Exelon’s proposed takeover of Pepco: what’s at stake

Exelon is the nation’s largest nuclear power utility, but burdened by a bevy of uneconomic nuclear reactors, it hasn’t been performing well financially in recent years and was forced to slash dividends to its shareholders a couple years ago–which it still hasn’t been able to resume. Wall Street took notice, and essentially told Exelon it had to diversify and expand its non-generation business. 

As it turns out, electricity generation–especially in the form of a generation portfolio dominated by nuclear power–is a pretty risky business. There are a lot of competitors, and some of them–in the form of renewables and natural gas–have become cheaper than nuclear power, especially because, as anti-nuclear activists predicted years ago, aging and decrepit reactors cost more to operate than shiny new reactors. And those shiny new reactors have turned out to be too expensive to build without a whole lot of taxpayer or ratepayer support (or, in the case of Southern Company’s Vogtle reactors, both taxpayer and ratepayer support).

The electricity distribution business, on the other hand, may not be as exciting as generation, but it’s pretty hard to mess up. It provides a steady, almost risk-free, revenue stream.

So Exelon looked around, as other companies have done before it, and seized upon the mid-Atlantic’s Pepco utility as its means to appease Wall Street–which wants those dividends to resume–and bring in a nice, steady cash flow.

But if Exelon thought taking over Pepco would be easy, they’re learning the hard way that isn’t the case.

The deal must earn regulatory approval from five different public service commissions: Maryland; Washington, DC; Delaware; New Jersey and Virginia. A denial by any of the PSCs would kill the entire takeover. The last two, in which Pepco is a very minor presence, already have approved the deal.

But Delaware, where Pepco owns Delmarva Power, is taking a harder line, and wants more concessions from Exelon than the utility is prepared to offer. Included in its demands are at least 200 MW of new renewable energy; a $40 million, ten-year fund set aside for energy efficiency measures and job protection for Delaware workers; a $50 payment to every Delmarva customer; and $1 million for a University of Delaware study on offshore wind development. Without the inclusion of these and some other conditions, the PSC “staff would again urge the commission to deny the application,” McDowell said. Connie McDowell is the PSC’s senior regulatory policy administrator

Exelon’s CEO Christopher Crane said, in what is undoubtedly an unconvincing overstatement, that “would completely wipe out Delmarva Power’s earnings for years.” Exelon’s goal is to use those earnings from Delaware ratepayers (and all Pepco ratepayers) to resume its dividend payments–not encourage development of new renewable energy or provide benefits to those ratepayers.

Washington and Maryland may prove an even greater obstacle to the takeover. Maryland, although it approved Exelon’s merger with Constellation Energy–the state’s largest electric utility–a few years ago, has a long history of denying mergers it doesn’t believe serve the public interest. And, despite Pepco’s history of reliability problems and outages during storms, Exelon will have a hard time convincing regulators that allowing a single out-of-state company to control virtually all of Maryland’s electricity distribution (and a good portion of its generation through Constellation) would be in the public interest. The reliability issue, which had many Maryland ratepayers up in arms against Pepco in recent years, may even boomerang on Exelon. Pepco has been aggressively addressing those issues and reliability has improved. More telling, Exelon so far refuses to commit to the state-mandated reliability improvement program that Pepco agreed to and is operating under.

Nuclear power is an issue in Washington DC. While it does purchase some nuclear power, Pepco has always been a non-nuclear utility (a mid-1970s proposal to build its own reactor in Maryland was quickly abandoned) and ratepayers have no exposure to nuclear-related costs like aging and expensive reactors, radioactive waste disposal and decommissioning. Since the major reason Exelon wants to take over Pepco is the economic failure of its nuclear fleet, avoiding such exposure has become a central issue in public hearings on the proposal. History isn’t promising for Exelon: in the 1990s, the DC PSC rejected a merger proposal between Pepco and Baltimore Gas & Electric (now owned by Constellation Energy) largely to prevent ratepayers from exposure to costs related to BG&E’s Calvert Cliffs reactors.

And in both jurisdictions, Exelon’s war on renewables is playing poorly. Pepco has been working to become a national leader in distributed generation, and rooftop solar installations are sprouting up all over the city. Maryland has a fairly aggressive Renewable Energy Standard of 20% renewable by 2020 and an effort is underway to double that to 40% renewable by 2025. As in Delaware, both Maryland and DC could be expected to require far more emphasis on renewable energy than Exelon would want, and both could deny the merger on those grounds alone.

Despite rather poor coverage from the region’s major media of the stakes involved in the deal, public interest in the merger proposal has been high. Four hearings were held in DC on the proposal–the final one last night–and all were packed. While Exelon tried to get as many supporters as possible to the hearings–especially nonprofit organizations it funds–opponents of the merger, organized in a group called PowerDC (NIRS is an active member of the group),  have greatly outnumbered Exelon’s paid-for advocates.

Exelon even has been sending multiple representatives to local Advisory Neighborhood Commission meetings to try to sell the merger, and contributed $10,000 to new Mayor Bowser’s inauguration committee. But, if anything, the opposition has only been gaining in strength.

In Montgomery County, Maryland last week, more than 100 people–nearly all opposed to the deal–turned out at the first Maryland PSC hearing.

Utility Dive yesterday published a very fair and comprehensive piece on the Exelon-Pepco merger proposal for those interested in more detail on the issues involved.

If this takeover effort fails, Exelon could be in real trouble. If it can’t get a sizable bailout from Illinois for its troubled reactors there–and even the state agencies charged with defining the case for a bailout couldn’t find much justification for one–and New York where its Ginna reactor is teetering on the edge of shutdown, and if it can’t find a new steady revenue stream of the kind Pepco could provide, the nation’s largest nuclear utility could find itself on a slow slide to well-deserved oblivion.

UPDATE: The Washington Post this morning reported that opposition to the merger has come from a new direction:

The Institute for Energy Economics and Financial Analysis, a Cleveland-based think tank centered on energy and the environment, urged the D.C. Public Service Commission to reject the merger, in part because Exelon’s business model relies too heavily on an aging group of nuclear power plants.

“Exelon’s shaky financial position gives it an incentive to raise rates, as it has done four times with Baltimore Gas & Electric just since 2012,” Cathy Kunkel, an IEEFA Fellow and the lead author, wrote in an e-mail. “The merger would weaken D.C.’s control over its electric utility and jeopardize progress toward the city’s renewable energy goals.”

….The two companies announced April 30 that Chicago-based nuclear energy giant Exelon would be acquiring Pepco in an all-cash transaction, which is a $2.5 billion premium above the value of the Washington-based utility’s assets in April of last year.

“The $2.5 billion acquisition premium further puts Pepco customers at risk, because Exelon must earn returns high enough to justify the premium,” according to the report.

We assume that the same analysis would apply for the Maryland PSC.

Michael Mariotte

January 21, 2015

Permalink: https://www.nirs.org/2015/01/21/exelons-proposed-takeover-of-pepco/

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