Elsevier

The Electricity Journal

Volume 21, Issue 1, January–February 2008, Pages 45-54
The Electricity Journal

The Likely Effect of the Proposed Exelon-PSEG Merger on Wholesale Electricity Prices

https://doi.org/10.1016/j.tej.2007.12.007Get rights and content

The New Jersey Board of Public Utilities blocked the merger in part because of its fear of higher wholesale electric power prices. However, an analysis using a supply function equilibrium model suggests that allowing the merger with the divestitures accepted by numerous regulatory agencies could have reduced electric power costs by over $1 billion per year.

Introduction

In December 2004, Exelon Corporation and Public Service Enterprise Group, Inc. (PSEG) proposed a merger valued at $16 billion. The companies had two primary motivations. First, the combination of Exelon, the owner of PECO Energy in and around Philadelphia, and Public Service Electric & Gas across the Delaware River in New Jersey would have provided operating efficiencies to the surviving company, Exelon Electric & Gas (EEG). Second, EEG would have benefited greatly from the combination of the two nuclear operating units. Exelon has been one of the largest and most efficient nuclear plant operators in the United States. PSEG, meanwhile, operated two nuclear plants in New Jersey in a less efficient manner. For example, for the period of 2002 through mid-2005, Exelon's nuclear units operated at a 92 percent operating rate, whereas PSEG's nuclear units ran at an 85 percent rate. If EEG were able to increase the efficiency of these units to match the Exelon fleet average, the benefits to EEG would have been around $460 million over five years.

Any merger of this magnitude involving regulated utilities presents a number of issues for regulators. For Exelon and PSEG the most contentious issue involved the combination of their generation fleets in an area known as PJM East, part of the PJM electric power market consisting of New Jersey, the Delmarva Peninsula, and the PECO service territory around the Philadelphia metro area. Exelon and PSEG have transferred their generation units to unregulated subsidiaries that sell power into the PJM market at market-based rates. Exelon and PSEG did not contend that combining the two companies would result in higher wholesale electric power prices in PJM East; the controversy centered on which assets would be divested to ensure that prices did not increase.1

The most contentious issue involved the combination of their generation fleets in an area known as PJM East.

On Sept. 14, 2006, Exelon and PSEG decided to terminate their merger plans as a result of demands by the New Jersey Board of Public Utilities (NJBPU). After nearly two years of negotiations with various regulatory bodies over the merger, each company decided that it would be in its best interest to go its separate way rather than concede to the demands of the NJBPU. The U.S. Department of Justice (DOJ), Federal Energy Regulatory Commission (FERC), and Pennsylvania Public Utilities Commission (PAPUC) had approved the merger with generation divestitures acceptable to each of the parties, but the NJBPU demanded additional divestitures and rate concessions to New Jersey electric customers that would have made the merger unattractive to both Exelon and PSEG.

The primary purpose of this article is to evaluate the contentious divestiture issue by simulating competition in wholesale electric power markets. We find that the merger could have reduced electric power payments by $5.9 billion over five years. In New Jersey alone, effects of lower electric power prices and other rate concessions could have been $1.3 billion. In summary, the evidence here indicates that blocking the proposed merger has led to higher electric power prices and rates.

Section snippets

Background

The proposed merger without any divestitures concerned the regulatory bodies, due to the potential market power in PJM East. The economics of the PJM market often lead to PJM East prices rising above the rest of PJM due to constrained power flows into the region from the west. In the western portion of the PJM market (central Pennsylvania and further west) an abundance of coal-fired generating units can produce power at a low cost. Meanwhile, in PJM East, many of the mid-merit units are

Modeling

To estimate the wholesale price effects of the transaction and the various proposed divestitures, we use a supply function equilibrium (SFE) model. In SFE models each firm provides a supply schedule to a formal market in which it provides bids for various quantities of electric power. For example, one firm may provide up to 200 MW of power for $30/MWh, 150 MW for $35/MWh, and 50 MW for $60/MWh. Other firms also provide supply schedules. Equilibrium is reached when no firm has an incentive to

Welfare Effects and the Incentive to Merge

The price effects and cost savings discussed above represent the potential gains to the purchasers of electric power. Some of the gains, however, come at the expense of the electric power producers. Table 3 breaks down the net welfare gains into the gains to consumers and the gains to producers. The gains to consumers match the annual savings for the entire market shown in Table 2. The next column shows the gains to producers. In the first four scenarios—those without hedging—about

Concluding Remarks

The proposed Exelon and PSEG merger presented regulators with the opportunity to reduce wholesale and retail electric power prices. Approving the merger with power generation plant divestitures would allow for lower prices through increased generation from low-cost nuclear power. The results from the SFE simulation models discussed above indicate that the annual savings to power purchasers could have been over $1 billion. Failure to approve the merger represents a lost opportunity. Only with

John R. Morris is a Principal at Economists Incorporated in Washington, DC. He testified on behalf of Exelon and PSEG concerning natural gas competition issues before the Pennsylvania Public Utilities Commission and the New Jersey Board of Public Utilities. He may be contacted at [email protected].

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    the Supply Function Equilibrium (SFE) approach, which is usually difficult in practical applications. The SFE-based models are defined by systems of differential equations what causes several computation problems, and therefore substantial simplifications are needed when attempting to use this approach (Klemperer and Meyer (1989); Green and Newbery, 1992; Bolle, 1992; Baldick, et al. 2004; Rudkevich, 2005; Morris and Oska, 2008; Holmberg, 2009; Gao and Sheble, 2010; Ciarreta and Espinosa, 2010). A comparison of the results of simulations carried out with the application of Cournot and SFE models was performed by Willems et al. (2009).

John R. Morris is a Principal at Economists Incorporated in Washington, DC. He testified on behalf of Exelon and PSEG concerning natural gas competition issues before the Pennsylvania Public Utilities Commission and the New Jersey Board of Public Utilities. He may be contacted at [email protected].

Daniel Oska is an Energy Analyst at Economists Incorporated in Washington, DC. He may be contacted at [email protected].

The authors thank Guangliang Ye for his helpful comments. The views expressed in this article are those of the authors and do not necessarily represent the views of Exelon or PSEG.

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