Affected market: Electricity generation
The OFT's decision on reference under section 22 given on 16 September 2004.
Centrica plc (Centrica) is a vertically integrated energy group. It is involved in electricity and gas production, supply and trading, as well as gas shipping and gas storage. It is also active in a range of home services. For the financial year ending 31 December 2003, its group turnover was approximately £18 billion.
Killingholme Power Limited (KPL) operated the Killingholme power station, a 665 MW combined cycle gas turbine (CCGT) power station in North Lincolnshire, in addition to carrying out some gas and electricity trading in support of the station. For the year ending 25 March 2003, the UK turnover of KPL was £164 million.
Centrica announced on 8 June 2004 that it had agreed to acquire most of the assets of KPL, including Killingholme power station. The transaction closed on 1 July 2004.
The 40 working day administrative deadline for this case is 16 September 2004. The four month statutory deadline expires on 31 October 2004.
As a result of this transaction, Centrica and KPL have ceased to be distinct. The UK turnover of Killingholme exceeds £70 million, so the turnover test in section 23(1)(b) of the Enterprise Act 2002 (the Act) is satisfied. A relevant merger situation has been created.
Centrica and KPL overlap in the generation of electricity.
Electricity suppliers and large businesses either negotiate bilateral contracts with generators, often setting prices by means of a formula based on the varying costs of generation, or buy electricity in the forward market (where contracts for electricity can be struck over a time scale ranging from that day to several years ahead of delivery) to hedge their exposure to price risk. Prices are likely to reflect the marginal costs of generation which will vary according to factors such as the type of plant, its age and operational efficiency.
An increase in the price of electricity charged by a particular generator or for electricity generated from a particular fuel source may result in suppliers or large businesses switching to alternative generators or fuel sources. The likelihood of switching will depend, however, on whether, for example, these customers have long term contracts or are vertically integrated. By contrast, domestic electricity end-customers and small businesses tend to view electricity as essentially homogeneous. Despite there being a growing awareness generally of renewable fuel types, smaller customers are generally indifferent to (or unaware of) the location or ownership of a plant, or the type of fuel it uses.
On the supply side, a plant is deemed flexible if it can respond to an increase in prices by raising output in the short term. This will vary according to the plant's input (nuclear power is virtually fixed, wind power depends on weather conditions, while gas and coal-fired plants are flexible). Most plants operate below their fuel capacity, however, so that an increase in demand can be met by the surplus of that same plant by increasing the plant's output.
As a result of the above considerations, the relevant frame of reference for the purposes of this assessment is electricity generation.
Although electricity is imported from Scotland (and France) into England & Wales by means of an interconnector, wholesale electricity market arrangement are different in England & Wales where electricity has been traded by generators and suppliers under the New Electricity Trading Arrangements (NETA) since 2001. Work is underway, however, to extend these trading arrangements to Scotland with the intended creation of the British Electricity Trading and Transmission Arrangements (BETTA) in 2005.
In light of the above considerations, it is considered appropriate to assess this transaction both at the level of England & Wales and also more widely, at the level of Great Britain.
For England & Wales, based on the parties' 2002/3 data, the merged entity will hold a share of supply in electricity generation of 7.4 per cent (increment 1.7 per cent) by capacity and 5.7 per cent (increment 1 per cent) by output. For Great Britain, the merged entity's share of supply is lower: 6 per cent (increment 1.4 per cent) by capacity and 5.3 per cent (increment 0.9 per cent) by output. These small shares and increments do not appear to raise concerns in light of the fact that the electricity generating sector is fully open to competition in England & Wales and the merged entity will, therefore, be constrained by a number of large operators, several with shares greater than its own.
Even if supply of electricity at peak demand is considered, for which gas-fired CCGT power stations are well suited due to their flexibility, the analysis does not materially differ as Centrica only has a share of about 20 per cent [by capacity and by output for] CCGT power stations post merger [at the levels of both England & Wales and Great Britain].
Barriers to entry and expansion
Barriers to entry are high: power stations necessitate large sunk costs to construct, need to be linked to the national grid and must meet increasingly stringent environmental and planning controls. However, the history of entrants to this sector indicates that these barriers are not insurmountable.
The parties submit that customers will have negotiating strength through their ability to switch supplier. On the whole, third parties agree that switching suppliers for domestic customers is easy, but may involve not insignificant costs for non-domestic customers. More generally, however, although suppliers and large businesses are likely to be sophisticated, it is not clear whether they have buyer power.
Centrica is a vertically integrated energy group, with interests throughout [most of] the chain of supply, including upstream gas production. Post-merger, Centrica supplies gas to fifteen CCGT power stations in England & Wales, including six under long term interruptible (LTI) contracts (see [note 1]). A third party raised the concern that Centrica can interrupt the gas supply to those competing generators, thus either driving up the wholesale price of electricity or gas, both of which it supplies. However, it is unclear whether there will be any significant increase in Centrica's ability to benefit from such behaviour as a result of this transaction, given the limited increase in generation capacity. The parties estimate that the CCGT power stations in Great Britain with which Centrica has LTI contracts account for only 3.7 per cent of capacity and 5.5 per cent of output, which would limit Centrica's ability to manipulate wholesale prices.
THIRD PARTY VIEWS
Ofgem has undertaken a public consultation exercise on this merger. It received one response in relation to LTI contracts, which has been dealt with above. Ofgem believes that the acquisition does not raise any significant concerns for competition in the electricity sector, or in relation to vertical integration, having taken into account the level of competition present in the generation sector and the relatively small increase in Centrica's position in this sector post-merger.
Third party enquiries generally revealed no concerns about this transaction.
The parties overlap in the generation of electricity. The combined shares of supply of the merged entity will be relatively low (less than 25 per cent) on even the narrowest product and geographical frame of reference, comparable or lower than the shares of its principal competitors. The increment to the share of supply will also be small (less than  per cent) in each case as a result of the transaction. Therefore, the addition of 665 MW to Centrica's portfolio will not give rise to any significant horizontal or vertical competition concerns. This conclusion is supported by the fact that the electricity generating sector in England & Wales is fully open to competition, with a number of large companies present.
Consequently, the OFT does not believe that it is or may be the case that the creation of the relevant merger situation has resulted or, may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom for goods or services.
This merger will therefore not be referred to the Competition Commission under section 22(1) of the Act.
- These are contracts under which power stations agree to take a specified minimum quantity of gas each year at prices determined by a formula, but with the right for supply to be interrupted by the supplier up to a maximum number of times per year.