BGE, Pepco face era of change With merger scrapped, how long can they remain independent?

December 28, 1997|By Kevin L. McQuaid | Kevin L. McQuaid,SUN STAFF

On the same day that Baltimore Gas and Electric Co. and Potomac Electric Power Co. scrapped plans for their $3 billion merger, the utility industry forever changed, and with it, perhaps, the fate of Maryland's power companies.

With the announcement Monday of a merger between American Electric Power Co. of Ohio and a Dallas-based utility, analysts contend, the energy industry entered a new era, in which geographic borders are no longer a factor in creating alliances.

As a result, BGE and Pepco may find their destiny is out of their hands, snatched away by industry trends toward deregulation and the economic equivalent of social Darwinism.

"The AEP merger really opens up the whole field," said Michael Worms, a CS First Boston Corp. utility analyst. "What it says is, acquiring companies don't have to be contiguous anymore. You could be dealing with a power company in Indiana or Arizona."

In the case of BGE and Pepco, that could mean an alliance with Duke Energy Corp. of North Carolina, Dominion Resources Inc. of Virginia, Peco Energy Co. of Pennsylvania, or some other out-of-state power concern such as Pacific Gas & Electric Corp. Neither BGE nor Pepco would comment on their merger plans.

"I wouldn't be surprised to see each of them hook up with another partner," said Ronald S. Tanner, a utility analyst at Legg Mason Wood Walker Inc. "Ultimately, I think they have to. Over the next couple of years, the industry eventually will be dominated by utilities with huge customer bases."

"Mergers allow companies to drive out costs and create operating efficiencies, just as it's happened in other industries," Tanner added. "And bigger mergers are the future. The American Electric and Central & Southwest Corp. deal illustrates that."

AEP's $6.45 billion deal for Central & Southwest Corp. isn't the first time two noncontiguous utilities have considered pairing up -- in July 1996 Houston-based electric wholesaler Enron Corp. announced a $2.1 billion bid to acquire Portland General Corp. of Oregon. But the AEP transaction marks the first time two utilities with individual service territories in different states have attempted to join forces.

Their proposed union also represents the first time a 1935 law prohibiting utility holding companies from pairing has been directly challenged, although industry experts predict the antiquated law will either be overturned or significantly eroded, the way Glass-Steagall banking laws have been watered down in recent years.

"The industry is moving so rapidly," said Edward J. Tirello, a NatWest Markets utility analyst. "And BGE and Pepco are now at risk because of their size. They're simply too small for the electric industry of tomorrow."

Enough customers

Tirello and other analysts contend the utility companies of tomorrow will need at least 5 million customers to remain competitive. BGE and Pepco each currently have roughly 1 million customers.

The advent of competition -- Maryland hopes to restructure its electric system and introduce customer choice by 2001 -- will also play a significant role, making it easier for giant energy providers to enter the state.

In breaking their agreement to create Constellation Energy Corp., which was to be the nation's ninth-largest power company, both BGE and Pepco said they would focus instead on influencing the path to deregulation at the state level.

"Both companies know that they need to focus their efforts toward restructuring now without the merger," said H. Russell Frisby Jr., chairman of the state's Public Service Commission, the agency that primarily regulates utilities.

BGE and Pepco aren't totally unprepared for the future, of course, and each has been taking steps to brace for competition by establishing new subsidiaries, streamlining operations and improving generation and distribution efficiency.

"We haven't been sitting on our hands for the past two years," said Arthur J. Slusark, a BGE spokesman. "Even while we were focused on the merger with Pepco, there was a lot of strategic planning. We're going to move forward as a strong, stand-alone company."

"We're a combination utility with both gas and electric, so we can offer an array of products," Slusark added. "A lot of electric utilities, for instance, are now trying to find ways to link up with natural gas companies. We're already there. The only thing we lack is the customer base that analysts contend that we need to compete effectively in the distribution market."

Pepco isn't wasting any time, either.

One day after regaining its independence, the Washington utility announced it would form six internal "super groups" comprising power generation, transmission and marketing, customer service and distribution, external affairs, corporate services and finance.

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