When the District of Columbia Public Service Commission announced it would hold a meeting this Friday to issue a ruling on the Exelon-Pepco merger, virtually everyone in the power sector expected one of two things: Either the PSC would reject the merger, or they would approve it, creating the largest utility in the country by customer base.

In the end, the commission did a little bit of both. First, they rejected the merger proposal in a 2-1 vote, saying that a settlement agreement struck between merger parties last year was not in the public interest. But they then outlined five changes to the settlement that would result in approval of the deal, if the companies accept them.

The settlement deal was the product of months of lobbying and behind-the-scenes work from the companies to secure the support of D.C. Mayor Muriel Bowser and several key merger stakeholders after the PSC rejected an initial acquisition bid last August. The D.C. PSC is the final regulatory body that must approve the merger if it is to close. Federal energy regulators, as well as state regulators in New Jersey, Virginia, Maryland and Delaware, have already approved the proposed $6.8 billion acquisition.

The companies now have 14 days to respond to the new merger conditions. Pepco and Exelon spokespersons told Utility Dive they are currently evaluating the decision, and will reserve judgement until they finish.

The substance of the decision

During the meeting, Commission Chair Betty Ann Kane outlined four areas that warranted rejection of the NSA. She and Commissioner Joanne Dotty Fort voted to reject the proposal, while Commissioner Willie Phillips voted to approve the settlement as submitted.

The four areas of concern:

• The companies failed to provide a persuasive rationale for excluding non-residential ratepayers from a $25.6 million allocation to a customer investment fund (CIF) meant for rate relief.

• Provisions in the NSA that allow Exelon to develop a solar facility and Pepco to construct four microgrids “undermine competition and grid neutrality and are inconsistent with the District’s restructured market.”                

• Proposed uses of the CIF for sustainability projects and Low Income Home Energy Assistance Program (LIHEAP) payments “do not improve Pepco’s distribution system nor advance the Commission’s objective to modernize the District’s energy systems and distribution grid.”

• The proposal in the NSA to allocate the CIF funds to D.C. government agencies “deprives the Commission of the ability to ensure that all of the funds are being used to enhance the distribution system and benefit District ratepayers, and to enforce the terms of the NSA.”

Moments later, regulators outlined improvements to the plan that they said would result in automatic approval of the merger if the companies and other parties to the settlement accepted them. In a separate 2-1 decision, Fort and Phillips voted to approve the conditions, while Kane dissented, preferring outright rejection of the merger.

These are the four changes that would result in approval:

• Allocation of the $25.6 million for rate relief in the CIF would be deferred until Pepco’s next rate case.

• The provision that designates Exelon as the developer for the D.C. Water solar facility would be eliminated, 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 CIF 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.

The settlement parties now have 14 days to file with regulators to accept the stipulations or propose further relief for ratepayers. Parties that do not go along with the conditions will have seven days from that filing to submit their comments.

The swing vote

As the PSC meeting unfolded, it became clear that Fort was the swing vote on the commission.

The NSA, by its own terms, could not be modified by the regulators, so the PSC was forced to accept or reject it as it was submitted. While Phillips favored approving the NSA and Kane would have opted for outright rejection, Fort penned the merger stipulations that kept the deal alive.

In discussion on the votes, Fort explained that while she agreed with Kane that the NSA should be rejected, she did not view the settlement agreement as “fatally flawed” because she believed “each of the four conditions and concerns that have been noted can be corrected in a revised NSA with alternative terms.”

“For that reason,” she said, “I have crafted alternative terms for the NSA and I am asking my fellow commissioners to approve sharing them with the settlement parties.”

She was joined in the vote to approve the settlement conditions by Phillips, who indicated that he would have preferred to approve the deal without them.

“I had no hand in fashioning the conditions that are being presented to the settlement parties,” he said. “As I have explained in my dissent, I believe the NSA as presented is in the public interest and should be approved. However, I do not have a majority vote in my favor. Therefore, I am voting to proceed ... in accepting the conditions for the sole purpose of giving the settlement parties … an avenue to consummate their agreement, instead of resulting in an outright denial.”

In his comments, Phillips said that he was in favor of imposing conditions on the merger earlier in the proceeding, but his colleagues were not.

“Now, when there is a settlement that is widely supported by a variety of the parties, as well as the District government, who sets energy policy for the district, my colleague seeks to add conditions to cure the agreement,” he said. “I think that decision is contrary to what we have been tasked to do and the public interest standard developed by the commission and the courts in this jurisdiction.”

Phillips said he would “reserve judgement” on whether the conditions make the NSA any better, but believes that they do not make them worse. “It is based on this rationale that I am voting to move forward on the rule... that if the settlement parties accept Commissioner Fort's alternative terms, then the revised NSA will be approved and no further action will be required.”

His comments came in stark contrast to those from Chair Kane, who voted against the new set of conditions on the NSA.

“While I agree that the four reasons cited in the order are a sufficient basis to reach this conclusion, and thus voted to deny, there are additional significant flaws in the NSA,” she said. “The fact remains unchanged from the original application that the takeover of Pepco will entangle the company in an ownership structure that is an inherent conflict of interest and that it takes it in the opposite direction from its sole focus on being a distribution company as required by the District's restructuring law and policy.”

Those comments mirror the concerns Kane listed back in August when the commission rejected Exelon’s initial merger bid. Just as today, the commission chair identified Exelon’s ownership of a large generation fleet as an “inherent conflict of interest” with D.C. energy law and policy, which stipulates the city’s utility must be focused on transmission and distribution functions. It was clear on Friday that the months of negotiations and hearings on the settlement did not ease her concerns.

“Indeed, in some ways, the management proposals in the NSA would make the situation worse,” she said. “The commission will be forever playing whack-a-mole to try to ensure a level playing field for everyone else.”

Even so, she said, Fort’s changes to the NSA do make improvements in accountability for the four flaws. Kane pointed especially to the stipulation that would allocate CIF funds as a part of Pepco’s next rate case, instead of giving them to the District government to spend itself.

“In particular, the alternative of protecting the funds proffered by Exelon from raid by city officials for other uses is good,” she said. “That is a raid that continues to this day.”

But even with those improvements, Kane said she could not support the new stipulations.

“The only alternative in my view is not to approve the acquisition,” she said. “There is no evidence in the record that Pepco could not continue to perform and perform adequately and reliably as required by law absent the acquisition of Pepco by Exelon.”

“Indeed, she continued, “the commission found … that PHI is financially healthy as a standalone company and would continue to be so if the merger were not consummated. I dissent from the conclusion that if the settlement parties accept the commitments proposed ... the acquisition would be the in the public interest and should be approved.”

Stakeholder reaction

The double-vote surprise clearly took the attendees at the PSC meeting by surprise. When asked how Pepco would proceed, communications manager Vincent Morris said it was too early to tell.

“Until we review the fine print, it's hard to say,” he said, “but obviously we still believe this is in the public interest and we're pleased they supported it and kept it going.”

His company’s line was reiterated in a statement from Exelon spokesperson Paul Adams.

“The Commission’s order prescribes new provisions that we and the settling parties must carefully review to determine whether they are acceptable,” he wrote. “Once we have had a chance to study the order and confer with the settling parties, we will have more to say about what it means and our next steps.”

While no one would speak to the specifics of the merger conditions, Sandra Mattavous-Frye, head of the Office of People’s Counsel, a ratepayer advocate in the District, said the new stipulations seemed encouraging at first glance.

“I think to say the least, it's an interesting ruling,” she said. “The commission rejected the settlement agreement as filed, and I respect the commission's decision in that respect. I believe though that because they found that there was a basis for finding that a settlement agreement was in the public interest, that they have put forward new conditions that would allow them to meet the standards that they have established.”

While the companies would not commit to the conditions at the outset, a number of stakeholders said they likely would.

Charlie Harak of the National Consumer Law Center, which represents low-income ratepayers in the merger case, told the Wall Street Journal that "based on a quick and limited review of the 270-page order, my instincts say this is not a deal breaker for Exelon—but they will have to say."

Paul Patterson, a utilities analyst for Glenrock Associates in New York, similarly told the paper that "it's more likely than not" that Exelon will go along with the new terms.

For merger opponents, the merger was a roller coaster of emotions. After a moment of excitement at the PSC’s rejection of the settlement agreement, opponents expressed dismay at the new stipulations that could result in a quick approval of the deal.

After the meeting, D.C. Councilmember Mary Cheh (D-Ward 3), a leading merger critic in the city, told reporters that the new merger conditions amount to “effectively nothing.” Echoing Kane, she said the entire merger proposal is rotten.

“The real problem with this deal, as the chair said — courageously and ethically and I'm so proud of her — is that there's an inherent conflict of interest for us to take our financially stable, well-functioning distribution company and tie it to this mammoth, distant, money-losing, last-century, atomic energy utility,” Cheh said.

While no officials from either company indicated their stance on the new stipulations, Cheh expected them to accept them with little protest, leaving few options for merger opponents.

“We're out of options because the opponents will have to await whether the settling parties agree to the conditions, but the conditions are almost laughable that they would be regarded as something serious,” she said. “They improve [the NSA], so they will go along with it, and … if they did go along with it, it's approved and there's nothing more to do.”

Asked if there are any legal options for opponents, the councilmember was not optimistic.

“There's no real legal step because once these decisions are made … you always have the option of saying that it was irrational or prejudicial or things of that nature, but that's such an extraordinarily high hurdle to get over to reverse an administrative decision that’s effectively done,” she said.

One reporter asked Cheh if that meant the merger opponents have lost the fight.

“Yes,” she sighed, “yes.”