In order to satisfy a federal complaint that its planned merger with Constellation Energy Group (NYSE:CEG) will give it too much market power in the PJM region, Exelon Corp. (NYSE:EXC) has formally agreed to sell the coal-fired C.P. Crane, H.A. Wagner and Brandon Shores power plants of Constellation.
When Exelon and Constellation announced the merger in April 2011, they said they planned to sell the three Maryland plants to ease power market concerns. But that promise wasn’t enough for the U.S. Department of Justice (DOJ), which on Dec. 21 filed suit at the U.S. District Court for the District of Columbia, complaining that the proposed acquisition by Exelon of Constellation would violate Section 7 of the Clayton Act. On the same day, Justice filed with the court a proposed settlement of the lawsuit, with that stipulated settlement outlined in a Dec. 28 Federal Register notice and now subject to 60 days of public comment.
“The stipulation entered into by the United States and defendants ensures that the divestiture assets are preserved and maintained and that competition is maintained during the pendency of the ordered divestiture,” Justice noted in the Federal Register notice. “First, the stipulation includes terms requiring that defendants maintain the divestiture assets as economically viable and competitive facilities. Second, the stipulation includes terms ensuring that defendants do not withhold output from the wholesale electricity market. In particular, the stipulation requires that defendants offer the output from certain generating units into the PJM auctions at no more than specified price levels until the divestiture assets are sold.”
The settlement agreement also requires the defendants to submit certain data about their offers to the Antitrust Division at Justice, to grant permission for the division to discuss that data and related information with PJM and the PJM Market Monitor, to submit certain proposed contracts for the output of generating assets not owned by the defendants to the federal government for review, and if required to do so by the division in its sole discretion, to hire an auditor to ensure that defendants are offering their units at the specified price levels and are not withholding generation to raise prices.
The combination of Constellation and Exelon’s generation would increase the merged firm’s ability and incentive to withhold selected output, forcing PJM to turn to more expensive generation to meet demand, resulting in higher clearing prices in PJM, Justice claimed. In determining the competitive effects of a company potentially withholding electricity, Justice considered the operating cost, offer, technology, and shift factor of generating units. These concepts impact the cost to the PJM system of PJM calling substitute generation when there is withholding, and the benefits and losses to the post-merger firm from the potential withholding strategy.
When they are running, baseload and mid-merit units like the three coal plants can benefit from an increase in wholesale electricity prices. Because they run so frequently, these units provide a relatively significant incentive to withhold output and raise prices, Justice noted, Higher-cost units provide the ability to withhold output to increase the market clearing price. Higher-cost units can have costs that are close to clearing prices for a substantial number of hours during the year. Where their costs are close to clearing prices, the opportunity cost of withholding output from these units is smaller than it would be for low-cost baseload units, Justice added.
The lawsuit alleged that entry through the construction of new generation or transmission capacity would not be timely, likely, and sufficient to deter or counteract an anticompetitive price increase. Given the necessary lead time for such projects, it would take years for that new capacity to be developed.
Exelon and Constellation were very aware from the beginning of the market power aspects of the proposed merger, saying in their April 28 merger announcement: “The companies are committed to mitigating any competitive issues including divesting three Constellation generating stations located in PJM, which is the only market where there is a material overlap of generation owned by both companies. These stations, Brandon Shores and H.A. Wagner in Anne Arundel County, Md., and C.P. Crane in Baltimore County, Md., include baseload coal-fired generation units plus associated gas/oil units located at the same sites, and total 2,648 MW of generation capacity.”
Exelon says this deal one of last major hurdles
Exelon noted in a Dec. 21 statement about the settlement with Justice that this deal is consistent with Exelon’s merger application to the Federal Energy Regulatory Commission (FERC). The company makes a number of commitments to mitigate market power concerns, including: divestiture of certain assets, granting Justice the right to approve the buyers of those assets, assurances about how the merged company will bid its units into the PJM markets pending divestiture, and deadlines for the sale of those assets.
“With DOJ’s action, we are pleased to have reached yet another important milestone in completing our merger with Constellation,” said Exelon President and COO Christopher Crane. “We continue to expect that we will finalize the merger in early 2012.”
“Our proposed merger has cleared two state regulators and the shareholders of both companies, and now the Department of Justice has cleared the way for the transaction,” said Constellation Chairman and CEO Mayo Shattuck III. “We’ve made considerable progress toward closing the merger and will continue working to move the process forward as smoothly as possible.”
The merger has so far been approved by the New York Public Service Commission, the Public Utility Commission of Texas and shareholders of Exelon and Constellation. It also requires regulatory approvals by FERC, the Nuclear Regulatory Commission and the Maryland Public Service Commission.
In a recent merger settlement with parties including the state of Maryland and the Maryland Energy Administration, Exelon, Constellation and Constellation’s Baltimore Gas and Electric unit agreed to provide a package of benefits totaling more than $1bn and expected to create more than 6,000 jobs in Maryland.
The merger settlement with the state of Maryland and others commits the merged companies to develop 285-300 MW of new generation in Maryland, including 165-180 MW of renewable generation and 120 MW of gas-fired generation. The total investment in this energy generation is at least $625m. The merged companies would also contribute $32m for offshore wind research and development and will assist the state of Maryland in its efforts to develop a major offshore wind energy project. Of the $32m, $2m will be awarded to a Maryland institution of higher learning to facilitate research on wind energy applications.