Appendix C

Case Study⁽⁵⁰⁾

In 1994 Cincinnati Gas & Electric Company (CG&E) merged with PSI Resources, Incorporated, to form a new registered holding company, CINergy Corporation (CINergy). The focus of this case study is to determine, using public data, if the objectives of the merger were realized. As proposed, the objectives were: (1) to receive the benefit of $750 million in cost savings expected over the 1994-2003 period; (2) to lower electricity rates for customers and enhance returns on stock equity for shareholders due to the cost savings; and (3) to create a larger, more efficient utility to better meet the challenges of a more competitive environment.⁽⁵¹⁾

Data sources for the analysis were: (1) Federal Energy Regulatory Commission (FERC): Merger Application and Testimony and FERC Form 1, (2) Securities and Exchange Commission: 10K filings, and (3) annual reports published by the merging companies.

Description of the Companies

Cincinnati Gas & Electric Company: CG&E is an investor-owned, gas and electric public utility incorporated in Ohio. It is a major utility⁽⁵²⁾ engaged in the production, transmission, distribution, and sale of electricity, and the transportation and sale of natural gas, to customers within Ohio. In addition to approximately 590,000 retail electricity customers, CG&E was under contract to satisfy full requirements of six municipal customers and two CG&E utility subsidiaries. Almost all of CG&E's electricity was produced by coal-fired generation plants. CG&E had four wholly-owned public utility subsidiaries and two wholly-owned nonutility subsidiaries when the merger closed. The four public utility subsidiaries were: Union Light, Heat and Power Company (Union), Miami Power Corporation (Miami), West Harrison Gas and Electric Company (West Harrison), and Lawrenceburg Gas Company (Lawrenceburg). The two nonutility companies were KO Transmission Company (formed in 1994 to become part-owner of an interstate gas pipeline company) and Tri-State Improvement Company (a company for acquiring and holding real estate in support of CG&E's utility operations.)

Union Light, Heat, and Power, also a major investor-owned public utility, is smaller than CG&E and owns no generation plants. At the close of the merger, Union purchased all of its electricity from its parent company, CG&E. Union engages in the transmission and distribution of electricity within Kentucky. During 1994, Union served approximately 110,000 retail electricity consumers and one full requirements wholesale municipal customer.

Miami, West Harrison, and Lawrenceburg are small utilities. At the close of the merger, Miami owned a 138 kV electric transmission line running from the Miami Fort Power Station to a point near Madison, Indiana. It is regulated by the FERC. West Harrison sold electricity over a 3-square-mile area, with a population of approximately 1,000, in southeastern Indiana. Lawrenceburg sold natural gas over a 60-square-mile area, with a population of 20,000, in southeastern Indiana.

PSI Resources, Incorporated: Prior to the merger, PSI Resources, Inc. was the parent company of PSI Energy, Inc. (PSI Energy), an electric utility serving Indiana. PSI Energy was approximately the same size utility as CG&E. In addition to approximately 630,000 retail electric customers within Indiana, PSI also supplied electric power for resale to municipal customers, rural electric membership corporations, the Wabash Valley Power Association (WVPA), and the Indiana Municipal Power Agency (IMPA). PSI owned its high-voltage transmission system as a tenant in common with IMPA and WVPA. In 1994, over 99 percent of PSI's electricity was produced in coal-fired plants; the remainder was hydroelectric generation. PSI Energy is regulated by the FERC for wholesale transactions, and by the Indian Utility Regulatory Commission (IURC) for retail electric rates.

At the time of the merger closure, PSI had two wholly-owned subsidiaries, PSI Energy Argentina, Inc. (formed to invest in foreign utility companies) and South Construction Company, Inc. (formed to hold title to real estate that was not used or useful in the conduct of PSI Energy's utility business).

CINergy Corporation: Following the merger, CINergy, a Delaware corporation, became the parent holding company for CG&E, PSI Energy, CINergy Investments, Inc. (CINergy Investments) and CINergy Services, Inc. (CINergy Services). PSI Resources, Inc. ceased to exist. The merger was accounted for as a pooling of interests, effected by an exchange of stock. Each preferred stock share of CG&E and PSI Resources, Inc. received one share of preferred stock of CINergy Corporation. One share of common stock of CG&E was converted into one common share of CINergy. Each common share of PSI Resources, Inc. was converted into 1.023 common shares of CINergy.

CINergy Investments, a nonutility subsidiary company, was created in 1994 to operate CINergy's nonutility subsidiaries and interests. These include utility management consulting services, utility investment services, demand-side management services, energy and fuel brokering services, and resource marketing services. CINergy Services was incorporated in 1994 to provide the companies of the CINergy system with a variety of administrative, management, and support services.

At the end of 1994, the newly formed CINergy had $8.15 billion in assets, $2.92 billion in annual operating revenues ($2.48 billion electric; $0.44 billion gas), $191 million in net income, and 8,868 employees.⁽⁵³⁾ CINergy became the 13^th largest electric utility in the Nation at the time.

Pre-Merger Estimated Cost Savings and Transaction Costs

The merging companies estimated $750 million in cost savings over the 1994-2003 period⁽⁵⁴⁾ primarily from three sources: (1) $113 million from electricity production (including fuel savings) from the joint dispatch of electric generation plants and lower reserve margin requirements;⁽⁵⁵⁾ (2) $400 million in lower revenue requirements due to capital expenditure reductions achieved through the deferral of new electricity generation capacity;⁽⁵⁶⁾ and (3) $230 million in administrative cost savings due to the elimination of approximately 400 redundant labor positions. Other initially non-costed administrative merger savings were expected to be derived from materials management savings, insurance premium savings, savings on software license fees, auditing and professional services, and lower capital expenditures on management information systems.⁽⁵⁷⁾ Before the FERC's approval of the merger in October 1994, the applicants had raised these cost savings estimates to approximately $1.3 to $1.5 billion, derived from: (1) combined production cost savings and lower revenue requirements due to deferral of new electricity generation capacity of $681 million (as compared to $513 million initially); (2) net personnel savings of $296 to $331.9 million based on workforce reductions of 400 to 450 positions, (3) non-labor cost savings of $239 to $357 million, and (4) avoided capital expenditure savings of $48.4 million (exclusive of generation capital expenditure and production cost savings).⁽⁵⁸⁾ These merger savings were expected to be shared approximately equally between CG&E (with Union) and PSI Energy.⁽⁵⁹⁾

There was not the same precision in the estimated merger transaction costs and costs to achieve merger savings (hereinafter collectively referred to as "merger costs") put forth by the merger applicants.⁽⁶⁰⁾ Adoption of ratepayer "hold harmless" provisions within settlement agreements made effective at the wholesale and retail rate level diminished the potential of merger costs on the ratepayer. Under the hold harmless provisions, merger costs could only be charged to customers if they were fully offset by demonstrated merger benefits.

PSI Energy's merger transaction costs were estimated at $27 million over the 1994-2003 period; its costs to achieve merger savings were estimated at $21 million, yielding total merger costs of approximately $48 million over ten years.⁽⁶¹⁾ During 1994, CG&E expensed $32 million of merger transaction costs and costs to achieve merger savings that were already incurred and were under the jurisdiction of the Public Utility Commission of Ohio (PUCO). Subsequent PUCO jurisdictional merger costs were to be expensed by CG&E in future years as incurred. The non-PUCO electric jurisdictional portion of merger costs was estimated at $14 million.⁽⁶²⁾ Therefore, by the end of 1994, total merger costs over the 1994-2003 period were estimated to be at least $46 million for CG&E (with Union), and $48 million for PSI Energy.

Allocation of Savings and Merger Costs to Customers and Shareholders

Each public utility regulatory commission provided formulas for allocating merger costs and savings between ratepayers and shareholders. These allocation formulas are worth noting because they may demonstrate the effects of the merger on electricity rates and shareholder returns on equity. The settlement agreement regarding the allocation formulas is usually complex and, therefore, only highlights of the formulas are discussed.

The Indiana Utility Regulatory Commission (IURC) approved a settlement agreement in February 1995 that effectively allocated net nonfuel merger savings 50/50 between customers and shareholders of PSI Energy. Retail customer base rate reductions were to begin immediately, and were scheduled to increase for three years. Fuel-related merger savings would be flowed through as incurred quarterly to the ratepayers via the fuel adjustment clause.⁽⁶³⁾ PUCO approved a settlement agreement in April 1994 which permitted CG&E to retain for the shareholders all of its electric nonfuel operation and maintenance (O&M) expense savings from the merger until 1999, in exchange for a moratorium on increases in base rates until that time. Fuel- cost-related merger savings would go directly to the ratepayers via the fuel adjustment clause as lower fuel costs were incurred.

In exchange for Kentucky Public Service Commission's (KPSC's) approval of the merger, Union accepted the KPSC's request for an electric rate moratorium commencing after Union's next rate case and extending to January 1, 2000. The KPSC also required CG&E and Union to agree that, for 12 months from consummation of the merger, no filings would be made to adjust CG&E's base purchase power rate charged to Union or Union's base electric rates. (As stated earlier in this report, at the time of the merger, Union purchased all of its electricity at wholesale from CG&E.) In July 1996, the KPSC issued an order authorizing a decrease in Union's electricity rates of approximately 1 percent to reflect a reduction in the cost of electricity purchased from CG&E.

As a condition of approval, the FERC made compliance with the plans of the merging entities to construct more high voltage (345 kV) transmission capacity mandatory in order to better integrate the two transmission systems, and to better allow for open access on CINergy's integrated system.

Effects of the Merger on CINergy's Overall Growth, Efficiency, and Profits

As described previously, one objective of the merger was to achieve net merger cost savings from greater efficiency in operations and administration, and thereby to increase equity returns to shareholders and reduce electricity rates to customers. Another objective was to better position the new company for increased competition in the utility industry. Achievement of better positioning is measured by the company's revenues, sales, and income after the merger.

Overall Growth Measurements

CINergy experienced a 3.1-percent annual growth in electric operating revenues before the merger (1991- 1994) exceeding the 2.4 percent national average of investor-owned electric utilities (IOUs) (Figure C1). However, after the merger (1994-1997), annual electric operating revenues growth accelerated rapidly at 15.9 percent, far exceeding the corresponding national average growth for IOU's at 2.9 percent.⁽⁶⁴⁾ This acceleration in electricity revenue growth after the merger was derived from growth in wholesale revenues, which more than quadrupled.

Growth in revenues after the merger was derived from rapidly growing wholesale sales of electricity. Annual wholesale sales before the merger were level, but after the merger they increased by more than a factor of five (Figure C2). The growth in wholesale sales is directly related to the growth in wholesale customers of CINergy's two subsidiaries with generation plants, namely PSI and CG&E (Figure C3).

Figure C1. CINergy's Operating Revenue, 1991-1997

Figure C2. CINergy's Retail and Wholesale Electricity Kilowatthour Sales, 1991-1997

Figure C3. CINergy's Subsidiaries' Wholesale Electricity Customers, 1991-1997

Because CINergy integrated and opened access to its transmission system during the merger, some of the credit for these additional wholesale sales can be attributed to the merger itself. This is illustrated by CINergy's annual average growth in wholesale sales in the 1994-1996 period (before FERC Order 888 was fully implemented) of 20 percent, compared to the annual average growth in wholesale sales of all U.S. investor- owned electric utilities of 7.4 percent over the same period. The remainder of the credit for CINergy's five-fold growth in wholesale sales in the 1994-1997 period can be attributed to the FERC's success in opening competition within the wholesale market by issuing Orders 888 and 889 in 1996.

Figure C4. CINergy's Subsidiaries' Total Employees, 1991-1997

Although revenues, wholesale electricity sales, and wholesale customers grew rapidly after the merger, the size of the company, measured by the number employees, declined. In an effort to realize merger savings, CG&E and PSI Energy completed voluntary workforce reduction programs in both 1994 and 1996. As a result, the number of employees at the three utility subsidiaries was reduced by half from 1994 to 1997, dropping from 7,521 to 3,768 (Figure C4). Workforce reduction actually began within CG&E in 1992 before the merger.⁽⁶⁵⁾ In 1992, CG&E eliminated 464 positions through voluntary workforce reductions in order to become more manpower efficient. The number of employees attributed to the electric utility department by CG&E and Union combined decreased by 350 between 1991 and 1992. (CG&E itself reduced 381 electric department employees, while Union increased electric department employees by 30.)

Only looking at CINergy's electric utility subsidiaries overstates the reduction in manpower, however, because of the creation of a new subsidiary, CINergy Services, in 1994. CINergy Services was established to provide administrative and support services to all of CINergy's subsidiaries, including the three major utilities. Some of the functions and positions attributed to the electric utility subsidiaries prior to the merger may have been transferred to CINergy Services after the reorganization in 1994.⁽⁶⁶⁾ Thus, a better indicator of the decline in manpower may be the reduction in total employees for all of CINergy, including all of its subsidiaries (utility and nonutility). After the merger (1994-1997), the total number of CINergy employees declined by 14.2 percent, from 8,868 to 7,609 (Figure C4).⁽⁶⁷⁾Because CINergy has been aggressively pursuing a more diverse set of activities since the merger (e.g., national energy trading, foreign acquisitions, joint ventures, etc.),⁽⁶⁸⁾ which tends to increase the number of employees associated with nonutility subsidiaries, the true reduction in the workforce associated with electricity sales and services in the CG&E, Union, and PSI franchise areas is probably somewhere within the broad range of 14 percent to 50 percent.

Overall Efficiency Measurements

The most important efficiency measurement to a ratepayer is the change in retail customer electricity rates. Retail electricity rate is defined as the average revenue per kilowatthour of sales to retail customers. CINergy's average annual retail electricity rate before the merger was increasing 1.09 percent, and only 0.46 percent annually after the merger (Figure C5). The lower growth in CINergy's retail rates after the merger occurred primarily because of the moratorium on rate increase through January 1, 1999 agreed to by CG&E when the merger was approved by PUCO. CG&E's retail rates were growing at 4.0 percent annually before the merger, but after the merger they declined at 1.68 percent per year. While this shows a decline in retail growth rates due presumably to the merger, increasing rates after the merger are in contrast to declining retail rates for all investor-owned electric utilities over the same 1994-1997 period, at 0.13 percent per year.

The merger appears to have little to no effect when the rates are adjusted for inflation. CINergy's average rates were declining by 1.5 percent annually before and after the merger in 1997 dollars (Figure C6). Thus, the merger produced no demonstrable benefits to the ratepayer in the form of lower real rates. Further, the national average rates were declining at about 3.2 percent annually from 1994 to 1997--more than double the percent decrease experienced by CINergy.

Figure C5. CINergy's and Major Investor-Owned Electric Utilities' Ultimate Customer Revenue, 1991-1997

Figure C6. CINergy's and Major Investor-Owned Electric Utilities' Retail Electricity Rates, 1991-1997

Figure C7. CINergy's and Subsidiaries' O&M Costs Minus Purchased Power Expenses, 1991-1997

A more direct measurement of efficiency gains in CINergy electricity production operations is found by inspecting changes in real operating and maintenance (O&M) costs. Prior to the merger, both major utilities with generation plants, PSI Energy and CG&E, were showing significant improvements in operational efficiency (Figure C7). From 1991 to 1994, PSI Energy reduced its real O&M costs by 3.1 percent annually, while CG&E showed an average annual reduction of 1.4 percent. When combined (although they were operating independently over much of this time), the real O&M cost declined by 2.4 percent annually. By the close of the merger, the two utilities were operating with coordinated generation dispatch, and the annual average efficiency gains under this measurement accelerated. Real O&M costs were reduced by an average annual rate of 3.7 percent between 1994 and 1997. As a result, by 1997, real O&M costs for the two utilities were 10.6 percent below the 1994 value, and 16.9 percent below the 1991 level.

Because CINergy projected merger savings due to workforce reductions, it is worthwhile to inspect indicators of electric department employee efficiency before and after the merger.⁽⁶⁹⁾ CINergy's total megawatthours of sales (ultimate consumer sales and sales for resale) per electric utility department employee increased dramatically after the merger (Figure C8). Before the merger, each electric department employee within the three subsidiaries was responsible for 6,331 megawatthours of sales on average. By 1994, this average had increased by 12.7 percent to 7,137 megawatthours of sales, primarily due to sales growth and voluntary workforce reductions. However, by 1997, each electric department employee within the three utilities was responsible for 28,894 megawatthours of sales on average, a gain by a factor of four over the 1994 average. This gain was due to: (1) an increase in the volume of sales for resale after the merger due to the integration of, and open access to, the transmission systems of PSI Energy and CG&E, and increased competition in the wholesale market; (2) voluntary workforce reduction programs after the merger;⁽⁷⁰⁾ and, as noted above, (3) a shift in some of the utility department employees and their functions to CINergy Services after the merger.

Another measurement of employee efficiency is the average number of electricity customers served per electric department employee. Prior to the merger, the number of customers serviced per employee had increased from 159 in 1991 to 177 in 1994, or 11.3 percent (Figure C9). After the merger, the average number of customers per electric department employee increased from 177 to 372, or 110 percent. This was due primarily to: (1) worker performance incentives;⁽⁷¹⁾ (2) the voluntary workforce reduction program completed in 1996; and (3) the probable shift of some administrative positions to CINergy Services after the merger.

Figure C8. CINergy's Megawatthour Sales per Electric Utility Department Employee, 1991-1997

Figure C9. CINergy's Electricity Customers per Electric Utility Department Employee, 1991-1997

Figure C10. CINergy's Customer Expense, 1991-1997

A customer-related measure of efficiency is customer expense per customer, adjusted for inflation. For this purpose, customer expense is defined as the sum of customer accounts expense and customer service and informational expenses. Real customer expense per customer decreased slightly before the merger, from $65.00 in 1991 to $61.00 per customer in 1994 (Figure C10). By the end of 1997, this measure had declined even further to $50.00 per customer, a savings of 18.0 percent from 1994 levels.

Figure C11. CINergy's Net Electric Utility Operating Income, 1991-1997

Overall Profitability Measurements

Net electric utility operating income for the sum of CINergy's three major utility subsidiaries peaked in 1995, the year after the closure of the merger, and each year through 1997 (Figure C11). Based on statements within CINergy's Annual Report for 1997, operating income declined for CINergy primarily for two reasons. First, the merger was good for only two to three years of earnings growth, and by 1997 merger-driven earnings growth had dissipated. Second, greater investment in CINergy's growth was needed after the merger for CINergy to meet its goal set at the end of 1996 of becoming the fifth largest combination electric and gas utility in the Nation within five years. This would be measured on January 1, 2002, on five dimensions: market capitalization, number of customers, gas and electric commodity trading, international markets, and productivity in key operational areas. The catchy phrase for this goal was "5 in 5 on 5." Movement toward this goal involved high costs for scaling up operations.⁽⁷²⁾Net utility operating income per kWh of total sales (retail and wholesale) for the period after the merger peaked in 1995 at 0.94 cents per kWh, and declined rapidly thereafter to 0.46 cents per kWh in 1997 (Figure C11).

In comparison, the net electric utility operating income per kWh for all IOUs also peaked in 1995, but at ahigher level than CINergy at 1.17 cents per kWh. Thus, CINergy followed the Nation's decline in profit margins on total kWh sales after 1995 despite the benefits of the merger.

CINergy's decline in net utility operating income per kWh after 1995 is due to the reduction in total electric operating income evidenced in Figure C11 combined with the rapid increase in wholesale sales, as earlier shown in Figure C2. The increase in wholesale sales was derived from increases in wholesale customers, shown in Figure C3, due, in part, to CINergy's acceleration of power marketing and trading activity in the wholesale market. As part of the "5 in 5 on 5" goal, CINergy set out to expand trading/marketing activities to their fullest. As a result, by the end of 1997, CINergy ranked 7^th in the Nation among electricity commodity trading companies, as measured by megawatthours purchased from power marketers. During 1997, CINergy was selected by the New York Mercantile Exchange (NYMEX) as one of only four electricity futures market trading hubs in the Nation. The trading hub was made operational in July 1998.⁽⁷³⁾

CINergy's actual net earnings per average common share were higher in each year after the merger through 1997 as compared with 1994 levels, which might be expected based on the high level of savings derived from the merger. However, net earnings per share declined substantially in 1998 (Figure C12) because of "charges that resolve uncertainties and provide a more solid footing for future growth."⁽⁷⁴⁾ These charges included 0.54 cents per share in the energy marketing and trading business for the establishment of net trading liabilities. In contrast, CINergy, in its 1998 Annual Report, shows "normalized earnings" (adjusted for operational noncomparable items, nonoperational noncomparable items, and effects of weather) growing steadily from $1.85 per share in 1994 to $2.50 per share in 1998.

Investors clearly have shown that they liked CINergy's growth objectives, increasing the market share of its common stock faster than the Dow Jones Utility Average (Figure C13). Total returns on common stock equity (dividend yield plus capital appreciation of the stock) for each year after the merger through 1997 were substantial (Figure C14). From October 1994 through December 31, 1998, total return on common stock equity to CINergy's shareholders was 92.75 percent. But this total return was below the average of a benchmark group consisting of the largest 25 electric utilities (98.19 percent) and below the average of the companies included in the Standard & Poor's (S&P's) electric index (100.74 percent). CINergy was above both of these comparable groups at the end of 1997, but experienced a negative total return in 1998 of 5.4 percent due to the 1998 drop in net earnings per common share cited above.⁽⁷⁵⁾

Figure C12. CINergy's and Major Investor-Owned Electric Utilities' Net Earnings per Average Common Share, 1991-1997

Figure C13. Comparison of CINergy Common Stock Price and Dow Jones Utility Average,October 1994-December 1998

Figure C14. CINergy Total Return on Equity, 1995-1998

One way to interpret CINergy's earnings and shareholder returns is that the shareholders truly gained from the merger, mainly because it led to high expectations in earnings growth, and led many investors to believe that CINergy would be one of the survivors in the industry when competition is fully implemented. Some of this earnings growth was actually realized in the 1994 to 1997 period, but by 1998, nearly all of the stimuli for earnings growth derived from the merger had been dissipated. By then, CINergy needed another major growth step in business operations in order to boost earnings and to maintain positive total annual returns on equity for the shareholders.

Assessment of Merger Effects on Ratepayers and Shareholders

Based on the overall growth, efficiency, and profitability measurements studied in this section, the following general conclusions can be drawn:

• The CINergy merger in 1994, when coupled with the opening of wholesale markets to competition in mid-1996, stimulated the rapid annual growth of electric operating revenues, wholesale kWh sales, and wholesale customers during the 1994 through 1997 post-merger period. In fact, growth in CINergy's business operations was the most noticeable result of the merger.


• CINergy's operational efficiency improved somewhat as a result of the merger. From 1994-1997, CINergy's real O&M costs per kWh declined faster than before the merger, its electric department workforce efficiency improved as measured by both megawatthour sales per employee and customers served per employee, and its real customer expense per customer declined. (Conclusions regarding electric department workforce efficiency gains have to be qualified because of the probable transfer of some electric department administrative functions to CINergy Services, the new subsidiary formed in 1994.)


• CINergy's ultimate (retail) customers enjoyed a slowdown in the growth of customer rates after the merger in nominal dollars (the 1.09 percent average annual increase in the 1991-1994 period dropped to 0.46 percent for the 1994-1997 period). However, adjusted for inflation, customer rates continued the same annual decline rate after the merger as before the merger (averaging 1.5 percent per year). Thus, retail ratepayers probably did not experience much real benefit from the merger. Wholesale customers did benefit by the integration of, and open access to, CINergy's transmission system.


• Shareholders of CINergy received the most direct benefit from the merger, at least through 1997. According to CINergy's 1998 Annual Report, shareholder total returns (dividends and common stock price gains) from merger closing through 1997 exceeded those for the S&P 500 electrics and a group of 25 of the largest combination electric and gas utilities. However, by the end of 1998, the impetus in growth of earnings and common share price from the merger had waned, and shareholders experienced a negative total return on common stock of 5.4 percent in 1998 due primarily to a downturn in operating income and net earnings per common share.

Analysis of Estimated Pre-Merger and Post-Merger Savings and Costs

As described previously, when CINergy first applied to the FERC for approval of the merger in 1992, it estimated that cost savings would be approximately $750 million over the 1994-2003 period. In 1993, CINergy increased its estimate to approximately $1.3 to $1.5 billion, but without providing many details. These cost savings were from elimination of redundant positions, deferred capital expenditures for generation, efficiency improvements in electricity production, and other improvements in the efficiency of administrative procedures. (See Table C1 for a summary of estimated pre-merger and post-merger cost savings.) Each of these potential cost savings categories are analyzed below, followed by an itemization of recorded merger costs.

CINergy initially estimated it was going to eliminate 400 employee positions made redundant by the merger, and increased the estimate to a range of 400 to 450, or about 10 to15 percent of "corporate" staff.⁽⁷⁶⁾ (PSI Energy and CG&E classified approximately 3,100 employees of 9,100 employees at the end of 1992 as "corporate staff.") These redundant position estimates were based on reduction ratios experienced by corporate departments in previous utility mergers and an analysis of employee efficiency ratios at comparable IOUs. These planned employee reductions were expected to lead to cost savings initially estimated at $229 million, and subsequently increased to a range of $296 to $331.9 million cumulative in the 1995-2003 period. CINergy based these estimates on an average salary in 1994 of $56,100, escalating at 4.5 percent per year in nominal dollars, and all employee reductions were phased in equally in three parts over the 1995-1997 period.

There is little doubt that the employee reductions occurred at least as well as planned. CINergy as a whole reduced its total number of employees by 1,259 (14.2 percent) over the 1994-1997 period, from 8,868 to 7,609. CINergy employees allocated to the electric departments at the three major subsidiaries declined by 3,753 (50 percent) over this same period, from 7,521 to 3,768. Some of these utility functions probably went to CINergy Services, Inc. But, since the whole company's total staff declined by about three times more than estimated, one can conclude that the employee reductions resulting from the merger were probably realized.

Figure C15. CINergy's Total Salaries and Wages of Corporate Employees, 1991-1997

Another question is whether the dollar savings from employee reductions were realized. Total "corporate employee" salaries and wages fell by 0.6 percent during the 1994-1997 period, as compared to a rise of 14.1 percent over this period as initially projected by the CINergy applicants (i.e., 4.5 percent annual growth rate in salaries and wages applied over three years) (Figure C15).⁽⁷⁷⁾ The savings from the reduction in salaries and wages accumulate to approximately $41 million over the period. Applying the reported average overhead rate of 30 percent for benefits and pensions yields a total salaries and benefits savings of approximately $53 million. When the savings are projected out from 1997 at the labor cost inflation rate used by CINergy of 4.5 percent per year, total salaries and benefits savings accrue to approximately 268 million in nominal dollars for the 10-year period 1994-2003. (Table C2 displays the worksheet used to project salaries and benefits savings.)

What cannot be determined from this analysis is the level of salaries and wages within CINergy Services that, prior to the reorganization in 1994, were properly attributed to the electric departments of CINergy's three major utility subsidiaries. This means that the total savings shown are probably overstated. However, with this qualification, it appears that public data support CINergy's estimate of savings due to the elimination of redundant employee positions within the broad range of $229 to $331.9 million.

What is surprising is that realized savings are close to estimated savings when the workforce within the electric departments of the three subsidiaries was actually reduced by 3,753 employees, which was far greater than the 400-450 positions estimated by CINergy, implying that the savings should have been higher than originally estimated. Figure C15 provides an understanding of what happened. Total wages and salaries per electric utility employee (including production, transmission, and distribution employees) grew at a rate of 24.2 percent per year in the 1994-1997 period, much higher than CINergy's projected average annual labor inflation rate of 4.5 percent. This was probably a direct result of: (1) CINergy's post-merger recruitment program aimed at attracting and retaining people talented in trading, marketing, and other competitive areas, in contrast to traditional utility functions;⁽⁷⁸⁾ and (2) CINergy's new employee incentive programs which provided cash as well as common stock bonuses based on performance.

The merging entities projected that coordination of the dispatch of their generation plants would result in an ability to cut their planning reserve margin⁽⁷⁹⁾ from 20 percent or more, to 17 percent. This allowed a deferral of constructing approximately 499 MW of new generation capacity over the 1995-2003 period. This included one 120 turbo power and marine combustion turbine

(CT) scheduled for 1995 by PSI, and one 400 MW coal baseload plant planned by CG&E for 2002. Larger CTs would be substituted for the CTs planned by PSI over the 1999-2003 period. In fact, the merger would allow CINergy to defer all baseload capacity additions until 2004 or beyond. Whereas the two generation systems operating independently would require 1,690 MW of capacity additions over the 1995-2003 period, CINergy would only require 1,191 MW. These deferrals were projected to result in a reduction of fixed charges of $400 million over the 1995-2003 period.⁽⁸⁰⁾

To determine whether these savings are being realized, one can inspect the capacity additions that actually occurred over the 1995-1998 period. The difference was expected to be the deferral of one 99 turbo power and marine CT in 1995 on the PSI system. Also, instead of three Asea Brown Boveri CTs amounting to 231 MW planned for the CG&E system in 1998, CINergy would be adding somewhere on its system only one 99 MW turbo power and marine CT. Deferred fixed charges to rates were projected to be $7.5 million in each of years 1995-1997, and $19.8 million in 1998, accumulating to $42.3 million over the 1995-1998 period.⁽⁸¹⁾ These merger savings were in fact realized because, according to CINergy's filed SEC 10-K reports for the corresponding years, CINergy added no new generation capacity over the 1995-1998 period. Instead, 129 MW of oil generation capacity at the Miami Fort Gas Turbine Station in North Bend, Ohio was eliminated over this period.

CG&E testified before the FERC in the initial merger application, that it took approximately four years of lead time to bring new CT capacity on line and 10 years for new coal-fired base load capacity.⁽⁸²⁾ Within its 1996 SEC Form 10-K, CINergy stated that it is no longer forecasting investments in new generating facilities under the belief that excess supply in the market will continue to exist at least through the transition to full retail competition. CINergy presented no capital investment plans for new generation capacity in the 1999-2003 period. Thus, it is likely that the entire $400 million in initially estimated reduced revenue requirements associated with deferred generation capacity additions will be realized over the 1995-2003 period.

The merging entities initially estimated in December 1992 production cost savings of $113 million over the 1994-2003 period, and in 1993, increased this estimate to approximately $281 million.⁽⁸³⁾ Electricity production cost savings included both O&M cost savings and fuel cost savings that resulted from the coordinated dispatch of the generation units to meet the electricity requirements of retail consumers and firm contract wholesale customers. Under the initial estimate, the savings were small in the early years, totaling $25 million from the closure of the merger through 1997 (Table C3). No annual details for the second estimate were provided to the FERC, but the simple scaling up of the $25 million initial estimate by the ratio of the two total production cost estimates yields a second estimate of $62 million in savings for the 1994-1997 period.

Table C3. Post-Merger Production Cost Savings For CINergy Corporation
	1993	1994	1995	1996	1997	Total
Actual Total Production Costs Minus Purchased Power Expenses per Net Generation kWh (c/kWh)	1.8338	1.8320	1.7506	1.7666	1.6961	--
Savings per kWh from 1993 (c/kWh)	--	0.0018	0.0832	0.0672	0.1377	--
Total Retail Sales and Wholesale Sales (MWh)	--	47,619,873	49,977,949	51,409,473	51,708,202	--
Estimated Actual Production Cost Savings (Million Dollars)	--	0.9	41.6	34.5	71.2	148.2
CINergy Initially Projected Production Cost Savings (Million Dollars)	--	7.0	3.0	3.0	12.0	25.0
-- = Not applicable.    Note 1: Source of Actual Data on Production Costs, Generation and Sales is FERC Form 1.    Note 2: Source of CINergy Initially Projected Production Cost Savings is Prepared Testimony of James E. Benning, FERC Docket No. EC93-6, December 21, 1992, Exhibit JEB-13.

This category of savings is difficult to assess using publicly available data because CINergy's projection of production costs savings is based on the execution of an electric power dispatch model, PROMOD III, and very few of the many assumptions used to run the model were discussed in CINergy's application to FERC. However, using FERC Form 1 data, one can obtain an estimate of these savings by observing changes during the 1994-1997 period in power production costs associated with generation. This can be approximated by subtracting purchased power expenses from total power production costs.

Figure C16. CINergy's Power Production Expenses, 1991-1997

The data suggest that the merging entities were becoming more efficient even before closure of the merger, as this measure of average native load power production costs decreased from 1.96 cents per kWh to 1.83 cents per kWh between 1991 and 1994, a decline of 6.4 percent (Figure C16). However, after the merger, the efficiency gains accelerated, and by 1997, total power production costs minus purchased power expenses per net generation kilowatthour dropped to 1.70 cents per kWh, a decline of 7.4 percent from the 1994 level.

Because the fuel price escalation assumptions underlying CINergy's PROMOD III model runs are unknown, apparent efficiency gains due to differences in actual and assumed fuel price escalation cannot be isolated from efficiency gains due to the coordination of generation dispatch. Therefore, the best available comparison with CINergy's projected production cost savings estimate is obtained by assuming that the entire decline in total power production costs minus purchased power expenses per net generation kilowatthour from 1994 to 1997 is due to efficiency gains from the coordination of generation dispatch. This produces a total estimated production cost savings of approximately $148 million through 1997 (Table C3). This apparent savings is far greater than the high estimate of $68 million for the 1994-1997 period as derived above from CINergy's second estimate of production cost savings. Thus, it is probable that CINergy attained at least its high estimate in production cost savings over the years 1994-1997. Furthermore, because CINergy did not actually add more generation capacity than expected at the time of the merger application, and generation dispatch will continue to be coordinated by the merged entities, it is likely that production cost savings will continue to accrue in the 1998-2003 period as estimated by CINergy utilizing the PROMOD III model. In conclusion, inferences that can be drawn from the FERC Form 1 data appear to support CINergy's high estimate of $281 million in production cost savings over the 1994-2003 period.

In the initial estimate of merger savings by the applicants (December 1992), non-labor cost savings were not estimated. They were expected to be derived from materials management savings, insurance premium savings, savings on software license fees, auditing and professional services, and lower capital expenditures on management information systems.⁽⁸⁴⁾ For the second estimate that was submitted to the FERC in July 1993, non-labor administrative cost savings were estimated at $239 to $357 million over the 1994-2003 period, and avoided capital expenditure savings (not related to generation capital expenditures and production cost savings) were estimated at $48.4 million. However, no details were provided to the FERC.⁽⁸⁵⁾

Figure C17. CINergy's Non-Labor Administrative Costs, 1991-1997

An inspection of non-labor administrative cost efficiency changes after the merger may provide a clue as to whether CINergy's estimated non-labor administrative cost savings are being realized. Figure C17 shows annual changes for a proxy from the FERC Form 1 data for non-labor administrative costs minus allocated salaries and wages. The costs are the sum of total customer accounts expenses, total customer service and information expenses, total sales expenses, and administrative and general expenses. Non-labor administrative costs for the three utility subsidiaries held reasonably steady at approximately $150 million over the 1991-1993 period, then increased dramatically with the reorganization in 1994 to over $225 million. In the post-merger period, non-labor administrative costs increased further to over $290 million by 1997. When these non-labor administrative expenses are divided by total customers as shown in Figure C17, efficiency gains after the merger are still not apparent. In fact, non-labor administrative costs increased from about $169 per customer in 1994 to over $207 per customer in 1997.

Based on these illustrations, it can be concluded that the FERC Form 1 data does not support the realization of CINergy's estimated non-labor administrative cost savings in the post-merger period through 1997. Because the estimated avoided capital expenditure savings of $48.4 million in CINergy's second estimate were not itemized before the FERC, publicly available data could not be applied to determine whether or not these capital expenditures were actually avoided.

At the end of 1994, total merger costs over the 1994-2003 period  were estimated to be $48 million for PSI Energy, at least $46 million for CG&E, and therefore at least $94 million for CINergy as a whole. However, actual costs attributed to the merger shown on CINergy's SEC 10-K annual reports for the years 1994 through 1998 totaled about $225 million (Table C4).

85. Op. cit., Response of Applicants to Staff Request for Information, July 26, 1993, page 3.

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