National Grid and Niagara Mohawk close in on merger

The US Securities and Exchange Commission (SEC) on Jan. 16 approved the $ 3-bn merger of utilities National Grid USA and Niagara Mohawk , clearing the last regulatory hurdle for creation of the nation's ninth-largest utility. Under the agreement, Niagara Mohawk shareholders will receive $ 18.89 for each share of common stock yield, valuing the equity of Niagara Mohawk at $ 3 bn.
The per-share consideration was determined on the average dollar price of five National Grid ordinary shares being $ 32.22 as calculated from 20 trading days randomly selected from the 40 consecutive trading-day period from Nov. 13 to Jan. 10. National Grid said it expects to complete its acquisition of Niagara by Jan.
31, 2002.

This merger, which is actually an acquisition of Niagara Mohawk that is being pursued by National Grid, has been in the works since September 2000 as the two companies have navigated through the various regulatory hurdles necessary to consummate their partnership. During that 16-month period, UK-based National Grid has emerged as one of the primary players in the US transmission market, having developed a partnership to serve as "independent managing member" with the Alliance RTO, one of the largest regional transmission organizations (RTOs) that has developed out of FERC's consolidation policy for transmission entities. Under the merger agreement, Niagara Mohawk will become a wholly owned subsidiary under National Grid USA and keep its headquarters in Syracuse, NY.
In a nutshell, perhaps the most important point to note about this acquisition is that National Grid wants to establish a major presence in the transmission and distribution sectors of the industry, primarily in the United States. The acquisition of Niagara Mohawk doubles the size of National Grid's US business and positions it nicely in the New York market, and positions the company as owner and operator of the most extensive transmission system (based on miles) in the United States.

National Grid, which as noted is based in the United Kingdom (in London), is one of the world's largest independent transmission companies. Niagara Mohawk is the third acquisition that National Grid has made in the United States, and all three purchases have been of utilities based in the North-eastern part of the country.
Previously, National Grid purchased New England Electric System (NEES) and Eastern Utilities Associates (EUA). For nearly two years, it has been National Grid's strategy to build shareholder value through developing earnings outside of its United Kingdom transmission business by using its core skills in the development and management of infrastructure assets and systems.
In other words, National Grid wants to establish a major presence in the transmission and distribution sectors of the industry, primarily in the United States. The two previous acquisitions of NEES and EUA provided National Grid with strong transmission and distribution assets in Massachusetts, Rhode Island and New Hampshire.

The acquisition of Niagara Mohawk also factors well into National Grid's North American strategy. In fact, the purchase of Niagara Mohawk doubles the size of National Grid's US business and positions it nicely in the New York market, where regulators have reached settlements reducing above-market power purchase contracts and providing favourable rate packages for in-state utilities.
The acquisition also benefits Niagara Mohawk, which is being purchased at a premium over current market. As noted, the addition of Niagara Mohawk to National Grid's portfolio will create the ninth-largest electric utility in the United States, with an electric customer base of approximately 3.3 mm. In addition, through Niagara Mohawk, National Grid will now own and operate the most extensive transmission system (based on miles) in the United States, and be the second-largest distribution business (based on power delivered) in the New England/New York market.
National Grid disclosed that it is confident it will meet its objective of earning anominal pre-tax return of 10.5 % on the expanded US business by March 2005, underpinning the group's target of increasing dividends per share by 5 % a year up to 2006.

Rightfully so, National Grid views the North-eastern part of the United States as a region where deregulation is comparatively advanced. This area of the country is providing National Grid with the best point of entry into the US energy market. The economic climate offers strong opportunities for competition, and the North-eastern states that have deregulation plans tend to offer performance-based regulation (rate of returns that are favourable for operating utilities in the area). In addition, the companies that have been acquired by National Grid will benefit from its track record of high-quality, low-cost transmission service in the competitive UK market.
In August 2001, National Grid signed a partnership with the Alliance RTO to serve as the transmission entity's independent managing member. At the time, both parties acknowledged that the Federal Energy Regulatory Commission (FERC) had to approve National Grid as a qualified non-market participant that could run the management of the transmission entity before any management responsibility can be turned over to National Grid.
Nevertheless, the partnership did represent a significant achievement for National Grid and a milestone in its goal toward becoming the leading transmission company in the United States. When fully operational, the Alliance RTO will cover a 182,000-square mile service territory in 11 states from Missouri to Virginia, serving about 35 mm customers and representing a peak load of roughly 108 GW.

From the agreement signed between National Grid and the Alliance RTO last August, certain elements of the partnership are clear. For instance, National Grid agreed to initially invest $ 75 mm in the company formed as the Alliance RTO and will make further investments between 5 and 20 % of the value of the transmission assets contributed to the company by its member utilities.
National Grid had agreed to make an investment of $ 75 mm for maintenance upgrades associated with the transmission assets in the Alliance RTO, but also expects to gain ownership in the range of 5 to 20 % for each transmission system that is divested by a utility participating in the Alliance RTO. Most likely, this was a condition driven by most of the utilities participating in the Alliance RTO, which presumably embrace the philosophy that it is better to have an RTO manager share some of the ownership of those transmission assets.

National Grid had planned to repay the Alliance RTO members' start-up costs when it took over operation of the transmission entity. However, in late December 2001, FERC approved the Midwest Independent Transmission System Operator (MISO), the Alliance RTO's competing transmission entity in the Midwest, as the nation's first RTO to manage a vast electricity grid stretching from North Carolina to North Dakota and down to Texas. In addition, FERC said the Alliance RTO must combine its resources with the MISO to form a single transmission manager.
Alliance "lacks sufficient scope and size" to exist as a stand-alone RTO, FERC said. Over the last couple of years the MISO and the Alliance RTO had competed for prominence in the Midwest region to serve as the organization in charge of establishing common rules governing how utilities will trade bulk electricity across the transmission systems within that region.

As a fundamental starting point, it is important to understand the difference between the MISO and the Alliance RTO, which are the two leading (and quite divergent) transmission models in the region. The MISO and the Alliance RTO differ dramatically in that the Alliance RTO is a transco (for-profit) model whereas the MISO represents the independent system operator, non-profit model.
In May 2001, FERC approved a settlement that appeared to allow the two competing entities to co-exist in the Midwest, operating as separate entities that would manage their owngrid assets under a single open-access tariff and rates. What has changed now under FERC's current ruling is that the commission does not believe the Alliance RTO has sufficient size to operate as a stand-alone entity, and thus FERC is ordering the Alliance RTO to merge with MISO.

It is important to note that FERC's most recent ruling on the structure for a Midwest RTO was not unanimous, but rather came in as a 3 to1 decision. Commissioner Linda Key Breathitt opposed the order, arguing against the commission's decision to mandate a single Midwest RTO. One of Breathitt's arguments was that the Alliance RTO has already spent about $ 90 mm in start-up costs and had previously received tentative approval from the FERC to proceed with its plans.
Breathitt's concerns may signal what could be an ongoing dispute on this issue, as the utilities involved in the Alliance RTO hinted in a recent filing with FERC that they would file suit in the event that they were ordered to combine with the MISO. Nevertheless, now that the Alliance RTO has been ordered to join forces with the MISO, it is not clear to what extent (if any) National Grid will still serve as the independent managing member of the combined transmission entity in the Midwest.