- Stand-Alone Repeal Of the Public Utility Holding company Act Will Impede Development of a Truly Competitive Electric Industry
Senate Majority Leader Trent Lott may soon seek to move Sen. Alfonse D'Amato's bill to repeal the Public Utility Holding Company Act in advance of, and unconnected to, comprehensive electric industry restructuring legislation. Holding-company proponents of PUHCA repeal are attempting to cast S. 621 as the long overdue elimination of an outdated securities law whose effect is limited to needlessly burdening the 17 registered multistate utility holding companies.
But as the mounting opposition shows, something much more fundamental is at stake: the elimination of structural limits on the size, scope, and activities of electric utilities at a critical moment of transition, before an alternative structure sufficient to support a competitive industry is in place. Stand-alone PUHCA repeal not only puts the cart before the horse, but erects roadblocks likely to impede movement toward a truly competitive electric industry.
Enactment of PUHCA in 1935 was one of the hardest fought battles of the New Deal. Congress sought to protect investors, consumers, and the public from the financial abuses of highly leveraged and concentrated utility holding companies. These abuses, including non-arm's-length contracts that permitted the "milking" of electric and gas utilities (and their customers) by their holding companies, were thought to be a major cause of the stock market crash of 1929 and the ensuing Great Depression. PUHCA was designed to promote economic and efficient utility operation, facilitate regulation, prevent cross-subsidization and undue concentration, and, by restricting diversification, maintain the focus of the holding company on the core utility business and limit financial risks to customers.
The so-called "death sentence" for nonintegrated holding companies, which were considered the most dangerous to the public interest, was one of the most bitter struggles in the enactment of PUHCA. This provision put an end to complex holding company "pyramids," which concentrated control over dispersed electric and gas utilities in the hands of a few and which bore no relation to efficient operations. The statute required "simplification" of utility holding companies and confined the resulting entities to single integrated public utility systems.
PUHCA Restrictions Beneficial
PUHCA limits acquisitions that result in ownership of 5 percent or more of two or more electric or gas utilities to those that serve the public interest, tend toward the economic and efficient development of an integrated public utility system, and are not detrimental to the interests of investors, consumers, or the proper functioning of the holding company system. PUHCA provides for ongoing review of the financial activities of "registered" multistate holding companies by the Securities and Exchange Commission, restricts their investments in unrelated enterprises, and prohibits certain inter-affiliate transactions unless specific requirements are met. In order to qualify for an exemption from PUHCA's rigorous regimen for registered holding companies, many utility holding companies confine themselves to a single state or contiguous areas.
In recent years, PUHCA's tight rein has been relaxed somewhat by the 1992 Energy Policy Act's exemption from PUHCA of "exempt wholesale generators" and certain acquisitions of interests in foreign utilities, as well as by the rather lax manner in which the SEC has interpreted and enforced the statute. Nevertheless, PUHCA continues to be a potent force in setting structural parameters both for registered holding companies and for all others seeking to avoid registration.
Thus, the statute bears much responsibility for the predominance of geographically compact electric utility systems in this country. PUHCA is the reason why electric utilities tend not to be owned by holding companies involved in unrelated businesses. It also makes acquisition of American utilities unattractive for foreign companies. PUHCA's restrictions have helped to keep utility holding companies focused on investments necessary to provide reliable electric service for a regulated return.
Repeal Brings Risks
Eliminating PUHCA now, as proposed in S. 621, would do far more than simply end the hassle of SEC regulation for the relatively few registered holding companies. It would also allow acquisitions of and by utilities in a manner very different from what we have seen before, in effect, clearing the way for resurrection of the previously dead and dismantled nonintegrated holding companies.
Merger review by the Federal Energy Regulatory Commission and the Department of Justice would, of course. continue. But federal barriers to utility acquisition by domestic and foreign holding companies with wide-ranging business interests would largely be lifted, as would federal limitations on utility holding company investments. For example, FERC has interpreted its public interest test for mergers to focus on increased concentration in wholesale power markets, and not PUHCA's concerns about diversification.
With utilities suddenly flush with billions in cash (from recovery of "stranded costs," and securitization of such costs, in connection with the introduction of retail competition in some states), the complexion of industry investment may change dramatically and rapidly — from those investments necessary to ensure reliable service, to those with potential for the greatest quick return, albeit with increased risk to the utility and its customers.
Eliminating PUHCA's protections and structural limitations before new market structures are in place would be particularly dangerous. The electric industry is undergoing a radical transformation toward greater reliance on competition (rather than regulation) to discipline generation prices at both wholesale and (on a state-by-state basis) retail levels. Letting down PUHCA's guard now would impede, rather than support, this transition by allowing the erection of formidable barriers to competition that may be difficult to tear down in the future.
Antitrust Concerns
Joel Klein, who heads the Justice Department's Antitrust Division, has recently advocated heightened vigilance regarding new utility combinations and acquisitions during this period. Klein has suggested before both the House Judiciary Committee and FERC that Congress may want to consider some type of merger moratorium (e.g., three years) while the electric industry restructures. As Klein said in a Jan. 2l speech to FERC, because of the current lack of experience with electric industry competition, "utilities may see this as a time when they have a window of opportunity in which to consummate mergers. Mergers with little immediate anticompetitive effect can nonetheless frustrate the emergence of competition." Klein further explained:
The moratorium idea reflects the general proposition that mergers are very difficult to undo after they prove to be anticompetitive and that, during a transition to competition, there is unlikely to be any prospect for meaningful relief after the damage is done. Missed opportunities for the emergence of competition at the outset of the transition are forever lost, with potentially substantial social costs.
Clearly, relaxation of restrictions on utility mergers and acquisitions by repealing PUHCA is not at all what the doctor ordered.
Does this mean that no reform of PUHCA is appropriate? Few opponents of S. 621 argue that the statute should be immune from change. Rather, they want to ensure that the statute is addressed only as part of comprehensive electric industry legislation, rather than in isolation and in advance of broader restructuring. Addressing PUHCA as part of comprehensive electric restructuring will prevent a regulatory gap that might encourage improvident mergers. It will enable legislators to ensure that the necessary protections are in place to support development of, rather than strangle in its infancy, the competitive industry of tomorrow.
Significantly. both the Department of Energy and the National Association of Regulatory Utility Commissioners have urged against stand-alone repeal of PUHCA. And the Clinton administration's Comprehensive Electricity Competition Plan, announced on March 25, "supports the repeal of PUHCA as part of a comprehensive electricity restructuring bill."
While observing that PUHCA's integration requirement is "not compatible with a more competitive electricity market," the administration's plan explicitly recognizes that "protection of consumer interests — particularly guarding against cross-subsidization and abusive market power — remains necessary." The administration recommends increasing FERC and state commission access to the books and records of holding companies and their affiliates "to assist them in guarding against interaffiliate abuse following repeal of PUHCA, in combination with the other reforms, such as additional merger and market power authority."
Alternative Structures
Modifications to PUHCA must, therefore, be considered in the context of alternative structures that are designed to achieve PUHCA's purposes while facilitating the development and maintenance of vigorously competitive electric markets. Specific areas of concern would include the following:
- Independent transmission. The transmission grid, the highway of commerce in electricity, is now predominantly in the hands of large vertically integrated utilities. If those utilities were required to transfer control or ownership of transmission to an independent regional entity with authority to operate, maintain, plan, and construct transmission, such as an independent system operator (ISO) or, better yet, an independent transmission company (transco) — the ISO or transco could ensure that the necessary investments were made to support reliable competitive rates.
Potentially more lucrative diversification efforts could not siphon off investment dollars from transmission (which is expected to remain regulated even after restructuring). Nor would the infrastructure be jeopardized if, for example, a holding company's risky foreign investments do not fare as well as hoped. Thus, clarifying FERC's authority to require such transfer of control or ownership of transmission facilities to an independent entity would achieve PUHCA's purposes of fostering essential investment and limiting the opportunity for improper shifting of costs from unregulated to regulated activities.
More generally, transfer of transmission facilities and "control area" functions to an entity completely independent of the influence and control of market participants is essential to development of competitive markets. The regime established by FERC Order 888 of individual utility "open access" tariffs is not sufficient to ensure truly nondiscriminatory transmission service, much less the region-wide access to alternative supplies at a single transmission charge that is a key ingredient for robust markets. Even with the FERC-ordered standards of conduct, which require transmission owners to "functionally separate" their employees and to treat themselves the same as third parties in supplying transmission services, transmission owners continue to have the incentive and opportunity to prefer themselves to the detriment of competitors. With the introduction of retail competition, that incentive and opportunity will only grow.
- PUCHA Is One Piece of Puzzle.
- Market power/market abuses. Given the high levels of concentration in today's electric industry, transmission ownership provides only one of many opportunities for exercise and abuse of market power in the emerging electric markets.
Market power may be present and exercisable where a utility (or small group of utilities) controls the bulk of resources with certain operating characteristics and within the same cost range. This can occur when only particular generators can be run to solve a voltage support or transmission constraint problem during certain seasons or time periods. The gaming recognized to have occurred in the United Kingdom's bid-based energy market appears to have frequently involved the withholding of bids on critical days, which significantly affected the market clearing price. Such abuses not only can distort the market and improperly shift huge amounts of money in very short time frames, but will undermine the integrity of the market itself.
In approving ISOs and bid-based "power exchanges," FERC has recognized the potential for exercise of market power and other abuses. The commission's answer is to make the ISOs a first line of defense, requiring them to monitor market operations and market power problems, and approving ISO authority to administer penalties (which may exceed estimated profits from abuses). See Pacific Gas & Electric Co, San Diego Gas & Electric Co. and Southern California Edison Co., 81 FERC ¶61,122 (1997), and Pennsylvania-New Jersey-Maryland Interconnection, 81 FERC ¶61,257 (1997).
However, FERC's statutory authority to swiftly address and correct market abuses and to prevent and remedy the exercise of market power in this manner is not so clear. FERC now considers market power only in the context of proposed mergers and approval of market-based rates. Its statutory role and available penalties differ considerably from those of the commissions that guard the integrity of the securities and commodities markets.
New policing structures must be instituted to prevent and remedy the exercise of market power and improper market manipulation, and the like. FERC needs authority to take all steps necessary to ensure vigorously competitive generation markets, including the ability to require divestiture of generation to unaffiliated entities. Expanded authority to address market power and enhanced merger authority are featured in the Comprehensive Electricity Competition Plan, the Bumpers-Gorton bill, and the Markey bill (H.R. 1960).
FERC's merger authority should be clarified and expanded expressly to include gas/electric "convergence" mergers, generation-only company mergers, and holding company mergers. Further, FERC should be explicitly empowered to disapprove mergers that adversely affect competitive markets unless (1) the adverse effects are remedied by conditions, and (2) benefits arising from the merger that are not otherwise achievable outweigh the potential harm to competition.
Finally, opportunities for market manipulation, predatory pricing, and affiliate abuse could be limited by requiring public reporting of price and key terms of all power contacts (without necessarily identifying individual buyers and sellers, as in a stock exchange). Effective penalties for insider trading, market manipulation, and other abuses are also needed to protect the integrity of the market.
- Reliability. A consensus is emerging that yesterday's reliability structures will not meet the challenge of tomorrow's competitive market. No longer can we rely on peer pressure among the large utilities that dominate the voluntary organizations — the North American Electric Reliability Council (NERC) and its regional councils — formed in the wake of the 1965 blackout. Nor can we assume that reliability rules developed by these councils will be competitively neutral, rather than potent weapons to cripple smaller competitors.
Both the Secretary of Energy Advisory Board's System Reliability Task Force and NERC's Electric Reliability ("Blue Ribbon") Panel recently reached the conclusion that NERC should evolve into an independent self-regulating organization that can impartially develop and enforce reliability rules applicable to all market participants, subject to FERC oversight. This concept has already been incorporated into the Comprehensive Electricity Competition Plan. Such change not only would lessen the risks to the consumer from diversification failures, against which PUHCA now guards, but should also enhance the likelihood that the electric industry will steer a steady course through the rough, uncharted waters ahead.
Consumer groups, environmental groups, large industrial consumers, small businesses, power marketers, municipal electric systems, rural cooperatives, and labor unions have all spoken out against stand-alone repeal of PUHCA. Congress must understand that the statute is just one piece of a very complex puzzle. To achieve procompetitive goals while preserving reliability, PUHCA must be addressed only as an integral pan of comprehensive electric industry restructuring.