Increased competition that has emerged from deregulation of the electric and gas industries has, in part, created an environment in which the convergence of the two industries can flourish. Increased competition has pressured electric utilities and natural gas companies to combine operations in order to become more efficient, to diversify products, to share expertise and experience in energy markets, and to take advantage of the growing use of natural-gas-fired power plants. Combining electric utilities and natural gas companies has been called convergence of the industries, and many companies that once sold only electricity or natural gas in retail markets now sell both electricity and natural gas, or are involved in other aspects of both industries.

A combined electric and natural gas utility is not something new to the industry. Many investor-owned utilities (IOUs) sell both electricity and natural gas to retail customers. What is new about the recent wave of mergers is that many of them are between electric utilities and natural gas production, processing, or interstate pipeline companies. These types of mergers expand greatly the business opportunities for electric utilities.

From 1997 through September 1999, 20 convergence mergers involving companies with assets valued at $0.5 billion or higher have been completed or are pending completion(Table 7).⁽²⁵⁾ No one knows for certain how long this trend will continue, but many industry observers agree that more convergence mergers will take place as deregulation of the electric power industry continues and electric and natural gas companies seek to diversify their businesses.

The natural gas industry has a relatively complicated structure which, depending on one's classification scheme, may consist of four major corporate segments (Table 8). Some of the major natural gas companies are vertically integrated, having exploration and production, pipelines, storage, local distribution, and marketing components. The majority of the companies are not vertically integrated but specialize in one or two areas. Local distribution companies (LDCs) are the largest segment of the industry, with approximately 1,400 LDCs operating in the United States. The benefits to an electric utility of a convergence merger depend on where the gas company is located in the production cycle. An analysis of the current wave of convergence mergers shows that the benefits of the merger generally fall into one or more of the following areas.

Expand and Strengthen Access to a Fuel Supply for Merchant Power Plants: Many electric utility holding companies are merging with natural gas companies that specialize in natural gas production, processing, pipeline operation, and storage. In the natural gas industry parlance these are called upstream and midstream functions. Distribution to the ultimate customer is a downstream function. Electric utility mergers with upstream or midstream natural gas companies position the new company to benefit from the growing demand for natural gas stimulated by the projected growth in gas-fired power plants across the country.Because of the rising demand for electricity and retirement of older power generation units, 363 gigawatts of new generating capacity will be needed in the United States by 2020(Figure 7). Between 1997 and 2020, 126 gigawatts of nuclear and fossil-steam capacity are expected to be retired. Assuming an average plant capacity of 300 megawatts, a projected 1,210 new plants will be needed to meet electricity demand and to offset retirements. Eighty-eight percent of that capacity is projected to be natural-gas-fired or dual-fired gas and oil combined-cycle or combustion turbine technology. These technologies have lower capital costs and operating and maintenance costs than other technologies, and they meet more easily local and Federal Government emissions constraints, which are expected to tighten in the future. In 1997, gas-fired power generators produced 15 percent of total electricity generation in the United States; by 2020 they are projected to produce 33 percent of the total.

Figure 7. Projections of Growth in New Gas-Fired Power Generation, 1996-2020

Electric utilities that own upstream and midstream natural gas resources will be positioned to compete for customers in growing natural gas markets brought on by the increase in demand for gas-fired plants. Also, by owning upstream and midstream gas resources, a company can expand its range of products and services and build a marketing strategy focused on a customer's total energy needs.

Since 1997, eight convergence mergers--either completed or announced--have created relatively large vertically integrated energy companies that own both power generation, transmission, and distribution assets and natural gas assets, which may include a combination of natural gas production, gathering, and processing facilities, pipelines, and local distribution facilities. These new energy companies represent the first significant combinations of electric and gas companies beyond the established electric-gas distribution utilities. Following is a discussion of three of the eight convergence mergers creating integrated energy companies.

Enron's acquisition of Portland General Corporation in 1997 was the first merger of a natural gas company with an electricity company. Enron is an integrated energy company which, through its subsidiaries and affiliates, engages primarily in natural gas transportation and gas marketing. At the time of the merger, Enron had significant investments in intra- and interstate pipelines, and it was one of the largest natural gas purchasers and marketers in the United States. Enron also owns power plants and engages in electricity trading. Portland General Corporation is a holding company for Portland Electric, a vertically integrated electric utility based in Oregon.

From Enron's perspective, the merger with Portland had significant benefits in two areas. First, the merger strengthened Enron's electricity marketing activities in the West by providing a physical presence and better operational understanding of the region. Second, Portland had experience in managing electricity transmission and distribution systems, which supported Enron's plans to expand its retail electricity business. Some industry observers say that this merger paved the way for other convergence mergers because it successfully tested the regulatory approval process with the Federal Energy Regulatory Commission, which is responsible for assessing the effects of mergers on competition and electricity prices.

Also in 1997, Duke Power Company took a major step in redefining and restructuring its business from predominantly an electric utility to a major integrated energy company by merging with PanEnergy Corporation. Duke Power was an IOU with about 17 gigawatts of generating capacity at the time, offering wholesale and retail electricity services in the southeastern United States. Through smaller acquisitions and joint ventures, Duke Power was already on its way to achieving its objectives of becoming an energy company with diversified products and enhancing its marketing and trading operations when the decision was made to merge with PanEnergy. Duke found that the time and effort required to build the company was taking longer than expected. To keep pace with the rapidly changing energy markets, a merger with a large well-established company was needed.

PanEnergy was a holding company with subsidiaries that operated more than 37,500 miles of natural gas pipelines in the Mid-Atlantic, New England, and Midwest States, and it had a successful gas and electricity marketing and trading subsidiary. The merger complemented Duke's energy trading capabilities and gave it the ability to provide a variety of energy-related products. PanEnergy's pipeline business was viewed by Duke as a reliable and steady source of revenue with the potential for revenue growth as the use of gas-fired power plants in the Mid-Atlantic and New England States increases. Duke is clearly positioning itself to take advantage of the increase in natural gas demand in other regions as well. Recently it unveiled plans to build, own, and operate a major interstate natural gas pipeline that will supply energy markets in Florida and Alabama, where the demand for new generating capacity is growing.

More recently, another electric power company announced a merger with a large natural gas company. Dominion Resources Inc., the parent company of Virginia Power, an electric utility, and Dominion Energy, an unregulated power and natural gas producer, announced plans to merge with Consolidated Natural Gas (CNG). CNG is an integrated natural gas company and one of the Nation's largest producers, pipeline operators, distributors, and retail marketers of natural gas. This merger will create one of the largest fully integrated electric and gas companies in the United States. The combined company expects to increase revenue by marketing a complete line of energy products in the Midwest, Mid-Atlantic, and Northeast States, which are advanced in deregulating electricity markets. The new company plans to build gas-fired merchant plants along CNG's pipelines in the Midwest and the Pennsylvania-New Jersey-Maryland region to meet both peaking and baseload demand. Both companies have retail marketing and sales operations with few overlapping customers. This provides an opportunity to cross-sell electricity to CNG's retail gas customers and natural gas to Dominion's retail electricity customers.

Many electric utilities are merging with natural gas distribution companies either to expand the number of retail customers they serve, or to offer additional products to their current retail customers. Since 1997, 11 mergers between electric and gas distribution companies have been completed or are pending completion(Table 7). Many of these mergers have been in the Northeast, where most electric utilities have divested or are in the process of divesting their power generation assets and are seeking to expand their energy delivery business, as discussed in detail in the previous chapter.

Utilities in other regions are following the trend. For example, natural gas distributor Indiana Energy is merging with SigCorp, a combined electric and gas holding company for Southern Indiana Gas & Electric. An executive of Indiana Energy captured the essence of this type of merger when he said. With this merger our assets will be split evenly between electricity and natural gas distribution. This balances the company's earning potential while positioning it to deliver energy in whatever form our customers need.⁽²⁶⁾ Many utility executives believe that convergence is being driven by a growing preference among customers for suppliers that can meet all their energy needs and provide additional services to enhance the overall value of the products offered.

Endnotes

26. Indiana Energy press release, "Indiana Energy and SigCorp Agree to $1.9 Billion Merger," (June 14, 1999).

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