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Introduction

Almost a year after the Federal Energy Regulatory Commission (FERC) approved the $16 billion merger between Exelon Corp. (Exelon) and Public Service Enterprise Group, Inc. (PSEG), the U.S. Department of Justice (DOJ) announced that it will require the merging parties to divest six fossil-fuel fired electricity generating plants with a total capacity of approximately 5,600 megawatts (MW) to resolve concerns that the merger would likely cause higher prices for electricity in the mid-Atlantic region.  The enforcement action is significant for several reasons:

• First, based on the theory of competitive harm sketched out in DOJ’s Complaint, this enforcement action appears to be the first case brought by DOJ against an electric utility merger to prevent potential anticompetitive conduct that may arise from so-called "fuel-curve effects."  
• Second, the case illustrates that differences remain in how DOJ and FERC address competitive issues, particularly with respect to remedies.  Parties cannot assume that FERC approval will eliminate enforcement action by the antitrust agencies or significantly speed up the antitrust approval process.  Moreover, the Exelon-PSEG merger shows that these differences can have a significant impact on the timing and outcome of the process.
• • FERC previously approved the Exelon-PSEG merger on the condition of (1) a more limited divestiture of fossil-fuel facilities (i.e., 4,000 MW of capacity from unspecified plants) and (2) a "virtual divestiture" of 2,600 MW of nuclear powered capacity (i.e., a firm sale of a plant’s output without selling the plant).  Nonetheless, the parties were unable to resolve DOJ’s concerns until nearly one year after receiving FERC approval and were ultimately required to make additional divesture commitments—both in terms of the overall amount of capacity to be divested and the identity of the specific facilities to be sold.
• Third, DOJ continues to define geographic markets narrowly based on the presence of transmission constraints that may limit the ability of suppliers to service customers in particular locations. 

Discussion and Key Implications

DOJ’s enforcement action against the Exelon-PSEG merger illustrates several key issues that the antitrust agencies examine in mergers involving electric utilities, as well as important differences with FERC’s approach to remedies. 

• Fuel Curve Effects. DOJ’s Complaint, as well as the proposed divestiture remedy, demonstrates that the agency’s analysis of the competitive effects of the Exelon-PSEG merger closely examined how the types of generating units owned by the merging parties would impact the combined entity’s incentive and ability to raise wholesale electricity prices.  While DOJ has examined these "fuel supply curve" issues in prior electricity mergers, this is the first electric utility enforcement action in which the government’s theory of harm rests heavily on concerns stemming from the so-called fuel curve effects of the merger.
• The cost of operating generating facilities can vary considerably depending on the type of fuel the plants use to produce electricity.  Nuclear power plants and coal-fired steam turbine facilities often have lower operating costs than "mid-merit" or "peaking" facilities, which typically include combined cycle and oil- and gas-fired combustion turbine units.  (Some coal-fired facilities are also considered "mid-merit" units.)  Since generators that serve a particular area are "turned on" in the order of their economic value, nuclear and coal facilities are usually considered "baseload" units that are more likely to run during normal or "off-peak" demand periods due to their lower operating costs.  In addition, baseload units, especially nuclear power plants, can be very expensive to bring on- and off-line.
• A merger that results in significant baseload generation units being combined with a large share of marginal "mid-merit" or "peaking" generation capacity may give the merged firm a greater incentive and ability to raise price by restricting output from the marginal plants, thereby raising the market-clearing price for sales from its baseload facilities.  DOJ’s Complaint specifically alleged that Exelon could, post-merger, "submit high offers in the PJM auctions for some of the capacity from its mid-merit units such that they are not called on to produce electricity."  DOJ contended that Exelon would have the incentive to engage in this type of withholding strategy because "it would earn higher prices on its expanded post-merger baseload capacity, which almost always runs, making it more likely that the benefit of increased revenues on its baseload capacity would outweigh the cost of withholding mid-merit capacity."
• Parties to mergers involving the combination of electric generation facilities need to be aware that DOJ will examine transactions for these so-called "fuel curve" effects.  Even if the combined firm controls a relatively small percentage of the total generation capacity that services a relevant area, DOJ may contend that an acquisition of additional generation assets could enhance either the incentive or ability of the combined entity to engage in an anticompetitive withholding strategy that increases electricity prices.
• Structural Remedies.  Based on the capacity of the six facilities that Exelon agreed to divest to resolve DOJ’s concerns, DOJ appears to have required the parties to divest (at least, "physically") more generation capacity than FERC.  These additional "physical divestitures" reflect the antitrust agencies’ preference to address competitive concerns through structural remedies that are self-sustaining.  In contrast, due to its ongoing oversight and regulatory role, FERC is generally more willing to accept behavioral remedies, such as "virtual divestitures," which require monitoring and review of the contracts involved.
• For instance, while the merger combined Exelon’s and PSEG’s baseload nuclear power facilities, neither DOJ nor FERC required the parties to sell any of these plants for the merger to proceed.  However, FERC did require the parties to agree to a "virtual" divestiture of 2,600 MW of nuclear power capacity through one of two forms: (i) a 15-year sales contracts for energy rights or (ii) an annual auction of 3-year output entitlements to energy in blocks of 25 MW. 
• DOJ, however, conditioned its approval of the transaction on more substantial divestitures of coal-fired steam turbine facilities.  While FERC’s approval of the merger required the parties to divest 700 MW of coal-fired facilities, the consent decree with DOJ directs the parties to divest coal-fired facilities comprising approximately 2,000 MW of capacity.
• Thus, while both FERC and DOJ appear to have been concerned that the combination of Exelon and PSEG’s baseload units may have increased the merged firm’s incentive to engage in this type of anticompetitive conduct, the agencies adopted different remedies to cure the potential harm.  DOJ selected a substantial divestiture of coal-fired generation plants while FERC selected a smaller set of coal-fired divestitures in combination with a "virtual" divestiture of nuclear power. 
• To limit the ability of the combined company to withhold higher cost or marginal generation capacity, both FERC and DOJ required similar levels of divestitures of "mid-merit" and "peaking" facilities.  FERC conditioned its approval of the merger on the divestiture of 3,300 MW of mid-merit and peaking capacity.  Likewise, DOJ required the parties to divest facilities that appear to comprise approximately 3,600 MW of mid-merit and peaking capacity.
• In combination, these two separate actions will require the parties to divest (either physically or virtually) a total of approximately 8,200 MW of generation capacity.  More importantly, the DOJ action makes it clear that parties cannot assume that the relief that satisfies one agency will necessary resolve the concerns of the other.  It’s likely that DOJ required additional divestitures of baseload units, in part, because of concerns about the effectiveness of the "virtual divestiture" ordered by FERC.  In addition, the DOJ investigation was likely lengthened by extensive negotiations between the parties and the agency over the specific facilities that must be divested.  FERC, in contrast, had approved the merger without requiring the parties to identify the assets to be divested, although it reserved the right to examine whether the actual divestitures would sufficiently mitigate the concerns about the competitive effects of the transaction. 
• One could speculate whether DOJ would have required more substantial divestitures of the parties’ baseload units if FERC had not previously ordered a "virtual divestiture" of nuclear power facilities.  Perhaps DOJ took this regulatory remedy into account when determining the amount of baseload unit divestitures it determined was appropriate.  Likewise, if parties had resolved DOJ’s concerns prior to completing the FERC review process, one could just as easily speculate that FERC may not have required the virtual divestitures given the larger amount of coal-fired capacity to be divested under DOJ’s proposed relief.  In any event, it’s important for parties involved in these types of deals to be aware of the agencies’ different approaches to resolving any competitive concerns that arise from their transaction.  Coordinating their strategies and dealings with both agencies will help parties avoid consecutive, and potentially redundant, remedies.
• Load Pockets.  Both DOJ and FERC examine the competitive effects of mergers in each geographic market in which the parties compete with one another to supply power.  As part of the analysis of the relevant geographic market, both agencies analyze whether there are constraints in the transmission grid during peak demand periods that may impact the ability of suppliers to reach customers in certain locations.  Because these constraints may limit or prohibit the ability of certain suppliers to provide additional electricity to customers located within these "load pockets," the agencies will define separate geographic markets for areas that may have inbound transmission constraints.
• For example, both Exelon and PSEG own electric generation plants that serve wholesale customers connected to the transmission grid overseen by PJM Interconnection, LLC (PJM), a FERC-approved Regional Transmission Operator.  The PJM grid serves customers across 13 states and the District of Columbia; however, the set of transmission lines that divide New Jersey and the Philadelphia area from the rest of the PJM grid are occasionally constrained during peak demand periods.  Likewise, DOJ alleged that two major lines that run from western to central Pennsylvania also become constrained at certain times.
• As a result, DOJ alleged in its Complaint that "PJM East" and "PJM Central/East" were relevant geographic markets due to these constraints.  According to DOJ, wholesale purchasers intending to use electricity in these areas have limited ability during peak demand periods to turn to suppliers outside of these areas.  Moreover, since the combined Exelon-PSEG entity would control 40-50% of generation capacity within these areas, DOJ alleged that the merged firm would have "the incentive and ability to raise wholesale electricity prices, resulting in increased retail electricity prices for millions of residential, commercial and industrial customers in these areas."
• Thus, parties to electric utility mergers need to be aware of any transmission constraints that occur in the areas they service.  To the extent constraints exist and the transaction combines generation facilities involved in the transaction within these "load pockets," the antitrust agencies may have concerns about the transaction even if the parties have relatively small shares of a broader market.

Conclusion

DOJ’s enforcement action in the Exelon-PSEG merger provides insight into several key issues that could impact the review of other electric utility mergers.  Specifically, DOJ will seek divestitures to protect competition in narrow, geographic areas where choices may be limited during periods of transmission constraints.  Likewise, when combining generation assets, parties need to be able to address how the transaction would impact the combined entity’s incentive and ability to profitably withhold capacity.  This will require a careful examination of each party’s portfolio of generating units, including the type of fuel utilized at the parties’ facilities and the costs to operate them.

While the antitrust agencies, FERC and state regulatory agencies share similar concerns about the competitive effects of mergers and acquisitions involving electric utilities and purport to apply similar standards during their review of such transactions, differences remain in how these agencies address competitive issues.  DOJ’s enforcement action in Exelon-PSEG illustrates some of the lingering differences between the antitrust agencies and FERC, particularly with respect to remedy choices.  Therefore, to develop effective legal strategies for resolving any potential concerns, electric utilities and other FERC-regulated entities need to understand these differences in order to minimize the delay to the transaction and the impact on the combined entity’s future business.