Figure ES1. Concentration of Ownership of Investor-Owned Utility Generating Capacity, 1992, 1998, and 2000

Since the passage of the Energy Policy Act of 1992, which opened the U.S. electric power industry to the start of competition,^(*) investor-owned electric utilities (IOUs) have been under pressure to cut costs, to become more efficient, and to expand their products and services. Mergers, acquisitions, asset divestitures, and other forms of corporate combinations have become widespread as IOUs seek to improve their positions in the increasingly competitive electric power industry. Since 1992 IOUs have been involved in 26 mergers, and an additional 16 mergers are pending approval. One effect of these mergers is that the industry is becoming more concentrated. In 1992 the 10 largest IOUs owned 36 percent of total IOU-held generation capacity, and the 20 largest IOUs owned 56 percent of IOU-held generation capacity (Figure ES1). By 2000, the 10 largest IOUs will own an estimated 51 percent of IOU-held generation capacity, and the 20 largest will own an estimated 73 percent.

In addition to mergers within the electricity industry, IOUs, seeing growth opportunities in the natural gas industry, are merging with or acquiring natural gas companies, contributing to what is referred to as convergence of the two industries. Since 1997, 20 convergence mergers involving companies with assets valued at $0.5 billion or higher have been completed or are pending completion. Combining energy marketing expertise, improving access to natural gas supply, and expanding products and services are reasons most often mentioned for the mergers.

Joint ventures and strategic alliances are alternative forms of corporate combinations used to meet the challenges of competition. Many IOUs have entered into ventures or alliances with other companies to construct or purchase power plants, to purchase energy products and services, and to market energy. The benefits of these arrangements are shared risks and costs.

Influenced predominantly by State-level electricity industry restructuring programs that emphasize the unbundling of generation from transmission and distribution, and in some cases by a desire to exit the competitive power generation business, IOUs are divesting power generation assets in unprecedented numbers. Starting in late 1997 through September 1999, IOUs collectively have divested or are in the process of divesting 133.0 gigawatts of power generation capacity, representing about 17 percent of total U.S. electric utility generation capacity. Divestiture means that the IOU will either sell its generation capacity to another company or transfer the generation capacity to an unregulated subsidiary within its own holding company structure.

Most of the sold capacity has been acquired by nonutility  power  producers  that are subsidiaries of utility holding companies. For the most part, the generation assets are sold through auctions. Final selling prices have been relatively high, usually 50 to 100 percent above book value (except for nuclear power plants, which have sold for less than book value).

As a result of mergers and divestitures over the past few years, the organizational structure of the electric power industry (i.e., the numbers and roles of the industry participants) is changing. The traditional role of the electric utility as a provider of electric power is giving way to the expanding role of nonutilities as providers of electric power. An analysis of electric power data collected by the Energy Information Administration for the period 1992 through 1998 offers the following insights:

• The number of IOUs has decreased by nearly 8 percent, while the number of nonutilities has increased by over 9 percent.

• Nonutilities are expanding and buying utility-divested generation assets, causing their net generation to increase by 42 percent and their nameplate capacity to increase by 72 percent from 1992 to 1998. Nonutility capacity and generation will increase even more as they acquire additional utility-divested generation assets over the next few years.

• The nonutility share of net generation has risen from 9 percent (286 million megawatthours) in 1992 to 11 percent (406 million megawatthours) in 1998.

• Utilities have historically dominated the addition of new capacity but additions to capacity by utilities are decreasing while additions by nonutilities are increasing. In the period 1985-1991, utilities were responsible for 62 percent of the industry's additions to capacity, but that figure dropped to 48 percent in the period 1992-1998.

The electric utility industry, once highly regulated, is becoming more competitive. In the past, retail customers purchased electricity from local utilities. Now, in some States, retail customers can shop around for an alternative electricity supplier with lower prices or better services. The transition to a competitive market for electricity has started but is not complete, nor is it occurring uniformly across the country. As of mid-1999, about 24 States are implementing retail competition, and more States are expected to follow.⁽²⁾

At the national level, the Energy Policy Act of 1992 (EPACT) and orders by the Federal Energy Regulatory Commission (FERC), the agency responsible for regulating interstate commerce of electricity, have promoted wholesale electricity competition. EPACT makes it easier for certain independent electricity suppliers to generate electric power and sell the power in wholesale electricity markets by exempting them from the constraints of the Public Utility Holding Company Act of 1935 (PUHCA).⁽³⁾ These independent electric companies compete against traditional electric utilities for the sale of electric power in wholesale and retail electricity markets. FERC Order 888 further promoted wholesale electricity competition by providing open access to the bulk power transmission grid to all electricity suppliers including power marketers, electric utilities, and nonutilities (i.e., power generation companies that are not utilities and therefore do not have a franchised service territory or own transmission facilities). Prior to Order 888, electric utilities owning bulk power transmission lines could restrict competitors' ability to move power by restricting access to their transmission lines.

Now that the industry is becoming more competitive, electricity suppliers are developing strategies to enhance their ability to compete. More and more the strategy involves a corporate combination such as a merger, joint venture, or business alliance to strengthen a company's position in the industry, or a divestiture of certain assets to  refocus  a  company's  business  line. Corporate com-

binations are not new to the electric power industry. Mergers between electric utilities, for example, have been employed many times to improve a company's performance. Over the past few years, however, the size and frequency of mergers among investor-owned electric utilities (IOUs) have increased dramatically.

This report presents data about corporate combinations involving IOUs in the United States, discusses corporate objectives for entering into such combinations, and assesses their cumulative effects on the structure of the industry. From the combinations that have taken place over the past few years, three trends have emerged: (1) an increase in the size of IOUs and the concentration of generation capacity within the IOU sector; (2) an expansion of IOUs, which once focused mainly on electricity production and delivery, into the natural gas industry (a trend that has been labeled "convergence" in the trade press and elsewhere); and (3) the move of many vertically integrated IOUs (i.e., utilities that own generation, transmission, and distribution assets) to exit the power generation business to become "wire" companies, enabling them to concentrate solely on operating their transmission and distribution systems.

Chapter 2 presents an overview of ownership in the electric power industry, comparing the ownership structure from 1992 to 1998. It compares and analyzes changes in the number of companies and in the relative shares of nameplate capacity, net generation, and additions to capacity by type of ownership. The year 1992 was selected because it was the year in which EPACT was passed by the U.S. Congress, and it represents, to a large extent, the beginning of the restructuring of the electric power industry.

Chapter 3 discusses mergers and acquisitions among electric utilities. It takes a quantitative look at the trend in consolidation of generation capacity caused by mergers and acquisitions, followed by a brief discussion of the primary reasons for electric utility mergers. Next, there is a discussion of specific developments in the industry related to the merger trend: (1) pending mergers that will create large vertically integrated power companies and significantly advance the consolidation trend in the industry; (2) the creation of large regional energy delivery companies; and (3) first-of-a-kind mergers involving electric utilities, independent power producers, and foreign utilities. The final section of the chapter discusses regulatory review of electric utility mergers and the FERC's role in ensuring Nonutilitythat combined companies will not have excess market power.

Chapter 4 discusses mergers and acquisitions between electric utilities and natural gas companies--or "convergence mergers." A combined natural gas and electric distribution utility is not new, but recent mergers involving vertically integrated electric utilities and integrated natural gas companies have created energy companies that produce, transport, market, and sell both gas and electricity. The chapter includes a listing of convergence mergers and a discussion of the rationale behind some of the major ones.

Two different forms of corporate combinations--joint ventures and marketing alliances of electric utilities--are discussed in Chapter 5. Many utilities enter joint ventures or marketing alliances in order to share the costs of new ventures, reduce risks, or capitalize on the expertise of other companies. Joint ventures and alliances have been around for some time, but in today's environment they tend to be used more.

Over the past year or more, many IOUs have sold  some or all of their power generation assets. This trend is new

to the electric power industry, and it signifies fundamental changes in corporate ownership of power generation in the United States. Chapter 6 analyzes utility divestitures of generating assets, which are expected to continue as more States move to restructure the electricity industry in their jurisdictions.

Appendix A presents a discussion of the Public Utility Holding Company Act of 1935. Many industry observers believe that this Act unfairly constrains registered holding companies, is no longer relevant in today's industry, and, therefore, should be repealed. Proposals to repeal or modify the Act have been introduced into the current Congress and are summarized in the appendix.

Appendix B contains case studies describing the process of asset divestiture for three utilities. It discusses the reasons given by the utilities for divesting their assets, the auction process, and special issues that may affect the selling of power generation assets.

Appendices C and D are two detailed case studies of electric utility mergers. Significant cost savings are almost always used to justify mergers to the regulatory authorities responsible for approving them. The objective of the case studies was to determine, using public data, whether the mergers resulted in the savings originally estimated by the companies.

Appendix E contains definitions of various types of corporate combinations.

Endnotes

2. Appendix A contains a discussion of the Public Utility Holding Company Act of 1935.

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