Dealing with Antitrust Questions in Energy Mergers & Acquisitions

1. Utility Mergers & Acquisitions Conference Center for Business Intelligence San Antonio, Texas October 19, 2001 Stephen Paul Mahinka Floyd L. Norton IV Washington, DC Dealing with Antitrust Questions in Energy Mergers & Acquisitions

2. Agencies & Enforcement Agencies Agencies Criteria Criteria Effects Effects Alleviate Harm Alleviate Harm Remedies Remedies

3. DOJ FTC FERC State Electricity Natural Gas Petroleum Convergence Enforcement Agencies Agencies Criteria Effects Alleviate Harm Remedies

4. State Enforcement Agencies Agencies • State attorney general offices have become more aggressive in reviewing mergers. • The level of involvement of the states varies greatly from state to state. California, Texas, New York and Virginia have been some of the more proactive states. Criteria Effects Alleviate Harm Remedies

5. FERC Review Agencies Agencies • Under Federal Power Act Section 203, FERC reviews mergers, dispositions of jurisdictional facilities or changes in control over jurisdictional facilities • Jurisdictional facilities include transmission facilities (including step-ups), wholesale rate schedules and contracts Criteria Effects Alleviate Harm Remedies

6. Criteria For Review Agencies Criteria Criteria Effects Effects Alleviate Harm Alleviate Harm Remedies Remedies

7. What types of acquisitions can the government review? Agencies • Any agreement or combination that may limit competition • Any merger valued over a certain dollar amount, must be reported to the FTC and DOJ under the Hart-Scott-Rodino Act Criteria Criteria Effects Alleviate Harm Remedies

8. Hart-Scott-Rodino Act Changes Agencies • Raised the dollar amount of transactions that must be reported to transactions over $50 million • Eliminated the 15% size of transaction threshold • Made transactions valued at more than $200 million reportable without regard to the “size of person” Criteria Criteria Effects Alleviate Harm Remedies

9. What are the review criteria? Agencies • Product Market • Geographic Market • Competitive Effects • Efficiencies Criteria Criteria Effects Alleviate Harm Remedies

10. ProductMarket Agencies • Can vary depending on energy sources involved in merger. • Can vary depending on transmission capability. • Can vary by time of day demand/supply. Criteria Criteria Effects Alleviate Harm Remedies

11. Geographic Market Agencies • What areas and regions will be affected by the merger? • Generally will be defined by practical transmission capability. • Agencies may differ on geographic market definitions. Criteria Criteria Effects Alleviate Harm Remedies

12. Competitive Effects Agencies How will the transaction affect consumers? Criteria Criteria Effects Alleviate Harm Remedies

13. Every other player’s % market share2 Merging firms’ % market share2 + = HHI Market Concentrations Agencies Herfindahl-Hirschman Index Criteria Criteria Effects If ‹ 1000 = unconcentrated Alleviate Harm If › 1000 ‹ 1800 = moderate Remedies If › 1800 = highly concentrated

14. Areas of FERC review Agencies • Effect on competition • Effect on rates • Effect on regulation Criteria Criteria Effects Alleviate Harm Remedies

15. FERC competition review Agencies • Horizontal Transactions: “Appendix A” analysis, from FERC’s Merger Policy Statement, based on Merger guidelines • Vertical Transactions: Vertical competitive analysis, from FERC’s Order No. 642 (November 2000) Criteria Criteria Effects Alleviate Harm Remedies

16. Competitive Effects Agencies Criteria Effects Effects Alleviate Harm Alleviate Harm Remedies Remedies

17. Competition and Energy Restructuring Agencies • Wholesale issues • Will the merger drive up prices in a number of organized “spot” markets for electric power? • Retail issues • Will the merger eliminate actual or potential competition in recently opened retail markets? • Can consumers switch to another supplier? Criteria Effects Effects Alleviate Harm Remedies

18. Will the merger raise wholesale prices? Agencies • Wholesale sales take many forms: • Long-term contracts for the sale of power between a generator and a utility; • A sale by a company that has taken financial risk by purchasing electric power with the intent to resell it for profit; • Spot sales that may be good for an hour or less. Criteria Effects Effects Alleviate Harm Remedies

19. Auctions Agencies • Organized spot markets run by the ISOs may be affected by a merger • Will a merger between owners of generating capacities change competitive incentives? • Would a merger lead to a different set of bidding strategies that may affect the market-clearing price? • Would there be a unilateral incentive to withhold capacity from the market, forcing the ISO to set the market-clearing price based on a higher-cost unit of capacity? Criteria Effects Effects Alleviate Harm Remedies

20. This theory fails to take into account that many suppliers of power may actually be net-buyers of power. Single Firm Behavior Agencies • What will a single merged firm do? • The government will often argue that the merger could expand the firm’s base of capacity and add incentives to force a higher market price. Criteria Effects Effects Alleviate Harm Remedies

21. Will other competitors take prices set by the merged firm or will they reduce price to gain market share? Collusive Behavior Agencies • Will the consolidation of two firms in the market change the way all firms in the market act? • Does the merger create an entity with enough market power to lead prices for the entire market? Criteria Effects Effects Alleviate Harm Remedies

22. Agencies • FERC Appendix A analysis measures changes in market concentration in relevant markets, using HHIs • Where HHI increase limits are exceeded, remedies may include generation divestiture, output auctions, as well as RTO participation and removal of transmission constraints Criteria Effects Effects Alleviate Harm Remedies

23. Agencies • FERC vertical analysis examines whether combination of interests in electric generation and gas assets or in electric generation and transmission assets will affect competition in electricity markets • FERC exempts certain types of transactions: where applicants do not provide both inputs to electricity products and electricity products in the same geographic markets Criteria Effects Effects Alleviate Harm Remedies

24. Alleviating Competitive Harm Agencies Criteria Effects Alleviate Harm Alleviate Harm Remedies Remedies

25. Entry Agencies • If prices increase, will new competitors enter the market? • New entry must be timely, substantial, and have a likelihood of defeating any potential price increase brought about by the merger. Criteria Effects Alleviate Harm Alleviate Harm Remedies

26. Efficiencies Agencies • Will the merger result in cost savings? Cost savings must be specific to the merger and be quantifiable. • Will these savings be passed along to the consumer to offset the potential competitive harm? Criteria Effects Alleviate Harm Alleviate Harm Remedies

27. Remedies Agencies What do you do if the enforcers cannot be convinced that a deal is not anticompetitive? Criteria Effects Alleviate Harm Remedies Remedies

28. Remedies Agencies • Comply with the government’s requests for information and go forward with the deal. • Divestitures Criteria Effects When deciding how to react to the government, it is critical to maintain a uniform approach in dealing with all involved agencies. Alleviate Harm Remedies Remedies

29. Divestitures Agencies • The government has required two types of divestitures. • Selling a stand-alone asset or a line of business to another firm. • Entering into long-term contracts with fixed price terms to prevent the merging firms from acting anticompetitively. Criteria Effects Alleviate Harm Remedies Remedies

30. Recent Developments in FERC Merger and Review Process Agencies • FERC Chairman Wood has urged that transmitting utilities or their jurisdictional affiliates not be allowed to merge unless utility participates in FERC-approved RTO Criteria Effects Alleviate Harm Remedies Remedies

31. Final Approval Agencies • Importance of coordination • among the companies • before all involved agencies Criteria Effects Alleviate Harm Remedies Remedies

32. Final Approval Agencies • Pre-Closing Coordination • Merging parties may undertake some joint activities prior to closing • Transition planning/transition implementation • Competitive significance/justification of the coordinated activities/asset transfers/long-term agreements. Criteria Effects Alleviate Harm Remedies Remedies