncompensated impairment is forbidden by the Contract Clause of the Constitution. Again, although states may impair their contractual obligations in an absolute sense, they must pay compensation in return. As with takings, this compensation necessarily includes the opportunity for utilities to recover their stranded costs and earn a reasonable return on their investment.
I. Background and Introduction
You have asked for my opinion whether a federal or state requirement that electric utilities allow open access to their transmission facilities at a price set without regard to the utilities' stranded costs would comport with the Constitution of the United States. For the reasons discussed below, I conclude that such a requirement would not pass constitutional muster.(see footnote 45)
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A. Historical Context
Traditionally, the bulk of our nation's electric power needs have been supplied by investor-owned electric utilities operating under the supervision of federal, state, and local officials. this regulatory environment, utilities had the obligation to plan for and provide on demand integrated generation, transmission, and distribution services to all customers within their exclusive service territories. This obligation included the duty to acquire supplies of electric power sufficient to meet all anticipated customer demand, using planning horizons of twenty years or more. In discharge of this duty and in order to comply with other statutory and regulatory directives, utilities have incurred significant costs. Unlike current operating expenditures that are reimbursed as they are incurred, such costs have been financed by bondholders or shareholders through the issuance of debt or equity.
The costs incurred by utilities in discharge of their legal obligations fall into four general categories. The first and perhaps most obvious category is the capital costs of constructing generating plants in order to satisfy anticipated demand for power. The second category is a special case of the first: the costs of decommissioning nuclear power plants, whether currently operating or not. Third, utilities face costs arising out of long-term purchase contracts with other power suppliers. Finally, utilities have incurred numerous expenses that have not yet been billed to customers because regulators have ordered recovery over longer periods than would be the case in a competitive market. These ''regulatory assets'' consist in large part of deferred taxes; they also include fuel contract buyout costs, promised employee pension benefits, and continuing obligations to comply with regulatory mandates relating to demand-side management, social concerns, and the environment.
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B. The Regulatory Compact
The above-described costs were incurred in compliance with what is usefully and commonly called a ''regulatory compact,'' under which utilities and regulatory authorities assumed corresponding obligations to each other. In its pathbreaking 1994 order opening rulemaking proceedings to restructure the electric power industry, the California PUC described the compact in succinct form:
The traditional compact is composed of several key components. First, it grants the utility monopoly franchise rights. Second, it ensures the utility's financial integrity by granting it an opportunity to recover reasonably incurred expenses and earn a fair return on its investment. In return for these privileges, the utility is subject to regulation by this Commission ... with that [regulatory] jurisdiction comes the Commission's duty to ensure the utility provides safe, reliable and reasonably priced service to all consumers within its monopoly franchise....
Proposed Policies Governing Restructuring of California's Electric Services Industry and Reforming Regulation (''CPUC 1994 Proposal''), 151 PUR4th 73, 88 (1994).
The regulatory compact has both ancient pedigree and modern acknowledgement. It was more than a century ago that the Supreme Court recognized that governments could and often did make binding contracts win private firms to provide utility services. For example, in Louisville Gas Co. v. Citizens' Gas Co., 115 U.S. 683, 699 (1885), the Court held that ''the grant to the Louisville Gas Company ... of the exclusive privilege of erecting gas-works in the city of Louisville during the continuance of its charter, and of vending coal gas-lights, and supplying that municipality and its people with gas by means of public works ... constitutes a contract between the State and that company.'' Accord New Orleans Gas Co. v. Louisiana Light Co., 115 U.S. 650, 660 (1885); New Orleans Water-Works Co. v. Rivers, 115 U.S. 674, 680–81 (1885).
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That the states have in fact made such contracts with respect to the supplying of electricity has, more recently, been explicitly acknowledged by regulators themselves. In addition to the California PUC, the regulatory authorities of many states could be cited. The Pennsylvania PUC, for example, has declared that ''in exchange for the utility's provision of safe, adequate, and reasonable service, the ratepayers are obligated to pay rates which cover the cost of servicer,] which includes reasonable operation and maintenance expenses, depreciation [i.e., capital expenses over time], taxes, and a fair rate of return to the utility's investors.'' Pennsylvania PUC v. Pennsylvania Gas & Water Co., 74 PUR4th 238, 245 (1986). As part of their study of the transition to greater competition in the industry, Maryland regulators described the compact at greater length:
Traditionally, an electric utility was granted a franchise or monopoly rights in a specified service territory. The utility's financial integrity was ensured by its ability to collect from customers all expenses reasonably incurred to serve them, including a fair rate of return on its stockholders' investment. In return for these assurances, the utility was placed under an obligation to provide safe, reliable and reasonably priced service to all customers within its monopoly franchise.... This arrangement has come to be called the ''regulatory compact.''
Electric Services, Market Competition and Regulatory Policies, Case No. 8678/Order No. 71459 (Md. PSC Sept. 19, 1994) (LEXIS, Energy library, AIIPUR file) (staff report). See also Order Approving Rates and Charges, Order No. 96–15, at 51 (S.C. PSC Jan. 9, 1996) (''Traditionally, utilities have operated under a set of interrelated principles collectively referred to as the 'regulatory compact' ....'').
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In this regulatory environment, utilities were guaranteed, as the California PUC put it, ''an opportunity to recover reasonably incurred expenses and earn a fair return on its investment.'' CPUC 1994 Proposal, 151 PUR4th at 88. They could recover these costs, including the four kinds of costs described above, in the rates they charged customers within their exclusive service territories, or franchise areas. This guarantee allowed utilities to attract the investment and credit necessary to provide, as Maryland regulators put it, ''safe, reliable and reasonably priced service to all customers within [their] monopoly franchise.'' Case No. 8678/Order No. 71459.
C. Stranded Costs
Recent federal and state legislative and regulatory proposals, however, would fundamentally transform the traditional regulatory environment. The most profound of these proposals would require investor-owned electric utilities to ''unbundle'' their various services (generation, transmission, and distribution) and sell them separately. Such proposals would require utilities to grant access to their transmission systems to any power supplier willing to pay a tariff set by regulation. Under this proposed regime of ''mandated open access'' (also called ''wheeling''), utilities would lose their existing franchises to sell self-generated or purchased power at guaranteed prices to all customers within their existing service territories. Consequently, customers would gain access to a multiplicity of competing suppliers.
These new suppliers of electric power will have a significant cost advantage over existing utilities. This is the case for several reasons. First, generating plants built today are much less expensive than those built by utilities under the traditional regulatory regime. In addition to great advances in technology, newer plants are not subject to the federal Fuel Use Act, which prohibited the use of natural gas and oil as fuels. Second, new suppliers are not burdened with the many above-market purchase contracts that utilities were required to enter into by the federal Public Utility Regulatory Policies Act. Finally, there are the many requirements imposed by regulators. As the California PUC recently acknowledged,
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many of today's high costs result from past regulatory promises made by [regulators] regarding the timing of the recovery of depreciation and taxes, past requirements to diversify sources of power by signing long-term contracts that in hindsight have high costs, and the costs incurred by utilities (most notably those associated with [independent power suppliers] and nuclear power) that were reviewed and deemed reasonable when incurred.
Proposed Policies Governing Restructuring California's Electric Services Industry and Reforming Regulation (''CPUC 1996 Proposal''), 166 PUR4th 1, 45 (1996).
This cost advantage will allow new suppliers to produce power less expensively than existing utilities. When mandated open access allows those suppliers to market their power to utilities' existing customers at lower rates, it is inevitable that some customers will elect other suppliers. The loss of these customers—or the reductions in rates necessary to gain them back—will deprive utilities of revenues sufficient to allow them to recover the four categories of costs described above. Costs that cannot be recovered due to mandated open access are said to be ''stranded.'' It is apparent, then, that adoption of mandated open access by regulators would constitute a repudiation of the regulatory compact on their part. Most obviously, utilities would lose the first of the ''key components'' of the compact, their exclusive franchise rights to serve particular territories. But, of course, that is not all: utilities would also lose the opportunity to recover reasonably incurred costs and earn a fair return on their investment.(see footnote 46)
Any proposal to restructure the electric utility industry must therefore grapple with the issue of ''stranded costs,'' which are estimated to total $200 billion or more. As a matter of elemental fairness, regulators must allow utilities to recover their stranded costs because it is regulators' breach of the regulatory compact that gives rise to those costs. It is important to remember that stranded costs will be paid for one way or the other. Those who advocate limiting or denying stranded cost recovery are really saying, ''shift the cost to others.'' If customers on whose behalf costs were reasonably incurred are able to choose new suppliers without paying the costs stranded by their departure, then either remaining customers or utility shareholders or both will have to pay for them. It is patently unfair for some customers to be able to shin incurred to serve them to other customers.
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It is also unfair and inefficient to shin the costs to shareholders. The relatively low rates of return on utility stocks indicate that investors have never been compensated for the risks surrounding mandated open access. Indeed, investors were induced to commit their capital to enterprises whose profits were strictly regulated only because they were promised by regulators, as part of the regulatory compact, that they would have the opportunity to recover their investment, together with a fair return on it. Furthermore, imposing stranded costs on shareholders is highly likely to increase the future cost of capital in what is the most capital-intensive industry in our economy. Investors will reasonably demand a higher return in exchange for bearing the risk that regulators will repudiate their promises whenever it is convenient for them. This will result in inefficient, higher costs for future generating plants.
Quite apart from fairness and efficiency, however, recovery of stranded costs is mandated by the Constitution of the United States. Specifically, the Just Compensation Clause of the Fifth Amendment and the Contract Clause of Article I, Section 10 require that electric utilities be allowed the opportunity to earn a reasonable rate of return on past investments, even if those investments would not have been made in today's more competitive environment.
II. The Just Compensation Clause Requires That Utilities Be Allowed To Recover Reasonably Incurred Costs That Would Be Stranded by Mandated Open Access
As proposed by various legislative and regulatory bodies throughout the country, mandated open access is a ''taking'' of property under the Fifth Amendment. Although governments have the power to take private property, the Constitution requires that they make just compensation in return. In the present context, just compensation to affected utilities necessarily includes allowing them to recover reasonably incurred stranded costs.
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A. Mandated Open Access Constitutes a Taking of Property that Triggers the Constitutional Obligation to Pay Just Compensation
The Just Compensation Clause of the Fifth Amendment provides: ''nor shall private property be taken for public use without just compensation.'' This prohibition on uncompensated takings of private property applies directly to the federal government and also indirectly, through the Due Process Clause of the Fourteenth Amendment, to the states. See Dolan v. City of Tigard, 114 S. Ct. 2309, 2316 (1994).(see footnote 47) The first question under the Clause is whether a particular governmental action has worked a ''taking'' of property in the constitutional sense.
Although the Supreme Court ''has been unable to develop any 'set formula' for determining when'' there has been a taking, Penn Cent. Transp. Co. v. New York City, 438 U.S. 104, 124 (1978), it has identified several categories of takings. First, there are ''per se'' takings: ''When faced with a constitutional challenge to a permanent physical occupation of real property, th[e] Court has invariably found a taking.'' Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419, 427 (1982). This is the result ''without regard to whether the action achieves an important public benefit or has only minimal economic impact on the owner.'' Id. at 435. Thus, the Court held that a taking occurred where the city authorized cable television installation involving ''a direct physical attachment of plates, boxes, wires, bolts, and screws to the [private owner's] building, completely occupying space immediately above and upon the roof and along the building's exterior wall.'' Id. at 438.
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Subsequent cases make clear that the concept of ''permanent physical occupation'' includes situations where the government mandates public access to private property in the form of an easement or the like. Thus, in 1987 the Court concluded that if a regulatory authority ''simply required [private owners] to make an easement across their beachfront available to the public on a permanent basis in order to increase public access to the beach ..., we have no doubt there would have been a [physical] taking.'' Nollan v. California Coastal Comm'n, 483 U.S. 825, 831 (1987). That mandated public access to a beachfront is a taking, explained the Court, followed directly from Loretto:
We have repeatedly held that, as to property reserved by its owner for private use, ''the right to exclude others is one of the most essential sticks in the bundle of rights that are commonly characterized as property.'' In Loretto we observed that where governmental action results in ''a permanent physical occupation'' of the property, by the government itself or by others, ''our cases uniformly have found a taking to the extent of the occupation, without regard to whether the action achieves an important public benefit or has only minimal economic impact on the owner.'' We think a ''permanent physical occupation'' has occurred, for purposes of that rule, where individuals are given a permanent and continuous right to pass to and fro, so that the real property may continuously be traversed, even though no particular individual is permitted to station himself permanently upon the premises.
Id. at 831–32 (quoting Loretto, 458 U.S. at 433, 434–35) (citations omitted).
This holding was reaffirmed less than two years ago in Dolan v. City of Tigard, in which the Court stated: ''Without question, had the city simply required petitioner to dedicate a strip of land along Fanno Creek for public use ..., a taking would have occurred. Such public access would deprive petitioner of the right to exclude others....'' 114 S. Ct. at 2316 (citing Nollan, 483 U.S. at 831). Under this rule, it does not matter if the access mandated by regulators is for themselves or for other private individuals: so long as the ''governmental action results in 'a permanent physical occupation' of the property, by the government itself or by others,'' there is a per se taking. Nollan, 483 U.S. at 831 (emphasis added); see also Hawaii Hous. Auth. v. Midkiff, 467 U.S. 229, 243–44 (1984) (holding that the ''government does not itself have to use property to legitimate [a] taking,'' which can occur even if property ''is transferred in the first instance to private beneficiaries'').
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Governmental action effecting a permanent physical occupation is a per se taking that automatically gives rise to liability for just compensation. But governmental action can also constitute a ''regulatory taking,'' a category derived from Justice Holmes's famous statement that ''while property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.'' Pennsylvania Coal Co. v. Mahon, 260 U.S. 393, 415 (1922). Although the regulatory taking analysis cannot be reduced to a set formula, ''the Court's decisions have identified several factors that have particular significance.'' Penn Central, 438 U.S. at 124. These include:
The economic impact of the regulation on the claimant and, particularly, the extent to which the regulation has interfered with distinct investment-backed expectations are, of course, relevant considerations. So, too, is the character of the governmental action. A ''taking'' may more readily be found when the interference with property can be characterized as a physical invasion by government, than when interference arises from some public program adjusting the benefits and burdens of economic life to promote the common good.
Id. More recent decisions have emphasized the first two of these factors: ''as we have acknowledged time and again, ''the economic impact of the regulation on the claimant and ... the extent to which the regulation has interfered with distinct investment-backed expectations' are keenly relevant to takings analysis generally.'' Lucas v. South Carolina Coastal Council, 505 U.S. 1003, 1019 n.8 (1992).
There is a third type of taking that is recognized in Fifth Amendment jurisprudence. Improper governmental regulation of public utilities can lead to ''confiscation,'' which is a species of unconstitutional taking. The principles applicable in this area were recently summarized in Duquesne Light Co. v. Barasch, 488 U.S. 299 (1989). In that decision, the Supreme Court stated:
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The guiding principle has been that the Constitution prohibits utilities from being limited to a charge for their property serving the public which is so ''unjust'' as to be confiscatory.... If the rate does not afford sufficient compensation, the State has taken the use of utility property without paying just compensation and so violated the Fifth and Fourteenth Amendments.
Id. at 307–08.
Although the Court has not defined with precision what level of compensation is ''sufficient'' so as to be non-confiscatory, some general principles have emerged over the years. Duquesne reaffirmed FPC v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944), which taught that ''the fixing of 'just and reasonable' rates [i.e., rates that comport with the Constitution] ... involves a balancing of the investor and the consumer interests.'' Hope went on to explain at some length that
the investor interest has a legitimate concern with the financial integrity of the company whose rates are being regulated. From the investor or company point of view it is important that there be enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock. By that standard the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital.
Id. (citation omitted).
As support for this explanation, Hope cited Justice Brandeis's opinion concurring in the judgment in Missouri ex ref. Southwestern Bell Telephone Co. v. Public Service Commission, 262 U.S. 276, 291 (1923), wherein he stated: ''The compensation which the Constitution guarantees an opportunity to earn is the reasonable cost of conducting the business. Cost includes not only operating expenses, but also capital charges.'' See also Permian Basin Area Rate Cases, 390 U.S. 747, 792 (1968) (holding that a constitutionally permissible rate structure must, among other things, ''reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed''); Bluefield Water Works & Improvement Co. v. Public Serv. Comm'n, 262 U.S. 679, 692 (1923) (holding that ''[a] public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs for the convenience of the public equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding risks and uncertainties'').
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Under the foregoing principles, proposals that would breach the regulatory compact by imposing a regime of mandated open access without the opportunity for utilities to recover their stranded costs would work a taking of utility property. Pursuant to such a regime, electric utilities would be required by law to grant competitors access to their own transmission systems. Regulations proposed by the Federal Energy Regulatory Commission (FERC), for example, would force utilities to ''offer wholesale transmission services (network and point-to-point), including ancillary services, on a non-discriminatory basis to third parties.'' Notice of Proposed Rulemaking (''Mega-NOPR''), 60 Fed. Reg. 17662, 17664 (1995). The New Hampshire PUC likewise has proposed to ''require electric utilities under [its] jurisdiction to accept power delivered to their local transmission facilities by other suppliers ... in order to effect third-party transactions.'' Retail Competition Pilot, 164 PUR4th 193, 199 (1995).
By forcing utilities to allow their facilities to be used for transmitting electricity generated and owned by other suppliers, mandated open access would effectively create a public easement in and through the wires and other elements of the utilities' transmission systems. This would have a double-barreled impact on the property of electric utilities. Specifically, mandated open access would permanently deprive utilities of the exclusive use of their property in wires and other transmission equipment. On a more general level, mandated open access would deprive utilities of the exclusive right to sell power to the customers in their service territories, thereby stranding the long-term costs incurred to provide current and future service to those customers, including investments in generating facilities and long-term contractual commitments.
This two-pronged deprivation undoubtedly constitutes a taking of property under all three categories of takings law. First, as to the transmission assets themselves, mandated open access works a per se taking by means of a permanent physical occupation. Mandated public access to a utility's transmission system is no different in kind from the mandated public access to a beachfront found to be a taking in Nollan and the mandated public access to a strip of land along a creek found to be a taking in Dolan. All three mandates similarly deprive property owners of ''the right to exclude others.'' By compulsion of law, utilities would no longer be able to exclude competitors from using the utilities' personal property in wires and other transmission equipment. To paraphrase Nollan, mandated open access would give third-party power suppliers a permanent and continuous right to send their power to and fro through the utilities' wires, so that the wires may continuously be traversed, even though no particular electricity is permitted to remain permanently in the transmission system. See 483 U.S. at 832. This would result in a ''permanent physical occupation'' of the transmission system. Regardless of its arguable benefits to the public or its impact on utilities, therefore, mandated open access would constitute a per se taking of utility property for purposes of Loretto. See 458 U.S. at 434–35.
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Second, mandated open access would also work a regulatory taking. A fundamental regulatory change like mandated access simply goes ''too far'' for government to escape its constitutional obligation to pay just compensation. Pennsylvania Coal, 260 U.S. at 415. The Penn Central factors identified above all indicate that a regulatory taking should be found here. See generally 438 U.S. at 124. ''The economic impact of the regulation on'' utilities would especially grave. As discussed above, mandated open access could produce stranded costs of more than $200 billion. Moreover, such a regime would undoubtedly interfere with utilities' ''distinct investment-backed expectations.'' Stranded costs result from investments made by utilities to comply with their obligations under the regulatory compact. Utilities made these investments with the reasonable expectation that regulators would comply with their corresponding obligations under the regulatory compact to allow utilities the opportunity to earn a reasonable rate of return. Finally, the ''character of the governmental action'' here is more than just an adjustment of the benefits and burdens of economic life. Mandated open access is, as explained above, best characterized as a ''physical invasion'' (or, to use Loretto's more precise term, a ''permanent physical occupation''), the kind of regulatory action most likely to be found a taking.
Third, mandated open access would work a taking by confiscation of utility property. Imposing that regime without allowing for the recovery of stranded costs would not afford utilities constitutionally sufficient compensation. Stranded costs are costs that cannot be recovered under the reduced level of revenues available to utilities as a result of mandated open access. Having entered into long-term contracts to buy power at rates higher than rates that would prevail under mandated open access, utilities will be unable to pay the current expenses of those contracts. Moreover, having incurred debt and sold stock to raise funds to construct facilities rendered uneconomical by mandated open access, utilities will be unable to service such debt or pay dividends on such stock. Together, these operating expenses (the costs of contract compliance) and these capital charges (the costs of debt repayment and dividends) are precisely what Justice Brandeis called ''the reasonable cost of conducting the business,'' which cost the Constitution guarantees utilities an opportunity to earn. Southwestern Bell, 262 U.S. at 291. As Hope put the point, ''it is important that there be enough revenue not only for operating expenses but also for the capital costs of the business.'' 320 U.S. at 603.(see footnote 48)
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Mandated open access, then, would constitute a per se taking, a regulatory taking, and a confiscatory taking of utility property. This conclusion is fortified by contrasting mandated open access with the regime established by Congress in the Pole Attachments Act, 47 U.S.C. 224. That statute authorized the Federal Communications Commission to regulate the price at which utility companies granted easements on their poles to cable television operators. In FCC v. Florida Power Corp., 480 U.S. 245 (1987), the Supreme Court held that the statute did not effect a taking. First, the Court rejected the Eleventh Circuit's holding that the statute authorized a ''permanent physical occupation of property, which, under the rule we adopted in Loretto [and later confirmed in Nollan and Dolan], is per se a taking for which compensation must be paid.'' Id. at 250. The crucial fact underlying this conclusion was that ''nothing in the Pole Attachments Act as interpreted by the FCC in these cases gives cable companies any right to occupy space on utility poles, or prohibits utility companies from refusing to enter into attachment agreements with cable operators.'' Id. at 251. By contrast, mandated open access would give third-party power suppliers the right to use utilities' transmission systems, and would prohibit utilities from refusing to enter into transmission agreements with such suppliers.
The Court in Florida Power also rejected the argument that the Pole Attachments Act worked a regulatory taking or confiscation. Citing the Permian Basin Area Rate Cases, the Court weighed the rate imposed by the FCC on the utilities against the constitutional ratesetting principles discussed above. This rate derived from the statutory formula under which the charge in any individual case was to be calculated ''by multiplying the percentage of the total usable space ... which is occupied by the pole attachment by the sum of the operating expenses and actual capital costs of the utility attributed to the entire pole.'' 47 U.S.C. 224(d)(1). The Court held that ''a rate providing for the recovery of fully allocated cost, including the actual cost of capital, ... does not effect a taking of property under the Fifth Amendment.'' 480 U.S. at 254 (emphasis added). By contrast, however, a regime of mandated open access without recovery of stranded costs would result in a rate not providing for the recovery of the actual cost of capital.
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If mandated open access works a taking of utility property, then certain consequences follow. Although governments have power to take the property of private utilities, ''[a] necessary condition of the taking is the ascertainment and payment of just compensation.'' Seaboard Air Line Ry. v. United States, 261 U.S. 299, 305 (1923). It is to the issue of such compensation that we now turn.
B. Just Compensation Necessarily Includes Recovery of the Costs of Generation Facilities, Long-Term Supply Contracts, and Other Assets that Would Be Stranded by Mandated Open Access
Under the Just Compensation Clause, governments have the ''obligation to compensate the loss incurred by the owner as a result of the talking of his property.'' United States v. 564.54 Acres of Land, 441 U.S. 506, 512 (1979) (quoting Kimball Laundry Co. v. United States, 338 U.S. 1, 5 (1949)). Because mandated open access works a taking, it gives rise to the obligation on the part of regulators to compensate utilities for the losses suffered as a result of the new regulatory regime. As described above, the loss suffered by any particular utility as a result of mandated open access is the loss of the exclusive right to sell power to customers within its franchise area at rates sufficient to recover the costs of generating plants, long-term supply contracts, and regulatory requirements. That is, utilities lose by being saddled with stranded costs. It follows, then, that in order to put utilities ''in as good a position pecuniarily as if [their] property had not been taken,'' id. at 510 (quoting Olson v. United States, 292 U.S. 246, 255 (1934)), regulators must give utilities the opportunity by some means or other to recover their stranded costs.
In FPC v. Natural Gas Pipeline Co., 315 U.S. 575, S86 (1942), the Court held that ''[t]he Constitution does not bind rate-making bodies to the service of any single formula or combination of formulas.'' No matter what formula regulators employ, ''the question is whether [the regulatory regime] 'viewed in its entirety' meets the requirements of the [Constitution].'' Hope, 320 U.S. at 602 (quoting Natural Gas Pipeline, 315 U.S. at 586). Under the ''just and reasonable'' standard, ''it is the result reached'' that is controlling; in other words, ''[i]t is not theory but the impact of the rate order that counts.'' Id. Rather than examining a regulatory regime piecemeal, one must focus on the ''total effect'' of the regime. Id. Accord Duquesne, 488 U.S. at 310, 314.
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The Supreme Court applied these principles in Duquesne to uphold Pennsylvania's departure from the historical cost/prudent investment system in certain subsidiary aspects of electric power ratemaking. The state generally allowed utilities to recover in its rates all prudent costs of constructing or expanding generating facilities, but a newly enacted statute limited recovery of such costs only to those facilities that were ''used and useful in service to the public.'' See generally id. at 302–05. The Court readily acknowledged ''the theoretical inconsistency of [the statute], suddenly and selectively applying the used and useful requirement, normally associated with the fair value approach, in the context of Pennsylvania's system based on historical cost.'' Id. at 313. But rather than focusing on the statute itself, the Court examined the ''overall impact'' of the rate orders of which the statute was a small part. It found this impact ''not constitutionally objectionable'' for two related reasons:
No argument has been made that these slightly reduced rates [resulting from disallowance of certain costs] jeopardize the financial integrity of the companies, either by leaving them insufficient operating capital or by impeding their ability to raise future capital. Nor has it been demonstrated that these rates are inadequate to compensate current equity holders for the risk associated with their investments under a modified prudent investment scheme.
Id. at 312.
Applying the Duquesne analysis to the present case, it is clear that a refusal to allow recovery of stranded costs is constitutionally objectionable if the ''total effect'' of the refusal is to jeopardize the financial integrity of a utility or inadequately compensate equity holders for their investments. The D.C. Circuit faced just such a situation in Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168 (D.C. Cir. 1987) (en banc). Arguing that its financial integrity would otherwise be impaired and that it would otherwise be unable to provide investors a return on equity, Jersey Central had sought to recover an admittedly reasonable $397 million investment in a nuclear generating station that was never completed. FERC summarily denied the utility's request to include all of this investment in its rate base, because the investment had not yielded ''used and useful'' assets. Applying the same principles from Hope that the Supreme Court subsequently applied in Duquesne, and observing that Jersey Central had made sufficient allegations that the ''end result'' of FERC's orders was not ''just and reasonable,'' the en banc appeals court reversed and remanded for a hearing on those allegations. The court did not fault FERC's employment of the ''used and useful'' test (as opposed to historical cost) in the abstract; however, ''[t]he fact that a particular ratemaking standard is generally permissible does not per se legitimate the end result of the rate orders it produces.'' Id. at 1180. Accordingly, FERC ''is not precluded from employing 'used and useful,' or any other specific rate-setting formula. It must ensure, however, that the resulting rate is just and reasonable.'' Id. at 1187.
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Read together, Duquesne and Jersey Central express a single principle relevant to the recovery of stranded costs: in making the transition to mandated open access, regulators can choose to employ any of several different methods to establish utilities' future revenues; but no matter what method they use, regulators must establish revenue structures that safeguard utilities' financial integrity, ensure their ability to service debt and raise capital, and allow their stockholders to make a fair return on investment.
With these principles in mind, it is useful to make some general observations about the financial consequences to utilities of mandated open access, even if regulators and courts eventually will have to examine the facts on a company-by-company basis. In some cases, the inability to recover stranded costs would not only raise ''concerns'' about the financial integrity of a company, it would wholly destroy the company's financial integrity by putting it into bankruptcy. As the D.C. Circuit observed in Jersey Central, even the most zealous advocate of regulation must concede that ''a court might [and indeed will] set aside a rate order under Hope if the order would drive the company into bankruptcy.'' 810 F.2d at 1179.
Of course, bankruptcy is not the only possible result of a failure to allow recovery of costs stranded under a regime of mandated open access, even if it is the most drastic one. The Jersey Central case illustrates the potentially grave financial consequences that can attend less than full recovery of reasonably incurred investments. The utility there had incurred debt and issued preferred stock to finance its investment—reasonable when made but ultimately abandoned—in a nuclear generating station. Because FERC refused to allow full recovery of those capital costs in rates, ''the need to pay interest on the company's debt and dividends on its preferred stock meant that common equity investors not only were earning a zero return, but were also forced to pay these interest costs and dividends.'' Id. at 1178. This situation rendered the company unable to sell senior securities, unable to borrow except under a revolving arrangement subject to termination, and unable to pay dividends on common stock for four years (with no prospect of future payment). See id. As the court recognized, this state of affairs did not comport with Hope's mandate that ''there be enough revenue not only for operating expenses but also for the capital costs of the business'' (which ''include service on the debt and dividends on the stock'') and also that ''the return to the equity owner ... should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital.'' 320 U.S. at 603.
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All this and more is the prospect for many utilities if regulators impose mandated open access without allowing recovery of stranded costs. It is therefore no surprise that regulators have acknowledged stranded cost recovery as a necessary element of the new regulatory regime in the electric power industry. As FERC stated last year in its proposal to mandate open access to transmission services in the wholesale market:
We cannot successfully and fairly encourage the development of competitive wholesale markets ... until we have made provision for electricity suppliers to seek recovery of existing uneconomic costs (primarily generation) which they have already incurred.... Recovery of legitimate and verifiable transition costs will permit all sellers ... to compete on a more equal footing in competitive bulk power markets.
Mega-NOPR, 60 Fed. Reg. at 17690. Accordingly, FERC ''determined that recovery of legitimate and verifiable stranded costs should be allowed, and that direct assignment of stranded costs to departing customers ... is the appropriate method for recovery.'' Id. See generally id. at 17722–23 (proposing to add new 18 C.F.R. 35.26, governing ''[r]ecovery of stranded costs by public utilities and transmitting utilities'').
Many states have made the same well-considered decision as part of restructuring proposals that would impose mandated open access. The initiative recently adopted by the California PUC concluded that ''utilities should be allowed to recover appropriate transition costs.'' CPUC 1996 Proposal, 166 PUR4th at 48.(see footnote 49) The California proposal would authorize, for a limited time, ''a nonbypassable charge, called the competitive transition charge,'' to be collected from every customer currently taking bundled service from electric utilities. Id. at 45. The Massachusetts Department of Public Utilities adopted five principles to guide the transition to a more competitive electric utility industry. The first of these principles would ''honor existing commitments'' to shareholders: ''Utilities should have a reasonable opportunity to recover net, non-mitigatable, stranded costs associated with commitments previously incurred pursuant to their legal obligations to provide electric service.'' Electric Industry Restructuring, 163 PUR4th 96, 112 (1995).(see footnote 50)
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In sum, just compensation for the taking of utility property that would be wrought by mandated open access includes the opportunity to recover stranded costs. Because the Constitution guarantees utilities the right to receive just and reasonable rates rates that will ensure financial stability and a fair return on investment and because mandated open access poses serious threats to that right, creating a mechanism for recovery of stranded costs is a constitutional imperative.
III. Mandated Open Access Without Recovery of Stranded Costs Would Breach the Regulatory Compact and Thereby Unconstitutionally Impair Government's Contractual Obligations
In addition to the Just Compensation Clause, the Contract Clause of Article I, Section 10 also compels the conclusion that utilities be able to recover stranded costs. That constitutional provision forbids states to ''pass any ... Law impairing the Obligation of Contracts.'' Even since such famous Marshall Court-era cases as Fletcher v. Peck, 10 U.S. (6 Cranch) 87, 137–39 (1810), and Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518 (1819), it has been established that ''the Contract Clause limits the power of the States to modify their own contracts as well as to regulate those between private parties.'' United States Trust Co. v. New Jersey, 431 U.S. 1, 17 (1977). This precept also applies to the federal government. See National R.R. Passenger Corp. v. Atchison, T. & S.F. Ry., 470 U.S. 451, 465–71 (1985).(see footnote 51)
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The contract in the context of mandated open access is the regulatory compact described in Part I.B above. Without completely duplicating the discussion in that section, it is worth repeating the California PUC's description of the compact:
The traditional compact is composed of several key components. First, it grants the utility monopoly franchise rights. Second, it ensures the utility's financial integrity by granting it an opportunity to recover reasonably incurred expenses and earn a fair return on its investment. In return for these privileges, the utility is subject to regulation by this Commission ...; with that [regulatory] jurisdiction comes the Commission's duty to ensure the utility provides safe, reliable and reasonably priced service to all consumers within its monopoly franchise....
CPUC 1994 Proposal, 151 PUR4th at 88.
Although it is not possible here to cite every statute, regulation, and judicial decision establishing the regulatory compact in each of the other fifty states, one may note how widely the compact has been acknowledged by the states themselves. In addition to the California, Pennsylvania, Maryland, and South Carolina authorities already mentioned, see supra pp. 4–6, many other acknowledgements could be cited. For example, the principles adopted by the Rhode Island PUC to guide the state's transition to a more competitive electric utility industry explicitly recognized the regulatory compact: ''Any electric utility restructuring plan should provide utilities with an opportunity to recover legitimate and verifiable costs incurred pursuant to the regulatory compact.'' Electric Industry Restructuring, 163 PUR4th 441, 451 (1995). Sometimes the compact is described in other terms, although the bottom line is the same. Thus, FERC has characterized the present ''regulatory regime'' as one in which utilities have been permitted to recover all reasonably incurred costs, ''plus the opportunity to earn a reasonable rate of return on their investment.'' Mega-NOPR, 60 Fed. Reg. at 17690. Finally, regulatory authorities may not use any special term, yet still unambiguously acknowledge their duty to utilities. Accordingly, the Washington Utilities and Transportation Commission recently stated: ''The [electricity service] provider is entitled to rates that are sufficient to provide it the opportunity to recover and earn a fair return on its investment dedicated to public service.'' Regulation of Electric Utilities, 165 PUR4th 401, 402 (1995).(see footnote 52)
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It is useful here to examine the compact in more detail. The costs that will be stranded by mandated open access were incurred for two related reasons. First, utilities reasonably believed that certain investments were necessary in light of their obligation to supply the power needs of their customer and to supply them without regard to whether it would be economical do so in a perfectly competitive environment.(see footnote 53) As the foregoing descriptions of the regulatory compact make clear, this obligation is a foundational principle in American public utility law. See also, e.g., United Fuel Gas Co. v. Railroad Comm'n, 278 U.S. 300, 309 (1929) (''The primary duty of a public utility is to serve on reasonable terms all those who desire the service it renders. This duty does not permit it to pick and choose and to serve only those portions of the territory which it finds most profitable....''); 26 Am. Jur. 2d Electricity, Gas, and Steam 18, at 228 (1966) (''an electric or gas company ... is under a legal obligation to render adequate and reasonably efficient impartially ... to all members of the public to whom its public use and scope of operation extend who apply for such service'').
It should be emphasized that this obligation extends to more than just the current demand of current customers: utilities must plan for future demand, both of customers they already serve and of any new customers that might demand service in the future. Accordingly, utilities have a duty to procure a supply of power sufficient to meet both existing and projected demand. The Maine PUC explained: ''The 'compact' includes the obligation for utilities to be ready to serve the future load of all customers in its service territory. As a result, utilities must invest in generating plant or enter long-term purchased power contracts to meet forecasted load.'' Recovery of Stranded Costs Rulemaking, 159 PUR4th 279, 282 (1995). Such plant and contracts, among other costs, stand to be stranded by mandated open access.
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In addition being compelled to invest in procuring power, utilities and their investors were induced to make the stranded investments. Significant commitments of capital were forthcoming on the basis of the above-described promises of regulators to provide the revenues necessary to recover the resulting operating and capital costs. That is, utilities could be induced to commit enormous sums of capital to enterprises whose profits are strictly regulated only on the basis of corresponding commitments by regulators to ensure the opportunity to earn a fair rate of return on that investment. As FERC has observed: ''Utilities have invested billions of dollars in order to meet their obligations. Those investments have been made under a 'regulatory compact' whereby utilities and their shareholders expect to recover prudently incurred costs.'' Mega-NOPR, 60 Fed. Reg. at 17663.
FERC also observed that ''[r]eliance on past contractual and regulatory practices must be recognized and past investments must be protected to assure an orderly, fair transition to competition.'' Id. FERC's terminology appropriately suggests an analogy to that branch of contract law dealing with detrimental reliance, or promissory estoppel. This is a well recognized basis for imposing liability on one who induces another to act: ''A promise which the promiser should reasonably expect to induce action or forbearance on the part of the promises ... and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.'' Restatement (Second) of Contracts 90(1) (1981). In the context of stranded costs, injustice can be avoided only if utilities receive the promised benefits that induced them to invest in the first place, namely, a return of their capital and a fair return on that capital. Having by their promises induced investment in generating facilities and long-term supply contracts and having reaped the benefits of such investment in the form of adequate and reliable supplies of electricity for existing and future customers regulators cannot in good conscience be allowed to repudiate the promises that made the investment possible.
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Good conscience, however, may not be enough to restrain those who would unfairly force shareholders and remaining customers to bear stranded costs. Because the regulatory compact is a contract between states and electric utilities, the Contract Clause forbids regulators to repudiate their obligations. This was established before the turn of the century:
[T]his court has too often decided for the rule to be now questioned, that the grant of a right to supply gas or water to a municipality and its inhabitants through pipes and mains laid in the streets, upon condition of the performance of its service by the grantee, is the grant of a franchise vested in the State, in consideration of the performance of a public service, and after performance by the grantee, is a contract protected by the Constitution of the United States against state legislation to impair it.
Walla Walla City v. Walla Walla Water Co., 172 U.S. 1, 9 (1898).
Although the supply of electricity depends not on laying pipes and mains but on building generation plants, transmissions systems, and distribution networks, the principle is the same. Pursuant to the regulatory compact, states have granted utilities the exclusive right to supply power to exclusive franchise areas upon condition of supplying the power in a safe and reliable manner; utilities have performed their obligations by making the enormous capital investments or contractual commitments necessary to ensure a reliable and adequate supply of power; the grant therefore has become ''a contract protected by the Constitution of the United States against state legislation to impair it.'' Id. Of course, legislation or other legal action imposing mandated open access would impair this contract by taking away utilities' exclusive franchise areas. Moreover, mandated open access would further impair the contract by taking away a related right a utility's opportunity to recover reasonably incurred expenses and earn a fair return on its investment.
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All of this is not to argue that mandated open access cannot be imposed under any circumstances. As recognized in United States Trust Co. v. New Jersey, ''[c]ontract rights are a form of property and as such may be taken provided that just compensation is paid.'' 431 U.S. at 19 n. 16. That is, governments may indeed impair contract rights, on condition that they pay just compensation. As described in Part II above, however, just compensation necessarily includes allowing utilities to recover their stranded costs.
In sum, the costs that would be stranded by the imposition of mandated open access were incurred pursuant to a regulatory compact between utilities and regulators, which compact granted investors the opportunity to earn a fair return on investment. Like other contracts between states and private parties, the regulatory compact is protected against impairment by the Contract Clause of the Constitution. Therefore, regulators may breach the compact only if they pay just compensation, that is, if they allow utilities the opportunity to recover all stranded costs.
CONCLUSION
The imposition of mandated open access without allowing the recovery of stranded costs would work a taking of utility property without just compensation. Such a regime would also breach the regulatory compact between regulators and utility shareholders and thereby unconstitutionally impair the obligation of contracts. Recovery of all stranded costs by utilities is therefore compelled by the Constitution.
Mr. CONYERS. You are suggesting that we pay for your mistakes, right?
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Mr. EARLEY. Mr. Conyers, they are not mistakes; they were decisions and investments that were made under the regulatory structure that had been in place for 90 years.
Mr. CONYERS. I just threw that out. That was not a question to be answered. Just testing.
Mr. Roy Thilly, welcome.
STATEMENT OF ROY THILLY, GENERAL MANAGER AND COUNSEL, THE WISCONSIN PUBLIC POWER, INC., SYSTEM, ON BEHALF OF THE AMERICAN PUBLIC POWER ASSOCIATION
Mr. THILLY. Thank you very much for the opportunity to appear this morning on behalf of the American Public Power Association.
By way of background, the utility that I run is owned by 30 cities in Wisconsin and serves all the requirements of those cities. We own generation, but we purchase most of our needs on the wholesale market. We are a low cost system in a low cost State.
Our major generation is in Minnesota, remote from our load, and we own no transmission whatsoever so we have to use the transmission systems of four utilities in order to serve our customers.
We have been an aggressive advocate of open access transmission, and as a new entrant into the industry, we have practical knowledge of market power barriers. We support industry restructuring that will benefit all customers, large and small.
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We shouldn't lose sight that the objective is lower prices and better service, not deregulation for the sake of deregulation. If States and Congress deregulate without fundamentally restructuring the industry, we will end up with deregulated monopolies and everyone will be worse off. So if we are going to do it, we have to do it right.
The key point is we are starting out with an industry dominated by large, vertically integrated, State-sanctioned monopolies. To be successful, we have to take affirmative action to create competitive markets. In doing that, we need to recognize unique characteristics of electricity.
First of all, it is an essential service. Most people don't have a choice; they need it and they need it all the time. Second, is a real-time business. We can't store electricity, and that makes manipulation of the market much more easy. We run into locational market power problems and market power problems at seasons or times of day.
In addition, the integrated transmission and generation system is highly interdependent, and the dispatch, running particular generators can cut off transmission access for competitors to get into the market. So it is complex, the system is easy to manipulate, but it is difficult to detect. There is definitely a Federal role in restructuring in the market power area, and we welcome this committee's concern. Most States, California aside perhaps, cannot effectively deal with the need for regional transmission or the market power of multistate companies, so there is definitely a Federal role.
The first thing we need to do is completely separate generation ownership from control of transmission and operation of transmission. We support the independent system operator concept, but the ISO has got to be the functional equivalent of divestiture, with the owners being investors, entitled to a return on their facilities but having no management or control of the operation of that system. There has to be Federal legislation on that point. FERC does not have clear authority to require independent system operators, and because they don't have clear authority, they will try to convince and get voluntary action. That will result in compromise, and we won't have true separation, so we need a statute. Once the FERC had clear authority to order transmission and we had comparability. Before that, we did not under EPACT because we had voluntary service.
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The other thing is the infrastructure is simply inadequate. In many places, there are bottlenecks of facilities, and you don't have a—competitive market because competitors can't get in through the transmission bottlenecks. So somehow we need to address the need to construct transmission in order to maintain—create and maintain a competitive environment.
Even with complete separation of generations and transmission, there will be horizontal market power, concentration in generation. And, ironically, concentration is getting worse with the merger trend we are facing, which is in direct conflict with the objective to create a competitive market with many sellers.
I think the key point is we cannot simply rely on existing antitrust laws to restructure the industry. Those laws are designed to police an already competitive market, not to create one. We need to preserve antitrust laws and antitrust enforcement.
We also need to limit the State action exemption because parts of the industry will remain regulated—distribution—and transmission, and we can't have people using State distribution regulation to get a competitive advantage in the competitive parts of the market.
But we should also dramatically change FERC's role from a settler of rates to an agency with an affirmative obligation to ensure a continuing competitive market at wholesale and retail, not to have to wait for violations of the antitrust laws and the long litigating process that takes place there, but to nip anticompetitive practices in the bud. And in my testimony that is filed, we have listed a number of explicit authorities that should be granted to FERC in order to take that role on.
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Thank you very much.
Mr. HYDE. Thank you very much, Mr. Thilly.
[The prepared statement of Mr. Thilly follows:]
PREPARED STATEMENT OF ROY THILLY, GENERAL MANAGER AND COUNSEL, THE WISCONSIN PUBLIC POWER, INC., SYSTEM, ON BEHALF OF THE AMERICAN PUBLIC POWER ASSOCIATION
Good morning, Mr. Chairman and Members of the Committee. I am Roy Thilly, General Manager and Counsel of The Wisconsin Public Power, Inc., System (WPPI). WPPI is a municipal joint action agency owned by 30 Wisconsin municipalities that operate electric distribution systems and provide retail electric service in Wisconsin. WPPI is a political subdivision of the state of Wisconsin and is empowered by statute to own and operate electric generation and transmission facilities and to supply all of the electric requirements of its member municipalities. WPPI's load is approximately 600 megawatts. WPPI member municipalities serve approximately 100,000 customers at retail.
WPPI owns 20% of a large, coal-fired electric generation station located in Grand Rapids, Minnesota. We also own two medium-sized natural gas combustion turbine generators in Wisconsin. WPPI purchases more than half of the requirements of its members at wholesale from a variety of suppliers, including utilities located throughout the upper Midwest and power marketers.
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WPPI owns no transmission facilities. In order to serve our member loads, we must use the transmission systems of four private utilities in Wisconsin, as well as transmission facilities in Minnesota and other states. For this reason, WPPI has been an aggressive advocate of equal access transmission and the development of independent regional transmission systems. As the newest major electric utility in the state of Wisconsin in many years, and as a transmission-dependent system that has aggressively sought to access competitive wholesale power sources on a regional basis, we are familiar with the market power barriers that stand in the way of developing vigorously competitive wholesale and retail electric markets.
I am here today on behalf of the American Public Power Association (APPA).
APPA is the service organization for the nation's locally-owned and locally-controlled, not-for-profit electric utilities that provide for the electric power needs of 35 million Americans.
APPA was created in 1940 as a not-for-profit, non-partisan organization to advance the public policy interests of its members and their consumers and to provide services to help ensure adequate, reliable electricity at a reasonable price with proper protection of the environment. Most public power systems are owned by municipalities, with others owned by states, counties or public utility districts. Public power consumers are utility-owners as well as electricity users, with local control over policy and service in public hands.
The positions in my statement today reflect the policies adopted by APPA's policy committee in February, and subsequently modified by a task force of APPA members in two meetings over the past few months. These policy positions will be put before the entire APPA membership at our annual meeting to be held on June 17 so they are still subject to modification. They do, however, reflect my own views and those of my utility.
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In accordance with House Rule XI, Clause 2W(4), attached to this testimony is my curriculum vitae.(see footnote 54) Neither I nor WPPI is a recipient of any federal grant. WPPI has an interchange contract with the Western Area Power Administration pursuant to which we buy and sell electricity, is a participant in the DOE's Global Climate Change Accord and an ally in the Environmental Protection Agency's Green Lights program. Attached is a disclosure statement(see footnote 55) on the sources and amounts of federal grants, contracts or sub-contracts of APPA.
I. THE PROBLEM: CREATING A VIGOROUSLY COMPETITIVE MARKET FROM A VERTICALLY INTEGRATED MONOPOLY STRUCTURE
For a number of years. federal and state regulators and other industry participants have been seeking to introduce competition into the electric industry in order to better discipline price and to produce better and more reliable electric service for consumers. In the Energy Policy Act of 1992 (EPACT), Congress took a major step toward creating vigorously competitive regional wholesale power markets. Since 1992, the Federal Energy Regulatory Commission (FERC) has issued a number of orders to implement EPACT, including most significantly, Order No. 888 requiring all jurisdictional utilities to file general availability transmission tariffs. FERC's actions have increased competition at wholesale significantly, though we still have a long way to go.
More recently, a number of states have begun to consider developing competitive retail markets for electricity. Several states, including California, have decided to implement retail competition. Others are weighing difficult and competing public policy concerns related to this essential service before moving forward.
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As consumer-owned systems, APPA members favor competition that will benefit all types of customers—large and small. However, APPA is very concerned that unless Congress and the states make fundamental changes to the structure of the electric utility industry to eliminate the ability of today's large, vertically integrated electric utilities to exercise market power, state efforts to implement retail competition will fail. The most likely result of deregulation without real restructuring will be deregulated monopolies, not vigorous competition. This will lead to higher prices and poorer service for most consumers. One cannot simply waive a wand over today's vertically integrated private power company monopolies and declare competition. To succeed, competitive markets for electricity must be carefully nurtured, and the substantial advantages of the incumbent vertically integrated monopolists that will allow them to exercise market power must be taken away.
The fundamental policy question facing state and federal legislators is whether retail competition in electricity can be implemented in a way that will result in lower electric costs and better service for all types of consumers—residential, small business and industry—while preserving or enhancing reliability. For this result to occur, market power concerns must be addressed decisively. In restructuring, Congress and the states should err on the side of fostering vigorous competition, rather than making piece-meal changes that will provide only limited competition.
The problem of moving from a state-sanctioned monopoly structure to a competitive market is made more complex by the importance and unique characteristics of electricity. First, electricity is an essential service, not a discretionary commodity. Customers need electricity at virtually all times for health and safety and to enable businesses to operate. Second, the provision of electric service is a real time business. The electricity that is producing the light in this room must be generated and delivered now. With minor exceptions, electricity cannot be purchased in times of surplus and stored for times of potential shortage. This factor increases opportunities for market manipulation substantially. Third, the bulk electric system consisting of generators located at various points on the integrated regional transmission system is highly inter-dependent. Generators at various locations must be run in order to sustain voltage and thereby allow imports of electricity from more distant sources to occur. The dispatch of generation—that is, which particular units are run in an hour—can significantly affect the capacity of transmission lines to allow electricity to be imported into an area from more distant sources.
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These factors—the lack of substitute products for many, the real-time nature of the business and the interdependence of transmission and generation—combine to create numerous and difficult-to-detect opportunities to exercise market power at particular locations, during particular seasons or times of day. The fact that the transmission system is controlled by the same vertically integrated utilities that also control substantial amounts of generation makes manipulation of the system virtually inevitable. In most places today, the incumbent utilities own virtually all the generation that is located close to major load centers. Potential competitors usually must access load from a distance over the transmission facilities of the incumbent. With the advent of competition, there will be tremendous incentives on the incumbent utilities to use their control of transmission and their dispatch of generation to favor their own local generation and to disadvantage existing and potential competitors.
In addition to these problems, the regional transmission network in many parts of the country is insufficient physically to provide the interstate highway system needed for vigorously competitive regional markets. Our transmission networks have been developed over a number of years as the industry has moved from isolated systems to interconnected systems that rely primarily on local generation. The primary purpose for development of the interconnected grid has been to improve reliability by facilitating mutual backup in the face of contingencies. As wholesale markets have developed, these interconnections have been used for a growing variety of economic transactions. However, the grid has not been designed and built to create competitive regional markets. Transmission bottlenecks exist throughout the system. As a result of these bottlenecks, in a number of places customers must obtain a substantial portion of their electric requirements from local generation, all of which is controlled by one or just a few incumbent utilities. If we want to displace regulation on a broad basis with competition sufficiently robust to discipline prices, we will need to build a much stronger and more flexible highway system.
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II. ROLE OF FEDERAL LEGISLATION
APPA does not support a federal mandate that retail competition be implemented by all states by a date certain. There are significant differences between high and low-cost states that should dictate the timing and the specifics of any move to retail competition. The regulation of retail electric service has been a traditional state function. Many states are moving toward implementing retail competition. A federal mandate is not necessary to foster this change.
The role of federal legislation should be to facilitate state decisions to implement retail competition by addressing issues that are necessary for retail competition to work, but which cannot be reached effectively by the states. Transmission in interstate commerce has been regulated by the federal government for many years. Regional markets go beyond state boundaries. As a practical matter, an individual state cannot regionalize the transmission grid and make it independent from generation. Nor can states effectively address the generation market power of large, multi-state utilities. Resolving market power problems decisively is a very important role for federal legislation.
Because we are talking about transforming an industry made up of state-sanctioned monopolies into an industry with many competing sellers, we cannot simply rely on existing antitrust laws to transform the market. These laws focus on correcting abuses and penalizing anticompetitive conduct. For electricity, we must first restructure the industry to create competitive markets or market power will be exercised pervasively from the date deregulation commences. To succeed, we need to reorganize the transmission system into a strong regional interstate highway system that is competitively neutral and open to all sellers on an equal basis. And, we need to take the steps that are necessary to ensure that there are a sufficient number of competitors for vigorously competitive regional generation markets to function. This means that we should reject mergers that will result in an unacceptable level of concentration in ownership of generation, and we should be prepared to require divestiture of generation when necessary to create a competitive market or to remedy effectively abuses of existing market power.
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The antitrust laws focus on the correction of abuses of a competitive market structure by those who would attempt to create a monopoly. In the case of electricity, the monopoly has existed and been sanctioned by the state, and the first need is to break the monopoly by creation of a competitive market. Since disaggregation of all of the functions of the vertically integrated utilities is highly unlikely, there will need to be a regulatory agency that can detect and deal with abuses in a much faster manner than the traditional utility regulatory agency has moved.
APPA believes that the expertise necessary to recognize and deal with abuses is primarily within FERC. To succeed, however, FERC's jurisdictional authority under the Federal Power Act must be expanded. While the antitrust laws should remain in effect as to the industry to allow for longer-term review, FERC clearly needs augmented authority as well to deal with anticompetitive schemes in their incipiency. The Federal Trade Commission's (FTC's) authority under Section 5 of the FTC Act, 15 U.S.C. Section 45, which is analogous to the authority given the Nuclear Regulatory Commission in Section 105(c) of the Atomic Energy Act, 42 U.S.C. Section 1235(c), is instructive. That authority to ''prevent persons, partnerships, or corporations ... from using unfair methods of competition in or affecting commerce and unfair or deceptive acts of practices in or affecting commerce'' would permit the agency with the expertise and knowledge of the area to deal with the problems of the industry on a timely basis. Such authority serves to ''supplement and bolster the Sherman and Clayton Act,'' by empowering an expert agency ''to stop in their incipiency acts and practices which, when full blown, would violate those Acts ... as well as to condemn as 'unfair methods of competition' existing violations of them. FTC v. Brown Shoe Co., 384 U.S. 316, 322 (1966); see also, e.g., Consumers Power Co., 6 NRC 892, 911–12 (Atomic Safety and Licensing App. Bd. 1977) (FTC Act and Atomic Energy Act both create agencies empowered to ''nip in the bud any incipient antitrust situation,'' without having to await infliction of competitive harm).
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In the past, FERC has focused on regulating the prices of monopoly providers of wholesale electric service to protect consumers. This has resulted in complex cost-of-service regulation and prices that do not always lead to economic efficiency. Cost-of-service regulation has been necessary because vigorous competition has not existed to control prices. For deregulation to work and consumers to benefit, we must be sure that competitive pressures will, in fact, exist to keep prices reasonable in all locations and at almost all times. As we move to competitive markets, FERC's mission must change from setting reasonable rates to an affirmative duty to establish and maintain vigorously competitive electricity markets. This major change in focus will require clarifying the authority of FERC to take a number of actions to eliminate existing market power and to prevent new market power from arising and providing FERC with new authority to act swiftly to prevent market power abuses.
In addition to changing FERC's role and augmenting its powers, changes need to be made to make the antitrust laws a more effective tool in a deregulated electric industry. In areas where there remains a state-regulated monopoly portion of the service. there will remain difficult questions of the application of the ''state action'' exemption set out in Parker v. Brown, 317 U.S. 341 (1943). Special care must be taken to prevent utilities from exploiting this doctrine through application to regulated activities (distribution-related) that provide competitive advantages to unregulated activities (retail sales). Clearly, the state action exemption must be done away with in all areas, including all generation product areas, where regulation is to be abandoned in favor of markets. This also means that the old ''filed rate doctrine,'' Montana-Dakota Utilities Co. v. Norwestern Public Service Co., 341 U.S. 246 (1951), needs to be expressly overruled if there is not to be a rate for generation product set by a state or federal agency, although there may be a constantly changing rate which is ''filed'' on the internet in accordance with state or federal regulation.
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III. REFORM OF THE TRANSMISSION FUNCTION IS ESSENTIAL TO ELIMINATING VERTICAL MONOPOLY POWER.
Congress should take three important steps to restructure the transmission function to eliminate vertical market power.
First, regional transmission grids should be created out of the transmission systems of individual companies to provide the infrastructure for regional generation markets. The ISO concept discussed below is a mechanism for accomplishing this objective.
The grid currently consists of a patchwork of individually-owned and operated company transmission systems that are interconnected and function electrically as an integrated system without regard to ownership. However, these individual ''systems'' are treated contractually and for tariff purposes as if each individual owner's ''system'' were a separate transmission grid. This patchwork structure creates numerous barriers to competition. These barriers include fictional contract path requirements, pancaked pricing from ''system'' to ''system'' for purchases from distant generation and other operational and scheduling impediments. Most participants in the industry agree that for competitive markets to work, broad regional grids must be created by combining the patchwork of individual systems. Regional single-system planning, operation and pricing should prevail, with all generators having equal access to regional load. The larger the regions, the better for competitive markets.
Second, the control and operation of the regional transmission grid, and decisions related to its expansion, should be separated from ownership and control of generation. There are far too many incentives for owners of generation that also own or control transmission to manipulate transmission availability and costs for competitors through operating practices, scheduling or delaying of maintenance, planning decisions and practices and the timing of additions to the grid. It is inevitable that decisions in these areas will be influenced by competitive considerations related to a vertically integrated transmission owner's much larger generation investments. The bottom line is that the airline industry would not be even as imperfectly competitive as it is if one company owned most of the planes, and the airport, and also acted as the air traffic controller. We cannot expect the electric industry to become competitive if the essential delivery system continues to be controlled and operated by one set of competitors—the set that also owns most of the existing generation.
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Two mechanisms for achieving this separation have been proposed. The first is to place the transmission facilities of all owners in a region under the control of an ISO. The second is divestiture to a regional transmission company that is prohibited from having any interest in the generation or retail services markets.
APPA supports the development of strong and truly independent ISOs. APPA believes that the ISO solution can work, but we must be very careful that any ISOs created actually result in the functional equivalent of divestiture, and not an illusion of separation of transmission from generation, with significant competitive advantages remaining with transmission owners.
While states may be able to compel the utilities within their borders to place their facilities under the control of an ISO, they lack authority to create the needed regional grids and ISOs that must go beyond state boundaries. With an appropriate record, FERC has authority to condition the approval of a merger on the merged company placing its facilities under the control of an ISO. However, FERC is likely to experience substantial difficulty reaching companies that are not seeking to merge. Any assertion by FERC of general jurisdiction in this area based upon its existing statutory authority is likely to be met by prolonged litigation.
For these reasons, federal legislation should grant FERC explicit authority to require the creation of strong and truly independent regional ISOs. Owners that participate in such an ISO should be like limited partners in a real estate venture. They will be entitled to a reasonable return on their investments, but have no management control.
To work, ISOs must have governance structures that do not permit control to be exercised by any class of market participants and must have clear authority over all transmission operations and maintenance, as well as the maintenance schedules for generation. As FERC found in the recent Primergy merger case, Wisconsin Electric Power Company, et al., 79 FERC Par. 61, 158 (May 14, 1997) decisions on the maintenance of generation can substantially affect the transfer capability of the transmission system.
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The ISO should provide transmission service to all participants in the industry on the same basis for all purposes, including the provision of service to transmission owners necessary for them to serve retail customers. The ISO must also have authority to require redispatch of generation in order to increase the transfer capability of the transmission system. As found in the recent Primergy case cited above, the ISO should act as the regional control area so that regional generation plus imports matches regional load on a real-time basis, and all generation market participants interface with the transmission system on the same equal basis. The ISO must either have the authority to build new transmission or to determine the facilities that must be built and to bid out construction and ownership of those facilities to entities ready and willing to construct and own them for the authorized return on investment.
The ISO concept should work, if properly implemented by FERC. However, FERC also must have the authority to eliminate transmission market power by requiring divestiture to a regional transmission company if an ISO does not. in practice, eliminate transmission advantages.
Third, Congress should create mechanisms that enable existing transmission bottlenecks to be physically remedied through the construction of additional transmission. For instance, in Wisconsin, most of our electric load is located in the eastern part of the state. The total load in this area is over 10,000 megawatts. We can reliably import electricity into this area from only two directions: the west and the south, due to the presence of the Great Lakes to the north and east. Our import capability on a reliable basis is only approximately 15% of the total load. This means that most customers in eastern Wisconsin must obtain their electric requirements from generation located in eastern Wisconsin. The ownership of this generation is highly concentrated in a few vertically integrated utilities that have joint plants. These utilities also own the transmission facilities that create the bottlenecks to access to competitive supplies. The existing owners have very little incentive to remedy these bottlenecks, since doing so would give competitors easy access to their customers. Instead, they will favor solutions such as congestion pricing that will raise the price of energy from outside sources, protecting local generation. Whether the transmission system is operated independently of generation or not, physical constraints will continue to exist without construction of new facilities. For this reason, if competition is the goal, state or federal policymakers must be prepared and able to authorize construction of new transmission facilities in order to create and maintain competitive markets, not simply to sustain reliability.
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IV. GENERATION MARKET POWER
Even with complete separation of transmission from generation, horizontal or generation market power will exist when ownership of generation within a regional market is highly concentrated. Today, we are witnessing a significant trend of mergers among adjacent utilities that is increasing generation concentration. Mergers are a defense against the advent of competition and the merger trend conflicts directly with the objective of creating competitive generation markets out of a highly concentrated industry. While numerous new power marketers have been created in the last few years that are doing significant business by aggregating and reselling surplus power and energy at wholesale, we need to look beyond the surface of marketers to the control of regional generation. Using another airline analogy, we will not have a competitive market no matter how many travel agents there are, if behind them there are only two airlines.
The conflict between competitive objectives and the merger trend should be resolved by erring on the side of creating vigorously competitive markets. Mergers should be denied unless benefits for consumers not otherwise obtainable outweigh the adverse impact on competition of eliminating a competitor.
Where significant concentration in ownership of generation already exists without a merger, or is created by means other than mergers such as plant acquisitions or joint operating arrangements, FERC should have authority to require divestiture or solve the problem by other means.
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As discussed above, the problem of horizontal market power in the electric industry is made complex by the fact that some generating units must be run in order for the transmission system to operate properly. All of the generation on the system cannot be built at one end of the system, with the load on the other end. Generation in and around large load centers must be operated to sustain voltage and to create transfer capacity on the transmission system. We are learning the importance of this issue in Wisconsin this spring. All three nuclear power plants in eastern Wisconsin are currently out of service, as are a number of nuclear plants in Illinois. When these large units are not running, the already quite limited capacity of our transmission system to import energy into Wisconsin becomes even more constrained.
As we develop competitive electricity markets, close attention must be paid to the ownership and control of ''must run'' units by entities that also own and control low-cost units that will compete in the electricity commodity market. This combination of ownership of essential units and competitive generation that will benefit from ''market'' prices being ''bid up'' may create an ability to control prices at particular locations or at particular times. Mechanisms must be created that govern the control, use and pricing for ''must run'' units.
V. RELIABILITY
The reliability of the integrated and interdependent electric system is extremely important to health and safety and the viability of our economy. In the monopoly paradigm of the past, reliability has been protected by mutual back-up arrangements among utilities and a regional reliability council structure that has relied primarily on peer pressure. This system of cooperation and mutual back-up without clearly enforceable rules and sanctions, and without competitively neutral entities to determine appropriate rules and enforce them on a non-discriminatory basis, will not work in an increasingly competitive market. In addition, most of the reliability councils today are controlled by the large, vertically integrated utilities. Reliability rules and their enforcement can have significant competitive impacts. It is essential that reliability be maintained and enhanced in the transition to competitive markets. To achieve this objective, and for competitive markets to work, reliability requirements in the future must be developed, adopted, implemented and enforced by neutral entities whose sole function is to maintain reliability for the benefit of all end-users within a region.
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VI. MEASURES NEEDED TO ELIMINATE MARKET POWER AND CREATE COMPETITIVE REGIONAL ELECTRICITY MARKETS
To summarize, APPA believes that to facilitate state decisions to implement retail competition, Congress should transform FERC from a rate regulator to an agency with an affirmative duty to create and maintain vigorously competitive regional electricity markets. To do so:
1. FERC must have clear authority to require that transmission be regionalized and completely separated from generation by mandating creation of truly independent, strong regional ISOs, or if ISOs prove ineffective, by ordering divestiture to independent regional transmission companies.
2. FERC must have the authority to require divestiture of generation where concentration threatens to impede vigorous competition. Marketbased generation sales must be limited to times and locations where markets are, in fact, competitive.
3. FERC should be required to reject mergers that will increase concentration in the ownership of generation in a region unless affirmative public benefits not achievable without the merger are shown to outweigh the potential detriments to competition. Convergence mergers between generators and gas companies also must be carefully reviewed to prevent adverse impacts on the competitive markets we are attempting to nurture.
4. FERC should be granted authority to oversee the development, implementation and enforcement of reliability requirements by neutral regional bodies on a non-discriminatory basis. FERC's role in this area can be light, if the existing North American Electric Reliability Council structure is properly reformed, ISOs take on sufficient responsibility.
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5. FERC should be granted power to require that all pricing for generation be public and transparent. Secret contracts that benefit very large users at the expense of residential and business consumers should not be permitted. The best protection against discrimination and affiliate abuse is sunshine.
6. FERC should be given broad authority and responsibility to preserve the integrity of regional markets, with authority to impose penalties for market manipulation, insider trading and unfair trade practices, such as predatory pricing and affiliate abuses. PUHCA should not be repealed or altered until alternative arrangements are in place that will prevent entities from leveraging benefits from regulated segments of the business—distribution and transmission—to competitive segments—generation and retail services.
7. FERC's procedural and remedial tools should be expanded so that FERC has the ability to protect markets quickly through temporary restraining orders directed at improper actions that are damaging competition, consumers and competitors on a real-time basis.
Mr. HYDE. Mr. Ricky Bittle, director of planning, rates, and dispatching, Arkansas Electric Cooperative Corp., Little Rock. Mr. Bittle.
STATEMENT OF RICKY BITTLE, P.E., DIRECTOR OF PLANNING, RATES AND DISPATCH, ARKANSAS ELECTRIC COOPERATION CORP., ON BEHALF OF THE NATIONAL ELECTRIC COOPERATIVE ASSOCIATION
Mr. BITTLE. Thank you, Mr. Chairman, members of the committee. Thank you, Mr. Hutchinson, for your introduction.
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When we are considering this transition to competition, we must recognize that from a single company's perspective that monopoly behavior is rational economic behavior. While monopoly behavior will not result in competition or benefit to the consumer, it does give us the perspective to look at the mergers that are taking place, and, in doing so, we should not be surprised by the number of mergers that are being proposed.
We must be aware that in these mergers, the reduction in the number of competitors is the point that we are focusing on, we do not want the number of competitors to drop to the point where the remaining competitors can exercise market power. The number and independence of these competitors is essential to ensure that there is fair and open competition.
We believe that there are three fundamental questions that must be examined. No. 1, will there be sufficient competition in the generation market to hold down retail prices; No. 2, will the measures, such as FERC's Order No. 888, provide sufficient open access to transmission facilities to prevent the owners of the facilities from favoring their own economic interest; and, three, will the trends in merging of electric and gas utilities provide value to consumers or merely a reduction in the number of competitors.
When we are talking about market—about mergers, the one thing that is up in the air right now is does anything go. Mergers seem to be continuing on an unabated type of process. The telecommunication industry mergers show where the electric industry could wind up. Currently, the expectation is that all mergers will be approved. Everyone expects that the industries are there to take care of themselves, but the real question is who is going to protect the consumers in this process. I believe that all consumers will be better served by a substantial number of real competitors, rather than a large set of interrelated astroturf competitors.
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There must also be continued vigilance on the idea of open transmission access. A single transmission owner cannot be allowed to favor itself over other customers. A single transmission system in a region is the most economic choice for society as a whole. This requires that all entities that depend on the transmission system must have complete and comparable access to the transmission system, both now and in the future.
To deal with these trends, NRECA recommends the following: FERC should continue to apply its new merger policy to the future of the competitive market and to protect the public interest over any single company's interest; the Federal Trade Commission and the Department of Justice antitrust review should be stepped up to better protect the public interest from actions that could preempt competition; Congress should carefully examine any decision to repeal consumer protection legislation, such as the Public Utilities Company Holding Act; the FERC should continue to focus on market power issues in dealing with market-based generation rates and for transmission tariff issues.
Finally, let me reiterate, market power issues in the electric industry are real and consumers must have an avenue to seek relief. I would like to thank the committee for the opportunity to testify today.
Mr. HYDE. Thank you, Mr. Bittle.
[The prepared statement of Mr. Bittle follows:]
PREPARED STATEMENT OF RICKY BITTLE, P.E., DIRECTOR OF PLANNING, RATES AND DISPATCH, ARKANSAS ELECTRIC COOPERATIVE CORP., ON BEHALF OF THE NATIONAL RURAL ELECTRIC COOPERATIVE ASSOCIATION
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INTRODUCTION
Mr. Chairman, Members of the Committee, for the record, I am Ricky Bittle, Director of Rates, Planning and Dispatch for the Arkansas Electric Cooperative Corporation (AECC), located in Little Rock, Arkansas. AECC is a generation and transmission cooperative which was formed in 1949 by 16 rural electric distribution cooperatives in Arkansas to provide them with wholesale electric power. AECC owns and operates coal-fired, oil/gas-fired, and hydroelectric generation facilities to provide electric power to its members, and also purchases power for them in the wholesale market. AECC is, however, primarily dependent on the transmission facilities of other utilities to transmit its generation output to its members' systems.
AECC's member cooperatives are local distribution utilities owned and controlled by the consumers they serve. They provide service to more than 365,000 homes, farms and businesses, and their service
territories cover more than 60% of Arkansas' land area.
AECC is a member of the National Rural Electric Cooperative Association (NRECA), the national trade association of 1,000 consumer-owned, not-for-profit electric systems. NRECA's member systems serve over 30 million consumer-owners in 46 states. I serve on NRECA's Transmission Task Force, an ad hoc group of NRECA members that assists NRECA in determining the positions it will take on wholesale power supply and transmission issues. I welcome the opportunity to testify on behalf of NRECA before this committee on the market power issues facing the electric industry.
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NRECA has been concerned for some time that the raging debate in Congress over whether to federally mandate retail competition in the electric industry has obscured more fundamental questions which must be addressed if competition in this industry is ever going to work. These questions are:
(1) Will there be sufficient competition in the electric generation sector to make sure that retail electric prices are as low as possible, or will we have only what we call ''astroturf'' competition (many affiliates of a few large, diversified energy entities)?
(2) Will measures be taken to make sure that owners of electric transmission facilities (which are generally monopoly facilities) cannot use their control of those facilities to extract high prices or to discriminate in favor of other aspects of their business?
(3) Will the trend towards ''convergence'' of the electric and natural gas industries reduce or expand consumer energy options?
I will first describe briefly the major changes now taking place in the electric industry. I will then discuss each of the above questions in turn. Finally, I will recommend some steps the federal government can take to address market power issues in the electric industry.
OVERVIEW OF THE ELECTRIC INDUSTRY
The electric industry is one of the largest in the nation, producing revenues of some $200 billion per year. It is also one of the most capital intensive. Electrical generation facilities have traditionally required large amounts of capital financing, long lead times for construction, and extensive permitting processes (although new generation technologies are now reducing lead times and plant sizes somewhat). High voltage transmission lines are expensive and difficult to build, and often create intense local opposition. Local distribution lines are less expensive, but raise similar local land use and environmental concerns. Once built, facilities in place cannot generally be redeployed.
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Because of these characteristics, the investor-owned utilities (IOUs) that serve 75 percent of the retail electric customers in this country have evolved as ''vertically integrated'' utilities. The same IOU has owned and operated the generation, transmission and distribution facilities serving its local markets. They generally provide service to consumers in service areas delineated by the state public utility commissions (PUCs) in each state. In return for the privilege of being the sole electric service provider in such a service territory, they accept PUC regulation of their retail rates and terms of service, and the obligation to serve all customers. There are approximately 240 IOUs in the nation, although their number is being steadily reduced due to merger activity.
The remaining 25% of consumers in the nation are served either by publicly owned utilities (14%) or cooperatively owned utilities (11%). There are approximately 2,000 municipal systems and 900 distribution cooperatives. They tend to be much smaller than their IOU counterparts, and are generally regulated by their locally elected governing boards, although some distribution cooperatives are also subject to PUC regulation. Many of them are dependent on IOUs for at least part of their electric power supply and transmission service, although many also obtain allotments of power from federal power marketing authorities (PMAs). Cooperative and municipal utilities, too, generally are the exclusive providers of retail electric service in their service areas.
During the industry's early years, many electric utilities competed against each other, with very little regulation. Electric utilities served those areas they wished to serve, and left unserved those areas they did not wish to serve. Eventually this competitive phase led to state PUC regulation of IOUs at the retail level and a consolidation phase, in which a small group of large multi-tiered utility holding companies took over many utilities, with accompanying abuses of both consumers and stockholders. By the late 1920s, 16 corporate ''families'' controlled more than 85% of the nation's power supply. The eventual result was three federal statutes: the Public Utility Holding Company Act of 1935 (PUHCA), which requires the Securities and Exchange Commission (SEC) to regulate the activities of utility holding companies; Part II of the Federal Power Act (FPA), passed in 1935, which requires what is now the Federal Energy Regulatory Commission (FERC) to regulate public utilities wholesale electric sales and interstate transmission service; and the Rural Electrification Act of 1936 (REAct), which provided federal loans through what is now the Rural Utilities Service of the Department of Agriculture (RUS) to electrify vast rural areas that then had no electric service at all. It was the REAct that spurred the formation of rural electric cooperatives like AECC's distribution members; they took on the daunting task of electrifying rural America.
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This basic industry structure set in the 1930s did not begin to change until the passage of the Public Utility Regulatory Policies Act of 1978 (PURPA). PURPA introduced the concept of non-utility generators of electricity, and required utilities to buy at wholesale the output of certain qualifying generation facilities built by these non-utility generators, at the utilities' ''avoided cost.'' The pace of change accelerated sharply with the passage of the Energy Policy Act of 1992 (EPAct), which gave the FERC authority to order utilities to ''wheel'' electricity over their transmission systems to qualified wholesale entities. FERC has been very active since 1992 in promoting competitive wholesale generation markets. In 1996, it issued new federal regulations (known in the industry as Order No. 888) requiring public utilities to file generic ''open access tariffs.'' These tariffs make transmission service available to all qualified entities if capacity is available for the transaction. NRECA was a supporter of EPAct, and generally supports FERC Order No. 888, because we believe increased competition in wholesale electric markets will benefit all consumers of electricity.
The debate now underway in Congress, however, concerns retail electric markets, which traditionally have been regulated by the states. Bills have been introduced in the 105th Congress in both the House and the Senate that would federally mandate the opening of the distribution wires of all utilities, so that competing marketers of generation can reach retail consumers. NRECA has a number of concerns with this concept (which is called ''retail wheeling,'' ''retail competition,'' or ''customer choice'' in our industry). I have attached to my testimony the resolution on retail wheeling which NRECA's members passed at their 1997 Annual Meeting held this last March, which details NRECA's concerns.
The market power concerns I will discuss next must be considered against the backdrop of the major changes now underway in the electric industry. We are in the middle of a very volatile transition. Competition is starting to take root in electric generation markets, but transmission and local distribution and sales are still largely monopoly functions. For the reasons I will outline, NRECA fears that real competition may never come to our industry if the transition is not closely monitored, and competition in the generation sector carefully nurtured. NRECA believes that vigorous enforcement of the antitrust laws and regulatory authorities, and the use of other available tools to police undue concentrations of market power, is needed to ensure our fears do not become reality.
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CONCENTRATION IN GENERATION MARKETS
As the electric industry restructures, we are seeing fundamental changes in the size and nature of the players in the electric generation and bulk power marketing sectors. Among the trends we are seeing which concern NRECA are: (1) mergers of already-sizeable ''side-by-side'' IOUs with monopolies in their respective states to create regional ''mega-utility'' monopolies that control very substantial amounts of generation, transmission and distribution—the pending merger of Baltimore Gas and Electric Company (BG&E) and Potomac Electric Power Company (PEPCO) to form Constellation Energy Corporation being a close-to-Congress example of this type of merger; (2) projections of decreased electric generation capacity margins in the coming years and the possibility of the accelerated shut-down of older, less economic generation facilities (such as aging nuclear units), which will further decrease generation available to the market; (3) larger power marketers (many of whom are already major natural gas marketers) acquiring a variety of smaller companies that specialize in niche markets (such as Enron's acquisition of Zond Corporation, an ailing windpower developer); (4) the absorption of the pioneer group of truly independent power producers (IPPs) which came into being in the wake of the enactment of PURPA into fewer and larger entities, who often are themselves subsidiaries or affiliates of traditional IOUs or major power marketers (the recent announcement of the acquisition of Destec Energy, Inc. being an example); and (5) lucrative overseas expansions by United States utilities (England and Australia are two of the most active overseas hunting grounds), which further build their competitive ''war chests.''
The Federal Energy Regulatory Commission's (FERC) May 14, 1997 decision not to approve the proposed merger of Northern States Power Company and Wisconsin Electric Power Company into Primergy Corporation illustrates the generation sector concentration concerns ''side-by-side'' IOU mergers raise. FERC found that the Primergy merger would ''create highly concentrated markets,'' noting that Primergy would have a market share of 42–47% of delivered energy markets in the relevant region. FERC also rejected the applicants' argument that the ease of entry by new competitors into the regional generation market, and the existence of open access transmission tariffs, would prevent the merger applicants from exercising their market power over generation. To the contrary, FERC found that factors such as regulatory delays, costs associated with environmental compliance, and the lack of planned new capacity in the region would prevent timely market entry by new generation competitors. Rather than rejecting the merger outright, FERC sent the case to a settlement judge, suggesting that generation plant divestiture by the applicants might offer a particularly useful approach to mitigate our market power concerns. The applicants, however, chose not to proceed with the merger.
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Generation markets are also influenced by the amount of generation capacity in excess of requirements, which affects the amounts of electric power available for purchase. The capacity margins periodically projected around the country for electric system reliability purposes show a ''moderate excess'' of capacity at the present time. That excess, however, is expected to be reduced gradually to the approximate level the industry generally likes to keep ''on call'' for emergency back-up (''reliability'') purposes by the year 2000. I have attached a table which shows these capacity margins for different regions of the country.
Moreover, we are increasingly seeing electric utilities making the decision to retire ''early'' (before the end of their useful lives) older generation units which are not economic to operate. For example, on May 28, 1997, the owners of the Maine Yankee nuclear plant in New England announced their decision to permanently close the plant, rather than to spend the substantial sums required to remedy safety and operational deficiencies. Such closures will further reduce capacity margins in a region, and can thus present opportunities to exploit generation market power. Decreased generation capacity also reduces the pool of electric power available for sale to marketers without their own generation assets.
IOUs attempting to justify their mergers often dismiss generation market power concerns by noting the burgeoning number of power marketers which hold FERC licenses to make power sales at market-based rates (288 marketers had such licenses by the end of 1996). But this number is deceptive; only 87 marketers actually reported any sales in 1996. Moreover, while the major power marketers may appear to be ''stand alone'' entities, in fact they each represent the tip of a hidden iceberg of corporate relationships that cut across the traditional IOU–IPP and gas-electric industry lines.
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A look at the top five power marketers in 1996 is instructive. In 1996, the number one electric power marketer, Enron Power Marketing, Inc., made 25.6% of all power marketer sales in the United States (230 million Mwh). Enron, of course, has proposed to merge with a traditional IOU, Portland General Electric Company. Enron controls all or part of a number of smaller ''niche'' energy providers, such as Zond Corporation, a wind generator, and Solarex, which sells photovoltaic units. It has a huge presence in natural gas pipelines and marketing. It has overseas operations from England to India.
The second marketer in terms of 1996 sales, Duke/Louis Dreyfus LLC, is a joint venture between Louis Dreyfus Corporation, a major gas marketer and financial house, and Duke Power Company, one of the nation's largest IOUs. Duke Power is in the process of merging with PanEnergy Corporation, a major natural gas pipeline and marketer which was itself formed from the merger of two major interstate natural gas pipelines, Panhandle Eastern Pipeline Corporation and Texas Eastern Transmission Corporation. Duke/Louis Dreyfus LLC has entered into partnerships with Lykes Energy, Inc., owner of Peoples Gas System, Inc., a Florida natural gas distribution utility, and with Eastern Utilities Associates, a registered electric utility holding company which owns three Northeast electric utilities.
The third largest power marketer, LG&E Power Marketing, Inc., is an affiliate of another IOU, Louisville Gas and Electric Company (LG&E), and its parent, LG&E Energy Corporation. LG&E has just announced a merger with its neighboring IOU, Kentucky Utilities. LG&E Energy also recently successfully bid in bankruptcy court for control of the substantial Kentucky-based generation assets of Big Rivers Electric Corporation, a generation and transmission cooperative. LG&E Energy in 1995 acquired Hadson Corporation, a well-known mid-size marketer of natural gas (now known as LG&E Natural).
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The fourth largest marketer, Electric Clearinghouse, Inc., is an indirect subsidiary of Natural Gas Clearinghouse, one of the nation's largest natural gas marketers, gatherers and processors. Natural Gas Clearinghouse has announced that it will acquire one of the ''pioneer'' IPPs, Destec Energy, Inc.
The fifth largest marketer, Citizens Lehman Power, has been recently acquired by The Energy Group PLC, a British company that also owns Peabody, the world's largest private coal producer. Peabody's coal fuels 9 percent of U.S. electric generation production.
Together, these five marketers made 56% of the total sales by power marketers in 1996. While they may appear on the list of power marketers as ''stand alone'' entities, as you can see, each is part of a larger corporate family, families which are growing and consolidating by leaps and bounds due to mergers, acquisitions and alliances. Faced with competition from large, multi-faceted entities such as these, it is not hard to predict that many of the entities now holding FERC power marketer licenses will never reach the critical mass needed to gain any significant market share. Some may develop niche markets, but most will never be major industry players. In fact, some industry experts say that companies which have not already established a significant presence in electric power marketing ''aren't going to at this point.'' They expect consolidation in this sector to continue. Attached to my testimony is an article from the May 18, 1997 Houston Chronicle discussing this subject.
NRECA is concerned that many of the ''new entrants'' we are seeing are (or will soon be) what we call ''astroturf''—competitors—they look like ''independent'' entities (or real grass) at a distance, but when you start to investigate, you realize they are ''astroturf''—subsidiaries of already well-established energy companies that are fast turning into large conglomerates through first, second and third generation mergers and acquisitions. Simply ''counting noses'' in such a market is insufficient. You must trace the almost Biblical lineage of these companies and expose the complex web of affiliate relationships among them.
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Moreover, electric power markets are complicated. To determine the true number of competitors in a regional market (or series of submarkets), you have to look at the products being provided. The FERC's merger policy statement recognized at least four separate electric power products: on-peak non-firm energy, off-peak non-firm energy, short term capacity, and long term capacity. We think an additional product is the generation-type services provided in conjunction with transmission services (called ''ancillary services'' in the industry). If you do not look at the specific product that needs to be delivered, you can reach the wrong conclusion about the number of competitors that can actually offer the product. Some products cannot be offered without specific contractual rights or ownership of physical facilities. All ''firm'' products must be backed by physical assets to ensure they will in fact be available. Certain provisions in the FERC-approved open access transmission tariffs of public utilities place restrictions on the use of generation owned or controlled by transmission customers to make sales to third parties. These restrictions reduce the number of competitors able effectively to offer certain kinds of electric power products in the wholesale marketplace.
If you assume that retail wheeling is going to be a feature of our industry (and a number of states have already mandated it), there also must be enough competitors offering electric power to each segment of the retail market to ensure that competition will keep prices down. Retail customers are not all alike; there are large industrial, small commercial, residential, and farming/ranching customers. We anticipate substantial competition for large industrial loads, which are the easiest and most profitable to serve. We fear, however, that less lucrative loads, especially those in rural areas, may have fewer options, and in fact may end up having to pay more. If there is going to be retail wheeling, we believe all customers must benefit, and this requires sufficient competition for the loads of all customer classes (even those less profitable to serve).
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The mere entry of a new competitor into a regional market to serve a particular niche (for example, short-term non-firm power) should not be taken as evidence that there are no barriers to market entry in that region. Large generation owners in that region who have low power costs (either due to low book costs or guaranteed stranded cost recovery) will have to ability to eliminate such competition almost at will by offering low-cost short term power supply arrangements.
Finally, there is the international expansion of our nation's utilities to consider. Our nation's IOUs have invested over $30 billion overseas in the past two years. Nearly $20 billion has been invested in the United Kingdom alone by such major public utility holding companies as Central and South West Corporation ($2.12 billion), Entergy Corporation ($2.1 billion), and the Southern Company ($1.8 billion in the U.K. and nearly $3 billion more in Germany and Asia). These same holding companies have been among the most ardent advocates of recovering the cost of ''stranded'' (high cost) utility assets from consumers if retail wheeling is mandated, and of the repeal of PUHCA. Through international investments, these IOUs can attain a size, critical mass, and financial ''war chest'' that makes them fearsome competitors even for other IOUs, much less for smaller utilities like AECC.
The electric industry badly needs increased federal oversight during this critical transition period, to protect and promote competition in electric generation markets. The captains of the electric industry, be they from IOUs, IPPs, or power marketers, and the deal makers on Wall Street are doing exactly what they would be expected to do, given the changes in the industry. They are acting in their own rational economic self-interests, preparing for the threat of increased competition by amassing as much market power as possible, aggressively taking out potential competitors by merging with them, and moving into new markets through acquisitions. (One need only look at the recent merger and acquisition activity in the telecommunications industry to see another display of such behavior.) Until FERC's Primergy decision, however, there were no public yellow lights from the federal government regarding any proposed mergers. The Department of Justice (DOJ) would periodically send attorneys to industry conferences to assure audiences that it was indeed ''looking at'' mergers and acquisitions, but little else was ever heard from it. The Federal Trade Commission (FTC) has been similarly silent. FERC, until it came out with its new merger policy statement in December 1996, was reviewing public utility mergers using standards over thirty years old.
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Even after FERC issued its 1996 policy statement updating its merger review standards, it continued to approve all of the mergers it considered, including the PEPCO–BG&E merger, which it approved in April even while acknowledging that the merger raises strong concerns about undue concentration in retail electric markets. And when FERC finally saw in the Primergy case a merger that in FERC Chair Elizabeth Moler's own words ''hit all the trip wires,'' FERC still did not reject it. Rather, in an attempt to save the merger, it appointed a settlement judge to conduct further negotiations. The applicants themselves then chose to abandon the merger, complaining that FERC already had taken too long to consider it.
The sense of the industry until now has been that electric utility mergers may take a considerable amount of time to implement, due to the need to obtain FERC and state public utility commission approvals, but that no entity—an industry regulatory agency, the DOJ or the FTC—will as a practical matter stand up and ''just say no.'' FERC's Primergy order has been the first signal that ''anything will not go,'' but it needs to be the start of a new trend rather than a mere blip on the merger radar screen. Otherwise, NRECA fears eventual consolidation of the energy sector of our economy into a handful of national (indeed, international) energy powerhouses with considerable market power over electric generation in this country. The sheer size and financial might of these competitors, coupled with the regulatory and environmental delays that can hamper new entrants into the generation market, would undermine the benefits which true competition, properly nurtured, can bring to electric generation markets.
CONTROL OF TRANSMISSION FACILITIES
The sale of electric power is a unique service. There is only one delivery system—our nation's high voltage bulk transmission facilities. Electric power must be instantaneously generated, transmitted across the network to its point of consumption, and consumed. The electricity you use every day is often sold in a ''day ahead'' or even ''hour ahead'' market, and is scheduled for transmission (''dispatched'') on an hourly basis. Electricity cannot be stored. This means that a deal delayed for lack of transmission service, even for an hour, is a deal denied, and the resulting lost revenue can never be recouped.
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Almost all electric industry analysts agree that high voltage bulk transmission of electric energy currently is and will continue to be a monopoly function. The high price tag for new transmission facilities and the difficulties in siting and obtaining land use and environmental clearances makes it extremely hard for existing transmission owners even to add to their current facilities, much less for new market entrants to build a duplicative transmission network. Moreover, the interconnected transmission network in this country has traditionally been deliberately planned as an engineering matter to avoid building duplicate facilities. This is in part why my own cooperative, AECC, is dependent upon the transmission systems of two very large neighboring public utility holding companies, Central and South West Corporation and Entergy Corporation. To entice my cooperative not to build its own duplicative transmission facilities, these IOUs contracted to provide transmission service to AECC over their transmission networks, and to accommodate AECC's future transmission needs in their facilities planning process. If in the future, AECC could not obtain transmission service on reasonable terms from these companies, it could not compete, and it would very soon be out of business. There are many smaller utilities in the same situation as AECC. In antitrust terms, they are dependent on bottleneck or essential high voltage transmission facilities of larger neighboring utilities—utilities with which they may soon be competing for retail loads.
The continental United States is not linked together by a high voltage transmission system that allows the free flow of power from one coast to another. The transmission ''grid'' is actually a patchwork of local and regional systems which have been linked together by high voltage interties which were generally planned and built for ''reliability'' reasons. They permitted one electrical region to assist another in event of the loss of a major generation facility or other system emergency; they were not designed for the transcontinental transmission of electric power. Our transmission grid is much like the nation's highway system before the interstate highway system was built—you could drive from one part of the country to another, but the roads were usually two-lane, the routes were not necessarily direct, and they could not handle large volumes of traffic. This is why generation markets in the electric industry are regional and even sub-regional in nature—transmission constraints prevent one ''seamless'' national power market.
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Control of the transmission network in a region or subregion can be likened to owning the only car in town. You can decide who is going to ride in it, when they can ride, and how much they have to pay for the privilege. FERC has historically regulated public utilities providing transmission service in interstate commerce for this very reason. In the past, it regulated primarily the price of transmission service; FERC did not generally order public utilities to offer transmission service. But since the passage of EPAct, FERC has changed its emphasis, requiring public utilities to provide transmission access to other qualified wholesale entities, even though those entities may be customers and/or competitors. The FERC's Order No. 888 requires all ''public utilities'' to provide open access transmission service under generic terms and conditions (an ''open access tariff'' or OAT) to any qualified customer.
While FERC took a big step forward in Order No. 888, OATs have by no means eliminated the ability of public utility transmission owners to use their control over transmission facilities to benefit themselves and disadvantage others. There are many more subtle ways, aside from an outright refusal to provide transmission service, to exercise transmission market power. For example, FERC's current Order No. 888 regulations allow transmission providers to ''discount'' transmission rates to customers on a delivery-point-by-delivery-point basis. This means transmission providers can offer transmission discounts to delivery points where they (or a corporate affiliate) provide service, while not offering corresponding discounts to nearby delivery points where other entities provide retail service. FERC is also requiring public utilities to include provisions in their OATs which make it difficult and expensive for transmission dependent utilities like AECC with customers and generation sources located in the service areas of more than one transmission provider to ''integrate'' those loads and resources—in other words, to use those generation resources effectively and economically to serve all of our customers.
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Moreover, the patchwork nature of our transmission grid means that each utility owning transmission facilities can levy a regulated transmission charge on power passing through its system. Assuming that transmission constraints do not prevent customers from moving power across a region, a deal may still be uneconomic because of the series of separate transmission charges that must be paid to move the power. This problem is called ''pancaking.'' It is one reason why FERC is strongly encouraging all the transmission utilities in a region to pool their high voltage transmission facilities together, and place them under the control of an ''Independent System Operator'' (ISO). The ISO could then administer a single OAT and set of transmission rates for the entire region.
FERC is also interested in promoting ISOs because they would, at least in theory, prevent transmission owners from using their control over transmission facilities to favor their own generation deals over those of third parties. FERC envisions that transmission-owning utilities would still legally own their facilities, but would not make the daily operating decisions about whose generation is scheduled for transmission service, at what transmission rate and in what order. Rather, the ISO would carry out these tasks. While FERC has a number of ISO proposals pending before it, none are yet operational, so it is too soon to know whether ISOs can effectively mitigate public utility market power over transmission facilities. We do know, however, that there are a great variety of opinions in our industry as to whether ISOs will work, how they will function, how they will be governed, and what their transmission rates will look like.
Transmission owners have an economic incentive to favor their own generation over that of third parties. You don't have to take it from me: FERC itself said in Order No. 888 that ''the inherent characteristics of monopolists make it inevitable that they will act in their own self-interest to the detriment of others by refusing transmission and/or providing inferior transmission to competitors in the bulk power markets to favor their own generation.'' (Order No. 888, 61 Fed. Reg. 21,567 (May 10, 1996).) Control over transmission can be exercised in many small ways that, taken separately, may not show up on the regulatory radar screen, but taken together, can cripple prospective competitors. Delays in granting transmission service can prevent deals from being made. Delays in constructing new transmission facilities intended for the use of a prospective competitor, while proceeding with the building of facilities that benefit the transmission owner, can harm competitors. Planning the transmission system in such a manner that some facilities become part of the grid (and are thus paid for by all users) while other facilities must be paid for solely by the user, can skew transmission economics. Whether it is through tariff conditions, ISOs or other mechanisms, transmission market power must be effectively mitigated if competitive electric markets are going to develop.
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CONVERGENCE OF THE ELECTRIC AND NATURAL GAS INDUSTRIES
We often hear the word ''convergence'' used in the energy industry today. It means the blurring of the traditional lines between the natural gas and electric industries, between the electric and telecommunications industries, and between traditional utility services and energy management services. NRECA certainly does not want to stand in the way of developing technologies or new trends that indeed benefit all consumers of energy services. But we are troubled by the recently announced mergers of gas and electric utilities that reduce the number of competitors in a local market, creating mega-utilities providing the same customer base two energy distribution services, natural gas and electricity, so fundamentally important to our nation's consumers. One way to ensure dominance in a market is to provide as many services as possible to the same customer.
Combinations such as that of Pacific Enterprises, parent company of Southern California Gas Company (SoCalGas, the largest gas distribution utility in the entire country) and Enova Corporation, parent company of San Diego Gas and Electric Company (one of California's three large IOUs) leave retail customers in their new overlapping distribution service territories with only one company providing both natural gas and electric distribution service to their homes. SoCalGas also has a monopoly on natural gas transportation in Southern California, so that any entity there wishing to burn natural gas for electric generation (the fuel of choice in Southern California for air quality reasons) must transport its natural gas over the SoCalGas system. While California has been on the leading edge of implementing retail competition for both electric and natural gas service, the incumbent utilities still serve the vast majority of their retail distribution customers with bundled natural gas and electric services. They will have a sizable leg up on prospective competitors when retail competition commences, an advantage which could well be even stronger if the same corporate entity provides both retail services.
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We see the same convergence trend in the power marketing sector. The leading power marketers are either affiliates of leading natural gas marketers, such as Enron and Natural Gas Clearinghouse, or have acquired gas marketers by purchase to ''round out'' their array of services, as LG&E Power Marketing has done. IOUs moving to develop a nationwide marketing presence are acquiring natural gas marketers, as Duke Power is doing in acquiring PanEnergy, and Pacificorp has done in announcing its acquisition of TPC Corporation. While these marriages of gas and electric marketers should not be a problem, so long as there are a sufficient number of them offering electric and gas services, as I have discussed above, we are at the same time seeing a strong overall consolidation and merger trend. We may well end up with a handful of vertically integrated, very large combined electric/natural gas supply and marketing entities that have very substantial market power in both types of energy. They will be able to offer a combined ''British Thermal Unit'' (Btu) price, where less diversified competitors can only offer either gas or electricity. The eventual end result could be fewer options for consumers—even as they are given the ''power to choose'' by legislators unaware of how few actual choices consumers may actually get.
In the past, local competition between gas and electric utilities for new customers and new installations of end-use equipment was one of the few sources of competition in an otherwise regulated monopoly utility regime. Local gas and electric utilities each wooed consumers and new home builders to install new gas or electric furnaces, heat pumps, and appliances, and tried to coax industrial customers expanding their manufacturing facilities to use gas or electricity to power new machinery. In the future, a consumer's ''choice'' of new gas or electric equipment may well be meaningless, if the same set of oligopolistic distributors and suppliers benefit no matter which source of energy is chosen. We may end up with ''astroturf'' choices provided by astroturf competitors.
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RECOMMENDATIONS
NRECA is not suggesting that this Committee try to ''stop the clock'' on the changes now taking place in the electric industry. It cannot be done. Competitive forces, advances in technology, and the advent of Madison Avenue-style marketing of electricity as a product are too strong. But Congress and federal departments and agencies can channel these forces to ensure that all consumers indeed benefit as the industry evolves.
First, FERC needs to apply its new merger review policy firmly. It must not bow to industry pressure to consider and approve mergers quickly, to avoid upsetting the merger applicants business plans. It is more important to protect the future competitive structure of the market than to process speedily any particular deal.
Second, to ensure that actual competition, and not just ''astroturf'' competition, develops in the electric generation and marketing sectors, federal antitrust law enforcers must pay much more attention to this industry. During this transition period, they must ensure that mergers, acquisitions, alliances, long-term contracts and other strategies to preempt competition are not allowed to go forward. Due to the unique nature of electric generation and transmission markets, the web of corporate relationships, and the sizable barriers to entry, merely counting the noses of competitors nationwide or relying on ''potential'' new entrants to act as a check on market power in this industry will not work. Formation of a joint Task Force composed of DOJ, FTC and FERC personnel to study market power issues in the electric industry and the electric-natural gas ''convergence'' phenomenon, and to release a report on their findings, would be a good first step.
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Third, Congress needs to examine carefully the likely consequences of repealing or radically amending the Public Utility Holding Company Act (PUHCA). While it may be increasingly archaic and full of loopholes, PUHCA is the only existing electric industry-specific statute which attempts to address utility market power and protect electric consumers. The problems it was enacted to remedy—complex multi-tier utility affiliate relationships which concealed the control of a few large holding companies, gas-electric utility combinations, and abuses of both shareholders and consumers—have a ''deja vu'' ring to them. The Securities and Exchange Commission (SEC) has shown little inclination in recent years to enforce PUHCA, and has in fact issued regulations that severely undercut its statutory protections, such as its recent Rule 58 regulations on diversification into non-utility ventures. But PUHCA does at least limit the activities of several large multi-state public utility holding companies. IOUs are mounting a multi-million dollar campaign to dismantle PUHCA for a reason, and it is not necessarily the reasons that their lobbyists give you when they come to visit. NRECA predicts ''megamergers'' and consolidations of an unprecedented scale if PUHCA is repealed.
Fourth, FERC needs to continue to focus on the issue of market power in electric transmission and pricing. It should not consider the OATs public utilities have filed in response to Order No. 888 to be the final word on transmission terms and conditions. Several of the provisions of these tariffs still substantially disadvantage competitors dependent on OAT service. FERC should also consider carefully the new transmission pricing methods which transmission-owning utilities are proposing, often in conjunction with ISOs. Some of these methods may result in over-collection of transmission costs, again disadvantaging transmission customers. FERC needs to make wholesale transmission services and rates as ''user-friendly'' as possible, so that smaller entities can participate meaningfully in the wholesale market. Finally, FERC needs to consider carefully public utilities' applications to charge market-based (rather than cost-based) rates for electric power sold at wholesale. It should not approve such applications if its analysis of the relevant generation market shows that the applicant has any market power over generation.
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Taking these steps would go some way towards positively influencing the future course of the industry. They can be taken without the passage of major new legislation. The tools are ready to be used; the will to do so is the key ingredient that needs to be added.
Finally, if Congress does decide at some time to take up electric industry restructuring legislation, it must fully consider and deal with market power concerns. Any such legislation must include limitations on electric industry mergers and acquisitions, prohibitions on the exercise of market power, and strong consumer protections. If these elements are not included in any federal legislation dealing with the electric industry, those who support retail wheeling may find that they won the retail wheeling battle, only to lose the competition war. If this happens, consumers will be the losers.
I thank you for your time and attention today.
INSERT OFFSET RING FOLIOS 16 TO 20 HERE
Mr. HYDE. Mr. Steven Burton, senior vice president and general counsel of SITHE—I hope I did not mangle that too much—SITHE, Energies, Inc., in New York.
First, I would like to know the pronunciation.
Mr. BURTON. We pronounce it SITHE. It is an acronym so it doesn't have a correct pronunciation.
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Mr. HYDE. Thank you very much, Mr. Burton.
STATEMENT OF STEVEN D. BURTON, CHAIR, ELECTRIC POWER SUPPLY ASSOCIATION (EPSA), AND SENIOR VICE PRESIDENT AND GENERAL COUNSEL, SITHE ENERGIES, INC.
Mr. BURTON. Thank you, Mr. Chairman. I would like to ask that my prepared testimony simply be entered into the record, and rather than refer to that, I would like to respond to some of the comments and discussion that this panel has begun, and the previous panel.
The gentlemen, the two to my right, mentioned this thing call the State action doctrine, and I would take issue with those that testified earlier that we don't need to do anything about the antitrust laws, that they are OK just the way they are.
The State action doctrine, I believe, is an impediment, simply to a private litigant seeking to enforce an antitrust claim against another litigant, specifically an independent power producer that seeks to bring an antitrust claim against a utility. I will give you an example. As independent power producers, we have to connect to the grid. We have to have our power plants connected to the system, and that is done by the utilities.
In one of our power plants, after we had a contract to be interconnected, the utility was doing the interconnection and the cost just kept going up and up and up and up. And we thought that in light of their market power, in light of the fact that we couldn't reach our customers if we couldn't interconnect, that antitrust should have been one of the remedies available to us. But it is not available to us due to the State action doctrine. So I would certainly urge counsel to take a look at that and see whether or not that is an appropriate role for this committee to get involved in the overall restructuring legislation.
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I do believe that the cleanest way to accomplish real competition is by separating the businesses. The ranking member kept talking about the largest remaining vertically integrated monopolies, and I think that is absolutely right, and I think that is where the danger lies, in remaining integrated monopolies. And we would certainly agree that open access, functional unbundling, ISOs, can all go a long way towards reducing this problem.
What we see so far, though, is that a little compromise on the ISO, a little compromise on functional unbundling, some open access that is not quite so open, and we remain concerned as to how real competition is going to work.
I would say that we are not advocating legislatively mandated divestiture. We don't believe that is the way to go. Ultimately, the commissioner from Massachusetts will talk about how divestiture is taking place in Massachusetts, how utilities are making business decisions, that the best thing to do is to be either in a regulated business, transmission and distribution, or in a generating business, which will hopefully be a nonregulated business.
Another example of why it is a problem if the generation companies continue to be owned by transmission and distribution companies is pure information. If we want to come in and compete, and hopefully in this new retail market, we need to know something about those customers, and the entity that has all the best information about their customers, about their usage, about time of day, about rate sensitivity, is the existing utility, and if that information remains proprietary, even though they functionally unbundle, I think there is a problem for new competitors, new competitors who want to go after the retail market.
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Finally, I would make a comment about the issue of reliability. Everybody agrees that reliability is important, but I think it is time for everyone to acknowledge that it is not an issue. In New York State, where we have five power plants, there are over 150 independent power producers connected to the grid. There has been no reliability problem. In fact, I would say reliability in New York has increased, because if we are not operating, we are not getting paid, and, therefore, the independent power producers have a great incentive to make sure they are reliable, to make sure they are operating, because if they are not, they are not earning anything. Thank you.
Mr. HYDE. Thank you, Mr. Burton.
[The prepared statement of Mr. Burton follows:]
PREPARED STATEMENT OF STEVEN D. BURTON, CHAIR, ELECTRIC POWER SUPPLY ASSOCIATION (EPSA), AND SENIOR VICE PRESIDENT AND GENERAL, COUNSEL, SITHE ENERGEIS, INC.
I am Steven Burton, Senior Vice President and General Counsel of SITHE Energies, Inc. SITHE Energies is a competitive power supplier engaged in the development, construction, operation and ownership of independent power plants throughout the United States and the world. SITHE Energies' plants are primarily natural gas-fired cogeneration and hydroelectric facilities. SITHE Energies operates in excess of 2000 megawatts (MOO) of electric power capacity to its customers, including steam and electricity to the United States Navy in San Diego, CA. SITHE Energies' principal shareholders are Compagnie Generale des Eaux, Marubeni Corporation and corporate management.
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SITHE Energies is a member, and I am Chair, of the Electric Power Supply Association (EPSA), the national trade association representing competitive power suppliers active in U.S. and global power markets. EPSA members, comprised of competitive power generators, power marketers and providers of goods and services to the electric industry, share a commitment to creating an efficient electric supply marketplace and to bringing the benefits of competition to all electricity customers.
The competitive power supply industry welcomes the opportunity to offer its views to the House Judiciary Committee with regard to the market power and anti-trust aspects of electric industry restructuring. I would especially like to thank Chairman Hyde for holding this hearing, for advancing the discussion on a very important aspect of electric industry restructuring, and for allowing EPSA the opportunity to appear before the Committee today.
The electric power industry, the largest remaining vertically-integrated monopoly industry in the United States, is undergoing a transition from a monopoly-based industry to a more competitive industry. Congress began this process in 1978 with the passage of the Public Utility Regulatory Policies Act (PURPA), which gave birth to many of the companies EPSA represents and introduced competition to the wholesale generation industry. PURPA was intended to promote energy efficiency by encouraging the efficient use of resources through cogeneration and the increased use of alternative energy sources in facilities utilizing renewable technologies. PURPA, however, provided a critical competitive benchmark, because it required utilities to consider a variety of sources of power generation. PURPA proved that generation no longer needed to be a natural monopoly and that vertical-integration was no longer needed for reliability or economies of scale.
In 1992, Congress again pushed the competitive process further with the Energy Policy Act (EPAct). EPAct created a new class of electricity producer, the Exempt Wholesale Generator (EWG), furthering the growth of competitive power producers and expanding the market in which we could operate. EPAct also helped open up the national transmission system to all wholesale suppliers, fueling increased competition in bulk power markets which has contributed to the explosive growth of a new industry marketing.
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Today, through federal regulatory actions like the Federal Energy Regulatory Commission's (FERC) Orders 888 and 889, and a host of state restructuring initiatives, remarkably productive changes are occurring in the industry. Prices are dropping, market efficiencies are growing, customer options are increasing and a regulatory framework that enhances competition is developing. Now is the time for Congress to capitalize on these favorable developments by acting to create the best possible federal framework for emerging competitive, nationwide electricity markets.
As Congress (through efforts like Energy & Power Subcommittee Chairman Dan Schaefer's ''Electric Consumers Power to Choose Act of 1997'' and Senator Dale Bumpers' ''Electric Consumers Protection Act of 1997'') and the states examine how to best make this transition to competition, many issues, like the market power and antitrust issues we are discussing today, must be carefully examined and addressed at the federal level. If the restructuring of the electric industry is not handled properly, and workably competitive markets are not created, the full benefits of competition will not be realized by all consumers. While full retail choice is an important component of industry restructuring, access to customers is not necessarily enough. Successful restructuring must eliminate barriers to entry and include appropriate safeguards against the abuse of market power.
To ensure an orderly and effective transition to full competition, comprehensive legislation is needed at the federal level that includes a ''date certain'' for all customers to choose their supplier. Electricity is an interstate commodity that is priced and traded in all regions of the country. It is the only commodity traded extensively in interstate commerce that is subject to intense jurisdictional review by the states. Congress is ideally positioned to rectify this problem now. Federal legislation which establishes competitive markets, but allows states options for the implementation of competition, should include:
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Safeguards against the abuse of market power and anti-competitive behavior.
A ''date certain'' when competition will exist for all consumers. Full recovery of all legitimate and verifiable stranded costs, including regulatory commitments and power purchase contracts.
Protections to preserve existing power purchase contracts (contract sanctity).
Pro-competitive policies that will lead to environmental benefits.
Establishment of independent system operators (ISOs) to control the transmission system.
Prospective repeal of the mandatory purchase provisions of Section 210 of PURPA.
A commitment to renewables technologies.
While this testimony will focus on anti-trust and market power issues in the context of restructuring, I will also touch upon issues of equal importance to competitive power suppliers in this restructuring debate.
II. NEW THINKING FOR A NEW INDUSTRY
As we move to a restructured and increasingly competitive electric industry, where the goal is to attain many buyers and many sellers, market power abuses are likely to occur, particularly during the transition to competition. The current industry structure relies on regulatory safeguards that will no longer function, or function well, in a new world. As the transition to a fully competitive electric industry continues, the thinking about market power issues needs to change; even the questions that are asked need to change.
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New market power issues are confronting the industry, and new tools and solutions are being developed to address these problems. The industry, and those who regulate it, already recognize that in the new world of competition, traditional regulatory mechanisms will no longer be sufficient. To prevent market power abuses in the future, and to establish truly competitive markets, we will need to define what the new markets are, what the relevant products are, who the market participants are and conduct new types of market concentration and market power analyses. Ultimately, we must use different tools—more akin to those used to discipline potential abuses of market power in other competitive markets—address market power issues.
III. SUPPORT FOR SAFEGUARDS AGAINST THE ABUSE OF MARKET POWER AND ANTI-COMPETITIVE BEHAVIOR
EPSA supports the development and application of policies that safeguard the restructured electric power industry against market power abuses. As power markets are transformed from a regulated industry structure to open competition, the potential exists for the exercise of horizontal or vertical market power. Too few competitors in constrained electricity markets, control over transmission bottlenecks and discriminatory operational rules can lead to market power abuses that will threaten the effectiveness of the developing competitive marketplace. The new market structure and the institutions developed to support it must be designed to minimize opportunities for anticompetitive conduct and the exercise of market power. As FERC has recognized in its Merger Policy Statement:
Competition is now the best tool to discipline wholesale electric markets and thereby protect the public interest. But the competition needed to protect the public interest will not be efficient and deliver lower prices in a poorly structured market.
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To allow the development of robust, fully competitive electric power markets that benefit all consumers, the industry will need:
Enforcement of the new merger policy by FERC, which resembles the Department of Justice (DOJ) merger guidelines for other non-regulated industries.
Increased scrutiny and enforcement actions under DOJ and Federal Trade Commission (FTC) traditional anti-trust and unfair trade practice laws, including the elimination of the ''state action'' doctrine.
Functional separation of generation facilities.
Establishment of an Independent System Operator (ISO) to manage the transmission system.
Open access to all transmission and distribution lines for all competitors.
Increased scrutiny by FERC in its enforcement of transmission access regulation.
Elimination of barriers to entry for all market participants.
Equal access to the information needed for all market participants to compete, including workable OASISs (Open Access Same-Time Information Systems) operating under auditable standards.
Workable implementation procedures at the state level which do not discriminate in favor of the traditional utility supplier.
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IV. SUPPORT FOR A NEW MERGER POLICY IN COMPETITIVE MARKETS
A new merger policy is one aspect of restructuring that will assure the development of truly competitive markets. In response to the changes occurring in the electric industry, many electric companies are consolidating and merging to reposition themselves so they will be as competitive as possible from the start. This trend is certainly bound to continue as we edge closer to competition. EPSA believes that decisions regarding whether or not to merge should be determined by private parties pursuant to the realities of the marketplace. However, certain regulatory safeguards must be in place to ensure that mergers are not harmful to competition.
Seeing this merger trend, and prudently anticipating that new competitive markets (and the transition period while these competitive markets develop) will require new answers to new questions, FERC recently adopted a new Merger Policy Statement which uses an approach similar to that the Department of Justice (DOJ) applies to other nonregulated industries. While FERC acknowledges that full and robust competition will be the best tool to discipline markets, the public interest must be protected where markets are not yet competitive, or where competitors are able to undermine the benefits of competition through the abuse of market power.
Until markets are fully competitive, FERC needs to thoroughly scrutinize merger applications and utilize appropriate tools such as requiring ISOs, transmission upgrades or divestiture, to address market power abuses. Ultimately, the decision whether to approve mergers or not should be based upon the merger's affect on competition in all relevant markets.
V. SUPPORT FOR THE DEVELOPMENT OF INDEPENDENTLY OPERATED TRANSMISSION SYSTEMS TO ALLEVIATE MARKET POWER CONCERNS
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EPSA supports the development of regional independent system operators (ISOs) to control and direct the operations of the transmission systems consistent with the guidelines issued by FERC in Order No. 888. ISOs, combined with functional unbundling, represent the most promising method for dealing with transmission market power. Without requiring changes in the current ownership of the transmission system, ISOs can serve several important functions in the transition to fully competitive electricity markets, especially with regard to market power issues.
To begin with, ISOs can foster FERC's goal of comparability, which is not yet being fully enforced, and ensure that all users of the transmission system (including transmission owners) are being provided access to that transmission system at comparable prices, terms and conditions in a non-discriminatory manner. In addition, ISOs can help eliminate concerns about potential abuses of market power that often accompany the transition from a regulated monopoly market to a disaggregated competitive market, providing confidence to all market participants that the system is being operated fairly. To alleviate market power concerns, ISOs must:
Be truly independent. ISOs should have no financial interest in the outcome of an energy transaction under its control. The management and control of the system must be completely separate from the ownership of the system. The ISO can adopt many different forms of governance to achieve this but should leave no stakeholder out of the decision-making process.
Control and direct the operation of the transmission system in a fair and nondiscriminatory manner for all users of the system. No advantages can accrue to the owners of the wires; all transmission users must receive equal treatment.
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Control the entire system, and not leave portions of the system under the control of transmission owners. This must occur in order to prevent abuses and provide for an efficient operation of the system.
Administer pricing principles which are fair, transparent and nondiscriminatory. Transmission tariffs must provide access to equal services at equal rates for all users of the system.
Operate and maintain the OASIS to assure that all market participants have access to the same information in order to fairly compete. In a competitive market, information is an important tool. All market participants must have access to the same information at the same time.
Properly structured ISOs can go a long way in addressing and resolving market power concerns in a restructured world.
VI. SUPPORT FOR FEDERAL LEGISLATION WITH A DATE CERTAIN TO ESTABLISH CUSTOMER CHOICE IN THE ELECTRIC INDUSTRY
The ultimate goals of electric industry restructuring are lower prices, improved services for end-use consumers and truly competitive markets. Customer choice—at the wholesale and retail levels—is the best way to achieve these goals. Robust competition, by definition, requires many buyers and many sellers.
EPSA believes that the best way to achieve an orderly, and ultimately successful, transition to a competitive market for all suppliers and consumers, is to require states to provide retail choice by a ''date certain,'' under national competitive standards. EPSA supports federal legislation that ensures consumer choice of generation suppliers as soon as possible, but no later than January 1, 2001. There are several reasons why a new national electric policy should be developed at the federal level:
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Only comprehensive federal legislation with a date-certain approach can ensure that the benefits of competition are available to all consumers as soon as possible. Without federal legislation, some states may chose not to introduce competition, thus denying individuals its benefits. Moreover, electricity is a commodity in interstate commerce. Individual states should not have the right to interfere with the ability of sellers to reach the marketplace. In short, this is not a states' rights issue, but one of individual rights.
A national framework is desirable and necessary to prevent a state-by-state hodgepodge of inconsistent and incompatible programs that would prevent the full benefits of competition from being achieved. How can businesses successfully function in a national marketplace when what might be allowed in one state is not allowed in another?
Experience with state implementation of PURPA suggests that movement towards implementing uniform policies has been slow and spotty, at best. Nineteen years after the enactment of PURPA, some states have yet to implement rules that include competitive generation resources in their planning and supply addition strategy.
Only Congress can address the corresponding changes that will be needed to existing federal energy laws.
A definitive timeframe for the transition to a fully competitive industry will minimize structural upheavals, eliminate confusion, and allow for an orderly transition to competition for all participants. Further, a definitive timeframe will enhance and accelerate the maturation process of the nascent competitive marketplace that exists today.
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Federal legislation to ensure that all customers see the benefits of industry restructuring will not take away the rights of the states with regard to retail electric services, as some wish to argue. States will still maintain an active role in regulating the electric industry. States will continue to regulate the activities of distribution companies and companies that sell directly to the public. States will still make decisions on power plant siting and permitting, public purpose programs, environmental programs and universal services. Elimination of price regulation for generation does not eliminate the role of a state in policing energy markets.
Federal legislation will force industry participants, including state policy makers and regulators, to focus on how to do it properly instead of debating whether restructuring is a good idea. Competition, brought to all electricity consumers across the nation by a date certain can be expected to:
Provide the lowest prices possible.
Allow all customers, for the first time ever, to choose their provider of electricity.
Improve technology and services.
Enhance reliability.
Improve environmental performance.
Protect consumers from anti-competitive behavior and market power
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abuses.
Strengthen the competitiveness of American industry.
VLL. CONCLUSION
Again, the Electric Power Supply Association thanks Chairman Hyde for the opportunity to share its views on electric industry restructuring today. Please consider EPSA a resource as you and your colleagues examine how to best restructure the last remaining monopoly industry in the United States so America's consumers can enjoy the full benefits of competition.
Mr. HYDE. Next, Mr. John Howe, chairman of the Massachusetts Department of Public Utilities.
STATEMENT OF JOHN B. HOWE, CHAIRMAN, MASSACHUSETTS DEPARTMENT OF PUBLIC UTILITIES, ON BEHALF OF THE NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS
(NARUC)
Mr. HOWE. Thank you very much. Good morning, Mr. Chairman, and members of the committee. My name is John Howe. I am chairman of the Department of Public Utilities in Massachusetts. I am appearing here today for the National Association of Regulatory Utility Commissioners, or NARUC.
We applaud your decision to convene this hearing now while we are still in the early stages of the restructuring debate. If NARUC has one overarching message, it is that if we turn our attention to antitrust related issues later, we may be too late. Antitrust law is far better viewed as a preventive rather than a corrective system of law. When it is invoked as a means of redress, it is slow, expensive, and contentious. Our Nation's consumers will be far better served if we simply don't allow situations to occur that could give rise to antitrust violations.
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Unfortunately, the risk of this happening is serious. We face a paradoxical situation in the Nation's electric power industry today. Legislators and regulators of all political persuasions are relaxing traditional forms of oversight. We are, for good reason, I believe, embracing the principle of consumer sovereignty and the discipline of competitive marketplace, yet, within the electric power industry itself, there is a massive and unprecedented rush to merge and consolidate operations.
Now we are still not in the habit of speaking of utilities and antitrust law in the same breath. For decades, utilities have enjoyed broad antitrust immunity under the so-called State action doctrine. Under this theory, conduct that might otherwise violate antitrust laws is permissible if it is subject to adequate State regulation.
Today, however, regulators are consciously and purposefully withdrawing from direct regulation. We are focusing efforts in a new direction, on cultivating effective competition and expanding customer choice. Surely, then, the rationale for such a State action exemption is becoming progressively less valid. Given the changing circumstances of the power industry and the sheer volume of mergers that have been announced, it is urgent that we achieve greater clarity on how antitrust laws will be applied. Prospective partners to these mergers have expressed a great deal of frustration at the delays they have encountered, but unfortunately, if the responsible agencies don't pay adequate attention to the competitive implications now, before the market power horse is out of the barn door, there is a real risk that these mergers could choke off the very same competitive forces we are seeking to unleash.
Mergers can be conditioned or stopped, if necessary, but once completed, they cannot be reversed, except at a very great cost. We must not, through inadvertence or neglect, trade in a system of regulated monopolies for one of unregulated market power. That would defeat the very purposes of restructuring.
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My written testimony suggests a number of ways in which mergers and consolidations could reduce choice and threaten competition. Horizontal mergers among direct competitors could result in excessive concentration of generation. Vertical mergers could present opportunities for a regulated monopoly to leverage its position into unregulated markets. So-called convergence mergers could hamper the force of interfuel competition. My written testimony also notes a number of other specific antitrust related concerns that warrant your attention.
Consider the topics of price squeeze, predatory pricing, territorial division, tying arrangements, price discrimination, and joint ventures. Recent antitrust jurisprudence has tended to regard these behaviors as less detrimental than was once thought when they occur in fully competitive sectors of the economy. But what is notable about each of these behaviors is that the opportunity to engage in them, and in doing so to inflict real harm on consumers, is in many ways inherent in utilities' current structure. We have not merely tolerated this structure; over several decades, we have actively blessed and encouraged the formation of vertically integrated, geographically exclusive and geographically extensive utility systems. We have endorsed the use of monopoly power to effect cross-subsidies.
Today, we have recognized that the natural monopoly characteristics that justified this regulatory approach are not present in all segments of the industry. One of the overarching challenges in restructuring is to change a fundamental culture, to transform and in some ways reverse the same patterns of organization and habits of minds we expressly encouraged for decades, and we must do so in sectors of the industry that are naturally competitive, such as generation, while preserving the traditional framework in other parts of the industry, such as in transmission and distribution.
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As the Judiciary Committee contemplates Federal restructuring legislation, let me briefly mention three items to consider: It may be appropriate to reinforce and make explicit FERC's authority to order divestiture or formation of ISO's as a condition of merger approval, an approach that several States are favoring in restructuring. We urge you to identify and fill any jurisdictional gaps so as to ensure that there is adequate authority to evaluate all competition related issues posed by mergers in full. And we urge you to focus on the particular issues raised by convergence mergers across industry lines and consider whether FERC needs additional Federal Power Act authority to evaluate them.
Thank you for the decision merely to conduct this hearing. It will heighten sensitivity to these vitally important issues. We promise to work with you to ensure that any legislation you may enact will provide for adequate consumer protections against the kinds of behaviors antitrust laws are designed to prevent. Thank you.
Mr. HYDE. Thank you, Mr. Howe.
[The prepared statement of Mr. Howe follows:]
PREPARED STATEMENT OF JOHN B. HOWE, CHAIRMAN, MASSACHUSETTS DEPARTMENT OF PUBLIC UTILITIES, ON BEHALF OF THE NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS (NARUC)
Good morning. My name is John B. Howe. I am Chairman of the Massachusetts Department of Public Utilities. I appear today on behalf of the National Association of Regulatory Utility Commissioners. NARUC is a quasi-governmental nonprofit corporation, founded in 1889, consisting of governmental agencies engaged in the regulation of utilities and carriers. The chief objective of NARUC is to serve the consumer interest by seeking to improve the quality and effectiveness of public regulation in America.
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NARUC congratulates the Judiciary Committee for convening this timely hearing on the relevance of antitrust issues to current legislative initiatives aimed at restructuring the nation's electric power industry. The issues under your committee's jurisdiction are of both great complexity and vital importance to the restructuring debate. In the view of NARUC's members, it is critically important to develop a framework for applying antitrust legal concepts to the utility industry before restructuring reaches an advanced stage. Antitrust law operates far better as a preventive and educational tool—aimed at assuring that conditions that might allow firms to engage in abusive activities do not arise—than as a means of securing remedies from such abuses. In actual application, antitrust proceedings have proven to be slow, expensive and contentious. The nation, therefore, will benefit from a proactive strategy to ensure that the market conditions that could give rise to antitrust violations are not allowed to develop.
2. STATEMENT OF THE PROBLEM
The transformation now taking place in the electric power industry presents a paradox. On the one hand, legislators and regulators are in the process of relaxing traditional forms of oversight, and placing increased reliance on the discipline of a marketplace. On the other hand, companies within the industry are pursuing a wave of mergers and consolidations that is massive and unprecedented. NARUC's members fear that, if this consolidation proceeds unchecked without adequate understanding of its long-term competitive implications, it could choke off the very forces that we are counting on to discipline market behavior in the future.
Regulators' movement toward competitive market structures. Economic regulation has operated as a surrogate for market-based competition in electric power throughout most of the 20th century. We have relied on this form of organization because, owing to the technological conditions of the industry, it appeared impossible to structure markets to provide for effective competition. Within the past two decades, however, tremendous innovations have occurred in power generation, communications and computing technology. Taken together, these advances have made it possible to envision a competitive form of market organization for power supply. It is now commonly recognized across partisan lines that, provided that the conditions for workable competition exist, a more open market structure offers the opportunity to achieve important benefits for consumers—lower prices, the development of innovative services, and the deployment of more advanced technologies. This has been the experience in other industries in our nation's economy, and it has been our embrace of the principle of consumer sovereignty that has made our nation's economy the most powerful on earth. NARUC's members have no interest in interfering with the delivery of these consumer benefits.
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However, the movement to open electricity markets to competition requires a fresh approach to the application of antitrust law. Under the traditional monopoly regulatory framework, courts have afforded to utilities a fairly broad exemption from the application of the antitrust laws under the theory of ''State Action'' immunity. Under this doctrine, it is assumed that Congress did not intend to preempt state regulation, and that conduct that might otherwise violate these laws is exempted if the conduct is subject to adequate state regulation.(see footnote 56) Yet inevitably, increased reliance on market forces will entail a deliberate withdrawal of certain dimensions of this oversight. To whatever extent courts recognized such a defense, therefore, the rationale for a ''State Action'' exemption is becoming progressively less valid.
Industry's move to consolidate. Meanwhile, as legislators and regulators pursue reforms to allow competitive entry into electricity markets, the industry is pursuing a pattern of mergers and consolidation on a massive and unprecedented scale. Industry leaders claim compelling business reasons for the proposed mergers and consolidations—notably, the need for size, sophisticated capabilities and access to capital as companies compete more and more on a global scale. Indeed, in many circumstances and regions of the country, it is apparent that some degree of consolidation could result in significant efficiencies.
3. THE POSSIBLE CONSEQUENCES OF FAILURE TO ANTICIPATE AND ADDRESS PROBLEMS
Nevertheless, a principal effect of such consolidation would be a significant reduction in the number of effective competitors in these newly emerging markets. This trend, therefore, carries the clear risk of limiting consumers' choices in various ways. For example, horizontal mergers could limit choice by concentrating ownership at a specific level in the chain of energy production and delivery (for example, generation within a given geographic region). Alternatively, vertical combinations may present a company with the opportunity to leverage its control of certain regulated essential facilities and thereby gain an advantage in another, unregulated business segment. Mergers across industry lines, based on theories of ''convergence'' between the electric power and natural gas industries (or electricity and telecommunications), have also been proposed. Such combinations could conceivably undermine the benefits of competition between alternative service delivery systems.
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Although there is a longstanding body of antitrust law related to regulated utilities, the widespread assumption of a ''State Action'' exemption for utilities has resulted in the circumstance that many in industry and legal circles have little direct experience with these concepts. It is urgent that policymakers develop a more thorough understanding of the possible adverse consequences that could arise from industry consolidation. Only if such consequences are anticipated may we take appropriate measures to avert them. Otherwise, restructuring will place the nation's consumers at risk of forfeiting the traditional benefits of regulation, not attaining the benefits of effective competition, and being exposed to an accumulation of unregulated market power. Certainly, while today's regulated monopoly structure may not yield optimal results in terms of efficiency and innovation, it is far preferable to a market dominated by unregulated monopolies.
4. SOME SPECIFIC ANTITRUST-RELATED CONCERNS
Determining the application of antitrust law to utilities requires, in the first instance, a delineation between two spheres of activity—those requiring regulation and those that are susceptible to competition. There are certain activities that, by virtue of their enduring natural monopoly characteristics, are legitimately subject to a state-sanctioned monopoly franchise. By contrast, several functions have demonstrably competitive characteristics. Clearly delineating these functions is a difficult task, complicated by the fact that technological change continues to redraw the lines and challenge long-held assumptions.(see footnote 57) While NARUC is not in a position to present detailed and definitive recommendations as to how restructuring legislation should address the following topics, we would call your attention to several areas of antitrust law, suggest why these issues are likely to be implicated in the restructuring process, and urge you to keep them in mind as Congress contemplates restructuring legislation. Each of these topics is discussed in greater detail in a study prepared by the National Regulatory Research Institute (''NRRI''), the research arm of NARUC, that was published in April 1996.(see footnote 58)
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a) ''Price squeeze'' and predatory pricing
Predatory pricing involves practices such as a firm pricing below its cost, so as to drive out competitors and permit the firm, subsequently, to raise its price and reap monopoly profits. One specific form of predatory pricing is ''price squeeze,'' in which one entity, acting as both a competitor in a retail market and a monopoly provider in a related wholesale market, is able to use its wholesale market power to preclude effective competition in its retail markets. Such behavior is a violation of Section Two of the Sherman Act, which prohibits monopolization and attempts to monopolize.(see footnote 59) In recent years, scholars have tended to discount the likelihood that a rational firm operating in a competitive environment would pursue a strategy of predatory pricing, since such a strategy can be expensive and carries a high risk of failure. However, utilities' particular hybrid structure, in which parts of their operations operate competitively while other parts remain regulated, may give rise to opportunities for predatory pricing behavior that simply do not exist in more purely competitive settings. A significant portion of utilities' cost structure is subject to a regulatory scheme that provides for assured recovery. The existence of this scheme may afford opportunities to cut prices in one segment of their business and enforce the collection of foregone revenues from monopoly ratepayers in another segment. It is often difficult for regulation to detect and correct such abuses.
b) Territorial division
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Territorial division relates to agreements among competitors to divide or ''carve up'' territories. Such agreements constitute one of the clearest per se violations of Section One of the Sherman Act.(see footnote 60) Yet the assignment of geographically exclusive service territories is the very hallmark of utility regulation in most parts of the nation. While restructuring efforts aim to foster the development of competitive markets in electric power supply, it remains the predominant view of policymakers that transmission and distribution services constitute natural monopolies requiring protection from competition. Absent appropriate safeguards, either behavioral or structural, the grant of an exclusive territory will present the monopolist with a clear opportunity to achieve a dominant market position in a related, competitive activity. Restructuring will highlight the necessity of such safeguards.
c) Tying arrangements
Tying arrangements involve the practice of offering for sale one product or service only on the condition that another product or service be taken. Tying violates Section One of the Sherman Act and may fall within Section Three of the Clayton Act.(see footnote 61) While courts generally took a harsh view of tying arrangements for many years, recently they have taken a more relaxed view under which tying is no longer seen as necessarily anticompetitive. However, it continues to be seen as a concern where the firm engaged in tying enjoys power in the market for the ''tying'' product. Of course monopoly regulation, by its very nature, grants utilities extensive market power in the function that is the subject of its exclusive franchise. While regulatory mechanisms such as open access and affiliated transaction codes of conduct may police against such abuses, the nature of the utility business meets the threshold condition that warrants concern about ''tying'' among public policymakers.
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d) Price discrimination
Price discrimination occurs when the sale of the identical commodity is made to two or more different buyers at different prices. Where the effect may be substantially to lessen competition, and where at least one of the sales is in interstate commerce, such action violates the Robinson-Patman Act.(see footnote 62) At present, most retail sales of power occur pursuant to rate schedules and tariffs that guard rigorously against undue discrimination, and in in-state, retail markets away from the realm of interstate commerce. However, in recent years it has become more commonplace for utilities to offer off-tariff sales arrangements in response to competitive pressure. Also, many utilities are beginning to recruit customers far beyond their service territories. Given that more broadscale price discrimination in commodity sales of electricity is possible, it would appear to serve the interests of utilities and a healthy competitive marketplace to establish guidelines to ensure that such practices do not trigger Robinson-Patman concerns.
e) Joint ventures
The formation of joint ventures and other agreements among competitors is recognized as a means of undermining competition and, thus, has long been a source of concern, as reflected in Section One of the Sherman Act and Section Seven of the Clayton Act.(see footnote 63) At the same time, Congress and the Supreme Court have recognized that such collaborative efforts can be justified as consistent with competitive markets. In general, such agreements are permitted to the extent they go no further than necessary to achieve their legitimate purpose. Historically, of course, utilities have engaged in extensive collaboration through power pools, reliability councils and similar institutions. At present, several regions are pursuing the formation of independent transmission system operators or ''ISOs'' which, as the Federal Energy Regulatory Commission (FERC) noted in its recent merger policy statement, ''are generally thought to be the proper vehicle for dealing with vertical market power.''(see footnote 64) The governance structures of these new bodies are intended to address concerns about agreements between competitors by ensuring that the ISO enjoys a significant degree of autonomy. Close cooperation and coordination between adjoining utility systems will, in all likelihood, continue to be essential to ensure the safe and reliable operation of the nation's grid. One of the key challenges in restructuring will be to ensure that participants in such collaborative efforts, to the extent they are found to have legitimate purposes, do not use them to exclude or disadvantage non-participating competitors.
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f) Mergers and acquisitions
Both the Sherman and the Clayton Acts permit but place limits on merger activity by establishing standards by which they are to be evaluated to ensure that they do not impair effective competition.(see footnote 65) Regulatory agencies, including the Securities and Exchange Commission (SEC), the Department of Justice (DOJ), and the Federal Trade Commission (FTC) have evolved specific guidelines, involving both quantitative and non-quantitative measures such as concentration indices, to assess the competitive implications of mergers. Most recently, the FERC has revised its guidelines for assessing mergers with its new Merger Policy Statement.(see footnote 66) One of the key challenges in assessing mergers involving electric utilities is to determine how to apply these standards, given that the products sold in electricity markets have unique characteristics.
As mentioned earlier in this testimony, the predominant antitrust-related concern among NARUC members today relates to the possible diminution of competition amidst a wave of mergers and acquisitions. NARUC's concern is heightened by the sheer volume of electric utility mergers currently pending regulatory approval. Analysis of the competitive effects of these mergers is complicated by the fact that electricity has characteristics that distinguish it from every other commodity of such importance to our economy. It is produced and consumed instantaneously; it moves vast distances at the speed of light; it traverses a complex interconnected network whose operation is subject to immutable physical laws. Constraints on the flow of electricity can appear or disappear at innumerable points on the network at any time based on the independent actions of a myriad of independent consumers and producers. As the FERC has properly recognized in its new Merger Policy Statement, conventional market power analyses may not capture fully the effects of such frequent and transitory changes in market conditions.
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The prospective partners to many of these mergers have expressed frustration at the lengthy delays that they have faced. Many electric company mergers have been pending for well beyond one year, whereas mergers outside the power industry are routinely completed in far less than one year. While these concerns are understandable, they do not justify a shortcutting in the evaluation of the public interest aspects of these mergers. Rather, they highlight the importance of developing a sophisticated framework for more rapidly analyzing mergers in the unique circumstances of the power industry. Because the potential consequences of electric industry consolidation are so great, it is essential to anticipate and address competition-related concerns up front—before the market power horse is out of the barn door. If mergers proceed without adequate review and attention to market power issues, it is possible that the only future remedy would be to apply the antitrust laws through the courts, and impose remedies retrospectively. Such a course would be expensive, disruptive and extremely time-consuming. In the meantime, consumers may be exposed to extensive harm.
5. A common context and areas for future focus
To put all of these topics into context, electric utility restructuring presents a special challenge to antitrust enforcement because the opportunity to engage in the types of behavior at issue is in many respects inherent in utilities' current structure. With the express blessing of government, for most of this century these companies have operated as vertically-integrated, geographically exclusive and in many cases geographically extensive entities. Now, to the extent legislators and regulators embrace a new policy approach favoring competition, utilities are being expected to open segments of their traditional business to competition from new entrants. Alternatively, many are suggesting that they exit those segments of the business altogether. Thus, one of the overarching challenges in restructuring is establish a fundamentally different culture in portions of the utility industry. Transforming, and in certain respects reversing, the very patterns of organization and habits of mind that government expressly encouraged in an earlier era may be among the biggest challenges in this process.
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NARUC's purpose in offering this testimony is not to propose detailed and specific actions for Congress to take in restructuring legislation. Rather, we have sought to highlight the various areas that will need attention. As Congress moves to the drafting stage, however, we believe a few areas will warrant a particular focus:
a) Reinforce FERC's conditioning authority relative to mergers
Congress could explore whether to enhance or make explicit FERC's authority to impose any of the types of conditioning authorities set forth in the agency's Merger Policy Statement. FERC has stated that, where a merger might tend to reduce competition, the agency could condition its approval of the merger on the merged entity taking specific steps to enhance competition within, and in the vicinity of, its service territory. FERC has suggested, in particular, that a merging entity might ''propose to divest a portion of its generating capacity so that its market share falls below the share that poses anticompetitive concerns under the Guidelines.''(see footnote 67) Congress may wish to consider whether it is appropriate to reinforce FERC's authority to order divestiture of generation as a remedy for the reduction in competition that accompanies a merger. Several state legislatures, recognizing a link between ownership of generation and the types of market power problems mentioned above, have included voluntary, mandatory or conditional divestiture of generation in their restructuring plans. For example, the California restructuring legislation provides that the major utilities voluntarily divest of at least 50% of their fossil generation.(see footnote 68) The Maine Legislature recently enacted a bill that requires utilities to divest of generation facilities by March 1, 2000.(see footnote 69) A Massachusetts legislative commission on restructuring has advanced a proposal that would condition stranded cost recovery on utilities' commitment to divest of non-nuclear generation on an accelerated schedule.(see footnote 70)
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b) Fill jurisdictional gaps
Under the current regulatory framework, FERC takes as its charge the evaluation of the competitive effects of mergers in wholesale markets. Meanwhile, individual state PUCs typically assess the implications of mergers on retail markets within their own borders. However, some of the large-scale mergers currently being contemplated pose regional competitive implications that may extend across state borders into adjacent states where there may be no direct opportunity to review the merger and give explicit consideration to its extraterritorial, retail market implications. Mechanisms could be explored to ensure that competition-related issues are evaluated in full—whether in wholesale markets or in retail markets; whether within the service territories of the merging companies or beyond their service territories—by an appropriate entity. This entity might be the FERC, the Federal Trade Commission, the Department of Justice, individual state commissions, or some combination of these entities operating through the mechanism of a Joint Board.
c) ''Convergence'' mergers
Congress should consider whether particular attention needs to be given in the merger review process to the competitive implications of mergers between electric companies and natural gas companies. These effects are likely to differ, depending upon whether the merger involves a natural gas producer, pipeline, distributor or marketer, as well as the geographic market area of the gas company. It may be necessary to review the Federal Power Act to provide FERC with expanded authority to review mergers involving non-electric companies.
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6. CONCLUSION
NARUC sincerely appreciates the opportunity to highlight these concerns. While there is no clear answer to many of the questions raised herein, the mere decision of the Committee to conduct a hearing on antitrust issues will have the salutary effect of heightening the sensitivity of the industry, other stakeholders, and members of Congress to the importance of such issues in any final restructuring legislation. This Committee should exert its authority to ensure that these issues are adequately addressed in any federal legislation on the topic of electric industry restructuring. NARUC commits to work with you to ensure that the Congress and the states discharge our common obligation, and secure our common interest, in assuring adequate consumer protections in any restructuring legislation that Congress may enact.
Mr. HYDE. Next, Mr. Michael Travieso, People's Counsel, State of Maryland, Baltimore.
STATEMENT OF MICHAEL J. TRAVIESO, MARYLAND PEOPLE'S COUNSEL, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES AND THE STATE OF MARYLAND OFFICE OF PEOPLE'S COUNSEL
Mr. TRAVIESO. Thank you, Mr. Chairman, Mr. Conyers, members of the committee. I am Michael Travieso. You were close, but no cigar today.
Mr. HYDE. Sorry.
Mr. TRAVIESO. I am here on behalf of the Office of People's Counsel of Maryland and also on behalf of the National Association of State Utility Consumer Advocates, known as NASUCA. That is an organization of 41 offices in 38 States and the District of Columbia. These offices are like mine, they represent the interests of consumers in utility matters.
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In Maryland, the People's Counsel Office represents, in particular, the interest of residential consumers. As you all know, consumers have a very, very serious and significant interest in the process that is now going on in the electric utility industry. The industry is moving from a highly regulated to a mixed competitive and regulated industry. It looks as if generation and certain electric retail services will become competitive, while most experts believe that transmission and distribution will remain regulated monopoly services. Because of this, it is very clear that the antitrust laws will become an important method of ensuring truly competitive markets to develop products and services that once were available only from regulated monopolies.
Utilities will function primarily in both markets. It may well be that the owners of distribution and transmission monopoly services will seek to sell electricity at wholesale and retail. Utilities will, as they have been, advance into unregulated businesses, where their knowledge of the usage patterns of their customers will give them advantages, that one of the witnesses has already referred to, and they will attempt to use those advantages to exclude others from competition; utilities will be forced to unbundle, that is, provide access to their transmission and distribution systems, which are essential facilities, and in doing so, they will again have opportunities to impede effective competition. And also there will be many new players in the market, brokers and all sorts of other players that were not in the market before who may be interested in forming legal or illegal relationships for their own benefits. These issues and circumstances will give rise to increased potential for antitrust violations and a need for more vigorous review, more resources at DOJ and FTC under existing antitrust laws and more resources at the FERC.
I would echo the comments of those who are saying deregulation is a misnomer. We are not deregulating, we are reregulating. An issue of particular concern to NASUCA is market power. This comes up in the merger cases and also in any restructuring process. Many States are adopting retail access, Congress is considering it. The theory, at least, is that competition fosters, well, in fact, competitive markets will foster lower prices and better services. I think that remains to be seen for the small consumer, just as it remains to be seen in the telecom industry, whether that will actually occur.
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NASUCA does not endorse a Federal mandate for a date certain for competition. NASUCA believes individual States should resolve the issues on a State-by-State basis. We would endorse competition if the result is that all ratepayers, and I emphasize the word all, can benefit from lower cost generation. We believe that if Congress acts, it must adopt policies which support proconsumer, competitive principles that benefit all consumers.
I would echo the concepts and the statements here that restructuring is, in fact, causing mergers in the electric industry. There have been 20 electric utility mergers proposed or completed in the last 3 years, and this is happening in an industry where generation resources are already highly concentrated. The 10 largest utilities in the United States now control over 30 percent of electric capacity. And the same thing is true on a regional basis to an even greater extent. NASUCA recommends existing antitrust and market power authority be preserved, fully enforced, and in some cases enhanced.
We believe FERC's new policy statement is a move in the right direction but we also believe FERC policy should reflect a net benefit test. NASUCA has joined a coalition of consumers who believe that any restructuring legislation must address market concentration, prevent cross-subsidy abuses, prevent affiliate abuses, and provide for independent control over transmission.
I see I am out of time. I wanted to have a chance to talk a little about what is going on in Maryland with BG and Pepco and perhaps if there are questions about that, I can answer them.
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Mr. HYDE. Thank you very much.
[The prepared statement of Mr. Travieso follows:]
PREPARED STATEMENT OF MICHAEL J. TRAVIESO, MARYLAND PEOPLE'S COUNSEL, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES AND THE STATE OF MARYLAND OFFICE OF PEOPLE'S COUNSEL
Chairman Hyde and members of the Judiciary Committee, my name is Mike Travieso. I am the Maryland People's Counsel. I also serve on the Executive Committee of the National Association of State Utility Consumer Advocates—NASUCA—an association of 41 consumer advocate offices in 38 states and the District of Columbia. NASUCA members are designated by the laws of their respective states to represent the interests of utility consumers before state and federal regulators and in the courts. I am here today both as the Maryland Consumer Advocate and on behalf of NASUCA.
On the behalf of NASUCA, I want to thank you for the opportunity to testify before this Committee on the anti-trust aspects of electricity deregulation. The first thing I want to tell the Committee is that I am not an anti-trust expert. In the very recent past, I didn't really need to be. I am an advocate for consumers of what are still monopoly utility services and products. People who do what I do have been experts in areas like costs of service, rate design, rate of return and revenue requirements. These are all terms which arise in connection with monopoly electric services that are highly regulated by both the federal government, at the FERC, and by the states through public utility commissions.
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Now everything is changing. Advocates, state utility commissioners and staff, FERC Commissioners and staff, as well as the electric utilities themselves, now need to become knowledgeable in anti-trust principles because of restructuring in the electric industry.
Furthermore, as we move from a highly regulated environment to a mixed competition/regulation environment the antitrust laws take on new importance for the electric industry. Eventually, the generation of electricity and certain retail customer services will likely become competitive with prices, products and services determined by the market. On the other hand, most experts believe that the transmission and distribution of electricity will remain regulated monopoly functions. With the removal of direct regulatory control over certain aspects of the industry, the anti-trust laws could become an important method of insuring that truly competitive markets develop for products and services that once were available only from regulated monopolies.
It is possible, even likely, that electric utilities will seek to participate, either directly, or through subsidiaries, in both regulated and closely related unregulated markets. For example, electric utilities which continue to own regulated distribution and transmission systems may seek to continue in the business of generating and selling electricity. Many utilities are increasingly entering into businesses which benefit from the fact that these utilities have exclusive and direct access to energy usage information about their customers, such as marketing and sales of related products and services including warranties; energy efficiency services; financing and HVAC sales and services. Moreover, as owners of the transmission and distribution facilities and as members of existing groups or joint ventures which control the use of and affect access to regional transmission grids, utilities have control over the facilities which competitors must use in the wholesale and retail generation markets. Obviously, these circumstances will give rise to an increased potential for anti-trust violations.
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While NASUCA has not endorsed federal action to mandate competition at the retail level, we do believe that if Congress acts it must adopt policies which support proconsumer competitive principles that benefit all electric utility consumers and reject proposals that will harm consumers and impede effective competition.
One of the most important issues that Congress—and this Committee—must grapple with is actually highlighted by the misnomer included in the title of this hearing—electric utility ''deregulation.'' In fact, we are not—or should not be—debating ''deregulation'' of this huge and essential industry. More accurately, the focus of this debate is really about reregulating century-old monopolies which have government created market power and creating, instead, a mixed system of regulated monopolies and competition that best serves the public's interest.
In this new mixed regulatory environment, anti-trust laws and market power protections take on added importance as they provide the structural foundation to insure that regulation is replaced by truly competitive markets. Absent careful consideration of these issues by legislators and regulators, any effort to increase competition in the generation market could lead this county back to the future of huge anticompetitive and anticonsumer electric utility empires.
Let's take a moment to put this all in perspective. During the last quarter of the 20th century regulators and policy makers have focused their attention on bringing competition to markets formerly thought to require extensive price regulation or to be natural monopolies. First it was airlines, then surface transportation, then natural gas, and finally telecommunications. Now Washington—and many states—are focusing on one of the last regulated monopolies—the electric utility industry.
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Already, several states—representing almost a third of our nation's population—have decided that it is in the best interest of their ratepayers to infuse competition into the generation of electricity. Some, like Idaho, have rejected competition. In my home state of Maryland, the Public Service Commission is in the midst of an electric restructuring docket and the legislature has enacted legislation to create a task force to study electric restructuring issues. And in Washington, several bills have been introduced that would facilitate or mandate retail competition.
Underlying this deregulatory fever is the belief that competition will serve consumers better than regulation, a basic premise of anti-trust law. In fact, according to Justice Black, speaking for the Supreme Count in 1958, the anti-trust laws were passed ''on the premise that the unrestrained interaction of competitive forces will yield the best allocation of our economic resources, the lowest prices, the highest quality and the greatest material progresses.''(see footnote 71)
NASUCA members do share Justice Black's pro-competitive view and support a future electric industry in which competition for electric generation resources is enhanced so that no ratepayers are forced to pay for uneconomic generation when less costly, reliable generation is available through a competitive generation market. NASUCA also believes, however, that there is a vast difference between competition and mere deregulation; and that deregulation, without full and fair competition, is the worst of all worlds for consumers—deregulated monopolies.
The fact is that the path to full and fair competition in generation must traverse the slippery and dangerous slope of the market power and dominance of existing investor-owned utilities. This new more competitive environment will require that existing federal anti-trust and market power authority be preserved, fully enforced, and, in some cases, enhanced in order to effectively deal with market power.
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Market power is not an abstract concept. It's real, it's powerful, and it will prevent true competition from developing—unless federal restructuring legislation addresses market power, self-dealing, cross-subsidy and entry barrier issues.
Consider these facts: the ten largest utilities in the U.S. now control over 30 percent of the total electric utility capacity. Concentration in regional and state markets is even greater. In Georgia, the Southern Company controls over 68 percent of the generation in the state. Northeast Utilities controls 72 percent of the generation in Connecticut, and Northern States Power Company controls 67 percent of generation in Minnesota.
Alarmingly, the market is growing even more concentrated as merger activity increases. Nearly 20 mergers of large investor-owned utilities have been proposed or completed in the past few years. More are expected. Mergers not only leave consumers with fewer supplier alternatives and less choice, but also increase the likelihood of antitrust abuses.
NASUCA has joined with a broad coalition comprised of consumer representatives, small businesses, environmental advocates, public power utilities, and large industrial customers to encourage Congress to effectively deal with these important market power issues. We have developed a guiding set of core principles that outline transitional actions that Congress must take to eliminate the market power of private utilities and foster a competitive market. These principles maintain and strengthen existing authorities in the Federal Power Act and the Public Utility Holding Company Act. The principles include:
Revising the Federal Merger Standard to Reduce Anti-Competitive Market Control. In addition to preserving the existing authority under Section Seven of the Clayton Act,(see footnote 72) Congress should direct FERC to reject or condition mergers that create, exacerbate, or maintain market power in any relevant geographic, product, or service. FERC should reject mergers if the claimed benefits can be achieved through other means.
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Moreover, NASUCA believes that FERC must modify its current merger policy so as to assure that customers directly benefit from any merger FERC should also have specific authority to impose conditions on the post-merger entity that reliably mitigate the anti-competitive effects of the merger.
While FERC has recently revised its merger policy to include market power considerations, these additional revisions are needed to deal with the merger mania at hand.
Reduce Concentration in the Electric Utility Industry. Undue dominance by a player in any geographic or product market will frustrate and eventually eliminate effective competition. Therefore, any market participant controlling sufficient resources to frustrate effective competition should be required to sell or spin-off assets.
Prevent Cross-Subsidies Between Regulated and Unregulated Utility Activities and Preclude Preferential Relations in the Use and Access to Resources and Information Between Affiliates. Certain functions of the industry—such as transmission and local distribution—will remain regulated monopolies. Effective mechanisms are needed to restrict the interaction between these regulated functions and the deregulated activities of any utility affiliate.
The entire text of the ''Core Principles Protection Against Market Power Abuses'' is attached as is a resolution on market power passed by NASUCA in 1996. They, coupled with vigorous enforcement of antitrust laws currently on the books, will at least give competition a fighting chance and consumers a share of the pot. However, if Congress fails to effectively deal with market power, consumers will become the victims of competition not the beneficiaries.
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In Maryland, the Office of People's Counsel has been vigorously opposing the proposed merger of the two largest electric utilities in the State, BGE and PEPCO. We believe that the merger of these two companies will eliminate not foster competition by creating unacceptable market concentration and market power in generation resources. This merger will create a utility which will control 75 percent of the retail market in Maryland if and when consumer choice becomes a possibility. My comments on this case represent my own views at this time and not necessarily those of NASUCA.
This merger was approved by the FERC. However, in its decision FERC specifically stated that it was not analyzing the retail market power issues because the retail jurisdiction utility commissions of the District of Columbia and the State of Maryland each claimed at the FERC that market concentration and market power issues at the retail level were District/State, not federal concerns and would be adequately dealt with at their agencies.
Nevertheless, the Maryland PSC approved the merger, with certain conditions, without even requiring that the applicants submit a retail market power study. The Maryland PSC did, however, to its credit, state that it would require the applicants to file market power study if retail access was adopted in Maryland. In addition, the Maryland PSC did condition the merger on flow-through of $56 million in merger savings to the ratepayers; a three-year rate freeze; and an earnings sharing mechanism. The applicants now have publicly claimed that these conditions are too onerous and that they will not merge unless the conditions are modified.
This case exemplifies the need for clear merger review standards and thorough review of the anti-trust aspects of utility mergers at both the FERC and State public utility commission jurisdictions. In Maryland, it remains to be seen whether a postmerger retail market power analysis will prove to be an effective tool to prevent market power abuses and to enhance competition. In its place, I would prefer a much more rigorous review by the Department of Justice and the FTC under the existing anti-trust laws of proposed mergers in the electric industry. If this requires additional resources, so be it. The views of DOJ should then be registered with a FERC that has stronger, clearer and more consumer friendly anti-trust and merger principles. FERC should be allowed to work with State commissions in merger reviews, but if State commissions are unwilling or unable to analyze anti-trust issues prior to merger approval, such issues ought to be reviewed by the FERC.
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I hope that my remarks are of some value to the Committee. I thank you on my own behalf and on behalf of NASUCA, for the opportunity to appear here today.
CONSUMERS FOR FAIR COMPETITION
CORE PRINCIPLES: PROTECTION AGAINST MARKET POWER ABUSES
In 1935, Congress enacted the Public Utility Holding Company Act (PUHCA) in order to reduce and constrain the exercise of market power in the investor owned electric, and natural gas utility industries as well as to prevent abusive stock and business practices of far flung investor owned electric and gas utility holding companies.
The electric utility industry has changed significantly since 1935, and more profound changes loom on the horizon. While PUHCA has protected consumers in part by restraining market power, the market dominance of utilities continues to threaten captive consumers and the emerging competitive market.
Mergers, barriers to entry, self dealing, and cross subsidies can be used to stifle competition. An efficient and competitive electric industry will not develop if the market consolidates to a handful of large players or if certain participants are allowed to engage in discriminatory actions.
Satisfying PUHCA's underlying purposes—the mitigation of market power and prevention of interaffiliate transactions and utility diversifications that threaten captive ratepayers—are the best policy options for ensuring a truly competitive marketplace. The administration of PUHCA has clear limitations. In a potential transition to a competitive electric marketplace, the implementation of specific consumer-oriented reforms will be necessary. Most importantly, Congress should direct the Federal Energy Regulatory Commission (FERC) to assume the authority of the Securities and Exchange Commission under PUHCA to protect consumers from market power abuses. In considering legislation affecting the structure of the electric industry, including PUHCA repeal or reform, Congress must address the following specific issues:
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Mergers and Acquisitions. When two competitors merge, one less participant competes in the marketplace. In addition to preserving the existing authority to address utility mergers at the Department of Justice and Federal Trade Commission, Congress should direct the FERC to reject or condition, as appropriate, any proposed merger including gas and electric combinations, or acquisition that creates, exacerbates, or maintains market power in any relevant geographic, product, or service market. The FERC should reject any merger in the anticipated consumer benefits can be achieved through other means.
Market Concentration. Undue dominance by a player in any geographic or product market will frustrate and eventually eliminate effective competition. Congress should direct the FERC to take any corrective action to eliminate undue concentration in any relevant geographic, product, or service market.
Utility Diversification. Consumers can face substantial risk when participants in a concentrated market diversify into unrelated or nonregulated businesses to benefit the shareholders. Congress should require and provide sufficient regulatory authorities to prohibit cross subsidies between regulated and nonregulated entities. Federal law should bar utility diversification that threatens captive customers (i.e., generation and transmission dependent consumers, consumers served by distribution systems that are not subject to competition) and fair competition, and prevent abusive or preferential affiliate transactions. Any definition of cross subsidization should capture the full value of tangible and intangible assets transferred between regulated and nonregulated entities. These protections should be waived when vibrant structural competition exists in relevant markets.
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Transmission. Even with the FERC's expanded transmission access authority granted under the Energy Policy Act of 1992, the potential exists for transmission owners to use their control of essential facilities to favor their own power sales. Moreover, payment of successive transmission fees for use of individual utility transmission facilities within a given geographic market can create economic inefficiencies and market distortions. To ensure implementation of competitive power markets and to check market abuse Congress should direct the FERC to develop guidelines for and require mechanisms to ensure the independent control, operation and planning of the grid and efficiently functioning nondiscriminatory and geographically broad independent transmission service.
Reliability. All market participants have responsibility to ensure effective functioning of a reliable and competitive electricity market. The FERC must ensure that no market participant is able to avoid responsibilities for reliability or to cloak anti-competitive activity in the guise of reliability concerns. FERC should establish and enforce nondiscriminatory rules and guidelines for ensuring reliability and that each market participant fulfills its contractual obligations, particularly in cases where a market participant attempts to manipulate operating procedures and guidelines so as to unduly influence the market clearing price.
FERC Review of Wholesale Electric Rates. The role of FERC in reviewing and setting wholesale electric rates will be vastly reduced in a vibrant competitive market. However, given the anticipated continued concentration and potential monopoly control of products and services in certain markets, and in certain time periods, it is important for FERC to retain its authority to regulate effectively rates—either on its own initiative or upon complaint—where the potential for market power abuse continues.
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Access to Information. To assist the efficient operation of a competitive market, Congress should: (1) provide federal and state regulators with complete and timely access to relevant corporate books and records to uncover and prevent discriminatory transfer pricing; (2) provide federal and state regulators with audit authority regardless of the corporation's location; (3) direct to appropriate regulatory bodies to provide competitors with comparable access to relevant customer information; (4) require the FERC to make all relevant transmission use and pricing information available to all interested parties on a real-time basis; (5) give the FERC the authority to require unregulated electric utility affiliates to disclose their affiliations; and (6) require that state regulatory authorities provide adequate protection for utility customer proprietary information and data. Utility information on individual customer sites should not be shared with affiliates in the aggregate unless such information is made available to competitors and individual site data should not be divulged unless the customer has provided knowledgeable written consent.
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NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES RESOLUTION
URGING THE CONGRESS AND FEDERAL AGENCIES TO ADDRESS MARKET POWER AS A COMPONENT OF ANY FEDERAL RESTRUCTURING ACTION
Whereas, Congress and the FERC are reviewing existing laws and rules governing the structure of the electric utility industry; and
Whereas, the FERC has issued a Notice Of Inquiry into the types of market and consumer protections that are necessary with respect to mergers in light of the trend toward competition in the electric utility industry; and
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Whereas, the Congress enacted the Public Utility Holding Company Act (PUHCA) in order to reduce and constrain the exercise of market power in the investor-owned electric and natural gas utility industries as well as to prevent abusive stock and business practices of far flung investor-owned electric and gas utility holding companies; and
Whereas, in the electric utility as well as other industries, mergers, barriers to entry, abusive self-dealing, and cross subsidies can be used to stifle competition; and
Whereas, an efficient and competitive electric industry will not develop if the market consolidates to a handful of large entities or if certain participants with market power are allowed to engage in unduly discriminatory actions; and
Whereas, undue dominance by an entity in any geographic or product market will frustrate and eventually eliminate effective competition, requiring corrective action; and
Whereas, the mitigation or elimination of market power through PUHCA's protections or other statutory and regulatory means is necessary to ensure competitive outcomes that are consistent with the public interest; and
Whereas, specific merger standards are needed which would enable the FERC (and others) to distinguish efficient from inefficient mergers, and pro-competitive from anticompetitive mergers; and
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Whereas, the goal of restructuring should be to send sufficiently clear and rational signals to the market so that the behavior of participants will be consistent with the public interest.
Therefore, Be It Resolved that the National Association of State Utility Consumer Advocates (NASUCA) urges Congress and federal agencies to adopt specific measures to protect consumers from market power abuses; and
Be It Further Resolved that in considering action affecting regulation or the structure of the electric industry, including PUHCA repeal or reform, Congress should require federal regulatory agencies to: 1) prevent abusive or preferential affiliate transactions, 2) continue oversight and protection over corporate and market structure to prevent abuses to consumers and competition, 3) disallow costs which are not prudent and reasonable from wholesale rates, 4) exercise sufficient regulatory authority to prevent ratepayers from bearing any risk of utility diversification and to prohibit cross-subsidies between regulated and nonregulated subsidiaries; and
Be It Further Resolved that NASUCA urges the FERC to reject or condition, as appropriate, any merger that creates or exacerbates market power in the relevant geographic and product markets and reject mergers whose anticipated consumer benefits can be achieved through other means; and
Be It Further Resolved that NASUCA authorizes its Executive Committee to develop specific positions and to take appropriate actions consistent with the terms of this resolution. The Executive Committee shall advise the membership of any proposed action prior to taking such action if possible. In any event, the Executive Committee shall notify the membership of any action taken pursuant to this resolution.
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Submitted by NASUCA Electricity Committee: Frederick J. Schmidt (NV), Chair, Rajuish Barua (DE), Paul Buckley (MD), Barry Cohen (OH), Nancy Vaughn Coombs (SC), Steven Cornell (MN), George Dean (MA), Margaret Force (NC), Larry Frimerman (OH), Robert Kelter (IL), Eugene Koss (CT), James Lewis (CO), Lewis Mills (MO), Thomas B. Nicholson (IN), Mark Payne (NC), Blossom Peretz (NJ), William Perkins (ME), Edward L. Petrini (VA), Irwin A. Popowsky (PA), Kenneth Traum (NH), and Donald Trotter (WA).
Approved by NASUCA: June 26, 1996, Chicago, IL.
Mr. HYDE. Mr. James Serota is chairman of the Fuel and Energy Industry Committee of the Antitrust Section of the American Bar Association and a partner with Huber, Lawrence & Abell, Mr. Serota.
STATEMENT OF JAMES I. SEROTA, PARTNER, HUBER LAWRENCE & ABELL, NEW YORK, NY
Mr. SEROTA. Thank you, Chairman Hyde.
Let me say, first of all, I am pleased to be here, not only on my own behalf but as a native of Chicago and as a ratepayer of Detroit Edison on behalf of my son, who is at the University of Michigan. My testimony today represents, however, my personal views only.
Rather than speak narrowly today about the importance of our antitrust laws as written, I will emphasize the principles of competition embodied in those laws.
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The hallmarks of antitrust are price, quality, and service. All power, whether it is public, IOU or independent, should be allowed to compete on its own merits, price, quality and service. It is often said that antitrust laws are economic rules of the road, but they are also neutral principles for economic competition. They do not tilt the playing field toward any competitor nor should they.
We must discourage burdens to interstate commerce in the form of barriers to entry of low cost power from one State to another. Whenever low cost power can supplant higher cost power, it should be able to do so.
Competition is like democracy, you can't predict the outcome. Competition means that when supply exceeds demand, as it does with various places on the east coast, you should reap the benefit of competition and get lower prices. Competition does not mean that when demand exceeds supply, as it may this summer in Illinois and Wisconsin, that you then suppress competition and retain regulation.
I believe Congresswoman Lee referred to take-or-pay contracts and her suffering from those. Twenty years ago, there were natural gas shortages and prices rose sharply. Various utilities signed long-term requirements contracts obligating them to take the supply or pay for it, if they chose not to take the supply. When the supply of gas increased and the price fell, these same purchasers who felt burdened with uneconomic agreements tried to avoid their past decisions, arguing the agreements violated the antitrust laws and were against public policy. The courts rejected those arguments. If the public wants competition, it must accept those risks. It is an essential corollary of antitrust that the public, both individuals and corporations, must be prepared to accept the consequences of their own economic choices.
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There is a problem in antitrust and that is a free rider problem—what do you do within a distribution system when certain persons compete only on price and leave the cost and the quality of necessary service in the network to others? Chairman Pitofsky alluded to this.
In 1977, the U.S. Supreme Court in GTE Sylvania v. Continental TV indicated that those who establish a distribution network can, within the limits of antitrust, remedy the problem of those who refuse to bear their share of the cost of supporting the network but seek to reap the rewards of that network. There are system costs in the delivery of electricity, both historical and ongoing, and if you want to play the game, antitrust recognizes that you have to ante up every time the cards are dealt.
The antitrust laws were generally designed to deal with commodities, sugar, steel, oil; the trusts. In manufacturing, when you sell everything you have, that is good, it is efficient. In a service business, when you have an obligation to serve the entire public, if you sell out your capacity, that is bad, it means someone who wants new service, someone who wants more service, they are out of luck.
In order to provide reliable electricity, you must have excess capacity. There is an opportunity cost to those who have to withhold some capacity in order to provide reliable service, which is not born by those who would rather sell everything they have but rather not pay for system reliability. When you sell electricity, you must provide ancillary services necessary to run the system. They are all necessary ingredients which have to be paid for by all participants in the deliver of electricity.
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I want to address State action. There is a principle Federal–State relation that supports continued recognition of regional differences, and I would commend this point to Representative Lofgren. The Supreme Court in FTC v. TICOR says States must be responsible for their intended acts. That principle is embodied in the State action immunity doctrine to the antitrust laws. It is not in the statutory law; it is a constitutional principle, it is a principle of Federalism, it is a part of our antitrust case law, it is not in a statute. When individual States directed utilities to buy or build additional generation or transmission or other programs in order to ensure system reliability, they put electric providers between a rock and a hard place. System improvements had to be implemented. The cost of those ongoing mandated programs can't be avoided now. Some regulators, and some here at this table, have suggested lifting State action immunity for acts which they command, now that the economic environment has changed.
With all due respect, it is antitrust nonsense. State action immunity is not a grant, it is not a boon, it is not a favor, it is a legal consequence that flows from following a State's direction. The Federal and State governments must accept responsibility for past commanded acts and continuing local responsibilities. Now that the obligation to pay for those costs is due, they should not be overruled or suppressed in the name of competition. That is not consistent with antitrust.
And if I may make one more point which I will leave with you, I will commend to you a symposium conducted by the American Bar Association in last year's winter Antitrust Law Journal. And my article, which specifically addresses many of your concerns, is on increasing competition in the electric utility industry and decreasing consumer welfare, an antitrust paradox.
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Thank you for the opportunity of being here and I will be pleased to answer your questions.
Mr. HYDE. Thank you, Mr. Serota.
[The prepared statement of Mr. Serota follows:]
PREPARED STATEMENT OF JAMES I. SEROTA, PARTNER, HUBER LAWRENCE & Abell, New York, NY
My name is James I. Serota. I am a partner in the New York City law firm of Huber Lawrence & Abell and am the Chair of the Fuel & Energy Industry Committee of the Antitrust Section of American Bar Association. My testimony today represents my personal views only.
Rather than speak narrowly today about the importance of our antitrust laws as written, I will emphasize the importance of the principles of competition embodied in those laws.
The hallmarks of antitrust are price, quality and service. All power public, IOU, or independent should be allowed to compete on its own merits-price, quality and service.
It is often said that the Antitrust laws are economic rules of the road, but they are also neutral principles for economic competition. They do not tilt the playing field toward any competitor nor should they.
We must discourage burdens to interstate commerce in the form of barriers to entry of low cost power from one state to another. Wherever lower cost power can supplant higher cost power, it should be able to do so.
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Competition is like democracy—you can't predict the outcome. Competition means that when supply exceeds demand as it does in various places on the East Coast, you should reap the benefit of competition and get lower prices. Competition does not mean that when demand exceeds supply as it may this summer in Illinois and Wisconsin, that you then suppress competition and retain regulation. Twenty years ago, there were natural gas shortages and prices rose sharply. Various utilities signed long term requirements contracts obligating them to take the supply or pay for it if they chose not to take the supply. When the supply of gas increased and the price fell, these same purchasers who felt burdened with uneconomic agreements, tried to avoid their past decisions arguing the agreements violated the antitrust laws and public policy. The courts generally rejected those arguments. If the public wants competition, it must accept those risks. It is an essential corollary of antitrust that the public, both individuals and corporations, must be prepared to accept the consequences of economic choices.
There is a problem in antitrust known as the free-rider problem—what to do within a distribution system where certain persons compete only on price and leave the cost of the quality and necessary service in the network to others. In 1977, the U.S. Supreme Court in GTE Sylvania v. Continental T.V., 433 U.S. 36 (1977) indicated that those who establish a distribution network can, within the limits of antitrust, remedy the problem of those who refuse to bear their share of the costs of supporting the network but seek to reap the rewards of the network. There are system costs in the delivery of electricity, both historical and ongoing. If you want to play the game, antitrust recognizes that, you have to ante up every time the cards are dealt.
The antitrust laws were generally designed to deal with commodities, i.e., sugar, steel, oil. In manufacturing, when you sell everything, you have that is good. It is efficient. In a service business, when you have an obligation to serve the entire public, if you sell out your capacity, that is bad—if someone new wants service, if someone wants more service, then they are out of luck.
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In order to provide reliable electricity, you must have excess capacity. There is an opportunity cost to those who have to withhold some capacity in order to provide reliable service which is not borne by those who would rather sell everything they have, but would rather not pay for system reliability. When you sell electricity you also must provide ancillary services necessary to run the system—voltage regulation (VAR), on-line spinning reserve, off-line black start capability, they are all necessary ingredients which have to be paid for and should be paid for by all participants as the delivery of electricity moves from regulated markets to competition.
Principle of Federal/State relations support continued recognition of regional differences. The Supreme Court in FTC v. TICOR Title Insurance, 112 S. Ct. 2169 (1992) says states must be responsible for their intended acts. That principle is embodied in the State Action immunity doctrine to the antitrust laws. That principle of federalism is a part of our antitrust case law. When individual states (or the FERC) directed utilities to buy or build additional generation or transmission or other programs in order to assure system reliability, they put electric providers between a rock and a hard place. System improvements had to be implemented. The cost of those ongoing mandated programs can't be avoided now. Some regulators have suggested lifting State Action immunity for acts which they command now that the economic environment has changed. This is antitrust nonsense. State Action immunity is not granted; it's a legal consequence that flows from following a state's direction. The Federal and State governments must accept responsibility for past commanded acts and continuing local responsibilities. Now that the obligation to pay for those costs is due, they should not be overruled or suppressed in the name of competition. That is not consistent with antitrust.
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INSERT OFFSET RING FOLIOS 21 TO 28 HERE
Mr. HYDE. And lastly, the chief executive officer and chairman of the Wheeled Electric Power Co. of Uniondale, NY, Mr. John O'Brien.
STATEMENT OF JOHN N. O'BRIEN, CEO AND CHAIRMAN, WHEELED ELECTRIC POWER CO.
Mr. O'BRIEN. Thank you for the opportunity to testify before you concerning what I consider to be one of the most important developments facing the American public.
Wheeled Electric Power Co. is a fully independent vendor of electric power to retail customers. We were formed in 1993, specifically to sell power to retail customers. We now have several thousand retail customers buying electricity and natural gas from us, and we are major participants in the retail electric pilot programs in the Northeast, including those in New Hampshire, Massachusetts, and New York. Most of our customers are residential in small business.
I am here today to discuss competitive issues concerning the electric industry restructuring that I believe must be recognized and dealt with under Federal jurisdiction in order to allow the U.S. retail electric consumers to fully realize the benefits of competition to which they are entitled. State regulators are not in a position to effectively address these issues, and Federal intervention is necessary to protect American consumers from anticompetitive practices by incumbent utilities in the retail electric marketplace.
During the restructuring of the industry, the two most important issues this committee should consider are, first, the market power that will result if State-authorized restructuring plans allow utility-owned generation to exercise market power in interstate commerce; and, second, the anticompetitive practices and tactics that may stifle the development of a robust competition in the retail electric markets. I intend to cover the second issue today.
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It is difficult to argue with the proposition that a fully competitive retail electric market, with competent consumer protection and reliability measures in place, will produce the optimal level of economic efficiency. Accordingly, this arrangement should be the principal goal in restructuring the electric industry. Unfortunately, there are no government agencies on the State or Federal level that are stepping up to the plate in order to foster and facilitate realization of this goal. Our experience in the Northeast retail electric markets has indicated that without Federal intervention, that goal will not be realized and consumers will not receive the full benefits of competition. In order to understand this issue, it is necessary to recognize the types of problems that can arise as the retail electric market inevitably moves towards full competition.
It is important to recognize virtually all new markets start out as monopolies. Markets historically have arisen from the development and introduction of marketing of a new unique product. The firm which owns the product will initially realize a monopoly. As a result of this, there is a well-developed body of academic marketing research on the shift from a monopoly market to a competitive market. This research shows that the new market will evolve in stages, from monopoly stage ultimately to a stage of equilibrium where buyers and sellers have equal economic power and economic efficiencies produce substantial consumer benefits.
However, the same body of research shows that there is an interim stage called, by some, the confusion stage where monopolists can use factors that do not produce economic efficiencies to maintain their monopoly and slow the development of competitive healthy market and equilibrium.
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In the case of electric restructuring, there are a number of factors that strongly motivate existing utilities to work aggressively to maintain their customer base. First, many of them own generation facilities that currently serve their own customers. It is not clear what those facilities would be worth if other generating facilities started serving those customers. Second, by and large, utilities have never had to sell anything to anyone in a competitive market, and the prospect of doing so, especially in their own service area, is very threatening. Lastly, every year that goes by where those customers are purchasing electricity from the existing utilities facilities, especially at above market rate, further amortizes those facilities and lowers strandable costs.
The result of these motivations, when laid over the backdrop of retail market and the interim confusion stage, is that former monopolists use various practices and arrangements to maintain monopolies for as long as possible. Our experiences in marketing electricity in pilot programs has highlighted these concerns. We have seen unregulated utility affiliates will sometimes tie their product of the electric commodity itself to the parent utility's product of reliable delivery. In this tying arrangement, consumers are led or allowed to believe that they cannot purchase the reliability product without purchasing the commodity product from the affiliate. The fact is, all competitors deliver with exactly the same level of reliability. In order to mitigate against this tying arrangement, affiliates should not be able to use the parent's trade name and address in order to foster the impression they are more reliable. Unfortunately, in New York, for instance, four proposed electric restructuring settlements between the PSC staff and the utilities would abandon that policy and would allow electric utility affiliates to use the utility's name in marketing within their own service area.
There are other ways they may have unfair advantage. For instance, a utility affiliate can use the creditworthiness of the parent utility to provide trade finance. Any competitor in the electric market faces trade finance requirements, which are high in a high volume, low margin business. Affiliates can use other resources, including the parent utility, to garner unfair advantages, the use of personnel, the use of customer education functions, and the sharing of information between the parent utility and affiliate. There are other measures as well, including the use of a standard offer, which may be below the wholesale price of electricity, as has been used in Massachusetts. The result of that, and the conclusion that I have reached, is that State regulators are simply not in a position to regulate the activities of the utility affiliates and that Federal intervention will be necessary or competition will not bring the benefits to American consumers that it has promised. Thank you.
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Mr. HYDE. Thank you very much, Mr. O'Brien.
[The prepared statement of Mr. O'Brien follows:]
PREPARED STATEMENT OF JOHN N. O'BRIEN, CEO AND CHAIRMAN, WHEELED ELECTRIC POWER CO.
Good Morning, my name is John O'Brien. Thank you for the opportunity to testify before you today concerning what I consider one of the most important developments facing the American public today.
I am the CEO and Chairman of Wheeled Electric Power Company which is a fully independent vendor of electric power to retail customers. Wheeled Electric was founded in 1993 specifically to market electricity to retail customers. We now have several thousand retail customers buying electricity and natural gas from us and we are major participants in all of the retail electric pilot programs in the Northeast including those in New Hampshire, Massachusetts and New York. Most of our customers are residential or small business consumers.
I am here today to discuss competitive issues concerning electric industry restructuring that, I believe, must be recognized and dealt with under federal jurisdiction in order to allow U.S. retail electric consumers to realize the benefits of competition to which they are entitled. As I will discuss, State regulators are not in a position to effectively address these issues and Federal intervention is necessary to protect American consumers from anticompetitive practices by incumbent electric utilities and other competitors in the retail electric marketplace.
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During the restructuring of the electric industry the two most important issues that this Committee should consider are (1) the market power that will result if state-authorized restructuring plans allow utility-owned generation to exercise market power in interstate commerce and (2) anticompetitive practices and tactics that may stifle the development of robust competition in the retail electric markets. I intend to cover the second issue in my testimony today.
It is difficult to argue with the proposition that a fully competitive retail electric market with competent consumer protection and reliability measures in place will produce the optimal level economic efficiency for the American public. Accordingly, this arrangement should be the principal goal in restructuring the electric industry. Unfortunately there are no government agencies, on the State or Federal level, that are stepping up to the plate to in order to foster and facilitate the realization of this goal. Our experience in the Northeast retail electric markets has indicated that, without Federal intervention, that goal will not be realized and consumers will not receive the full benefits of competition. In order to understand this issue, it is necessary to recognize the types of problems that can arise as the retail electric market moves toward full competition.
It is important to acknowledge that virtually all new markets start out as monopolies. Markets historically have often arisen from the development, introduction and marketing of a new, unique product. The firm which owns that unique product will realize a monopoly. As a result of this, there is a well-developed body of academic research on the shift from a monopoly market to a competitive market. This research shows that a new market will evolve, in stages, from a monopoly stage, ultimately, to a stage of equilibrium, where sellers and buyers have equal power and economic efficiencies produce substantial consumer benefits including, for instance, retail pricing that equals marginal cost and low barriers to entry for new, more efficient competitors. However, this same body of research also shows that there is an interim stage of development called by some the ''confusion'' stage where monopolists can use factors that do not produce economic efficiency to maintain their monopoly and slow the development of a competitive, healthy market in equilibrium.
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In the case of electric restructuring, there are a number of factors that strongly motivate existing utilities to work aggressively to maintain their current customer base. First, many of them own the generation facilities that currently serve those consumers and it is not clear what those facilities would be worth if other generating facilities started serving those loads. Second, by and large, utilities have never had to sell anything to anyone in a competitive market, and the prospect of having to do so, especially in their own service area, is very threatening. Lastly, every year that goes by where those consumers are purchasing their electricity from the existing utility's facilities, especially at above market rates, further amortizes those facilities and lowers strandable cost exposure.
The result of these motivations, when laid over the backdrop of a retail market in the interim ''confusion'' stage, is that the former monopolists will use various practices and arrangements to maintain their monopolies for as long as possible. Our experiences in marketing electricity in the Northeast pilot programs has highlighted those concerns. We have seen that unregulated utility affiliates will sometimes tie their product, the electric commodity itself, to the parent utility's product, reliable delivery. In this tying arrangement, consumers are led to believe that they cannot purchase the reliability product without purchasing the commodity product from the affiliate. The fact is that in the Northeastern pilot programs, all competitors deliver with exactly the same level of reliability because the arrangements for scheduling and sourcing power are the same for all competitors. In fact, in the New England pilot programs, it is impossible for a competitor to provide a lower level of reliability than the incumbent utility or its affiliate.
In order to mitigate against tying arrangements, affiliates should not be able to use the parent utility's trade name and dress in order to foster the impression that they are more reliable. Unfortunately, four proposed electric restructuring settlements between the PSC Staff and utilities now under review by the PSC would abandon that policy and would allow electric utility affiliates to use the utility's name in their marketing within the utility's service territory. In one instance, the Consolidated Edison settlement, the utility would be allowed to engage in unregulated retail marketing under its own name.
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There are also other ways in which utility affiliates may have an unfair advantage over independent competitors. For instance, an affiliate can use the creditworthiness of the parent utility to provide trade finance for its own independent purchases and sales. Any competitor in the electric market faces trade finance requirements which, in a high volume, low margin market, can be very costly. Allowing any affiliate to ''borrow'' the parent utility's balance sheet constitutes a substantial advantage for the affiliate in the marketplace which arises solely from the consumers that the parent utility serves.
An affiliate can also use other resources the parent utility has to garner an unfair advantage in the retail electric market: (1) the use of personnel with intimate knowledge of the parent utility's customer base and service area; (2) the use of ''customer education'' functions to promote the affiliate; (3) the sharing of information between the parent utility and the affiliate. All of these factors introduce unjustifiable advantages to the parent utility's affiliate and will stifle the development of a competitive and economically efficient retail electric market.
Utilities have advocated still other measures that would stifle competition. Some unnecessary barriers to entry for new competitors are masqueraded as consumer protections. For example, substantial credit requirements for independent competitors that bear no relation to the actual protection of consumers. These credit requirements will serve only to assure that new innovative and efficient competitors will not enter the market and compete with utility affiliates. Another example is burdensome sign up requirements involving complex paperwork and contracts that must be filed by the customers and the competitors in order for a consumer to switch to an alternative supplier. While these requirements may help in preventing slamming, there are less costly procedures which are equally effective. Moreover, what is forgotten is additional, unnecessary requirements represent added transaction costs that inevitably will be passed on to consumers, not absorbed by competitors. Put simply, any unnecessary and burdensome transaction costs that are imposed on a transaction are always paid by the consumer. Minimizing these costs in a truly competitive market will always lower costs for consumers.
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Another arrangement that utilities have proposed to hinder competition, is a below market ''standard offer''—a measure that has been approved in Massachusetts. Under this arrangement, the parent utility competes with independent competitors by offering a standard offer price to retail customers which is below the cost of electricity that independent vendors must incur to serve those same customers. While this arrangement was made to give Massachusetts consumers an immediate 10% discount from their current rates, it also assures that no competitor to the parent utility can sell to those same consumers without incurring substantial losses. The parent utility's losses are offset by generous provisions for strandable cost recovery and deferrals which future rate payers will pay. These deferrals give the parent utility assurance that it will not face competitors and that any losses that are incurred by the utility in making the standard offer are minimized in the process.
The principal problem with all of this is that no State or Federal agency has claimed jurisdiction over these anticompetitive arrangements. States claim that, while they do have jurisdiction and authority over the actions of the parent utility, they do not have jurisdiction over unregulated utility affiliates. In addition, since many of the utility affiliates have multistate operations, they cannot be controlled through State jurisdiction. Further, to the extent that State approved arrangements, like a ''standard offer,'' negatively affect the development of truly competitive markets, federal jurisdictional agencies should become involved.
I would strongly recommend that this Committee hold hearings to consider how many of the anticompetitive arrangements I have discussed, and others that will arise as the retail electric market moves toward competition, will adversely affect American consumers. Moreover, the jurisdictional issues which are preventing effective oversight of utility affiliates in interstate commerce and adequate consideration of state approved restructuring schemes that produce market power in interstate commerce should be addressed and resolved by this Committee.
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This concludes my testimony. Thank you.
Mr. HYDE. And now Mr. Conyers.
Mr. CONYERS. I am glad you forgot.
Mr. HYDE. No, I just always want to hear what you have to say.
Mr. CONYERS. Oh, yes, you are so generous.
First of all, I thank the witnesses and Chairman Hyde.
What about the problem that arises when utilities use their control over local distribution to unfairly compete in air-conditioning contracting, using their fleet trucks, their good will customer lists and billing inserts?
I remember during the telecommunications battle, the little home alarm industries came and they said, we are going to be put out of business if you allow them to compete, and all the telecommunications people said, we wouldn't do that; these are our fine customers. They ate them up alive.
Is that a potential problem here or should we just take a couple of aspirin and check with the doctor tomorrow? How bad is this, or potentially?
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Mr. HOWE. I think you are correct, Mr. Conyers, to point to this as a potential issue. We do periodically hear complaints from independent contractors in Massachusetts that feel they cannot compete directly with utilities because of the opportunity to cross-subsidize. In our State, we recently established a code of conduct that governs the relationship between utilities and their nonregulated energy affiliates that are involved in selling electricity or natural gas commodity.
A year ago when we conducted the rulemaking that led to that code of conduct, we hadn't envisioned it would include this issue, but it has become more prominent on our screen in the last year, and it may be appropriate—I can't say today whether it is necessary to address it through Federal legislation, but it is becoming more of a concern.
Mr. SEROTA. Cross-subsidization is best handled by audits. I am surprised the head of the Massachusetts Public Utility Commission thinks he doesn't have the power to audit the books of utilities. If there is cross-subsidization, send it to your accountants. We are about antitrust. Antitrust says, and the Supreme Court says, that it protects competition, not competitors. As long as we are competing above price, go get them, because the lower prices will go down and be passed along to consumers.
Mr. CONYERS. But as an attorney, you know the accountants can hide a multitude of sins in those books. Talk about go open up the books. I remember Keating used to invite the Federal Reserve people to come in and they would walk into a warehouse full of books and he would say, go get them, fellows, you want to look at books, look at these records.
Mr. HOWE. If I might briefly respond also to a point you made in the last panel, there are issues of conduct and issues of structure. We don't have accountants to do this, we don't have an army. We have a very lean staff and most public utilities commissions are understaffed. Structural remedies tend to be far preferable to policing conduct, I believe in protecting against this.
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Mr. CONYERS. And guess what, the utilities know that.
Mr. O'BRIEN. I would also add, I agree with Mr. Howe, the fact is there are not accounting procedures in place to measure the effectiveness of a utility using its trade name and trade name and trade address and other types of things in marketing products on an unregulated matter. There is no way of accounting for that; it must be dealt with through a code of conduct.
Mr. CONYERS. I yield to the gentleman from Massachusetts.
Mr. DELAHUNT. I just want to make a brief comment and I want to welcome my colleague from Massachusetts. I was going to make the point in response to Mr. Serota's question, and I think you answered it, and I would presume, nationally, every department of public utilities at the State level is vastly underfunded, has limited resources, and is in no way positioned to effectively deal with the strength and overwhelming resources of the regulated utilities; is that a fair statement?
Mr. HOWE. I can only speak for myself. I would say in our circumstances, I think that is a fair statement.
Mr. SEROTA. Let me just point out, as Mr. O'Brien and I were in a case together and he alleged questions of cross-subsidization and the New York Public Service Commission sent in its accountant, looked at the questions, audited the matter and found that, in fact, we were pricing above cost and it was OK. Some commissions do a good job, some commissions are understaffed and some don't do a good job, but it is often said that the best solution in government is to get closest to the people and I think this is the kind of activity that should be kept closest to the people at the State level.
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Mr. EARLEY. If I may add to that, as someone who has been regulated. It is going to take a reallocation of resources. Clearly, this is an issue that needs to be engaged. The question is whether Federal legislation would be more appropriate or whether, locally, the State legislator should be a part of this reallocation of resources. As we deregulate portions of the business, it should free up some resources.
In the States that I am familiar with, Michigan and New York, there are huge resources associated with monitoring the adequacy of generation reserves, a huge process in planning for generation in the future. That process in an unregulated environment will not need to be carried on, and those resources ought to be shifted to where they are needed to make sure that a new environment, where you have both regulated and unregulated functions, can work.
Mr. TRAVIESO. I would like to weigh in on this as well as a consumer advocate. I think there is a tremendous potential for abuse to occur in these areas, both between regulated and unregulated activities and between activities which have always been unregulated, that is HVAC businesses and things like that. And what is happening in Maryland, there has been a constant flow in the last 3 or 4 years of HVAC contractors and small business men, down to the Maryland Legislature, in an effort to get sort of mini or little PUHCA bills enacted, and obviously we think the PUHCA bill serves a very good purpose on the Federal level but on the State level that has not been successful, but there has been legislation enacting an audit bill, so that utilities are required to pay for and conduct an audit of their own unregulated business activities every 3 years. Our commission is also handling a case right now in which we are heavily involved in which we are going to investigate the unregulated business activities of monopoly utilities.
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Mr. DELAHUNT. Why were you unsuccessful, not you, but the proponents of the PUHCA bills, why were they unsuccessful?
Mr. TRAVIESO. Do you want a candid answer to that? Because utilities have a very strong lobby and they have access to the important policymakers in the State of Maryland. It is perfectly legitimate, but they do.
Mr. DELAHUNT. Thank you, Mr. Travieso. You made my point.
Mr. THILLY. Can I make one comment on the tie to the antitrust laws? State regulators, one of the most difficult things they do is regulate affiliate interest transactions. I think the Chair of the FTC said that allocation issues are very, very difficult to get at. The utilities control all the resources and the books. State regulators will have to deal with the regulated distribution company's relationships with the unregulated retail company and the generation company, and it will be a real struggle. But anything that the State regulator does will then—the argument will be it is insulated from antitrust attack because of the State action doctrine, and so that is where the link is and that is where the problem is. So we have to very narrowly construe or limit that State action doctrine if we are going to protect competition.
Mr. HYDE. I thank you. Mr. Bryant.
Mr. BRYANT. Thank you, Mr. Chairman.
I think most of you were present during the first panel and these are very far-reaching and broad issues that I think you all are interested in discussing, and I tend to be more parochial and bring up the TVA and I know some of you here have an interest in that.
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I am trying to identify all the players here. But certainly, with the potential for deregulation, as it has been defined here today, you have, from a congressional standpoint, with it being a governmental entity, and I am wondering how those who have a relation with TVA, competitive or otherwise, or who would have a relationship, I would like to hear from you as to where you envision TVA, and especially in terms of the antitrust exemption they have, falling out in this. Would it continue to be, in your view, a governmental entity? Would it be privatized? Would it be a mixture or something? Does anyone have an opinion?
Mr. EARLEY. Let me just comment on EEI's position. We have not taken a position on whether governmental entities ought to be somehow privatized or changed as such. This is probably the only industry where government entities are major players in the industry, both at the Federal and the State level.
But EEI's position is that if those governmental entities want to participate in the competitive marketplace, then the rules ought to be the same for everyone. And the rules ought to be the same in terms of antitrust rules, in terms of tax rules, and subsidies, so that everyone is playing with the same set of rules as they compete.
For those governmental entities that don't want to break into the competitive market, I think, it has been EEI's view that fine, leave them alone. That is not an issue we need to deal with. There is enough to deal with in terms of trying to just restructure the investor-owned marketplace right now.
Mr. BRYANT. Mr. Earley, let me just—since you volunteered to answer, let me ask you a followup. Mr. Jenkins asked a question. Mr. Jenkins formerly served on the TVA board of directors many years ago, and he indicated that if TVA is to become competitive and the so-called fence is to come down, that it should be both ways, and I interpret your remarks that we all be on a level playing field, that TVA could go out and sell beyond their fences?
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Mr. EARLEY. It should work both ways. The playing field should be level, and you should be able to do that. But that assumes that the other advantages that a Federal agency like TVA has are changed so that they are competing on the same basis.
Mr. BRYANT. OK. Thank you.
Mr. Chairman, I would yield back my time.
Mr. HYDE. I thank you, Mr. Bryant.
Mr. Pease.
Mr. PEASE. Mr. Chairman, thank you. I want to apologize to the Chair and to this panel. I try to make everything, but I missed most of your presentations today because of a conflict.
For that reason, Mr. Chairman, I think I would rather ask consent to submit questions in writing to members of the panel at a future time, but will do so promptly, and then yield the balance of my time.
Mr. HYDE. Well, I thank you.
Mr. Delahunt wants a little more time. Go ahead.
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Mr. DELAHUNT. I want to thank everybody. This has been very informative and I think very, very important. And as I have listened to the testimony, particularly from this panel, because you are dealing with real-life situations and clearly many of you are not dealing in theory or in a vacuum, if you will, it is clear that there are some major concerns and, I sense, a very major problem. Clearly, there is much to learn here.
I think many members on the panel, with the exception of the Chair and the ranking member, have a serious learning curve—perpendicular in some cases. But I keep hearing that many of you are encouraging proactive efforts as opposed to reactive ones. And then I look at the data in this table entitled ''Investor-Owned Utilities, Major Mergers and Acquisitions from 1994 to 1997.'' It says there were two in 1994. There were 12 in 1996, and the assets in the billions for some of these companies; $14 billion, $21 billion, $24 billion, $16 billion.
I guess my question is: Are we too late? Are we too late? And when you talk about market power, I presume that these mergers and acquisitions are in response to the fact that deregulation was about to occur. And I think it was Mr. Thilly that made the point, you know, maybe this committee, this Congress, ought to consider an ongoing monitoring process before the cow or the horse is out of the barn, so to speak, because my memory is the breakup of AT&T, that was a 12- or 13-year effort, and what could have occurred in those 13 or 14 years might have benefited the consumer.
But am I misreading? Am I misinterpreting?
Mr. HYDE. If the gentleman would yield just briefly.
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Mr. DELAHUNT. Certainly.
Mr. HYDE. The Chair would like to say that generic questions about deregulation and mergers are interesting and significant. They are a part of our jurisdiction, and we intend to address those. We are here discussing a rather specific problem, although it has overlapping issues with other topics, such as telecommunications. We hope we went to school on that one and learned something that we can use here. But we are talking about the electrical industry that has some unique problems and some not unique. But I am reluctant to get into a morass of mergers because there are many other considerations that drive those things. But they are important to our economy. We do have antitrust jurisdiction, and we are going to look at them.
And I want to also say on telecommunications, it hasn't been a howling success, but that has not been the law's fault, nor our fault. It has been that the long distance companies haven't yet gotten into local service. We assume they will at some point. They will get their feet wet. But we intend to exercise oversight over that major development in antitrust law insofar as it is within our jurisdiction, which is antitrust only.
But we don't think it is a good idea to make these changes and then walk away from them. We are going to do oversight on immigration, on welfare, and on telecommunications. If we ever get through with electrical deregulation, we will do oversight on that. But I just wanted to add that.
So does anybody have any comments on Mr. Delahunt's question?
Mr. EARLEY. If I could just make one observation. This still is a very fractured industry. There are over 200 investor-owned utilities. There are literally thousands of players. And, yes, there has been an increase in the number of mergers.
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But when you look at concentrations, I think Mr. Travieso mentioned that 10 have 30 percent of the market. If you look at other businesses like airlines, the top 4 have 56 percent of the market; the pulp business, 4 have 44 percent; and rail, the top 4 have 70 percent. So in comparison to other industries, it is still a very diverse industry.
And, yes, the number of mergers have increased, and you would expect them to increase, but it is not out of line with a number of other industries that are out there that have gone through this process.
Mr. THILLY. One quick comment. FERC recently rejected a merger for the first time in the electric area, which was the Wisconsin Electric/Northern States/Primergy merger. It surprised a lot of us. We thought they had never seen a merger they didn't like over there. But they have adopted a new policy which does put competitive impacts as the primary indicator or thing that they look at.
But what we need, going forward in connection with restructuring, is a statute that makes it clear that they can't approve a merger unless the net benefits to consumers outweigh the harms to competition; not simply an inconsistent-with-a-public-interest standard, but an affirmative standard to help us create this competitive market.
We have a diverse industry today. That is a great benefit. Let's not lose it, and yet we are in danger of losing it.
Mr. TRAVIESO. I would like to make one quick comment, too, if I could. I think there is a difference between the electric industry and some of the other industries with respect to concentration, and that is that the system wasn't designed to facilitate the transfer of power across long distances. It was designed to facilitate the transfer of power within a monopoly, franchised service territory. And within those territories, traditionally there is one provider who owns virtually all generation—not necessarily all, but virtually all generation—and has every single customer.
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So there is a significant difference when you are talking about antitrust issues, market concentration, mergers and potential problems in the future between this industry and other industries. And we need to focus on transmission constraints and those kinds of issues.
Mr. HYDE. This does—I am sorry.
Mr. SEROTA. I would just have one brief comment. I have known Bob Pitofsky for about 25 years. He is probably one of the brightest antitrust thinkers of our age. I think that he is perfectly capable of enforcing the antitrust laws as they are written right now.
I, as an antitrust lawyer who has been at this for a long time, have real concerns about mixing questions of social benefits with antitrust analysis. I think it would muck up the courts and our precedents in a way that I think would be—relate to great uncertainty over the near term to the point that—let's remember one thing. We are trying to get from here to there. We are trying to move this industry from regulation to deregulation. If we get involved in questions of weighing social benefits, we are never going to get there.
Mr. O'BRIEN. Mr. Chairman.
Mr. HYDE. Yes, sir.
Mr. O'BRIEN. I would just like to point out briefly that the FCC has done a reasonably good job in assuring that there is actually competition and fair competition for small independent vendors of telecommunications services. There is no equivalent on the Federal level to assure fair competition within the electric markets. And the State—as I mentioned in my testimony, the State regulators are not in a position to handle it. So there is a vacuum, and I would ask you to recognize that.
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Mr. CONYERS. Mr. Chairman.
Mr. HYDE. Yes, sir.
Mr. CONYERS. The next time you see Mr. Serota, ask him about pollution, too. I guess that doesn't have anything to do with anything, either.
Mr. SEROTA. Well, we are here for antitrust.
Mr. CONYERS. Yes. But antitrust is related to pollution issues, whether you understand it or not.
Mr. SEROTA. Oh, I absolutely agree with you because pollution involves cost-shifting. Antitrust at its base abhors cost-shifting. And in pollution, and although I am not an environmental lawyer, I would agree with you that there is an element of cost-shifting when one person uses lower cost goods to create pollution which imposes costs on someone else.
Mr. CONYERS. Well, here is the problem. I mean, we are here in a discussion mode. There isn't even a bill in front of us. So warning people what not to talk about is a little presumptuous. We let you guys talk about anything you want.
Mr. HYDE. Well, does the gentlelady from Houston have any questions?
Ms. JACKSON LEE. I do, Mr. Chairman.
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Mr. HYDE. She does, and we recognize her for 5 minutes.
Ms. JACKSON LEE. I certainly wanted to offer that this is a time when there should be no holds barred for what we discuss.
Mr. Serota, I would simply say that Professor Calabrese of Yale Law School taught me well that you do balance issues of social interest and others in making decisions that ultimately may prove positive or negative, prove regulatory or nonregulatory. So let me just offer that as a comment.
I noted a statement that was made that the industry probably has a greater spread than some of our other industries in terms of competitiveness. However, it is well to note that most of the weight of this industry falls in the investor-owned utilities. They have roughly 70 to 75 percent.
I have a series of questions I am going to ask them, and then I would like to open it up to the gentlemen that I have called on to answer the questions.
Mr. Earley, I would appreciate if you would tell me who will rush in—and I am going to ask a series of questions—if we deregulate this industry? What can we imagine and where will it place a company like DTE Energy? That is one.
Mr. Travieso, if you would answer in what way do you want our antitrust laws enhanced? Specifically, do you include both the FTC and the Department of Justice? You heard their testimony. Are they well equipped from your perspective?
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And then, Mr. O'Brien, tell us how we could help the States. So many of our States obviously have their own public utility commissions dealing with this question. So many of our State legislatures, I have indicated to you earlier, have already been discussing this, and, as the ranking member said, we don't have a bill before us. And I think we should be open to any discussion on trying to resolve this in the manner that poses the most competition for the ultimate one who will be burdened, and that is the consumer, as well as create a good business atmosphere for those who are interested in this issue.
Mr. Earley.
Mr. EARLEY. Thank you, Congresswoman. Who will rush in? Many of them are sitting here at this table. There are literally hundreds of entrants who want to get access to markets. You only have to look at some of the experiments that are being run in Massachusetts, New York, New Hampshire. There are plenty of players who want to get into the competitive generation business.
Ms. JACKSON LEE. Is that good?
Mr. EARLEY. That is good, and that is going to create even more competition that ultimately will drive costs down in this business. It will also drive consolidation in the business.
There was a question earlier about, well, shouldn't people be doing that already? But because of regulation, sometimes the consolidation of resources, or better use of resources, couldn't occur on a regional basis. Now they will be forced to occur on a regional basis. So it will be good.
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For a company like DTE Energy, we are forced to recognize that, one, we are going to lose customers. Today we have 100 percent of the customers in southeastern Michigan, and we don't kid ourselves that when customers have choice, some of them are going to choose to select another supplier.
We have to figure out what is our area of expertise. We happen to have a lot of expertise in the area of burning low sulfur western coal. We believe we can expand our expertise throughout the Midwest that should have positive environmental consequences and good financial consequences for us.
Ms. JACKSON LEE. I thank you.
Mr. Travieso, if I have your name correct.
Mr. TRAVIESO. Yes. NASUCA does not advocate new antitrust laws as such, but what we are advocating is more resources at DOJ and FTC, more enforcement, better analysis. For example, it appears to us as if the analysis being done now is predicated on the fact that there are existing monopoly retail services, and that is not an appropriate analysis.
The market is changing. There is going to be retail competition, and we think that any analysis done by FTC, DOJ, or FERC or anyone else ought to take into account this fact. There is going to be retail access and competition.
With respect to FERC, we are urging that FERC find that a merger have positive benefit, not just that it does no harm. That is kind of the old test that they have used. Now they have adopted the DOJ guidelines, which do take into account market concentration, market power. They use the HHI index, and they go through that analysis.
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But in terms of balancing the risks and the detriments against the purported benefits, we would like to see them adopt a net benefit test so that any merger would have a positive benefit for all ratepayers. That is something we think is important.
And we also have a resolution on board that says it would be a good idea for FERC to go back and actually study the mergers that it has approved to see whether the proffered benefits were actually achieved; that is, the synergy savings and all of the things that typically show up in a merger application, because we are not certain that they have been achieved, and it would be useful, I think, in evaluating future mergers to determine whether those efficiencies have actually been obtained.
Mr. HYDE. The time of the gentlelady has expired.
Ms. JACKSON LEE. Mr. Chairman, I would ask for an additional 1 minute so that Mr. O'Brien could answer my question. I did pose a question to him, and I would certainly appreciate the chairman's indulgence.
Mr. HYDE. Without objection, the gentlelady is recognized for 1 minute.
Ms. JACKSON LEE. I thank the chairman.
Mr. O'Brien, would you add your comment on consumer confusion?
Mr. O'BRIEN. Yes. The fact is that there is no FCC in the electric business, and I will use one particular example of what is being done by utilities to hold up competition and make an advantage for themselves.
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The cost of the transaction itself, in a competitive market when you add mandatory transaction costs to a transaction, the consumer pays them. There is no doubt about that. The provider does not absorb them.
In the case of telecommunications, the large telecommunications carriers fought to have a long, lengthy transaction with paperwork and other things so they could maintain market share. The FCC recognized the value of new innovative companies coming into the marketplace and, in fact, streamlined the transaction process.
We need new innovative companies in the electric business. We don't need the old companies doing the old things and snuffing out competition.
As I have pointed out, there is a vacuum on the Federal and State level. I would say that the Massachusetts Department of Public Utilities did a very good job in adopting the FCC rules with regard to sign-up procedures for participants in their State. Other States, however, are not doing that, and we need some Federal oversight with regard to assuring that competition can take place with low barriers to entry and new ideas coming into the marketplace.
Ms. JACKSON LEE. Thank you.
Mr. HYDE. I thank the gentleman, and I thank the gentlelady, and I want to really congratulate a first-rate panel. You have all brought intelligence and insight to a complicated and difficult subject, and we like to feel that we can refer to you in the future if we have further problems.
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And meanwhile all of your testimony will be incorporated in the record, will be studied and hopefully acted upon. So I want to thank you for your contribution, and the committee stands adjourned.
[Whereupon, at 12:51 p.m., the committee adjourned.]
A P P E N D I X
Material Submitted for the Hearing
U.S. House of Representatives,
Committee on the Judiciary,
Washington, DC, June 9, 1997.
Mr. ANTHONY F. EARLEY, JR.,
President and Chief Operating Officer,
The Detroit Edison Co.,
Detroit, MI.
DEAR MR. EARLEY: I appreciate your appearing before the Committee on the Judiciary to testify at the hearing on ''Antitrust Aspects of Electricity Deregulation'' on Wednesday, June 4, 1997.
Mr. Conyers has asked that you answer additional written questions for the record. I have attached a copy of the questions. I would appreciate your answering the questions in writing and returning your answers to the Committee for inclusion in the hearing record within two weeks.
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If the Committee can provide you with any additional information, please do not hesitate to contact Joseph Gibson by phone at (202) 225–3951 or by fax at (202) 225–7682. I appreciate your participation in our hearing.
Sincerely,
HENRY J. HYDE, Chairman.
cc. Hon. John Conyers, Jr.
Mr. Conyers' questions for the record to ask of Anthony Earley, Detroit Edison Co.:
Q. In your written testimony you state that all fifty states and the District of Columbia are considering some form of retail competition, what is Michigan doing to initiate retail competition?
Q. You are critical of parties who advocate a FERC merger review standard to prohibit utility mergers that do not serve to reduce market power. In your view, should electric utility monopolies be subject to a stricter merger standard?
Q. Electricity restructuring raises market power issues. What tools are available to the states to address market power issues?
Q. How does the degree of regulation of the electric utilities industry compare to other industries?
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The Detroit Edison Co.,
Detroit, MI, July 8, 1997.
Hon. HENRY J. HYDE,
Chairman, Committee on the Judiciary,
U.S. House of Representatives,
Washington, DC.
DEAR CHAIRMAN HYDE: This is in response to your letter of June 9, 1997. You requested that I respond to additional written questions, which were submitted by Congressman John Conyers, for inclusion in the hearing record on the ''Antitrust Aspects of Electricity Deregulation.'' Enclosed please find the responses to these questions. If there is additional information which you require, please let me know. Thank you for inviting me to testify at the hearing.
Sincerely,
Anthony F. Earley, Jr.,
President and Chief Operating Officer.
Enc.
cc: Hon. John Conyers, Jr.
———
ANSWERS OF ANTHONY EARLEY, PRESIDENT OF DTE AND DETROIT EDISON TO QUESTIONS SUBMITTED BY CONGRESSMAN CONYERS
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Q. 1. What is Michigan doing to initiate retail competition?
A. For several years, Michigan entities have been working toward the development of a state retail access program that would permit all Michigan consumers to participate in the emerging competitive marketplace under circumstances in which no customer would experience increased rates. The effort began when the Michigan Public Service Commission initiated formal hearings on the topic in late 1992.
In 1996, the MPSC conducted comprehensive public hearings on a set of restructuring proposals forwarded to the Commission by the Governor. In December, 1996, the MPSC Staff submitted a detailed report recommending initiation of a retail wheeling program the principal objectives of which include: a) the protection of interests of smaller customers, b) the provision of opportunities to strengthen Michigan's business community, c) the assurance that employees are not adversely impacted by restructuring, d) the institution of measures to assure that existing utilities have a fair opportunity to prepare for competition, including the opportunity to recover stranded costs, and e) the initiation of competition on a level playing field.
The MPSC sought additional public comment on the Staff recommendations and, on June 5, 1997, issued an order finding that a phased retail access program for Michigan consumers is reasonable and should begin. Coincident with this administrative activity, committees of both houses of the Michigan legislature have been conducting joint hearings on electric restructuring issues. On June 19, 1997, both Detroit Edison and Consumers Energy, Michigan's largest electric utilities, submitted voluntary proposals to the MPSC for authority to initiate retail access programs contingent on appropriate state and federal approvals that would bring direct access to all retail customers in Michigan by January 1, 2002.
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Q. 2. You are critical of parties who advocate a FERC merger review standard to prohibit utility mergers that do not serve to reduce market power. In your view, should electric utility monopolies be subject to a stricter merger standard?
A. No. Utility mergers should be subject to the same standards as mergers in any other type of business. As I said in my written testimony, both the Clayton Act and the Federal Power Act focus review on whether a merger or acquisition will significantly reduce competition in a relevant market. If a merger will not significantly reduce competition in a relevant market, the merger is approved, if it may significantly reduce competition, the merger will be challenged and may be denied or mitigation measures may have to be adopted to go forward The mitigation measures are designed to remedy the problem of potentially reduced competition.
Experience in other industries demonstrates that it is natural to expect mergers as part of restructuring, since the goal of restructuring is to promote efficiency. Mergers are a wax of achieving efficiencies by reducing overhead while serving more customers with more products.
We agree with the written comments of Federal Trade Commission Chairman Robert Pitofsky who said that ''in an industry that has been pervasively regulated for many years, efficiencies are likely to play an enhanced role in motivating restructuring after deregulation. Where capital mobility was once circumscribed by regulators, firms will now be able to pursue the most efficient, market-determined structure'' and that ''[I]n the electric power industry, for instance, potential anticompetitive behavior may be monitored by FERN, state public utility commissions, or the federal antitrust agencies, depending on the pace and mix of deregulatory efforts. In a deregulatory environment, it is important to equalize treatment by reducing burdens whenever possible, rather than increasing them.''
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In addition, it is important to recognize that notwithstanding any merger, the ''monopoly'' regulated functions of two merging utilities will continue to be regulated. Thus, the fact that some parts of the operations of two merging utilities may be regulated ''monopolies'' does not justify a higher standard of review for mergers of such companies—particularly since FERN has expressly incorporated examination of the effects of a merger on regulation as part of its standard for merger review.
Moves to bar mergers unless they actually reduce market power ignore the many years to decisions under the Clayton Act that teach that the economic benefits of mergers—when they are found, or can be structured, to not ''substantially lessen competition''—should be determined by competitive markets and not by regulators. The ''no harm to competition'' standard embodied in the Clayton and Federal Power Acts recognizes that regulators will do a less good job of producing societal benefits than competition. Any attempt to determine whether a merger would reduce market power and whether such a merger would produce superior societal results would entail regulatory decisions, not market driven decisions. In fact, we need to keep in mind that our energy supply is being deregulated precisely to unleash these competitive forces to produce more benefits for consumers. Setting a ''higher'' standard for electric utility mergers would be moving right back into more regulation.
Q. 3. Electric restructuring raises market power issues. What tools are available to the states to address market power issues?
A. The states have broad authority to address the market power issues associated with their efforts to restructure their retail electric utility industries to eliminate regulation and promote competition. All the states and the District of Columbia are now actively pursuing restructuring. While public utility commissions in some states have managed the restructuring process, in other states the legislatures are passing new laws to address restructuring issues. The twelve states that have adopted competition have addressed market power issues head on, typically in multi-stakeholder proceedings.
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Among the tools available to the states are the following:
Open access to the retail distribution system (to assure all competitors a fair chance to compete),
Functional unbundling (separating regulated from unregulated business activities),
Codes of conduct (to eliminate any preference toward own affiliates),
Creation of independent system operators (ISOs) to manage the transmission system to guarantee nondiscriminatory open access,
Creation of power exchanges (PXs) to facilitate establishment of hourly spot markets and bilateral markets for energy,
Divestiture of certain generating assets, and
Regulation of terms and conditions of retail marketing activities.
In addition, of course, the states will continue to regulate the core distribution functions—both as to rates and terms and conditions—and to assure that regulated business activities do not pay the costs of competitive activities. Moreover, most states have state laws that parallel the key federal antitrust provisions, and many states have been very active in antitrust enforcement, both individually and through the National Association of Attorneys General. FERC will continue to regulate transmission rates and open access performance as well as rates for wholesale power sales.
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Q. 4. How does the degree of regulation of the electric utility industry compare to other industries?
A. The commercial activities of electric utilities are heavily regulated at both the federal and state level and are far more regulated than other industries and will continue to be so even after restructuring.
The Federal Energy Regulatory Commission (FERC) regulates wholesale electric rates (sales for resale) and interstate transmission rates. Mergers and acquisitions are regulated by FERC. FERC administers the Uniform System of Accounts that governs all the accounting of every jurisdictional utility.
Electric utility corporate structure is heavily regulated by the Securities and Exchange Commission under the Public Utility Holding Company Act of 1935 (PUHCA). And, electric utilities are required to purchase power from non-utility generators under the Public Utility Regulatory Polices Act of 1978. PURPA is administered not only by FERC but, by delegation, the states as well.
At the state level, state commissions set electric utility retail rates—rates to ultimate customers. They also regulate permits for construction of new power plants and transmission lines, often requiring economic justification for such projects. They also have substantial control over how utility companies do business.
After restructuring, FERC and the states will continue to have the power and authority to ensure that deregulation does not compromise the expected consumer benefits of competition. In particular, they will continue to regulate the wires—transmission at the federal level and distribution at the state level—and will continue to assure that utilities do not exploit monopoly power and to assure that there are no cross subsidies of unregulated activities by regulated activities.
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National Rural Electric Corporative Association,
Arlington, VA, June 6, 1997.
Hon. HENRY J. HYDE,
Chairman Committee on the Judiciary,
U.S. House of Representatives,
Washington, DC.
Re: June 4 Hearing on Antitrust/Market Power Issues in the Electric Industry.
DEAR MR. CHAIRMAN: The purpose of this letter is to clarify for the record of the above-noted hearing a statement made in the written testimony of Ricky Bittle, Director of Rates, Planning and Dispatch for Arkansas Electric Cooperative Corporation, on behalf of the National Rural Electric Cooperative Association (NRECA), and to respond to a comment on that statement made at the hearing by Douglas Melamed, Principal Deputy Assistant Attorney General, Antitrust Division, United States Department of Justice.
In his prepared testimony, at page 15, Mr. Bittle stated that ''[T]he Department of Justice (DOJ) would periodically send attorneys to industry conferences to assure audiences that it was indeed 'looking at' mergers and acquisitions, but little else was ever heard from it.'' At the hearing, Rep. Asa Hutchinson (R–AR), read this passage from Mr. Bittle's testimony to Mr. Melamed, and asked if it was correct. Mr. Melamed responded that it was not, and noted that in a substantial number of electric industry mergers reviewed by DOJ, DOJ had issued a ''second request'' to the entities proposing the merger, seeking additional information for DOJ's review.
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While DOJ may have issued these ''second requests,'' such follow-on requests for information are generally handled as a private matter between DOJ and the parties proposing the merger. Thus, those in the industry are usually unaware that DOJ has issued such second requests.
Moreover, as Mr. Melamed himself testified, of the some 20 electric industry mergers DOJ has examined to date, DOJ has chosen to challenge none of them.
If you need further information, or have any questions, please feel free to contact me.
Very Truly Yours,
Susan N. Kelly,
Senior Regulatory Counsel.
cc: The Honorable Asa Hutchinson.
———
Public Utilities Commission,
State of California,
San Francisco, CA, June 4, 1997.
DEAR MEMBERS OF THE JUDICIARY COMMITTEE: Today, John P. Howe, Chairman of the Massachusetts Department of Public Utilities, is testifying before you on behalf of NARUC on the relevance of antitrust issues to current legislative initiatives at the Federal level aimed at restructuring the nation's electric power industry. This letter, and the materials attached to it, serve to underscore Chairman Howe's testimony by providing a ''case study'' of how California has address the market power problems identified in that testimony.
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Chairman Howe's testimony distinguishes two basic types of market power. The first is horizontal market power associated principally with the concentration of ownership of electric generation. The second is vertical market power, in which ownership of essential electric transmission facilities is potentially used by utilities to favor their own generation over that of their competitors.
The California Commission had to deal with both types of market power when it set out to restructure the electric industry in California. The three largest investor-owned California utilities control over 60 percent of electric generation in the state. Each company controls substantial transmission facilities which historically have been reserved principally to deliver the power from its own generation facilities to its retail customers. Both of these two types of market power concerns were considered to be absolutely essential to be addressed or our overall all effort of restructuring would not promote truly competitive market prices.
In its Preferred Policy Decision (D.95–12–063), which established the basic parameters of electric restructuring in California, the California Commission separately addressed these two problems. For horizontal market power, it got the two largest utilities to agree voluntarily to divest themselves of at least 50 percent of their gas-fired generation. Gas-fired generation was expected to be ''key'' generation in the sense that such units were likely most often to be on the margin and therefore setting the spot price for electricity in the wholesale energy market. Southern California Edison went further than the minimum and volunteered to further divest themselves of all of gas fired plants.
To address vertical market power concerns, the Commission called on the utilities to surrender the operational control of their transmission systems to an Independent System Operator. By separating the control of transmission from ownership of generation, this operational disaggregation of the traditional vertical market structure in electricity promotes fair competition among all generation producers.
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This summary of the market-power concerns of the California Commission herein—and its responses to those concerns—does not do full justice to the care and attention that went into those issues. For the Committee's information, I am attaching to this letter the market-power discussion in the Preferred Policy Decision to which I referred earlier. The discussion there, I believe, serves as a useful supplement to Chairman Howe's testimony by providing a casebook study of market power issues and one ''real world'' solution to those problems.
I thank the committee for the opportunity to provide it with this information. If the California Commission can help you with additional information or answer any specific questions, please contact me at (415) 703–2440 or John Scadding, my Chief Advisor, at (415) 703–1175.
Sincerely,
P. GREGORY CONLON,
President of the Commission.
———
MARKET POWER DISCUSSION IN THE PREFERRED POLICY DECISION
IV. MARKET POWER
We introduce competition to the California electricity market with the conviction that it will deliver desirable market characteristics that have not been delivered by the regulated market Reese of the past. But because competition is the foundation of this restructuring, we must be concerned that market power could undermine this foundation and negate the benefits of competition. This concern has served as a screening device in our review of policy options and the choices reflected in today's decision. This concern also compels us to take additional steps to ensure that market power does not impede development of a competitive electricity market in California.(see footnote 73)
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Market power is the ability of a particular seller or group of sellers to maintain prices profitably above competitive levels for a significant period of time.(see footnote 74) The higher prices reduce economic efficiency because they do not reflect an accurate societal valuation of resources given actual resource supplies. An equally important concern is that high prices stemming from market power abuse cause an inefficient transfer of wealth from the consumer to the producer.
Market power in itself is not necessarily costly. It is the abuse of market power that reduces the societal efficiencies of competition. Practically speaking, however, the mere existence of market power can undermine our goals for electric restructuring and should be avoided. The presence of market power carries with it the threat of market power abuse. This threat can stifle entrepreneurial innovation and diversity of customer choice, and requires continued monitoring for market power abuse. For this reason, our restructuring mechanisms and mitigation programs are designed to eliminate or reduce market power to the greatest practicable extent.
A competitive market mitigates market power abuse by means of contestability. Contestability is the threat that other competitors and new industry entrants will steal market share any competitor attempting to abuse market power by raising prices. In this instance, if market entry is timely, likely, and sufficient, higher profit margins from the price increase are more than offset by loss of sales volume or market share. Ensuring contestability, therefore, is a direct approach to employing natural market safeguards to protect against market power abuse. The primary means of ensuring contestability are to eliminate any undue competitive advantages to existing competitors and eliminate barriers to entry of prospective competitors.
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Our restructuring program involves a transition from cost-of-service regulation to a fully competitive market for generation. In the early stages of this transition, the utilities might retain market power, and a continued regulatory presence might cause market distortions. If our transition is successful, distortions will be minimized and market power abuses will be thwarted until the threat of timely, likely, and sufficient entry is finely established to ensure a workably competitive electric market.
A. Potential for Market Power in California's Future Electric Industry
1. Vertical Market Power
Vertical market power can arise from ownership or control of more than a single step in the process of production and delivery of a particular product. Control of vertically integrated assets results in barriers to entry if an entity at one stage of the production and delivery process gives preferential treatment to an affiliated entity operating at another stage of the production and delivery process.
In the electric industry, vertical market power generally refers to a single utility controlling generation, transmission, and distribution functions in a specific geographic market. Vertical market power abuse could arise, for example, if system operators gave priority to affiliated generation assets in dispatch and transmission. For purposes of market power analysis, the transmission function is a key link in the chain of production. To a certain extent, the potential for transmission-level market power depends on the success of the FERC's development and implementation of comparable and nondiscriminatory open access tariffs.
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Mitigation: Our restructuring program incorporates two features that are crucial for effective mitigation of vertical market power. First, it isolates control of transmission in the ISO. Second, it establishes an independent dispatch ordering mechanism. For independent and transparent dispatch ordering, we create the Power Exchange, which develops purely price-based dispatch rankings. We also allow for development of direct access contracts markets and other markets. Provision for an ISO and independent dispatch results in an operational unbundling, in which vertically integrated electric processes are separated and operational control is spread among entities that are independent of the owners of assets in other levels of the chain of production.
The issue of jurisdiction win respect to the regulation of California's investor-owned utilities in a restructured environment has been discussed in our hearings and in this order. As we indicated, we find the institution of the vertically integrated utility seeking to be self-sufficient with respect to generation, transmission and distribution to be rooted in the past and incompatible with emerging markets and opportunities. It is our desire to see California's investor-owned utilities evolve and prosper in those areas in which they will compete for markets as well and in those areas in which they will remain the functions and responsibilities of a natural monopoly. In our view, generation is an activity remitted to a competitive market in which utility and nonutility entrants and participants will vie for customer allegiance. Transmission retains the attributes of a natural monopoly and will be consolidated, from an operational perspective, in the Independent System Operator. We view distribution as a natural monopoly with respect to serving those customers who do not opt for self-generation or construct transmission and distribution facilities to sense their consumption.
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The issue we now confront is whether our jurisdictional utilities ought to adopt a corporate structure which reflects these distinctions. We direct PG&E, SCE and SDG&E to submit written comments on the feasibility, timing and consequences of a corporate restructuring which would be premised on distinguishing their activities and assets with respect to generation, transmission and distribution. Without seeking to limit the form in which such a restructuring might take, we ask them to address a holding company with three wholly owned subsidiaries.
Based on our experience in dealing with transactions between different competitively provided and monopoly services in other industries, separation of transmission, distribution, and generation assets and operations into affiliates would reduce regulatory oversight needed to protect against self-dealing and allow for easier monitoring of any discriminatory preferences to affiliates. Separation would also help facilitate a bright line between state and federal jurisdiction with respect to transmission and distribution. That separation may, however, impose costs. Those costs may include changes in bondholders' credit positions, possible interest rate changes, and changes in tender offer cost or premiums. We want to consider those costs in reviewing utilities' comments.
These comments would be due 90 days after the effective date of this decision. We will await the initial comments of the utilities to gauge the obstacles or disadvantages of increased separation, and weigh them against the potential benefits.
a. System Planning and Upgrades Under the ISO.—If a transmission-owning utility were to build new transmission facilities, the new facilities might, by eliminating existing transmission constraints, create a new opportunity for competition from nonutility-owned generation. The additional competition might reduce the opportunities for the transmission-owning utility to profit from generation it also owns.
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Even if the ISO controls the operation of the transmission system, if ownership of the transmission system remains with the vertically integrated transmission-owning utility, that utility might be reluctant to build needed new transmission which would allow additional competition with its own generation.
Planning decisions for new transmission facilities and upgrades are necessarily somewhat subjective and are subject to constant updating and second-guessing. If the vertically integrated transmission-owning utility has control or influence over the planning of new transmission or upgrades, the utility might create additions that favor its own generation or harm competitors.
Mitigation: If the ISO could collect costs above the embedded or marginal cost of construction of new transmission facilities, and could use that income to build and own the new transmission facility, it might be possible to build and upgrade economically justified transmission.
b. ISO Balancing Services.—A critical question is whether the ISO, in performing its load-balancing functions, will be able to procure services on a competitive basis from my source or whether it will be required to procure generation services only from generators bidding into the Power Exchange. Load balancing is an ancillary service and FERC will set rates for that service. We intend to participate in the applications before FERC to establish the ISO to ensure that load balancing can, as currently contemplated by FERC, be self-provided, provided by a third party, or provided by the ISO at competitively procured rates, and that the protocols for provision of load following are nondiscriminatory.
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c. Utility Ownership of Natural Gas Distribution Facilities.—SDG&E and PG&E have a further potential to exercise vertical market power because they are dual utilities, having interests both in the generation of electricity and in segments of the natural gas market. Natural gas fuels the most efficient and accessible generation technologies available to existing industry participants and prospective industry entrants. Discrimination in the price and availability of delivered natural gas could create a significant barrier to entry to industry contestants who depend on reasonable and fair gas prices and availability to compete.
Mitigation: In general, existing conditions in the market for natural gas make it unlikely that dual utilities could effectively engage in vertical market power abuse. We will monitor this in conjunction with our regulatory responsibilities for gas services, and respond if the circumstances change.
d. Utility Energy Procurement and Ownership of Generation Facilities.—After restructuring, the distribution utility will still perform an energy procurement function for customers who so choose. The distribution utility and its affiliate generators might share an interest in dealing with each other to the exclusion of other industry contestants.
Mitigation: Until the market structure is fully implemented, all the CTC has been collected and all customers are eligible for direct access, a distribution utility affiliated with a generation company will be prohibited from entering contracts with an affiliated generator.(see footnote 75)
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2. Horizontal Market Power
Market power can take place at any level of the production chain if there are significant barriers to entry or few market participants. This kind of market power is usually referred to as horizontal market power and can be manifested as an ability either to influence prices or to create or maintain effective barriers to entry.
The most common example of horizontal market power is when a single competitor or a small group of competitors owns or controls most of the competitive resources at a particular level of production. Horizontal market power abuse can take several different forms that concern us in evaluating the future competitive market. Our focus is on the generation sector.
a. Market Concentration Analysis.—An analysis of horizontal market power begins with an assessment of market concentration. By market concentration we mean how much market participation is dominated by a small group of firms. Without a sufficient level of market concentration, it is unlikely that potential and existing competitive advantages or market abuses will harm the overall market enough to warrant potentially distorting interventions by us or other government agencies. Many parties have a reasonable suspicion that there is excessive market concentration in electric generation.(see footnote 76) While this suspicion alone justifies the discussion of potential market power abuses and mitigation options in this decision, we recognize the need for a rigorous empirical market concentration analysis to establish strong conclusions and to verify or disprove this suspicion.
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b. Concentration of Generating Facility Ownership or Control.—Concentrations of ownership or control of generation facilities can result in market power because a single competitor might control enough assets to alter the supply-demand equilibrium and thus be able to increase prices by withholding generation from the market (decreasing supply). Another manifestation could take place if a single competitor controls an asset or specific block of assets that is indispensable for meeting demand. Many parties, including the FTC and Paul Joskow, note the importance of the ''mid-merit order'' generating units which are likely to be the units providing the final increment in the supply portfolio. The concentration of ownership of this group of assets might be more important than overall generation concentration. In both cases the powerful entity may control the final increment in the market-clearing supply portfolio and thus control the marginal price for generation.
In addition to mid-merit order generating units, some units may be located relative to the transmission system such that they have an inherent potential for abuse of market power. Some areas, which may be identified and defined by the transmission system once the restructured market is in place, may not be susceptible to immediate entry of lower priced competitors. Entry of competing generation in the near term may not be an option because of the need to upgrade transmission or build new generation in that area. We are concerned the mere divestiture of such units to entities other than investor-owned utilities will not decrease the potential market power or exercises of that power that lead to excessive prices.
Mitigation: We are severely limiting utilities' ability to obtain operating costs through the transition cost balancing account for their nonnuclear units. The only operating costs eligible for that account must be demonstrably necessary for reactive power/voltage control. Further, that recovery is limited in time: as soon as market based rates for reactive power/voltage control are established, or the unit is market valued (no later than 2003), that recovery ceases. Utilities may request that operating costs related to reactive power/voltage control be established under a PBR mechanism, which would be designed to further mitigate market power of the units primarily used for reactive power/voltage control. Without these limitations, discussed in Section V, some of the utilities' nonnuclear units would benefit from their location, and could be used as strategic assets to manipulate Exchange prices in certain transmission-constrained areas.
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Concerns about the concentrated ownership of generation units by the utilities and the potential for anticompetitive effects resulting from that concentration are particularly acute in the early stages of the restructured industry. The issue of concentration must be addressed early and effectively or the competitive market we envision will not get off the ground. We conclude that market power problems almost certainly will require the existing investor-owned utilities to divest themselves of a substantial portion of their generating assets, particularly their fossil generating plants located within their service territory.(see footnote 77) Therefore, we will require PG&E and SCE to file within 90 days of the effective of date of this order a plan to voluntarily divest themselves through a spinoff or outright sale to a nonaffiliated entity of at least 50% of their fossil generating assets. Ideally this divestiture would resolve many, if not most, of the market power problems identified by the Department of Justice and FERC, and allow for a competitive market.
To provide an incentive for the utilities to voluntarily divest these assets, we will tie the utilities allowed rate of return on the equity component of the non-nuclear and non-hydroelectric equity component of its transition cost CTC balancing accounts. We will grant an increase in the rate of return for the equity component of up to 10 basis points for each 10% of fossil generating capacity divested.
Utilities will file applications for the voluntary divestiture of fossil generating assets under 851. In those proceedings, we will review the potential that asset has for exercising locational market power, and will address mitigation strategies intended to relieve or eliminate the exercise of such power.
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Additionally, we retain the ability to assess market power concerns should utilities seek authorization for acquisition of new generation or generation rights.
c. Cross-Subsidization.—Cross-subsidization takes place when a competitor is able to subsidize competitive operation with revenues from another part of its business or chooses to shift funds from one part of its business to another in order to gain a competitive advantage. In an environment where utilities participate in both the regulated and unregulated sides of an industry, a utility might attempt to use funds from its stable and profitable regulated business to gain an advantage in its unregulated businesses through cross-subsidies.
Specifically, utilities can exploit their regulated markets to obtain leverage in the competitive markets in two ways: they can shift revenues properly attributable to their regulated services to their competitive services, or they can shift costs properly attributable to their competitive services to their regulated services. In both cases, such improper shifting effectively subsidizes the utilities' unregulated services with monopoly profits from its regulated services to the detriment of both monopoly ratepayers and competitors.
Mitigation: Again, limiting CTC recovery of operating expenses is one effective means of preventing cross-subsidization. Additionally and as discussed above, we want to consider the feasibility of separating the transmission, distribution, and generation functions into separate wholly owned subsidiaries, which would allow easier detection of cross-subsidies.
d. Design of PBR/Transition Cost Mechanisms.—Parties to our proceedings have devoted considerable attention to problems associated with ongoing transition cost determination based on a market price, in conjunction with PBR treatment for utility assets. Several problems were identified in the transition cost hearings last December. The problems involve the potential that utilities might use transition costs to subsidize operation of plants that are not competitive in the Exchange. This problem concerns us because the subsidization of inefficient generation assets results in a barrier to entry for more competitive industry contestants.(see footnote 78)
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This problem arises because regulatory revenue requirements are based on an average office operating costs of individual generating units. At any particular moment in utility operations, this averaging means that efficient generating unit are subsidizing the operating costs of inefficient generating units. Although this was a prudent regulatory practice in the past, in our transition to competition it conflicts with our intent to ensure optimal market outcomes in the future, return the full value of efficient generating assets to consumers, and ensure market contestability.
Although averaging operating costs of production facilities might occasionally be necessary due to lumpy production increments or other factors, competitors are generally inclined to avoid this practice because of the increased costs they absorb.(see footnote 79) Generally, this disincentive ensures efficient societal outcomes in competitive markets. But ongoing transition cost determination, in conjunction with PBR, has the potential of creating incentives for a utility to subsidize the operating costs of assets that are not cost-competitive Exchange if the CTC included those costs.
Mitigation: Our proposal severely limits subsidization of any costs other than the undepreciated, book value (rate base) of nonnuclear, nonhyrdoelectric generating units. The potential to recover any operating costs at all will be constrained to particular units and particular times when reactive power/voltage support is not yet procurable at market-based rates in locations where it is needed. We need to safeguard the stability of the transmission system to the extent Exchange prices are sufficiently low that a generator critical for reactive power/voltage support could not recover sufficient costs from the Exchange to run.
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Further mitigation of this problem might be addressed in design of the PBR mechanisms which utilities may seek to have applied to such units and the limited operating costs.
e. Manipulated Market.—Critics of the May pool proposal to create a single mandatory spot market for energy cite, among other things, the ease with which powerful market participants could manipulate prices in such a market. As discussed above, parties have also raised general concerns that the utilities might be able to manipulate prices in the Power Exchange through control of vertically integrated assets, horizontal market concentration, and strategic assets. Parties feared that the potential for these problems might be magnified by a mandatory spot market.
Mitigation: Our proposal mitigates problems of market manipulation by provision of independent system operator, for fair, nondiscriminatory provision of transmission to all suppliers. Furthermore, through contracts for differences and direct access contacts, customers will have opportunities to curb the impact of price fluctuations of the Exchange or avoid them entirely.
f. Thin Markets.—Parties commenting on previous proposals to create such a market also raised concerns that we refer to as thin market concerns. A thin market is a market that is not sufficiently broad to provide a price that reflects the true societal value of the relevant product in the relevant geographic market. NYMEX, ENRON, the Attorney General of California, the Energy Producers and Users Coalition (EPUC), and others have expressed doubts that the Power Exchange price would accurately reflect the true market value, and thus would promote anticompetitive activities.
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Parties have identified an instance in which a thin market might be a problem in the single mandatory spot market scenario. This instance is related to proposals to require the spot market to take the output of certain generation resources, regardless of their cost-competitiveness, to meet contractual obligations or policy goals.(see footnote 80) In this case there is a possibility that the quantities of market competitors' generation will be sufficiently small relative to the must-take resources that market-clearing prices will fail to reflect actual societal resource values.
g. Predatory Pricing.—Predatory pricing is an illegal pricing strategy that a firm undertakes to drive current competitors out of the market and to prevent new entrants by selling a product below cost.(see footnote 81) It is a short-term strategy firms undertake to meet their long-term goal of sustaining market power. Firms that already have market power have also used the threat of predatory pricing as a strong barrier to entry. Certain circumstances are necessary for a firm to engage in or threaten predatory pricing. In particular, a firm must have the ability to withstand the short-term losses and to absorb the increased demand stimulated by the low predatory price. Furthermore, the firm must be able to profit from the venture by eventually earning sustainable monopoly profits. This generally requires that the market have strong barriers to entry, such as prohibitively high initial capital or other investment costs. Several parties, including EPUC, have expressed concern that the utilities might be able to use predatory pricing or the threat of it to increase or maintain their market power.
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We will be alert to specious allegations of predatory pricing made by unhappy rival firms to protect their own competitive interests. In many healthy competitive markets firms will temporally price below average total cost for good reasons and with insignificant harm to the industry. These instances include low-priced introductory offers, expiring inventory sales, sales from firms exiting the industry, and incremental sales needed to reach minimum efficient scale. The duration of these activities, the concentration of the market, the competitive importance of the firm, and the reason for the pricing must be considered before we or other governmental industries should contemplate intervening in the market.
Mitigation: By the creation of an ISO, the strict limitations on recovery of operating costs for nonnuclear, nonhydroelectric units through the CTC, and our further consideration of utilities' applications or comments on divesting up to 50% of their fossil generation and separation into three subsidiaries, we are satisfied that we are taking adequate steps to curb this form of market power abuse. Additionally, we retain our ability to react to particular instances of market power abuse through our complaint procedures, monitoring of the market structure we establish, and reforms that may become necessary as the market evolves.
h. Information.—As a monopoly provider of integrated generation, transmission, and distribution services, the incumbent utility has access to considerable information about its customers, including individual load profiles and billing histories. In a competitive arena, access to such information is quite valuable for marketing purposes. Because this information is not automatically available to the utility's competitors, the incumbent utility has a major marketing advantage that could allow it to target and sign up preferred customers before its competitors can. The Framework Parties voice significant concern about this possibility.
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Mitigation: We will require that customer specific information necessary for the distribution (accounting and billing) functions of the utility be made available on terms that are fair to all competitors in the generation sector. Because customer confidentiality concerns attach to this information, customer consent will be a prerequisite for all suppliers that obtain access. Separation of a separate distribution subsidiary would assist our efforts to make customer information available on equal terms and conditions; however, it is not essential. The implementation of this policy should be addressed by the Working Group.
Access to information about transmission will be largely resolved through the protocols of the ISO and FERC's efforts to establish transmission information networks (call the RIN NOPR). All market participants will have the same access to information about the transmission system.
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PREPARED STATEMENT OF THE NATIONAL ALLIANCE FOR FAIR COMPETITION
The National Alliance For Fair Competition (NAFC) is a coalition of nine national trade associations representing over 30,000 small businesses throughout the United States.
These organizations consist of small, private sector businesses engaged in the design, supply, rental, sale, design, installation and servicing of electrical and mechanical products, equipment, and systems, as well as providing energy fuels. These firms operate in residential, commercial and industrial markets. While a few larger firms are included within this group, the majority of business are small by any standard of measurement and many are family owned and operated. The organizations themselves are independent entities but share common goals and, in some cases, individual members.
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The present members of NAFC include: The Air Conditioning Contractors of America (ACCA), the American Supply Association (ASA), Associated Builders and Contractors (ABC), the Independent Electrical Contractors (IEC), the Petroleum Market's Association of America (PMAA), the Mechanical Contractors Association of America (MCAA), the National Association of Plumbing, Heating and Cooling Contractors (NAPRCC), the National Electrical Contractors Association (NECA), and the Sheet Metal and Air Conditioning Contractors National Association (SMACNA).
INTRODUCTION
The diversification of utilities into areas outside of their publicly regulated role as producers and suppliers of energy has occasioned significant and continuing harm to small, private sector firms engaged in energy service fields. Utilities now routinely sell appliances, provide plumbing, heating, and cooling equipment and service contracts, engage in insulation work and sales of storm windows and doors, provide outdoor lighting and interior lighting fixtures. With the advent of deregulation, they are also beginning to enter into security and alarm monitoring markets, telecommunications, and related energy service markets such as energy management and energy monitoring. This competition has spawned considerable friction between those small private sector firms who have traditionally supplied such products and services and the utilities, which can call on considerable marketing advantages usually associated with monopoly power. There is also considerable potential for small businesses to be denied access to newly emerging markets which are the key to future expansion, job growth, and profitability as deregulation progresses.
The Small Business Administration has documented the problems encountered by small businesses from unfair utility competition in two published studies.(see footnote 82) The SBA has concluded that existing legal and regulatory frameworks are inadequate to protect small firms engaged in competition with utilities.
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... utility supply and installation programs cannot be effectively regulated to eliminate improper subsidies and other competition problems. Such unregulated activity by the utility does not provide significant public benefits which outweigh the hazard to competition and the cost or regulatory oversight.
To some extent, utilities have always engaged in some sales and service activities which parallel those of private sector firms, especially in the sales and installation areas. However, it wasn't until the 1970's that this form of competition greatly expanded. In that decade, Congress passed the National Energy Conservation and Policy Act and the Energy Security Act which federally mandated utilities to provide low cost, or no cost, energy audits. Residential customers were serviced under the provisions of the Residential Conservation Service (RCS) program while commercial establishments were covered under the Commercial and Apartment Conservation Service (CACS) program. The costs of the RCS and CACS audits above $15 were to be subsidized by ratepayers. At that level, virtually no private sector firm could compete with utilities which could recoup their expenses through a ratebase. Small businesses were effectively crowded out of the energy audit business.
The collapse of the energy audit market for small businesses provides an telling example of the deleterious effects of well-intentioned but uninformed legislative policy. The Sheet Metal and Air Conditioning Contractors National Association (SMACNA) has documented an irreversible pattern of layoffs and dismissals of employees in that industry who were engaged as energy auditors. Entire divisions of firms were terminated due to the loss of this business. One of the saddest examples occurred in Iowa. There, the state chapter of SMACNA entered into a joint arrangement with an agency of the State to train junior college graduates as energy auditors. Funding was provided through SMACNA and state training grants. Hundreds of workers, many of whom were unemployed, were trained. However, this laudable program had to be terminated in the face of market losses occasioned by competition from utilities—competition mandated by legislative policy, praiseworthy in intent and beneficial in aim, but unmindful of the harmful consequences it spawned: loss of a market, loss of jobs, and, for those trained under programs like that in Iowa, loss of the hope of jobs. It is also worth noting that while, in the Iowa case, the true costs of the audits offered by utilities exceeded $300 (compared to private sector rates in the $75–$125 range), the utilities were able to charge customers a price which was less than the market price due to cross-subsidization. Here is a clear example of the impact which DSM programs have on small businesses.
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Most troubling to NAFC and its members, are certain aspects of deregulation which remove even the present inadequate legal remedies to aggrieved small businesses and which will result in an unwarranted interference in the free market while adding to the existing monopolistic advantages utilities have enjoyed in competing against small businesses.
''UNFAIR'' COMPETITION
The primary obstacle to free, fair and open competition in existing markets, as well as emerging ones, is the ability of the utility to leverage its entry into, and penetration of, traditional private sector markets (typically through its non-utility subsidiaries or affiliates) by means unavailable to business entities which do not enjoy a status as a state sanctioned monopoly.
It must be emphasized that the ''unfairness'' of such competition does not arise due to the utility's (of its subsidiary's or affiliate's) size, or due to any inherent advantage associated with corporate management, or with expertise in the field or relevant markets. Rather, the ''unfairness'' arises from the fact that as a utility, the state has conferred upon a particular business entity, to the exclusion of all others, a monopoly complete with a captive customer base in the tens, if not hundreds, of thousands of customer sites; a mechanism by which costs can be dispersed over this rate base; an enormous reservoir of name recognition due to monopoly status; an ability and the legal right to gather customer site information regarding energy usage (and future energy marketing leads); and, a complete profile of each customer with respect to billing and credit history.
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None of these attributes is shared by a private sector competitor, large or small.
(a) The persistence of monopolies in energy distribution after deregulation
It must also be emphasized that even after current deregulation and restructuring proposals are implemented, utilities will still enjoy a monopoly at the distribution level. Current deregulation proposals focusing on ''customer choice'' mainly impact the generation and commodity supply functions of a utility but do not significantly impact distribution functions. Inasmuch as unfair competition problems faced by small business, private sector competitors occur mainly at the distribution stage, these problems will continue to exist and, in the face of poorly crafted legislation, become exacerbated.
A current example of deregulation inimical to the viability of small businesses can be found in the Securities and Exchange Commission (SEC) decision regarding Rule 58 promulgated under its authority conferred in the Public Utility Holding Company Act of 1935 (PUHCA).(see footnote 83) Under Rule 58, multi-state registered utility holding companies may now invest in ten new categories of non-utility operations without prior SEC approval and without providing prior notice and opportunity for public comment. Among the ten specified deregulated activities are: Energy and demand side management services, appliance sales, thermal energy products, sales and expertise, and electrotechnologies.
These are areas in which private sector businesses are already engaged and for whom the potential for domination by utility affiliates or subsidiaries is now significantly expanded.
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The desire of utilities to enter into non-utility markets traditionally served by private sector firms, most of which are small businesses, is a direct result of utility deregulation and efforts to bring competition to the energy marketplace. Once utilities must compete for customers of their commodity business (the generated power) they will need to fend off challenges from lower priced suppliers of electricity. Individual utilities with fixed costs higher than those of a competitor will need some means to prevent erosion of its customer base. Increasingly, utilities have settled on entry into the energy services and related markets as a means of holding on to customers. Thus, utilities now seek to dominate the residential appliance sales and services markets, the HVAC and air conditioning markets for residences and commercial sites, the security and fire alarm markets for such sites, as well as others noted earlier.
Private sector businesses small and large welcome competition, as a rule. The deregulation of the utility industry in this country may be accorded a similar response if it is accompanied by steps designed to ensure that resulting competition is other than imperfect, unbalanced, and generally unfair, discriminatory and, ultimately, anti-competitive.
(b) Cross-subsidization
Of all the abuses which can accompany deregulation, the potential for cross-subsidization is the most substantial and significant. Cross-subsidization, usually impermissible but difficult to uncover and regulate, can occur where the utility's cost of entering and dominating a non-utility market is financed by reliance on the utility's rate base. In such situations, utility subsidiaries or affiliates can offer products and service contracts at below cost thereby driving out established private sector competitors, especially small business competitors.
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Remedies for such cross-subsidized competition are not particularly helpful to competitors seeking to either prevent such harm or to obtain compensation for it. Unfortunately, antitrust law is not usually applicable to such situations. As an example, predatory pricing may not be found to exist in such situations since the competing utility subsidiary or affiliate may never substantially raise its prices to reap the benefits after driving off the competition because the main goal of the utility is to hold customers for its commodity (power) market rather than to profit from its nonutility business.
The normal avenue of redress for cross-subsidization is through the state regulatory commission. However, even where state commissions have found cross-subsidization to exist, their only remedy is to deny the utility all or part of its requested rate. The private sector business owner is left without any compensation for damages or lost market since this is beyond the power of the state regulatory authority. Numerous examples of the impact of cross-subsidization are available. Among some of the more notable:
The Washington Utilities and Transportation Commission, after reviewing the appliance operations of Washington Natural Gas Company, not only denied its requested rate increase but required the utility to effect a reduction in rates of approximately $16.9 million due to its subsidization of non-utility operation in the appliance merchandising area.
A Michigan court found that it was ''... undisputed that [Consumers Power Company} ... share of prepaid service contracts was very large (over 90%).'' The court held that the utility violated certain state consumer protection laws but did not uphold the antitrust claim due to plaintiffs failure to properly define the relevant market.(see footnote 84)
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The Minnesota Public Utilities Commission issued an order in 1995 requiring Minnegasco to stop subsidizing its appliance sales and service program due to proven cross-subsidization estimated as high as $6 million. Evidence in that case indicated that the utility controlled over 40% of the appliance service market prior to the entry of judgment.
The Maryland Public Service Commission investigated the appliance sales and services operations of a local utility and uncovered a subsidy over $500,000.(see footnote 85)
Again, while these examples indicate that such activity can be eventually uncovered and addressed at the state regulatory level, the sanctions imposed do not compensate the affected businesses for damages, lost customers or lost markets. Rather the sanctions are designed to prevent ratepayers from incurring higher utility bills than would otherwise be the case. For the small business driven out of the market, the prospect of a lower monthly utility bill is of little comfort.
(c) Asset Transfers
Increasingly, utilities are resorting to means of conferring a competitive advantage upon their non-utility subsidiary or affiliate which is not normally recognized by state regulators as falling under the traditional definition of cross-subsidization. This more modern subsidy is the transfer of intangible assets (or even some tangible assets) at very little or no cost to the nonutility subsidiary or affiliate. Typically, this would be in the form of marketing data either in the aggregate or with reference to specific customer sites.
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Once again, because of its nature as a utility, the local energy provider is in a position to acquire specific information regarding a customers energy usage. This can include more than just total or average consumption, but also the type of equipment being used, its load profile, the customers frequency and type of repairs, equipment age and model, customer credit and billing history. Such information is possessed by the utility by virtue of its monopoly status and can be easily transferred to its non-utility affiliate or subsidiary for use in providing a significant competitive advantage against private sector competitors which are unable to obtain such information no matter what the cost.
The advent of fiber optic cable and advanced energy monitoring capability now make it possible for utilities to know in advance of even the customer when residential or commercial equipment may fail. Such information may be fumed over to the utility's service affiliate without any opportunity for private sector competitors to service even existing accounts. It is no surprise that investor owned utilities have invested billions of dollars into telecommunications in order to capture this market.
(d) Name and Trademark
Another asset of substantial value which is conferred upon non-utility affiliates and subsidiaries is the ability to trade upon the utility's goodwill (name and logo). Having been conferred a monopoly franchise for decades during which their existing captive customer base became acquainted with a utility's name and trade marks, utilities now routinely provide their non-utility subsidiaries and affiliates with all the good will previously acquired. Although, the owners of the utility have a right to summit usage of their identifying marks to those they deem fit, they should not be permitted to do so without recovering the fair market value of such an asset since failure to do so represents a subsidy from the utility side of operations to the non-utility side.-While ratepayers may not be entitled to ownership rights in the asset, they have a beneficial interest in it and have certainly contributed to its value. Failure to compensate them not only unduly drives up rates by foregoing revenues which could otherwise accrue to the utility but also conveys a substantial unfair competitive advantage over private sector competitors.
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(e) Self-dealing
Closely related to the problem of asset transfers is utility self-dealing or discriminatory treatment of competitors. In such circumstances, information possessed by a utility by virtue of its being a utility is made available exclusively or on more favorable terms to a utility's affiliate or subsidiary than to competitors. Such information may be customer lists, or customer referrals obtained by virtue of the utility's relationship to customers. As an example, customers calling to report power outages or to obtain access to electric or gas connections may be steered to an affiliated or subsidiary operation for equipment purchases or repair services available from competing merchants. Once again, it is the monopoly enjoyed in one market which provides the means to penetrate other non-utility markets.
LEGISLATIVE REMEDIES
Fortunately, Congress has already established a legislative precedent in rectifying a number of the potential anticompetitive aspects of deregulation faced by private sector businesses. An excellent point of departure for crafting pro-competitive law can be found in the 1995 Telecommunications Act.
Title I Subtitle 2, Part III, Sections 271–275 spell out restrictions on Bell Operating Companies as the relate to competition with small business entities in the interLATA services (section 271), electronic publishing (section 274) and alarm monitoring (section 275). In addition, provisions dealing with operations of BOC affiliates (section 272) and manufacturing (section 273) were contained in the final bill.
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For example, section 272 establishes certain requirements which require BOCs to establish separate affiliates from which to provide activities which compete with certain small businesses (e.g., alarm monitoring, interLATA services, manufacturing), a BOC may jointly market certain services with its affiliate but only if competitors are treated equally and without discrimination.
Section 274 establishes restrictions on the use of name and trade marks by BOC affiliates when they compete against others in the electronic publishing business. In addition to the requirement of dealing out of a separate subsidiary, this section also requires that separate books, records and accounts be maintained. The affiliate is also prohibited from using the name or trademark of the BOC under specified circumstances; prohibited from incurring debt in a manner in which recourse may be had to the BOC; provide for the proper valuation of assets transferred from the BOC to the affiliate to prevent cross-subsidization. The BOC is also prohibited from performing a number of activities on behalf of its affiliate including hiring or training personnel, providing equipment, or engaging in research and development.
Section 275 prohibits discrimination by a telephone company in the provision of services, either by refusing to provide competitors the same services as it provides itself or by cross-subsidizing from local telephone service.
Thus, it can clearly be seen that Congress has already considered the problems of small businesses which compete with utilities and has developed meaningful remedies to the anticompetitive conduct anticipated in connection with overhauling the Nation's telecommunications laws.
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Now, similar treatment should be accorded to small businesses confronted by unfair competition from energy utilities.
(a) Suggested provisions
NAFC suggest the following provisions be included in any legislation deregulating the utility industry.
Prohibition on cross-subsidization. Although cross-subsidization is generally impermissible as a violation of the utility's obligation to charge just and reasonable rates, it needs to be codified into law. First, it is not a statutorily-based cause of action but one which is an outgrowth of ''common law'' or case decisions. Second, only a handful of states actually have codified this matter and having a federal statute would go a long way toward getting the states to follow suit. Third, as utility competition progresses, there is the increasing potential for small businesses to lose this legal remedy since utility monopolies will be restructured or eliminated. With the elimination of the monopoly franchise, the obligation to charge a just and reasonable rate may well disappear along with this particular legal remedy. Finally, even in those areas where regulated utility functions remain (distribution), state regulatory authorities will likely be pressed to allow utilities to bundle product (energy) and services to at least some extent. Thus, there is an increased potential for creating permissible cross-subsidizations with which utilities will compete against small businesses.
Adequate definition of cross-subsidization. The present understanding of what constitutes impermissible cross-subsidization fails to adequately cover modern subsidy situations. Traditional concepts of cross-subsidization focus on money aspects and/or misallocation of joint costs between the utility and the non-utility subsidiary or affiliate. This limitation fails completely to take into account the more common problems encountered in today's market: transfer of tangible and intangible assets at less than value (book or market) or at no charge at all. This would include goodwill (name and logo issues), marketing information and customer site data, customer referrals, etc. Cross-subsidization needs to be defined to cover its traditional meanings with respect to costs, as well as those situations noted above where a utility forgoes revenues which would otherwise inure to the benefit of rate payers.
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In addition, self-dealing (including the steering of customers by utility employees to utility-affiliated subsidiaries) must be closely scrutinized and should be prohibited as a form of cross-subsidization since such ''steering'' is usually the result of information, or marketing data initially acquired by the utility by virtue of its monopoly status and utility functions.
Separation of utility and non-utility functions and operations. As utilities are restructured in a competitive environment, there will be a need to configure them in such a way as to assure that those functions, and only those functions, which are inherent to the utility monopoly franchise are not co-mingled with competitive operations. This be especially true at the distribution level (DISCO) which will lie partly within utility and partly within competitive, private sector markets.
Energy services which can be procured competitively from private sector companies can and should be distinguished from, and not bundled with, the utility functions. Non-utility operations should be legally separated from the utility and conducted through a separate, distinct entity to assist in the prevention of cross-subsidization.
Adoption of, and adherence to, proper cost allocation rules. Many states do not have cost allocation rules. It should be a requirement of any deregulation proposal that states adopt such rules (the FCC's telecommunications cost allocation formulae are an example) as we move toward a competitive and restructured environment in order to prevent abuses such as cross-subsidization.
Protection of customer proprietary information and data. Energy utilities are rapidly expanding their capability to exploit optical fiber and other new technologies to provide customers with energy monitoring and management services. The recent telecommunications bill contained provisions which permitted energy utilities to enter this field without restrictions—even less than what was imposed upon telecommunications utilities—and the permissive approach allotted to energy utilities under that bill substantially threatens small business markets.
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Customer generated information and data is the property of the one generating such data. The transference of such information without the consent (or even knowledge) of the customer is an invasion of privacy as well as outright theft of valuable commercial data. Energy monitoring (a permissible utility activity since it serves the need to acquire data on present and future load demands) allows the utility to gather exactly the kind of information which would be of considerable commercial value in a competitive market. By passing this information along, either in the aggregate or with reference to specific sites, to its non-utility, competitive subsidiary or affiliate at no cost, the utility imparts an exceptional and substantial competitive advantage over private sector competitors.
Customer generated information and data should stay with the utility and be used only for utility functions. It should not be shared with a utility's subsidiary or affiliates in aggregate form unless and except it is made available to all competitors under non-discriminatory terms. With respect to specific customer sites, it should never be disclosed without the written, knowledgeable consent of the customer.
Equal, non-discriminatory access to incumbent architecture and systems. This is necessary in order to permit small business competitors access to utility owned property. It is the same remedy which was applied in the telecom bill and, like the remedy there, utilities should be permitted to charge just, reasonable and non-discriminatory fees for granting such access. Absent such a provision, substantial and significant barriers to competition and the creation of new firms and employment opportunities would exist. This is especially relevant to the emerging energy monitoring and management markets for residential and commercial sites.
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JUDICIARY COMMITTEE JURISDICTION
The House Judiciary Committee contributed substantially to the final language adopted by Congress in connection with the Telecommunications Act. It needs to again assert jurisdiction over deregulation of energy utilities and revision of existing statutes such as PUHCA and the Public Utility Regulatory Policies Act (PURPA). Without such jurisdiction, the interests of thousands of small businesses will be substantially damaged.
Unfortunately, legislation now pending in Congress is focused on generation aspects and ''customer choices'' rather than taking a more comprehensive view toward the impact deregulation and restructuring will have on businesses which compete with utilities in the energy services markets.
NAFC applauds Chairman Hyde and the other members of the Judiciary Committee for initiating this inquiry into the antitrust aspects of utility deregulation. We encourage the Committee to continue its inquiries and to provide the thousands of small business owners faced with anticompetitive conduct a means to address such problems.
NAFC believes that the proper forum in which to discuss the potential solutions to anticompetitive conduct and to fashion rules for ensuring free, fair, and open competition is this Committee.
We hope that the Committee will choose to explore legal remedies such as those indicated in this testimony as well as others, such as monopoly leveraging theories, when considering legislation in this area.
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PREPARED STATEMENT OF THE AIR CONDITIONING CONTRACTORS OF AMERICA
The Air Conditioning Contractors of America (''ACCA'') would like to commend the Members of this Committee for their foresight in addressing the antitrust implications of electricity restructuring. ACCA is a national trade association representing heating, ventilation, air conditioning and refrigeration (''HVACR'') contractors that design, install, maintain and service HVACR systems with more than 4,000 members and 60 chapters across the country. The majority of ACCA's member companies are small and medium-sized contractors working on all manner of HVACR systems for residential, commercial, industrial and governmental customers. ACCA has also joined with the National Alliance for Fair Competition, a coalition of construction-based trade associations, and Consumers for Fair Competition to advocate solutions to potential market power abuses during the transition to a fully competitive electricity market.
To date, a great deal of attention has been focused on the impact that electricity deregulation would have on utility service and on the relative benefits to different classes of consumers flowing from deregulation. However, ACCA's members are concerned that an aspect of the debate which has largely been ignored up to this point is the potential for anticompetitive conduct by utilities to gain an unfair competitive advantage in related service markets to defray the costs of making the transition to a competitive marketplace. Such conduct would have an unfair and adverse impact on small and medium-sized businesses in particular who would be unable to compete with services funded by the utilities' ratepayer-based assets. Let us be clear—ACCA fully supports open competition in both the electricity market and in what is already a highly competitive market for HVACR services provided that such competition is truly free and fair.
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The use of ratepayer-based assets by a monopoly to defray the costs of entering into related competitive markets, a practice known as ''cross-subsidization,'' obviously raises serious competitiveness concerns. Examples of cross-subsidization include the use of billing inserts for ''free'' advertising for related services, the use of utility-owned trucks and facilities, and accumulated customer goodwill—the true cost of all of these advantages borne, of course, by the ratepayer. Nor are these concerns merely abstract as they are occurring NOW in the markets in which ACCA members compete to provide HVACR services.
ANTITRUST IMPLICATIONS OF CROSS-SUBSIDIZATION
Cross-subsidization of competitive services by monopoly services has been held by several courts to violate section 2 of the Sherman Act, 15 U.S.C. 2 (1997), under the ''monopoly leveraging'' theory.(see footnote 86) Monopoly leveraging has been defined as ''the use of monopoly power in one market to gain a competitive advantage in ano-ther....''(see footnote 87) By this definition, the utilities use of ratepayer-based assets to compete in the HVACR service market appears to be a textbook case of monopoly leveraging. Large utilities using ratepayer-based assets to compete against small and medium-sized HVACR contractors of necessity creates an unfair competitive advantage. Even among those courts requiring a showing of monopoly, or attempted monopoly,(see footnote 88) one court has expressly noted that regulated monopolies create a special concern when they attempt to evade limitations on their monopolies by penetrating adjacent markets.(see footnote 89) Nor are the benefits that enable the utilities to compete merely the result of natural monopolistic efficiencies, but have been gained through regulated marketshare and rates paid by ACCA members and other ratepayers.
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While it may be argued that the lower prices made possible by cross-subsidization are in fact a boon to consumers, this logic is fundamentally flawed in two important respects. First, this argument ignores the fact that the consumer has already paid the hidden cost for these services through higher utility rates. Second, and more importantly, these prices are sure to rise as independent contractors are forced from the market by artificially low prices and the cross-subsidized entrants into HVACR service gain market dominance. This is the very result that our ''predatory pricing'' laws are designed to prevent.
THE NEED FOR LEGISLATIVE LANGUAGE TO PREVENT CROSS-SUBSIDIZATION
The obvious anticompetitive impact of utility cross-subsidization could ultimately result both in higher prices for utility consumers and anticompetitive harm to HVACR contractors forced to compete with utility subsidiaries whose prices are artificially low. However, Congress has the opportunity to prevent this result and promote competition that is truly fair and open by including language in any deregulation bill prohibiting cross-subsidization.(see footnote 90)
Cross-subsidization must be prohibited in no uncertain terms. A failure of utilities to charge the full and fair market price for services offered to non-regulated subsidiaries amounts to taking money from the ratepayers pockets to defer the costs of entering a competitive market. Such practices must be stopped.
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Second, utilities should be divested of non-utility functions, and such divestiture should occur quickly. As long as utility and non-utility functions are maintained within the same organization, impermissible transfers of value will be hidden and difficult to evaluate or to stop. These relationships—potentially adverse to the policies underlying our antitrust law—should be severed at once. Of the relationships which may continue, precautions must be taken to ensure that structural restrictions or special trading arrangements do not provide non-regulated subsidiaries any unearned advantages in the marketplace.
Third, the true value of the customer relationship must be established. Just as the Internal Revenue Service and the Securities and Exchange Commission require the evaluation of ''good will'' in commercial transactions, so too do our businesses derive enormous value from our customer lists and good names. For utilities to pretend these assets have minimal or little value is simply to work from a false premise. The extensive customer lists of the utilities—which often include information regarding the appliances used in the households—should not be shared with unrelated subsidiaries competing with our businesses. If utilities do share these assets, our companies should have access to this information on a non-discriminatory basis. After all, these customer lists and other assets were originally acquired by the utilities under the terms of a public franchise.
CONCLUSION
This Committee's jurisdiction over the nation's antitrust policy and enforcement leaves it uniquely positioned to see that electricity deregulation legislation effectively prevents anticompetitive conduct by utility monopolies as the transition is made to a competitive market. As the Committee is well aware, new concerns are already arising in other newly deregulated markets about the potential for market power abuses in the wake of increasing consolidations. ACCA urges the Committee to take action now to allay such concerns as the electricity market is deregulated. Only by such action can fair and open competition be assured from the outset and can benefits to the consumer be guaranteed.
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42–584CC
1997
ANTITRUST ASPECTS OF ELECTRICITY DEREGULATION
HEARING
BEFORE THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
FIRST SESSION
JUNE 4, 1997
Serial No. 19
Printed for the use of the Committee on the Judiciary
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Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON THE JUDICIARY
HENRY J. HYDE, Illinois, Chairman
F. JAMES SENSENBRENNER, Jr., Wisconsin
BILL McCOLLUM, Florida
GEORGE W. GEKAS, Pennsylvania
HOWARD COBLE, North Carolina
LAMAR SMITH, Texas
STEVEN SCHIFF, New Mexico
ELTON GALLEGLY, California
CHARLES T. CANADY, Florida
BOB INGLIS, South Carolina
BOB GOODLATTE, Virginia
STEPHEN E. BUYER, Indiana
SONNY BONO, California
ED BRYANT, Tennessee
STEVE CHABOT, Ohio
BOB BARR, Georgia
WILLIAM L. JENKINS, Tennessee
ASA HUTCHINSON, Arkansas
EDWARD A. PEASE, Indiana
CHRISTOPHER B. CANNON, Utah
JOHN CONYERS, Jr., Michigan
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BARNEY FRANK, Massachusetts
CHARLES E. SCHUMER, New York
HOWARD L. BERMAN, California
RICK BOUCHER, Virginia
JERROLD NADLER, New York
ROBERT C. SCOTT, Virginia
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
SHEILA JACKSON LEE, Texas
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
STEVEN R. ROTHMAN, New Jersey
THOMAS E. MOONEY, Chief of Staff-General Counsel
JULIAN EPSTEIN, Minority Staff Director
C O N T E N T S
HEARING DATE
June 4, 1997
OPENING STATEMENT
Hyde, Hon. Henry J., a Representative in Congress from the State of Illinois, and chairman, Committee on the Judiciary
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WITNESSES
Bittle, Ricky, P.S., director of planning, rates, and dispatch, Arkansas Electric Cooperation Corp., on behalf of the National Electric Cooperative Association
Burton, Steven D., chair, Electric Power Supply Association (EPSA), and senior vice president and general counsel, SITHE Energies, Inc.
Earley, Anthony F., Jr., president and CEO, DTE Energy and Detroit Edison Co., on behalf of Edison Electric Institute
Howe, John B., chairman, Massachusetts Department of Public Utilities, on behalf of the National Association of Regulatory Utility Commissioners (NARUC)
Melamed, A. Douglas, Principal Deputy Assistant Attorney General, Antitrust Division, U.S. Department of Justice
O'Brien, John N., CEO and chairman, Wheeled Electric Power Co.
Pitofsky, Robert, Chairman, Federal Trade Commission
Serota, James I., partner, Huber Lawrence & Abell, New York, NY
Thilly, Roy, general manager and counsel, the Wisconsin Public Power, Inc., System, on behalf of the American Public Power Association
Travieso, Michael J., Maryland People's Counsel, on behalf of the National Association of State Utility Consumer Advocates and the State of Maryland Office of People's Counsel
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Bittle, Ricky, P.S., director of planning, rates, and dispatch, Arkansas Electric Cooperation Corp., on behalf of the National Electric Cooperative Association: Prepared statement
Burton, Steven D., chair, Electric Power Supply Association (EPSA), and senior vice president and general counsel, SITHE Energies, Inc.: Prepared statement
Page 305 PREV PAGE TOP OF DOC
Earley, Anthony F., Jr., president and CEO, DTE Energy and Detroit Edison Co., on behalf of Edison Electric Institute: Prepared statement
Howe, John B., chairman, Massachusetts Department of Public Utilities, on behalf of the National Association of Regulatory Utility Commissioners (NARUC): Prepared statement
Lofgren, Hon. Zoe, a Representative in Congress from the State of California: Correspondence: dated June 6, 1997, to Chairman Hyde from Chairman Bliley; dated March 20, 1997, to Chairman Bliley from 52 Members of Congress; and dated April 23, 1997, to Representative Jerry Lewis, from Chairman Bliley
Melamed, A. Douglas, Principal Deputy Assistant Attorney General, Antitrust Division, U.S. Department of Justice: Prepared statement
O'Brien, John N., CEO and chairman, Wheeled Electric Power Co.: Prepared statement
Pitofsky, Robert, Chairman, Federal Trade Commission: Prepared statement
Serota, James I., partner, Huber Lawrence & Abell, New York, NY: Prepared statement
Thilly, Roy, general manager and counsel, the Wisconsin Public Power, Inc., System, on behalf of the American Public Power Association: Prepared statement
Travieso, Michael J., Maryland People's Counsel, on behalf of the National Association of State Utility Consumer Advocates and the State of Maryland Office of People's Counsel: Prepared statement
APPENDIX
Material submitted for the hearing
(Footnote 1 return)
This written statement represents the views of the Federal Trade Commission. My oral presentation and response to questions are my own, and do not necessarily represent the views of the Commission or any other Commissioner.
(Footnote 2 return)
See Comment of the Staff of the Bureau of Economics, Federal Trade Commission, ''Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities, Recovery of Stranded Costs by Public Utilities and Transmitting Utilities,'' Dkt. No. RM96–6–000 (Aug. 7, 1995) (''BE/FERC I'').
(Footnote 3 return)
See Comment of the Staff of the Bureau of Economics, Federal Trade Commission, ''Inquiry Concerning Commission's Merger Policy Under the Federal Power Act,'' Dkt. Nos. RM95–8–000 and RM94–7–001 (May 7, 1996) (''BE/FERC II'').
(Footnote 4 return)
See Comment of the Staff of the Bureau of Economics of the Federal Trade Commission to the South Carolina Legislative Audit Council on The Statutes and Regulations Covering the South Carolina Public Service Commission (Feb. 28, 1994); Letter to The Honorable Kim Malcolm, Administrative Law Judge, Public Utilities Commission of the State of California, from Ronald S. Bond, Acting Director of the Bureau of Economics, Federal Trade Commission, enclosing South Carolina Comment (June 8, 1994).
(Footnote 5 return)
15 U.S.C. 41–18.
(Footnote 6 return)
15 U.S.C. 12–27.
(Footnote 7 return)
15 U.S.C. 18.
(Footnote 8 return)
See R. Crandall and J. Ellig, Economic Deregulation and Customer Choice: Lessons for the Electric Industry, Center for Market Processes at 2–3 (1996) (within 10 years of substantial deregulation, prices in the natural gas, long distance telecommunications, airlines, trucking, and railroad industries decreased between 25 and 50 percent while quality of service improved).
(Footnote 9 return)
In the electric power and telephone industries, for instance, regulatory agencies require providers to offer basic, low-cost service that may be subsidized by consumers who purchase additional services.
(Footnote 10 return)
Green, R.J. and Newbery, D., ''Competition in the British Electricity Spot Market,'' 100 J. Pol. Econ. 929 (1995). See also Alex Henney, ''The Mega-NOPR: A Brit Crosses the Pond to Explain What's Happening at FERC,'' Pub. Utils. Fort., July 1, 1995 at 29; ''U.K.'s National Power, Powergen Must Sell Off Up to 6000 MW, Lower Rates,'' Elec. Util. Wk., Feb. 21, 1994.
(Footnote 11 return)
There also are a number of municipally owned power companies in the United States that buy wholesale power under contract.
(Footnote 12 return)
The problem of reliability in the transmission of electrical power is complicated by a ''loop flow'' technical problem. Due to the physical laws that govern the flow of electricity, decisions made in one area of the transmission grid will affect capacity, reliability, and costs in other areas of the grid. Thus, the interconnection of any vertically integrated system with any outside source of generation or transmission will require some entity to monitor the entire grid to prevent outages and physical damage to equipment.
(Footnote 13 return)
Under section 203 of the Federal Power Act, 16 U.S.C. 824b, FERC authorization is required for mergers of public utilities subject to its jurisdiction. Any electric utility that is owned by a holding company is regulated by the Securities and Exchange Commission under the Public Utility Holding Company Act of 1935 (''PUHCA''), 15 U.S.C. 79–79z–6. Approximately 20 percent of U.S. electric utility assets are currently held by entities subject to PUHCA.
(Footnote 14 return)
Unlike the banking, communications and transportation common carrier, and air carrier industries, section 11 of the Clayton Act does not entrust enforcement of the Clayton Act with respect to the electric utility industry to the regulatory agency for the industry (FERC), but rather to the FTC. The Department of Justice also has enforcement authority concerning these mergers under section 15 of the Clayton Act.
(Footnote 15 return)
For a short history of recent technological and public policy changes in the electric power industry, see The Economic Report of the President at 181–89 (Feb. 1996) and 197–200, 205–208 (Feb. 1997). See also Pierce, ''Antitrust Policy in the New Electricity Industry,'' 17 Energy L.J. 29 (1996).
(Footnote 16 return)
16 U.S.C. 2601–2645. PURPA was intended to deregulate some aspects of electric utilities and to encourage new sources of domestic power generation.
(Footnote 17 return)
42 U.S.C. 13201–13556.
(Footnote 18 return)
Dkt. RM958–000.
(Footnote 19 return)
See California Assembly Bill 1890 (1996); California Public Utilities Commission, Proposed Policy Decision, Dkts. R.94–04–031 and I.94–04–032 (May 24, 1995).
(Footnote 20 return)
Open access refers to the principle that a monopoly owner of transmission or distribution assets must make them available to independent generators at price and service levels equal to those provided to its owned generators. FERC has focused on behavioral rules for open access and on developing mandatory common information sources concerning supply and transmission conditions. See BE/FERC I at 15–16.
(Footnote 21 return)
A number of utilities have followed a path of voluntary divestiture in order to compete more effectively in the deregulated climate. See Comments of Pacific Gas and Electric Company on Divestiture of Generation Facilities, ''Order Instituting Rulemaking on the Commission's Proposed Policies Governing Restructuring California's Electric Services Industry and Reforming Regulation,'' Dkt. No. R.94–04–031 (Mar. 19, 1996).
(Footnote 22 return)
See FERC Order 888, supra note 18.
(Footnote 23 return)
Brennan, ''Cross Subsidization and Cost Misallocation by Regulated Monopolists,'' 2 J. Reg. Econ. 37 (1990).
(Footnote 24 return)
See BE/FERC I at 3.
(Footnote 25 return)
Operation of a transmission system by an independent system operator should assist investors in distinguishing between high transmission prices caused by physical bottlenecks at peak demand periods and high prices caused by the exercise of market power.
(Footnote 26 return)
Because supply and demand for electricity are so time-sensitive, even the slightest delay in transmission can have serious impact on the reliability of any generator. A regulatory agency might find it very difficult to implement functional unbundling because of the difficulty of monitoring the numerous individual transactions nationwide to prevent degradations of contracts between independent generators and wholesale purchasers. See BE/FERC I at 5–9.
(Footnote 27 return)
U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines, 4 Trade Reg. Rep. (CCH) 13,104 (Apr. 2, 1992), as amended, April 8, 1997. Recently, FERC announced that it would follow the principles in the Guidelines in its own analysis of utility consolidations. See Inquiry Concerning the Commission's Merger Policy under the Federal Power Act, RM96–6–000, 61 Fed. Reg. 68,595 (Dec. 18, 1996).
(Footnote 28 return)
Specifically, the markets are defined by asking whether a hypothetical monopolist could raise prices by a ''small but significant and nontransitory'' amount, such that not enough buyers would switch to alternatives to make the price increases unprofitable. If the price increases would not be profitable, the relevant market is too narrowly defined. See Merger Guidelines 1.11.
(Footnote 29 return)
Other things being equal, an acquiring firm will find it more difficult to engage in anticompetitive conduct, either unilaterally or in conjunction with others, in an unconcentrated than in a concentrated market. See Merger Guidelines 2.0.
(Footnote 30 return)
Federal Trade Commission and Department of Justice, Revised Section 4 of the Horizontal Merger Guidelines (Apr. 8, 1997).
(Footnote 31 return)
The task force consists of representatives from the Department of Energy, the Environmental Protection Agency, the Federal Trade Commission, the Federal Energy Regulatory Commission, the Food and Drug Administration, and the Energy Information Administration, which is part of the Department of Energy.
(Footnote 32 return)
16 C.F.R. Part 260 (1996).
(Footnote 33 return)
''1995 Capacity and Generation of Non-Utility Sources of Energy,'' Statistics Department, Edison Electric Institute, November 1996.
(Footnote 34 return)
Compiled by the Regulatory Research Services Section, Edison Electric Institute, based on quarterly reports of filings by power marketers with the Federal Energy Regulatory Commission.
(Footnote 35 return)
Edison Electric Institute's Catalogue of Investor-Owned Utilities, 1995.
(Footnote 36 return)
Trends in Telephone Service, Industry Analysis Division, Common Carrier Bureau, Federal Trade Commission, March 1997.
(Footnote 37 return)
Air Transport Association, February 1997.
(Footnote 38 return)
1987 Census of Manufacturers.
(Footnote 39 return)
Analysis of Class I Railroads 1995, Policy & Economic Department, Association of American Railroads.
(Footnote 40 return)
Security Industry Yearbook 1995–6, Securities Industry Association.
(Footnote 41 return)
''Power Players,'' by Tony Mack, Forbes, May 19, 1997, p. 114.
(Footnote 42 return)
FERC Order No. 888 Environmental Impact Statement.
(Footnote 43 return)
Duqesne Light Co., v. Barasch, 488 U.S. 299 (1989); FPC v. Hope Natural Gas Co., 320 U.S. 591 (1944).
(Footnote 44 return)
Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419 (1982).
(Footnote 45 return)
I am counsel to the law firm of Mayer, Brown & Platt. In the Administration of President George Bush, I served as Assistant Attorney General for the Home of Legal Counsel, the office charged with interpreting the Constitution for the Executive Branch. In that capacity, as well as in the course of my private legal practice, I have rendered opinions on a variety of constitutional matters, including issues arising under the Just Compensation Clause and the Due Process Clause of Fourteenth Amendment. I have also testified before various committees of Congress regarding constitutional law issues.
(Footnote 46 return)
Other mandates proposed by regulators—changes in corporate structure or relinquishment of control over transmission, for example—may also breach the regulatory compact and result in stranded costs.
(Footnote 47 return)
The Just Compensation Clause provides a federal constitutional floor for the protection of private property. The constitutions of many states provide even greater security by requiring compensation not only when property is ''taken'' by state action, but also when it is merely ''damaged.''
(Footnote 48 return)
In certain circumstances, it may be reasonable for a utility to discharge its long-term continuing contractual liability to buy power by making a one-time payment to withdraw from the contract. This course of action would convert stranded future operating costs into stranded capital costs. Because the applicable constitutional principles require opportunity for utilities to recover both kinds of stranded costs, this potential conversion does not affect our analysis.
(Footnote 49 return)
Thus, the California PUC ''will allow [utilities] to recover completely costs associated with contracts for power and prior regulatory commitments, called regulatory assets. [It] will also continue to honor regulatory commitments regarding the recovery of nuclear power costs.'' Id. at 45–46. With respect to other generation-related stranded costs, the California PUC will allow full recovery, but at a reduced rate of return to reflect the reduced degree of risk that utilities would face in recovering the costs. On the portion of the costs financed by debt, the authorized rate of return would be set at the embedded cost of debt; on the portion financed by equity, it would be set at 90% of the embedded cost of debt. See id. at 54. It has been estimated that the overall rate of return on these non-nuclear generated-related stranded costs would approximate 7.4%.
(Footnote 50 return)
See also, e.g., Restructuring of the Electric Industry, 163 PUR4th 1, 92 (Conn. Dep't of Util. Control 1995) (''Connecticut utilities are entitled to a reasonable opportunity to recover net, nonmitigatable, strandable investment.''); Electric Industry Restructuring, 163 PUR4th 441, 451 (R.I. PUC 1995) (''Charges to recover stranded costs should apply to customers within a utility's retail franchise territory....''). Cf. Recovery of Stranded Costs Rulemaking, 159 PUR4th 279, 283 (Me. PUC 1995) (''Because retail wheeling would clearly constitute a significant and abrupt change in the regulatory compact, we expect that stranded cost recovery ... would be applied in the event that retail competition is authorized in the State.'').
(Footnote 51 return)
To be sure, courts ''proceed cautiously both in identifying a contract within the language of a regulatory statute and in defining the contours of any contractual obligation'' on the part of a state. Id. at 466. As described in the immediately following text, however, the regulatory compact is well recognized not only by utilities but also by state regulators themselves.
(Footnote 52 return)
Acknowledgements of the regulatory compact similar to one or another of these formulations have been made by, among others, the Connecticut Department of Utility Control, see Restructuring of the Electric Industry, 163 PUR4th 1, 72 (1995); the Maine PUC, see Recovery of Stranded Costs Rulemaking, 159 PUR4th 279, 282 (1995); the Idaho PUC, see Idaho Power Co., Case No. IPC–E–90–2/Order No. 23520 (Jan. 18, 1991) (LEXIS, Energy library, AIIPUR file); and the New York PSC, see Plans for Meeting Future Electricity Needs, 95 PUR4th 300, 315 (1988).
(Footnote 53 return)
As Justice Brandeis observed, it has long been the law that ''[e]very investment may be assumed to have been made in the exercise of reasonable judgment, unless the contrary is shown.'' Missouri ex rel. Southwestern Bell Tel. Co. v. Public Serv. Comm'n, 262 U.S. 276, 289 n. 1 (1923) (opinion concurring in the judgment).
(Footnote 54 return)
The curriculum vitae is in the subcommittee files.
(Footnote 55 return)
Disclosure statement is in the subcommittee files.
(Footnote 56 return)
Parker v. Brown, 317 U.S. 341 (1943). See also James E. Meeks, ''Antitrust Concerns in the Modern Public Utility Environment,'' National Regulatory Research Institute, Columbus, OH, April 1996, pp. 99–101. For the Committee's convenience, the title page and executive summary of this report are included as Attachment 1.
(Footnote 57 return)
For example, the California Public Utilities Commission, in its efforts to establish a competitive market in generation, has recently found it necessary and appropriate to open the functions of marketing, billing and information systems to competition as well. See CPUC order in R.94–04–031/I.94–04–032, May 6, 1997. Technological change may, in time, render other aspects of the business of transmitting and distributing electric power susceptible to competition.
(Footnote 58 return)
Meeks, op. cit. Detailed discussions of the topic areas listed below can be found in Ch. 5 of this report, at pp. 61–99.
(Footnote 59 return)
Id. pp. 61–68 (discussion of price squeeze) and pp. 68–71 (for a more general discussion of predatory pricing).
(Footnote 60 return)
Id., pp. 71–72.
(Footnote 61 return)
Id., pp. 73–77.
(Footnote 62 return)
Id., pp. 77–79.
(Footnote 63 return)
Id., pp. 79–86.
(Footnote 64 return)
Inquiry Concerning the Commission's Merger Policy Under the Federal Power Act: Policy Statement, Order No. 592, 61 Fed. Reg. 68,595 (1996), III FERC Stats. & Regs. 31,044 (1996) (''Merger Policy Statement''), slip op. at 81.
(Footnote 65 return)
Meeks, op. cit., pp. 91–97.
(Footnote 66 return)
Merger Policy Statement, op. cit., pp. 2–8.
(Footnote 67 return)
Merger Policy Statement, op. cit., sip op. at 30.
(Footnote 68 return)
California Assembly Bill 1890, enacted August 16, 1996.
(Footnote 69 return)
L.D. 1804, enacted May 29, 1997 at P.L. Ch. 316 (1997).
(Footnote 70 return)
Final report of the Special Legislative Committee on Electric Utility Restructuring of the Massachusetts Legislature, March 20, 1997.
(Footnote 71 return)
Northern Pac. Ry v. United States, 356 U.S. 1, 4 (1958).
(Footnote 72 return)
15 U.S.C. 18.
(Footnote 73 return)
For the most part we are concerned with potential market power on the part of incumbent investor-owned utilities. We have also considered market power as it applies to other future industry participants.
(Footnote 74 return)
cf. Department of Justice (DOJ)/Federal Trade Commission (FTC) Horizontal Merger Guidelines.
(Footnote 75 return)
A generator may indirectly provide power to an affiliated distribution company if it is a winning bidder in the Power Exchange. The neutral mediation of the Power Exchange removes market power concerns.
(Footnote 76 return)
Framework Parties, DRA, Enron Capital and Trade Resources, Inc. (ENRON), and many others have mentioned the problem of generation concentration. Also, as mentioned in the May pool proposal, we recognize problems attributed to the concentration of generation in the United Kingdom pool.
(Footnote 77 return)
By referring to fossil units, we specifically exclude other sources of nonnuclear and nonhyrdoelectric generation like Helms and geothermal units. SDG&E's so-called steam units would be considered fossil units, should we subsequently find that mitigation is necessary in its service territory as well.
(Footnote 78 return)
We are also concerned with the loss of societal efficiencies associated with such an outcome.
(Footnote 79 return)
An exception might be predatory pricing. See later discussion on this topic.
(Footnote 80 return)
Resources that might be provided this treatment are QF contracts, nuclear generating facilities operating under settlement provisions, and long-term import energy contracts.
(Footnote 81 return)
The practice is illegal under the Clayton Act of 1914.
(Footnote 82 return)
[See: Utility Competition with Small Businesses: Recommendations for States on Utility Energy-Related Programs and the Commercial and Apartment Conservation Service Program, 1984; and, Final Report: Utility Competition with Small Business, June 10, 1986, prepared for the Office of Advocacy, SBA.]
(Footnote 83 return)
Vol 62, No 34 FR 7900, Feb. 20, 1997; 17 CFR Parts 250, 259; SEC Release No. 3526657; File no. S7–12–95.
(Footnote 84 return)
Day and Night Heating & Cooling Company, et al. v. Consumers Power Company, Michigan Court for the County of Ingram, 3–9–95, File No. 88–62001–CP).
(Footnote 85 return)
Ernst & Young audit required by the Maryland Public Service Commission for Case #85877.
(Footnote 86 return)
Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d 263 (2d Cir. 1979), cert. denied, 444 U.S. 1093 (1980); Kerasotes Michigan Theatres v. National Amusements Inc., 854 F.2d 135 (6th Cir. 1988), cert. dismissed, 490 U.S. 1087 (1989); see also, Radford Comm. Hosp. v. Giles Mem. Hosp., 910 F.2d 139, 149 (4th Cir. 1990).
(Footnote 87 return)
Berkey Photo, 603 F.2d at 276.
(Footnote 88 return)
Alaska Airlines, Inc. v. United Airlines, Inc., 948 F.2d 536 (9th Cir. 1991), cert. denied, 112 S.Ct. 1603(1992); Fineman v. Armstrong World Ind., Inc., 980 F.2d 171 (3dCir. 1992),cert. denied, 113 S.Ct. 1285 (1993).
(Footnote 89 return)
Alaska Airlines, 948 F.2d at 549 n. 17 (noting that case did not present the ''special problem'' of a regulated monopolist evading price caps by moving into adjacent, unregulated markets).
(Footnote 90 return)
Legislative action to prevent such unfair practices is not without precedent. To use a recent example, to use an example from recent history, section 272 of the Telecommunications Act of 1996 imposes a separate subsidiary requirement on former Bell System operating companies to prevent such unfair practices in the market for telecommunications services. Telecommunications Act of 1996, Pub. L. No. 104–104, 272 (1996).