Move over, Duke Energy—there’s a new largest electric utility in the country.

On March 23, regulators in Washington, D.C. approved the $6.8 billion acquisition of mid-Atlantic utility Pepco Holdings by Exelon, a Chicago-based utility holding company.

With the addition of Pepco’s more than 2 million customers to a portfolio that already includes Chicago’s Commonwealth Edison, Baltimore Gas & Electric and Pennsylvania’s PECO, Exelon will now have the largest electricity consumer base in the nation.

The decision was the product of nearly two years of deliberations in the nation’s capital, which ultimately held final say over the deal’s approval. After federal regulators and state regulatory commissions in New Jersey, Delaware, Virginia and Maryland approved the acquisition, the merger met it stiffest opposition in D.C.

In August 2015, the city’s Public Service Commission (PSC) rejected the companies’ initial merger offer, setting off a series of protracted negotiations with merger stakeholders that concluded with approval of a revised settlement agreement on March 23. Exelon announced later that day it had closed the deal with Pepco, though there is still a 30-day review period open at the PSC.

The approval was met with surprise by city stakeholders and power sector analysts, many of whom had anticipated regulators would reject Exelon’s latest proposal due to a lack of consensus among parties to the settlement.

In the hours after the vote, Utility Dive spoke with PSC Chairman Betty Ann Kane and Commissioner Willie Phillips in separate interviews about the contentious process that led to merger approval and the commission’s role going forward. Commissioner Joanne Dotty Fort declined an interview request.

How we got here: The path to approval

Even in an era when utility mergers are taking longer than ever to close, the nearly two-year process of debate and negotiation around the Exelon-Pepco deal was unprecedented, the two regulators told Utility Dive.

“I think we're breaking new ground here,” Phillips said. “I have never seen anything like this.”

Opposition to the Exelon deal was visible in the the D.C. area early on in the merger proceeding. In late 2014, after federal regulators cleared the acquisition, a group of progressive activists in D.C. and Maryland formed Power DC, a coalition committed to defeating the deal. The group made their presence felt in the first round of hearings in the District, packing PSC meetings with protesters and stretching public comment portions into the night.

Regulators in Maryland, the other jurisdiction to see significant backlash to the proposal, approved the merger in May 2015, but attached more than 40 conditions to the deal.

In D.C., the commission took a different route, unanimously rejecting the merger in August rather than considering conditions after city leaders, including the attorney general and ratepayer advocate, announced their opposition.

“In this case, in August we all rejected [the merger], and I partially dissented,” Phillips said. “My view was we should have a two-step process where we considered conditions.”

At the time, Chairman Kane cited what she called an “inherent conflict of interest” between District law — which stipulates the city’s utility must be a transmission and distribution company only — and Exelon’s business model, which includes the largest nuclear generation fleet in the nation.

The PSC's rejection of the deal set off months of behind-the-scenes meetings between the companies and D.C. officials, aimed at hammering out a settlement agreement that would persuade regulators to approve the merger on appeal. In October 2015, Utility Dive broke the news that the companies had come to an agreement with D.C. Mayor Muriel Bowser (D), the city’s attorney general, ratepayer advocate and a group of other merger intervenors. Under the settlement conditions, Exelon and Pepco would increase their proposed investment in the District from $14 million to $78 million.

“The parties come back with a settlement agreement which I think followed the roadmap that the commission laid out in its August order,” Phillips said. “So we reopened the record for the specific purpose of considering the settlement agreement and whether or not it was in the public interest.”

After another round of hearings, the Commission was widely expected to approve the proposed settlement when it met in early February 2016. Instead, the regulators rejected the settlement in a 2-1 vote, with Fort and Kane saying the deal was not in the public interest. Phillips dissented, preferring to approve the settlement.

That vote would have spelled the end of the merger, but Commissioner Fort stepped in to play dealmaker, offering four conditions on the settlement deal that would result in automatic approval of the merger if all the parties adopted them. In another 2-1 decision, Phillips joined Fort to vote to offer the conditions to the merger parties, while Kane dissented.

There are 140-odd terms in the merger proposal, Kane said. Four were changed by Fort’s conditions:

• Allocation of $25.6 million set aside for residential rate relief would be decided in Pepco’s next rate case.

• Exelon would be removed as the developer for a solar facility at D.C. Water and Pepco would commit to interconnect any facility the water treatment agency installed through its own procurement process.

• The companies would create an escrow fund with two sub-accounts to hold $32.8 million of the $72.8 customer fund promised by Exelon. One account would put $21.55 million toward innovative pilot projects for the distribution grid; the other would contribute $11.25 million for energy efficiency and conservation initiatives focused on multi-family housing and low and limited income residents.

• Provisions regarding Pepco’s role in developing public purpose microgrids would be eliminated as premature.

Settlement parties were widely expected to adopt the four conditions, but in a surprise, both the Office of People’s Counsel (OPC) — the city’s ratepayer advocate — and Mayor Bowser rejected the new conditions, saying they did not do enough to protect residential ratepayers.

With automatic merger approval off the table, Exelon filed with the commission once again, asking it to approve the merger proposal on its merits.

“One of the options they had under the order, under our rules, was to request other relief,” Chairman Kane told Utility Dive. “So they requested other relief and ... they gave us three options: Approve the settlement, approve the settlement with the four changes, or approve some additional changes.”

Commissioners Fort and Phillips opted for Option 2 — to approve the settlement agreement with the conditions that the mayor and OPC had rejected just weeks before. Kane, again, dissented, preferring to end the deal altogether.

“We approved Option 2, which included the alternative terms that Commissioner Fort put forth,” Phillips said. “I had initially reserved judgement on the substance of those terms, but now, given where we are, and really I think this is the best option, we went with Option 2.”

The rationale for approval

While he voted for approval of the merger settlement back in February, Phillips said in an interview that he would have preferred if the approval process had gone differently.

“I'm not happy today that we're acting on the merits [of the merger proposal],” he said. “My preference would have been that we acted on the settlement agreement that was broadly supported by the majority of the parties.”

In his February dissent, Phillips noted that adding any conditions on the settlement struck between D.C. leaders and the companies risked unraveling the entire agreement. That is exactly what happened here, he argued, with the mayor and OPC backing out of the settlement — only to have the terms approved by the commission anyway.

As one of Fort’s conditions, $25.6 million of the customer investment fund that was set aside for residential ratepayers in the settlement will now be allocated as a part of Pepco’s next rate case.

While the PSC could approve putting the funds toward residential rate relief, People’s Counsel Sandra Mattavous-Frye released a statement in the hours after the vote saying she is “deeply concerned that residential consumers are losing out on the guaranteed rate protections OPC has sought since this case began two years ago.”

But while Phillips said he was not happy approving the deal on its merits, it was a better option than letting it die before the commission.

“If you look at the decision we made today, I still think that it's in the public interest because if we didn’t act on one of the options that was presented, the city would have lost $25.6 million to offset rates, $14 million in direct credits for residential customers — that's almost $50 per meter,” he said. “[There is] $5.2 million for workforce development. You had $10 million for green facilities. These are real benefits and I just think that it would have been a mistake and a missed opportunity for the District.”

Phillips said the money promised by Exelon will help the commission fund new projects and initiatives aimed at moving toward a cleaner, more flexible electricity system, such as a new grid modernization proceeding open at the commission.

“We're in the early stages in that proceeding, but eventually we'll get around to issuing some type of directive, and now we actually have real funds to achieve whatever goals we decide are necessary,” he said. “I think that's important, and that's something that's important to even the opponents of this case.”

Kane’s concerns with the deal

While Chairman Kane said she thought the four conditions put forth by Commissioner Fort improved the merger proposal around the edges, she told Utility Dive after the vote that they did not address her fundamental concerns with the merger.

“I have the same concerns and I have had those concerns from the beginning,” she said. “My concern has never been addressed or mitigated by the additional new deals, the new offers, the new changes, etc.”

Under District’s electric restructuring law, the utility “is to be out of the business of generating electricity, of selling electricity, is to operate an open-access distribution system for suppliers and customers, and is to have very arm’s length dealing with any affiliate,” including not sharing office space or employees, Kane said.

Exelon’s acquisition plan for Pepco appears to run afoul of those legal requirements, she said, and none of the changes to the company’s merger proposal over the past two years have addressed that core issue.

In fact, some of the changes have made the problem worse, Kane argued, pointing to the fact that the CEO of Pepco Holdings, under the merger agreement, will sit on the Exelon executive committee.

“As I said in that [February] dissent, [if] you're sitting there on the Exelon executive committee and you're working on the board, you're not going to sit there and say, 'I'm not going to say anything about generation,’” she said. “You're part of the whole corporate world and you have to be. That's your fiduciary duty. That’s your executive duty. You've got to now think of the good of the whole company, not just Pepco, and there are things that could conflict.”

Entanglement of Pepco and Exelon business 'inevitable'

Throughout the process, backers of the merger proposal have pledged to keep Pepco’s distribution utility business walled off from the larger corporate dealings of Exelon. In particular, they pointed to ring fencing provisions in the merger proposal the company said would insulate Pepco ratepayers from any harms emanating from another part of Exelon’s business. As the name suggests, "ring fencing" legally walls off the assets of a subsidiary from its parent company and its businesses. 

When OPC endorsed the Exelon settlement back in October, Mattavous-Frye said the ring fencing provisions were more than adequate to protect District ratepayers. Phillips echoed that view last week.

“I believe the ring fencing provisions that we approved today, which are even stronger than the ones offered in August, do go a long way to mitigating the risk,” he said.

Spokespersons from Exelon and Pepco echoed those comments in an email to Utility Dive. 

"The Commission concluded that the stringent 'ring-fencing' provisions to which we’ve committed protect Pepco from Exelon’s other businesses, including its power generation business," they wrote. "Even in the unlikely event of financial trouble at Exelon, neither Pepco nor its customers would pay for the debts of Exelon or any of its other businesses."

But Kane said that the focus on ring fencing misses the point. Likening the provisions to disaster insurance, she said they would help protect ratepayers from a large financial event, like the failure of an Exelon nuclear plant, but they would not address the “day-to-day inevitable entanglement” of Pepco and Exelon’s other businesses.

In her February dissent, Kane outlined one example of the potential conflicts that could arise as a result of the merger approval.

When D.C. Water, the city’s water treatment agency, signed on to the settlement agreement with Exelon last fall, they did so “because it was going to help them get their 7 MW of solar built at Blue Plains,” their purification facility, Kane said.

D.C. Water had an RFP out for the array and chose Washington Gas and Energy Services as the developer, but the company struggled to get an interconnection agreement with Pepco, making the developer worry it would miss out on federal tax credits that were, at the time, slated to expire at the end of 2016.

But when D.C. Water announced that Exelon was going to build out the solar facility, “now suddenly the interconnection problem goes away,” Kane said.

While one of Commissioner Fort’s conditions removed Exelon as the developer for the Blue Plains facility, “that only takes care of one project,” Kane said. “How many more times is that going to happen and we don’t see it?”

Spokespersons from Exelon and Pepco said Kane need not be concerned. 

"Pepco treats all energy-market competitors — solar developers, retail electric suppliers or bidders into Pepco's wholesale procurements — equally and will not favor any competitive Exelon affiliate for the Blue Plains project or any other," they wrote in an email. "The D.C. Public Service Commission and federal regulators have strict rules prohibiting it, and Pepco and Exelon embrace those rules and take seriously their obligations to promote fair competition."

"It’s also worth noting that we’ve made commitments to improve Pepco's interconnection process to make it easier to advance solar projects, such as the one at Blue Plains," the companies wrote.

Phillips was less concerned about the possibility of conflicts between Exelon’s many businesses, pointing out that the commission did not cite environmental impacts of the merger, such as its effect on renewable energy deployment, as a sufficient reason to reject the merger back in last August.

“Pepco is still going be our distribution company, and they're still going to be focused on distribution and the commission will still have authority over Pepco,” he said. “That does not change. I think with all of that taken into consideration, I'm satisfied. I'm comfortable that the commission can still do its job as we all said in our initial order.”

But for Chairman Kane, simply having authority over Pepco as it enters the Exelon era is not her concern. Back in her February dissent, she said that regulators would “forever be playing whack-a-mole” to ensure the companies are fairly operating in the District if the merger were to close.

Before the merger, Pepco had no financial interest as to who ended up as the provider for their default electricity service or who signed their PPAs, but “now they will,” Kane said, “and Exelon as a company will have an interest in seeing that those things [like the Blue Plains deal] happen more in the District.”

“They want to have their affiliates get the thing,” she said. “That’s what I mean by whack-a-mole.”

In response, company spokespersons stressed that there will be arm's length between Pepco and Exelon's other businesses.

"Pepco remains an entirely separate business with its own financial resources, and Pepco and its customers are only responsible for Pepco’s costs and operations. Exelon can’t pass any costs from its other businesses on to Pepco customers through distribution rates," they wrote. "Pepco will continue to purchase power for its customers the same way – from a variety of competitive suppliers, based on the lowest price. And Pepco customers can still choose their own retail electric supplier – an option Pepco and Exelon strongly support."

D.C. regulators will 'have to have eternal vigilance’

Now that the PSC has approved the merger, a 30-day period for review and reconsideration has begun.

“If nobody files [the merger deal] would go into effect after 30 days, which would be April 22,” Kane said. “So that's what's next is to see what happens.”

Despite a nearly two-year process involving countless hours of testimony, debate and behind-the-scenes negotiations, the two regulators agreed this is how the process is supposed to work, even if they are on opposite sides of the debate.

“I think we're breaking new ground here, but this is regulatory law,” Phillips said. “I've done this for over a decade and usually it's very boring and I think it's supposed to be that way. This has gotten more attention because ... there's a lot at stake.”

The stakes of the deal clearly contributed to the proceeding's length and contentious nature, Kane concurred.

“What’s done is done. It’s a big deal,” she said. "This is not like a rate case where 2 years later or 18 months later we have another application in front of us and can say, ‘Oh, the 2% increase wasn’t right’ … This is forever.”

While the merger proceeding stoked plenty of controversy among District politicians, with activists calling for an investigation of Mayor Bowser related to the settlement agreement, the commissioners said the political pressure did not factor much into their deliberations.

“We act like a court. It is a quasi-judicial process and we are like judges in a court.” Kane said. “I looked at the law, certainly considered it and was aware of what everyone was saying … but we've had rate cases where we've had dozens and dozens of people come in to oppose a rate increase but you have to look at the record and see what's right.”

“My fidelity is to the public interest,” Phillips said, “and I think if you talk about some of the other players in the city, they wear a different hat. They are politicians and I'm not. As much as I would like to be able to say, 'This is what I want, so let it be,' we have to abide by the law.

“In this case, if the law had cut the other way, and the [companies] did not meet their burden of proof, then I would have no issue with rejecting the merger again. But that's not what we were presented with,” he said.

Whatever D.C. residents think about whether the merger met their burden of being in the public interest, Kane said her job as a regulator got a little bit more difficult last week.

“I think we're going to have to have eternal vigilance,” she said. “How are you going to be sure that D.C. ratepayers are only paying for distribution costs in D.C.? Is there really arm’s length? Is there really no subtle kind of favoritism and inside knowledge, those sorts of things?”

“It’s all very hard when it's all happening far away in Chicago and with people you're not dealing with all the time,” she added.