State regulators are putting up fewer obstacles to U.S. utility mergers as companies become more skillful at emphasizing benefits, from limiting job cuts to restraining rate increases.
Exelon Corp. (EXC), Duke Energy Corp. (DUK) and AES Corp. (AES) have announced a combined $25.1 billion in takeovers this year and are counting on speedier approvals of the transactions, which would help them bulk up to handle costs for new environmental rules and modernizing the electric grid.
Regulators may be seeing the benefit to consumers of larger companies that can operate more efficiently to keep rates from rising rapidly while ensuring a steady supply of electricity, said Tony Clark, president of the National Association of Regulatory Utility Commissioners.
“Utility companies may be getting better at providing what regulators need to feel comfortable with a merger,” Clark, who also serves as chairman of the North Dakota Public Service Commission, said in an interview. “There are just huge investments that are coming on down the line, and some of the potential advantages of size and scale may be working their way into some of these decisions.”
Utilities face more than $40 billion in spending to meet air-pollution reduction regulations planned by the U.S. Environmental Protection Agency, according to IHS Inc.’s Cambridge Energy Research Associates, a Cambridge, Massachusetts-based adviser to energy companies.
For a utility facing such capital expenditures, combining with a larger company may make it easier and less expensive to borrow money and spread costs, Todd Shipman, a utility credit analyst for Standard and Poor’s in New York, said in an interview.
Regulators may be amenable to a merger that promises savings for customers as utilities struggle with escalating expenses amid slow power sales, William Johnson, chairman and chief executive officer of Progress Energy Inc., said in an interview.
“I really think the world has changed in many respects since 2005 when some mergers didn’t happen,” said Johnson, whose company agreed to be acquired by Duke Energy in January. “The growth that used to be there to cover increases in costs, when you had more customers using more, that dynamic has changed.”
Since 2009, natural-gas and electric utility takeovers larger than $1 billion have typically taken 12 months or less to be completed, according to Bloomberg data. Before 2007, some mergers languished before state officials for almost twice that long.
State regulators, who are responsible for setting customer electricity rates, generally have veto power over mergers if the transaction involves a new owner of a power distributor in their jurisdiction. Officials judge a takeover by considering whether it will result in harm to the customer or, in some states, whether it will actually benefit consumers, Robert Burns, a utility-regulation researcher at Ohio State University in Columbus, Ohio said in an interview.
Since 2003, at least five takeovers have been canceled after state officials demanded more concessions than companies were willing to make. Transactions also must pass federal regulatory reviews, William Mogel, a Washington-based attorney and founder of the Energy Law Journal, said in an interview.
In 2006, Chicago-based Exelon gave up on an almost two- year-old bid to buy Public Service Enterprise Group Inc. of Newark, New Jersey, after failing to reach agreement with state officials concerned that the companies might dominate power markets and inflate prices.
The same year, a proposed takeover of Constellation Energy Group Inc. (CEG) of Baltimore by NextEra Energy Inc. (NEE) of Juno Beach, Florida, then called FPL Group Inc., was abandoned because of the prospect of a “protracted and open-ended merger review” in Maryland over customer-bill increases, the companies said in an October 2006 statement.
In contrast, this year FirstEnergy Corp. (FE) of Akron, Ohio, completed its $4.7 billion takeover of Allegheny Energy Inc. of Greensburg, Pennsylvania, which required approval in four states, in less than 13 months. The companies agreed to about $50 million in customer payments or rate credits, according to regulatory filings.
Big Get Bigger
State regulators may now be better at negotiating timely settlements than they were initially after the 2005 repeal of a Depression-era law that restricted utility takeovers, Clark of the Washington-based regulators’ association said. The law, called the Public Utility Holding Company Act of 1935, was designed to prevent companies from becoming too big and abusing their monopoly power.
The trend toward approving mergers may not be good for consumers as “these mergers need to be scrutinized very closely,” said David Kolata, executive director of the Citizens Utility Board, a Chicago-based advocacy group for Illinois consumers.
“You have a situation where the big are getting bigger, and that raises some concerns about market concentration,” Kolata said in an interview. “With a few giant players, you wonder if you are going to get the best possible prices for the customer.”
Since the recession, state officials seem focused on limiting job losses and preserving the local presence of an acquired company when evaluating takeovers, Shipman, the utility analyst, said.
To gain approval in Pennsylvania, FirstEnergy promised to avoid firing some workers at Allegheny’s headquarters for at least five years. FirstEnergy also agreed to $16.9 million in rate credits for West Penn Power customers over three years.
The company also offered a rate freeze through October 2012 and agreed to invest in renewable energy. With these concessions, FirstEnergy forecasts merger-related pretax earnings benefits of $210 million this year, climbing to $450 million in 2013, according to a regulatory filing by the company.
Pennsylvania regulators found “a proper balance” between “encouraging companies to achieve long-term costs savings” and “flowing benefits back to consumers in the short term” in its decision, Public Utility Commission Chairman Robert Powelson said in an e-mailed statement.
Duke, Progress Takeover
Given FirstEnergy’s success, other companies have gained confidence that they can do “deals that pass regulatory muster” and add to earnings, Travis Miller, a Chicago-based utility analyst for Morningstar Inc. said in an interview.
Duke Energy’s $13.7 billion takeover of Progress Energy is expected to be completed by the end of this year, Johnson, the Progress CEO, said on a June 28 conference call with investors.
Johnson has said the combination will help the utilities afford investments in new power plants, including nuclear reactors, to reduce carbon-dioxide emissions.
“Everything the regulators want for these systems to be updated, technologically and environmentally, costs money, and they look at the impact of that on rates,” Jeffrey Holzschuh, a vice chairman at Morgan Stanley in New York, said in an interview. “If the deals make sense, regulators are trying to find a way to do it.”
Companies are also offering financial incentives to support state policies, such as in renewable and energy efficiency mandates, Thomas Flaherty, a senior partner who consults on energy mergers for Booz & Co. in Dallas, said in an interview.
Duke and Progress said on June 28 they reached a merger settlement with Kentucky officials, offering a rate freeze for two years and $825,000 for economic programs. The companies also need federal, North Carolina, South Carolina and shareholder approvals.
Exelon met with Maryland’s Democratic Governor Martin O’Malley before offering what it said is $250 million in economic incentives in its $7.9 billion offer for Baltimore- based Constellation. The package includes a $100 credit to every customer of Constellation’s Baltimore Gas and Electric unit and a promise to not cut jobs at the utility for at least two years.
Approval for the deal, which may close early next year, is needed from the Maryland Public Service Commission, as well as utility regulators in New York and Texas, and shareholders, the companies have said.
The $3.5 billion acquisition of DPL Inc. by AES of Arlington, Virginia, includes a pledge to limit firing workers at the Dayton, Ohio-based company through December 2013.
The takeover will help DPL with the costs of pollution- control rules for its power generators and compete with larger Ohio utilities, the company said in a regulatory filing. The companies have said they expect the deal to close by early in next year’s first quarter.
“Companies have come to realize that they have to put something on the table, and regulators recognize that they are only going to get so much,” William Lamb, a New York-based attorney who is co-head of the utilities mergers and acquisitions group at Dewey & LeBoeuf LLP, said in an interview.