Opponents of the proposed $6.4 billion Pepco-Exelon merger rally outside the city's John A. Wilson Building in this file photo. (Aaron Davis/The Washington Post)

District regulators rejected a proposal Friday to allow Chicago-based Exelon to merge with Pepco, halting the deal for a second time and sending supporters scrambling to salvage a pact to create the nation’s largest electric utility.

The D.C. Public Service Commission voted 2 to 1 against a $78 million plan negotiated chiefly by Mayor Muriel E. Bowser’s office. Under that plan, the city would have held down residential rates for the next four years and directed tens of millions of dollars to environmental projects, low-income energy assistance and workforce-training programs.

But the commission said the way Bowser (D) intended to spend the money that utilities were willing to pay the city in exchange for support was “not in the public interest.”

A majority of the commission found there was no “persuasive rationale” for giving residents almost $26 million to cushion expected rate increases through 2019. That would exacerbate an imbalance in which businesses and the federal government subsidize residential rates in the nation’s capital, the PSC said.

But the commission offered a narrow path forward to keep the $6.8 billion merger on track. It said Pepco and Exelon could reapply with new terms, under which the PSC would decide how the $26 million is allocated. That would potentially send millions of dollars in credits to businesses or the federal government — not residents — to equalize rates.

That would create a politically perilous path for Bowser, the city’s chief advocate for ratepayers, the District’s attorney general and others who supported the deal late last year on the grounds that residents would be insulated from rate hikes for at least four years.

Under the PSC’s proposal, the nine parties involved have 14 days to approve the new terms.

Anya Schoolman, head of DC Solar United Neighborhoods, which opposed the merger, said it was a “slap” at Bowser’s plan.

“This is a huge slap at the mayor’s office, saying ‘Keep your hands off ratepayers’ money,’ ” Schoolman said, referring to Bowser’s plan to spend the money in ways to win political support for the deal.

In a statement, Bowser said she was reviewing her options and that her rejected plan had wide support, including from longtime merger critic Sandra Mattavous-Frye, the District’s chief advocate for ratepayers, and D.C. Attorney General Karl A. Racine.

“Last year, in conjunction with the Office of the People’s Council, Attorney General Racine and others, the District advanced a deal that ensures D.C.’s energy future — focused on reliability, affordability and sustainability,” Bowser said. “The Public Service Commission took the framework we negotiated and made adjustments. We will have to carefully review the commission’s order to determine if it meets our goals for ratepayers, especially residents.”

But Racine was more openly skeptical. He said that the credits to insulate residents from increases through 2019 was an “essential protection” in the deal and “given that that provision is now in doubt, the benefit to residential ratepayers also now is in doubt.”

Exelon spokesman Paul Elsberg said the company was still reviewing how it could move forward.

“The commission’s order prescribes new provisions that we and the settling parties must carefully review to determine whether they are acceptable,” he said.

Elsberg said that after discussions with the mayor’s office and others, Exelon “will have more to say about what it means and our next steps.”

The PSC’s decision Friday gave some in the room whiplash, with opponents of the deal first standing and cheering at the rejection and then later bemoaning that the deal could still go through.

PSC Chairman Betty Ann Kane proposed a motion to reject the merger. Then the commission voted on a plan to give the companies terms for eventual approval. That also passed 2 to 1, but this time with Kane dissenting.

She said that, as in August when the PSC first rejected the plan, she saw an “inherit conflict of interest” in putting the city’s electricity distribution in the hands of an out-of-town nuclear-power generator.

“The fact remains unchanged from the original application that the takeover of Pepco will entangle the company in an ownership structure that is an inherit conflict of interest and that it takes it in the opposite direction from its sole focus of being a distribution company that is required” under D.C. law, Kane said.

Commissioner Joanne Doddy Fort introduced a set of terms for the merger to go forward, which also won the backing of Commissioner Willie L. Phillips.

That plan would leave intact an approximate $50, one-time credit for each ratepayer. In addition to giving the PSC authority over allocating future rate credits, it would also redirect an additional $29 million from projects earmarked by the mayor to those selected by the commission.

In an interview, Kane said that would ensure that the money would be used in the ratepayers’ best interest. Schoolman noted that one of the funds the mayor had proposed filling with money from Exelon — an account for low-income assistance — was raided last year in the mayor’s budget to cover other expenses.

D.C. Council member Mary M. Cheh (D-Ward 3), another opponent, said she felt dejected and that the deal would ultimately pass, calling the option for the companies to still move forward “a win” for Exelon and Pepco. The timeline, however, is complicated. The 14-day window would run past a March 4 deadline that Pepco and Exelon had set, and in a recent earnings call with investors, Exelon’s chief executive said that if a deal was not secured by then, the company would walk away.

Exelon, however, has spent about a quarter-billion dollars on the merger and would have to sell bonds to cover those costs, so if an agreement is within striking distance, analysts said the deadline could probably be extended.

Another potential pitfall is whether the PSC proposal would require a larger payout to the District. Any major changes would potentially force Exelon to match the offer to other participating states, including Maryland, New Jersey and Delaware.

In all, the PSC decision was another surprising setback for nuclear-energy giant Exelon and supporters who said the company’s deep pockets would bring capital and long-term stability to customers of Pepco, which has a dismal reliability record when it comes to keeping the lights on in Washington suburbs after storms.

It also raises new questions for D.C. ratepayers about whether the deal would be in their best interest.

In Baltimore and other cities where Exelon is the service provider, reviews of performance and customer service have been mixed.

Exelon had earlier promised to finish improvements to make Pepco’s system more reliable in the District and Maryland and would freeze rate increases for four years. After that, residents could have faced major balloon increases.

The PSC’s eventual decision could have lasting reverberations for Bowser, who revived the deal in August after the panel unanimously rejected it, saying it would hinder the city’s goal of encouraging more green-energy production.

Bowser’s top aides held private negotiations with Exelon after the rejection. She won concessions, persuaded critics to drop their opposition and then announced she would back the plan after earlier saying she had reservations.

Bowser’s effort drew rebukes from local and national environmental groups but won praise from the city’s business community, which has backed Pepco, whose shareholders would get a 25 percent premium on their stock value from the day the merger was announced.