Exelon to buy PEPCO—what's the deal?

The merger of PEPCO into Exelon, announced Wednesday, would consolidate some 2 million of Maryland's electric power customers under one company's control. If the $6.8 billion buyout goes through, Chicago-based Exelon will have about 10 million ratepayers, making it the biggest utility company in the U.S. The Sun covered the story here. The Washington Post here.Not covered anywhere is an analysis of the per-customer cost of the deal, and what the expected pay-back period would be for Exelon shareholders. At first glance, it looks like a 30-year plan."This is a big acquisition price for essentially 2 million customers," says Tyson Slocum, who directs the energy program at Public Citizen. "What's clear here is it's a straight up risk transfer—from Exelon shareholders to PEPCO ratepayers."This kind of consolidation of the power business has been underway since deregulation took hold in the mid 1990s, and it's accelerating now since the whole deregulated business model is not working so well (as evidenced by sagging profits as many merchant power companies and the amazing bankruptcy, announced this week, of Texas-based Energy Future Holdings).It's much like what we saw 20 years ago in the banking industry, where small town and state regional banks—along with a whole raft of unsavory subprime lenders like Associates First Capital—got rolled up by the likes of Bank of America, CitiGroup, and Wells Fargo into giant financial conglomerates.As the banks did their thing, regulators got tepid and regulations got relaxed. Hopefully, you know the rest of that story.Power companies are not exactly like financial services companies. But the businesses are similar enough to compare. Both do a lot of commodity trading, for example (and cheat at it). Both use substantial leverage. Both face a mix of federal and state regulation.Banks, though, never got what BGE, PEPCO, and other regulated utility companies have: an effective local monopoly on product distribution.That's the part of the business these companies fled over the past decade. Now they're coming back. "They're looking for stable distribution revenue," says Paula Carmody, the Maryland People's Counsel. Carmody's job is advocate on behalf of utility rate payers. She says she expects to find out if the deal makes business sense when the case goes before the commission in the coming six months.The Exelon proposal (which faces regulatory review in four states, plus the Federal Energy Regulatory Commission and the PJM interconnect) amounts to about $3,450 per customer—plus a promised $50 to each customer to sweeten the deal—raising the cost to an even $3,500 per. In its 2011 rate case, the Public Service Commission reported PEPCO's rate base at about $1.2 billion and a rate of return of 7.63 percent—which computes to about $90 million in annual profit. (Net operating income is given at just under $74 million).PEPCO itself (as opposed to PEPCO Holdings) has about 800,000 customers in Maryland. Presumably, the PSC figures apply to those customers only, and not the other 1.2 million or so that other subsidiaries serve in Delaware and New Jersey.So let's assume that $90 million accrues only from the 800,000 Maryland customers, at about $112 per year from each customer.At that (perhaps generous) rate, it would take more than 31 years for the business to repay the $3,500 per customer Exelon is proposing to pay.(Exelon CEO Christopher Crane estimated the deal could save $80 million in annual costs though "efficiencies," but even if that savings could be projected indefinitely into the future--an unlikely prospect in a regulated industry--it would reduce the payback time only to about 17 years).For Exelon shareholders, the deal could only make sense if either some big price increases are coming or if the company's unregulated units are going to make a lot more money in the wholesale market in the coming decade than they have recently. Slocum thinks it can be arranged. "Ten million captive ratepayers is an awesome thing to have," he says."What Exelon has done, with the buying Constellation and PEPCO, is they have recreated the old vertically-integrated utilities," Slocum says. "But without the old wholesale regulation."Well, that appears to be the plan at least.Now let's see if utility regulations follow the well-trod path financial services regulations took in the 1990s and 2000s.

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