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File No. 070-09195
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
AMENDMENT NO. 3
TO
FORM U-1
APPLICATION/DECLARATION
UNDER
THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
EASTERN ENTERPRISES
9 Riverside Road
Weston, Massachusetts 02193
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(Name of company or companies filing this statement and
addresses of principal executive office)
EASTERN ENTERPRISES
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(Name of top registered holding company parent of each applicant or declarant)
David W. Walker, Esq L. William Law, Jr., Esq.
Foley, Hoag & Eliot LLP Senior Vice President and General Counsel
One Post Office Square Eastern Enterprises
Boston, Massachusetts 02109 9 Riverside Road
Weston, Massachusetts 02193
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(Names and addresses of agents for service)
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1. Applicant hereby amends Item 6, Exhibits and Financial Statements, by filing
the following:
D-2 Order of the Massachusetts Department of Telecommunications
and Energy, issued September 18, 1998
F-2 Opinion of Keegan, Werlin & Pabian, LLP
I Subsidiaries (amended)
NOTE: Amendment No. 2, filed July 7, 1998, restated Items 1 through 7 of this
Application.
2
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SIGNATURE
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Pursuant to the requirements of the Public Utility Holding Company Act
of 1935, the undersigned company has duly caused this Amendment to be signed on
its behalf by the undersigned officer thereunto duly authorized.
EASTERN ENTERPRISES(1)
Date: September 25, 1998 By: /s/ Walter J. Flaherty
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Walter J. Flaherty
Senior Vice President and Chief
Financial Officer
(1) Reference is hereby made to the declaration of trust establishing Eastern
Enterprises (formerly Eastern Gas and Fuel Associates) dated July 18, 1929, as
amended, a copy of which is on file in the office of the Secretary of the
Commonwealth of Massachusetts. The name "Eastern Enterprises" refers to the
trustees under said declaration as trustees and not personally; and no trustee,
shareholder, officer or agent of Eastern Enterprises shall be held to any
personal liability in connection with the affairs of said Eastern Enterprises,
but the trust estate only is liable.
3
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EXHIBIT INDEX
See Item 6, "Exhibits and Financial Statements," for statement of locations of
exhibits incorporated by reference.
Exhibit No. Description
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D-2 Order of the Massachusetts Department of Telecommunications
and Energy, issued September 18, 1998
F-2 Opinion of Keegan, Werlin & Pabian, LLP
I Subsidiaries (amended)
4
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EXHIBIT D-2
THE COMMONWEALTH OF MASSACHUSETTS
DEPARTMENT OF
TELECOMMUNICATIONS AND ENERGY
September 17, 1998
D.T.E. 98-27
Joint Petition of Eastern Enterprises and Essex County Gas Company for approval
of a merger by the Department of Telecommunications and Energy, pursuant to G.L.
c. 164, ss. 96. Eastern Enterprises and Essex County Gas Company also seek the
Department's approval of a rate plan for Essex County Gas Company, pursuant to
G.L. c. 164, ss. 94.
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APPEARANCES: Robert J. Keegan, Esq.
Robert N. Werlin, Esq.
Cheryl M. Kimball, Esq.
Keegan, Werlin & Pabian, LLP
21 Custom House Street
Boston, Massachusetts 02108
FOR: EASTERN ENTERPRISES AND
ESSEX COUNTY GAS COMPANY
Petitioners
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-and-
L. William Law, Jr., Esq.
Senior Vice President and General Counsel
Eastern Enterprises
9 Riverside Road
Weston, Massachusetts 02193
FOR: EASTERN ENTERPRISES
Petitioner
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Scott Harshbarger, Attorney General
By: James W. Stetson, Esq.
George C. Brooks, Esq.
Assistant Attorneys General
Regulated Industries Division
200 Portland Street
Boston, Massachusetts 02114
Intervenor
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Warren H. Pyle, Esq.
Bryan C. Decker, Esq.
Pyle, Rome & Lichten, P.C.
90 Canal Street, 4th Floor
Boston, Massachusetts 02114
FOR: LOCAL 12086, USWA, AFL-CIO AND
THE ALLIANCE OF UTILITY WORKERS' UNIONS
Intervenors
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TABLE OF CONTENTS
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I. INTRODUCTION............................................................1
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II. DESCRIPTION OF PROPOSAL.................................................3
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A. Structure of Merger.................................................3
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B. Rate Plan...........................................................5
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1. Base Rate Freeze................................................6
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2. Gas Costs.......................................................6
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C. Costs Associated with Merger........................................7
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III. STANDARD OF REVIEW......................................................7
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IV. SPECIFIC CONSIDERATIONS OF THE MERGER..................................10
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A. Effect on Rates, Resulting Net Savings and Alternatives to Merger..10
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1. Base Rate Freeze...............................................10
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a. Introduction...............................................10
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b. Positions of the Parties...................................11
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i. Intervenors......................................11
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ii. Petitioners......................................12
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c. Analysis and Findings.....................................14
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2. Gas Costs......................................................21
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a. Introduction...............................................21
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b. Positions of the Parties...................................23
i. Intervenors......................................23
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ii. Petitioners......................................24
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c. Analysis and Findings......................................26
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B. Effect on Quality of Service.......................................30
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1. Introduction...................................................30
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2. Position Of The Parties........................................30
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a. Intervenors................................................30
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b. Petitioners................................................31
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3. Analysis and Findings..........................................32
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a. Service Quality Plan.......................................32
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b. Response to Odor Calls.....................................35
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c. Telephone Service..........................................36
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d. Lost-time Accidents........................................37
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e. Service Appointments Met As Scheduled......................37
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f. Meter Reads................................................38
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g. Consumer Division Complaints and Billing Adjustments.......39
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C. Societal Costs.....................................................40
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1. Introduction...................................................40
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2. Positions Of The Parties.......................................41
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a. Intervenors................................................41
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b. Petitioners................................................42
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3. Analysis And Findings..........................................42
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D. Effect On Competition And Economic Development.....................44
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1. Introduction...................................................44
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2. Analysis And Findings..........................................45
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E. Cost Allocation Issues.............................................45
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1. Introduction...................................................45
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2. Analysis And Findings..........................................46
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F. Transaction and Merger Integration Costs...........................48
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1. Introduction...................................................48
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2. Positions Of The Parties.......................................48
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a. Intervenors................................................48
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b. Petitioners................................................50
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3. Analysis And Findings..........................................51
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G. Acquisition Premium................................................57
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1. Introduction...................................................57
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2. Positions Of The Parties.......................................59
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a. Intervenors................................................59
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b. Petitioners................................................60
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3. Analysis And Findings..........................................61
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H. Summary............................................................66
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V. STOCK ISSUANCE.........................................................71
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A. Introduction.......................................................71
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B. Standard of Review.................................................72
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C. Analysis and Findings..............................................74
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VI. CONFIRMATION OF ESSEX'S FRANCHISE RIGHTS...............................75
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A. Introduction.......................................................75
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B. Analysis and Findings..............................................75
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VII. ORDER..................................................................76
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D.T.E. 98-27 Page 1
I. INTRODUCTION
On February 27, 1998, Eastern Enterprises ("Eastern"), Essex County Gas
Company ("Essex"), and ECGC Acquisition Gas Company[1] ("Acquisition Company")
(collectively, the "Petitioners") jointly filed with the Department of
Telecommunications and Energy ("Department") a petition for approval: (1)
pursuant to G.L. c. 164, ss. 96, of the merger of Acquisition Company and Essex;
(2) pursuant to G.L. c. 164, ss. 94, of Essex's rate plan ("Rate Plan"); and (3)
pursuant to G.L. c. 164, ss. 14, of the issuance and sale of 100 shares of
common stock, $1.00 par value, by Acquisition Company to Eastern. The
Petitioners also seek confirmation that Essex, as the surviving corporation of
the proposed merger of Acquisition Company into Essex, will retain the franchise
rights and obligations that were held by Essex prior to the merger, and that no
further action pursuant to G.L. c. 164, ss. 21 is required to consummate the
merger. The Department docketed this matter as D.T.E. 98-27.
Pursuant to notice duly issued, the Department conducted a public hearing
in Haverhill on May 7, 1998, to afford interested persons an opportunity to
comment on the Petitioners' proposal. The Department conducted evidentiary
hearings at its offices in Boston on June 18-19 and June 24-25, 1998. The
Department granted the petitions to intervene of the United Steelworkers of
America, AFL-CIO, Local 12086, and the Alliance of Utility Workers
(collectively, the "Unions"). The Attorney General of the Commonwealth
("Attorney
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[1] While the Petitioners used "Merger Company" as a generic name in the
Petition to refer to Acquisition Company, the draft articles of
organization identify the company as ECGC Acquisition Gas Company (Exh. DTE
1-30). The Petitioners stated that Eastern will comply with the business
name requirements of G.L. c. 164, ss. 5A, at the time the subsidiary
actually is organized (Exh. DTE 1-28; Petitioners Brief at 1).
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D.T.E. 98-27 Page 2
General") intervened as of right pursuant to G.L. c. 12, ss. 11E. The Department
granted limited participant status to Bay State Gas Company.
The Petitioners sponsored the testimony of five witnesses: (1) Paul J.
Murphy, managing director of Salomon Smith Barney's Global Power Investment
Banking Group; (2) Joseph F. Bodanza, senior vice president and treasurer of
Boston Gas Company ("Boston Gas");[2] (3) William R. Luthern, vice president of
gas resources for Boston Gas; (4) James H. Hastings, vice president and
treasurer of Essex; and (5) Walter J. Flaherty, senior vice president and chief
financial officer of Eastern.[3] The Attorney General sponsored the testimony of
one witness, David J. Effron, a consultant in utility regulation. The Unions
sponsored the testimony of three witnesses: (1) Steven W. Ruback, principal of
the Columbia Group, a consulting firm; (2) Paul Hannon, an inspector employed by
Boston Gas and former president of Local 12003, United Steelworkers of America;
and (3) Thomas D. Boody, a service man employed by Essex and president of Local
12086, United Steelworkers of America. The Petitioners, the Attorney General,
and the Unions submitted both briefs and reply briefs.
Eastern operates as an unincorporated voluntary association established
under a Declaration of Trust dated July 18, 1929, as amended (Exh. WJF-1, at 2).
Eastern's principal
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[2] Both Essex and Boston Gas are gas companies within the meaning of G.L. c.
164,ss.1.
[3] The joint petition underlying this investigation was supported by testimony
of officers of the Petitioners, Eastern and Essex, and of Eastern's
subsidiary, Boston Gas. Unless the context clearly warrants otherwise, the
Department construes all testimony in support of this petition and all
arguments on brief as jointly advanced by the Petitioners and Boston Gas.
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D.T.E. 98-27 Page 3
subsidiaries are Boston Gas and Midland Enterprises, Inc. ("Midland"). Boston
Gas is a local distribution company ("LDC") serving approximately 530,000
residential and commercial and industrial ("C&I") customers in Boston and 73
other communities in eastern and central Massachusetts (ID.). Midland transports
coal and other dry bulk commodities on the Ohio and Mississippi Rivers, the Gulf
Intracoastal Waterway, and the Gulf of Mexico (ID.). In 1997, Eastern
established two additional subsidiaries, ServicEdge Partners, Inc.
("ServicEdge"), and AMR Data Corporation. ServicEdge provides heating,
ventilation and air-conditioning products and services, while AMR Data
Corporation provides meter service to electric, gas and water utilities
throughout the Northeast (ID. at 2-3).
Essex is an LDC that serves approximately 42,000 customers in the cities of
Haverhill, Newburyport and Amesbury, as well 14 other municipal communities
covering an area of approximately 280 square miles (Exh. JHH-1, at 2). The Essex
service territory is composed primarily of residential communities, with a
number of small C&I businesses (ID.). Essex's subsidiaries include LNG Storage,
Inc. ("LNG Storage"), which owns a liquified natural gas facility that is leased
to Essex, and Northern Energy Company, Inc. ("Northern Energy"), which currently
is inactive (Exh. Joint Petitioners-1, Sch. 4.2).
II. DESCRIPTION OF PROPOSAL
A. STRUCTURE OF MERGER
The Petitioners request Department approval of an Agreement and Plan of
Merger ("Merger Agreement") that would result in Essex becoming a wholly-owned
subsidiary of Eastern (Exh. Joint Petitioner-1, at 2). To effect the merger,
Eastern intends to form
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D.T.E. 98-27 Page 4
Acquisition Company as a wholly-owned subsidiary of Eastern (Exhs. WJF-1, at 9;
DTE 1-30).[4] Acquisition Company would serve as a shell corporation for the
purpose of transforming Essex from an independent company to a wholly-owned
subsidiary of Eastern via the merger of Acquisition Company into Essex (Exh.
WJF-1, at 9-10). After the merger, Essex would be the surviving company, and
Acquisition Company's corporate existence would be extinguished (ID. at 10). LNG
Storage and Northern Energy would remain subsidiaries of Essex (Exh. DTE 1-36).
The Petitioners propose that, upon Acquisition Company's merger with Essex,
each share of Acquisition Company common stock, issued and outstanding
immediately prior to the merger, would be converted into one share of Essex's
common stock (Exh. WJF-1, at 10). Each share of Essex's common stock, issued and
outstanding immediately prior to the merger, would be changed and converted into
the right to receive 1.183985 shares of Eastern's common stock (ID.; Exhs. Joint
Petitioners-1, Att. 1, at 2-3; PJM-1, at 8; AG 1-45). The Petitioners determined
this exchange ratio using the purchase price of $47.50 per share for Essex's
common stock and the average Eastern common stock price of $40.11875 per share
during the ten trading days prior to December 17, 1997 (Exh. DTE 1-19; Tr. 1, at
23-24).[5]
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[4] SEE note 1, above.
[5] The actual exchange ratio would be adjusted as necessary if Eastern's
common stock falls below $38.01 per share or rises above $42.23 per share,
as measured by the average Eastern closing price for the ten trading days
prior to, and including the fifth trading day prior to, the consummation of
the merger (the "Closing Date" as described in articles 2.1(c) and 3.1 of
the Merger Agreement) (Exhs. Joint Petitioner-1, at 2-3; AG 1-45; Tr. 1, at
36).
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D.T.E. 98-27 Page 5
According to the Petitioners, the purpose of this form of transaction is to
structure the merger as a tax-free event for Essex's shareholders and to avoid
Essex's payment of approximately $3.9 million in certain debt-related
prepayments that would be triggered if Essex were not the surviving company
(Exhs. WJF-1, at 9-10; DTE 1-15; DTE 1-16).
The Petitioners intend to account for the transaction through pooling of
interests accounting, whereby the balance sheets of the acquired company, Essex,
and the acquiring company, Eastern, would be combined into a single entity,
without any adjustment to the book values of the assets and liabilities of the
merged entities (Exh. PJM-1, at 8-9). The Petitioners state that, although
pooling of interests accounting does not involve adjusting the book value of the
acquired assets, Eastern's shareholders would experience earnings dilution, or
an "acquisition premium,"[6] of approximately $47.1 million[7] (ID.).
B. RATE PLAN
The Rate Plan consists of two components: (1) a base rate freeze; and (2) a
five percent reduction in the burner-tip price of gas (Exh. JFB-1, at 2).
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[6] While acquisition premiums technically are not recorded under pooling of
interests accounting, the Department recognizes that the term "acquisition
premium" is used in this petition to describe the earnings dilution that
occurs under pooling of interests accounting. Either way, it is a cost
borne by shareholders to consummate a merger or acquisition. For
convenience, the Department uses the terms "acquisition premium" and
"earnings dilution" interchangeably in this Order. The appropriateness of
resort to pooling of interests accounting as a means of corporate merger or
acquisition found recognition in MERGERS AND ACQUISITIONS, D.P.U. 93-167-A
at 10-11 (1994).
[7] The acquisition premium is based on a purchase price of $47.50 per Essex
share less Essex's book value of $21.01 per share, multiplied by 1,778,058
Essex shares outstanding as of December 1, 1997 (Exhs. PJM-1, at 8-9, 13;
AG 1-18; USA 1-15).
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D.T.E. 98-27 Page 6
1 BASE RATE FREEZE
The base rate freeze would cover a period of ten years, subject only to
changes for exogenous factors (ID. at 7). According to the Petitioners,
exogenous factors include changes in tax laws, accounting changes, and
regulatory, judicial, or legislative changes. The Petitioners assume that Essex
would avoid the need for a base rate increase of approximately $1.8 million in
1999, and two increases of $2.0 million each in 2002 and 2005 (ID. at 6-7; Exh.
JFB-3). The Petitioners state that as a result of the base rate freeze, Essex's
customers would realize savings of $33 million over the term of the Rate Plan
(Exhs. JFB-1, at 6; JFB-3).
2 GAS COSTS
The Petitioners state that the five percent reduction in the burner-tip
price of gas currently paid by Essex customers would be achieved by: (1)
synergies[8] resulting from coordinating the gas supply resources of Boston Gas
and Essex; (2) releasing Essex's Tennessee Gas Pipeline Company long-haul
capacity contract ("Tennessee Contract"); and (3) crediting Essex's customers
with $900,000 per year through the local distribution adjustment clause
("LDAC")[9] for the first two years of the Rate Plan [10] (Exh. JFB-1, at 3).
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[8] Synergies are combined and coordinated actions whereby greater effects are
achieved than through independent actions. See, E.G., AMERICAN HERITAGE
DICTIONARY 1233 (2nd coll. ed. 1985).
[9] The LDAC is a mechanism that allows an LDC to recover, or credit on a fully
reconciling basis, costs that have been determined to be
distribution-related costs but are not included in base rates. Such costs
include demand side management costs, environmental response costs
associated with manufactured gas plants, and Federal Energy Regulatory
Commission Order 636 transition costs. The LDAC is applicable to
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D.T.E. 98-27 Page 7
The Petitioners estimate that these gas supply savings, which would be passed
back to Essex customers through the cost of gas adjustment charge ("CGAC"),
would total approximately $23.5 million11 over the term of the Rate Plan, or
$2.35 million[11] per year (ID.).
C. COSTS ASSOCIATED WITH MERGER
The Petitioners project that the total costs of the merger will be
$63,825,000, consisting of: (1) $9,120,000 in merger integration costs[12]
incurred to achieve proposed synergies; (2) $7,605,000 million in transaction
expenses (I.E., investment banking fees, legal and regulatory expenses, and
filing fees); and (3) $47,100,000 representing the earnings dilution or the
"acquisition premium" associated with the purchase of Essex's common stock
(Exhs. JFB-5; JFB-6; JFB-7; Tr. 1, at 50-53).
III. STANDARD OF REVIEW
The Department's authority to review and approve mergers and acquisitions
is found at G.L. c. 164, ss. 96, which requires the Department to find that
mergers and acquisitions are "consistent with the public interest" as condition
for approval. In BOSTON EDISON COMPANY,
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all firm customers (both sales and transportation).
[10] The $900,000 LDAC credit represents the additional amount needed to bring
Essex's customers' estimated annual gas cost savings to the five percent
reduction threshold, or $2.35 million per year, based on Essex's total
normalized revenues of $46.9 million (Exh. JFB-1, at 3).
[11] Based on Essex's total normalized revenues of approximately $46.9 million
(pursuant to ESSEX COUNTY GAS COMPANY, D.P.U. 96-70 (1996) and its 1997
CGAC filings) (Exh. JFB-1, at 3).
[12] Merger integration costs include retirement and severance costs incurred to
reduce redundant positions, retraining costs, system and facility
consolidation costs, and
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D.T.E. 98-27 Page 8
D.P.U. 850, at 6-8 (1983), the Department construed ss. 96's standard of
consistency with the public interest aS requiring a balancing of the costs and
benefits attendant on any proposed merger or acquisition. The Department stated
that the core of the consistency standard was "avoidance of harm to the public."
D.P.U. 850, at 5. Therefore, under the terms of D.P.U. 850, a proposed merger or
acquisition is allowed to go forward upon a finding by the Department that the
public interest would be at least as well served by approval of a proposal as by
its denial. ID. at 5-8. In MERGERS AND ACQUISITIONS, the Department reaffirmed
that it would consider the potential gains and losses of a proposed merger to
determine whether the proposed transaction satisfies the ss. 96 standard.
MERGERS AND ACQUISITIONS, D.P.U. 93-167-A at 6, 7, 9 (1994); BOSTON EDISON
COMPANY, D.P.U. 97-63, at 7. The public interest standard, as elucidated in
D.P.U. 850, must be understood as a "no net harm," rather than a "net benefit"
test.[13] The Department considers the special factors of an individual proposal
to determine whether it is consistent with the public interest. D.P.U. 97-63, at
7; MERGERS AND ACQUISITIONS at 7-9. To meet this standard, costs or
disadvantages of a proposed merger must be accompanied by offsetting benefits
that warrant their allowance. D.P.U. 97-63, at 7; MERGERS AND ACQUISITIONS at
18-19.
Various factors may be considered in determining whether a proposed merger
or acquisition is consistent with the public interest pursuant to G.L. c. 164,
ss. 96. These factors
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customer/employee communication costs (Exh. JFB-1, at 12-13).
[13] The Department notes that a finding that a proposed merger or acquisition
would probably yield a net benefit does not mean that such a transaction
must yield a net benefit to satisfy D.P.U. 850.
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D.T.E. 98-27 Page 9
were set forth in MERGERS AND ACQUISITIONS: (1) effect on rates; (2) effect on
the quality of service; (3) resulting net savings; (4) effect on competition;
(5) financial integrity of the post-merger entity; (6) fairness of the
distribution of resulting benefits between shareholders and ratepayers; (7)
societal costs, such as job loss; (8) effect on economic development; and (9)
alternatives to the merger or acquisition. D.P.U. 97-63, at 7-8; MERGERS AND
ACQUISITIONS at 7-9. This list is illustrative and not "exhaustive," and the
Department may consider other factors when evaluating a ss. 96 proposal. MERGERS
AND ACQUISITIONS at 9.
With respect to the recovery of acquisition premiums, the Department has
found that if a petitioner can demonstrate that denial of recovery of an
acquisition premium would prevent the consummation of a particular merger that
otherwise would satisfy ss. 96, then the Department will consider recovery of an
acquisition premium.[14] ID. at 18. The Department, however, will not
automatically allow recovery of all premiums associated with every merger. ID.
The Department has determined that it will consider on a case-by-case basis
individual proposals for the recovery of an acquisition premium, and the
appropriate level of any recoverable acquisition premium. ID. at 18-19. The
Department will determine whether an acquisition premium should be allowed in a
specific case by applying the general balancing of costs and benefits under the
ss. 96 consistency standard. ID. Thus, allowance or disallowance of an
acquisition premium would be but one part of the cost/benefit analysis under the
ss. 96 consistency inquiry. ID. at 7.
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[14] Thus, MERGERS AND ACQUISITIONS removed the PER SE bar to recovery of
acquisition premiums and treated them as just another kind of costs to be
reckoned in the balancing of costs and benefits required by ss. 96 in
D.P.U. 850.
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D.T.E. 98-27 Page 10
The public interest judgment the Department is required to make under ss.
96 must rest on a record that quantifies costs and benefits to the extent such a
judgment is susceptible of quantification. ID. at 7. A ss. 96 petitioner who
expects to avoid an adverse result cannot rest its case on generalities, but
must instead demonstrate benefits that justify the costs, including the cost of
any premium sought. ID. This admonition is particularly apt where allowance of
an acquisition premium is sought. ID.
IV. SPECIFIC CONSIDERATIONS OF THE MERGER
In considering this proposal, the Department's analysis focuses on the
following factors: (1) effect on rates, resulting net savings and alternatives
to merger; (2) effect on the quality of service; (3) societal costs; (4) effect
on competition and economic development; (5) cost allocation; (6) transaction
and merger integration costs; and (7) acquisition premium.
A. EFFECT ON RATES, RESULTING NET SAVINGS AND ALTERNATIVES TO MERGER
1 BASE RATE FREEZE
a. INTRODUCTION
The first component of the Rate Plan is a ten-year freeze in Essex's base
rates. This base rate freeze would be adjusted for exogenous costs, which the
Petitioners define as changes in tax laws, accounting changes, and regulatory,
judicial, or legislative changes (Exh. JFB-1, at 7).
<PAGE> 15
D.T.E. 98-27 Page 11
b POSITIONS OF THE PARTIES
i INTERVENORS
The Attorney General argues that the Petitioners have based the projected
ten-year $33 million savings from avoided base rate increases on a "speculative
forecast" of future rate increases and failed to provide any information on
either cost trends or possible changes in the Department's regulatory policies
(Attorney General Brief at 12). The Attorney General argues that a ten-year
base-rate freeze would prevent any rate reductions resulting from excess
earnings (ID. at 11). The Attorney General asserts that Essex's average return
on common equity ("ROE") of 12.77 percent for calendar year 1997 is 150 basis
points above Essex's last allowed return, and that such a "robust return" is
inconsistent with the Petitioners' claim that Essex would file a rate case in
1999 (ID. CITING Exh. DJE-2, at 11). The Attorney General asserts that
Department adoption of long-term rate plans lacking review provisions may be
beyond the agency's authority, because of the Department's obligation under G.L.
c. 164, ss. 94 to establish just and reasonable rates (ID. at 12-13).
The Attorney General proposed an alternative plan that includes the
following general provisions: (1) a $3.5 million reduction in base rates upon
the consummation of the merger; (2) the institution of quality of service
standards to ensure service integrity; (3) a three-year rate freeze (subject to
changes for exogenous factors); (4) a customer earnings sharing mechanism above
a designated threshold; and (5) a provision that holds ratepayers harmless from
resulting increases in Essex's cost of capital and risks that forecasted merger
savings will not occur (Exh. DJE-1, at 29-37). The Attorney General argues that
his alternative plan is fair
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D.T.E. 98-27 Page 12
to both Essex's customers and shareholders for the following reasons: (1) most
of the projected merger savings flow back to customers via a rate reduction; and
(2) the proposed earnings sharing mechanism would allow shareholders to retain
half of the earnings up to 200 basis points in excess of the benchmark ROE and
to retain 25 percent of earnings in excess of 200 basis points above the
benchmark ROE, which mechanism is adequate to compensate Eastern shareholders
for any earnings dilution (ID. at 37-38).
The Unions contend that the proposed rate freeze constitutes performance
based regulation ("PBR") and thus should be subject to the constraints of G.L.
c. 164, ss. 1E[15] (Unions Brief at 6). The Unions state that the rate freeze
is a PBR because: (1) it will not be subject to traditional rate of return
regulation by the Department; (2) it will allow Eastern to retain any savings
it achieves; and (3) it aligns the interest of shareholders and ratepayers
through the sharing of costs and benefits (ID.).
ii PETITIONERS
The Petitioners contend that the projected $33 million customer savings
over the ten-year term of the Rate Plan is conservative given the historical
rate increase trend of Essex (Petitioners Brief at 23-24). Further, the
Petitioners argue that not only will the rate freeze provide savings that would
not be available absent the merger, but it also will insulate Essex's
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[15] Section 1E(a) authorizes the Department to promulgate rules and regulations
pertaining to PBR regulation, and requires that the Department establish
service quality standards as part of any PBR. Section 1E(b) prohibits gas
or electric utilities filing PBR proposals to engage in any labor
displacement or staff reductions below those levels in place as of November
1, 1997, unless such workforce reductions are part of collective bargaining
agreements or are found by the Department after evidentiary hearings not to
"adversely disrupt" service quality standards established pursuant to ss.
1E(a).
<PAGE> 17
D.T.E. 98-27 Page 13
customers from increases resulting from (1) inflation, (2) depreciation expense,
and (3) capital investments necessary to implement industry restructuring
initiatives (ID. at 24).
The Petitioners disagree with the Attorney General's position on Essex's
ROE. The Petitioners maintain that the Department's evaluation of a company's
earnings and need for a rate adjustment is premised on return on rate base, not
ROE (ID. at 25). The Petitioners argue that, based on Essex's five-year
financial plan, Essex projected a return on rate base of 8.10 percent for fiscal
year 1998, which the Petitioners claim produces a ROE of approximately 7.6
percent after the cost of debt is excluded (id., CITING Exh. AG 1-15 (supp.);
Tr. 1, at 151-152; Tr. 4, at 112-114). The Petitioners maintain that this
calculation indicates that Essex experienced a revenue deficiency of $1.2
million at the end of 1997 (Petitioners Brief at 25, CITING Tr. 3, at 55; Tr. 4,
at 15).
With respect to the Attorney General's contention that the ten-year term of
the rate freeze conflicts with the Department's statutory responsibilities, the
Petitioners contend that under G.L. c. 164, ss. 94, the Department remains
responsible for determining whether any rate petition filed by Essex during the
term of the Rate Plan is consistent with the terms of the Rate Plan (Petitioners
Reply Brief at 11). Additionally, the Petitioners argue that G.L. c. 164, ss. 93
would still allow the Department to investigate issues of pricing and quality of
service during the term of the Rate Plan (ID. at 12).
The Petitioners assail the Attorney General's alternative rate plan as
having no basis in either regulatory policy or financial theory, and serving
only to prevent the merger from taking place, thus denying Essex's ratepayers
the immediate and long-term benefits of the merger
<PAGE> 18
D.T.E. 98-27 Page 14
(Petitioners Brief at 34-35). The Petitioners argue that the Attorney General's
witness made no detailed analysis of either Essex or Department ratemaking
policy (ID. at 35, CITING Tr. 4, at 15-33). Furthermore, the Petitioners contend
that the Attorney General's earnings dilution analysis and earnings sharing
mechanisms are one-sided and based on unrealistic assumptions (ID. at 36-38).
c ANALYSIS AND FINDINGS
As noted in Section IV.A.1.b, above, the Attorney General has questioned
the Department's authority to approve a ten-year rate freeze under the existing
statutory framework. The relevant statutory provisions can be found in G.L. c.
164, ss.ss. 93 and 94.
Section 93 requires the Department to conduct a hearing on complaints
relative to price and service quality upon petition filed by the Attorney
General, the mayor of a city, the selectmen of a town, or a petition of at least
20 customers. In addition, ss. 93 provides that the Department, on its own
motion, can initiate such a hearing. The right to file such a complaint applies
to all filed rates, including any Essex rates approved in this case or in D.P.U.
96-70. We find that ss. 93 provides appropriate relief for the investigation of
issues of price or quality of service should they arise during the course of the
proposed Rate Plan. Approval of the Rate Plan does not -- indeed, cannot --
contradict the grant of authority made by ss. 93. However, any proceeding
arising under ss. 93 during the ten years of the Rate Plan must account for
costs incurred by the Petitioners in consummating the merger in reliance on this
Order and for the opportunity, explicitly recognized by this Order, accorded to
the Petitioners to recoup those costs. SEE Petitioners Reply Brief at 11-13.
<PAGE> 19
D.T.E. 98-27 Page 15
Section 94 mandates the mechanism by which gas, electric, and water
companies may petition the Department for a change in rates and the procedures
for the Department to follow in reviewing any proposed rate change. Moreover,
ss. 94 provides that the Department on its own motion may commence an
investigation of a filed rate. The Court has found that the Department has broad
discretion in exercising its authority to regulate rates under G.L. c. 164, ss.
94. SEE AMERICAN HOECHEST CORP., 379 Mass. 408, 411, 412, 413 (1980) (Department
free to select or reject particular method of regulation as long as choice not
confiscatory or otherwise illegal). The Department's actions under ss. 94 have
been accorded deference in the realm of economic regulation by the Court. SEE,
E.G., MASSACHUSETTS OILHEAT COUNCIL, 418 Mass. at 802-807. In the past, the
Department has approved rate freezes. SEE BAY STATE GAS COMPANY, D.P.U. 97-97
(1997); BLACKSTONE GAS COMPANY, D.P.U. 96-65 (1996); FALL RIVER GAS COMPANY,
D.P.U. 96-60 (1996). The ten-year rate freeze period proposed here is similar to
prolonged periods during which some utilities have kept rates in place and
refrained from exercising their statutory authorization to file rate increases
under ss. 94. SEE FITCHBURG GAS AND ELECTRIC LIGHT COMPANY, D.T.E. 98-51
(pending before the Department); SOUTH EGREMONT WATER COMPANY, D.P.U. 86-149, at
1 (1986); MANCHESTER ELECTRIC COMPANY, D.P.U. 17832, at 1 (1974). Moreover,
Essex's rates, which the Petitioners propose to be frozen for ten years,
recently were found to be just and reasonable. SEE D.P.U. 96-70, at 7.
For the reasons stated above, the Department concludes that there is no
express or implied language in either ss. 93 or ss. 94 that limits the
Department to any particular regulatory scheme or to its specific duration.
Therefore, we conclude that approval of a ten-year rate
<PAGE> 20
D.T.E. 98-27 Page 16
freeze is consistent with the discretion afforded the Department under these
statutory provisions. SEE NYNEX, D.P.U. 94-50 (February 2, 1995 Interlocutory
Order); D.P.U. 94-158, at 12-13.
With respect to the issue of whether the Rate Plan is a PBR, we note that a
PBR is a substitute for traditional cost of service regulation. INCENTIVE
REGULATION, D.P.U. 94-158, at 3-10, 52-55 (1995). Although the proposed Rate
Plan contains features that can create incentives similar to those found in
PBRs, a PBR is far more complicated. A PBR typically features annual filings
based on a predetermined formula that takes into an account inflation factor,
analyses of industry productivity compared to economy-wide productivity, and
consideration of whether there should be an earnings sharing mechanism. SEE
D.P.U. 96-50 (Phase I) at 259-339; D.P.U. 94-50, at 91-273. Since the proposed
Rate Plan does not include either an inflation factor or an analysis of industry
productivity, there will be no change to the traditional cost of service
regulation by which the Department currently regulates the rates of Essex. The
proposed Rate Plan is better analogized to rate settlements approved in the past
by the Department, whereby a company agrees not to file a rate case for a
specified period of time. SEE D.P.U. 96-70, at 3; FALL RIVER GAS COMPANY, D.P.U.
96-60, at 3 (1996); BOSTON EDISON COMPANY, D.P.U. 92-92, at 10 (1992).
Therefore, despite some similar elements, the Department finds that the Rate
Plan does not constitute a PBR.
With respect to the application of G.L. c. 164, ss. 1E(a) in this case, we
conclude that it is not applicable because of our determination above that the
Petitioners have not proposed a PBR mechanism. While quality of service
standards are required to be set under a PBR
<PAGE> 21
D.T.E. 98-27 Page 17
pursuant to the directives in G.L. c. 164, ss. 1E, quality of service also is a
factor to be considered under the Department's standard of review for mergers.
MERGERS AND ACQUISITIONS at 7-8. Moreover, pursuant to its general supervisory
authority under G.L. c. 164, ss. 76, the Department has jurisdiction to ensure
appropriate levels of service quality. Therefore, the Department's requirement
for development of a service quality index ("SQI") in Section IV.B.3, below,
does not bring this proceeding under the specific requirements of G.L. c. 164,
ss. 1E(a). The Department addresses the applicability of G.L. c. 164, ss. 1E(b)
in Section IV.C of this Order, below.
With respect to the arguments raised by the parties concerning claimed
overearnings by Essex, the Department concludes that there is no persuasive
record evidence (beyond Mr. Effron's mere assertion in Exh. DJE-1, at 11-13) to
support the Attorney General's assumption that Essex will earn rates of return
in excess of the level authorized in its previous rate proceeding. Moreover,
Essex anticipates incurring costs related to (1) capital expenditures after the
merger, and (2) compliance with any future Department directives in UNBUNDLING
OF LDC SERVICES, D.T.E. 98-32 (Exhs. AG 1-30 (att. at 9-13); AG 1-15; Tr. 1, at
60-61; Tr. 4, at 22). The evidence in this case demonstrates that Essex
customarily has filed base rate cases approximately every two to three years
(Exh. AG 1-28 (supp.)). [16] Past rate-filing practices by
- ----------
[16] Essex's recent rate case history is as follows: (1) ESSEX COUNTY GAS
COMPANY, D.P.U. 87-59 (1987) (3.7 percent increase); (2) ESSEX COUNTY GAS
COMPANY, D.P.U. 89-107 (1989) (4.2 percent increase); (3) ESSEX COUNTY GAS
COMPANY, D.P.U. 91-107/110/111 (1991) (4.2 percent increase); (4) ESSEX
COUNTY GAS COMPANY, D.P.U. 93-107 (1993) (4.2 percent increase); and (5)
D.P.U. 96-70 (4.6 percent increase) (Exh. AG 1-28 (supp.)).
<PAGE> 22
D.T.E. 98-27 Page 18
a given company indicate but do not predetermine future conduct. However, our
assessment of the position of a small LDC at the end of the interstate pipeline
(such as Essex) leads us to conclude that the same economic and operational
pressures driving Essex to ss. 94 filings on the schedule described in Exhibit
AG 1-28 will persist over the next ten years. The Rate Plan promises to contain
upward pressure on customer rates. Accordingly, given that the ss. 96 public
interest standard is satisfied, we would be remiss in foregoing this opportunity
to contain Essex's rates.
With respect to the arguments raised by the parties concerning the use of
ROE or return on rate base to evaluate Essex's earnings, it is unnecessary to
make a finding on this issue. Regardless of what financial ratio is selected, a
single year of financial results provides an insufficient basis for determining
a particular company's future earnings. SEE BOSTON GAS COMPANY, D.P.U. 88-67
(Phase I) at 1-2, 427 (1988). As noted, the Department recently judged Essex's
current rates to be just and reasonable. D.P.U. 96-70, at 7. This case was not
noticed as a reinvestigation of Essex's earnings, nor is one necessary in light
of the relatively recent (1996) rate settlement approved in D.P.U. 96-70, which
the Attorney General, as a signatory, urged the Department to adopt. Again, the
Rate Plan will freeze these rates for ten years.
With respect to the arguments about the effect the emerging competitive gas
market would have on the value of the rate freeze, the Department finds that the
Attorney General's concerns are misplaced. First, under traditional cost of
service regulation, a company's allowed rate of return is based on its
investment in plant and equipment, not on its gas supply
<PAGE> 23
D.T.E. 98-27 Page 19
costs which are considered to be pass-through expenses.[17] Therefore, Essex's
base rate freeze would have no impact on gas commodity costs, which are the only
LDC costs likely to be subject to competitive pressure. Second, whatever the
results of the gas unbundling issues currently being examined by the Department
in D.T.E. 98-32, a base rate freeze would not preclude Essex's customers from
engaging in the purchase of gas from competitive suppliers at a price different
from that offered through the Rate Plan.
With respect to exogenous factors, the Department finds that, for purposes
of the Rate Plan, exogenous factors shall be defined as positive or negative
cost changes actually beyond Essex's control, including, but not limited to,
cost changes resulting from: (1) changes in tax laws that uniquely affect the
local gas distribution industry; (2) accounting changes unique to the local gas
distribution industry; and (3) regulatory, judicial, or legislative changes
uniquely affecting the local gas distribution industry. D.P.U. 96-50 (Phase I)
at 292.
The Department has considered the Attorney General's alternative rate plan.
While the Attorney General's proposal offers a rate reduction of $3.5 million
per year, with a term of three years, the Petitioners' Rate Plan offers greater
advantages to ratepayers through the longer term of ten years and allows an
opportunity for full recovery of merger-related costs without harm to customers.
Approval of a three-year rate plan is very unlikely to afford
- ----------
[17] Pursuant to a rate settlement approved in D.P.U. 96-70, Essex unbundled its
rates so that all costs of distributing gas from the city-gate to
customers' meters (operation and maintenance expense, depreciation and
amortization, taxes, and return on rate base) are recovered through base
rates. Essex recovers, on a fully reconciling basis, all gas supply costs
(I.E., gas commodity costs, upstream storage and transportation to the LDC
city-gate, a portion of local production and storage facilities, and gas
supply planning and acquisition costs) through the CGAC.
<PAGE> 24
D.T.E. 98-27 Page 20
Eastern a sufficient opportunity to recover the transaction costs associated
with this merger. More importantly, Essex's ratepayers would not be guaranteed
the level of savings associated with a ten-year rate freeze. Under the Attorney
General's proposal, Essex would be free to file for a base rate increase at the
end of three years, as compared with the ten years provided under the Rate Plan.
With respect to the Attorney General's earnings sharing component, the
Department considers the Rate Plan's ten-year rate freeze to provide adequate
protection for ratepayers against changes in Essex's costs over the term of the
Rate Plan. CF. D.P.U. 96-50 (Phase I) at 325-326 (earnings sharing mechanism
adopted by Department as part of Boston Gas's PBR plan because of uncertainty
associated with productivity factor). With respect to the Attorney General's
quality of service mechanism, the Attorney General did not offer a specific
quality of service plan (Exh. DJE-1, at 31-32). As part of this Order, the
Department establishes a quality of service requirement in Section IV.B.3,
below.
Finally, the Attorney General has proposed that, as a condition of the
merger, Essex's ratepayers be held harmless against any potential increases in
Essex's cost of service, cost of capital, or affiliate transactions (Exh. DJE-1,
at 36-37). The Petitioners have stated that ratepayers will not bear any risk
that projected cost savings may not materialize (Exh. JFB-1, at 14; Tr. 1, at
60-61). Moreover, both the Petitioners and Boston Gas already are required to
conduct their transactions with affiliates in accordance with 220 C.M.R. ss.ss.
12.00 ET SEQ. SEE STANDARDS OF CONDUCT, D.P.U./D.T.E. 97-96 (1998) and STANDARDS
OF CONDUCT, D.P.U. 96-44 (1996). Therefore, the Department finds that the
Attorney General's concerns on these issues have been addressed.
<PAGE> 25
D.T.E. 98-27 Page 21
On balance, the Department concludes that the rate freeze provides
greater benefits to Essex's ratepayers than does the Attorney General's
alternative. Therefore, the Department declines to condition approval of the
transaction on adoption of the terms in the Attorney General's proposal. Essex's
ratepayers would be at least as well off with the proposed base rate freeze than
they would be absent the proposed merger.
2 GAS COSTS
a INTRODUCTION
As discussed in Section II.B.2 above, the Rate Plan proposed by the
Petitioners provides for an estimated five percent reduction in the total
burner-tip price of gas currently paid by Essex customers. Based on Essex's
total normalized revenues of approximately $46.9 million, determined in Essex's
1996 rate settlement in D.P.U. 96-70, the Petitioners estimate that the annual
gas cost reduction to Essex customers would be $2.35 million per year over the
term of the Rate Plan (Exh. JFB-1, at 2-3).
To achieve the proposed $2.35 million annual gas cost savings over the
ten-year term of the Rate Plan, the Petitioners determined that Essex would
release its Tennessee Contract[18] of 15,728 Mcf per day and obtain 70 percent
of the current maximum tariff rate, or $2.2 million,[19] in the capacity release
market each year until the contract expires on
- ----------
[18] The Petitioners state that they have not identified any contracts, other
than the Tennessee Contract, that could be reduced or eliminated without
jeopardizing the ability to meet Essex's system requirements (Exh. WRL-1,
at 6).
[19] The $2.2 million was calculated by multiplying the $3.1 million value of
the Tennessee Contract by the Petitioners' estimate of the percentage of
the maximum tariff rate that could be obtained through the release, or 70
percent. According to Mr. Luthern's
<PAGE> 26
D.T.E. 98-27 Page 22
November 1, 2000 (Exh. WRL-1, at 5). Of the $2.2 million annual capacity release
revenue for the split-year 1998/99, the Petitioners estimate that approximately
$1.04 million[20] would be credited to Boston Gas via a CGAC adjustment as
compensatiofn for the opportunity revenues foregone to serve Essex customers
(ID. at 8-9). The Petitioners further project that approximately $300,000 per
year[21] in reduced commodity costs would be attained through synergistic
purchasing economies (Exh. JFB-1, at 4). In order to achieve the $2.35 million
in annual gas cost reduction, the Petitioners propose to credit Essex customers
$900,000 per year through the LDAC until November 1, 2000, when the Tennessee
Contract expires (ID. at 3).
After the expiration of the Tennessee Contract on November 1, 2000, the
Petitioners estimate that, through coordinated supply efforts with Boston Gas,
Essex customers can avoid having to renew the Tennessee Contract worth $3.1
million[22] in annual demand charges while maintaining Essex's system
reliability (Exh. WRL-1, at 5-6). For the remaining eight years of
- ----------
testimony, the 70 percent estimate was based on: (1) Boston Gas's
experience in releasing capacity of similar magnitudes; and (2) information
received from the marketplace relative to the value of capacity for New
England (Exh. AG 3-24; Tr. 2, at 19, 21).
[20] Eastern calculated the $1.04 million estimate of Boston Gas's foregone
first year revenue capacity release activity by using Boston Gas's dispatch
analysis to identify the particular resources of the Boston Gas portfolio
that would be used to serve Essex customers (SEE Exhs. DTE 1-11; WRL-3)
[21] Essex pays an annual reservation charge of approximately $.06 per MMBtu
versus Boston Gas's annual reservation charge of $.01 per MMBtu. The
resulting difference when applied to Essex's annual volume of 5.7 Bcf
equals approximately $300,000 annual savings (SEE Exh. USA 1-98).
[22] Calculated as follows: (15,728 MMBtu per day) x ($16.47 MMBtu/day/month) x
(12 months) (Exh. DTE 1-27).
<PAGE> 27
D.T.E. 98-27 Page 23
the Rate Plan beginning on November 2, 2000, the Petitioners propose that the
$2.35 million annual reduction in gas costs to Essex would be derived from: (1)
crediting Essex with the estimated $300,000 per year commodity costs achieved
through supply synergies as discussed above; (2) crediting Essex with the
estimated $3.1 million from avoiding Tennessee's fixed year charge associated
with the expired capacity contract; and (3) transferring an estimated $1.04
million[23] from Essex's CGAC to Boston Gas's CGAC, representing a charge to
Essex intended to compensate Boston Gas for its foregone capacity
transactions.[24]
b POSITIONS OF THE PARTIES
i INTERVENORS
The Attorney General argues that the proposed $2.35 million annual gas cost
savings to Essex customers are "speculative" and "unverifiable" and could be
achieved without the merger (Attorney General Brief at 9). The Union concurs
with the Attorney General's position (Unions Reply Brief at 2). The Attorney
General argues that the savings are speculative because: (1) the Petitioners
have not provided and will not agree to a mechanism to ensure gas cost savings
from the merger; (2) as gas costs fluctuate over time, there is no way to track
the gas cost savings attributable exclusively to the merger; and (3) to the
extent that existing Essex customers elect alternative gas suppliers as a result
of industry restructuring, any benefits from the proposed CGAC decrease would be
lost for those
- ----------
[23] After the first year and at the start of each subsequent heating season
under the Rate Plan, the Petitioners represent that Boston Gas would
prepare an analysis of estimated foregone capacity release revenue (Exh.
WRL-1, at 9-10).
[24] Total savings projections are calculated as: $300,000 + $3,100,000 -
$1,040,000.
<PAGE> 28
D.T.E. 98-27 Page 24
customers choosing alternative suppliers (Attorney General Brief at 10). As a
result, the Attorney General maintains that the total value of reduction in
purchased gas costs would be less than the estimated $2.35 million per year (ID.
CITING Exh. DJE-1, at 9). Further, the Attorney General claims that attaining
the proposed gas cost savings is not dependent upon a merger (Attorney General
Brief at 11). Moreover, the Attorney General maintains that LDCs at all times
should be pursuing cooperative gas supply agreements as part of their obligation
to provide least-cost service (ID. CITING MERGERS AND ACQUISITIONS at 4-5).
The Attorney General concludes that because the Petitioners failed to
quantify any real gas cost savings, with the exception of the $900,000 LDAC
credit during the first two years of the Rate Plan, the proposed Rate Plan is
not consistent with the public interest and should be denied (ID. at 9-11).
ii PETITIONERS
The Petitioners argue that the magnitude of projected gas cost savings
could not be accomplished absent the merger. In support of their contention, the
Petitioners maintain that the majority[25] of the proposed $2.35 million in
annual gas cost savings will only be achieved by releasing Essex's Tennessee
Contract upon consummation of the merger. Essex's permanent release of its
Tennessee Contract would not occur, the Petitioners argue, without
- ----------
[25] Based on the Department's calculations, the release of the Tennessee
Contract represents approximately 49 percent (($2.2 million - $1.04
million)/$2.35 million) of Essex's total annual gas-related savings.
Beginning in the year 2000, the non-renewal of the Tennessee Contract
represents approximately 88 percent (($3.1 million - $1.04 million)/$2.35
million) of Essex's total annual gas-related savings (SEE Exhs. WRL-1, at
5-9; JFB-1, at 2-3).
<PAGE> 29
D.T.E. 98-27 Page 25
the assurance that the reliability of its system would be permanently secured by
Boston Gas (Petitioners Reply Brief at 7-8).
The Petitioners also contend that, although a cooperative gas supply
arrangement between Boston Gas and Essex would use the existing resources at a
more efficient level, it would not produce the savings that elimination of a
particular resource from Essex's portfolio would achieve (ID. at 9). Further,
the Petitioners assert that efficiencies gained as a result of the coordinated
gas supply portfolios (E.G., the potential to renegotiate commodity contracts)
would only add to the level of savings achieved by the release of the Tennessee
Contract (Petitioners Brief at 29).
Lastly, the Petitioners assert that small companies, such as Essex, lack
the financial ability to capture economies of scale that are derived from larger
operations (ID. at 21, CITING Exh. JFB-1, at 21). In response to the Attorney
General's concern that migrating customers would not receive the benefits of gas
cost savings, the Petitioners argue that once capacity is released, these
customers would be relieved permanently of the cost of that capacity as they
migrate to transportation service (Petitioners Reply Brief at 9). Finally, the
Petitioners emphasize that any and all benefits realized from the reduction of
gas costs will flow back to Essex customers through the CGAC mechanism.
According to the Petitioners, these gas cost savings would be at least equal to
the sum of the value received for the Tennessee Contract, plus the savings
realized from the commodity cost reductions, plus the $900,000 Essex LDAC
<PAGE> 30
D.T.E. 98-27 Page 26
credit for the first two years of the merger (Petitioners Brief at 29;
Petitioners Reply Brief at 9).
c ANALYSIS AND FINDINGS
In MERGERS AND ACQUISITIONS, the Department reaffirmed the importance of
cost savings by utility companies and expected all utilities to explore any and
all measures that provide the opportunity for these savings. MERGERS AND
ACQUISITIONS at 18. The Department further stated that mergers and acquisitions
are a useful and potentially beneficial mechanism for utility companies to
consider in meeting their service obligations. ID. The Department here evaluates
(1) whether the opportunity exists for the Petitioners to achieve the savings
described in the proposal while maintaining the level of service and reliability
Essex customers have experienced; and (2) whether the projections of the
Petitioners are reasonable, based on the supporting record evidence.
The Department recognizes that the $2.35 million per year in gas cost
savings from the Rate Plan are estimated and that the magnitude of this value
would vary from year to year. That the savings are estimated is not grounds for
rejection of the Rate Plan. All calculations of the impact of future events are
based on an estimation of likelihood. The point is to judge whether, based on
logic, fact, and law, such estimations may reasonably be relied upon in
assessing costs and savings. Accordingly, the Department has evaluated each
component of the proposed $2.35 million in annual gas cost savings.
Specifically, the Department reviewed the reasonableness of the Rate Plan's
proposal to (1) release the capacity from Essex's Tennessee Contract up to the
November, 2000 expiration and obtain $2.2 million or 70 percent
<PAGE> 31
D.T.E. 98-27 Page 27
of the maximum Federal Energy Regulatory Commission ("FERC") tariff rate; (2)
debit Essex customers and credit Boston Gas customers an estimated annual amount
via the CGAC to account for Boston Gas's foregone capacity release
opportunities; (3) credit Essex customers $900,000 each year via the LDAC until
the November, 2000 expiration of the Tennessee Contract; (4) achieve the
projected $300,000 in annual commodity cost savings from coordinated supply
efforts over the term of the Rate Plan; and (5) attain $3.1 million in annual
avoided cost savings (beginning in November 2000) from Essex's non-renewal of
its Tennessee Contract.
With regard to the capacity release component, the record evidence
indicates that Boston Gas's recent capacity release experience of similarly
sized contracts has yielded values similar to the Petitioners' projections (Exh.
AG 1-49). The record further indicates that the Petitioners' estimate of 70
percent attainment of the maximum FERC tariff rate in the capacity release
market tracks Boston Gas's historical market value of New England capacity (Tr.
2, at 19-21). Accordingly, the Department finds that the Petitioners' estimates
of cost savings from capacity release are reasonable for the purposes of this
case.
Regarding the estimated foregone capacity release debit to Essex (and a
corresponding credit to Boston Gas), the Department recognizes that, through
coordinated supply efforts with Essex, Boston Gas will be denied some level of
capacity release opportunities for which Boston Gas should be compensated.
Therefore, the Department finds that it is reasonable for Eastern to reduce
Essex's gas costs savings by an amount intended to compensate Boston Gas and its
customers for their foregone capacity release opportunities. The Department
<PAGE> 32
D.T.E. 98-27 Page 28
recognizes that Boston Gas's foregone capacity release opportunities may vary
from year to year as a result of industry dynamics. Therefore, in order for the
Department to review the value of Boston Gas's foregone capacity release
opportunities as they relate to this merger, the Department directs the
Petitioners to submit a semi-annual analysis justifying the CGAC amount to be
credited to Boston Gas for such lost opportunities. These analyses are to be
coincident with the filing of Essex's semi-annual CGAC.
Regarding the $900,000 two-year LDAC credit, the Department notes that
Essex customers are assured gas cost savings of at least $900,000 for each of
the first two years of the Rate Plan. This represents the amount needed to bring
Essex's customers' estimated annual gas cost savings to the five percent
reduction threshold (Exh. JFB-1, at 3). Therefore, even if, under a worst case
scenario, none of the other projected savings were to come to fruition, LDAC
savings of this magnitude would be guaranteed to ratepayers. Such a guarantee
does not exist absent the merger.
Regarding the projected $300,000 annual commodity cost savings component,
we find that the volume and diversity of the Boston Gas portfolio offers gas
suppliers the opportunity to sell more gas than they would to a smaller LDC such
as Essex. Suppliers are often more willing to grant larger volume users a
reduction in their reservation charge for the opportunity to continue serving
their needs. The record indicates that Essex pays approximately $.05 per MMBtu
more than Boston Gas. When applied to Essex's annual volume of 5.7 Bcf, this
difference equates to $300,000 in avoided gas cost savings (SEE Exh. USA 1-98).
The
<PAGE> 33
D.T.E. 98-27 Page 29
Department notes that, absent enhancement of Essex's purchasing power achieved
by affiliation with Boston Gas, these savings are not likely to be attainable by
Essex.
With respect to the reasonableness of the $3.1 million in annual avoided
cost savings resulting from Essex's non-renewal of its Tennessee Contract in
November 2000, there is no dispute that Essex can eliminate the Tennessee
Contract given post-merger coordination of the Essex supply portfolio with that
of Boston Gas. In turn, such non-renewal of Essex's Tennessee Contract would
avoid costs of about $3.1 million per year -- the value of the Tennessee
Contract's demand charge (Exh. DTE 1-27). The issue before us is whether Essex
would be capable of achieving this magnitude of gas-related savings, absent the
merger. We note that for the year ended August 31, 1997, approximately 81
percent of Essex's gas supply was delivered using Tennessee capacity (Exh. USA
1-31, at 14). Essex would not be in a position to release its Tennessee Contract
on a permanent basis and readily find comparable replacement resources in the
absence of the merger (Tr. 2, at 11-12). Therefore, absent the permanent
coordination of Essex's supply portfolio with that of Boston Gas, which can best
be achieved as a result of the merger, the savings associated with the release
of the Tennessee Contract would likely not materialize.
Finally, the Department does not regard as valid the Attorney General's
contention that Essex's customers migrating to transportation service would not
receive the benefits of the expected gas cost savings. On the contrary, once the
Tennessee Contract is released, these migrating customers would benefit from
such release because they would no longer be responsible for the cost of that
capacity (ID. at 28-29).
<PAGE> 34
D.T.E. 98-27 Page 30
Accordingly, for all of the reasons set forth above, the Department finds
that the Petitioners' estimates regarding the gas cost savings find substantial
support in the record evidence in this case. The estimates are carefully
calculated and support our findings that the proposed Rate Plan will likely
provide gas costs savings to Essex customers, of the magnitude projected by the
Petitioners, and that these savings would be unavailable in the absence of the
proposed merger.
B. EFFECT ON QUALITY OF SERVICE
1. INTRODUCTION
In their initial filing, the Petitioners did not propose a quality of
service plan for Essex. Subsequently, the Petitioners indicated that they would
be willing to implement a quality of service plan for Essex using the measures
implemented in D.P.U. 96-50 (Phase I) as a model (Tr. 4, at 93-94; RR-DTE-4, at
1). In response to a Department record request, the Petitioners proposed a time
period of eighteen months in which to provide the Department with a quality of
service plan for Essex (Tr. 4, at 94-96; RR-DTE-4, at 2).
2. POSITION OF THE PARTIES
a. INTERVENORS
The Attorney General contends that the proposed Rate Plan fails to protect
ratepayers because it does not include an SQI (Attorney General Reply Brief at
9-10). The Attorney General asserts that the Department recognized that a
company operating under a PBR would have an incentive to allow service quality
to deteriorate and earn an excessive return unless an
<PAGE> 35
D.T.E. 98-27 Page 31
SQI were established and monitored (ID. at 9, CITING D.P.U. 96-50, at 304,
325-326; NYNEX, D.P.U. 94-50, at 235 (1994)). The Unions argue that the
Department must consider the impact the merger will have on quality of service
and that, in this case, the Petitioners have failed to show that the quality of
service will not deteriorate under the proposed merger (Unions Brief at 4, 6).
According to the Unions, quality of service is related to the level of staffing,
and, therefore, the reduction in the number of Essex employees will result in
degradation of service (ID. at 6, 9). Moreover, the Unions contend that by
enacting ss. 1E, the Legislature intended to ensure that the restructured gas
and electric companies maintain the high levels of service quality that
customers in the Commonwealth have come to expect (ID. at 6).
b. PETITIONERS
The Petitioners agree that it is appropriate for the Department to consider
quality of service when evaluating a merger filed pursuant to ss. 96. The
Petitioners maintain that they are committed to continuing the quality of
service and reliability now provided to Essex customers and will not compromise
employee or public safety in achieving the goal of cost savings (Exh. JFB-1, at
11; Tr. 3, at 20-22; Tr. 4, at 91-92; Petitioners Reply Brief at 25). Moreover,
the Petitioners state that Essex will rely on Boston Gas's information system
resources and customer service experience to enhance the quality of service to
Essex's customers (Exh. JFB-1, at 17; Tr. 4, at 82-85; Petitioners Brief at
19-20).
Essex states that while it has not had in place the systems necessary to
track many of the quality of service measures included in Boston Gas's PBR plan,
it would be able to
<PAGE> 36
D.T.E. 98-27 Page 32
integrate Boston Gas's information system resources into its own operations
within approximately six months following the merger (RR-DTE-4; Tr. 4, at
85-88).[26] Once such systems are implemented, the Petitioners represent that
Essex would be able to report service quality measurements similar to those of
Boston Gas (RR-DTE-4, at 1-2).
The Petitioners disagree with the arguments of both the Unions and the
Attorney General regarding the applicability of ss. 1E. According to the
Petitioners, the intent of ss. 1E is to ensure that the introduction of
competition in the public utility industry does not result in diminution of
service quality (Petitioners Reply Brief at 21). The Petitioners argue that ss.
1E does not apply here because the proposed merger is neither a restructuring
plan nor a form of deregulation (ID. at 20-23). In addition, the Petitioners
assert that the proposed Rate Plan should not be categorized as a PBR and
conclude that ss. 1E is not applicable in this proceeding (ID.).
3. ANALYSIS AND FINDINGS
a. SERVICE QUALITY PLAN
Although the Department has found that the Petitioners' filing does not
constitute a PBR, quality of service is an essential factor in reviewing a
merger; and an SQI can be an important bulwark against deterioration in Essex's
quality of service. SEE BOSTON EDISON
- ----------
[26] Boston Gas tracks the following SQI measures: (1) Class I and Class II odor
calls; (2) lost-time accidents; (3) telephone service; (4) service
appointments met on the same day as scheduled; (5) customer complaints and
bill adjustment dollars; and (6) on-cycle meter reads. D.P.U. 96-50-C
(Phase I) at 76. Essex does not track: (1) service appointments met on the
same day as scheduled to be met; (2) customer complaints; or (3) billing
adjustment dollars (RR-DTE-6; RR-DTE-7; RR-USA-1; Tr. 4, at 116-122).
<PAGE> 37
D.T.E. 98-27 Page 33
COMPANY, D.P.U./D.T.E. 97-63, at 15 (1998); MERGERS AND ACQUISITIONS at 8-10.
Moreover, even under the Rate Plan, the Department retains oversight of service
quality pursuant to ss. 76. While the Petitioners represent that no degradation
of service would occur, the Petitioners have not presented a service quality
plan (Exh. JFB-1, at 17; Tr. 4, at 82-84). Lack of a service quality plan is an
omission that needs remedy, for under the Rate Plan, merger costs will be
recouped by seeking efficient ways to reduce costs. In a monopoly environment,
and without proper controls, this arrangement could lead to a reduction in
service quality.[27]
Although Essex currently does not track all the quality of service measures
implemented in D.P.U. 96-50 (Phase I), the Petitioners indicated that those SQI
measures could be used as the foundation for establishing Essex's own quality of
service standards (RR-DTE-4, at 1; Tr. 4, at 93-94). The Petitioners state that
within a six-month period following the consummation of the merger, Essex would
be able to implement monitoring and information systems to track and record
quality of service measures. Once these systems are in place, the Petitioners
propose a twelve-month data collection period before establishing baseline
performance levels against which Essex's future performance could be evaluated
(RR-DTE-4, at 2). According to the Petitioners, the levels of performance and
associated benchmarks would be in place no later than 18 months after the merger
(ID.). The Department finds the approach the Petitioners have outlined to be
reasonable and acceptable.
- ----------
[27] In the future, the Department directs companies filing requests for
approval of mergers or acquisitions to include a service quality plan that
is designed to prevent degradation of service following the merger. This
directive reaffirms the importance of service quality as a factor cited in
MERGERS AND ACQUISITIONS at 8-10.
<PAGE> 38
D.T.E. 98-27 Page 34
In view of the software modifications that would be necessary for Boston
Gas's information systems, the Department finds that the proposed six-month time
period (following the consummation of the merger) for integrating Essex's
database into Boston Gas's information systems is reasonable. The Department
further finds that, for those SQI measures not currently in place,[28] a
twelve-month data collection period (beginning after the six-month data
integration period) is a reasonable period for Essex to collect quality of
service information to establish baseline performance levels. This same
twelve-month time period should also be used by Essex to collect additional data
for those SQI measures for which Essex currently maintains data.
Therefore, the Department will require Essex to record results for ALL SQI
measures, including those that it currently tracks and those that it will begin
to track after the data integration period, for the twelve-month period
following the six-month data integration period. One month after the close of
this 18-month period, Essex shall file proposed benchmarks for all SQI measures.
Upon receipt of this filing, the Department will open a proceeding to
investigate establishing service quality standards and associated penalties as
disincentive to or safeguards against deterioration of service. During the
intervening 18-month period, however, the Department expects that Essex will
maintain its current service quality and undertake to improve it.
The following sections provide details concerning each of the service
measures and Department directives regarding data collection to establish
baseline service levels.
- ----------
[28] SEE note 26 above.
<PAGE> 39
D.T.E. 98-27 Page 35
b. RESPONSE TO ODOR CALLS
Essex currently tracks and records response times to odor calls (Exhs. USA
2-2; USA 3-2). The data indicate that Essex currently responds to 91.29 percent
of odor calls within one hour or less (Exhs. USA 2-2; USA 3-2).[29] We note that
in D.P.U. 96-50 (Phase I) at 304-305, the Department determined that a 95
percent response to odor calls within 60 minutes or less was reasonable for
Boston Gas. According to Boston Gas, that company now maintains a 97 percent
response rate within one hour or less to Class I and Class II odor calls (Tr. 4,
at 108). With the integration of Boston Gas's information service technology
into Essex's operations, the Department expects that Essex could achieve a
higher response rate for Class I and Class II odor calls. With respect to
categories of odor calls, Essex does not differentiate between Class I and Class
II odor calls (ID.; SEE D.P.U. 96-50 (Phase I) at 294).(30) Differentiating the
two classes permits quicker response to those calls more immediately critical to
public safety. Accordingly, the Department directs Essex, commencing no later
than the beginning of the data collection period, to record separately response
times to Class I and Class II odor calls. This information will then be used, in
conjunction with Boston Gas's
- ----------
[29] The Department incorporated into the record by reference the odor call
records filed with the Pipeline Engineering and Safety Division (Tr. 4, at
123). SEE 220 C.M.R. ss. 1.10(3).
[30] A Class I Odor call is defined as those calls which relate to a strong odor
of gas throughout a household or outdoor area, or a severe odor from a
particular area. A Class II Odor call relates to calls involving an
occasional or slight odor at an appliance. D.P.U. 96-50 (Phase I) at 294.
<PAGE> 40
D.T.E. 98-27 Page 36
odor call information, in the Department's review of Essex's future SQI proposal
for odor calls.
c. TELEPHONE SERVICE
Essex also currently tracks and records data on response times to telephone
service calls (RR-USA-1). According to the information provided by the
Petitioners, between June 1996 and May 1998, Essex answered telephone calls
within 60 seconds of the first ring 94.81 percent of the time (ID.). Essex
currently does not differentiate between emergency calls and service/billing
calls. In D.P.U. 96-50-C (Phase I) at 76, the Department determined that a 90
percent response time for emergency calls and an 80 percent response time for
service and billing calls answered within 40 seconds were reasonable for Boston
Gas.
Following the consummation of the merger, telephone calls placed to Essex's
customer service department will be handled through Boston Gas's central inquiry
facility in West Roxbury, which has the capability to differentiate between
these calls (Tr. 4, at 111; SEE ALSO D.P.U. 96-50 (Phase I) at 305). Therefore,
requiring Essex to differentiate between emergency and service/billing calls
places no additional burden on either Essex or Boston Gas. Essex should achieve
a faster response to both emergency and service/billing calls, following the
merger, because of the availability of Boston Gas's information technology
services. Accordingly, the Department directs Essex to begin tracking and
recording separately telephone response times for: (1) emergency calls; and (2)
service and/or billing calls no later than the end of the six-month data
integration period. This information will then be used, in
<PAGE> 41
D.T.E. 98-27 Page 37
conjunction with Boston Gas's telephone service information, in the Department's
review of Essex's future SQI proposal for telephone service.
d. LOST-TIME ACCIDENTS
Essex currently gathers data on lost-time accidents related to employees
out of work as a result of injury or illness (RR-DTE-5). These data are provided
to the U.S. Department of Labor in accordance with P.L. 91-596 (ID.). Essex
submitted data to the Department covering the period from August 1996 through
February 1998 (ID.). However, this information does not include total employee
work-hours (ID.). Data on total employee work hours is needed to provide,
combined with Essex's lost-time accident records, sufficient detail to establish
a benchmark for Essex's future SQI. In D.P.U. 96-50 (Phase I) at 295 and 305,
the Department determined that a three-year running average for lost-time
accidents was reasonable for Boston Gas. The Department directs Essex to track
and record lost-time accidents in relation to total employee work-hours during
the twelve-month data-collection period. We recognize that the twelve-month
data-collection period is not comparable to the three-year running average used
for Boston Gas. Therefore, the Department shall take this data limitation into
consideration when reviewing Essex's future SQI proposal for lost-time
accidents. This information will then be used, in conjunction with Boston Gas's
lost-time accidents information, in the Department's review of Essex's future
SQI proposal for lost-time accidents.
e. SERVICE APPOINTMENTS MET AS SCHEDULED
Essex does not currently maintain records of service appointments that were
met on the same date as scheduled to be met (Tr. 4, at 120-121; RR-DTE-6). In
D.P.U. 96-50-C
<PAGE> 42
D.T.E. 98-27 Page 38
(Phase I) at 76, the Department determined that a 95-percent benchmark for
appointments met on the day scheduled to be met was reasonable for Boston Gas.
To determine the appropriate benchmark for Essex, the Department directs Essex
to track and record appointments met on the same day scheduled during the twelve
month data collection period. This information will then be used, in conjunction
with Boston Gas's service appointments information, in the Department's review
of Essex's future SQI proposal for appointments met on the same day as
scheduled.
f. METER READS
Essex currently maintains records on meter reads only for those meters that
have not been read for more than two months (Tr. 4, at 119-120; RR-DTE-7). In
D.P.U. 96-50-C (Phase I) at 76, the Department determined that a 95-percent
benchmark for actual, on-cycle meter reads was reasonable for Boston Gas.[31]
The Department concludes that Essex's meter reading data are not collected in
sufficient detail to establish a benchmark for on-cycle meter reads. Boston Gas
will integrate its information service technology into Essex's operations, even
as Essex converts to automatic meter-reading ("AMR") devices (Exh. AG 1-30, at
8). Success in both these programs will permit Essex's meter reading performance
to reach the levels currently achieved by Boston Gas. The Department directs
Essex to track and record actual on-cycle meter reads. The Department further
directs Essex to maintain records differentiating between on-cycle meter reads
taken by AMR devices and those manually
- ----------
[31] An "actual," as distinct from an "estimated," meter read occurs when the
bill presented is based on a reading of the meter by company personnel and
not on a pattern of past use extrapolated to the current billing period.
<PAGE> 43
D.T.E. 98-27 Page 39
recorded, in order to track Essex's progress towards integrating its AMR program
with Boston Gas's AMR program. The Department expects that Essex will achieve
higher percentages of on-cycle meter reads through the use of AMR devices. SEE
D.P.U. 96-50 (Phase I) at 306. Doing so would improve service quality and
capture synergistic efficiencies. This information will then be used, in
conjunction with Boston Gas's meter reading information, in the Department's
review of Essex's future SQI proposal for on-cycle meter reads.
g. CONSUMER DIVISION COMPLAINTS AND BILLING ADJUSTMENTS
Boston Gas's service quality is measured, in part, using statistics from
the Department's Consumer Division. These statistics can also provide a useful
measure of Essex's service quality. We have incorporated the Department's
Consumer Division records on Essex's customer complaints and bill adjustments,
the two other measures adopted in D.P.U. 96-50 (Phase I), into this record
pursuant to 220 C.M.R. ss. 1.10(3) (Tr. 4, at 123). For Boston Gas, the
Department found it appropriate to adopt a two-year average in deriving the
benchmarks for these SQI measures in order not to skew the results against
Boston Gas's efforts towards improving its quality of service. SEE D.P.U.
96-50-C (Phase I) at 66-69. Given that Essex will be integrated with Boston Gas,
the Department finds that it is appropriate to use a similar average to assess
Essex's service quality in this area. Accordingly, the Department will use the
average for the two-year period ending at the close of the data-collection
period in our review of Essex's future SQI proposal for Consumer Division
complaints and bill adjustments.
<PAGE> 44
D.T.E. 98-27 Page 40
C. SOCIETAL COSTS
1. INTRODUCTION
As a result of the merger, the Petitioners estimate that 31 management
positions and 19 union positions at Essex will be eliminated out of the total
workforce of 124 employees, primarily through Essex's conversion to
information-system technology that is currently used by Boston Gas (Exhs. JFB-1,
at 8-9; USA 1-2). The 31 management positions consist mainly of managerial and
supervisory positions that, the Petitioners state, could be integrated with
Boston Gas's operations (Exh. USA 1-65). The 19 union positions consist mainly
of clerical positions that, the Petitioners state, could be reduced through the
successful integration of certain elements of Essex's operations with those of
Boston Gas (Exh. USA 1-66). The Petitioners estimate that approximately
$1,181,000[32] of the potential operating and maintenance ("O&M") labor savings
are associated with union positions covered by a collective bargaining agreement
that expires February 4, 1999, and thus these savings are dependent upon the
outcome of Essex's future collective bargaining efforts (Exh. JFB-1, at 9-10;
Tr. 1, at 109-110). The Petitioners represent that potential early retirement,
severance, retraining, and other programs may provide options for employees
whose positions would be eliminated as a result of the merger (Exhs. JFB-1, at
20-21; USA 1-65; USA 1-66; USA 1-80; USA 1-81).
- ----------
[32] This amount represents 23 percent of the total projected labor operating
and maintenance savings ($1,181,000 divided by the total labor savings of
$5,101,000) (Exh. JFB-1, at 9).
<PAGE> 45
D.T.E. 98-27 Page 41
2. POSITIONS OF THE PARTIES
a. INTERVENORS
The Unions entered into the record a Letter of Understanding incorporated
in Essex's collective bargaining agreement that they state prohibits: (1)
employees with at least four years of service from being laid off for lack of
work during the term of the collective bargaining agreement; and (2) permanent
employees from being laid off as a result of Essex installing any labor-saving
machinery (Exhs. TDB-1, at 8; TDB-2, at 39). After the expiration of the
collective bargaining agreement, the Unions contend that Essex would have to
negotiate successfully a change in the Letter of Understanding before any job
elimination could take place (Exh. TDB-1, at 8). The Unions further contend that
the workforce restrictions contained in ss. 1E(b) may preclude the Petitioners
from realizing as much as 72 percent of the projected $5,101,000 in annual O&M
savings (Unions Brief at 9).
The Unions estimate that 29 union positions actually will be lost as a
result of the merger (ID., CITING Exh. TDB-1, at 11-13). According to the
Unions, when Boston Gas eliminated its appliance service function and reassigned
this work to ServicEdge, approximately one-third of Boston Gas's service
personnel were displaced (Exh. TDB-1, at 13-15). Therefore, the Unions also
anticipate job displacement in Essex's gas appliance service division as a
result of operational synergies (ID. at 13-14). The Unions assert that the
Petitioners have not provided evidence to determine how the fifty proposed
layoffs will affect (adversely or otherwise) the quality of service offered to
Essex customers (Unions Brief at 1, 6).
<PAGE> 46
D.T.E. 98-27 Page 42
b. PETITIONERS
The Petitioners assert that they are committed to honoring the February 4,
1996, collective bargaining agreement, which expires February 4, 1999, and to
entering into "good-faith" negotiations for a new collective bargaining
agreement (Petitioners Brief at 14, CITING Tr. 1, at 109-110). In addition, the
Petitioners assert that the societal costs resulting from the elimination of
positions is expected to be minimal because of Eastern's commitment to maintain
Essex's field operations within the service territory, including Essex's
Amesbury office, and to undertake all reasonable efforts to provide employees
who may be displaced with access to employee placement programs (ID. at 22,
CITING Exhs. JFB-1, at 20-21; USA 1-80; USA 1-81). Finally, the Petitioners
claim that the workforce level requirements of ss. 1E(b) are not applicable
here, because the Rate Plan is not a PBR (Petitioners Reply Brief at 22-23).
3. ANALYSIS AND FINDINGS
The only issue addressed by the parties under societal costs is the effect
on employment. The Petitioners and the Unions appear to agree that 31 management
positions at Essex would be eliminated as a result of the merger (SEE Exhs.
JFB-1, at 8-9; TDB-1, at 10). The Attorney General offered no argument on this
issue. The Petitioners and the Unions disagree on the number of Essex's union
employees who could be displaced. The Petitioners estimate that 19 union
positions will be eliminated, based on the Petitioners' assessment of the
potential to integrate Essex's operations with those of Boston Gas (Exhs. AG
1-34 (Proprietary); USA 1-28 (Proprietary); USA 1-66). The Unions estimate that
29 union
<PAGE> 47
D.T.E. 98-27 Page 43
positions would be affected (Exh. TDB-1, at 11-13). This estimate is based on
their evaluation of current Essex union job duties, in light of the Petitioners'
objective to eliminate administrative and clerical positions to attain
operational synergies between Essex and Boston Gas (Exh. TDB-1, at 10-13). There
appears to be broad agreement among the Parties that between 50 and 60 Essex
employees could be displaced as a result of the merger.[33] The precise number
of positions that may be eliminated can be known only after the merger, once
merger integration efforts have been completed and a new collective bargaining
agreement has been reached.[34]
While perpetuation of job redundancies in a consolidated Essex-Boston Gas
system would impose avoidable costs and thus be detrimental to ratepayers, the
elimination of these redundancies can and should be accomplished in a way that
mitigates the effect on Essex's employees. The Petitioners themselves have so
noted (Exh. JFB-1, at 20-21). The Petitioners represent that they will continue
the current programs and establish new programs that assist displaced employees.
For example, the Petitioners state that they have assisted and will
- ----------
[33] For purposes of this estimate, the Department has assumed that Essex's
appliance business would continue in place, rather than being absorbed by
ServicEdge, because the Petitioners have represented that Essex will
continue its service business (Exh. USA 1-40; Tr. 1, at 122-124). However,
even if ServicEdge absorbed Essex's appliance business, the Department
estimates that about seven to ten positions would be displaced in Essex's
gas appliance service division (Exhs. TDB-1, at 14; PH-1, at 2). Given that
the number of positions affected ranges from 50 to a high estimate of 70,
the Department uses the midpoint figure of 60 in its analysis in Section
IV.H, below.
[34] The Petitioners have represented that Essex will engage in good-faith
negotiations with the Unions for a successive collective bargaining
agreement (Tr. 1, at 110). There is no evidentiary basis for questioning
this representation.
<PAGE> 48
D.T.E. 98-27 Page 44
continue to assist Essex's workers through job placement and retraining (Exhs.
JFB-1, at 21; USA 1-80; USA 1-81; Tr. 1, at 118-119). Additionally, the
Petitioners state that any workforce reductions will be carried out in
accordance with all applicable collective bargaining agreements and with all
laws and regulations governing employment and termination relationships (Exh.
Joint Petitioner-1, Att. 1, at 31; Tr. 1, at 109-110).
The Department notes that societal costs must be weighed and balanced
against the benefits resulting from the merger and Rate Plan. We do not lightly
regard the effect of this or any other merger on employment. Future proponents
of mergers or acquisitions must demonstrate that they have a plan for minimizing
the effect of job displacement on employees. To follow up on the effectiveness
of the instant Petitioners' proposed efforts to assist displaced workers, the
Department directs the Petitioners to submit annual reports detailing their
displaced worker assistance efforts. Three reports shall be required. The first
report shall be filed one year after the consummation of the merger, with the
second and third reports to be submitted annually thereafter.
D. EFFECT ON COMPETITION AND ECONOMIC DEVELOPMENT
1. INTRODUCTION
The Petitioners were the only party to address the issue of competition in
this proceeding. The Petitioners state that they intend to combine the resource
portfolios of Boston Gas and Essex, as well as the use of Boston Gas's Broker
Management System to facilitate communications with third-party marketers in
Essex's service territory (Exh. JFB-1, at 18). The Petitioners maintain that
these measures will reduce transaction costs and streamline
<PAGE> 49
D.T.E. 98-27 Page 45
systems for third-party gas marketers, making it easier for marketers to offer
service in Essex's service territory (Petitioners Brief at 22, CITING Exhs.
JFB-1, at 18, USA 1-79).
2. ANALYSIS AND FINDINGS
While Boston Gas has invested in specialized information technology for
third-party marketers, I.E., its Broker Management System, to facilitate the
development of its own transportation program, Essex has not developed a system
with the same capabilities (Exhs. USA 1-78; USA 3-32). To the extent that Boston
Gas's information systems facilitate access by third-party marketers to Essex's
service area, Essex's ratepayers would benefit through the additional choices
afforded in a competitive market (Exh. USA 1-79). Therefore, the Department
finds that the merger should have a beneficial effect upon competition in the
gas industry.
E. COST ALLOCATION ISSUES
1. INTRODUCTION
As a result of the merger, the Petitioners state, Boston Gas would perform
some of the functions now carried out by Essex, including gas procurement (Exh.
JFB-1, at 10; Tr. 1, at 105). The Petitioners represent that Boston Gas would
not allocate any of these common costs to Essex during the term of the Rate Plan
(Tr. 1, at 105). Rather, Boston Gas would assign to Essex only those incremental
costs that Boston Gas would incur as a result of the merger (ID. at 136-137).
The intervenors did not address this issue on brief.
<PAGE> 50
D.T.E. 98-27 Page 46
2. ANALYSIS AND FINDINGS
In determining whether rates are just and reasonable, the Department may
examine affiliate transactions to ensure that dealings between affiliated
companies provide direct benefits to ratepayers and that associated costs are
reasonable and allocated in a nondiscriminatory manner. G.L. c. 164, ss. 76A;
CAMBRIDGE ELECTRIC LIGHT COMPANY, D.P.U. 92-250, at 78 (1993); BAY STATE GAS
COMPANY, D.P.U. 92-111, at 134-135 (1992). The Department historically has
exercised its obligation and authority to ensure that a company's affiliate
costs passed on to the company's ratepayers are reasonable and that ratepayers
pay no more than a fair portion of the costs. D.P.U. 92-111, at 136-137; NEW
ENGLAND TELEPHONE AND TELEGRAPH COMPANY, D.P.U. 86-33-G at 113-211 (1989);
OXFORD WATER COMPANY, D.P.U. 1699, at 10-13 (1984).
The Department's standard for reviewing affiliate transactions was first
articulated in D.P.U. 1699. In that case, the Department found that in order to
recover costs incurred from an affiliate, a company must show that those costs:
(1) are specifically beneficial to the individual company seeking rate relief
(as opposed to other subsidiary members of the system as a whole); (2) reflect a
reasonable and competitive price; and (3) are allocated by a formula that is
cost-effective and nondiscriminatory. D.P.U. 1699, at 13. The Department
previously has noted the desirability of direct assignment of costs where
possible. BERKSHIRE GAS COMPANY, D.P.U. 90-121, at 58-59 (1990). In the case of
indirect common costs, which are not amenable to direct assignment, the
Department has required the use of cost allocations that are appropriate to the
particular cost that is being allocated between companies. ID. at 64-70.
<PAGE> 51
D.T.E. 98-27 Page 47
SEE ALSO MASSACHUSETTS-AMERICAN WATER COMPANY, D.P.U. 95-118, at 101 (1996);
SOUTH EGREMONT WATER COMPANY, D.P.U. 94-161, at 3 n.3 (1995). More recently, the
Department has elaborated on this policy, noting that services should be
provided to an affiliate at fully allocated costs, which cost allocation method
ensures that all direct costs and a portion of indirect costs are recovered from
the affiliate. D.P.U./D.T.E. 97-96, at 7 (1998).
Although it may be more appropriate in an economic sense, the Petitioners'
reliance on the use of "incremental" cost accounting for affiliate transactions
between Essex and Boston Gas is not consistent with Department precedent. The
Department has noted that the "standards of conduct" for affiliate transactions,
as embodied in 220 C.M.R. secs. 12.00 ET SEQ., are not intended to prohibit
regulated distribution companies from sharing costs and services. D.P.U./D.T.E.
97-96, at 12. One of the Petitioners' stated reasons for the merger is to
achieve operating synergies between Essex and Boston Gas (Exh. WJF-1, at 5-6).
The Petitioners' incremental cost approach would fail to share these synergies
for the benefit of both Boston Gas and Essex ratepayers. Therefore, the
Department finds that the Petitioners' approach is not an acceptable method for
accounting for affiliate transactions between the two LDCs.
Accordingly, the Petitioners are hereby directed to develop a cost
allocation system for transactions between Boston Gas and Essex consistent with
Department precedent. In preparing this system, the Petitioners must
functionalize all costs, classify the expenses in each functional category,
identify the appropriate allocators, and allocate all costs. D.P.U. 92-250, at
90. Furthermore, the Petitioners must explain the underlying criteria or
rationale for the
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D.T.E. 98-27 Page 48
choice of allocators used to allocate the costs among Essex, Boston Gas, or any
other operating company. ID. The Petitioners shall provide the Department and
other parties in this proceeding with their proposal within nine months from the
date of this Order. This information is required so that the Department may
properly exercise its supervisory authority under G.L. c. 164, ss. 76, and to
provide a reference by which the costs of future merger proposals may be
evaluated.
F. TRANSACTION AND MERGER INTEGRATION COSTS
1. INTRODUCTION
According to the Petitioners, the merger will result in expenses of
$9,120,000 in integration costs necessary to achieve the anticipated economies
of scale associated with the merger, such as retirement, severance, and system
consolidation costs, plus $7,605,000 in transaction costs, such as legal and
regulatory expenses (Exhs. JFB-5; JFB-6; Tr. 1, at 50-53). The Petitioners state
that the Rate Plan has been designed to provide Eastern's shareholders a
reasonable opportunity to recover these costs (Exh. JFB-1, at 14). While these
transaction and merger integration costs are not being charged directly to
ratepayers, an evaluation of these costs is necessary as part of the balancing
of costs and benefits required under our ss. 96 standard.
2. POSITIONS OF THE PARTIES
a. INTERVENORS
The Attorney General opposes the inclusion of any of the $7,605,000 in
transaction costs as part of merger costs. The Attorney General contends that
because shareholders will
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D.T.E. 98-27 Page 49
benefit from the merger, the transaction costs are more appropriately attributed
to shareholders (Attorney General Brief at 24-25, CITING Exh. DJE-1, at 14;
BOSTON EDISON COMPANY, D.P.U. 1350, at 166-167 (1983)).
The Attorney General and the Unions argue that the Petitioners have
overstated the $9,120,000 in merger integration costs (ID. at 25-29; Unions
Reply Brief at 2). The Attorney General maintains that $2,507,000 in separation
costs related to seven employees is unnecessary, since Essex's disclosure
statement to its shareholders suggests that these employees actually will remain
in the employ of Essex (Attorney General Brief at 25-26, CITING Exh. AG 1-1). In
the alternative, the Attorney General proposes that if the Department allows any
executive separation costs, costs related to these employees should be adjusted
pro rata to reflect comparable separation costs associated with the other
employee positions proposed to be eliminated, for a reduction of $1,826,000 (ID.
at 26).
The Attorney General also contests the inclusion of $500,000 in directors'
retirement fees and $1,472,000 in directors' deferred compensation fees as part
of the merger integration costs (ID. at 26-28). With respect to directors'
retirement fees, the Attorney General argues that the Petitioners' actuarial
assumptions underlying the calculations are flawed and fail to account for
approximately $100,000 in liabilities that have already been reflected on
Essex's books (ID. at 27). Using what he considers more reasonable assumptions,
the Attorney General proposes to reduce directors' retirement fees by $300,000
(ID., CITING Exh. DJE-1, at 17). With respect to the directors' deferred
compensation fees, the Attorney General contends that (1) Essex already has
recorded these fees on its books, and (2) the deferred
<PAGE> 54
D.T.E. 98-27 Page 50
compensation is in the form of common stock that the Petitioners factored into
the earnings dilution analysis (ID. at 27-28).
The Attorney General also disputes the proposed inclusion of $1,628,000 in
additional post-retirement health care and life insurance costs arising from the
application of Statement of Financial Accounting Standards Board No. 106 ("FAS
106") to Essex's early retirement options (ID. at 28-29). According to the
Attorney General, the Petitioners first raised their FAS 106 costs as an expense
during evidentiary hearings (ID. at 28). The Attorney General argues that the
Petitioners failed to support the proposed adjustment because they provided no
description of the actuarial assumptions upon which they relied, not indicating
the extent, if any, to which these costs were the result of accelerated outlays
arising from the merger, and not explaining whether any portion of these costs
is being recovered through Essex's current rates (ID. at 28-29, CITING
RR-DTE-1).
b. PETITIONERS
The Petitioners contend that the costs and benefits associated with the
merger are inextricably linked and that all demonstrable costs should be
considered recoverable (Petitioners Reply Brief at 14-15, CITING Tr. 4, at 48).
Regarding the proposed executive separation costs, the Petitioners maintain that
the references in the shareholder disclosure statements upon which the Attorney
General relied describe the immediate post-merger situation, during which
Eastern may need to retain certain Essex executives on a short-term basis to
continue certain administrative functions. (ID. at 15, CITING Tr. 1, at 138).
The Petitioners argue that the executive separation costs represent obligations
created by valid
<PAGE> 55
D.T.E. 98-27 Page 51
contracts entered into long before any merger-related decisions were made by
Essex, and that the upfront costs are significantly outweighed by the long-term
savings in O&M expense (Petitioners Reply Brief at 15-16). Regarding the FAS 106
adjustment, the Petitioners claim that the Attorney General had ample
opportunity to question or rebut the information provided in Record Request
DTE-1, either through cross-examination, additional record requests, or through
further inquiry (ID. at 16).
3. ANALYSIS AND FINDINGS
In MERGERS AND ACQUISITIONS, the Department stated that the public interest
judgment required under ss. 96 requires the quantification of costs and benefits
to the extent such a judgment is susceptible of quantification. MERGERS AND
ACQUISITIONS at 7. An evaluation of the transaction and merger integration costs
is necessary to assess the costs and benefits of the merger. The Department
recognizes that certain merger-related costs are not subject to the same level
of precision as generally can be attained in a traditional cost-of-service rate
proceeding. Therefore, the Department evaluates the proposed transaction and
merger integration expenses according to whether and to what extent such costs
can be quantified.
Concerning the estimated $7,605,000 in transaction costs, the Department
previously has excluded these types of expenses from cost of service. BAY STATE
GAS COMPANY, D.P.U. 777, at 7, 32 (1982). The basis for such treatment rested
upon the premise that acquisitions of operating companies by holding companies
benefit both shareholders and ratepayers, and that in the absence of a clear
apportionment of these costs to shareholders, such costs would be denied. ID. at
7. However, in MERGERS AND ACQUISITIONS at 16, 18-19,
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D.T.E. 98-27 Page 52
the Department recognized that there are transaction costs associated with a
merger or an acquisition, and that these costs may be allowable if the public
interest standard of ss. 96 is satisfied. Certain transaction costs, such as
regulatory filing fees, are elements necessary to the completion of the merger
(Exhs. WJF-1, at 11; USA 1-73; Tr. 4, at 48).
The estimated transaction costs consist of $2,700,000 in investment banking
fees, broken down as $1,050,000 to Salomon Smith Barney and $1,650,000 to Furman
Selz, LLC ("Furman Selz") (Exh. USA 1-73). Legal and regulatory fees consist of
$350,000 to Ropes & Gray, $800,000 to Wachtel Lipton, $35,000 to Hamel, and
$300,000 to Keegan, Werlin & Pabian (ID.; Exh. JFB-6). In addition, the
transaction costs include $200,000 in accounting fees to Arthur Anderson,
$37,000 in SEC filing fees, $45,000 in filing fees required under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, $155,000 in other
expenses, and $2,983,000 in income tax obligations[35] (Exhs. WJF-1, at 11;
JFB-6; USA 1-73). The Attorney General has objected to the inclusion of these
fees on a general basis but without directly contesting the record evidence
offered to support the reasonableness of these costs. Therefore, the Department
concludes that these transaction costs are commensurate with the complexity of
the merger and are reasonable in amount. The overall scope of the transaction --
as measured by the probable value of the stock transfer -- is about $84
million.[36] Transaction costs of $7.6 million are reasonable in view of the
magnitude of the assets
- ----------
[35] The transaction costs are not considered deductible for income tax purposes
(Exh. AG 1-44; Tr. 1, at 95-96).
[36] This value is based on the purchase price of $47.50 per Essex share,
multiplied by 1,778,058 Essex shares (Exhs. PJM-4; AG 1-18).
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D.T.E. 98-27 Page 53
involved, the complexity of the transfer and the immediate and long range
benefits Essex's shareholders can expect. Accordingly, the Department includes
the full $7,605,000 in transaction costs in our estimation of the costs
associated with the merger.
Concerning the estimated $4,445,000 in separation costs for Essex
executives, the disclosure statement filed by Essex indicates that seven
executive-level employees (Essex's president, five vice presidents, and
corporate clerk) are parties to employment agreements that provide for severance
payments and related benefits (Exhs. AG 1-1, at 33; USA 1-29). These employees
may continue to be employed by Essex for some period of time after the merger,
pending an evaluation of staffing requirements (Exh. AG 1-1, at 33). The primary
role of these employees after the merger will be to maintain corporate
continuity during some nominal, interim period. The Department finds no basis in
the record to conclude that these individuals will remain as employees of Essex
for any significant period after the merger.[37]
The Department has considered the nature of the separation agreements and
notes that these types of agreements are common (Tr. 4, at 41). Essex's
estimated separation costs are based on signed agreements entered into from 1987
through 1995, before Essex initiated the process that resulted in its
negotiations with Eastern (Exh. USA 1-30; Tr. 2, at 43-44). The Department
concludes that the affected employees' severance packages consist of lump sum
payments and bonuses, benefits, payroll taxes, and supplemental executive
retirement plan
- ----------
[37] The Department recognizes that retention of these employees is dependent
upon the results of Eastern's evaluation of Essex's post-merger staffing
requirements. We accept the Petitioners' representation of their present
intent but require a status report concerning the execution of these
severance agreements a year following the merger.
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D.T.E. 98-27 Page 54
payments (Exhs. AG 1-1, at 33; USA 1-72, at 2 (Proprietary)). The Department
concludes that these payments are commensurate with the employees'
responsibilities at Essex, and are necessary components for Essex's
participation in the labor market. Therefore, the Department finds that the
total separation costs are reasonable. Accordingly, the Department includes the
$4,445,000 in executive separation costs in our evaluation of the costs
associated with the merger.[38]
Concerning the addition of $1,628,000 in FAS 106 expenses, this adjustment
stems from the application of FAS 106 to the post-retirement health care and
life insurance features of Essex's early retirement program, which had not
originally been incorporated into the estimated severance and retirement costs
(Tr. 1, at 50-52, 133-135). Our examination of the underlying factors behind the
development of the FAS 106 costs leads us to conclude that the $1.6 million in
FAS 106-related costs are related only to those costs that would be incurred as
a result of the merger, and not otherwise reflected in Essex's rates. The
Department finds that the calculations provided by the Petitioners provide
sufficient detail to assess the proposed inclusion of FAS 106-related costs in
the merger integration costs.
Under Essex's early retirement plan, retirees would be receiving benefits
both earlier and for a longer period than originally anticipated by Essex's
pension actuaries (Tr. 1, at 51-52, 135). While early retirement costs
associated with union employees are
- ----------
[38] In so stating, we draw a direct and express parallel to the Petitioners'
representation that fair and reasonable efforts will be undertaken to
accommodate the needs for other displaced employees at lower levels of the
organization, who lacked the organizational or economic leverage to
negotiate severance agreements for themselves.
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D.T.E. 98-27 Page 55
acknowledged by the Petitioners as contingent upon the results of the collective
bargaining process, the Department has reviewed the FAS 106-related costs, and
concludes that the $1,628,000 represents a reasonable estimate of Essex's FAS
106 obligations created as a result of the merger. Accordingly, the Department
includes the $1,628,000 in FAS 106 costs in our evaluation of the costs
associated with the merger.
With respect to the $500,000 in directors' retirement fees, the Department
has examined the assumptions underlying the Petitioners' calculations. In the
preparation of their estimate, the Petitioners assumed that directors would live
20 years past the retirement age of 72, and applied a five percent discount rate
to develop the net present value of director retirement fees (Exh. USA 1-72, at
3 (Proprietary)). The Department concurs with the Attorney General that the
assumptions used to develop the net present value calculation are questionable,
particularly in light of the 7.5 percent discount rate used by Essex in its
actuarial assumptions used to determine its pension obligations (Exh. AG 1-2
(1997 Essex Annual Return to the Department at 27)). Although the Petitioners
had ample opportunity to address this issue, they failed to do so either during
evidentiary hearings or on brief. The Department finds that the Petitioners'
proposed directors' retirement fees are overstated. The Department accepts the
Attorney General's proposed adjustment. Accordingly, the Department excludes
$300,000 in directors' retirement fees from our evaluation of the costs
associated with the merger.
With respect to the directors' deferred compensation fees of $1,472,000,
the Department notes that this amount represents 51,523 shares of Essex common
stock issuable as
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D.T.E. 98-27 Page 56
of August 31, 1997, to Essex's directors under an optional deferral program
(Exhs. AG 2-1; USA 1-15; USA 1-72 (Proprietary)). To arrive at the $1,472,000,
the Petitioners took the difference between an assumed stock price of $50 per
share and an average price of $21.42 per share recorded as of August 31, 1997,
which was $28.58, and multiplied that net difference by the 51,523 common
shares, producing a directors' deferred compensation balance of $1,472,527 (Exh.
AG 2-1). The 51,523 shares are also included in the 52,821 deferred directors'
shares issuable as of January 1, 1998, which are a component of the Petitioners'
reported 1,778,058 common shares of Essex used in the Petitioners' calculation
of the estimated $47.1 million acquisition premium (Exhs. AG 1-18; USA 1-15; USA
1-72, at 6 (Proprietary)). Therefore, the Department concludes that the
directors' deferred compensation fees have been included twice in the
Petitioners' estimate of the merger integration costs, and that inclusion of the
directors' deferred compensation fees in both places inappropriately results in
double-counting of these costs. Accordingly, the Department excludes $1,472,000
in deferred director compensation fees from our evaluation of the costs
associated with the merger.
Based on the foregoing, the Department has excluded a total of $1,726,000
from the Petitioners' proposed merger integration expenses for purposes of
evaluating the merger. In doing so, we emphasize that our decision here does not
deprive Eastern of any reasonable opportunity to recover legitimate
merger-related costs through the Rate Plan. Rather, our decision rests on the
fact that the Department's standard for evaluating merger proposals under
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D.T.E. 98-27 Page 57
ss. 96 requires a record that quantifies costs and benefits to the extent such a
judgment is susceptible of quantification. SEE Section III, above.
While the Department will consider transaction and merger-integration costs
of $15,089,000 in our evaluation of the costs and benefits associated with the
merger, the transaction expenses cannot be determined with finality until after
the completion of the merger. Moreover, certain merger integration costs, such
as those related to union employees, are classified by the Petitioners as
dependent upon the results of the collective bargaining process, and thus may
not be ultimately incurred by Eastern. Accordingly, the Department hereby
directs the Petitioners to provide the Department with an accounting of the
final transaction and merger integration costs. Specifically, the Petitioners
shall provide a detailed listing of the transaction costs 90 days from the date
of consummation of the merger and provide a detailed listing of the merger
integration costs nine months from the date the merger is consummated.
G. ACQUISITION PREMIUM
1. INTRODUCTION
The Petitioners estimate that the merger will result in an acquisition
premium of approximately $47.1 million, representing earnings dilution that
would be experienced by Eastern shareholders. This acquisition premium also
corresponds to the difference between the purchase price of $47.50 per share of
Essex common stock and Essex's book value of $21.01 per common share, multiplied
by 1,778,058 Essex shares outstanding as of December 1, 1997 (Exh. PJM-1, at
13).
<PAGE> 62
D.T.E. 98-27 Page 58
The Petitioners propose that Eastern's shareholders recover the acquisition
premium, together with the transaction costs and merger integration costs,
through the estimated $5.1 million in annual savings (representing 41 percent of
Essex's fiscal year 1997 O&M expense)[39] anticipated as a result of the merger
over the term of the Rate Plan (Exh. JFB-1, at 11-12; Tr. 1, at 50-53). The
Petitioners state that these savings will be achieved primarily from the
implementation of certain information-technology systems used by Boston Gas,
thereby eliminating the need for 31 management and 19 union positions[40] (Exhs.
JFB-1, at 8-9; USA 1-65; USA 1-66). The Petitioners estimate that the wage and
salary cost reductions associated with these positions are approximately
$2,693,000,[41] plus an additional $969,000 in employee benefits (Exhs. JFB-1,
at 9; JFB-4; USA 3-28).[42] Further, the Petitioners estimate that additional
savings totaling $1,439,000[43] would occur from the consolidation of programs
- ----------
[39] The Petitioners' estimate of 41 percent was derived by dividing the
estimated O&M savings, or $5,101,000, by Essex's actual O&M expenses for
the year ending August 31, 1997 of $12,584,000.
[40] The Petitioners consider the projected $5.1 million O&M savings to be
achievable if the issue of union employment can be resolved during the
collective bargaining process (Exh. JFB-1, at 9).
[41] The $2,693,000 in estimated employee reductions was calculated by adding
$2,015,000 in management employee expenses and $678,000 in union employee
expenses (Exh. JFB-1, at 9; Tr. 1, at 49-50).
[42] The $969,000 in employee benefits was calculated by taking the estimated
average cost per employee of $19,380 times the estimated employee
reductions (Exh. USA 3-28).
[43] The $1,439,000 is the result of total non-wage/salary savings of $2,408,000
less employee benefits of $969,000 (Exh. JFB-1, at 9).
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D.T.E. 98-27 Page 59
and expenditures relating to insurance, audit and consulting fees, shareholder
services and other general corporate functions (Exhs. JFB-1, at 9; JFB-4; USA
1-67).
The Petitioners state that, unless reasonable opportunity to recover the
calculated acquisition premium is allowed, a per-share earnings dilution would
occur for Eastern shareholders and would negate the value of the acquisition to
Eastern and eliminate any reason to proceed with the merger (Exhs. PJM-1, at
13-14; WJF-1, at 8). Based on a ten-year projection of Eastern's fiscal year
1998 earnings per share of $2.82, escalated each year by three percent, the
Petitioners conclude that Eastern's shareholders would need to realize and
retain savings resulting from the merger of at least $46 million in pre-tax
earnings over the next ten years, for an annual average of $4.6 million per
year, in order to compensate for the earnings dilution (Exhs. PJM-1, at 14-16;
PJM-4).
2. POSITIONS OF THE PARTIES
a. INTERVENORS
The Attorney General characterizes the Petitioner's earnings dilution
analysis as a "surrogate acquisition premium" (Attorney General Brief at 15).
The Attorney General and the Unions maintain that, contrary to the Petitioners'
contention, there is no acquisition premium associated with the merger because
of the use of pooling of interests accounting (ID., CITING MERGERS AND
ACQUISITIONS at 10; Attorney General Reply Brief at 4; Unions Reply Brief at 2).
The Attorney General contends that granting any form of acquisition premium in
this case would result in a detriment to ratepayers that would outweigh any
"illusory benefits" offered by the Petitioners' proposed gas cost reduction and
rate freeze (Attorney General Reply Brief
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D.T.E. 98-27 Page 60
at 4). The Attorney General advocates that the Department require Eastern's
shareholders to bear the cost associated with any earnings dilution resulting
from this merger (Attorney General Brief at 16).
In the alternative, the Attorney General proposes that, if the Department
were to allow recovery of anticipated earnings dilution, the sole basis for
measuring the estimated dilution of earnings should be the dilution of Eastern's
book value per share (ID. at 20-21, CITING Exh. DJE-1, at 23-24). Based on the
anticipated dilution to Eastern's book value of $0.35 per share applied to the
20,378,000 Eastern shares outstanding prior to the merger, plus $1,110,000
related to premiums on the additional Eastern shares to be issued under the
merger, the Attorney General concludes that the appropriate level of earnings
dilution that could be considered for recovery is no more than $8,242,000 (ID.
at 24).
b. PETITIONERS
The Petitioners argue that, as a result of Eastern's exchange of its common
stock for the shares of Essex, Eastern shareholders would realize a lower level
of earnings per share for Eastern stock (Petitioners Brief at 15). According to
the Petitioners, the earnings dilution analysis identifies the cost savings
resulting from the merger that must be retained by Eastern in order to
compensate Eastern's shareholders for this earnings dilution (ID. at 31-32;
Petitioners Reply Brief at 20). Moreover, the Petitioners argue that the
Department has acknowledged the concept of earnings dilution and its
significance in pooling of interests accounting (Petitioners Reply Brief at 19,
CITING MERGERS AND ACQUISITIONS at 14, 15 n.10). The Petitioners claim that the
earnings dilution analysis represents a conservative estimate of
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D.T.E. 98-27 Page 61
the impact the merger will have on Eastern's earnings per share, taking into
account Eastern's historic growth rate and the range of growth rates for gas
distribution companies (Petitioners Brief at 32, CITING Exhs. PJM-1, at 14;
PJM-4; Tr. 1, at 34; SEE ALSO Petitioners Reply Brief at 19).
The Petitioners assert that the Attorney General's dilution-to-book-value
analysis is flawed in its failure to account for the entire economic cost of the
premium inherent in the transaction (Petitioners Reply Brief at 18). The
Petitioners contend that, in the face of the $47.00 per share purchase price and
Essex's book value of $21.01 per share, the Attorney General's earnings dilution
calculation defies logic (ID. at 18-19). The Petitioners conclude that because
the Rate Plan produces immediate and long-term benefits to ratepayers, recovery
of the transactions costs, including the acquisition premium, is justified (ID.
at 20).
3. ANALYSIS AND FINDINGS
The Department has stated that it will consider, on a case-by-case basis,
individual merger or acquisition proposals that seek recovery of an acquisition
premium, as well as the appropriate recovery level of such a premium. MERGERS
AND ACQUISITIONS at 18-19. Under the Department's standard, a company proposing
a merger or acquisition must, as a practical matter, demonstrate that the costs
or disadvantages of the transaction are accompanied by benefits that warrant
their allowance. Thus, allowance or disallowance of an acquisition premium would
be just one part (albeit an important one) of the cost/benefit analysis under
the ss. 96 standard. ID. at 7.
<PAGE> 66
D.T.E. 98-27 Page 62
As noted, the Attorney General and Union contend that under pooling of
interests accounting acquisition premiums are equal to zero. In MERGERS AND
ACQUISITIONS, a number of commenters stated while pooling of interests
accounting did not give rise to an acquisition premium PER SE, earnings dilution
for the acquiring company would represent a factor warranting consideration in a
merger petition. MERGERS AND ACQUISITIONS at 14-15 n.10. While pooling of
interests accounting does not translate into revalued books for accounting
purposes or an acquisition premium as found under purchase accounting, it does
give rise to direct costs, as well as indirect costs, through the impact upon
earnings (Exh. USA 3-19, Att. 1 at 37-39).[44] Pooling of interests accounting
reasonably recognizes costs that investors must have an opportunity to recover,
and provides an incentive for mergers and acquisitions that benefit ratepayers,
but that would otherwise not take place without recovery of these costs. As
discussed below, we find that the level of acquisition premium resulting from
this merger is reasonable.
The Attorney General and Unions have proposed that if the Department allows
recovery of any acquisition premium, the premium should be limited to the
resulting dilution to Eastern's book value per share. Although the dilution in
book value is indicative that a premium has been paid, this measure of dilution
does not account for all of the costs associated with mergers. In a pooling of
interests transaction, which is the method being used to account for this
merger, the purchase price is determined on the basis of the earnings stream
expected from the transaction and the retention of sufficient earnings to, at a
minimum, offset the costs
- ----------
[44] SEE note 6, above.
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D.T.E. 98-27 Page 63
of the transaction (Exh. PJM-1, at 9; Tr. 1, at 26). The exchange ratio at which
the stock transactions take place typically reflects a premium over the market
value of the acquired company, thus diluting both the book value and the
earnings per share of the acquiring company (Exhs. PJM-1, at 9; USA 3-19, Att. A
at 5; Tr. 1, at 17-18). The Petitioners evaluated the earnings dilution
associated with this merger by comparing the projected earnings for Essex with
the projected earnings for Eastern, using an approach that accounts for both the
expected return on Eastern's investment in Essex and Eastern's cost of capital
(Exhs. PJM-1, at 14-15; PJM-4; Tr. 4, at 34-35). Under this merger, Essex
shareholders will receive cash or Eastern shares worth $47.50 in exchange for
Essex stock with a book value of $21.01 per share (Exh. JFB-1, at 14).
Consequently, Eastern's shareholders will experience both book and earnings
dilution in the value of their holdings (Exh. PJM-1, at 13). Unless Eastern
obtains a reasonable opportunity to maintain its earnings per share, the result
will be a loss in Eastern's earnings stream and a diminution in the market value
of Eastern's stock (ID.).
Under the Attorney General's proposal, the value of Eastern's holdings
associated with the merger would fall from approximately $40 per share to $21.54
per share (Exhs. AG 1-23; DJE-1, at 25-26). The Attorney General's approach,
would, if adopted, be genuinely harmful to Eastern's shareholders and would
nullify any reason for Eastern to consummate the merger. Essex's ratepayers
would be the principal losers, for Essex would remain a small LDC at the end of
the interstate pipeline system, increasingly challenged to respond in a
competitive market dominated by much larger players. The Department therefore
concludes that the earnings dilution analysis presented by the Petitioners in
this proceeding is fairly representative
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D.T.E. 98-27 Page 64
of the economic costs that Eastern's shareholders would bear as a result of this
merger.
With respect to the level of consideration paid by Eastern for Essex, the
record evidence demonstrates that the purchase price was evaluated in light of
both a comparison with purchase prices associated with other recent mergers and
acquisitions by LDCs and an assessment of the potential cost savings resulting
from the merger (Exhs. PJM-1, at 7; PJM-3). A purchase price at a multiple of
book value expresses a buyer's expectations of the acquired company's future
contributions to combined operations. The particular exchange rate involved in
merger and acquisition stock transactions expresses a number of matters of value
to the buyer, including a premium for management control and long-term strategic
and economic value perceived by the buyer as accruing from the transaction (Exh.
PJM-1, at 6, 8). Historic merger and acquisition activities in the natural gas
distribution industry have been achieved with purchase prices ranging between
1.4 times and 3.5 times the book value of the acquired company (Exhs. PJM-1, at
5; PJM-3). More recent mergers and acquisitions have occurred at purchase prices
in the range of 1.9 to 2.8 times book value (Exhs. PJM-1, at 5; PJM-3).
The proposed purchase price for Essex's stock is 2.3 times book value (Exh.
PJM-1, at 7). This price represents a price-earnings multiple of 18.6 times
Essex's most recent earnings (ID.). The proposed purchase price and exchange
ratio in this case are consistent with industry experience (Exh. PJM-3). Both
Eastern's and Essex's independent advisors, Salomon Smith Barney and Furman
Selz, respectively, have pronounced these terms of the transaction to be
reasonable (Exhs. AG 1-1, at B-1 through B-3; USA 3-15 (Proprietary)).
Therefore, the Department finds that the proposed purchase price for Essex's
common stock and proposed
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D.T.E. 98-27 Page 65
exchange ratio are in line with experience in other gas acquisitions and
therefore are reasonable and valid expressions of today's market conditions. CF.
HAVERHILL ELECTRIC COMPANY, D.P.U. 2138 (1926) (Department rejected proposed
one-to-one stock exchange ratio, and directed parties to apply a seven-to-ten
exchange ratio). Because the stock exchange, when it occurs in fact, will be
based on the actual number of Essex shares outstanding and Eastern's common
stock price per share on the consummation date, the actual amount of the
acquisition premium cannot be precisely calculated until the consummation date
or shortly thereafter --although its range is formulaically determined. The
Petitioners are hereby directed to provide the Department with a copy of the
journal entries or a schedule summarizing such entries upon completion of the
merger, in sufficient detail so as to provide the actual acquisition premium.
Throughout this proceeding, Eastern has represented repeatedly that its
shareholders, not Essex ratepayers, would bear any risk that operational savings
and synergies arising from the merger would be insufficient to cover the annual
amortization of the acquisition premium (Exhs. JFB-1, at 14; USA 1-60; Tr. 1, at
60-61, 80-82; Petitioners Brief at 16). This repeated representation is one to
which Eastern and Essex may and will fairly be held throughout the period of the
Rate Plan.
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D.T.E. 98-27 Page 66
H. SUMMARY
The Department has evaluated the benefits and costs associated with the
merger based on the following seven factors: (1) effect on rates, resulting net
savings, and alternatives to the merger; (2) effect on quality of service; (3)
societal costs; (4) effect on competition and economic development; (5) cost
allocation issues; (6) transaction and merger integration costs; and (7)
recovery of an acquisition premium.
With respect to effect on rates, resulting net savings, and alternatives to
the merger, the Department found that approval of a ten-year freeze of base
rates will yield benefits to Essex's ratepayers and results in just and
reasonable rates. Further, the Department recognized that the proposed merger
will provide Essex's ratepayers with guaranteed savings in gas costs that would
be unavailable absent the merger. Based on our evaluation of the Rate Plan, the
Department also concludes that the five percent rate reduction and ten-year rate
freeze, in conjunction with the opportunity for Eastern's shareholders to
recover the costs associated with the merger, represents a fair allocation of
the benefits between shareholders and ratepayers.
With respect to the proposed merger's effect on quality of service, the
Department has determined that it is necessary to implement a quality of service
plan in order to ensure that Essex's ratepayers experience no degradation of
service following the merger. The Department has outlined service quality
measures to be tracked and recorded and we have indicated that we will conduct a
proceeding to investigate establishing service quality benchmarks and penalties
for failure to meet those standards.
Referring to societal costs, the Department found that while the merger
will cause
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D.T.E. 98-27 Page 67
workforce reductions for Essex, these costs will be balanced by the benefits of
the merger and Rate Plan. The Petitioners represent that they will act to
mitigate adverse effects on Essex's workforce. The Department has required three
annual reports on the effectiveness of these mitigation efforts and will use
this information to evaluate the Petitioners' efforts to mitigate the effect of
the merger on displaced employees.
With respect to the impact on competition and economic development, the
Department found that the integration of Boston Gas's information systems with
Essex's will facilitate access of third party gas marketers to Essex's service
territory. The Department further found that increased market access to Essex's
service territory is likely to have a beneficial effect on both competition and
economic development in Essex's service territory.
Regarding the allocation of the costs between Boston Gas and Essex, the
Department found that the Petitioners' proposed method of incremental cost
pricing for affiliate transactions fails to comply with Department policy. As a
result, the Department has directed the Petitioners to account for affiliate
transactions between Boston Gas and Essex on a fully-allocated cost basis, and
to provide the Department within nine months of the issuance of this Order a
proposal for implementation of affiliate transaction accounting in accordance
with Department policy.
With respect to transaction and merger integration costs, the Department
found that a total of $1,726,000 from the Petitioners' proposed merger
integration expenses should be excluded for purposes of evaluating costs and
benefits of the merger. The Department has found that $7,605,000 in transaction
costs, and $7,394,000 in merger integration costs, for a
<PAGE> 72
D.T.E. 98-27 Page 68
total of $14,999,000, represent a reasonable level of these expenses for
purposes of quantifying these cost components associated with the merger.
Regarding recovery of an acquisition premium, the Department found that
earnings dilution to Eastern's shareholders that results from the merger
represents a cost that may and should be taken into consideration as part of the
evaluation of the costs and benefits of the merger. The Department found that
the proposed purchase price for Essex's common stock and proposed exchange ratio
are reasonable. Therefore, the Department accepted the Petitioners' estimate of
$47,100,000 for the acquisition premium and has found it to be reasonable.
The Department finds that the total transaction costs, merger integration
costs, and acquisition premium are estimated at $62,099,000, allowing for the
adjustments made by the Department to the merger integration costs. Under the
Rate Plan, Essex's ratepayers will not pay for these costs. Instead, Eastern
will have an opportunity to recoup these costs by seeking to capture
merger-related efficiencies for shareholders during the term of the Rate Plan.
Over the term of the Rate Plan, the Department estimates that those expected
efficiencies, including the midpoint of the range of union positions which may
be eliminated as a result of the merger, will be $56,530,000. While the expected
efficiencies are less than the total merger-related costs, Essex's ratepayers
are not at risk for any underrecovery of these costs by Eastern, and no
incremental charges will be applied to ratepayers to recover the premium.
Therefore, the Department concludes that Petitioners' proposed recovery plan for
the acquisition premium is consistent with the general reckoning of cost and
benefit under the
<PAGE> 73
D.T.E. 98-27 Page 69
ss. 96 consistency standard. MERGERS AND ACQUISITIONS at 18-19. In addition,
customers will actually receive benefits in the form of base rate freeze and a
reduction in gas costs, both of which would not have been realized without the
merger.
Based on our evaluation of the costs and benefits associated with the
aforementioned factors, the Department finds that the public interest would be
at least as well served by approval of the proposed merger as by its denial,
I.E., there is no net harm to ratepayers. Therefore, the proposed merger is
consistent with the public interest. Accordingly, the Department hereby approves
the Merger Agreement and Rate Plan, subject to the directives related to quality
of service and cost allocation contained herein, under the terms of G.L. c. 164,
secs. 96 and 94.
I. CONCLUSION
As noted, the Department is approving this merger because it is consistent
with our standard of review for such transactions. D.P.U. 850, at 6-8. We
believe that it is useful at this point to provide some background and further
discussion of those standards.
The Department has stated that simulation of the results of a competitive
market is a principal goal of regulation. SEE D.P.U. 94-50, at 110. One of the
features of a competitive market is that firms will evolve in size and scope in
a way that maximizes efficiency over time (under the requirements of antitrust
statutes). Thus we see both consolidation and fragmentation in competitive
markets, as firms seek to find the size and scale that provides the lowest
possible costs consistent with providing high quality products and services. In
regulated utility markets, however, changes in the size and scope of utility
companies are driven in part by requirements and
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D.T.E. 98-27 Page 70
standards imposed by regulators.
The Department's long-standing prohibition against the recovery of an
acquisition premium was an example of a regulatory barrier to consolidation.
Companies in competitive markets do not undertake mergers without a reasonable
opportunity to recover the costs associated with merging (including any
acquisition premium) through higher productivity. A utility company under
cost-of-service regulation, however, would not have the same opportunities
because regulators would be expected to capture all of the productivity benefits
for the utility's customers. Therefore, if utility mergers consistent with the
public interest are to take place, it is necessary for regulators using a
cost-of-service system to allow explicitly for recovery of the costs associated
with a merger or acquisition, either through an actual "premium" included on the
company's books or through the opportunity for allocation of expected
productivity gains to shareholders for a limited period of time. Recovery of a
reasonable acquisition premium should be considered a worthwhile initial
investment in obtaining greater efficiencies for the future benefit of
ratepayers. Our "no net harm" standard ensures that -- even with recovery of the
premium or allocation of productivity gains --the public interest will be at
least as well served by approval of the merger as by denial. We believe that our
"no net harm" requirement also is consistent with the competitive market model
because efficient firms in competitive markets cannot make their customers worse
off in order to recover their firm-specific transaction costs.
<PAGE> 75
D.T.E. 98-27 Page 71
The Department's PER SE prohibition against recovery of an acquisition
premium was removed in MERGERS AND ACQUISITIONS in order to allow utilities to
seek their most efficient size and scope with the opportunity to recover
reasonable merger-related costs, as long as customers are at least as well off
with the merger as they would be without it. In this way, merger and acquisition
activity will be undertaken primarily on the basis of providing high quality
utility services at the least possible cost, and not on the basis of regulatory
requirements. The standards outlined in D.P.U. 850 and MERGERS AND ACQUISITIONS,
as applied in this Order to approve the merger of Eastern and Essex, should
encourage consummation of utility mergers at a pace and on a scale achieved by
forces in an efficient competitive market.
V. STOCK ISSUANCE
A. INTRODUCTION
Acquisition Company is intended to have an authorized capitalization of
200,000 shares of common stock, $1.00 par value, of which 100 shares have been
subscribed by Eastern for sale to Eastern at a price of $1.00 per share (Exhs.
DTE 1-30; WJF-1, at 10). The Petitioners request that the Department authorize
and approve the proposed issuance of 100 shares of this common stock to Eastern
(Exh. WJF-1, at 12). The Petitioners state that the proposed issuance is
reasonably necessary to effect the merger (Exh. Joint Petitioner-1, at 4). While
the Petitioners restated their request on initial brief, the remaining parties
to the proceeding did not specifically address this issue on brief.
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D.T.E. 98-27 Page 72
B. STANDARD OF REVIEW
In order for the Department to approve the issuance of stock, bonds, coupon
notes, or other types of long-term indebtedness[45] by an electric or gas
company, the Department must determine that the proposed issuance meets two
tests. First, the Department must assess whether the proposed issuance is
reasonably necessary to accomplish some legitimate purpose in meeting a
company's service obligations, pursuant to G.L. c. 164, ss. 14. FITCHBURG GAS &
ELECTRIC LIGHT COMPANY V. DEPARTMENT OF PUBLIC UTILITIES, 395 Mass. 836, 842
(1985) ("FITCHBURG II"), CITING FITCHBURG GAS & ELECTRIC LIGHT COMPANY V.
DEPARTMENT OF PUBLIC UTILITIES, 394 Mass. 671, 678 (1985) ("FITCHBURG I").
Second, the Department ordinarily must determine whether a company has met the
net plant test.[46] COLONIAL GAS COMPANY, D.P.U. 84-96 (1984).
The Court has found that, for the purposes of G.L. c. 164, ss. 14,
"reasonably necessary" means "reasonably necessary for the accomplishment of
some purpose having to do with the obligations of the company to the public and
its ability to carry out those obligations with the greatest possible
efficiency." FITCHBURG II at 836, CITING LOWELL GAS LIGHT COMPANY V. DEPARTMENT
OF PUBLIC UTILITIES, 319 Mass. 46, 52 (1946). In cases where no issue exists
about the reasonableness of management decisions regarding the requested
financing, the Department limits its Section 14 review to the facial
reasonableness of the purpose to which
- ----------
[45] Long-term refers to periods of more than one year after the date of
issuance. G.L. c. 164,ss.14.
[46] The net plant test is derived from G.L. c. 164, ss. 16.
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D.T.E. 98-27 Page 73
the proceeds of the proposed issuance will be put. CANAL ELECTRIC COMPANY, ET
AL., D.P.U. 84-152, at 20 (1984); SEE, E.G., COLONIAL GAS COMPANY, D.P.U. 90-50,
at 6 (1990).
The FITCHBURG I AND II and LOWELL GAS cases also established that the
burden of proving that an issuance is reasonably necessary rests with the
company proposing the issuance, and that the Department's authority to review a
proposed issuance "is not limited to a `perfunctory review.'" FITCHBURG I at
678; FITCHBURG II at 842, CITING LOWELL GAS at 52.
Where issues concerning the prudence of a company's capital financing have
not been raised or adjudicated in a proceeding, the Department's decision in
such a case does not represent a determination that any specific project is
economically beneficial to a company or to its customers. In such circumstances,
the Department's determination in its Order may not in any way be construed as
ruling on the appropriate ratemaking treatment to be accorded any costs
associated with the proposed financing. SEE, E.G., BOSTON GAS COMPANY, D.P.U.
95-66, at 7 (1995).
Regarding the net plant test, a company is ordinarily required to present
evidence that its net utility plant (original cost of capitalizable plant less
accumulated depreciation) is equal to or exceeds its total capitalization (the
sum of its long-term debt, preferred stock, and common stock outstanding) and
will continue to do so after the proposed issuance. D.P.U. 84-96, at 5. If the
Department determines at that time that the fair structural value of the net
plant and land and the fair market value of the nuclear fuel, gas or fossil fuel
inventories owned by the company are less than its outstanding debt and stock,
it may
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D.T.E. 98-27 Page 74
prescribe such conditions and requirements as it deems best to make good within
a reasonable time the impairment of the capital stock. G.L. c. 164, ss. 16.
C. ANALYSIS AND FINDINGS
The Department finds that the issuance of 100 shares of common stock by
Acquisition Company, at a par value of $1.00, is a necessary mechanism for the
purpose of forming Acquisition Company and then effecting the proposed merger.
Accordingly, the Department finds that the proposed stock issuance is reasonably
necessary and is in accordance with G.L. c. 164, ss. 14.
With regard to the net plant test requirement of G.L. c. 164, ss. 16, the
record demonstrates that Acquisition Company has no assets, and thus could not
meet the net plant test as contemplated by G.L. c. 164, ss. 16. However, the
Department notes that the purpose of the stock issuance is to set up a transient
framework for the consummation of the Merger Agreement and acquisition of Essex
by Eastern. The Merger Agreement would extinguish the corporate existence of
Acquisition Company and consequently, remedy any net plant deficiency of
Acquisition Company. BOSTON EDISON COMPANY, D.P.U./D.T.E. 97-63, at 73 (1998).
The purpose of the net plant test is to protect investors from hidden watering
of stock. Application of the test has no place in a transaction as patent and
transparent as the instant one. No public protective purpose would be served by
applying the test here. It is sufficient to note that the transaction is
structured to prevent any adverse risk to the investing public and immediately
to correct any theoretical problem with the Acquisition Company shares.
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D.T.E. 98-27 Page 75
Therefore, the Department finds it unnecessary to impose further conditions upon
Acquisition Company under G.L. c. 164, ss. 16.
VI. CONFIRMATION OF ESSEX'S FRANCHISE RIGHTS
A. INTRODUCTION
The Petitioners have requested that the Department confirm that Essex, as
the surviving company of the merger between Acquisition Company and Essex, will
continue to have all the franchise rights and obligations that were previously
held by Essex, and that further legislative action pursuant to G.L. c. 164, ss.
21, is not necessary to consummate the Merger Agreement (Exhs. Joint
Petitioner-1, at 6; WJF-1, at 12). While the Petitioners restated their request
on brief, the remaining parties to the proceeding did not specifically address
this issue on brief.
B. ANALYSIS AND FINDINGS
As the surviving company, Essex's corporate existence would continue
unimpaired after the merger as if the merger had not taken place. No sale of
assets or surrender of Essex's ability to provide service is proposed here.
There will merely be a wholesale change in Essex stock ownership. Thus, the
Department finds that no transfer of any franchise rights would result from this
merger. HAVERHILL GAS COMPANY, D.P.U. 1301, at 3-4 (1984). Moreover, the
Department finds that approval of the merger pursuant to G.L. c. 164, ss. 96
obviates the need in this case for legislative approval under G.L. c. 164, ss.
21. D.P.U. 1301, at 4-5. None of the conditions requiring legislative approval,
such as a transfer of franchise, lease of works, or contract with a third party
to operate Essex's works, applies here. Accordingly, the Department hereby
ratifies and confirms that all the franchise rights and
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D.T.E. 98-27 Page 76
obligations currently held by Essex shall continue in effect after the
consummation of the merger.
VII. ORDER
Accordingly, after due notice, hearing and consideration, the Department
VOTES: That pursuant to G.L. c. 164, ss. 14, the proposed issuance of 100
shares common stock of ECGC Acquisition Gas Company, at a par value of $1.00 per
share, is reasonably necessary for the purposes stated; and it is
ORDERED: That pursuant to G.L. c. 164, ss. 14, the issuance by ECGC
Acquisition Gas Company of 100 shares of common stock to Eastern Enterprises in
consideration of $100 by Eastern Enterprises is hereby approved and authorized;
and it is
FURTHER ORDERED: That pursuant to G.L. c. 164, ss. 96, the merger of ECGC
Acquisition Company into Essex County Gas Company is hereby approved; and it is
FURTHER ORDERED: That pursuant to G.L. c. 164, ss. 96, the Agreement and
Plan of Merger dated as of December 19, 1997, between Essex County Gas Company
and Eastern Enterprises, and the terms thereof, are hereby approved; and it is
FURTHER ORDERED: That pursuant to G.L. c. 164,ss.94, the Rate Plan for
Essex County Gas Company is hereby approved; and it is
FURTHER ORDERED: That, upon consummation of the merger of ECGC Acquisition
Gas Company with and into Essex County Gas Company, Essex County Gas Company as
surviving company shall have all rights, powers and privileges, franchises,
properties, real, personal or mixed, and immunities held by Essex County Gas
Company
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D.T.E. 98-27 Page 77
necessary to engage in all the activities of a gas utility company in all the
cities and towns in which Essex County Gas Company was engaged immediately prior
to the merger, and that further action pursuant to G.L. c. 164, ss. 21 is not
required to consummate the merger; and it is
FURTHER ORDERED: That a copy of the journal entries, or a schedule
summarizing such entries, recording the effect of the merger shall be filed with
the Department upon consummation of the merger; and it is
FURTHER ORDERED: That Eastern Enterprises, Essex County Gas Company, and
ECGC Acquisition Company shall comply with all directives contained in this
Order.
By Order of the Department,
/s/ Janet Gail Besser
----------------------------------------
Janet Gail Besser, Chair
/s/ James Connelly
----------------------------------------
James Connelly, Commissioner
/s/ W. Robert Keating
----------------------------------------
W. Robert Keating, Commissioner
/s/ Paul B. Vasington
----------------------------------------
Paul B. Vasington, Commissioner
/s/ Eugene J. Sullivan, Jr.
----------------------------------------
Eugene J. Sullivan, Jr., Commissioner
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D.T.E. 98-27 Page 78
Appeal as to matters of law from any final decision, order or ruling of the
Commission may be taken to the Supreme Judicial Court by an aggrieved party in
interest by the filing of a written petition praying that the Order of the
Commission be modified or set aside in whole or in part.
Such petition for appeal shall be filed with the Secretary of the
Commission within twenty days after the date of service of the decision, order
or ruling of the Commission, or within such further time as the Commission may
allow upon request filed prior to the expiration of twenty days after the date
of service of said decision, order or ruling. Within ten days after such
petition has been filed, the appealing party shall enter the appeal in the
Supreme Judicial Court sitting in Suffolk County by filing a copy thereof with
the Clerk of said Court. (Sec. 5, Chapter 25, G.L. Ter. Ed., as most recently
amended by Chapter 485 of the Acts of 1971).
<PAGE> 1
EXHIBIT F-2
KEEGAN, WERLIN & PABIAN, LLP
Attorneys at Law
21 Custom House Street
Boston, Massachusetts 02110-3525
August 5, 1998
The Securities and Exchange Commission
Washington, D.C. 20549
Re: Essex County Gas Company -- Form U-1
Ladies and Gentlemen:
This opinion is furnished to you in connection with the Form U-1 (the
"Form U-1") filed with the Securities and Exchange Commission pursuant to the
Public Utility Holding Company Act of 1935, as amended, by Eastern Enterprises,
a Massachusetts voluntary association ("Eastern"). The Form U-1 has been filed
in connection with the acquisition by Eastern of all of the outstanding shares
(the "Essex County Shares") of common stock, no par value, of Essex County Gas
Company, a Massachusetts gas utility company ("Essex County") in exchange for
shares (the "Eastern Shares") of common stock, $1.00 par value, of Eastern. The
Eastern Shares are to be issued pursuant to an Agreement and Plan of Merger,
dated as of December 19, 1997 (the "Merger Agreement"), by and between Essex
County and Eastern providing for the merger (the "Merger") of a Massachusetts
corporation to be formed by and to be the wholly-owned subsidiary of Eastern
with and into Essex County, as a result of which Essex County will be the
surviving corporation.
We have acted as counsel to Essex County in connection with the Merger
Agreement and the proposed exchange of the Essex County Shares contemplated
thereby. For purposes of this opinion, we have examined and relied upon such
documents, records, certificates and other instruments as we have deemed
necessary.
We express no opinion as to the applicability of, compliance with or
effect of federal law or the law of any jurisdiction other than the Commonwealth
of Massachusetts.
Based on the foregoing, we are of the opinion that:
1. Assuming consummation of the Merger in accordance with the terms
of the Merger Agreement, the Merger will comply with all applicable provisions
of the laws of the Commonwealth of Massachusetts.
2. Essex County is a corporation duly organized, validly existing
and in good standing under the laws of the Commonwealth of Massachusetts.
3. Assuming consummation of the Merger in accordance with the terms
of the Merger Agreement, the Essex County Shares to be acquired by Eastern
pursuant to the terms of the Merger Agreement will be duly authorized, validly
issued, fully paid and non-assessable and will entitle Eastern as the holder
thereof to all the rights and privileges pertaining thereto as set forth in the
Charter and By-laws of Essex County.
We hereby consent to the filing of this opinion as an exhibit to
Eastern's form U-1.
It is understood that this opinion is to be used only in connection
with the Form U-1 and may not be relied upon for any other purpose.
Very truly yours,
/s/ Keegan, Werlin & Pabian, LLP
Keegan, Werlin & Pabian, LLP
<PAGE> 1
EXHIBIT I
SUBSIDIARIES OF EASTERN ENTERPRISES
Utility Subsidiary:
Boston Gas Company
Non-Utility Subsidiaries:
AllEnergy Marketing Company, Inc. (inactive)
AMR Data Corporation - performs automated reading services for BGC and
others
Massachusetts LNG Incorporated (subsidiary of Boston Gas Company) - holds
title to LNG storage facilities
Boston Gas Services, Inc. (inactive)
Eastern Associated Capital Corp. - holds interest in an investment
partnership
Eastern Associated Securities Corp. - holds title to investment securities
Eastern Energy Systems Corp. (inactive)
Eastern Enterprises Foundation - makes charitable contributions
Eastern Rivermoor Company, Inc. - holds title to real estate used by BGC
Eastern Urban Services, Inc. (inactive)
Midland Enterprises Inc. - Midland and all active subsidiaries are engaged
in river barge transportation services and related support activities
Capital Marine Supply, Inc.
Chotin Transportation, Inc.
Eastern Associated Terminals Company
Federal Barge Lines, Inc.
River Fleets, Inc.
Hartley Marine Corp.
Minnesota Harbor Service, Inc.
Ohio River Company (The)
Ohio River Company Traffic Division, Inc. (The)
Ohio River Terminals Company (The)
Orgulf Transport Co.
Orsouth Transport Co.
Port Allen Marine Service, Inc.
Red Circle Transport Co.
West Virginia Terminals, Inc.
Mystic Steamship Corporation (inactive)
PCC Land Company, Inc. - holds title to real property in Pennsylvania
Philadelphia Coke Co., Inc. (inactive)
ServiceEdge Partners, Inc. - installs and services HVAC equipment
Water Products Group Incorporated (inactive)
Western Associated Energy Corp. (inactive)
SUBSIDIARIES OF ESSEX COUNTY GAS COMPANY
(All are non-utility)
LNG Storage, Inc. - holds title to LNG Storage Facilities
Northern Energy Company, Inc. (inactive)
