Is monopoly power coming to the independent, non-utility generating sector of the electricity business? A recent analysis from the University of California, Berkeley’s Energy Institute at Haas says the recent mega-merger of Constellation Energy and CalpineCorp. gives the combined company the ability to assert market power in several major electricity markets.
On Jan. 10, Baltimore-based Constellation, owner of the nation’s largest nuclear fleet, announced it will buy Houston-based Calpine, which owns the largest fleet of natural gas generating plants, for $29.1 billion (including $12.7 in debt). The Wall Street Journal lauded the deal as a “win-win for both parties and highlights just how much fortunes have shifted for once-ignored power stocks.” Constellation is publicly traded (NASDAQ:CEG) while Calpine is privately owned.
Photos Copyright Noah Berger / 2018
Economist Lucas Davis, a business and technology professor at the Hass School of Business, in a recent blog post, writes, “Much has been written about motivations for the proposed merger (e.g. here and here), but there has not been much discussion about the potential for market power. The combined company would have a significant market share in several important U.S. wholesale electricity markets, exactly at a time when electricity demand is increasing steadily.”
Davis observes that the merger is big not just in dollar terms, but in combined gross generating capacity of 59.8 GW. That’s “5% of total U.S. generation capacity, and an even larger percentage in specific geographic markets.”
Davis notes that the “core” of Constellation is its 22 GW of nuclear generation, or 23% of total U.S. nuclear generation and 68% of Constellation’s total generation (the rest is 19% gas and 12% oil, wind, pumped hydro, and solar. For Calpine, 25.3 GW of gas provides 94% of the company’s generation, with the rest 3% of geothermal, 3% of battery storage, and less than 1% oil.
Both Constellation and Calpine are offspring of the late 20th century electric restructure in the U.S., upsetting the conventional notion of a “natural monopoly” in electricity, consisting of generation, high-voltage transmission, and local distribution in a seamless web. In 1981, two government bureaucrats and brilliant visionaries, Roger Sant and Dennis Bakke, formed an energy consultant company, Applied Energy Services. They saw through the natural monopoly fiction, forming AES in 1988 to become the nation’s first “independent power producer,” or IPP, with a generating plant each in California, Pennsylvania, and Texas.
A 2008 Justice Department history described what came next, involving “the divestiture of generation from utilities, the formation of organized wholesale spot energy markets with non-discriminatory economic mechanisms for the rationing of scarce transmission resources, the introduction of retail choice programs, and the establishment of new forms of market oversight and coordination.”
Constellation Energy was a conventional vertically-integrated utility, with its retail business Baltimore Gas and Electric, operating under the PJM interconnection, until it merged with Chicago giant Exelon Corp., with a large unclear portfolio. Exelon spun off Constellation and its nuclear fleet into a free-standing company in 2022, operating in 48 states.
Calpine was born in 1984 in California with eight employees to provide management services to independent power companies. It soon got into generation itself with a geothermal plant in California. Calpine has grown to the where it now has assets of some $16 billion and about 2,200 employees, operating in 22 states and Canada.
“Nuclear power plants, by themselves, are not well suited for exercising market power.” — Lucas Davis
It’s the combination of nuclear and gas generation that gives the merged company the possibility to exert market power. Davis says, “Nuclear power plants, by themselves, are not well suited for exercising market power.” They operate 24-7 and can’t follow load to take advantage of price changes. They are wed to wholesale prices.
He adds, “But each time demand increases, some pesky natural gas plant shows up and prevents prices from rising very much. If only there were some way for those natural gas plants to show up less frequently, that could really help profits. And it wouldn’t hurt that marginal natural gas plant much because it wasn’t collecting large operating profits anyway….
“Voila! Calpine’s portfolio is, in contrast, mostly natural gas…Calpine is overwhelmingly natural gas and with a presence in most U.S. wholesale markets.”
Where does this combination give the merged company market power opportunities? Here’s Davis’s suggestions:
- “By itself, Constellation already had 9.6% of PJM’s total generating capacity, but add in Calpine and the combined company would control 12.2%. Not coincidentally, there are already discussions underway about the company divesting a “limited” amount of PJM assets, as part of regulatory approval.”
- In the Texas-only wholesale market “the combined company would also be in the double digits” with11.0% of total generation.
- California, where CAISO where the combo company will have 9.2% of the market, mostly due to Calpine.
- New York, where NYISO will see 8.5% concentration, mostly die to Constellation.
It’s also worth looking at sub-regions in those independent system operators. “During periods when transmission constraints bind, the relevant market can quickly become much smaller, as has been studied in previous Energy Institute research (here and here),” Davis advises.
Looking at California’s instructive experience, Davis observes “ that due to electricity’s unique features (inelastic demand, limited storage, etc.), a company with even a small market share can still influence prices by restricting output.”
A true academic, Davis suggests, “This would be a fantastic dissertation topic for a PhD student, and much more could be said with additional data analysis and modeling. It would be interesting to think not only about market power in electricity markets, but also in related markets for capacity and ancillary services.”
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