Exelon, FirstEnergy Fleeing “Free Market”

During the HB2201 fight, we have heard a lot of WV legislators and power company lobbyists bloviating about “the free market.” In the electrical industry right now, no power companies support free markets.  They are all pushing as many of their assets into state regulated monopolies as possible to protect their shareholders from new competition from innovation and decentralization.

I have covered Exelon’s attempt to take over Pepco Holdings in an earlier post.  Pepco Holdings owns small utilities in NJ, DE and East VA, but the big fight will be in MD and DC, in the heart of Pepco’s customer base.  MD and DC PSCs are right in the middle of their merger cases.

Last week, the state of MD filed its brief in the MD PSC case.  The brief is a scathing but well argued case for rejection of Exelon’s merger bid.

After twelve (12) days of hearings, the receipt of testimony from dozens of witness, and the development of a record that spans several thousand pages, the answer to this question is clear: Maryland and its ratepayers will not be “better off’ if the merger is completed-unfortunately, the opposite is likely true. The merger enjoys no support from the State or numerous affected stakeholders. This is not surprising-other than a $54 per customer rate credit, there is nothing in this nearly $7 billion transaction that is of tangible benefit to customers or Maryland’s economy. Worse, the transaction poses significant potential harms, and Applicants’ commitments fail to mitigate them. Indeed, implementation of certain of the commitments could make things worse than would otherwise be the case.

Two of the main issues in the case involve Exelon’s lack of commitment to Pepco’s system reliability and to supporting innovation and development of more distributed generation, including small scale solar power.  Here is what MD officials have to say on these subjects:

Reliability. Applicants promise to improve reliability in the Pepco/Delmarva territories, subject to a spending cap-actions which will allegedly provide almost $500 million in economic value in the form of reduced outages. Evidence adduced at trial shows that these claims are false. Contrary to the assumption of its own expert witness, Exelon revealed that it has no “engineering plan” supporting its reliability targets, and will need at least six months in the field to ascertain what reliability improvements can be achieved, by when, and at what cost.

Needed reliability projects may be delayed, and reliability may suffer as Exelon brings itself up to speed.

Worse, unlike pending proposals from Pepco and Delmarva, and contrary to Commission regulations, Exelon’s reliability commitment includes no targets for 2015,2016, or 2017, and no annual targets for 2018, 2019, or 2020. In fact, Exelon’s proposal would not bind it to any reliability target until the end of 2020, roughly five years after consummation of the merger. A Pepco or Delmarva customer experiencing a power outage in the meantime is unlikely to care whether Exelon can meet a “three-year average” atthe end of 2020.

And, if Exelon fails to meet its commitment, then the Company-not the Commission-gets to determine when any penalty is imposed, based on when Exelon files a rate case. Even if this regimen were acceptable, Exelon’s commitment is based on internal annual goals that are in some instances indisputably less stringent than the annual standards already proposed by Pepco and Delmarva, rendering the commitment a harm rather than a benefit. And whatever can be achieved will come with an unknown price tag. Exelon’s budget “commitment” is no more than a promise to seek Commission approval to raise rates even further if Exelon needs more money than it thought-which is likely given that Exelon is yet to perform what it considers to be essential engineering studies. Rather than taking responsibility for these unknown risks, Exelon expects customers, not shareholders, to bear them.

Competition and Innovation. Post-merger, Exelon will control service to 80% of the State’s ratepayers. Internal documents show that Exelon plans to operate its distribution utilities to protect the Company’s massive, multi-billion dollar investment in unregulated generation (including its economically challenged nuclear plants) by seeking to control the pace of distributed energy resource (DER) penetration in retail service territories. The State’s testimony demonstrates that Exelon has both the incentive and, through its utilities, the ability to stifle the implementation of innovative, customer-driven DER, including resources that may improve service reliability. And the contrast could not be more stark: pre-merger, PHI was developing a “Utility 2.0” plan, but that effort is now on hold; Exelon-affiliate Baltimore Gas & Electric (BGE), on the other hand, possesses not a single piece of paper concerning this initiative. The stakes are high: the competitive issues raised by the merger involve the future of Maryland’s electric industry at a time of transformative change. That future is better served by Pepco and Delmarva offering proposals and insights uncompromised by the need to protect Exelon’s merchant generation. As the industry moves toward the distribution “utility of the future,” Maryland’s regulated utilities should be focused on embracing-not undermining pro-consumer reforms. Applicants’ commitments ignore this issue entirely, and there is no meaningful way to mitigate the attendant harms.

MD is an “deregulated” state, unlike WV.  Pepco, as it now exists, does not generate any electricity of its own, so the company is free to seek the lowest cost electricity on the market.  Exelon, however, owns big and obsolete generating plants.  A merger would re-integrate Pepco into a company that owned generation and transmission.

This vertically integrated structure is exactly what causes a lot of our problems here in WV.  AEP and FirstEnergy are free to charge all the costs of their high-cost, obsolete coal burners to WV rate payers.  The situation is a little different with Exelon and Pepco, because Exelon owns nominally “independent” merchant generating plants that wouldn’t provide electricity directly to Pepco. However, Exelon would manage Pepco in such a way that Pepco’s policies would not undermine the value of its generating plants through incentives for solar generation or energy efficiency.

Exelon is seeking to capture Pepco, because Pepco is a stable company that is regulated by state PSCs.  Distribution-only companies like Pepco do have their rates and costs regulated, even in “deregulated” states, because these companies sell electricity directly to retail customers.  Exelon is “investing” in Pepco, because it no longer wants to invest in power plants that have to operate in the free market.  Exelon has learned that its generation technologies are obsolete and cannot compete in a fair and open marketplace, so the company is seeking monopoly markets where its profits are protected by government regulators.

If you want to see another power company holding company that can’t hack “the free market,” look no further than Cathy Kunkel’s assessment of FirstEnergy’s situation:

FirstEnergy’s most recent quarterly numbers and its outlook for 2015 are both dismal and in line with a report we published last fall, “FirstEnergy Seeks a Subsidized Turnaround.”

If anything, FirstEnergy’s problems have only gotten worse since we issued our report:

  • FirstEnergy’s net income (revenues less expenses) continues to decline. Here’s the spiral: From $869 million in 2011 to $392 million in 2013 to $299 million in 2014.
  • Its earnings per share fell to its lowest point in a decade. Earnings per share in 2014 were $0.51, down from $0.90 in 2013.
  • Its long-term debt, already among the highest in the utility industry, increased from $15.8 billion in 2013 to $19.2 billion in 2014, and on its fourth-quarter earnings call, the company’s chief financial officer conceded that the parent holding company is carrying more debt than “we are comfortable with.”

FirstEnergy’s weak performance stems from its merchant generation business, which is dominated by obsolete coal-fired generation that is struggling to compete in the wholesale power markets. FirstEnergy’s merchant generation segment posted negative net income in 2014 — even more negative than in 2013.

And how did FirstEnergy respond to its disastrous free market experience?

In the company’s fourth-quarter earnings call, executives emphasized how it is relying on a proposed power-purchase agreement in Ohio to improve its financial performance. Under the proposal, FirstEnergy’s regulated electricity distribution companies would enter into a 15-year agreement to purchase power from several of FirstEnergy’s merchant power plants at a fixed price. In other words, Ohio electricity customers would be required to subsidize these plants—by paying more than the market price for their output—so that FirstEnergy can keep operating them. In its testimony to the Public Utilities Commission of Ohio, FirstEnergy stated very clearly that the reason it is angling so hard for ratepayer subsidies is that “markets have not, and are not, providing sufficient revenues to ensure continued operation of the plants.”

Until recently, FirstEnergy was a vociferous champion of free markets, a stance it began to express when electricity markets were deregulated in Ohio in 2000. FirstEnergy has taken a big step back from that rhetoric now that the free market is not working out for the company. In that fourth-quarter earnings calls, a few words in particular from Chuck Jones, FirstEnergy’s new CEO, spoke volumes: “We trust the regulator to look out for a future Ohio more than we do the markets.”

The company’s bet on ratepayer subsidies might not pan out. The Public Utilities Commission of Ohio (PUCO) last week ruled against a very similar proposal by American Electric Power, noting that the AEP pitch would have raised rates without offering any additional benefits to Ohio electricity consumers.

And if you think power companies’ anti-free market actions are something new, take a look at what I wrote in 2009.  The fact is that free market rhetoric has been a smokescreen for monopoly strategies from the beginning of the US shareholder-owned electric power industry.

3 thoughts on “Exelon, FirstEnergy Fleeing “Free Market”

  1. Great post Bill. What we are witnessing here in WV and throughout the country is an energy transformation revolution where obsolete business models will be taken apart and personal freedom and independence will be the norm. We will no longer be paying to “rent” our power but instead we will own it, produce it on our rooftops and share it with our neighbors. What we experienced in WV this past session is the beginning of the overt war on solar where our solar warriors will be heard, understood, and embraced and more and more people will transition away from fossil fuels into renewable s for domestic power as well as transportation. The future is bright and its fueled by the sun.

  2. Although a well-written article, there is one significant error in your article. Exelon’s plants are not “nominally independent merchant generation” any more than are FirstEnergy’s (minus the Harrison plant). Both Exelon’s and FE’s plants are bid into the grid during capacity auctions and both are equally independent merchant generation – neither are explicitly for the purpose of serving Exelon’s or FE’s local utilities’ customers, although the way the grid is designed, they may end up serving them due to existing transmission line power flows. In WV the regulatory structure is different, yes. However, in MD, Exelon’s and FE’s plans can both be viewed as independent merchant generation from the customer’s point of view. Just as many of the utility megamergers have done, the Exelon/Pepco merger is likely to be harmful to independent, localized generation because, as you point out, Exelon will likely do everything possible to see to it that local regulatory policy in Pepco’s territory does not undermine the value of Exelon’s troubled nuclear fleet via solar generation, efficiency initiatives, etc. – Exelon’s tendencies in this regard are bad policy any way you cut it.

    • Tom, thanks for the clarification. You should note, however, that I used the word “nominally” with reference to Exelon’s plants. On TPL, I try to write for a more general audience that doesn’t necessarily know all the ins and outs of how generating plants sell their output. Plants owned by holding companies that also own LSEs end up serving those LSEs one way or another. At the same time, in “deregulated” states, they have to maintain the nominal fiction that the plants are independent.

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