Electric Utility Mergers: Industry Concentration and Corporate Complication

            My third book, Regulating Mergers and Acquisitions of U.S. Electric Utilities:  Industry Concentration and Corporate Complication, will be published by Edward Elgar Publishing around October 2020. Each of my next 14 essays will excerpt from the book’s 13 chapters, in sequence starting with the Preface. (Click here for a Summary of Contents.) I hope this essay series, and the book, will stimulate a community-wide discussion on this crucial topic.

           What happens when electric utility monopolies pursue their acquisition interests—undisciplined by competition, and insufficiently disciplined by regulators responsible for replicating competition?                

            Since the mid-1980s. a stream of mergers and acquisitions has cut the number of local, independent electric retail utilities by more than half. Nearly 80 transactions, mostly debt-financed, have converted retiree-suitable investments into subsidiaries of geographically scattered conglomerates—multi-layered, multi-state and multinational holding company systems that mix lower-risk utilities in with higher-risk ventures.

            No one—no legislator, no regulator, no utility CEO, no bond analyst, no investment banker—intended this result. No objective analyst ever recommended that the U.S. electric utility industry look like it does now. And no thinking citizen would find comfort with these five facts:

            1.  Control of a public privilege—the government-granted, monopoly utility franchise—is sold and re-sold by the private franchisee to the highest bidder, in multi-billion-dollar transactions undisciplined by normal competitive market forces.

           2.  The gain extracted from these sales goes mostly to the acquired utility's shareholders and executives, even though the economic value underlying that gain comes not from shareholder risk-taking or executive decision-making, but from customers—customers made captive by state laws that protect the utility from competition.

            3.  The purpose commonly claimed by the merging companies—“synergies”—is non-factual because they create their efficiencies estimates only after they sign their merger agreements.

            4.  The regulators responsible for deciding who should control these franchises have no plan or procedures for finding the most cost-effective provider. Instead they let their utility choose—knowing that the utility will base its choice on gain to its shareholders rather than performance for its customers.

            5.  While the merging companies seek to maximize return for their shareholders, the regulators seek mostly to avoid harm to the customers—a passion gap that produces predictably lopsided results.    

The harms

            Our utility merger policy—or lack of policy—causes four harms

            Economic waste: When companies undisciplined by competition choose their partners based on price instead of performance, they preclude more cost-effective couplings. They waste the economy's resources.

            Misallocated value: A utility’s franchise is not its private asset. Unlike corporate stock, buildings, or trucks, the franchise was not bought with dollars; unlike a baseball star's 10-year contract, it was not earned through merit. The franchise is a privilege, not an asset; so the utility has no logical or legal claim to the gain from its sale. Yet the merging companies keep that gain all for themselves, leaving none for the customers whose captivity creates the value underlying the gain.

            Weakened competition: By enabling anticompetitive conduct and vesting unearned advantages, mergers can weaken competition in traditional electricity markets. In emerging product markets—renewable energy, storage microgrids, and other distributed resources—mergers can create first-mover advantages: advantages based not on merit but on government-protected incumbency. Mergers are concentrating these markets at the same time that policymakers are seeking to diversify them.

            Customer risk from parent-utility conflict: Between the holding company's business objectives and its utility subsidiaries’ service obligations, conflicts are unavoidable. Those conflicts cause harms: overcharging customers to pay off acquisition debt, diverting utility funds to support non-utility affiliates, raising electricity rates to cover capital costs inflated by the holding company's higher risks.

            Merger advocates say their transactions exploit economies of scale, improve access to capital, diversify investment risk, and spread best practices. The economies-of-scale argument is only an argument; it no finds factual support in any objective study—or in reality, because the small Madison Gas & Electric thrives alongside the giant Exelon Corporation. The capital-raising argument fails because small utilities access capital routinely, as long as their regulators set rates properly. Shareholders can diversify their own investments; they don't need a holding company to do it for them. And "best practices" are an obligation of every franchise-holding utility; no executives needs a  merger to learn best practices.

            Merger supporters argue, accurately, that no merger has gone sour. That's the wrong standard for a multi-trillion-dollar, infrastructural industry on which our economy and lives depend. The right standard is not failure-avoidance but maximum performance. Electricity mergers fail that test.

The regulatory lapses

            Why do utility regulators, charged by law to replicate the discipline of competition, routinely defer to mergers undisciplined by competition?  Why do regulators allow the gain from these sales to go almost entirely to the utility’s shareholders? Why has no regulatory agency paused to consider how its individual approval, combined all other approvals, will increase the nation’s cumulative costs—of economic waste, reduced competition, misallocated gain, and customer risk? Three reasons stand out.

           Checklists instead of visions: No regulatory commission, state or federal, has described a vision for the electric industry—in terms of ownership type, asset concentration, corporate structure, financial structure, and business activities. From 1935 to 2005, the Public Utility Holding Company Act required utilities and their holding companies to be local, conservatively financed, and largely uninvolved in non-utility ventures.  Their electricity assets had to be interconnected or capable of interconnection. In 2005 Congress repealed that vision, leaving states to create their own. No state did. Instead of visions and standards, commissions have only checklists.

            Passion gap: Merger promoters have affirmative objectives: Increase shareholder value, grow market share, add to earnings, discourage competitors. Merger regulators lack affirmative objectives, so they focus on avoiding negatives. Their requests are few and small—intentionally small, so as not to kill transactions.  They say, in effect:  Keep the gains, maintain market dominance; just don't raise rates, don’t degrade service, don't fire workers immediately, don't act anticompetitively." Deference to a merger can be logical when the merger comes from, and improves, a competitive market. Mergers of electric utility monopolies don't qualify.           

            Systematic mental errors:   In official proxy statements, target utilities tell their shareholders the real story: "We sought and got the highest possible price." In applications for regulatory approval, they tell regulators a different story:  "We're merging to benefit our customers." Why does the latter story prevail so often? Nobel Prize winners Daniel Kahneman and Richard Thaler have proven that the human mind has two "systems": an automatic, instinctive system; and an effortful, analytical system. The automatic system exerts power over the effortful system, causing our initial impressions to harden into beliefs. That powers causes a host of mental errors. Applying their insights to electricity mergers raises this question: When regulators address mergers, which force is more powerful—instinct or analysis?


            Electricity’s concentration and complication continue. Prospective targets want the gains gotten by prior targets. Prospective acquirers want to get larger because their neighbors have gotten larger. As energy conservation flattens sales, and as large coal and nuclear generation is replaced by local renewable generation, utilities seek new revenue sources. Some choose acquisitions.

            To channel these urges in productive directions, regulators need to replace passivity with planning. They need first to ask the basic questions: What resource mix do we want? What services do customers need? Who should supply those services—incumbent utilities or new competitors? Without answering these questions, without creating their own electric industry visions, regulators cannot assess a merger proposal objectively. The typical regulatory approach—letting the target choose its acquirer based on price instead of performance, then trying to induce the post-acquisition company to meet the commission's standards for performance—does things backwards.

            The right commission vision requires best-in-class performance, low risks, and no business distractions—mergers motivated by customer service rather than revenue streams. With a vision in place, a commission can develop its must-haves and must-not-haves—the screens that distinguish mergers that satisfy the vision from those that don’t.