[Federal Register Volume 64, Number 14 (Friday, January 22, 1999)]
[Notices]
[Pages 3551-3571]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1393]
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DEPARTMENT OF JUSTICE
Antitrust Division
Public Comments and Response of the United States; United States
v. Enova Corporation
Notice is hereby given pursuant to the Antitrust Procedures and
Penalties Act, 15 U.S.C. 16(b)-(h), that public comments and the
response of the United States thereto have been filed with the United
States District Court for the District of Columbia in United States v.
Enova Corporation, Civil No. 98-CV-583 (RWR).
On March 9, 1998, the United States filed a Complaint seeking to
enjoin a transaction in which Pacific Enterprises (``Pacific'') would
merge with Enova Corporation (``Enova''). Pacific is a California gas
utility company and Enova is a California electric utility company.
Enova sells electricity from plants that use coal, gas, nuclear power,
and hydropower. Pacific is virtually the sole provider of natural gas
transportation and storage services to plants in southern California
that use natural gas to produce electricity. The proposed merger would
have created a company with both the incentive and the ability to
lessen competition in the market for electricity in California. The
[[Page 3552]]
Complaint alleged that the proposed merger would substantially lessen
competition in the market for electricity in California, in violation
of Section 7 of the Clayton Act, 15 U.S.C. 18.
Public comment was invited within the statutory sixty-day comment
period. The two comments received, and the responses thereto, are
hereby published in the Federal Register and filed with the Court.
Copies of the Complaint, Stipulation and Order, Proposed Final
Judgment, Competitive Impact Statement, Public Comments, and
Plaintiff's Response to Public Comments are available for inspection in
Room 215 of the U.S. Department of Justice, Antitrust Division, 325
Seventh Street, NW., Washington, DC 20530 (telephone: (202) 514-2481)
and at the office of the Clerk of the United States District Court for
the District of Columbia, 333 Constitution Avenue, NW., Washington, DC
20001. Copies of these materials may be obtained on request and payment
of a copying fee.
Constance K. Robinson,
Director of Operations, Antitrust Division.
United States of America, U.S. Department of Justice, Antitrust
Division, 325 Seventh Street, NW., Suite 500, Washington, DC 20530,
Plaintiff, v. Enova Corporation, 101 Ash Street, San Diego, CA
92101, Defendant.
[Case Number: 98-CV-583 (RWR); Judge Richard W. Roberts]
Plaintiff's Response to Public Comments
Pursuant to the requirements of the Antitrust Procedures and
Penalties Act (``APPA''), 15 U.S.C. 16(b)-(h) (``Tunney Act''), the
United States hereby responds to the two public comments received
regarding the proposed Final Judgment in this case.
I. The Complaint and Proposed Judgment
The United States filed a civil antitrust Complaint on March 9,
1998, alleging that the proposed merger of Pacific Enterprises
(``Pacific''), a California natural gas utility, and Enova Corporation
(``Enova''), a California electric utility, would violate Section 7 of
the Clayton Act, 15 U.S.C. 18. The Complaint alleges that as a result
of the merger, the combined company (``PE/Enova'') would have both the
incentive and the ability to lessen competition in the market for
electricity in California and that consumers would be likely to pay
higher prices for electricity.
The Complaint further alleges that prior to the merger, Pacific's
wholly owned subsidiary, Southern California Gas Company, was virtually
the sole provider of natural gas transmission and storage to natural
gas-fueled electric generating plants in Southern California (``gas-
fired plants''). As a consequence and without regard to the merger, it
had the ability to use that market power to control the supply and thus
the price of natural gas available to the gas-fired plants. Prior to
the merger, however, Pacific did not own any electric generation
plants, so it did not have the incentive to limit its gas
transportation, sales or storage or to raise the price of gas to
electric utilities in order to increase the price of electricity.
The Complaint alleges that in early 1998, the California electric
market experienced significant changes as the result of a legislatively
mandated restructuring. In this new competitive electric market, gas-
fired plants, which are the most costly electric generating plants to
operate, set the price that all sellers receive for electricity in
California in peak demand periods. Thus, if a firm could increase the
cost of the gas-fired plants by raising their fuel prices, it could
raise the price all sellers of electricity in California receive, and
increase the profits of owners of lower cost sources of electricity.
Based on these facts, the Complaint alleges that the merger
violated Section 7 of the Clayton Act because the acquisition of
Enova's low-cost electric generating plants gave Pacific a means to
benefit from any increase in electric prices. The Complaint challenges
the acquisition of these specific plants:
Once Pacific's pipeline is combined with Enova's low cost
electricity generation facilities, PE/Enova would have the ability
to raise the pool price of electricity either by (a) limiting the
availability of natural gas to competing gas-fired plants that
supply the most expensive units of electricity into the pool, or (b)
by limiting gas or gas transportation to gas-fired plants that are
more efficient and would otherwise have kept the pool price for
electricity down. PE/Enova would have the incentive to raise the
pool price after the merger because, through its ownerships of low
cost generation facilities, it could profit substantially from any
increase in the pool price of electricity and its incremental
profits would more than offset any losses of gas transportation
sales that would result from withholding gas from competing gas-
fired plants. PE/Enova thus will have the incentive and ability to
lessen competition substantially and increase the price of
electricity in California during periods of high demand.
(Compl. para.24 (emphasis added).)
The proposed Final Judgment directly remedies this harm by
requiring Enova to divest its low-cost generating units to a purchaser
or purchasers acceptable to the United States in its sole discretion.
These divestiture assets are the Encina and South Bay electricity
generation facilities owned by Enova and located at Carlsbad and Chula
Vista, California, and include all rights, titles and interests related
to the facilities.\1\ By requiring this divestiture, the incentive that
was created by the merger for PE/Enova to raise electricity prices is
removed, providing a full remedy to the harm alleged in the
Complaint.\2\
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\1\ The Final Judgment provides that the approvals by the United
States required by this decree for sale of these assets are in
addition to the necessary approvals by the California Public
Utilities Commission (``CPUC'') or any other governmental
authorities for the sale of such assets. Enova must submit required
applications to divest the assets no later than ninety days after
entry of the Final Judgment, and complete the divestiture as soon as
practicable after receipt of all necessary government approvals, in
accordance with the proposed Final Judgment.
\2\ As explained in the Competitive Impact Statement (``CIS''),
the decree does not require the divestiture of the merged company's
nuclear assets, as the price of electricity from those assets will
be regulated during the cirtical first years of the decree, which
means that ownership of those assets will not give the merged firm
an incentive to raise prices. In 2001, if the nuclear power prices
become deregulated, the decree provides for safeguards to ensure
that any incentive to use these assets to raise price is minimized
or eliminated.
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As part of the settlement, the United States also obtained the
Defendant's agreement to protection that are beyond those needed to
remedy directly the harm created by the acquisition. The proposed
decree includes limitations on PE/Enova's ability in the future to
acquire other low cost gas-fired generating assets that could give the
merged firm the same incentive and opportunity to raise electricity
prices that the acquisition of the divested Enova assets would have
presented. Recognizing that PE/Enova would have numerous acquisition
opportunities over the next few years as a consequence of the State of
California's orders that many generating assets be divested (see CIS at
13), the proposed decree requires PE/Enova to seek prior approval from
the United States before acquiring ownership or ownership-like rights
to other low-cost, California generating assets. The United States can,
at its sole discretion, disallow any acquisition of such assets,
without incurring the costs and risks of litigation.\3\ The types of
transactions
[[Page 3553]]
subject to this prior approval process include outright acquisition of
any existing California Generating Assets (Final Jmt. Sec. V.A.1); any
contract that allows PE/Enova to control such assets (Final Jmt.
Sec. V.A.2); any contract for the operation and sale of the output from
generating facilities owned by the Los Angeles Department of Water and
Power (``LADWP''), the second largest generator of electricity in
California and an entity owning more generation than Enova even prior
to the divestiture (Final Jmt. Secs. V.A.2, II.B); power management
contracts of California Generating Facilities with the LADWP (Final
Jmt. Secs. V.C.4,II.C); and future tolling arrangements of the type
that would most clearly mimic true ownership of the tolled facilities
(Final Jmt. Secs. V.A.2, V.C.3).
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\3\ The Final Judgment does not prevent PE/Enova from building
new capacity in California, or from acquiring capacity built in
California after January 1, 1998. New capacity will only be built in
California if the output is inexpensive enough to be sold in many
hours. By increasing the amount of less expensive power available to
meet demand, new, low-cost capacity will reduce the number of hours
in which the most costly gas-fired capacity is needed. This in turn
will limit PE/Enova's ability to raise the pool price since it is
more costly and difficult for PE/Enova to restrict gas to more
numerous low-cost plants. For the same reasons, the Final Judgment
allows the merged company to acquire or gain control of plants that
are rebuilt, repowered, or activated out of dormancy after January
1, 1998. Output from such plants is the equivalent of output from
new-build capacity. CIS at 13-14.
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In addition, the United States has the ability to monitor PE/
Enova's entry into many power management contracts not subject to prior
approval (Final Jmt. Sec. V.C.5). The United States thus has the
opportunity to review these contracts, which are relatively new in the
deregulated California market, and determine whether they would give
PE/Enova the same incentive to raise electricity prices that ownership
of the divested Enova assets would have created. The United States can
then challenge any contracts that would do so.
In sum, the decree provides two types of relief for the United
States. First, it achieves a direct remedy for the harm caused by
Pacific's acquisition of Enova's low-cost generating assets by ordering
divestiture of those specific assets. Second, it provides the
additional benefits of the prior approval and contract monitoring
provisions. These additional provisions are not meant to (nor can they)
prevent PE/Enova from entering any transaction or acquiring any asset
that could give it the incentive to exploit Pacific's pipeline market
power in the electricity market. Instead they provide the United States
with a check on potentially anticompetitive transactions, where the
acquisition of such assets would again create incentives similar to
these created by the assets acquired (and divested) in the transaction
before this Court.
The United States and Enova have stipulated that the proposed Final
Judgment may be entered after compliance with the APPA.
II. Response to Public Comments
On June 8, 1998, the United States filed the CIS in this docket and
on June 18, 1998, the Complaint, Final Judgment and CIS were published
in the Federal Register. The Federal Register notice explained that
interested parties could provide comments to the Department for a
period of 60 days. Two parties filed comments with the Department:
Edison International (``Edison'') and the City of Vernon.
A. Edison's Comments
Edison's primary comment is that the decree does not strip PE/Enova
of the ability or incentive to increase electricity prices, but only
eliminates one opportunity to do so. Despite the decree, Edison argues,
PE/Enova still can use Pacific's market power over natural gas
transmission and still can enter into transactions that will give it
the incentive to exercise that power and raise electricity prices.
Edison enumerates and discusses particular transactions that would give
Pacific that incentive:
1. Building or acquiring new or repowered generating facilities;
2. Entering into tolling agreements;
3. Entering into power generation management contracts; and
4. Entering into financial contracts (derivatives) tied to prices
in the California Electric market.
But Edison's criticism misses the mark, because each of the
potential transaction it lists is a transaction that Pacific could
engage in whether or not it merges with Enova. Thus, Edison's comments
do not focus on the harm caused by the merger, but rather on the harm
to competition that might result from Pacific's premerger ownership of
a monopoly gas pipeline. In contrast, the United States' Complaint is
focused only on the effects that flow from the merger.
Edison's assertion (Edison Comments at 13) that Pacific had no
premerger incentive to manipulate electricity prices is simply wrong.
As soon as California deregulated retail electricity prices, Pacific
had the incentive, among other things, to build or acquire new and/or
repower other existing generating assets, purchase derivatives, and
make gas tolling agreements in order to exploit its pipeline's market
power over gas-fired generators. The ability and incentive of Pacific
to exercise its natural gas transmission market power for gain in the
electric market in any of these manners does not require acquisition of
any of Enova's generating assets or its ``electricity expertise.'' \4\
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\4\ Edison's comments, which mention Enova's ``electricity
expertise'' in one sentence, do not define this term, identify where
in Enova it resides, or assert that pacific, the pipeline's parent
company, did not already have such expertise prior to the merger or
have the ability to obtain it by a number of means, including hiring
employees with electric experience.
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Nevertheless, Edison argues that the Final Judgment is defective
because the United States did not also ``understand[ ], anticipat[e],
and then prohibit[ ] all the various means by which the merged company
could seek to retain or create incentives to earn profits through
electricity price manipulations.'' (Edison Comments at 20.) To the
extent that Edison means to suggest that, once any merger transaction
is found to violate the Clayton Act, a merger decree should enjoin any
and all other means by which the defendant might violate the antitrust
laws in the future, the suggestion plainly is incorrect.\5\ Contrary to
Edison's suggestions, enforcement of the merger laws, Section 7 of the
Clayton Act, is aimed at remedying the competitively harmful changes in
market structure or other conditions that result from the merger. Here,
the merger takes Pacific's ability to profitably raise electric prices
and adds the incentive provided by Enova's low cost generating assets.
The proposed decree severs those assets from the merged company,
remedying the change in incentive and ability from the status quo ante.
The Final Judgment requires these assets to be sold to a party that
will not own the monopoly pipeline and removes the new incentive
provided by the acquired Enova assets for PE/Enova to use the
pipeline's already existent market power.\6\
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\5\ See Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S.
100, 133 (1969) (explaining that a court may not enjoin ``all future
violations of the antitrust laws, however unrelated to the violation
found by the court''); Hartford-Empire Co. v. United States, 323
U.S. 386, 409-10 & n.7 (1945) (citing NLRB v. Express Publ'g Co.,
312 U.S. 426, 433, 435-36 (1941)).
\6\ Edison also makes the same argument from the opposite
perspective--that competition is separately harmed because Enova has
gained an ability via the merger to raise price. (Edison Comments at
5.) Again, there is no additional pipeline monopoly power created by
the merger. The proposed remedy is effective against the harm caused
by the combination (the pipeline and Enova's low cost generating
assets), whether the Southern California Gas Company pipeline's
monopoly power is wielded by Enova or by Pacific.
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Just as Edison's critical comments do not address the merger-
related harms alleged in the Complaint, its comments do not address
whether the parties' proposed decree is adequate to remedy the harms
alleged in that Complaint. Instead, Edison proposes its own alternative
remedies that either do not
[[Page 3554]]
address the harm caused by the merger, or are not as effective as the
decree. Edison suggests that: (1) The merger be rescinded, (2) the
pipeline be divested, (3) the pipeline be controlled by an independent
system operator, or (4) the merged company be barred from trading in
financial instruments for Southern California electricity markets
(Edison Comments at 6).\7\
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\7\ Edison compares its preferred options with the proposed
Final Judgment, calling the remedy in the proposed Final Judgment
``the least attractive option'' from Edison's perspective. (Edison
Comments at 3 (``The last but least attractive option is to try to
lessen the merged firm's incentive to exercise its monopoly power in
order to profit from higher electric prices.'').) Edison finds this
course less attractive because ``it requires a complex latticework
of provisions * * * [that is] difficult to write and even harder to
administer.'' Id. The alternative it suggests, creating an
independent system operator for the pipeline system, has never been
done anywhere in the United States and, while possible, cannot be
assumed to be easy to write and easier to adminster.
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Two of Edison's proposed remedies--the independent system operator
and the bar on trading--are aimed at controlling the preexisting market
power of the gas pipeline rather than remedying any harm created by the
merger. And, ironically, the Edison remedies aimed most closely at the
merger--rescission or divestiture of the pipeline--would not place any
limits on the pipeline's new owner's ability to raise the price of
electricity or limit the pipeline owner from acquiring assets or
contracts that would give it the incentive to do so, even though this
incentive and ability is purportedly the gravamen of Edison's concern.
The Proposed Final Judgment, in contrast, gives this emerging electric
market more protection than Edison's suggested remedies through prior
notice and market monitoring provisions.\8\
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\8\ For example, Edison argues that the FTC's consent decree in
PacificCorp (PacifiCorp/The EnergyGroup, FTC File No. 9710091)
provides a superior remedy. It mischaracterizes the FTC decree as
equivalent to the divestiture of Pacific's gas pipeline assets that
constitute virtually all of the assets Pacific contributed to the
merger with Enova. Unlike this case, however, the divesture of coal
assets in PacifiCorp was not the equivalent of rescission of the
merger. PacifiCorp is a large integrated electric utility with coal
holdings in the western United States. It was acquiring the Energy
Group, an international electric company, the second largest
electric distribution company in the United Kingdom, which also held
coal reserves in both eastern and western United States. The FTC
decree did not requirement the Energy Group to divest its coal
business, much less its primary utility business, as Edison would
have the decree in the instant case require divestiture of Pacific's
utility pipeline business. Instead, the FTC decree required a
specific subset of the Energy Group's western coal mines to be
divested. The FTC's PacifiCorp decree stopped with divesture of
those specific assets and, unlike the Final Judgment proposed here,
did not go further to limit the merged company's reacquisition of
assets that would create the same vertical problem as the divested
assets.
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In the end, Edison's preference for a different remedy is not
relevant to the Court's inquiry. Under the Tunney Act, the Court may
not choose or fashion a remedy that is ``better'' in someone's opinion
than the one negotiated and agreed to by the parties. To the contrary,
``a proposed decree must be approved even if it falls short of the
remedy the court would impose on its own, as long as it falls within
the range of acceptability or is `within the reaches of the public
interest.' '' \9\ The proposed Final Judgment meets and exceeds this
legal standard.
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\9\ United States v. American Tel. & Tel. Co., 552 F. Supp. 131,
153 n.95 (D.D.C. 1982), aff'd sub nom. Maryland v. United States,
460 U.S. 1001 (1983)(mem.).
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B. City of Vernon's Comments
The City of Vernon recognizes in its comments that the Proposed
Final Judgment focuses entirely on the potential of PE/Enova to reduce
competition in the electricity market in Southern California. It
comments that the proposed judgment ``ignores'' the effect of the
merger on the natural gas transmission market in Southern California.
The case brought by the Department, however, involved the electricity
market in Southern California, and the relief addressed in the Proposed
Final Judgment remedies the competitive harm posed by the proposed
acquisition to that market. The Complaint does not allege violations in
the natural gas transmission market, and the City of Vernon's proposed
relief is thus not relevant to this proceeding.
III. The Legal Standard Governing the Court's Public Interest
Determination
Once the United States moves for entry of the proposed Final
Judgment, the Tunney Act directs the Court to determine whether entry
of the proposed Final Judgment ``is in the public interest.'' 15 U.S.C.
Sec. 16(e). In making that determination, ``the court's function is not
to determine whether the resulting array of rights and liabilities is
one that will best serve society, but only to confirm that the
resulting settlement is within the reaches of the public interest.''
United States v. Western Elec. Co., 993 F.2d 1572, 1576 (D.C. Cir.)
(emphasis added, internal quotation and citation omitted), cert.
denied, 114 S. Ct. 487 (1993).
The Court is not ``to make de novo determination of facts and
issues.'' Western Elec., 993 F.2d at 1577. Rather, ``[t]he balancing of
competing social and political interests affected by a proposed
antitrust decree must be left, in the first instance, to the discretion
of the Attorney General.'' Id. (internal quotation and citation
omitted). In particular, the Court must defer to the Department's
assessment of likely competitive consequences, which it may reject
``only if it has exceptional confidence that adverse antitrust
consequences will result--perhaps akin to the confidence that would
justify a court in overturning the predictive judgments of an
administrative agency.'' Id. \10\ The Court may reject a decree simply
``because a third party claims it could be better treated,'' United
States v. Microsoft, 56 F.3d 1448, 1459 (D.C. Cir. 1995), or based on
the belief that ``other remedies were preferable,'' id. at 1460.
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\10\ The Tunney Act does not give a court authority to impose
different terms on the parties. See e.g., American Tel. & Tel., 552
F. Supp. at 153 n. 95; accord H.R. Rep. No. 93-1463, at 8 (1974). A
court, of course, can condition entry of a decree on the parties'
agreement to a different bargain, see e.g., American Tel. & Tel.,
552 F. Supp. at 225, but if the parties do not agree to such terms,
the court's only choices are to enter the decree the parties
proposed or to leave the parties to litigate.
United States v. Thomson Corp., 949 F. Supp. 907 (D.D.C. 1996),
cited by Edison (Edison Comments at 9-10), does not support Edison's
argument to reject the Proposed Final Judgment. That case involved
the Tunney Act review of a proposed final judgment that required one
of the merging companies to license a copyright that it claimed but
had not licensed prior to the merger. While there was some
controversy as to whether the decree's license provisions could have
been extracted as the result of a trial, see Thomson, 949 F. Supp.
at 927, the Court nevertheless considered comments on the specific
terms of the license proposal because of the potential
anticompetitive harm that could result from ``the merger of these
two publishing giants in conjunction with'' the asserted copyright
claim. Id. at 928. The Thomson Court addressed comments on the
license provision on that ground, and not because the decree would
remedy preexisting wrongs; nor did the court add or alter any
provisions to the Final Judgment that had not been agreed to by the
parties. Here, in contrast, Edison is not commenting on a specific
remedy agreed to by the parties as a means of addressing the harms
related to a merger. Instead, Edison is asking this Court to insert
an entirely new mechanism for relief into the decree, in order to
address Pacific's preexisting pipeline market power as it could be
exercised in relation to the acquisition of any electricity assets,
regardless of Pacific's merger with Enova. Edison's proposed
approach is completely at odds with Judge Friedman's actions in the
Thomson case. Judge Friedman, as Edison concedes, was careful not to
substitute his judgment for the government's and, further, did not
adopt proposed remedies that were unrelated to the merger. (See
Edison Comments at 10).
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Further, the Tunney Act does not contemplate judicial reevaluation
of the wisdom of the government's determination of which violations to
allege in the Complaint. The government's decision not to bring a
particular case on the facts and law before it, like any other decision
not to prosecute, ``involves a complicated balancing of a number of
factors which are peculiarly within [the government's expertise.''
Heckler v. Chaney, 470 U.S. 821, 831 (1985). Thus, the Court may
[[Page 3555]]
not look beyond the Complaint ``to evaluate claims that the government
did not make and to inquire as to why they were not made.'' Microsoft,
56 F.3d at 1459; see also United States v. Associated Milk Producers,
Inc.. 534 F.2d 113, 117-18 (8th Cir. 1976).
The government has wide discretion within the reaches of the public
interest to resolve potential litigation. See e.g., Western Elec. Co.,
993 F.2d 1572; American Tel & Tel., 552 F. Supp. at 151. The Supreme
Court has recognized that a government antitrust consent decree is a
contract between the parties to settle their disputes and differences,
United States v. ITT Continental Baking Co.. 420 U.S. 223, 235-38
(1975); United States v. Armour & Co., 402 U.S. 673, 681-82 (1971), and
``normally embodies a compromise; in exchange for the saving of cost
and elimination of risk, the parties each give up something they might
have won had they proceeded with the litigation.'' Armour, 402 U.S. at
681. As Judge Greene has observed:
If courts acting under the Tunney Act disapproved proposed
consent decrees merely because they did not contain the exact relief
which the court would have imposed after a finding of liability,
defendants would have no incentive to consent to judgment and this
element of compromise would be destroyed. The consent decree would
thus as a practical matter be eliminated as an antitrust enforcement
tool, despite Congress' directive that it be preserved.
American Tel. & Tel., 552 F. Supp. at 151. This Judgment has the virtue
of bringing the public certain benefits and protection without the
uncertainty and expense of protracted litigation. See Armour, 402 U.S.
at 681; Microsoft, 56 F. 3d at 1459.
Finally, the entry of a governmental antitrust decree forecloses no
private party from seeking and obtaining appropriate antitrust
remedies. Defendants will remain liable for any illegal acts, and any
private party may challenge such conduct if and when appropriate.
IV. Conclusion
After careful consideration of the public comments, the United
States concludes that entry of the proposed Final Judgment will provide
an effective and appropriate remedy for the antitrust violation alleged
in the Complaint and is in the public interest. The United States will
therefore ask the Court to enter the proposed Final Judgment after the
public comments and this Response have been published in the Federal
Register, as 15 U.S.C. 16(d) requires.
Dated: January 11, 1999.
Respectfully submitted,
Jade Alice Eaton
D.C. Bar #939629, Trial Attorney, U.S. Department of Justice, Antitrust
Division, 325 Seventh Street, N.W., Washington, DC 20530. Phone: (202)
307-6316.
Certificate of Service
I hereby certify that I have caused a copy of the foregoing
Plaintiff's Response to Public Comments, as well as attached copies of
the public comments received from the City of Vernon, California, and
from Southern California Edison Company, to be served on counsel for
defendant and for public commentators in this matter in the manner set
forth below:
By first class mail, postage prepaid:
Steven C. Sunshine,
Shearman & Sterling, 801 Pennsylvania Avenue, N.W., Washington, DC
2004.
John W. Jimison,
Brady & Berliner, 1225 Nineteenth Street, N.W., Suite 800, Washington,
DC.
J.A. Bouknight, Jr.,
David R. Roll,
James B. Moorhead,
Steptoe & Johnson LLP, 1330 Connecticut Ave., N.W., Washington, DC
20036.
Dated: January 11, 1999.
Jade Alice Eaton,
D.C. Bar # 939629. Antitrust Division, U.S. Department of Justice, 325
Seventh Street, N.W., Suite 500, Washington, DC 20530, (202) 307-6456,
(202) 616-2441 (Fax).
Brady & Berliner
1225 Nineteenth Street. N.W., Suite 800, Washington, DC 20036
August 17, 1998.
Mr. Roger W. Fones,
Chief Transportation Energy & Agriculture Section Antitrust
Division, U.S. Department of Justice, 325 Seventh Street, N.W.,
Suite 500, Washington, DC 20530.
Re: Comments of the City of Vernon, California, on the Proposed
Final Judgement, Stipulation in the Competitive Impact Statement in
U.S. v. Enova Corporation, Civil No. 98-CV-583
Dear Mr. Fones: Pursuant to the legal notice issued by the
Antitrust Division on June 18, 1998 the City of Vernon, California,
(``Vernon'') hereby provides these comments in opposition to the
approval of the Proposed Final Judgement Stipulation in the
Competitive Impact Statement in U.S. v. Enova Corporation, Civil No.
98-CV-583 (``Proposed Judgement'').
Vernon submits that the Proposed Judgement would permit a merger
to be consummated that will alter and damage the potential for
competition in the California natural gas market. The Proposed
Judgement focuses entirely on the potential of the merged entity to
reduce competition in the electricity market in southern California,
and orders as a remedy the divestiture of certain electricity
generating stations owned by the San Diego Gas & Electric Company
(``SDG&E''). The Proposed Judgement ignores the fact that the merger
will combine the two largest natural gad transmission and
distribution companies in southern California. The merger will thus
eliminate the potential for competition between them, or for support
by either of them for new natural gas transmission pipeline which
would compete with the other.
Vernon operates a municipal electricity utility including its
own gas-fired power plant and will complete this year a municipal
natural gas utility. Vernon and other natural gas distributing
entities in southern California have lacked any meaningful
alternative to the monopoly natural gas transmission service from
the Southern California Gas Company (``SoCalGas''), the parent of
which, Pacific Enterprises, is merging with Enova. Although two
interstate pipelines were built into California in the first years
of this decade, their systems terminate in the Bakersfield,
California, region and do not compete with SoCalGas in its service
territory in the large Los Angeles metropolitan region, including
Vernon.
In order for a competing pipeline to be constructed into Los
Angeles, the sponsor must overcome significant hurdles and expenses
of locating and obtaining an environmentally suitable right-of-way,
and must have agreements with shippers for an adequate volume of
natural gas to support the expensive project. Having large
prospective shippers under contract to use a new pipeline is a
prerequisite to constructing one. Despite these obstacles, there
have been a number of potential pipelines discussed and considered
that would have competed with SoCalGas' gas transmission service
into the Los Angeles area. However, to date, SoCalGas' actions to
frustrate and oppose any such competition have been successful.
These efforts have included special discounted contracts offered to
the most likely customers of a new pipeline and adopting a penalty
tariff that effectively forbids any customer of a new pipeline from
taking any service at all from SoCalGas--even at different
locations--without paying the full SoCalGas system tariff for
transmission in addition to the cost of the competing pipeline.
The single largest potential ``anchor'' customer of a new
pipeline to compete with SoCalGas was SDG&E. The merger that would
be approved by the Proposed Judgement would eliminate SDG&E's
potential role as an anchor shipper on a new pipeline, and cement a
permanent alliance between SDG&E and SoCalGas to sustain their joint
monopoly on gas transmission services in southern California.
While the divestiture of SDG&E's power plant may have reduced
the potential that the merged entity would use that monopoly to
favor its own gas-fired generators in a competitive electricity
market, that limited divestiture does nothing to reduce the damage
to competition created by this merger in the natural gas market.
Across the United States, competition among natural gas
transportation companies has benefitted consumers with improved
[[Page 3556]]
service at lower tariffs. With the exception of those customers in
the Bakersfield area, and those selectively receiving discounts to
ensure they will not support competing pipelines, the customers in
southern California have not had any benefits of competition among
gas transmission providers. The approval of the Proposed Judgement
and consummation of the merger it approves will reduce their chances
of such benefits.
Vernon submits that approval of the merger should have been
conditioned not only on actions to reduce the potential risks to
competition in the electricity market, but also to reduce the injury
to competition in the natural gas market. Such action could have
included a requirement that SoCalGas sell to independent entities a
volume of transportation capacity equivalent to that which it had
traditionally used to serve SDG&E, or a requirement that SoCalGas
offer transportation rights on its system which can be released and
brokered to others, creating the potential for a competitive third-
party market among gas shippers with defined rights. No such action
was taken in the Proposed Judgement.
For this reason, Vernon opposes the approval of the Proposed
Judgement.
Respectfully submitted,
John W. Jimison, Esq.,
Attorney for The City of Vernon.
Comments of Amicus Curiae Southern California Edison Company on the
Proposed Final Judgment
Kevin J. Lipson,
Mary Anne Mason,
Hogan & Hartson LLP, Columbia Square, 555-Thirteenth Street, NW,
Washington, DC 20004-1109, (202) 637-5600.
Stephen E. Pickett,
Douglas Kent Porter, Southern California Edison Company, P.O. Box 800,
2244 Walnut Grove Avenue, Rosemead, California 91770, (626) 302-1903.
J.A. Bouknight, Jr.,
David R. Roll,
Steptoe & Johnson LLP, 1330 Connecticut Avenue, NW, Washington, DC
20036, (202) 429-3000.
Dated: August 17, 1998.
Comments of Amicus Curiae Southern California Edison Company on the
Proposed Final Judgment
Southern California Edison Company (``SCE'') respectfully submits
the following comments on the proposed Final Judgment in the above
referenced matter.\1\
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\1\ As a part of these Comments, SCE is attaching the Affidavit
of Paul R. Carpenter, an economist who has extensive experience in
analyzing energy markets.
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Introduction and Summary
This is a case about an electric utility. Like any company in our
capitalistic system, this utility would like to raise its prices in
order to increase profits for its shareholders. Finding that
competition constrains its ability to increase electricity prices, the
utility decides to buy the only company in the world that will give it
that ability to raise electricity prices in the area where the utility
competes. Not surprisingly, the Department of Justice (``DOJ'') finds
the merge to be an obvious violation of the antitrust laws. DOJ then
files a complaint and proposes a Final Judgment that permits the merger
without eliminating the competitive problem identified in the
complaint.
The violation alleged in DOJ's complaint is straight-forward. Enova
Corporation (``Enova''), the owner of one of California's three major
electric utilities, has acquired Pacific Enterprises (``Pacific''),
which owns and operates the intrastate gas pipeline system that
provides virtually all of the natural gas consumed in southern
California. As DOJ's complaint alleges, control of this pipeline system
will provide Enova with monopoly control of natural gas in the southern
California market. This in turn will permit Enova to control the price
of electricity in southern California much of the time, because natural
gas is used to generate electricity ``on the margin'' during most hours
of the year in southern California.
In competitive markets, the cost characteristics of a producer on
the margin are likely to set the market-clearing price. In southern
California, as of April 1, 1998, this is necessarily true, because
California has created a power exchange (``PX'')--the first such market
in the United States--in which generators of electric power bids for
each hour and all successful bidders are paid a price determined by the
highest bid that is accepted. Thus, where gas-fueled generation is on
the margin, as it is most of the time, an increase in the price of
natural gas leads directly to an increase in the price for every
kilowatt hour of electricity consumed in southern California.
Prior to the merger, Enova had every incentive to raise electricity
prices but it lacked the ability to do so because it has no control
over natural gas prices. On the other hand, before the merger, Pacific
had the ability to control natural gas prices but had not succeeded in
entering the electricity marketing business.\2\ Thus, Enova has the
incentive but not the ability to manipulate electricity prices; Pacific
had the ability but lacked the incentive.
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\2\ Before the merger, Pacific had established a subsidiary for
gas and electricity marketing and tried to enter the electricity
marketing business. However, as Enova explained to the Federal
Energy Regulatory Commission (``FERC''), this subsidiary had not
succeeded in securing any contracts to sell electricity at the time
of the proposed merger. See Ensource, 78 FERC para. 61,064, at
61.231 (1997) (``Since Ensource never has engaged in marketing
activity* * *'').
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DOJ correctly concluded that a merger of these two firms, which
combines the ability and incentive to raise electricity prices in the
southern California market, violates the antitrust laws. In the face of
this violation, what is the remedy? The most obvious remedy, of course,
is to stop the merger from happening. Short of that, the next most
effective and logical remedy is to remove the source of the merged
firm's monopoly power, either by requiring divestiture of the natural
gas pipeline system or by creating an independent system operator
(``ISO'') to operate that system. The last but least attractive option
is to try to lessen the merged firm's incentive to exercise its
monopoly power in order to profit from higher electricity prices. This
is the least attractive option because curbing incentives to profit
from higher electricity prices requires a complex latticework of
provisions designed to prevent the merged firm from retaining and
acquiring contractual rights and other types of economic interests in
electric power. Such a remedy is difficult to write and even harder to
administer.
Rather than stopping the merger in its tracks or adopting a
structural remedy to remove the source of the monopoly power. DOJ asks
this Court to approve a remedy that will have little or no impact on
the merged company's incentive to raise electricity prices. The
proposed Final Judgment should be rejected because the merged entity
still has the unfettered ability to enter into a variety of electric
power transactions, which will enable it to profit from higher
electricity prices. Specifically:
While the proposed Final Judgment requires Enova to
divest two of its gas-fueled electric generating plants, totaling
some 1650 megawatts, it allows the merged company to acquire an
unlimited amount of generating facilities built after January 1,
1998, or any repowered/rebuilt facilities, whatever the fuel-type.
Thus, the 1650 MW divestiture requirement can be undone with a
single purchase of a large new facility.
There is no prohibition on the merged company
contracting, the day after divestiture, to purchase the electrical
output of those same divested generating facilities (or other
facilities).
The proposed Final Judgment explicitly permits the
merged firm to enter into ``tolling'' arrangements by which it can
in essence rent electric generating plants to convert gas into
electricity.
There is no prohibition on the merged company entering
into financial contracts (derivatives such as options and futures)
that
[[Page 3557]]
would enable it to prohibit from changes in southern California
electricity prices.
Under the proposed decree, the merged firm can acquire both new and
repowered/rebuilt electric generation assets. It can acquire by
contract the economic attributes of ownership of electric generation.
It can rent generating units to produce electric power. And it can
trade in electricity financial contracts for the southern California
market. If it can do all this, then it obviously can benefit from
increases in the price of electricity just as it could if it still
owned the divested electric generating facilities. Consequently, the
proposed Final Judgment does not eliminate the merged firm's incentive
to exercise market power in order to increase electricity prices. And
it does not even purport to address market power. Therefore, the
proposed Final Judgment does not even come close to solving the
fundamental competitive problem articulated in DOJ's complaint.
One rationale that DOJ has put forward for having accepted the
ineffective remedial measures in the proposed Final Judgment is that
more effective remedies would involve relief that extends beyond the
effect of the merger, as Pacific could theoretically have engaged in
theses activities without a merger. But this is an unlawful merger.
Without the acquisition, Enova's incentive to raise electricity prices
is not backed by any ability to do so. The merger dramatically and
unlawfully changes the landscape by immediately coupling Enova's
incentive and electricity-expertise with Pacific's natural gas muscle.
The argument that a substantial link between the gas pipeline system
and electricity markets could easily have been established without the
merger ignores the fact that this merger creates that substantial link.
If, for whatever reason, DOJ prefers not to stop the merger and not
to address the upstream source of the market power, but instead chooses
to focus on the incentives to exercise its market power in the
downstream electricity market, then the public interest requires that
it craft remedies designed to curb the incentives that are sufficiently
effective to cure the antitrust violation. Because DOJ failed in that
task, this Court is faced with a proposed Final Judgment that falls far
short of being within the reaches of the public interest.\3\
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\3\ As a diversionary tactic, Enova can be expected to urge the
Court to disregard SCE's comments, no matter how persuasive they may
otherwise be, because SCE is merely a self-interested competitor of
the merged firm. While it is true that SCE is a competitor for
electricity sales, SCE's principal interest in this matter is at the
largest purchaser of electricity in the southern California market,
one that will be directly and significantly harmed by electricity
price increases resulting from this merger. Under the California
restructuring legislation, the legislature ``froze'' electricity
rates at levels in effect as of June 1996. See Cal. Pub. Util. Code
Sec. 368(a). During the rate freeze period which will end December
31, 2001, SCE must purchase all the energy that it sells to its
utility service customers from the PX. SCE's rates include separate
components for transmission, distribution, etc. The sum of these
separate components is less than the frozen rate levels, with that
residual difference being used by SCE to recover costs associated
with generation-related assets that would not otherwise be recouped
if cost recovery were determined solely by selling energy purchased
from these assets at the prevailing market price. As a consequence,
SCE's shareholders are at risk and will be directly harmed if PX
electricity prices rise to a level that would cause SCE's costs to
exceed the frozen rate levels.
---------------------------------------------------------------------------
In summary, SCE urges that the proposed Final Judgment be rejected.
If DOJ nevertheless concludes that a salvage effort is appropriate, DOJ
and Enova can be sent back to the bargaining table to produce a Final
Judgment that remedies the competitive problem described in the
complaint. Such remedies would include one of the following:
(1) Rescission of the merger;
(2) Divestiture of the gas pipeline system or, alternatively,
establishment of an independent system operator to operate it
independently of the merged company; or
(3) Adoption of measures that will eliminate the merged company's
incentive to participate directly, and indirectly through financial
instruments, in the southern California electricity market in any
manner that would allow it to profit from increased electricity prices.
Argument
I. The Tunney Act Standard of Review Requires This Court To Determine
Whether the Proposed Final Judgment Is in the Public Interest
On March 9, 1998, the Antitrust Division of DOJ filed a complaint
against Enova alleging that the merger of Enova and Pacific will
violate Section 7 of the Clayton Act. Along with the complaint, DOJ
filed a Stipulation and Order pursuant to which the parties consented
to entry of a proposed Final Judgment and Enova agreed to abide by its
terms pending its entry by the court.
The filing of the proposed Final Judgment triggered a proceeding
under the Antitrust Procedures and Penalties Act, commonly known as the
Tunney Act.\4\ The purpose of the Tunney Act is to provide notice to
the public, an opportunity to comment, and judicial scrutiny of consent
decrees in antitrust cases to determine whether they are in the
``public interest.'' The Tunney Act requires DOJ to publish the
proposed Final Judgment and to file and publish a competitive impact
statement (``CIS'') explaining the case, the anti-competitive conduct
involved, the proposed remedy, and any alternative remedies considered
by it. DOJ must also furnish to the Court any comments that it receives
from the public during a 60-day period commencing with the noticing of
the CIS, its response to these comments, and any documents it
``considered determinative in formulating'' the decree.
---------------------------------------------------------------------------
\4\ 15 U.S.C. Sec. 16(b)-(h).
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Before a court may approve a proposed Final Judgment, the Tunney
Act requires the court to ``determine that the entry of such judgment
is in the public interest''.\5\ The Act provides that in making its
public interest determination, the court may consider:
---------------------------------------------------------------------------
\5\ 15 U.S.C. Sec. 16(e).
(1) the competitive impact of such judgment, including
termination of alleged violations, provisions for enforcement and
modification, duration or relief sought, anticipated effects of
alternative remedies actually considered, and any other
considerations bearing upon the adequacy of such judgment;
(2) the impact of entry of such judgment upon the pubic
generally and individuals alleging specific injury from the
violations set forth in the complaint including consideration of the
public benefit, if any, to be derived from a determination of the
issues at trial.\6\
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\6\ Id.
The scope of Tunney Act review was articulated in a 1995 decision
of the Court of Appeals for the D.C. Circuit in Microsoft.\7\ In that
case, District Judge Sporkin had declined to enter a proposed consent
decree settling an action by DOJ alleging monopolization and various
exclusionary practices. Although the Court of Appeals reversed and
ordered entry of the proposed decree without revision, it set forth
certain guidelines, among others, that are relevant to the Court's
public interest determination in this case:
---------------------------------------------------------------------------
\7\ United States v. Microsoft, 56 F.3d 1448 (D.C. Cir. 1995).
``[T]he court's function is not to determine whether
the resulting array of rights and liabilities is the one that will
best serve society, but only to confirm that the resulting
settlement is within the reaches of the public interest.'' \8\
---------------------------------------------------------------------------
\8\ Id. at 1460 (emphasis in original, internal citations and
quotation marks omitted).
``[I]f third parties contend that they would be
positively injured by the decree, a district judge might well
hesitate before assuming that the decree is appropriate.'' \9\
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\9\ Id. at 1462.
[[Page 3558]]
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``A district judge * * * would and should pay special
attention to the decree's clarity [and may] insist on that degree of
precision concerning the resolution of known issues as to make this
task, in resolving subsequent disputes, reasonably manageable * * *
. If the decree is ambiguous, or the district judge can foresee
difficulties in implementation, we would expect the court to insist
that these matters be attended to.'' \10\
---------------------------------------------------------------------------
\10\ Id. at 1461-62.
Under Microsoft, it is now clear that a court may not reject a
remedy simply because it is not the ``best'' remedy that could have
been selected. On the other hand, it is equally clear under Microsoft
that a court has discretion to reject a negotiated remedy which is
ineffective because it does not seek to address and resolve the core
competitive problem identified in DOJ's complaint.
Following Microsoft, courts have continued to scrutinize proposed
consent decrees to determine whether they effectively address and
resolve the fundamental competitive problems articulated by DOJ. For
instance, in Thomson, District Judge Friedman examined concerns about
several aspects of a proposed consent decree as expressed in briefs
submitted amicus curiae by two competitors of the merging parties, in
public comments submitted to DOJ, and at an extended public
hearing.\11\ Judge Friedman carefully examined arguments concerning
each of the four separate areas of concern, noting proposed
supplemental commitments \12\ and modifications to the initially filed
proposed consent decree to resolve some of these concerns.\13\ He was
careful not to substitute his own judgment for DOJ's as to what could
be the best remedy \14\ and he declined to suggest relief for conduct
unrelated to the merger.\15\ Nonetheless, Judge Friedman refused to
enter even the revised decree, because neither the original nor the
proposed revision resolved substantial concerns that the decree would
maintain, by court order, a dubious copyright claim that DOJ's
complaint and commentators had identified as a substantial barrier for
new competitors seeking to enter the relevant market.\16\ Only after
the parties submitted a further amendment addressing these concerns did
Judge Friedman order entry of the consent decree.\17\
---------------------------------------------------------------------------
\11\ United States v. The Thomson Corp., 949 F. Supp. 907, 909,
912 (D.D.C. 1996), aff'd per curiam 1998 U.S. App. LEXIS 12921 (May
29, 1998).
\12\ See, e.g., id. at 916 (noting that ``Thomson confirmed in
writing that it will continue'' a practice that commentators and
amicus curiae thought might cease after the merger).
\13\ See, e.g., id. at 916 (noting adoption of new consent
decree provision barring Thomson from taking certain actions to
undermine viability of products to be divested under the decree);
id. at 924 (noting proposal to add language to proposed decree to
ensure that licenses to one of the products to be divested may be
sublicensed); id. at 925 (noting further change to proposed consent
decree after Tunney Act hearing to ensure that divestiture will not
affect pre-existing rights under a particular contract). See also
id. at 926 nn. 19-20 (noting changes to initial proposed decree in
response to concerns expressed in comments and at the hearing).
\14\ See id. at 919.
\15\ See, e.g., id. at 920 (refusing to consider requests to
reopen bidding on past contracts, because not related to competition
among the parties to the merger).
\16\ See id. at 927-930 (discussing complaint's allegations and
decree's proposed remedy regarding copyright claim).
\17\ See United States v. The Thomson Corp., 1997-1 Trade Cas.
(CCH) para. 71,735, 1997 U.S. Dist. LEXIS 1893 (Feb. 27, 1997).
---------------------------------------------------------------------------
II. The Proposed Final Judgment is Not in the Public Interest
Under standards laid down in Microsoft and implemented in Thomson,
the proposed Final Judgment is not within the ``reaches of the public
interest'' because it does not remedy the core competitive problem
identified in DOJ's complaint--namely, that the merged entity will have
the ability and incentive to increase electricity prices. Unless and
until DOJ and Enova agree to a remedy which addresses and resolves this
problem, the Court must reject the proposed decree.
A. The Complaint Correctly Identifies the Root of the Competitive
Problem: Pacific's Control of Natural Gas Transportation and Storage in
California
As a result of its monopoly over intrastate transmission and
storage of natural gas, Pacific (via its subsidiary, SoCal Gas), has
the power and ability to increase the price of natural gas to gas-fired
electric generators which in turn will increase the price of
electricity in California. In its complaint, DOJ found that,
notwithstanding regulatory oversight, Pacific has the ability to use
its control over those assets to manipulate the price of gas to
consumers, including gas-fueled electric generators:
Pacific has ``a monopoly of transportation of natural
gas within southern California [and] a monopoly of all natural gas
storage services throughout California.'' \1\\8\
---------------------------------------------------------------------------
\1\\8\ Complaint para.15.96 percent of gas-fueled generators in
southern California buy gas transportation services from Pacific.
Proposed Final Judgment and Competitive Impact Statement; United
States v. Enova Corp. (``CIS''), 63 FR 33393, at 33403 (June 18,
1998).
---------------------------------------------------------------------------
``[A]lthough regulated by the California Public
Utilities Commission (`CPUC'), Pacific has the ability to restrict
the availability of gas transportation and storage to consumers, by
limiting their supply or cutting them off entirely, which has the
effect of raising the price they pay for natural gas.'' \19\
---------------------------------------------------------------------------
\19\ Complaint para.16; see also Complaint para.20.
The attached Affidavit of Dr. Paul Carpenter describes the numerous
means by which Pacific (via SoCalGas) can exercise its monopoly power,
as charged by DOJ, to restrict the availability of gas transportation
and gas storage capacity in southern California. These means include
SoCalGas' ability to (a) control and deny access to its intrastate
transmission and storage assets, (b) manipulate the price of intrastate
services, such as short-term balancing or emergency supply services,
(c) withhold the quantity of interstate capacity it makes available in
secondary markets in order to raise price, (d) determine the volume of
flowing supplies on a day-to-day basis through its core-related storage
injection and withdrawal decisions, and (e) manipulate prices and
access through its possession of valuable operational
information.\2\\0\
---------------------------------------------------------------------------
\2\\0\ Aff. at para.8.
---------------------------------------------------------------------------
The ability of Pacific to restrict the availability of gas
transportation and storage to consumers, including gas-fueled
generators, is the key to its power to increase electricity prices in
southern California for two related reasons. First, as explained by
DOJ, most electricity generated in California is bought and sold
through the California PX, which is a computerized bidding system that
matches electricity supply and demand every hour.\21\ The price of
electricity for all units sold is determined by the most expensive unit
sold in that hour, regardless of the cost or bidding price of less
expensive units.\22\ Stated differently, all sellers receive the PX's
marginal price, regardless of their bid, and all buyers pay the
marginal price.\23\
---------------------------------------------------------------------------
\21\ CIS at 33403. The CIS states that the matches occur every
half-hour; in fact, the matches are hourly.
\22\ CIS at 33403.
\23\ Aff. at para.9. This is true with one exception involving
nuclear-powered generators, which are covered by a different pricing
scheme.
Second, ``gas-fired plants are in general the most costly to
operate.'' \24\ In other words, gas-fueled plants are usually on the
margin. Because of the California PX, an increase in the price of
natural gas to these gas-fired plants will translate in an increase in
the price of all electricity sold in California through the PX. DOJ
made this point in its CIS as follows:
---------------------------------------------------------------------------
\24\ CIS at 33403.
[d]uring these periods [of high electricity demand], the gas-
fired plants, as the most costly to operate and thus the highest
bidders
[[Page 3559]]
into the [PX], are able to set the price for all electricity sold
through the [PX].\25\
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\25\ Id. DOJ is certainly correct in this critical finding.
Attachment B to Dr. Carpenter's affidavit depicts the electricity
supply curve for all generating resources in the western United
States. As shown, actual demand for electricity (which varies by
time of day and by season) falls within a certain band (70,500
megawatts to 93,500 megawatts) about two-thirds of the time. Within
that band, 90 percent of the megawatts that can be generated come
from gas-fired generators. And, 69 percent of those megawatts come
from California gas-fired generators. Aff. at Attach. B.
---------------------------------------------------------------------------
In short, what this all means is that as a consequence of its
monopoly over gas transportation and storage, Pacific has the
unquestioned ability to directly and materially affect the price of
electricity in southern California. As summarized by DOJ:
By virtue of its monopoly over natural gas transportation and
storage, Pacific currently has the ability to increase the price of
electricity, when during high demand periods, electricity from
California gas-fired generators is needed to supplement less costly
electricity. Pacific can restrict gas-fired generators' access to
gas, which has the effect of raising the cost of gas-filed
generators in general. Alternatively, Pacific can cut off or impede
the more efficient gas generators' access to gas, leaving the
higher-cost generators to meet consumer demand for electricity. In
either case, Pacific is able to increase the cost of electricity
from gas-fired plants, thereby increasing the prices they bid into
the [PX] and ultimately the price of electricity sold through the
[PX].\26\
\26\ CIS at 33404 (emphasis added).
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To be sure, Pacific's ability to increase electricity prices
existed absent the merger. Without the merger, however, Pacific had no
incentive to use its market power because it was not in the electricity
business, and it had no economic interest in electricity sales.\27\ It
is surely no coincidence that Enova--one of California's ``big three''
electric utilities and one which every incentive to raise electricity
prices--sought out Pacific, the one company in the world that could
raise prices in the soon-to-be deregulated California electricity
market (the PX). It is also no coincidence that the timing of the
merger was to coincide almost precisely with the commencement of
operation of that deregulated market.
---------------------------------------------------------------------------
\27\ A Pacific affiliate did have paper authority from the
FERC--the federal overseer of wholesale electricity sales--to make
electricity sales but it never made any such sales and, in fact,
voluntarily terminated its marketing certificate once the Enova-
Pacific merger was announced. See Ensource, 78 FERC para. 61,064
(1997).
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To take the position, as apparently DOJ does, that Pacific's
ability to raise gas prices and hence, electricity prices is not merger
related, and therefore should not be subject to any merger-related
remedy is to ignore reality. But for this merger, Enova would not be
able to affect electricity prices. It is the merger that transforms
Pacific's previously benign ability to affect electricity prices into a
serious, immediate threat to stifle competition in a nascent but
vitally important market.
B. The Competitive Problem Attendant to This Merger Calls for a
Structural Remedy Directed at the Natural Gas Transportation and
Storage Assets
Having identified the source of the competitive problem, and having
concluded that the merger was unlawful, DOJ then had to fashion an
appropriate remedy. Logic, traditional antitrust policy and precedent,
and one of the very terms of the proposed Final Judgment, all point to
a structural remedy aimed directly at the source of the market power--
Pacific's natural gas transportation and storage assets.\28\ Such a
remedy would separate Pacific's gas transportation and storage assets
from the merged company's other assets, either by divestiture or by
creation of an ISO to operate those assets. But, for unexplained
reasons, the proposed Final Judgment does no such thing; indeed, this
remedy apparently was not even seriously considered. In a section of
the CIS entitled ``Alternatives to the Proposed Final Judgment'', the
only alternative DOJ stated that it considered was a full trial on the
merits.\29\ The remedies that the DOJ did adopt are all aimed at
curtailing the incentive of the merged company to carry out it proven
ability to manipulate gas and, hence, electricity prices. The
ineffectiveness of these remedies is discussed in the following
section.
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\28\ Of course the most obvious and most effective remedy--
preventing this unlawful merger from being consummated--was
apparently rejected by DOJ. No explanation was given for eschewing
this proven, simple method of remedying the effects of this unlawful
merger.
\29\ See CIS at 33407.
Ironically, a provision in the proposed Final Judgment itself makes
clear that the only completely effective remedy is a structural remedy
aimed at the source of the market power; the same provision undermines
the effectiveness of the remedies actually proposed by DOJ and Enova,
which focus only on incentives. Article XIII. A of the proposed Final
Judgment provides that all of the complex provisions of the decree will
abruptly terminate in the event ``an Independent System Operator has
assumed control of Pacific's gas pipelines within California in a
manner satisfactory to the United States.\30\ Termination under these
circumstances would be appropriate in DOJ's view, because
---------------------------------------------------------------------------
\30\ Proposed Final Judgment at 33402.
[i]n that event, PE/Enova will lose the ability to control access to
gas transportation and storage. Without these tools, the merged
company will not be able to raise the price for electricity sold
through the [PX] by reducing its gas sales, and the basis for the
Final Judgment would be removed.\31\
---------------------------------------------------------------------------
\31\ CIS at 33406 (emphasis added).
Thus, DOJ's own reasoning supports the position that the only way to
completely eliminate the merged company's ability to increase
electricity prices is to eliminate Pacific's control over its gas
transportation and storage assets. This structural remedy serves the
public interest because it addresses the core competitive problem and
is certain to be effective over the long term. No policing is
---------------------------------------------------------------------------
necessary.
The staff of the Bureau of Economics of the Federal Trade
Commission (``FTC'') recently expressed its view that structural
remedies aimed directly at the source of market power are the most
effective remedies because such structural remedies alter incentives
(by eliminating the ability to exercise market power) while behavioral
remedies do not:
As a general proposition, we have found that structural
remedies, such as divestiture in merger cases, are the most
effective and require the least amount of subsequent monitoring by
government agencies. The effectiveness of structural remedies lies
in the fact that they directly alter incentives. Behavioral
remedies, in contrast, leave incentives for discriminatory behavior
in place and impose a substantial burden on government agencies to
monitor subsequent conduct.
In 1995, with regard to competition in electric generation and
transmission, we suggested that FERC [the Federal Energy Regulatory
Commission] promote independent system operators (ISOs) to control
the regional electric transmission grids, as an alternative to
ordering divestiture of transmission lines or relying solely on open
access rules to promote competition in electric generation
markets.\32\
\32\ Comments of the Staff of the Bureau of Economics of the
Federal Trade Commission Before the Public Utilities Commission of
Texas, at 2 (June 19, 1998). See Aff. at para. 13. Adoption of a
structural remedy aimed at the source of the market power would be
consistent with traditional antitrust policy and precedent. See,
e.g., California v. American Stores Cos., 495 U.S. 271, 294 n.28
(1990) (citing 2 P. Areeda & D. Turner, Antitrust Law Sec. 328b
(1978) (``[D]ivestiture is the normal and usual remedy against an
unlawful merger''.); United States v. American Cyanamid Co., 719
F.2d 558, 565 (2d Cir. 1983) (citing Ford Motor Co. v. US, 405 U.S.
562,573 (1972) (``[D]ivestiture is not uncommonly the appropriate
relief when a Section 7 violation is proven''). See also United
States v. Merc & Co., Inc., Proposed Final Judgment and Competitive
Impact Statement, 45 F.R. 60044 (1980) (ordering divestiture of
assets that would give the defendant the ability to exercise market
power in violation of Section 7 of the Clayton Act and Sections 1
and 2 of the Sherman Act).
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[[Page 3560]]
Thus, as explained by Dr. Carpenter, in a merger of electricity
transmission and generation companies, the FTC would focus its relief
on the source of the market power--the transmission facilities--rather
than the generation facilities that provide the incentive to engage in
the anti-competitive activity.\33\
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\33\ Aff. at para. 13.
Earlier this year in an analogous situation, the FTC entered into a
consent order settling a challenge to a proposed acquisition by an
electric power company of a coal supplier.\34\ Like the merger in the
present case involving electricity and natural gas pipelines, the FTC
found that a merger involving electricity and coal posed a direct
threat to competition in western U.S. electricity markets. In so
concluding, the FTC made findings remarkably similar to DOJ's findings
in this case:
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\34\ PacifiCorp/The Energy Group, File No. 971 0091. PacifiCorp,
headquartered in Portland, Oregon, makes electricity sales
throughout the western United States. The Energy Group PLC
(``TEG''), headquartered in London, England, is a diversified energy
company that owns, among other things, Peabody Coal Company, which
produces roughly 15 percent of the coal mined in the United States.
See FTC Restructures Electric/Coal Combination to Ensure that All
Consumers Reap Low Prices From Electricity Deregulation, FTC News
Release, Feb. 18, 1998.
``PacifiCorp's acquisition of Peabody, which is the
exclusive supplier of coal to certain power plants that compete with
PacifiCorp's own power plants, raises antitrust concerns.'' \35\
---------------------------------------------------------------------------
\35\ Analysis of Proposed Consent Order to Aid Public Comment
(``Analysis'') at 4.
During off-peak periods in the western United States,
``coal-fired plants frequently are the price-setting, marginal
plants.'' \36\
---------------------------------------------------------------------------
\36\ Analysis at 3.
---------------------------------------------------------------------------
PacifiCorp's acquisition ``would give PacifiCorp the
power to raise the price (or otherwise diminish the availability) of
coal, a necessary input for any firm seeking to compete with
PacifiCorp in electricity generation.'' \37\
---------------------------------------------------------------------------
\37\ Statement of The Federal Trade Commission Upon Withdrawal
From Consent Agreement, In the Matter of PacifiCorp, File No. 971
0091, (``Statement'') at 1 (emphasis added).
---------------------------------------------------------------------------
``PacifiCorp would have an incentive to increase fuel
costs at Navajo and Mohave in order to drive up the market price of
electricity in the western United States.'' \38\
---------------------------------------------------------------------------
\38\ Analysis at 4 (emphasis added).
Prior to the acquisition, the coal supplier (Peabody) had the ability
to raise coal prices to competing electric generators, but it had no
incentive to do so. On the other hand, before the acquisition, the
electricity company (PacifiCorp.) had the incentive to increase
electricity prices but lacked the ability. It was the merger of the
two, bringing together that ability and that incentive, that gave rise
---------------------------------------------------------------------------
to the FTC's concerns.
In stark contrast to DOJ's remedy in the present proceeding, the
FTC in PacifiCorp/The Energy Group did not hesitate to adopt a remedy
which went to the heart of the market power problem identified in the
FTC's complaint. The FTC proposed a remedy that required PacifiCorp to
divest Peabody Western Coal Company--the owner of the coal mines that
conferred market power on the merged firm and enabled it to increase
fuel prices at competing generating facilities (Navajo and Mohave).
And, the FTC directly addressed and rejected the proposals of several
commenters who had recommended conduct/behavioral remedies to resolve
the antitrust problem:
``Public comments on the consent agreement recommended
that we substitute conduct provisions for the order's divestiture
requirement, but we were not persuaded that the suggested course of
action would be preferable.'' \39\
---------------------------------------------------------------------------
\39\ Statement at 1 n.1.
---------------------------------------------------------------------------
``The divestiture remedy is consistent with
longstanding Commission policy which favors the structural approach
to remedies, rather than the behavioral approach which seeks to
govern conduct through the use of rules.'' \40\
---------------------------------------------------------------------------
\40\ Analysis at 8. The merger never was consummated because
PacifiCorp subsequently withdrew its bid in the face of a competing
offer. In closing the investigation, the FTC stated: ``Absent this
turn of events, the Commission would have been inclined to issue the
final order against PacifiCorp without modification.'' Statement at
1.
In both PacifiCorp and this case, the fuel supply assets are the
source of the competitive problem identified by the federal enforcement
authorities. The simple, direct way to remedy that problem is to cut
out and divest those assets or require that they be controlled by an
independent system operator.
C. The Remedies Adopted in the Proposed Final Judgment Fail To
Effectively Curb the Merged Company's Incentive To Manipulate
Electricity Prices
As explained above, DOJ made no pretext of selecting a remedy
designed to address the gas market power problem. Rather, DOJ focused
all of its attention on the electricity side of the merged company's
business and proposed a complicated set of conditions that are supposed
to curb the incentive of the merged company to manipulate electricity
prices. DOJ's theory is that if there is no financial gain to be made
from electricity price manipulations, then the merged company likely
would not engage in such conduct even if it possessed the power and
ability to do so. There is nothing wrong with this theory from an
analytical point of view. But having chosen this least attractive
remedial approach, DOJ needed to `'get it right'' by understanding,
anticipating, and then prohibiting all the various means by which the
merged company could seek to retain or create incentives to earn
profits through electricity price manipulations. DOJ, however, did not
do so.
The proposed Final Judgment requires and allows the following:
Enova is required to sell its Encina and South Bay
electricity generation facilities, totaling some 1650 megawatts, to
a purchaser acceptable to DOJ.\41\
---------------------------------------------------------------------------
\41\ Proposed Final Judgment art. IV(A) at 33398 (requiring
divestiture) & (D)(3) at 33398 (specifying DOJ's right to prior
approval of purchaser) & (I) at 33399 (specifying the criteria for
DOJ approval). The divestiture is to occur within eighteen months,
subject to extension by DOJ, or a trustee will be appointed.
Proposed Final Judgment art. IV(E) at 33399.
Enova is enjoined from acquiring ``California
Generation Facilities'' without prior notice and approval of DOJ.
\42\
---------------------------------------------------------------------------
\42\ Proposed Final Judgment art. V(A)(1). The term ``California
Generation Facilities'' is defined to mean electricity generation
facilities in California in existence on January 1, 1998, and any
contract to operate and sell output from generating assets of the
Los Angeles Department of Water and Power (``LADWP''). Proposed
Final Judgment art. II(B) at 33397. ``Acquire'' is defined to mean
``obtaining any interest in any electricity generating facilities or
capacity, including but not limited to, all real property * * *
capital equipment * * * or contracts related to the generation
facility, and including all generation, tolling, reverse tolling,
and other contractual rights.'' Proposed Final Judgment art II(A).
---------------------------------------------------------------------------
Enova is enjoined from entering any contracts that
allow it to ``control any California Generation Facilities'' without
prior notice and approval of DOJ.\43\
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\43\ Proposed Final Judgment art. V(A)(2) at 33399. ``Control''
means to have the ability to set the level of output of an
electricity generation facility.'' Proposed Final Judgment art.
II(E) at 33398.
---------------------------------------------------------------------------
In general, Enova is allowed to acquire or control up
to 500 MW of capacity of California Generation Facilities without
prior DOJ approval.\44\
---------------------------------------------------------------------------
\44\ Proposed Final Judgment art. V(B)(1) at 33399. The cap may
be increased to 800 MW upon Enova's sale of all of its existing
nuclear generating capacity, but only up to 10% of its total retail
electricity sales. Proposed Final Judgment art. XIII(D) at 33402.
---------------------------------------------------------------------------
Enova is allowed to ``own, operate, control, or acquire
any electricity generation facilities other than California
Generation Facilities [and] any cogeneration or renewable generation
facilities in California.'' \45\
---------------------------------------------------------------------------
\45\ Proposed Final Judgment art. V(C)(1) and (2) at 33399.
---------------------------------------------------------------------------
Enova is also allowed to ``enter into tolling and
reverse tolling agreements with any electricity generation
facilities in
[[Page 3561]]
California,'' provided it does not ``control'' them.\46\
---------------------------------------------------------------------------
\46\ Proposed Final Judgment art. (V)(C)(3) at 33399.
As explained by Dr. Carpenter, these remedies are ineffective
because they are incomplete.\47\ While their aim is to curb the merged
company's incentives to harm competition by restricting its
participation in certain activities, they also allow other activities
that can completely undo what DOJ seeks to achieve. It is as if DOJ
closed one door to anti-competitive activity but left wide open several
other doors.
---------------------------------------------------------------------------
\47\ Aff. at Paras. 19, 21.
---------------------------------------------------------------------------
The rationale underlying DOJ's required divestiture of the 1650 of
the 1650 MW of Enova generating facilities is that infra-marginal
assets (assets that are low-cost relative to the market price of
electricity) create incentives through the price-clearing mechanism in
the PX for the merged company to manipulate gas prices. As stated by
DOJ:
The Final Judgment requires Defendant to sell all generation
assets that would likely give PE/Enova the inventive to raise
electricity prices. [footnote excluded] To that end, the Final
Judgment requires Defendant to divest all of its low-cost gas
generators * * *. Because these generators operate in almost all
hours of the year and are relatively low-cost, if PE/Enova were to
own them, it could earn substantial profits (revenues exceeding its
costs) by restricting the supply of natural gas which, as explained
above, would increase the overall price for electricity in the pool
and thus the prive PE/Enova would receive for electricity.\48\
\48\ CIS at 33404.
But, what DOJ overlooked is that many other arrangements and
transactions that are not prohibited by the proposed Final Judgment
will allow the merged entity to directly, or indirectly through
financial instruments, collect the earnings from infra-marginal
generating facilities. Specifically, the proposed Final Judgmebnt has
left in place significant anti-competitive incentives by permitting the
merged company to:
Build or acquire new or repowered generating facilities;
Enter into tolling agreements;
Enter into power generation management contracts;
Enter into financial contracts tied to prices in the
California electricity market
1. Acquisition of New or Repowered Generating Facilities
While the merged company would generally be prohibited from owning
or controlling existing California generating facilities over and above
the 500 MW cap, the proposed Final Judgment allows it to build or
acquire new generating facilities and to acquire plants that are
rebuilt, repowered or activated out of dormancy after January 1, 1998.
While adding new facilities is generally procompetitive, here that is
not the case. Acquisition of new (or rebuilt/repowered/reactivated)
generating facilities will create incentives to manipulate gas prices
that the merged company does not have, easily undoing via vertical
market power the otherwise positive horizontal effect of adding new
generation facilities.\49\ DOJ required the divestiture of Enova's two
generation plants because, as low-cost facilities, they could ``earn
substantial profits'' under the PX pricing mechanism (see supra at p.
22). That same rationale holds equally true for the types of generating
facilities that the proposed Final Judgment permits the merged company
to acquire.
---------------------------------------------------------------------------
\49\ Aff. at para. 22.
---------------------------------------------------------------------------
By way of example, consider two scenarios. In scenario one, the
merged company divests 1650 MW of Enova's generating facilities, and
then builds a 1650 MW facility to replace the lost output. Because of
technology improvements, the new facility can be brought on-line with
costs roughly equal to those of the old facilities. In scenario two,
the merged company retains its 1650 MW of existing facilities and a
disinterested third party builds a 1650 MW facility. In both scenarios,
the market has the same amount of megawatts available for consumption
and the merged company has roughly the same incentive to raise gas
prices.\50\ The proposed Final Judgment permits scenario one but
prohibits scenario two. A provision such as that can hardly be said to
be within the reaches of the public interest.
---------------------------------------------------------------------------
\50\ See Aff. at para. 23.
---------------------------------------------------------------------------
2. Tolling Agreements
The proposed Final Judgment permits the merged company to enter
into tolling or reverse tolling agreements so long as it does not
control the level of the plant's output. Under a tolling agreement, a
party who owns natural gas enters into a contract with the owner of the
generating facility to use (``rent'') that facility, thereby allowing
the gas-owning party to produce electricity for a set fee. The gas-
owning party can then sell the electricity at the market price, which
may be higher or lower than the set fee.\51\
---------------------------------------------------------------------------
\51\ Aff at para. 24.
---------------------------------------------------------------------------
The problem is that tolling agreements are akin to virtual
ownership because they provide the merged company with the same
incentive to increase electricity prices as does physical ownership.
And, the agreement need not provide for control of the plant's output
for that incentive to exist. For example, the merged company could
enter into tolling agreements with the two Enova generating facilities
that it has agreed to divest. The facilities' operator, whoever that
is, would bid into the PX at the facilities' marginal cost and the
facilities would operate whenever the bids are successful. To the
extent that the agreement provides the merged company with electricity
at a fixed price, the company has an incentive to increase the PX price
by increasing gas prices--it will simply pocket the additional
revenue.\52\
---------------------------------------------------------------------------
\52\ Aff. at para. 25.
---------------------------------------------------------------------------
The failure of the proposed Final Judgment to close this gap is
another reason to find it not in the public interest.
3. Power Generation Management Contracts
A further reason to reject the proposed Final Judgment is due to
its failure to prohibit the merged company from entering into
management contracts under which it would operate a generation facility
owned by a third party. Such arrangements are similar to tolling
agreements in that they permit a sharing in a facility's profits.\53\
---------------------------------------------------------------------------
\53\ Aff. at para. 26. A management contract may be structured
to be more complex than a tolling agreement (e.g., clauses with
operating cost incentives) but, in essence, both arrangements have a
built-in incentive to make the facility as profitable as possible.
Id.
---------------------------------------------------------------------------
Importantly, the proposed Final Judgment recognizes the potential
harm to competition that such contracts can cause. It requires the
merged company to notify and/or obtain approval from DOJ for management
contracts entered into with the Los Angeles Department of Water and
Power and with the California Public Power Providers. These
restrictions go part way to reducing incentives but apparently they do
not apply to contracts relating to all other California generating
facilities.\54\ Permitting such contracts for certain but not all
California generating facilities is inconsistent and not in the public
interest.
---------------------------------------------------------------------------
\54\ There is some ambiguity due to the definition of
``acquisition'' in the proposed Final Judgment. ``Acquire'' could be
interpreted to prohibit any financial interest, or it could be
interpreted to prohibit any ownership interest. The latter
interpretation leaves open the possibility of entering into
management contracts. See proposed Final Judgment at art. II(A); see
also Aff. at para. 28.
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[[Page 3562]]
4. Financial Market Contracts
Finally, the proposed Final Judgment fails to place any
restrictions whatsoever on the merged company's ability to enter into
financial contracts (e.g., forwards, futures, options and other
derivatives) that provide the same incentive to increase electricity
prices.\55\ Financial contracts can be used to approximate the same
financial position the merged company would have by virtue of owning
generation facilities.\56\ The merged company, for example, could
contract for a one-year call option for 1000 MW of output at a certain
``strike price.'' The higher the electricity market price is above the
strike price, the greater the profit when the option is exercised.\57\
---------------------------------------------------------------------------
\55\ A forward contract is a non-standardized bilateral contract
for future delivery of electricity at a pre-specified price. A
futures contracts is a standardized forward contract that is traded
on an organized exchange. California-Oregon border and Palo Verde
electricity futures contracts, both of which are traded on the New
York Mercantile Exchange, are accessible to the California market.
Option contracts, which can be either traded on an exchange or done
bilaterally, include additional flexibility for the buyer or the
seller. For example, a call option gives the buyer the right but not
the obligation to purchase electricity in the future at a specified
price. Aff. at para.29 fn.9.
\56\ Aff. at para.29.
\57\ Aff. at para.29.
---------------------------------------------------------------------------
As explained by Dr. Carpenter, financial contracts have the
potential to foster more anti-competitive creativity than ownership of
generation facilities because they are more flexible. While it is
difficult to change ownership, it is simple to contract for electricity
in varying amounts over differing time horizons and to change positions
quickly and frequently. This flexibility allows the merged company to
tailor its electricity market position to most advantage itself.\58\
---------------------------------------------------------------------------
\58\ Aff. at para.29.
---------------------------------------------------------------------------
Both individually and collectively, the shortcomings of the
proposed Final Judgment are significant because they completely
undermine DOJ's effort to curb the merged entity's incentive to
increase electricity prices. DOJ's failure to eliminate this incentive
renders the proposed Final Judgment ineffective and thus outside the
reaches of the public interest. This Court should reject it as
presently written.
Respectfully submitted,
Kevin J. Lipson,
Mary Anne Mason,
Hogan & Hartson LLP, Columbia Square, 555--Thirteenth Street, NW,
Washington, DC 20004-1109. (202) 637-5600.
Stephen E. Pickett,
Douglas Kent Porter,
Southern California Edison Company, P.O. Box 800, 2244 Walnut Grove
Avenue, Rosemead, California 91770. (626) 302-1903.
J.A. Bouknight, Jr.,
David R. Roll,
Steptoe & Johnson LLP, 1330 Connecticut Avenue, NW, Washington, DC
20036. (202) 429-3000.
Affidavit of Paul R. Carpenter
Kevin J. Lipson,
Mary Anne Mason,
Hogan & Hartson LLP, Columbia Square, 555--Thirteenth Street, NW,
Washington, DC 20004-1109. (202) 637-5600.
Stephen E. Pickett,
Douglas Kent Porter,
Southern California Edison Company, P.O. Box 800, 2244 Walnut Grove
Avenue, Rosemead, California 91770. (626) 302-1903.
J.A. Bouknight, Jr.,
David R. Roll,
Steptoe & Johnson LLP, 1330 Connecticut Avenue, NW, Washington, DC
20036. (202) 429-3000.
Dated: August 17, 1998.
1. My name is Paul Carpenter. I am a Principal of The Brattle
Group, an economic and management consulting firm with offices at 44
Brattle Street, Cambridge, Massachusetts 02138, in Washington D.C., and
London, England.
2. I am an economist specializing in the fields of industrial
organization, finance, and regulatory economics. I received a Ph.D. in
Applied Economics and an M.S. in Management from the Massachusetts
Institute of Technology, and a B.A. in Economics from Stanford
University. Since the early 1980s, I have been involved in research and
consulting regarding the economics and regulation of the natural gas,
oil, and electric power industries in North America, the United
Kingdom, and Australia. I have testified frequently before the Federal
Energy Regulatory Commission (``FERC''), the Public Utilities
Commission of the State of California (``CPUC''), other state and
Canadian regulatory commissions, federal courts, the U.S. Congress, the
British Monopolies and Mergers Commission, and the Australian
Competition Tribunal on issues of pricing, competition and regulatory
policy in the natural gas and electric power industries. For at least
ten years I have been extensively involved in the evaluation of the
economics and structure of the natural gas industry in California,
including the interstate pipelines that serve the state, appearing as
an expert witness in many CPUC, FERC and Canadian regulatory
proceedings regarding the certification and pricing of interstate
pipeline capacity to California. Further details of my professional and
educational background and a listing of my publications are provided in
my curriculum vitae appended as Attachment A.
Introduction and Summary of Opinion
3. I have been asked by Southern California Edison Company
(``Edison'') to prepare this affidavit. Its purpose is to evaluate
whether the U.S. Department of Justice (``DOJ'') Final Judgment in this
proceeding (as further explained in its accompanying Competitive Impact
Statement (``CIS'')) remedies the competitive problem identified in
DOJ's Complaint--namely, that as a result of their merger, Pacific
Enterprises (``Pacific'') and Enova Corporation (``Enova'') will have
the incentive and ability to lessen competition in the market for
electricity in California.
4. The DOJ observed correctly in its Complaint and CIS that the
merger will give the combined company (``the Merged Entity'') both the
incentive and the ability to harm competition in the California
electricity market by limiting the supply and/or raising the price of
natural gas supplied to gas-fired electric generating plants in
southern California.
5. In my opinion, the Proposed Final Judgment does not remedy the
serious competitive problem identified by the DOJ in its complaint. The
bases for my opinion are summarized here and elaborated upon in the
remainder of this affidavit:
The DOJ correctly concluded that the merger will give the
Merged Entity both the ability and incentive to raise electricity
prices in southern California.
The DOJ could have remedied this competitive problem by
eliminating the ability of the Merged Entity to exercise market power
by requiring either:
The divestiture of Pacific's intrastate natural gas and
storage assets to a third party; or
The creation of an Independent System Operator to hold and
operate Pacific's natural gas assets.
This type of structural remedy is favored by antitrust
authorities because it is aimed directly at the source of the
competitive problem--market power--and it is clean and easy to enforce,
requiring no ongoing administrative involvement in reviewing the
conduct and performance of the suspect market.
[[Page 3563]]
The remedy chosen by the DOJ is to leave the Merged
Entity's market power intact, and instead to try to curb the Merged
Entity's incentives to harm competition by requiring the sale of two
generating plants and by restricting its participation in certain
activities. This remedy is ineffective. Not only does it leave market
power intact, it fails to eliminate significant anticompetitive
incentives that are equivalent financially to the ownership of the two
power plants.
The Proposed Final Judgment has left in place significant
anti-competitive incentives by permitting the Merged Entity to:
Build or acquire new or repowered generating capacity.
Enter into tolling agreements or management contracts.
Enter into financial contracts (e.g., forwards, futures,
options and other derivatives) for electricity.
These overlooked capabilities are a very real part of the
incentives of the Merged Entity, are a standard part of the package of
services of any major energy marketer, and they are consistent with the
avowed strategic business plans of the Merged Entity.
The Competitive Problem Associated With the Merger
6. Pacific, through its wholly owned subsidiary Southern California
Gas Company (``SoCalGas''), is effectively the sole provider of
intrastate natural gas transmission and storage services to almost all
of the gas-fired electric generating plants in southern California. As
a consequence of this market power, SoCalGas has the ability to limit
the supply and/or raise the price of natural gas to gas-fired plants.
Prior to the merger, however, it had no strong incentive to do so
because it had no position in or control over electricity markets.
7. The DOJ has recognized Pacific's ability to restrict the
availability of gas transportation and storage to gas-fired generators,
and to raise the price of delivered gas to such generators:
Gas-fired power plants cannot and do not switch to other fuels in
response to price increases in natural gas transportation or storage
services, and in California Pacific controls almost all gas-fired
generators' access to gas supply because the state of California has
granted Pacific a monopoly on transportation of natural gas within
southern California. Consequently, 96% of gas-fired generators in
southern California buy gas transportation services from it. Pacific
also has a monopoly on all natural gas storage services throughout
California. Although regulated by the California Public Utilities
Commission (``CPUC''), Pacific has the ability to restrict the
availability of gas transportation and storage to consumers, including
gas-fired generators, by limiting their supply or cutting them off
entirely. Limiting or cutting off gas supply raises the price gas-fired
plants pay for delivered natural gas and in turn raises the cost of
electricity they produce.\1\
---------------------------------------------------------------------------
\1\ Competitive Impact Statement (Case 98-CV-583), at 5-7. See
also Complaint, at 6.
---------------------------------------------------------------------------
8. The Merged Entity has numerous means to raise prices or limit
supply to gas-fired generators in the southern California market. These
means are derived primarily from SoCalGas' control of the intrastate
transmission, distribution and storage system in southern California,
its role as gas buyer for ``core'' residential and small commercial
customers, and its holding of excess interstate pipeline capacity under
long-term contract.
Intrastate transmission and storage access. As operator of
the intrastate transmission, distribution and storage system. SoCalGas
has considerable authority and autonomy to determine which gas will
flow and under what conditions. It decides on the amount of intrastate
capacity available at each interstate pipeline interconnect, based on
subjective procedures that are not articulated in any tariff or
internal procedural manual. It also has discretion in determining
storage availability.
Pricing of intrastate services. As the provider of hub and
storage services, SoCalGas is allowed under California regulation to
exercise pricing discretion with regard to certain negotiated services.
These services include short-term balancing or emergency supply
services.
Interstate access and pricing. SoCalGas has discretion in
determining the price and quantity of capacity it makes available in
secondary (``capacity release'') markets. This discretion presents the
Merged Entity with one more means by which to influence the delivered
price of gas to its electricity market rivals.
Core procurement behavior. SoCalGas has substantial
flexibility in its core-related storage injection and withdrawal
decisions that allows it to determine the volume of flowing supplies on
a day-to-day basis, notwithstanding customer demand.
Use of operational information. As the operator of the
intrastate natural gas transportation and storage system. SoCalGas
possesses considerable operational information that is extremely
valuable in the restructured natural gas and electricity markets. For
example, as system operator. SoCalGas will receive regular nomination
information from all of its shippers. Because SoCalGas has considerable
discretion in operating its system, it can do so in a manner that can
result in the manipulation of prices and access, and thus the cost of
rivals of using its system. Such manipulations would be almost
impossible to detect, difficult to prove, and not readily subject to
cure.
Each one of these advantages is sufficiently potent to enable to
the Merged Entity to manipulate the price of gas and/or the quality of
service to electricity generators.
9. As of March 31, 1998, California launched the Power Exchange
(PX), through which much of the electricity is now bought and sold in
California. The PX's price per unit of electricity for any given hour
is determined by the bid of the marginal generator--the most expensive
generator required to meet load in that hour. All sellers receive the
marginal price, regardless of their bid, and all buyers pay the
marginal price. As DOJ has acknowledged, because of California's mix of
generating capacity, gas-fired generators usually are the marginal
suppliers, and the marginal-cost pricing instituted by the PX means
that the price bid by gas-fired generators will set electricity prices
in the California market the majority of the time.\2\ The marginal bid
price setting mechanism of the PX means that California gas-fired
capacity will have a dominant effect on electricity prices.\3\
---------------------------------------------------------------------------
\2\ To illustrate, Attachment B to this affidavit depicts the
electricity supply curve for both utility and non-utility generating
resources for the entire Western Systems Coordinating Council
(WSCC). This supply curve distinguishes gas-fired capacity and
California gas-fired capacity from other generation capacity. As
illustrated, actual load (which varies by time of day and
seasonally) falls within a band of 70,500 MW to 93,500 MW
approximately two-thirds of the time. Within this same band of the
supply curve, 90% of the capacity is gas-fired capacity, and 69% is
California gas-fired capacity.
\3\ While not all California gas-fired capacity is served by
SoCalGas, the majority of it is, and it has been found that the
prices paid in northern California for gas delivered by Pacific Gas
& Electric Co. (PG&E) are determined by the gas supply alternatives
available at the southern California border. See CPUC Decision 97-
08-055. August 1, 1997, at p.10.
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10. Enova, through its wholly owned subsidiary, San Diego Gas &
Electric (SDG&E), owns gas-fired electric generating stations and
controls over 2,600 MW of electric generating capacity. DOJ recognized
that SDG&E's control of substantial quantities of electricity sold into
the PX gives SDG&E and incentive to raise the PX's electricity price,
making sales of its own
[[Page 3564]]
electricity more profitable. To this existing incentive, the merger
with Pacific adds the ability to increase the price of electricity. The
Merged Entity can accomplish this by increasing the price of natural
gas to gas-fired generating plants in southern California, which in
turn will raise their cost of producing electricity. Because California
gas-fired capacity dominates the electric margin, this will increase
the PX's price per unit of electricity to all sellers.\4\
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\4\ Much of the gas-fired generating capacity in California is
currently under temporary ``must-run'' contracts for reliability,
which when invoked will prevent these units from setting, or
profiting from, the PX price. However, this will have no effect when
must-run conditions are not declared, and the arrangement is
scheduled to expire in three years.
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Failure of the Proposed Final Judgment To Impose a Structural Remedy
Aimed at Market Power
11. The proposed Final Judgment fails to eliminate the competitive
harm caused by the PE/Enova merger because: (1) it does not contain any
provisions designed to curb the Merged Entity's ability to harm
competition through its monopoly over natural gas transportation and
supply, and (2) while it requires SDG&E to divest ownership of two gas-
fired electric generating plants, it permits the Merged Entity to
replicate ownership by entering into contractual arrangements which
offer the same incentives to engage in anti-competitive activity.
12. The proposed Final Judgment fails to impose the obvious,
traditional, and assuredly effective remedy to a market power problem
in a merger proceeding. It could have eliminated the ability of the
Merged Entity to harm competition by eliminating its ability to
exercise market power. It could have done this by requiring the
divestiture of Pacific's intrastate natural gas transmission and
storage assets, or by requiring the creation of an Independent System
Operator (``ISO'') for those assets.
13. The staff of the Bureau of Economics of the Federal Trade
Commission has recently expressed its view that structural remedies
(such as ISOs) aimed directly at the source of market power are the
most effective remedies because such structural remedies alter
incentives (by eliminating the ability to exercise market power) while
behavioral remedies do not:
As a general proposition, we have found that structural
remedies, such as divestiture in merger cases, are the most
effective and require the least amount of subsequent monitoring by
government agencies. The effectiveness of structural remedies lies
in the fact that they directly alter incentives. Behavioral
remedies, in contrast, leave incentives for discriminatory behavior
in place and impose a substantial burden on government agencies to
monitor subsequent conduct.
* * * In 1995, with regard to competition in electric generation
and transmission, we suggested that FERC [the Federal Energy
Regulatory Commission] promote independent system operators (ISOs)
to control the regional electric transmission grids, as an
alternative to ordering divestiture of transmission lines or relying
solely on open access rules to promote competition in electric
generation markets.\5\
---------------------------------------------------------------------------
\5\ Comments of the Staff of the Bureau of Economics of the
Federal Trade Commission Before the Public Utilities Commission of
Texas, at 2 (June 19, 1998).
I agree with this view. Thus, for example, in a merger of
electricity transmission and generation companies, the FTC would focus
its relief on the source of the market power--the transmission
facilities--rather than the generation facilities that provide the
incentive to engage in anti-competitive activity. As stated above, the
FTC would place the transmission facilities in the hands of an
independent entity, an ISO, and would prevent those facilities, which
confer market power, from being controlled by the merged entity.
14. In remedying the anti-competitive effects of vertical mergers
like the present one, the antitrust authorities have opted, and should
continue to opt, for structural remedies that eliminate the source of
the market power. Recently, in addressing the anti-competitive effects
of a proposed merger between an electric utility and a coal company,
the FTC insisted on divestiture of the coal supply assets that were the
source of the market power which in turn led to anti-competitive
control over electricity prices. I agree with this approach and this
remedy. A copy of the FTC's reasoning in that case is appended as
Attachment C.
15. A structural remedy in this case, requiring intrastate gas
transmission and storage divestiture or the creation of an ISO, would
eliminate cleanly the Merged Entity's ability to control the price of
electricity in California, and it would eliminate the enforcement
difficulties associated with behavioral remedies that attempt to
control anti-competitive incentives after the fact.\6\
---------------------------------------------------------------------------
\6\ Nowhere in its CIS does DOJ explain why it has failed to
impose a remedy that eliminates the ability of the merged entity to
raise prices.
---------------------------------------------------------------------------
The Proposed Final Judgment Does Not Remedy the Competitive Problem
Identified by DOJ
16. The proposed Final Judgment does not attempt to eliminate the
Merged Entity's market power over natural gas transportation and
storage which gives it the ability to harm competition and raise prices
in electricity markets. Instead, DOJ has chosen to attempt to curb the
Merged Entity's incentive to harm competition by requiring Enova to
divest itself of 1,644 MW of generation assets, namely, the Encina and
South Bay gas-fired electricity generating plants. In addition, the
Final Judgment caps the Merged Entity's ownership of California
electricity generation assets at 500 MW.\7\ The Final Judgment also
enjoins the Merged Entity from acquiring electricity generation
facilities in California which were in existence on January 1, 1998
(except facilities that are rebuilt, repowered, or activated out of
dormancy after January 1, 1998) and/or entering into any contract for
operation and sale of output from generating assets of Los Angeles
Department of Water and Power (``LADWP''), without prior notice to, and
approval of, the United States. Finally, the Final Judgment enjoins the
Merged Entity from entering into any contracts that allow it to control
the output of electricity generation facilities in California in
existence on January 1, 1998 without prior notice to and approval of
the United States.
---------------------------------------------------------------------------
\7\ Since nuclear plants in California will remain price
regulated (i.e., will not receive the PX price) until 2001, Enova's
20% (430 MW) interest in the San Onofre Nuclear Generating Station
(``SONGS'') will not be included in the 500 MW cap. If nuclear power
prices become deregulated after 2001, SONGS capacity will be
included in the cap and the period of the final judgment will be
extended from five to ten years. A 75 MW contract with Portland
General Electric will be included in the cap, unless the contract is
terminated or divested. Finally, the capacity of the Encina and
South Bay generation facilities will be included in the cap for as
long as Enova owns these assets.
---------------------------------------------------------------------------
17. Importantly, this merger involves much more than an effort to
combine SDG&E's electricity generation assets with SoCalGas' natural
gas transmission and distribution assets. The problem with the merger
is that it combines SDG&E's expertise in profiting through the
acquisition and sale of electric power with SoCalGas' ability to
control the price of natural gas in California through its monopoly
over natural gas transportation and storage services in California.\8\
As explained further below, this combination of electricity expertise
and natural gas control creates a serious competitive problem that is
not remedied by the divestiture of assets and other conditions set
forth in the Final Judgment. Specifically, such
[[Page 3565]]
electricity expertise could be used to enter into tolling agreements,
management contracts and forward and futures contracts that perpetuate
the Merged Entity's incentive to manipulate gas prices for anti-
competitive ends, notwithstanding the Final Judgment's generation
ownership restrictions.
---------------------------------------------------------------------------
\8\ The California Commission noted in its merger decision that
``* * * each company sees unregulated energy services (particularly
electricity marketing) as a way to increase earnings. But each feels
that it lacks critical skills and physical assets.'' See D. 98-03-
073, at 24.
---------------------------------------------------------------------------
18. As a general matter, it is extremely difficult to eliminate all
of the anti-competitive incentives facing a utility in a restructured,
partially deregulated wholesale electricity market. Those incentives
manifest themselves in many different ways--only one of which is
through ownership of existing gas-fired plants. Yet to be confident
that the harm is competition is eliminated (when the ability to
exercise market power remains), the antitrust authority or regulator
must identify all of the potential incentives to profit from market
manipulation and then design remedies that will curb each and every
incentive. As explained below, the Final Judgment fails to curb very
significant incentives.
19. The Competitive Impact Statement (CIS) correctly defines the
Merged Entity's incentive but misconstrues the relationship between the
kinds of transactions the Merged Entity might pursue and the incentives
that would be created. As a result, the behavioral remedies put forward
in the Final Judgment eliminate only part of the Merged Entity's
incentives to raise prices.
20. The CIS recognizes that infra-marginal assets (assets that are
low-cost relative to the market price of electricity) create incentives
through the price-clearing mechanism in the California PX for the
Merged Entity to manipulate gas prices. For example, the CIS states (at
page 9):
The Final Judgment requires Defendant to sell all generation
assets that would likely give PE/Enova the incentive to raise
electricity prices [footnote excluded] To that end, the Final
Judgment requires Defendant to divest all of its low-cost gas
generators * * *. Because these generators operate in almost all
hours of the year and are relatively low-cost, if PE/Enova were to
own them, it could earn substantial profits (revenues exceedings its
costs) by restricting the supply of natural gas which, as explained
above, would increase the overall price for electricity in the pool
[PX] and thus the price PE/Enova would receive for electricity.
21. In making this finding, the DOJ overlooks the fact that many
other arrangements and transactions that are not prohibited by the
proposed Final Judgment create financial positions equivalent to, and
potentially even more profitable than, the physical ownership of an
infra-marginal generating unit. Any arrangement that allows the Merged
Entity to collect or share in the earnings of an infra-marginal
generator will give it the incentive to manipulate the spot price of
power by increasing gas prices. The Final Judgment does not prohibit,
and in fact explicitly allows, several such arrangements. Under the
Final Judgment, the Merged Entity is allowed to (1) acquire new,
rebuilt or repowered generation, (2) enter into tolling agreements with
third-party generation owners, (3) enter into power generation
management contracts, and (4) take forward contractual positions in the
electricity market. All of these permitted transactions allow the
Merged Entity to profit by manipulating the price of electric power,
and will risk the abuse of market power as long as the Merged Entity
has the continuing ability to influence gas prices that the CIS has
acknowledged. As I explain below, in each of these situations the Final
Judgment's restrictions simply do not eliminate the Merged Entity's
incentives to exercise market power.
New or Repowered Generation Capacity
22. Under the proposed Final Judgment, the Merged Entity would be
prohibited from owning or controlling existing generating facilities,
but it is permitted to built or acquire new generating capacity and to
gain control of plants that are rebuilt, repowered or activated out of
dormancy after January 1, 1998. However, the addition of new generation
by the Merged Entity is not necessarily benign. All else equal, adding
generating capacity is usually procompetitive. However, in this case,
all else is decidedly unequal. Allowing the Merged Entity to acquire
new generation (or to rebuild, repower or reactivate generation) will
give it incentives to manipulate gas prices which it would not
otherwise have, easily undoing via vertical market power the otherwise
positive horizontal effect of adding capacity. By giving the Merged
Entity an incentive to raise gas prices, ownership of new or repowered
generation could lead to an across-the-board increase in the cost of
most of the margin-setting capacity in the market. Thus, the Final
Judgment should prohibit the acquisition of new generating capacity for
the same reason it requires divestiture of existing capacity. Holding
any sort of interest in generating capacity eligible for the PX price
gives the Merged Entity an incentive to exercise its market power in
the gas market, to the detriment of the electricity market.
23. Another way to view this is by considering two scenarios: (A)
the Merged Entity divests its existing generation to a third party, and
builds a new generator, or (B) the Merged Entity keeps its existing
generation and a disinterested third party builds the new generator. In
both scenarios, the market has the same amount of generation, and the
Merged Entity has essentially the same incentive to raise gas prices.
However, while the CIS correctly recognizes (B) as problematic, the
Final Judgment explicitly (though incorrectly) allows (A), the
acquisition of new or repowered capacity.
Tolling Agreements
24. In a ``tolling'' agreement, one party contracts for the use of
another party's generating capacity, allowing the first party to
convert its own gas into electricity for a set fee. The first party can
then sell the electricity at the market price, and will be able to
collect the associated profit (or loss) as if it owned the generator.
The proposed Final Judgment explicitly allows the Merged Entity to
enter into tolling agreements, so long as it does not control the
plant's output level in the process.
25. Tolling agreements create virtual ownership positions in power
plants, and provide the Merged Entity with the same incentives to
increase electricity prices as does physical plant ownership. A tolling
agreement would allow the Merged Entity to receive all or most of the
generator's infra-marginal net revenues, whether or not it controls the
plant's output level. The proposed Final Judgment's restriction against
controlling plant output displays a misconception of how the Merged
Entity could exercise market power. It is not by withholding generating
capacity from the market that the Merged Entity would manipulate
electricity prices. Withholding capacity is an issue in horizontal
market power, but not in the vertical market power that is of concern
in this instance. Vertical market power arises here because the Merged
Entity has the ability to raise the price of electricity by raising the
price of gas--the dominant margin-setting fuel, and a vertical input to
electricity. The Merged Entity can profit from gas market manipulation
if it holds a claim on the net revenues of any infra-marginal plant
that is operating when gas-fired generation is setting the PX price,
regardless of whether it controls the plant's output. The plant
operator, whoever it is, would simply bid into the PX at the plant's
marginal cost, so that the plant would dispatch when economical. Thus,
for example, if the Merged Entity enters into a tolling agreement with
the owners of the two plants it has agreed to divest, its
[[Page 3566]]
financial stake will be essentially identical to what it would have
been under direct ownership. While physical plant ownership is rightly
prohibited, the Final Judgment fails to curb the Merged Entity's
incentives because it allows tolling agreements that give the Merged
Entity the same profit-making potential.
Management Contracts
26. The same issues arise with ``management contracts,'' under
which the Merged Entity would operate a plant owned by a third party,
typically for a share of the plant's profits. Such arrangements are
similar to tolling agreements in that they allow the Merged Entity to
share in a plant's net revenues.
27. The problem with the proposed Final Judgment is that it does
not clearly prohibit the Merged Entity from entering into management
contracts with existing California generating facilities (e.g. its own
divested generators or those of others). Thus, the Merged Entity could
sign a management contract for one or more of the plants divested by
itself or others and enjoy essentially the same financial incentives it
could have had by retaining its own plants. Moreover, these units under
management contract need not be gas-fired for them to create price
manipulation incentives. To perpetuate such incentives, all that is
required is that the plant(s) under contract be infra-marginal (i.e.,
lower cost than the marginal gas-fired plant that is setting the PX
price.) To eliminate the anti-competitive incentives associated with
management contracts, the Merged Entity would have to be explicitly
prevented from entering into a management contract with any entity
owning or building generation in California.
28. The proposed Final Judgement recognizes the problems with
management contracts when it requires that the Merged Entity notify
and/or obtain approval from DOJ for management contracts with assets
owned by California Public Power Providers (``CPPP'') and the Los
Angeles Department of Water and Power (``LADWP''). These restrictions
go part way in reducing the Merged Entity's incentives. But since
similar restrictions are not applied to management contracts involving
other assets, the Final Judgment gives the appearance of endorsing such
contracts. Relatedly, the Final Judgment prohibits the ``acquisition''
of California Generation Facilities without prior approval. However, by
carving out exceptions for management contracts, the meaning of
``acquire'' becomes ambiguous, despite being defined as ``obtaining any
interest in any electricity generating facilities or capacity''.
``Acquire'' could be interpreted to prohibit any financial interest
(which it must do to be effective), or could it be interpreted more
narrowly to prohibit only ownership interest--which leaves open the
possibility of management contracts. By explicitly restricting
management contracts with respect to LADWP and CPPP assets only, the
proposed Final Judgment appears to endorse a narrow interpretation of
``acquire'', and threatens to leave the Merged Entity with significant
incentives to exercise its market power. Such debates concerning
interpretation mean that at a minimum, in order to enforce the Final
Judgment the DOJ will have to put itself in a significant oversight
position to ensure consistency of interpretation and compliance. The
need for such continuing regulatory activity by the antitrust authority
would have been eliminated had the Final Judgment imposed a structural
solution to the market power problem.
Financial Markets
29. It is apparent from the proposed Final Judgement that the DOJ
fails to recognize that financial market contracts (derivatives such as
forwards, futures, and options) which the Merged Entity may acquire
could also provide it with incentives to act anti-competitively.\9\ In
fact, financial contracts can be used to essentially recreate the same
financial position one would have by virtue of power plant ownership.
For example, holding a one-year call option for 1,000 MW is financially
akin to a year's ownership of a 1,000 MW power plant with variable cost
equal to the ``strike price'' of the call (the contract price paid for
power if the option is exercised. Such financial market contracts are,
in effect, ``virtual generation assets.'' \10\ The equivalence between
financial and physical assets is such that it is now common for
electric industry planners to treat power plant ownership as equivalent
to holding a series of call options and/or forward contracts to serve
future spot markets for power.
---------------------------------------------------------------------------
\9\ A forward contract for power is simply a non-stardized
bilateral contact for future delivery at a pre-specified price.
Futures are standardized forward contracts traded on an organized
exchange, such as the California-Oregon Border (COB) and Palo Verde
(PV) electricity futures contracts which are traded on the New York
Mercantile Exchange (NYMEX) and which are accessible to the
California market. Options contracts are also derivatives that
include additional flexibility for either the buyer or seller. For
example, a call option, a common type of derivative, gives the buyer
the right but not he obligation to purchase power in the future at a
specified price.
\10\ Financial contracts can foster even more anti-competitive
creativity than power plant ownership, because they are far more
flexible. For instance, while it is difficult to change one's
ownership of generating capacity, it is simple to contract for power
in varying amounts over differing time horizons (a year, a month, a
week, a day), and to change one's position quickly and frequently.
This would allow the Merged Entity to tailor its electricity market
position to make it most advantageous.
---------------------------------------------------------------------------
30. Consequently, to the extent power plant ownership creates anti-
competitive incentives, so would an equivalent bundle of forward or
derivative contracts. While the Final Judgment does attempt to restrict
the future acquisition of existing generating capacity in order to
prevent anti-competitive behavior, it fails to restrict financial
market participation, which creates the same incentives to abuse market
power.
Conclusion
31. In its Complaint in this matter, the DOJ found that the
proposed merger of Pacific Enterprises and Enova results in the
creation of an entity that has the ability and incentive to harm
competition in the market for wholesale electric power in California.
The proposed Final Judgment, however, fails to rectify the problem
because it preserves the ability of the Merged Entity to harm
competition while imposing remedies that fail to eliminate the
incentives. In particular, the Final Judgment fails entirely to deal
with the incentives which the Merged Entity could create through
ownership of new or repowered generation or contracting for power via
tolling agreements, management contracts or financial contracts. The
CIS provides no justification for distinguishing between the
acquisition of physical assets and financial assets in creating anti-
competitive incentives. The limited restrictions that the proposed
Final Judgment does place on the future activities of the Merged Entity
in the areas of new capacity, tolling and energy management contracts
will not eliminate or even substantially curb the Merged Entity's
incentives to harm competition.
32. The proposed Final Judgment does not remedy the serious
competitive problem identified by the DOJ in its Complaint.
Attachment A--Paul R. Carpenter, Principal
Dr. Carpenter holds a Ph.D. in applied economics and an M.S. in
management from the Massachusetts Institute of Technology, and a
B.A. in economics from Stanford University. He specializes in the
economics of the natural gas, oil and electric utility
[[Page 3567]]
industries. Dr. Carpenter was a co-founder of Incentives Research,
Inc. in 1983. Prior to that he was employed by the NASA/Caltech Jet
Propulsion Laboratory and Putnam, Hayes & Bartlett, and he was a
post-doctoral fellow at the MIT Center for Energy Policy Research.
He is currently a Principal of The Brattle Group.
Areas of Expertise
Dr. Carpenter's areas of expertise include the fields of energy
economics, regulation, corporate planning, pricing policy, and
antitrust. His recent engagements have involved:
Natural Gas and Electric Utility Industries: consulting
and testimony on nearly all of the economic and regulatory issues
surrounding the transition of the natural gas and electric power
industries from strict regulation to greater competition. These
issues have included stranded investments and contracts, design and
pricing of unbundled and ancillary services, evaluation of supply,
demand and price forecasting models, the competitive effects of
pipeline expansions and performance-based ratemaking. He has
consulted on the regulatory and competitive structures of the gas
and electric power industries in the U.S., Canada, the United
Kingdom, Australia and New Zealand.
Antiturst: expert testimony in several of the seminal
cases involving the alleged denial of access to regulated
facilities; analysis of relevant market and market power issues,
business justification defenses, and damages.
Regulation: studies and consultation on alternative
rate making methodologies for oil and gas pipelines, on ``bypass''
of regulated facilities before the U.S. Congress; advice and
testimony before several state utility commissions and the National
Energy Board of Canada on new facility certification policy.
Finance: research on business and financial risks in
the regulated industries and testimony on risk, cost of capital, and
capital structure for natural gas pipeline companies in the U.S. and
Canada.
Professional Affiliations
International Association of Energy Economists
American Bar Association (Antitrust Section)
American Economic Association.
Academic Honors and Fellowships
Stewart Fellowship, 1983
MIT Fellowships, 1981, 1982, 1983
Brooks Master's Thesis Prize (Runner-up), MIT, 1978.
Publications
``Pipeline Pricing to Encourage Efficient Capacity Editions,'' (with
Frank C. Graves and Matthew P. O'Loughlin), prepared for Columbia
Gas Transmission Corporation and Columbia Gulf Transmission Company,
February 1998.
``The Outlook for Imported Natural Gas,'' (with Matthew P.
O'Loughlin and Gao-Wen Shao), prepared for The INGAA Foundation,
Inc., July 1997.
``Basic and Enhanced Services for Recourse and Negotiated Rates in
the Natural Gas Pipeline Industry'' (with Frank C. Graves, Carlos
Lapuerta, and Matthew P. O'Loughlin), May 29, 1996, prepared for
Columbia Gas Transmission Corporation, Columbia Gulf Transmission
Company.
``Estimating the Social Costs of PUHCA Regulation'' (with Frank C.
Graves), submitted on behalf of Central and South West Corp. to the
U.S. Securities and Exchange Commission in its Request for Comments
on the Modernization of Regulation of Public Utility Holding
Companies, File No. S7-32-94, February 6, 1995.
``Review of the Model Developer's Report, Natural Gas Transmission
and Distribution Model (NGTDM) of the National Energy Modeling
System'', December 1994, prepared for U.S. Department of Energy,
Energy Information Administration and Oak Ridge National Laboratory
under Subcontract No. 80X-SL220V.
``Pricing of Electricity Network Services to Preserve Network
Security and Quality of Frequency Under Transmission Access'' (with
Frank C. Graves, Marija Ilic, and Asef Zobian), response to the
Federal Energy Regulatory Commission's Request for Comments in its
Notice of Technical Conference Docket No. RM93-19-000, November
1993.
``Creating a Secondary Market in Natural Gas Pipeline Capacity
Rights Under FERC Order No. 636'' (with Frank C. Graves), draft
December 1992, Incentives Research, Inc.
``Review of the Component Design Report, Natural Gas Annual Flow
Module, National Energy Modeling System,'' August 1992, prepared for
the U.S. Department of Energy, Energy Information Administration.
``Unbundling, Pricing, and Comparability of Service on Natural Gas
Pipeline Networks'' (with Frank C. Graves), November 1991, prepared
for the Interstate Natural Gas Association of America.
``Review of the Gas Analysis Modeling System (GAMS): Final Report of
Findings and Recommendations,'' August, 1991, prepared for the U.S.
Dept. of Energy, Energy Information Administration.
``Estimating the Cost of Switching Rights on Natural Gas Pipelines''
(with F.C. Graves and J.A. Read), The Energy Journal, October 1989.
``Demand-Charge GICs Differ from Deficiency-Charge GICs'' (with F.C.
Graves), Natural Gas, Vol. 6, No. 1, August 1989.
``What Price Unbundling?'' (with F.C. Graves), Natural Gas, Vol. 5
No. 10, May 1989.
Book Review of Drawing the line on Natural Gas Regulation: The
Harvard Study on the Future of Natural Gas, Joseph Kalt and Frank
Schuller eds., in The Energy Journal, April 1988.
``Adapting to Change in Natural Gas Markets'' (with Henry D. Jacoby
and Arthur W. Wright), in Energy, Markets and Regulation: What Have
We Learned?, Cambridge: MIT Press, 1987.
Evaluation of the Commercial Potential in Earth and Ocean
Observation Missions from the Space Station Polar Platform, Prepared
by Incentives Research for the NASA Jet Propulsion Laboratory under
Contract No. 957324, May 1986.
An Economic Comparison of Alternative Methods of Regulating Oil
Pipelines (with Gerald A. Taylor), Prepared by Incentives Research
for the U.S. Department of Energy, Office of Competition, July 1985.
``The Natural Gas Policy Drama: A Tragedy in Three Acts'' (with
Arthur W. Wright), MIT Center for Energy Policy Research Working
Paper No. 84-012WP, October 1984.
Oil Pipeline Rates and Profitability under Williams Opinion 154
(with Gerald A. Taylor), Prepared by Incentives Research for the
U.S. Department of Energy, Office of Competition, September 1984.
Natural Gas Pipelines After Field Price Decontrol: A Study of Risk,
Return and Regulation, Ph.D. Dissertation, Massachusetts Institute
of Technology, March 1984. Published as a Report to the U.S.
Department of Energy, Office of Oil and Gas Policy, MIT Center for
Energy Policy Research Technical Report No. 84-004.
The Competitive Origins and Economic Benefits of Kern River Gas
Transmission, Prepared by Incentives Research, Inc., for Kern River
Gas Transmission Company, February 1994.
``Field Price Decontrol of Natural Gas, Pipeline Risk and Regulatory
Policy,'' in Government and Energy Policy Richard L. Itteilag, ed.,
Washington, D.C., June 1983.
``Risk Allocation and Institutional Arrangements in Natural Gas''
(with Arthur W. Wright), invited paper presented to the American
Economic Association Meetings, San Francisco, December 1983.
``Vertical Market Arrangements, Risk-shifting and Natural Gas
Pipeline Regulations,'' Sloan School of Management Working Paper no.
1369-82, September 1982 (Revised April 1983).
Natural Gas Pipeline Regulation After Field Price Decontrol (with
Henry Dr. Jacoby and Arthur W. Wright), prepared for U.S. Department
of Energy, Office of Oil and Gas Policy, MIT Energy Lab Report No.
83-013, March 1983.
Book Review of An Economic Analysis of World Energy Problems, by
Richard L. Gordon, Sloan Management Review, Spring 1982.
``Perspectives on the Government Role in New Technology Development
and Diffusion'' (with Drew Bottaro), MIT Energy Lab Report No. 81-
041, November 1981.
[[Page 3568]]
International Plan for Photovoltaic Power Systems (co-author), Solar
Energy Research Institute with the Jet Propulsion Laboratory
Prepared for the U.S. Department of Energy, August 1979.
Federal Policies for the Widespread Use of Photovoltaic Power
Systems (contributor), Jet Propulsion Laboratory Report to the U.S.
Congress DOE/CS-0114, March 24, 1980.
``An Economic Analysis of Residential, Grid-connected Solar
Photovoltaic Power Systems'' (with Gerald A. Taylor), MIT Energy
Laboratory Technical Report No. 78-007, May 1978.
Speeches/Presentations
``Opening Remarks from the Chair: Rates, Regulations and Operational
Realities in the Capacity Market of the Future,'' AIC conference on
``Gas Pipeline Capacity `97,'' Houston, Texas June 17, 1997.
``Lessons from North America for the British Gas TransCo Pricing
Regime,'' prepared for AIC conference on: Gas Transportation and
Transmission Pricing, London, England, October 17, 1996.
``GICs and the Pricing of Gas Supply Reliability,'' California
Energy Commission Conference on Emerging Competition in California
Gas Markets, San Diego, Ca. November 9, 1990.
``The New Effects of Regulation and Natural Gas Field Markets: Spot
Markets, Contracting and Reliability,'' American Economic
Association Annual Meeting, New York City, December 29, 1988.
``Appropriate Regulation in the Local Marketplace,'' Interregional
Natural Gas Symposium, Center for Public Policy, University of
Houston, November 30, 1988.
``Market Forces, Antitrust, and the Future of Regulation of the Gas
Industry,'' Symposium of the Future of Natural Gas Regulation,
American Bar Association, Washington D.C., April 21, 1988.
``Valuation of Standby Tariffs for Natural Gas Pipelines,'' Workshop
on New Methods for Project and Contract Evaluation, MIT Center for
Energy Policy Research, Cambridge, March 3, 1988.
``Long-term Structure of the Natural Gas Industry,'' National
Association of Regulatory Utility Commissioners Meeting, Washington
D.C., March 1, 1988.
``How the U.S. Gas Market Works--or Doesn't Work,'' Ontario Ministry
of Energy Symposium on Understanding the United States Natural Gas
Market, Toronto, March 18, 1986.
``The New U.S. Natural Gas Policy: Implications for the Pipeline
Industry,'' Conference on Mergers and Acquisitions in the Gas
Pipeline Industry, Executive Enterprises, Houston, February 26-27,
1986.
Various lectures and seminars on U.S. natural gas industry and
regulation for graduate energy economics courses at Massachusetts
Institute of Technology, 1984-96.
Panelist in University of Colorado Law School workshop on state
regulations of natural gas production, June 1985. (Transcript
published in University of Colorado Law Review.) ``Oil Pipeline
Rates after the Williams 154 Decision,'' Executive Enterprises,
Conference on Oil Pipeline Ratemaking, Houston, June 19-20, 1984.
``Issues in the Regulation of Natural Gas Pipelines,'' California
Public Utilities Commission Hearings on Natural Gas, San Francisco,
May 21, 1984.
``The Natural Gas Pipelines in Transition: Evidence From Capital
Markets'', Pittsburgh Conference on Modeling and Simulation,
Pittsburgh, April 20, 1984.
``Financial Aspects of Gas Pipeline Regulation,'' Pittsburgh
Conference on Modeling and Simulation, Pittsburgh, April 19-20,
1984.
``Natural Gas Pipelines After Field Price Decontrol,'' Presentations
before Conferences of the International Association of Energy
Economists, Washington D.C., June 1983, and Denver, November 1982.
``Spot Markets for Natural Gas,'' MIT Center for Energy Policy
Research Semi-annual Associates Conference, March 1983.
``Pricing Solar Energy Using a System of Planning and Assessment
Models,'' Presentations to the XXIV International Conference, The
Institute of Management Science, Honolulu, June 20, 1979.
Testimonial Experience
Antitrust/Federal Court/Arbitration
In the matter of the Arbitration between Western Power Corp. and
Woodside Petroleum Corp., et al., Perth, Western Australia, May-July
1998.
In the United States District Court for the District of Montana,
Butte Division, Paladin Associates, Inc. v. Montana Power Company,
November-December 1997.
In the United States District Court for the District of Colorado,
Atlantic Richfield Co. v. Darwin H. Smallwood, Sr., et al., July
1997.
In the Australian Competition Tribunal, Review of the Trade
Practices Act Authorizations for the AGL Cooper Basin Natural Gas
Supply Arrangements, on behalf of the Australian Competition and
Consumer Commission, February 1997.
In the Southwest Queensland Gas Price Review Arbitration, Adelaide,
South Australia, May 1996.
In the matter of the Arbitration between Amerada Hess Corp. v.
Pacific Gas & Electric Co., May 1995.
In re Columbia Gas Transmission Corp., Claims Quantification
Proceeding in the U.S. Bankruptcy Court for the District of
Delaware, Before the Claims Mediator, July and November 1993.
Deposition Testimony in Fina Oil & Gas v. Northwest Pipeline Corp.
and Williams Gas Supply (New Mexico) 1992.
Testimony by Affidavit in James River Corp. v. Northwest Pipeline
Corp. (Fed. Ct. for Oregon) 1989.
Deposition and Testimony by Affidavit in Merrion Oil and Gas Col, et
al., v. Northwest Pipeline Corp. (Fed. Ct. for New Mexico) 1989.
Deposition Testimony in Martin Exploration Management Co., et al. v.
Panhandle Eastern Pipeline Co. (Fed. Ct. for Colorado) 1988 and
1992.
Trial Testimony in City of Chanute, et al. v. Williams Natural Gas
(Fed. Ct. for Kansas) 1988.
Deposition Testimony in Sinclair Oil Co. v. Northwest Pipeline Co.
(Fed. Ct. for Wyoming) 1987.
Deposition and Trial Testimony in State of Illinois v. Panhandle
Eastern Pipeline Co. (Fed. Ct. for C.D. Ill) 1984-87.
Economic/Regulatory Testimony
Before the National Energy Board of Canada, Application of Alliance
Pipeline Ltd., Hearing Order GH-3-97, December 1997, April 1998.
Before the California Public Utilities Commission, Pacific
Enterprises, Enova Corporation, et al. Merger Proceedings, Docket
A.96-10-038, on behalf of Southern California Edison, August 1997.
In the Superior Court of the State of California for the County of
Los Angeles, Pacific Pipeline System Inc. v. City of Los Angeles, on
behalf of Pacific Pipeline System Inc., January 1997.
Before the U.K. Monopolies and Mergers Commission, British Gas
Transportation and Storage Price Control Review, on behalf of Enron
Capital and Trade Resources Limited, January 1997.
Northern Border Pipeline Company, Federal Energy Regulatory
Commission (FERC) Docket No. RP96-45-000, July 1996.
Wisconsin Electric Power Co., Northern States Power Co. Merger
Proceedings. FERC Docket No. EC 95-16-000, on behalf of Madison Gas
& Electric Co., Wisconsin Citizens Utility Board and the Wisconsin
Electric Cooperative Association, May 1996.
Before the California Public Utilities Commission, Application of
PG&E for Amortization of Interstate Transition Cost Surcharge,
Application 94-06-044, on behalf of El Paso Natural Gas, December
1995.
Tennessee Gas Pipeline Company, FERC Docket No. RP95-112-000, on
behalf of JMC Power Projects, September 1995.
Before the National Energy Board of Canada, Drawdown of Balance of
Deferred Income Taxes Proceeding, RH-1-95, on behalf of Foothills
Pipe Lines Ltd., September 1995.
Pacific Gas Transmission, FERC Docket No. RP94-149-000, on behalf of
El Paso Natural Gas, May 1995.
Before the California Public Utilities Commission, Application of
Pacific Pipeline System, Inc., A.91-10-013, on behalf of PPSI, April
1995.
Before the National Energy Board of Canada, Multipipeline Cost of
Capital Proceeding, RH-2-94, on behalf of Foothills Pipe Lines Ltd.,
November 1994.
[[Page 3569]]
Before the California Public Utilities Commission, Pacific Gas &
Electric 1992 Operations Reasonableness Review, Application 93-04-
011, on behalf of El Paso Natural Gas, November 1994.
Before the National Energy Board of Canada, Foothills Pipe Lines
(Alta.) Ltd., Wild Horse Pipeline Project, Order No. GH-4-94,
October 1994.
Iroquois Gas Transmission System, L.P., FERC Docket No. RP94-72-000,
on behalf of Masspower and Selkirk Cogen Partners, September 1994.
Tennessee Gas Pipeline Co., FERC Docket No. RP91-203-000, on behalf
of JMC Power Projects and New England Power Company, February, May
1994.
Before the California Public Utilities Commission, on the
Application of Pacific Gas & Electric Company to Establish Interim
Rates for the PG&E Expansion Project, July 1993.
Before the Florida Public Service Commission, Petition of Florida
Power Corporation for Order Authorizing A Return on Equity for
Florida Power's Investment in the SunShine Intrastate and the
SunShine Interstate Pipelines, FPSC Docket No. 930281-EI, June 4,
1993.
Before the Florida Public Service Commission, Application for
Determination of Need for an Intrastate Natural Gas Pipeline by
SunShine Pipeline Partners, FPSC Docket No. 920807-GP, April-May
1993.
Northwest Pipeline Corp., et al., FERC Docket No. IN90-1-001,
February 1993.
City of Long Beach, Calif., vs. Unocal California Pipeline Co.,
before the California Public Utilities Commission, Case No. 91-12-
028, February 1993.
Alberta Energy Resources Conservation Board, on Applications of NOVA
Corporation of Canada to Construct Facilities, January 1993.
Before the California Public Utilities Commission, on the
Application of Pacific Gas & Electric Co. to guarantee certain
financing arrangements of Pacific Gas Transmission Co. not to exceed
$751 million, 1992.
Mississippi River Transmission Co., FERC Docket No. RP93-4-000,
October 1992, September 1993.
Unocal California Pipeline Co., FERC Docket No. IS92-18-000, August
1992.
Before the California Public Utilities Commission, in the Rulemaking
into natural gas procurement and system reliability issues, R.88-08-
018, June 1992.
Alberta Energy Resources Conservation Board, Altamont & PGT Pipeline
Projects, Proceeding 911586, March 1992.
Before the California Utilities Commission, on the Application of
Southern California Gas Company for approval of capital investment
in facilities to permit interconnection with the Kern River/Mojave
pipeline, A.90-11-035, May 1992.
Northern Natural Gas, FERC Docket No. RP92-1-000, October 1991.
Florida Gas Transmission, FERC Docket No. RP91-1-187-000 and CP91-
2448-000, July 1991.
Tarpon Transmission, FERC Docket No. RP84-82-004, January 1991.
Before the California Public Utilities Commission, on the
Application of Pacific Gas & Electric Co. to Expand its Natural Gas
Pipeline System, A. 89-04-033, May 1990 and October 1991.
CNG Transmission, FERC Docket No. RP88-211, March 1990.
Panhandle Eastern Pipeline, FERC Docket No. RP88-262, March 1990.
Mississippi River Transmission, FERC Docket No. RP89-249, October
1989, September 1990.
Tennessee Gas Pipeline, FERC Docket No. CP89-470, June 1989.
Empire State Pipeline, Case No. 88-T-132 before the New York Public
Service Commission, May 1989.
Before the U.S. Congress, House of Representatives, Committee on
Energy and Commerce, Subcommittee on Energy and Power, Hearings on
``Bypass'' Legislation, May 1988.
Tennessee Gas Pipeline, FERC Docket No. RP86-119, 1986-87.
Mojave Pipeline Co., FERC Docket No. CP85-437, 1987-88.
Consolidated Gas Transmission Corp., FERC Docket No. RP88-10, 1988.
Panhandle Eastern, FERC Docket No. RP85-194, 1985.
On behalf of the Natural Gas Supply Association in FERC Rulemaking
Docket No. RM85-1, 1985-86.
On behalf of the Panhandle Eastern Pipeline Co. in FERC Rulemaking
Docket No. RM85-1, 1985.
BILLING CODE 7515-01--P
[[Page 3570]]
[GRAPHIC] [TIFF OMITTED] TN22JA99.002
BILLING CODE 4410-11-C
[[Page 3571]]
Attachment B--1996 WSCC Electric Supply Curve (Notes and Sources)
Sources
Electric Supply and Demand Database (NERC); RDI 1996 Fuel Price
Forecast.
Notes
For graphical clarity, units with dispatch cost above $60/MWh
are excluded (30 oil-fired turbines, 740 MW total capacity).
Nameplate capacity has been derated to reflect approximate average
annual availability; hydro derated to reflect available energy.
The WSCC is the electric reliability council consisting of 11
western states and portions of Canada and Mexico; it contains
162,000 MW of generating capacity from over 1,400 generating units.
The annual average WSCC load is approximately 82,000 MW, and one
standard deviation of coincident load is approximately 11,500 MW, so
a one-standard deviation band around average load encompasses the
range from 70,500 MW to 93,500 MW. Actual values fall within one
standard-deviation of the average approximately two-thirds of the
time.
Note that this is an ``average annual'' supply curve, in that
nameplace capacity of units has been derated to reflect average
annual availability (annual energy limits for hydro). Some care must
be taken in interpreting this curve, because at any particular point
in time, the actual supply curve will differ somewhat, depending on
which particular units are actually available at that time. However,
it clearly demonstrates that gas, and particularly California gas,
is the dominant fuel of the price-setting marginal units in the
entire WSCC. Of course, the effect of California gas-fired capacity
on just the California market is even greater.
Affidavit of Paul R. Carpenter, Ph.D.
Commonwealth of Massachusetts, County of Middlesex
ss
I, Paul R. Carpenter, being first duly sworn on oath depose and
say as follows:
I make this affidavit for the purpose of adopting as my sworn
testimony in this proceeding the attached material entitled
``Affidavit of Paul R. Carpenter, Ph.D.'' The statements contained
therein were prepared by me or under my direction and are true and
correct to the best of my knowledge, information, and belief.
Further affiant saith not.
Paul R. Carpenter
Subscribed and sworn to before me, a notary public in and for
the Commonwealth of Massachusetts, County of Middlesex, this 4th day
of August, 1998.
[SIGNATURE ILLEGIBLE].
[FR Doc. 99-1393 Filed 1-21-99; 8:45 am]
BILLING CODE 4410-11-M
