Energy M&A Market Power

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Overview of Market Power Issues in Energy M&A Transactions

Catherine [email protected]

June 3, 2010

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U.S. Utility M&A Volume

155

84

15

36

81

11

28

126

105 4 5

0

20

40

60

80

100

120

140

160

2007 2008 2009 2010 (YTD)

Total Utility

Electric

Gas

Billions (USD)

91 (est.)

73 (est.)

12 (est.)

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U.S. Energy M&A Volume

125112

75

2611 14 16

190

0

20

40

60

80

100

120

140

160

180

200

2007 2008 2009 2010 (YTD)

Energy

Pipelines

Billions (USD) 190 (est.)

40 (est.)

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Overview of U.S. M&A Market

● U.S. Energy/Utility M&A Landscape

– Financial crisis led to a sharp decline in M&A activity due to:

♦ Uncertain valuation levels

♦ Concerns about liquidity overtaking strategic initiatives

♦ Loss of access to debt financing

– Benefits of economies of scale continue to favor consolidation, particularly with respect to:

♦ Construction of new generation (nuclear and other) and other major infrastructure improvements

♦ Addressing credit, volatility and liquidity concerns regarding trading and hedging

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Overview of U.S. M&A Market cont'd

● U.S. Energy/Utility M&A Landscape

– As valuation levels have stabilized and liquidity concerns have diminished, interest in M&A has increased

– Current level of deal activity on pace to meet or exceed 2008 levels

– Obstacles to M&A remain

♦ Regulatory uncertainty - investors remain concerned about the cost, time and distraction of the regulatory process, particularly when several states are involved

♦ How much of the benefits of mergers will state regulators let companies keep?

♦ Uncertainty with respect to carbon legislation and the price of carbon

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U.S. M&A Market – Energy/Utilities

● Proposed Acquisition of E.ON U.S. (the parent company of LG&E and KUC) by PPL

– Cash transaction with a purchase price of $7.625 billion (PPL to receive approximately $450 million in tax benefits)

– PPL is seeking to increase earnings from regulated operations to “rebalance” its business mix

– PPL is viewed as paying a premium – press reports indicate an active auction with even the City of Louisville putting together a bid

– LG&E has a pending application to increase its rates (12% electric; 8% gas)

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U.S. M&A Market – Energy/Utilities cont'd

● Proposed Merger of Mirant with RRI

– The all-stock merger (fixed exchange ratio) will create GenOn Energy with approximately 24,700 MW of electric generating capacity

– Creates one of the largest independent power producers in the U.S.

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● Proposed Acquisition of Conectiv Energy

– Calpine will purchase 4,490 MW of Conectiv power generation assets from Pepco Holdings for $1.65 billion

– Conectiv trading book, collateral requirements and load-serving auction obligations excluded from the transaction

– Includes a fully contracted 565 MW combined-cycle plant currently under construction

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● Proposed Merger of FirstEnergy and Allegheny Energy

– All stock merger (fixed exchange ratio) for a value of $4.7 billion in the aggregate, plus the assumption by FirstEnergy of $3.8 billion in Allegheny debt

– Logical combination – parties have adjacent service territories

– Merger requires regulatory approval before FERC and in Virginia, West Virginia, Pennsylvania and Maryland

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● Other Notable Energy/Utility Transactions

● Exelon bid for NRG

– Initial bid represented a 37% premium over current stock price (October 2008); NRG stock price: $19.33

– Rejected by NRG board for inadequate price

– NRG announced acquisition of Reliant retail business (March 2009); NRG stock price: $18.56

– Exelon raised bid; revised bid represented an 8% premium over current market price (July 2009); NRG stock price: $24.80

– Exelon slate of directors not elected by NRG shareholders at annual meeting; Exelon terminated offer (July 2009)

– Since Exelon terminated its offer, NRG stock has traded as high as $29.26 and closed on May 24, 2010 at $22.50


FERC Merger Issues

● FERC Section 203 Review

– Transactions subject to review

– Timing for approval

♦ Term sheet ok

● FERC Standard of Review

– No adverse effect on

♦ Rates

♦ Regulation

♦ Competition

– Review of Potential for Impermissible Cross-Subsidization as a result of or following transaction


FERC Merger Issues: Rates, Regulation and Competition

– Effect on rates and regulation is largely handled through commitments

– Effect on Competition

♦ HHI Screen Failures

♦ Mitigation

♦ Other Factors

♦ NRG-Exelon

♦ FirstEnergy-Allegheny


FERC Merger Issues: Cross-Subsidization

– Cross-Subsidization Analysis

♦ Ring-fencing requirements

♦ Approach in recent transactions

Macquarie - Puget

Iberdrola – Energy

NRG - Exelon

FirstEnergy - Allegheny


DOJ/FTC New Merger Review and FERC’s Market Power Analyses

● September 2009- DOJ and FTC announce intent to revise Horizontal Merger Guidelines (last updated in 1992)

– Comment period follows

● Specific proposal released for Comment on April 20, 2010

● May 20 Comment Period Extended to June 4

● Among other things, proposing to modify use of Herfindahl-Hirschman Index

– De-emphasize the significance of HHI changes at lower levels

– Highly concentrated markets now above 2500 (before 1800)


DOJ/FTC New Merger Review and FERC’s Market Power Analyses cont’d

● 1996 – FERC begins to use DOJ/FTC Merger Guidelines

– “Basic framework” for reviewing certain deal approvals where M&A result in significant combinations of owned or controlled jurisdictional assets in common market

– HHI is used as part of a competitive analysis screen

● FERC said its analysis “should be generally consistent” with DOJ/FTC

– Did not attempt to make analysis identical

● In market-based rate context – HHI used for applicants that do not pass screen tests


DOJ/FTC New Merger Review and FERC’s Market Power Analyses cont’d

● Change to FERC policies if DOJ/FTC change will not be automatic

● Although FERC statutory mandate is different, it will likely consider updating its merger review should the proposed changes be implemented by the other agencies

“[W]hile the HHI thresholds contained in the DOJ/FTC 1992 Horizontal Merger guidelines provide useful measures for analyzing market conditions, these thresholds are based on the antitrust agencies’ obligations to prohibit mergers that substantially lessen competition . . . Our standards are based on the Commission’s statutory obligation under section 205 [rate provisions] of the FPA [Federal Power Act] to ensure that wholesale rates are just and reasonable.”


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