The Federal Energy Regulatory Commission has embarked on a review of the analysis it uses when looking at two key areas of the power sector — M&A deals and participation in competitive power markets.
FERC’s notice of inquiry (NOI) seeks comments from stakeholders on possible changes to sections 203 and 205 of the Federal Power Act.
Proposed mergers or acquisitions must pass a Section 203 review to satisfy FERC that the new combination would not reduce competition. Companies that want to sell power at competitive rates must pass a Section 205 review and thereafter pass a triennial review.
In June FERC revoked market-based rate authority for almost two dozen subsidiaries of Berkshire Hathaway Energy, including Nevada Power, Sierra Pacific Power and PacifiCorp, saying they failed wholesale market share screens.
FERC says there was no particular concern or event that triggered the NOI review, but it is not out of the blue either.
“This is something the FERC has done periodically,” said Peter Fox-Penner, academic advisor at the Brattle Group and a professor at Boston University.
In 2011 FERC issued an NOI seeking comment on whether or not it should revise its approach to examining horizontal market power when reviewing proposed M&A transactions under Section 203 and when analyzing filings for market-based rate authority under Section 205.
The impetus was a 2010 revision by the Department of Justice and the Federal Trade Commission of their guidelines for reviewing M&A transactions, particularly deals involving partial acquisitions and minority ownership stakes.
The five-step framework set out by the DOJ and FTC in 1992 serves as the basis for FERC’s analysis of the competitive effects of proposed mergers.
After reviewing the comments, FERC in 2012 decided to retain its existing policies and terminated the proceeding.
Then one year ago, in Order 816, FERC clarified and streamlined some aspects of its requirements for market-based rate authority under Section 205.
As stated in the current NOI, FERC is examining the “harmonization” of the analyses it uses in sections 203 and 205. For instance, FERC notes that Order 816 addressed the analysis of ancillary services in Section 205, but did not make any corresponding finding in Section 203.
The current NOI is looking to bring the standards used in 203 and 205 into tighter accord, but “it is much more than that,” Sandra Rizzo, a partner at Arnold & Porter, says.
A non-de minimis list
FERC’s NOI lays out an extensive and detailed list of issues on which it is seeking stakeholder comment. One is whether to establish a specific de minimis threshold under which transactions are exempt from Section 203 review.
In current practice, FERC says it has accepted “various representations made by applicants” and in some cases applicants have claimed their transaction’s effect on horizontal competition is de minimis even where an applicant’s post-transaction market share is large but the increase in an applicant’s post transaction installed capacity is relatively small. FERC says that relying on the “algebraically simple ‘2ab analysis’” that it currently uses “may be inappropriate.”
FERC also is seeking comments on whether or not it should include serial acquisitions in its competition analysis, as well as in its analysis of whether a transaction is de minimis.
FERC also notes that Section 203 review has been a forward-looking analysis that largely focuses on the “concentration of the market and not an examination of market share changes or accumulation of market share over time." The agency asks whether or not it should add a market share analysis to its review and if that analysis should be applied to capacity and ancillary markets, as well as energy markets.
FERC is also seeking comment on whether or not to add a supply curve analysis to its Section 203 horizontal market power review.
In its current calculations, FERC uses a delivered price test (DPT) to look at aggregate capacity in a geographic region, but that analysis does not look at the structure of capacity. FERC wants to know if adding a supply curve to the analysis would better reflect the responsiveness of prices to reductions in supply. One of the issues at stake is whether or not a newly merged entity would be able to withhold marginal capacity for the benefit of its baseload units.
In a similar vein, FERC asks whether or not it should change how it looks at power purchase agreements in its Section 203 analysis. Currently if an acquiring power company enters into a PPA with a generator before filing a Section 203 application to acquire that generator, the commission has included that capacity as part of the purchasing company’s pre-acquisition capacity, which means it would not represent an increase in market share under current FERC screens, even if the PPA expires shortly after completion of the merger.
The NOI also looks at whether an analysis used in Section 205 review should also be applied to mergers and acquisitions. FERC takes up the issue of its pivotal supplier analysis used in Section 205 reviews and says that in many cases the test does not reflect actual market practice. FERC says the test is meant as a “conservative threshold,” but says, experience shows “this does not seem to be the case.”
The regulator asks whether replacing the current wholesale load proxy with the area’s annual peak load would improve “the accuracy and usefulness” of the analysis.
FERC acknowledges that using the more conservative peak load screen could trigger “false positives” that put “additional burdens on sellers to rebut the presumption of market power and require additional analysis.” So the agency is seeking comments on the magnitude of the additional burden and whether that burden is outweighed by the benefits.
FERC also asks whether an updated pivot supplier screen should be applied to Section 203 applications and if the use of the screen should be expanded to apply not only to energy markets but to capacity and ancillary markets, as well, for both 203 and 205 applications.
The NOI also asks for comment on whether or not documents submitted to the DOJ and FTC as part of the merger approval process should also be submitted to FERC. And the NOI asks whether FERC should continue to provide blanket Section 203 authorizations for holding companies that own only exempt wholesale generators (EWG) to acquire additional EWG.
That treatment may no longer be “appropriate,” FERC said, because EWGs now comprise “a significant portion of supply and any transaction involving these generators could affect wholesale rates by impacting competition.”
FERC watchers say the commission has been trying to square up the forward-looking Section 203 tests with the backward-looking Section 205 screens for some time, but it is unclear how far the agency will go in this exercise.
In part, the review is an effort by FERC to bring both standards in line with changes in the market and to shift from screens that assess the ability of an entity to exert market power to screens that account for incentives to wield market power as well.
In that sense, depending on whether and how the issues raised in the NOI are implemented, market power tests for M&A applicants could be more stringent and result in tougher mitigation measures that are imposed to offset the impact of potential competition issues.
“The supply-mixed analysis proposed in the NOI examines whether a merged firm is likely to withhold output in order to drive up prices without losing its profit. The use of both supply and existing DPT analyses could tighten its M&A review standard and raise the bar for issues such as mitigation for some cases,” said Romkaew Broehm, principal at The Brattle Group.
In the meantime one consultant noted that anything that increases regulatory uncertainty tends to raise transaction costs.
Stakeholders have until Nov. 28 to submit comments on the NOI. If FERC decides to take action on the comments, it would have to issue a notice of proposed rule making and have time to field comments. If FERC moves forward with the process, the earliest new standards could be put in place would likely be the end of 2017.
“The bigger picture is that FERC is not planning on doing anything radical,” said Robert Shapiro, a partner with Chadbourne & Parke.