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Citizen Power 2121 Murray Ave Pittsburgh, PA 15217 (412) 421-6072 (412) 421-6162 Fax info@citizenpower.com	Citizen Power Reports THE REAL DEAL ON THE FIRST ENERGY-GPU MERGER & RATE CASE Roger Odisio, PhD, Citizen Power Economist July 19, 2001 Introduction On November 9, 2000, FirstEnergy (Akron, Ohio) and General Public Utilities, Inc. (GPU) (Morristown, N.J., Metropolitan Edison and Pennsylvania Electric Companies in Pennsylvania) filed a merger application with the Pennsylvania Public Utility Commission. On November 29, 2000, Met-Ed and Penelec filed a petition at the PUC seeking permission to implement an "interim deferral tracking mechanism" that would allow GPU to recover its excess Provider Of Last Resort (POLR) costs from customers. GPU projected substantial losses due to the difference between what it can charge its customers for power and what it has to pay for that power at the wholesale level. The PUC consolidated these proceedings. The law requires that applicants must demonstrate by a preponderance of the evidence that a merger will "affirmatively promote the service, accommodation, convenience or safety of the public in some substantial way." On June 20 the PUC issued an order adopting a proposed Settlement in the FE/GPU joint merger and rate case, despite the fact that the Settlement was opposed by almost twice as many parties (9) as signed it (5). As required by the Settlement, the Order adopts the Administrative Law Judge's (ALJ) Recommended Decision with a few minor changes, approves the merger, and resolves GPU's request for rate relief to pay its excessive POLR costs. Citizen Power has been a party to settlements in the past. As such, we recognize that settlement results are usually far short of what is desired. Although there are provisions in this Settlement that are the result of negotiating efforts by Citizen Power, we oppose the Settlement that was finally approved because, as this paper will show, if implemented, it is likely to cause harm to the environment and to GPU ratepayers. Executive Summary On June 20, the PUC adopted a proposed Settlement that threatens both consumers' pocketbooks and Pennsylvania air quality. At a time when competition lies dormant and the very viability of “ElectriChoice” is in doubt, the PUC approved the FirstEnergy/GPU merger despite the Companies' failure to show it (1) would not harm competition, and (2) offered substantial net benefits to customers. The PUC also refused to consider the likely degradation of Pennsylvania's air quality from FirstEnergy's plan to run its dirty coal plants more extensively to help meet GPU's load; or the potential financial impact a pending Department of Justice lawsuit against FirstEnergy for alleged Clean Air Act violations could have on FirstEnergy’s fitness to merge. The Settlement may actually significantly reduce the amount GPU would have contributed to the Sustainable Development Fund from 2005 through 2007. FirstEnergy promises to spend $10 million on a laundry list of “broadly defined” energy related projects, but retains full control of how that money will be spent. Besides approving the merger, the Settlement tries to resolve GPU's claims of substantial losses in meeting its POLR obligations due to the rise in wholesale prices for power. However, the Settlement offers very different "solutions" depending on whether or not the merger is consummated. If the merger is consummated, contrary to what was ordered in the 1998 Restructuring Settlement, GPU will be allowed to collect excess POLR costs instead of stranded costs through its Competitive Transition Charge (CTC ). The stranded costs, including payments to Non-utility Generators (NUGs), will be deferred for later collection. GPU will collect as much of its POLR costs as it can through the CTC, at a rate fixed by the settlement, through 2010. Any remaining amount must be written off. However, the deferred stranded costs can be recovered in a five-year period beginning in 2011. This means that customer rates between 2011 and 2015 are likely to be higher than they would have been without the Settlement. Moreover, the deferrals of stranded costs can only be accomplished by illegally reneging on the stranded cost payments to NUGs, which were not only established by GPU's Restructuring Settlement, but also contractually obligated under the terms of the Public Utility Regulatory Policies Act (PURPA). The Order directs the money supposed to be paid to NUGs to instead be used to pay some of GPU's POLR costs. If the merger is not consummated, consumers will be much worse off. The deferral of stranded costs that was designed to maintain GPU's rate caps will be eliminated. GPU will be guaranteed dollar for dollar recovery of all of its excess POLR costs from June 1 to approximately the end of the year. This means that, despite widely reported headlines to the contrary, customer rates will be increased. And because power is much more expensive in the summer, the total rate increase paid by customers will be substantial--it is likely to exceed $150 million for 2001 alone. After that, continued recovery of POLR costs throughout the rest of the transition period (lasting perhaps until 2020 in some cases) has been made easy by the PUC's finding that the decisions that led to the problem, including GPU's sell-off of its generation, were prudently made. The PUC's order is also likely to make it easier for other Pennsylvania utilities to recover POLR costs, thereby weakening price cap protection. Discussion The Order does the following: (1) Approves the FirstEnergy-GPU merger without even evaluating its potential effect on retail competition, or requiring the Companies to show substantial net benefits, or to quantify merger savings and share them with customers. (2) Rejects consideration of both the potential harmful environmental consequences of the merger and the potential financial impact of the DOJ/EPA suit against FirstEnergy alleging Clean Air Act violations. (3) Finds that, despite clear evidence to the contrary, GPU is entitled to recover its excess POLR costs because the decision to sell its generation plants was prudent and it could not earn a fair return without rate relief. (a) If the merger is consummated, permits POLR cost recovery (instead of stranded costs) through the CTC, but without raising total revenue from generation rates ("price to compare" + CTC) through 2010. The stranded costs will be deferred for recovery beginning in 2010. At that time, however, GPU would have greater certainty of collecting them, thus likely raising customer rates. (b) If the merger is not consummated for any reason, (1) guarantees GPU recovery of all POLR costs from June 1 until the PUC issues a new order after a hearing (probably at the end of the year), and (2) provides an easy basis for recovery of POLR costs for the rest of the transition period (which could last to 2020) by finding that GPU acted prudently in divesting its power plants and relying on a combination of selling off its POLR obligations and wholesale market power purchases. (4) Changes parts of the 1998 GPU Restructuring Settlement, including the amount of contributions to the GPU Sustainable Development Fund, without the agreement of several parties to the Restructuring Settlement. Citizen Power opposes the Settlement adopted in the Order for several reasons: (1) The Companies failed to show, as they are required to do, that the merger will not adversely affect competition in retail markets and will provide substantial public benefits. (2) The Order fails to address the merger's likely adverse effect on Pennsylvania air quality and the potential financial impact on FirstEnergy customers from the DOJ/EPA lawsuit. It substantially reduces the GPU Sustainable Development Fund amount for 2005-2008 that was approved in the 1998 GPU restructuring proceeding. (3) GPU is not entitled to recover its excess POLR costs because they are the result of the Company's own failed restructuring strategy. (4) If the merger is abandoned, it guarantees GPU dollar for dollar recovery of most of this year's POLR costs and establishes an easy basis for GPU to collect POLR costs for the rest of the transition period. In addition, it is likely to enable other POLR providers to more easily recover excess costs from ratepayers. (5) In its attempt to resolve GPU's problem of excessive POLR costs, the PUC has not only misinterpreted The Electric Generation Customer Choice and Competition Act (Act) standards for rate increases, but also illegally altered several terms of GPU's Restructuring Settlement without the consent of the signatory parties to that agreement. THE MERGER CASE The Order approves the merger without explanation and despite the fact that the Companies failed to meet several of their burdens to show the merger would be in the public interest. The Order's assertion (p. 74), without any facts or analysis to support it, that the merger "is not likely to result in anti-competitive or discriminatory conduct, or in the unlawful exercise of market power" merely regurgitates statutory language. The record does not even contain a definition of the relevant retail market--the Companies offered none--let alone any analysis of the effect the merger would have on it. It is utterly meaningless for the PUC to talk, as the Order does, of anti-competitive conduct without reference to a specific market. For that reason alone the merger cannot lawfully be approved. The ALJ found that the wholesale market is noncompetitive. Retail competition is essentially dormant throughout Pennsylvania as well. No retail suppliers currently offer service at or below the "price to compare" in any utility service area in the state. Surely, then, this is not the time to approve a merger that further reduces the number of potential suppliers without clear evidence it will not further harm competition. FirstEnergy and GPU offered no such evidence. The Order's finding that the merger would produce substantial, affirmative net benefits, is unsupported by the record. It is clear that the Companies decided to merge without first conducting any analysis about potential benefits to the public. As a result, the Companies provided a list of benefits that consisted almost entirely of boons to shareholders and claims about an absence of an adverse affect. In short, the Companies' merger benefit claims are nothing but vague abstractions without any commitment for substantial benefits to the public. They cannot provide a basis to approve the merger. Merger Savings Unlike other mergers, the Companies offered neither an acceptable quantification of merger savings nor a commitment to share them with customers. The ALJ recommended extending transmission and distribution (t&d) rate caps as a "benefit" to customers, presumably as a way to capture some unspecified share of savings for customers. But with no clear evidence that such an extension would benefit ratepayers, this was largely an empty gesture. In fact, some parties argued that t&d rates appear to be excessive, so extending them would actually be a detriment to ratepayers. Stating that the lack of evidence in the record about both the role FirstEnergy will play in assisting GPU post-merger and the quantification of merger savings "makes it impossible, at this point, to approve the disposition of the merger savings", Commissioner Fitzpatrick's May 24 Motion set the disposition of merger savings for further discussion in the collaborative that led to the Settlement. The Motion was later given effect by one of the PUC’s June 20 Orders. Yet the Settlement does not even address either the quantification, or the disposition, of merger savings. Rather, it simply requires the PUC to adopt in its June 20 Order the ALJ's position it found "impossible" to accept in its May 24 Motion. No explanation is offered for this obvious contradiction. As a result, FirstEnergy stockholders will be free to keep all savings from the merger. Environmental Impacts Citizen Power, along with the Clean Air Council and the PennFuture Parties, raised serious concerns about the potential harmful consequences of merger consummation: (1) the increased pollution from FirstEnergy running its dirty coal plants more extensively to meet GPU demand after the merger, and (2) the potential financial harm to GPU customers from the DOJ lawsuit filed on behalf of the EPA alleging Clean Air Act violations at FirstEnergy's Sammis Plant. The Order rejected our contentions. The PUC simply found all environmental effects of the merger to be beyond its jurisdiction, despite: (a) the Commission's mandate to protect the public interest, (b) the Commission's undeniable ability to condition a merger, as it did in this Order, so as to make it acceptable, as long as the condition reflects something that results from the merger, and (c) the language in section 2811(21) of the Act which specifically notes that environmental impacts are a public interest that the PUC should consider. In addition, the Settlement will likely lower the amount of money that was to be added to the GPU Sustainable Development Funds. Under the GPU Restructuring Plan, the fund would have gained an estimated increase of $8.2 million from $0.01/kWh charge from 2005 through 2007, if distribution rates are unchanged. The Settlement freezes current distribution rates through 2007 and substitutes the $0.01/kWh charge with a one-time FirstEnergy payment of $5 million to the GPU Sustainable Development Funds, for a potential net decrease of millions of dollars. FirstEnergy promises to spend an additional $10 million on a laundry list of very "broadly defined" energy projects that may or may not include renewable sources. FirstEnergy will decide what projects will be funded. Given the Company's environmental record, Citizen Power is not optimistic about how FirstEnergy will spend these funds. Citizen Power simply could not agree to a deal that ignores the harmful environmental consequences of the merger, substantially reduces GPU's Sustainable Fund, and offers only FirstEnergy promises to invest in “broadly defined” energy supply and demand side initiatives. THE POLR CASE Is GPU entitled to recover excess POLR costs? In its June 20 Order, the PUC unequivocally found that GPU met the standard under the Act for recovering its excess POLR costs from customers. The order claims GPU met both prongs of the statutory test for rate relief: (1) GPU's decision to sell off its generation was prudent at the time it was made, but it left the company at the mercy of wholesale prices over which it has no control, and (2) as a result, without rate relief, GPU would be unable to earn a fair rate of return. By accepting the settlement, the PUC had to make such a finding and offer some arguments to support it, however weak they are, for the following reasons. First, the Settlement requires that, except for a few minor modifications, the PUC adopt the ALJ's decision in its entirety. The ALJ found that GPU was entitled to rate relief from its POLR costs. The PUC had to either agree with this finding or reject the Settlement outright; no changes are permitted without the signatory parties’ agreement. Second, the PUC may not simply accept a Settlement as in the public interest, but must be able to justify its decision with stated reasons that take account of objections to the Settlement. That is especially critical, where, as here, about twice as many parties refused to support the Settlement as signed it. Even if the Settlement did not specifically require the adoption of the ALJ's finding, to approve it, the PUC would still have had to make a finding that GPU was entitled to relief because some parts of the Settlement require rate relief. In deciding if GPU was responsible for its predicament, and, if so, should bear the consequences, however, the issue is not, as the Order claims, whether GPU's decision to sell off its generation was somehow prudent, but whether it was prudent for GPU to do so without making reasonable provision for its POLR obligations. GPU decided to rely on a combination of (a) auctioning off its POLR obligation and (b) the wholesale market, to supply power to its remaining customers. In particular, relying on the spot wholesale market for significant supply, as GPU did, was a risky choice in light of evidence of market price volatility. Had wholesale prices been driven lower by, for example, vigorous competition, GPU could have earned extra profits for its stockholders beyond a "fair return. It's safe to conclude that GPU would not have filed with the PUC for permission to refund that money to customers. But prices soared instead. GPU must now bear the consequences of its decision. For markets to work to lower prices and achieve efficiency, bad decisions must be penalized just as surely as good ones are rewarded. GPU is not entitled to have customers fund its losses. Moreover, whether or not the PUC's decision to allow POLR cost recovery in this case is a legal precedent binding it in future cases, such a finding severely damages deregulation in Pennsylvania. Other utilities may at times have to pay soaring wholesale power costs. The PUC's Order paves the way for them to collect these costs from ratepayers, thereby punching holes in existing rate caps. These utilities will now have an even better argument for passing them through to customers than that offered by GPU because they still own generation and only partially rely on wholesale markets for power. In addition, in explaining its reasoning that GPU cannot earn a fair return without rate relief, the PUC contradicts itself. GPU inappropriately excluded transmission and distribution (t&d) revenue in estimating its returns. The Order recognizes this: "Since we believe that an appropriate analysis of the rate of return issue should include a consideration of t&d revenues, we are not satisfied to rely solely on these rate of return projections to support a grant of relief under Section 2804 (iii) (D)." (Order at 18). Other parties in the case showed that if t&d revenues were included, GPU would be able to earn a reasonable return. The PUC does not cite this evidence, or any evidence to the contrary. Yet, inexplicably, the PUC nevertheless concludes that the Companies have demonstrated they cannot earn a fair return. To say the least, this is not reasoned decision making. In sum, the Companies failed to show either that their actions that led to the POLR costs were prudent, or that they cannot earn a fair return without rate relief. Will rates go up if the merger is consummated? If the merger is consummated, the Order provides no additional revenue from customers through 2010, yet the PUC claims that GPU's financial problems with excessive POLR costs will be solved. However, the order does provide for likely rate increases starting in 2011 to enable GPU to collect stranded costs that were replaced in the CTC by POLR cost collections. The Order sets up separate accounts to keep track of POLR costs and stranded costs beginning the first of this year. Originally the CTC was designed to recover GPU's stranded costs at a rate established by the Restructuring Settlement. Under this new Settlement, if the merger is consummated, the CTC will instead be used to recover POLR costs incurred through 2005. When POLR costs for a particular year exceed the amount that can be collected through the CTC, the difference will be deferred and collected whenever possible, through 2010. Any remaining POLR costs will be written off at that time. The stranded costs displaced by POLR recovery will be deferred and GPU will have the opportunity to collect them for five years beginning in 2011. Here is an example of how it works. Suppose GPU may collect $100 through its CTC, but has incurred $150 in POLR costs. It will collect $100 of its POLR costs and defer the remaining $50 for possible collection some time before the end of 2010. It will also defer the $100 in stranded costs it would have passed through the CTC for collection from 2011 through 2015. As part of the Settlement, the CTC has been reduced a small amount and the price to compare correspondingly raised, so the total rate customers pay for both (assuming they buy from GPU) is unchanged through 2010. The PUC trumpets it's holding of the line on the rate caps: "By this Settlement, all generation rates are frozen through 2010." Order at 15. That is a true, though disingenuous, statement. GPU will not collect one penny more from customers under the Settlement through 2010 than it would have collected without it. However, in making this claim, repeated afterward in headlines around the state, the Order deliberately ignores the last five years covered by the agreement, from 2011 through 2015. The Order's claims about rate impacts must be judged on the whole fifteen-year period covered by the agreement, not just until the end of 2010. What will happen to rates during 2011-2015? The PUC doesn't know. Before the Settlement, the amount of stranded cost recovery after 2010 was unknown (Order at 23), depending, for example, in part on the payments required under GPU's contracts with NUGs that cannot be known at this point with certainty. Those obligations remain, but the Settlement fixes the amount of CTC collection after 2010 at the same rate as collected from 2006-2010. It follows that, unless none of the deferred stranded costs is actually collected between 2011 and 2015, beyond what would have been collected without the Settlement, customers will pay more for power. And to the extent they do pay more, it is customers who will have actually funded the POLR payments, the shifting and deferring of accounts notwithstanding. We think it is likely that customers will pay more, and that would explain why GPU would agree to go to the trouble of establishing a deferred account for stranded costs in the first place, instead of writing them off when they are replaced in the CTC by POLR costs. As to the terms in general, if the merger is consummated the PUC is trying to have it both ways. Simultaneously with claiming customers will pay nothing extra to GPU, the PUC asserts that the agreement "adequately addresses GPU's current financial concerns" (Order at 10), implying that Wall Street and GPU's creditors will be satisfied. But will they? GPU estimates it will have bills for generation totaling about $250 million this year that it can't pay out of current customer generation revenue and still earn a fair return. The Settlement provides no extra revenue through 2010. Yet GPU's financial problems are supposed to disappear. How? According to the PUC, it is because a regulatory asset (the account for deferred POLR costs) has been created that it believes will satisfy Wall Street and GPU's creditors. But, the problem is, as we have explained, there are two regulatory assets being created-for stranded costs as well as POLR costs-both of which can only be collected through CTC rates that are fixed and remain unchanged by the Settlement. As result, the Settlement has created regulatory assets that, taken together through 2010, cannot produce even one dollar from customers to pay GPU extra POLR costs. The Settlement will help GPU pay its POLR creditors, though not because any "asset" was created. Instead, the Settlement allows GPU to renege on it NUG contracts and use the money to pay POLR bills. While this may appear to "solve" a dilemma, at least in the short run, it not only illegally changes the terms of GPU's Restructuring Settlement without the consent of, and in some cases notice to, the signatories to that agreement, it violates the terms of the contracts NUGs have with GPU under federally mandated PURPA standards as well. While this manipulation of accounts, debts, and contracts may satisfy GPU's current creditors, it seems unlikely to convince Wall Street that a lasting solution to GPU's POLR problems has been found. The violation of the NUG contracts has already led to a swift appeal in court of the Order by ARRIPA, on behalf of the affected NUGs. The PUC also doesn't seem to understand the terms of POLR collection through the CTC as spelled out by the Settlement it has adopted. The Order says GPU would collect POLR costs through the CTC "during the years from 2006 through 2010" (Order at 20). This is incorrect. The Settlement (paragraph 4) provides that, if the merger is consummated, the CTC will be used to collect POLR costs "through 2010". Paragraph 2 of the Settlement allows GPU, "immediately upon entry of an order by the PAPUC accepting this Stipulation," to defer its POLR costs incurred from the first of this year for collection through the CTC. No mention is made of waiting until 2006 to start collecting POLR costs, nor, of course would it make any sense to do so. If GPU could not collect any POLR costs until 2006 that would mean stranded costs would continue through the CTC for the next five years with all of the POLR costs left to be stuffed into CTC collections for the five years after that. If the merger is abandoned for any reason, GPU ratepayers will pay a lot of money. If the merger is not consummated, things get drastically worse for customers. The Settlement provides that GPU write off its POLR costs incurred from the first of this year through May 30. But it then guarantees that GPU will collect all of its remaining POLR costs beginning June 1 until approximately the end of the year. Because power is much more expensive in the summer, these costs are likely to total more $150 million by GPU's estimates. Stranded costs will be collected through the CTC as originally intended; all deferrals of them will be eliminated. POLR costs will be collected separately from, and in addition to, stranded costs, which means only one thing: customer rates must rise. The "method and timing" of such rate hikes is left to the hearing that will commence 10 days after merger abandonment. But the POLR costs will be collected. That is what the order means when it says: "No such subsequent PAPUC determination shall prevent the recovery of any deferred POLR costs accrued between 6/1/01 and the date of such final PAPUC order..." By contrast, as previously explained, no such guaranteed recovery exists if the merger is consummated. In that event, GPU will collect as much of its POLR costs as it can through the CTC at a rate fixed by the settlement. Any amount uncollected by 2010 must be written off. In order to recover stranded costs after this year, the Settlement merely says GPU must show that such costs are "subject to normal prudency [sic] and just and reasonable rate requirements applicable to all utility expenditures." By its Order, however, the Commission has already determined that GPU's sell-off of its generation and subsequent wholesale purchases--which underlies its current and future claims for cost recovery--were prudent. This should make it relatively easy for GPU to continue to collect POLR costs beginning in 2002. Meeting the prudence standard will be simple in deregulated markets: GPU need only show it paid the prevailing market price for power. Moreover, GPU's commitment to limit accruals of POLR costs only through 2005 is contingent on the merger being consummated (paragraph 2 of the Settlement); it disappears if the merger is abandoned. In that case, Met Ed and Penelec will be able to collect excess POLR costs until the end of their transition periods, whenever that turns out to be. In summary, if the merger is abandoned the cost to ratepayers is likely to be severe. Is the merger likely to be abandoned? Merger abandonment is no mere theoretical concern. It could happen for one of several reasons: (1) the New Jersey BPU may reject the merger, (2) The appeals court may overturn the PUC's approval of it, or (3) FirstEnergy may itself abandon the merger for several reasons (GPU rate relief being inadequate, delays preventing timely consummation, etc.). Citizen Power is cautiously optimistic that the New Jersey BPU, which has held hearings that have been much more thorough than those in Pennsylvania, will reject the merger for the reasons similar to those advanced by Citizen Power, i.e., that the Companies did not even come close, and some cases didn't even try, to meet their statutory burdens to show the merger would be in the public interest. By tying POLR collection to the date of a PUC order to be issued in the reopened POLR proceeding, the Settlement provides an incentive for the Companies to delay announcing merger abandonment as long as feasible, so that the PUC cannot issue an order before the end of the year. That way, GPU will be able to collect all excess POLR costs incurred in 2001. Consider this question. If you were GPU management faced with this Settlement, you would have the following choice: (1) be acquired by FirstEnergy, or (2) have guaranteed recovery of most of this year's POLR costs, plus a strong basis, courtesy of the PUC's findings, for recovering all POLR costs thereafter until the end of the transition periods for Met Ed and Penelec. What would you do? We think GPU has good reasons to choose the latter. It also appears that FirstEnergy may have cooled a bit toward the merger because of GPU's cost problems and the plummeting of GPU's stock price from its value when the merger deal was announced. On balance then, because it provides for guaranteed POLR cost relief if the merger is abandoned, the Settlement seems to have increased the chances that the merger will not be consummated, an ironic result for those who have supported both it and the merger. Maybe getting rate relief and then abandoning the merger is just what FirstEnergy and GPU management had in mind when they agreed to the Settlement. Citizen Power, Inc. July 19, 2001 Home \| Search \| Feedback \| Links

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Citizen Power Reports

THE REAL DEAL ON THE FIRST ENERGY-GPU MERGER & RATE CASE
Roger Odisio, PhD, Citizen Power Economist
July 19, 2001
Introduction
On November 9, 2000, FirstEnergy (Akron, Ohio) and General Public Utilities, Inc. (GPU) (Morristown, N.J., Metropolitan Edison and Pennsylvania Electric Companies in Pennsylvania) filed a merger application with the Pennsylvania Public Utility Commission. On November 29, 2000, Met-Ed and Penelec filed a petition at the PUC seeking permission to implement an "interim deferral tracking mechanism" that would allow GPU to recover its excess Provider Of Last Resort (POLR) costs from customers. GPU projected substantial losses due to the difference between what it can charge its customers for power and what it has to pay for that power at the wholesale level. The PUC consolidated these proceedings.
The law requires that applicants must demonstrate by a preponderance of the evidence that a merger will "affirmatively promote the service, accommodation, convenience or safety of the public in some substantial way."
On June 20 the PUC issued an order adopting a proposed Settlement in the FE/GPU joint merger and rate case, despite the fact that the Settlement was opposed by almost twice as many parties (9) as signed it (5). As required by the Settlement, the Order adopts the Administrative Law Judge's (ALJ) Recommended Decision with a few minor changes, approves the merger, and resolves GPU's request for rate relief to pay its excessive POLR costs.
Citizen Power has been a party to settlements in the past. As such, we recognize that settlement results are usually far short of what is desired. Although there are provisions in this Settlement that are the result of negotiating efforts by Citizen Power, we oppose the Settlement that was finally approved because, as this paper will show, if implemented, it is likely to cause harm to the environment and to GPU ratepayers.

Executive Summary
On June 20, the PUC adopted a proposed Settlement that threatens both consumers' pocketbooks and Pennsylvania air quality. At a time when competition lies dormant and the very viability of “ElectriChoice” is in doubt, the PUC approved the FirstEnergy/GPU merger despite the Companies' failure to show it (1) would not harm competition, and (2) offered substantial net benefits to customers. The PUC also refused to consider the likely degradation of Pennsylvania's air quality from FirstEnergy's plan to run its dirty coal plants more extensively to help meet GPU's load; or the potential financial impact a pending Department of Justice lawsuit against FirstEnergy for alleged Clean Air Act violations could have on FirstEnergy’s fitness to merge.
The Settlement may actually significantly reduce the amount GPU would have contributed to the Sustainable Development Fund from 2005 through 2007. FirstEnergy promises to spend $10 million on a laundry list of “broadly defined” energy related projects, but retains full control of how that money will be spent.
Besides approving the merger, the Settlement tries to resolve GPU's claims of substantial losses in meeting its POLR obligations due to the rise in wholesale prices for power. However, the Settlement offers very different "solutions" depending on whether or not the merger is consummated.
If the merger is consummated, contrary to what was ordered in the 1998 Restructuring Settlement, GPU will be allowed to collect excess POLR costs instead of stranded costs through its Competitive Transition Charge (CTC ). The stranded costs, including payments to Non-utility Generators (NUGs), will be deferred for later collection. GPU will collect as much of its POLR costs as it can through the CTC, at a rate fixed by the settlement, through 2010. Any remaining amount must be written off. However, the deferred stranded costs can be recovered in a five-year period beginning in 2011.
This means that customer rates between 2011 and 2015 are likely to be higher than they would have been without the Settlement. Moreover, the deferrals of stranded costs can only be accomplished by illegally reneging on the stranded cost payments to NUGs, which were not only established by GPU's Restructuring Settlement, but also contractually obligated under the terms of the Public Utility Regulatory Policies Act (PURPA). The Order directs the money supposed to be paid to NUGs to instead be used to pay some of GPU's POLR costs.
If the merger is not consummated, consumers will be much worse off. The deferral of stranded costs that was designed to maintain GPU's rate caps will be eliminated. GPU will be guaranteed dollar for dollar recovery of all of its excess POLR costs from June 1 to approximately the end of the year. This means that, despite widely reported headlines to the contrary, customer rates will be increased. And because power is much more expensive in the summer, the total rate increase paid by customers will be substantial--it is likely to exceed $150 million for 2001 alone.
After that, continued recovery of POLR costs throughout the rest of the transition period (lasting perhaps until 2020 in some cases) has been made easy by the PUC's finding that the decisions that led to the problem, including GPU's sell-off of its generation, were prudently made. The PUC's order is also likely to make it easier for other Pennsylvania utilities to recover POLR costs, thereby weakening price cap protection.

Discussion
The Order does the following:
(1) Approves the FirstEnergy-GPU merger without even evaluating its potential effect on retail competition, or requiring the Companies to show substantial net benefits, or to quantify merger savings and share them with customers.
(2) Rejects consideration of both the potential harmful environmental consequences of the merger and the potential financial impact of the DOJ/EPA suit against FirstEnergy alleging Clean Air Act violations.
(3) Finds that, despite clear evidence to the contrary, GPU is entitled to recover its excess POLR costs because the decision to sell its generation plants was prudent and it could not earn a fair return without rate relief.
(a) If the merger is consummated, permits POLR cost recovery (instead of stranded costs) through the CTC, but without raising total revenue from generation rates ("price to compare" + CTC) through 2010. The stranded costs will be deferred for recovery beginning in 2010. At that time, however, GPU would have greater certainty of collecting them, thus likely raising customer rates.
(b) If the merger is not consummated for any reason, (1) guarantees GPU recovery of all POLR costs from June 1 until the PUC issues a new order after a hearing (probably at the end of the year), and (2) provides an easy basis for recovery of POLR costs for the rest of the transition period (which could last to 2020) by finding that GPU acted prudently in divesting its power plants and relying on a combination of selling off its POLR obligations and wholesale market power purchases.
(4) Changes parts of the 1998 GPU Restructuring Settlement, including the amount of contributions to the GPU Sustainable Development Fund, without the agreement of several parties to the Restructuring Settlement.

Citizen Power opposes the Settlement adopted in the Order for several reasons:
(1) The Companies failed to show, as they are required to do, that the merger will not adversely affect competition in retail markets and will provide substantial public benefits.
(2) The Order fails to address the merger's likely adverse effect on Pennsylvania air quality and the potential financial impact on FirstEnergy customers from the DOJ/EPA lawsuit. It substantially reduces the GPU Sustainable Development Fund amount for 2005-2008 that was approved in the 1998 GPU restructuring proceeding.
(3) GPU is not entitled to recover its excess POLR costs because they are the result of the Company's own failed restructuring strategy.
(4) If the merger is abandoned, it guarantees GPU dollar for dollar recovery of most of this year's POLR costs and establishes an easy basis for GPU to collect POLR costs for the rest of the transition period. In addition, it is likely to enable other POLR providers to more easily recover excess costs from ratepayers.
(5) In its attempt to resolve GPU's problem of excessive POLR costs, the PUC has not only misinterpreted The Electric Generation Customer Choice and Competition Act (Act) standards for rate increases, but also illegally altered several terms of GPU's Restructuring Settlement without the consent of the signatory parties to that agreement.

THE MERGER CASE
The Order approves the merger without explanation and despite the fact that the Companies failed to meet several of their burdens to show the merger would be in the public interest. The Order's assertion (p. 74), without any facts or analysis to support it, that the merger "is not likely to result in anti-competitive or discriminatory conduct, or in the unlawful exercise of market power" merely regurgitates statutory language. The record does not even contain a definition of the relevant retail market--the Companies offered none--let alone any analysis of the effect the merger would have on it. It is utterly meaningless for the PUC to talk, as the Order does, of anti-competitive conduct without reference to a specific market. For that reason alone the merger cannot lawfully be approved.
The ALJ found that the wholesale market is noncompetitive. Retail competition is essentially dormant throughout Pennsylvania as well. No retail suppliers currently offer service at or below the "price to compare" in any utility service area in the state. Surely, then, this is not the time to approve a merger that further reduces the number of potential suppliers without clear evidence it will not further harm competition. FirstEnergy and GPU offered no such evidence.
The Order's finding that the merger would produce substantial, affirmative net benefits, is unsupported by the record. It is clear that the Companies decided to merge without first conducting any analysis about potential benefits to the public. As a result, the Companies provided a list of benefits that consisted almost entirely of boons to shareholders and claims about an absence of an adverse affect. In short, the Companies' merger benefit claims are nothing but vague abstractions without any commitment for substantial benefits to the public. They cannot provide a basis to approve the merger.

Merger Savings
Unlike other mergers, the Companies offered neither an acceptable quantification of merger savings nor a commitment to share them with customers. The ALJ recommended extending transmission and distribution (t&d) rate caps as a "benefit" to customers, presumably as a way to capture some unspecified share of savings for customers. But with no clear evidence that such an extension would benefit ratepayers, this was largely an empty gesture. In fact, some parties argued that t&d rates appear to be excessive, so extending them would actually be a detriment to ratepayers.
Stating that the lack of evidence in the record about both the role FirstEnergy will play in assisting GPU post-merger and the quantification of merger savings "makes it impossible, at this point, to approve the disposition of the merger savings", Commissioner Fitzpatrick's May 24 Motion set the disposition of merger savings for further discussion in the collaborative that led to the Settlement. The Motion was later given effect by one of the PUC’s June 20 Orders.
Yet the Settlement does not even address either the quantification, or the disposition, of merger savings. Rather, it simply requires the PUC to adopt in its June 20 Order the ALJ's position it found "impossible" to accept in its May 24 Motion. No explanation is offered for this obvious contradiction. As a result, FirstEnergy stockholders will be free to keep all savings from the merger.

Environmental Impacts
Citizen Power, along with the Clean Air Council and the PennFuture Parties, raised serious concerns about the potential harmful consequences of merger consummation: (1) the increased pollution from FirstEnergy running its dirty coal plants more extensively to meet GPU demand after the merger, and (2) the potential financial harm to GPU customers from the DOJ lawsuit filed on behalf of the EPA alleging Clean Air Act violations at FirstEnergy's Sammis Plant.
The Order rejected our contentions. The PUC simply found all environmental effects of the merger to be beyond its jurisdiction, despite: (a) the Commission's mandate to protect the public interest, (b) the Commission's undeniable ability to condition a merger, as it did in this Order, so as to make it acceptable, as long as the condition reflects something that results from the merger, and (c) the language in section 2811(21) of the Act which specifically notes that environmental impacts are a public interest that the PUC should consider.
In addition, the Settlement will likely lower the amount of money that was to be added to the GPU Sustainable Development Funds. Under the GPU Restructuring Plan, the fund would have gained an estimated increase of $8.2 million from $0.01/kWh charge from 2005 through 2007, if distribution rates are unchanged. The Settlement freezes current distribution rates through 2007 and substitutes the $0.01/kWh charge with a one-time FirstEnergy payment of $5 million to the GPU Sustainable Development Funds, for a potential net decrease of millions of dollars.
FirstEnergy promises to spend an additional $10 million on a laundry list of very "broadly defined" energy projects that may or may not include renewable sources. FirstEnergy will decide what projects will be funded. Given the Company's environmental record, Citizen Power is not optimistic about how FirstEnergy will spend these funds.
Citizen Power simply could not agree to a deal that ignores the harmful environmental consequences of the merger, substantially reduces GPU's Sustainable Fund, and offers only FirstEnergy promises to invest in “broadly defined” energy supply and demand side initiatives.

THE POLR CASE
Is GPU entitled to recover excess POLR costs?
In its June 20 Order, the PUC unequivocally found that GPU met the standard under the Act for recovering its excess POLR costs from customers. The order claims GPU met both prongs of the statutory test for rate relief: (1) GPU's decision to sell off its generation was prudent at the time it was made, but it left the company at the mercy of wholesale prices over which it has no control, and (2) as a result, without rate relief, GPU would be unable to earn a fair rate of return.
By accepting the settlement, the PUC had to make such a finding and offer some arguments to support it, however weak they are, for the following reasons. First, the Settlement requires that, except for a few minor modifications, the PUC adopt the ALJ's decision in its entirety. The ALJ found that GPU was entitled to rate relief from its POLR costs. The PUC had to either agree with this finding or reject the Settlement outright; no changes are permitted without the signatory parties’ agreement.
Second, the PUC may not simply accept a Settlement as in the public interest, but must be able to justify its decision with stated reasons that take account of objections to the Settlement. That is especially critical, where, as here, about twice as many parties refused to support the Settlement as signed it. Even if the Settlement did not specifically require the adoption of the ALJ's finding, to approve it, the PUC would still have had to make a finding that GPU was entitled to relief because some parts of the Settlement require rate relief.
In deciding if GPU was responsible for its predicament, and, if so, should bear the consequences, however, the issue is not, as the Order claims, whether GPU's decision to sell off its generation was somehow prudent, but whether it was prudent for GPU to do so without making reasonable provision for its POLR obligations. GPU decided to rely on a combination of (a) auctioning off its POLR obligation and (b) the wholesale market, to supply power to its remaining customers. In particular, relying on the spot wholesale market for significant supply, as GPU did, was a risky choice in light of evidence of market price volatility.
Had wholesale prices been driven lower by, for example, vigorous competition, GPU could have earned extra profits for its stockholders beyond a "fair return. It's safe to conclude that GPU would not have filed with the PUC for permission to refund that money to customers. But prices soared instead. GPU must now bear the consequences of its decision. For markets to work to lower prices and achieve efficiency, bad decisions must be penalized just as surely as good ones are rewarded. GPU is not entitled to have customers fund its losses.
Moreover, whether or not the PUC's decision to allow POLR cost recovery in this case is a legal precedent binding it in future cases, such a finding severely damages deregulation in Pennsylvania. Other utilities may at times have to pay soaring wholesale power costs. The PUC's Order paves the way for them to collect these costs from ratepayers, thereby punching holes in existing rate caps. These utilities will now have an even better argument for passing them through to customers than that offered by GPU because they still own generation and only partially rely on wholesale markets for power.
In addition, in explaining its reasoning that GPU cannot earn a fair return without rate relief, the PUC contradicts itself. GPU inappropriately excluded transmission and distribution (t&d) revenue in estimating its returns. The Order recognizes this: "Since we believe that an appropriate analysis of the rate of return issue should include a consideration of t&d revenues, we are not satisfied to rely solely on these rate of return projections to support a grant of relief under Section 2804 (iii) (D)." (Order at 18). Other parties in the case showed that if t&d revenues were included, GPU would be able to earn a reasonable return. The PUC does not cite this evidence, or any evidence to the contrary. Yet, inexplicably, the PUC nevertheless concludes that the Companies have demonstrated they cannot earn a fair return. To say the least, this is not reasoned decision making.
In sum, the Companies failed to show either that their actions that led to the POLR costs were prudent, or that they cannot earn a fair return without rate relief.
Will rates go up if the merger is consummated?
If the merger is consummated, the Order provides no additional revenue from customers through 2010, yet the PUC claims that GPU's financial problems with excessive POLR costs will be solved. However, the order does provide for likely rate increases starting in 2011 to enable GPU to collect stranded costs that were replaced in the CTC by POLR cost collections.
The Order sets up separate accounts to keep track of POLR costs and stranded costs beginning the first of this year. Originally the CTC was designed to recover GPU's stranded costs at a rate established by the Restructuring Settlement. Under this new Settlement, if the merger is consummated, the CTC will instead be used to recover POLR costs incurred through 2005. When POLR costs for a particular year exceed the amount that can be collected through the CTC, the difference will be deferred and collected whenever possible, through 2010. Any remaining POLR costs will be written off at that time. The stranded costs displaced by POLR recovery will be deferred and GPU will have the opportunity to collect them for five years beginning in 2011.
Here is an example of how it works. Suppose GPU may collect $100 through its CTC, but has incurred $150 in POLR costs. It will collect $100 of its POLR costs and defer the remaining $50 for possible collection some time before the end of 2010. It will also defer the $100 in stranded costs it would have passed through the CTC for collection from 2011 through 2015.
As part of the Settlement, the CTC has been reduced a small amount and the price to compare correspondingly raised, so the total rate customers pay for both (assuming they buy from GPU) is unchanged through 2010. The PUC trumpets it's holding of the line on the rate caps: "By this Settlement, all generation rates are frozen through 2010." Order at 15. That is a true, though disingenuous, statement. GPU will not collect one penny more from customers under the Settlement through 2010 than it would have collected without it. However, in making this claim, repeated afterward in headlines around the state, the Order deliberately ignores the last five years covered by the agreement, from 2011 through 2015. The Order's claims about rate impacts must be judged on the whole fifteen-year period covered by the agreement, not just until the end of 2010.
What will happen to rates during 2011-2015? The PUC doesn't know. Before the Settlement, the amount of stranded cost recovery after 2010 was unknown (Order at 23), depending, for example, in part on the payments required under GPU's contracts with NUGs that cannot be known at this point with certainty. Those obligations remain, but the Settlement fixes the amount of CTC collection after 2010 at the same rate as collected from 2006-2010. It follows that, unless none of the deferred stranded costs is actually collected between 2011 and 2015, beyond what would have been collected without the Settlement, customers will pay more for power. And to the extent they do pay more, it is customers who will have actually funded the POLR payments, the shifting and deferring of accounts notwithstanding. We think it is likely that customers will pay more, and that would explain why GPU would agree to go to the trouble of establishing a deferred account for stranded costs in the first place, instead of writing them off when they are replaced in the CTC by POLR costs.
As to the terms in general, if the merger is consummated the PUC is trying to have it both ways. Simultaneously with claiming customers will pay nothing extra to GPU, the PUC asserts that the agreement "adequately addresses GPU's current financial concerns" (Order at 10), implying that Wall Street and GPU's creditors will be satisfied. But will they? GPU estimates it will have bills for generation totaling about $250 million this year that it can't pay out of current customer generation revenue and still earn a fair return. The Settlement provides no extra revenue through 2010. Yet GPU's financial problems are supposed to disappear.
How? According to the PUC, it is because a regulatory asset (the account for deferred POLR costs) has been created that it believes will satisfy Wall Street and GPU's creditors. But, the problem is, as we have explained, there are two regulatory assets being created-for stranded costs as well as POLR costs-both of which can only be collected through CTC rates that are fixed and remain unchanged by the Settlement. As result, the Settlement has created regulatory assets that, taken together through 2010, cannot produce even one dollar from customers to pay GPU extra POLR costs.
The Settlement will help GPU pay its POLR creditors, though not because any "asset" was created. Instead, the Settlement allows GPU to renege on it NUG contracts and use the money to pay POLR bills. While this may appear to "solve" a dilemma, at least in the short run, it not only illegally changes the terms of GPU's Restructuring Settlement without the consent of, and in some cases notice to, the signatories to that agreement, it violates the terms of the contracts NUGs have with GPU under federally mandated PURPA standards as well.
While this manipulation of accounts, debts, and contracts may satisfy GPU's current creditors, it seems unlikely to convince Wall Street that a lasting solution to GPU's POLR problems has been found. The violation of the NUG contracts has already led to a swift appeal in court of the Order by ARRIPA, on behalf of the affected NUGs.
The PUC also doesn't seem to understand the terms of POLR collection through the CTC as spelled out by the Settlement it has adopted. The Order says GPU would collect POLR costs through the CTC "during the years from 2006 through 2010" (Order at 20). This is incorrect. The Settlement (paragraph 4) provides that, if the merger is consummated, the CTC will be used to collect POLR costs "through 2010". Paragraph 2 of the Settlement allows GPU, "immediately upon entry of an order by the PAPUC accepting this Stipulation," to defer its POLR costs incurred from the first of this year for collection through the CTC. No mention is made of waiting until 2006 to start collecting POLR costs, nor, of course would it make any sense to do so. If GPU could not collect any POLR costs until 2006 that would mean stranded costs would continue through the CTC for the next five years with all of the POLR costs left to be stuffed into CTC collections for the five years after that.
If the merger is abandoned for any reason, GPU ratepayers will pay a lot of money.
If the merger is not consummated, things get drastically worse for customers. The Settlement provides that GPU write off its POLR costs incurred from the first of this year through May 30. But it then guarantees that GPU will collect all of its remaining POLR costs beginning June 1 until approximately the end of the year. Because power is much more expensive in the summer, these costs are likely to total more $150 million by GPU's estimates.
Stranded costs will be collected through the CTC as originally intended; all deferrals of them will be eliminated. POLR costs will be collected separately from, and in addition to, stranded costs, which means only one thing: customer rates must rise. The "method and timing" of such rate hikes is left to the hearing that will commence 10 days after merger abandonment. But the POLR costs will be collected. That is what the order means when it says: "No such subsequent PAPUC determination shall prevent the recovery of any deferred POLR costs accrued between 6/1/01 and the date of such final PAPUC order..."
By contrast, as previously explained, no such guaranteed recovery exists if the merger is consummated. In that event, GPU will collect as much of its POLR costs as it can through the CTC at a rate fixed by the settlement. Any amount uncollected by 2010 must be written off.
In order to recover stranded costs after this year, the Settlement merely says GPU must show that such costs are "subject to normal prudency [sic] and just and reasonable rate requirements applicable to all utility expenditures." By its Order, however, the Commission has already determined that GPU's sell-off of its generation and subsequent wholesale purchases--which underlies its current and future claims for cost recovery--were prudent. This should make it relatively easy for GPU to continue to collect POLR costs beginning in 2002. Meeting the prudence standard will be simple in deregulated markets: GPU need only show it paid the prevailing market price for power.
Moreover, GPU's commitment to limit accruals of POLR costs only through 2005 is contingent on the merger being consummated (paragraph 2 of the Settlement); it disappears if the merger is abandoned. In that case, Met Ed and Penelec will be able to collect excess POLR costs until the end of their transition periods, whenever that turns out to be.
In summary, if the merger is abandoned the cost to ratepayers is likely to be severe.
Is the merger likely to be abandoned?
Merger abandonment is no mere theoretical concern. It could happen for one of several reasons: (1) the New Jersey BPU may reject the merger, (2) The appeals court may overturn the PUC's approval of it, or (3) FirstEnergy may itself abandon the merger for several reasons (GPU rate relief being inadequate, delays preventing timely consummation, etc.). Citizen Power is cautiously optimistic that the New Jersey BPU, which has held hearings that have been much more thorough than those in Pennsylvania, will reject the merger for the reasons similar to those advanced by Citizen Power, i.e., that the Companies did not even come close, and some cases didn't even try, to meet their statutory burdens to show the merger would be in the public interest.
By tying POLR collection to the date of a PUC order to be issued in the reopened POLR proceeding, the Settlement provides an incentive for the Companies to delay announcing merger abandonment as long as feasible, so that the PUC cannot issue an order before the end of the year. That way, GPU will be able to collect all excess POLR costs incurred in 2001.
Consider this question. If you were GPU management faced with this Settlement, you would have the following choice: (1) be acquired by FirstEnergy, or (2) have guaranteed recovery of most of this year's POLR costs, plus a strong basis, courtesy of the PUC's findings, for recovering all POLR costs thereafter until the end of the transition periods for Met Ed and Penelec. What would you do? We think GPU has good reasons to choose the latter. It also appears that FirstEnergy may have cooled a bit toward the merger because of GPU's cost problems and the plummeting of GPU's stock price from its value when the merger deal was announced.
On balance then, because it provides for guaranteed POLR cost relief if the merger is abandoned, the Settlement seems to have increased the chances that the merger will not be consummated, an ironic result for those who have supported both it and the merger. Maybe getting rate relief and then abandoning the merger is just what FirstEnergy and GPU management had in mind when they agreed to the Settlement.

Citizen Power, Inc. July 19, 2001

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