Duke/Progress: FERC rejection of virtual divestiture a ‘surprise’

FERC’s rejection of the virtual divestiture solution that Duke Energy (NYSE:DUK) and Progress Energy (NYSE:PGN) proposed to mitigate market power concerns arising from their merger came as a surprise to the companies, a Progress spokesperson told TransmissionHub Dec. 16.

“It’s a bit of a surprise in this case because we believed the mitigation plan did address the issues that were raised,” he said.

The North Carolina-based utilities are now evaluating all of the mitigation measures the commission offered in September. The companies expect to have another proposed solution and specific merger timeline “in the coming days,” the spokesperson said. 

Though the proposal was rejected, a virtual divestiture is not off the table.

“Our analysis and discussions of potential remedies is going to span the whole scope of what’s available and attempt to address FERC’s concerns without eroding any of the value of the merger,” the spokesperson said.

FERC seems to be pressing for a transmission solution, said two industry lawyers and a source familiar with the situation. FERC did not return a call for comment as of press time.

In its Sept. 30 conditional approval, FERC offered four measures to mitigate the merger’s failed horizontal market power screens: membership in a regional transmission organization (RTO), the implementation of an independent coordinator of transmission arrangement, transmission upgrades and/or a physical or virtual generation divestiture.

Duke and Progress on Oct. 17 opted for a virtual generation divestiture, which assumed there would be at least two buyers of their power at wholesale prices in their balancing areas. FERC in its Dec. 14 order said it found this assumption speculative and inadequate to mitigate market concerns, the first industry lawyer noted.

“Building transmission is pretty straightforward,” the source familiar said. “They’ll take a close look at it.”

Though joining an RTO would likely be accompanied by a commitment to build transmission, the second industry lawyer said, a pledge to build transmission alone is likely to facilitate the quickest merger close.

However, the first lawyer pointed out that FERC may not accept a mere commitment by the companies to build transmission after the merger closes. In the past, FERC would approve deals on the condition that transmission be built, but companies would eventually say they tried and failed.

“FERC can’t undo deals they’ve approved, so they’ve said, ‘We’re going to make it so that you’re not going to get approval till transmission gets built,’” the first lawyer said. “People haven’t gone down that path recently because it’d be a significant delay for the deal. To me, FERC is sending a strong signal that if you don’t go into an RTO it’s going to make your life hard.”

But joining an RTO could also be time-consuming, the source familiar said. “It may require a lot of hearings and evaluations, and the state commission has the potential to drag out the merger pool process,” the source said. “The companies’ first objective is to find a solution to address FERC’s concerns and get the deal closed.”

Merger close has been pushed back from year-end until at least March, the spokesperson said.

Furthermore, North Carolina Utilities Commission staff has argued that participation in an RTO would not benefit either of the companies’ retail customers.

This argument does not come as a surprise, however, the second lawyer noted. State commissions in the South are likely to resist joining an RTO, as doing so would mean higher energy costs.

“The South has traditionally had some of the lowest rates in the country,” the second lawyer said. “The South says there’s nothing for it to gain from this, and the RTOs are expensive.”

A physical divestiture of generation is unlikely the first choice, the two lawyers and source familiar said. NCUC staff has argued that a physical divestiture would harm both wholesale and retail native load customers by reducing service reliability and increasing costs to customers. Furthermore, many of the merger’s cost savings derive from the companies’ joint dispatch plans.

“It’s not a feasible path to divest generation,” the second lawyer said. “They probably feel the generation they have is cheaper than what they’d have to buy in a competitive market.”

He added, “Building transmission doesn’t require them to sell their power; it just allows others to compete with them.”

The NCUC staff supported a virtual divestiture over the other alternatives.

Part of FERC’s order Dec. 14 provided some guidance on virtual divestitures, or examples of virtual divestures that FERC has approved in the past, the Progress spokesperson noted.

Rather than propose a solution that assumes buyers for their generation, Duke and Progress could figure out a way to sell their power under contract, the first lawyer said.

It is unlikely the deal will fall through, the lawyers and the source familiar said, as the companies will do whatever it takes to assuage FERC’s concerns.

“We’ve had discussions with FERC,” the spokesperson said. “Certainly we are very interested in fully understanding their concerns so we can develop a plan that remedies them.” 

About Rosy Lum 525 Articles
Rosy Lum, Analyst for TransmissionHub, has been covering the U.S. energy industry since 2007. She began her career in energy journalism at SNL Financial, for which she established a New York news desk. She covered topics ranging from energy finance and renewable policies and incentives, to master limited partnerships and ETFs. Thereafter, she honed her energy and utility focus at the Financial Times' dealReporter, where she covered and broke oil and gas and utility mergers and acquisitions.