Affected market: Electricity generation
International Power plc [(IP)] (see [note 1]) is an international developer and operator of power generation facilities with the majority of its operations based overseas. IP own two power stations in England and Wales, namely, Rugely (coal-fired) and Deeside (combined cycle gas turbine), currently providing a generation capacity of 1,296 MW. [AES Drax Holdings Ltd (AES Drax)] (see [note 2]) is a 3,945 MW coal-fired power station. [It is owned by US energy company AES Corporation (AES)] (see [note 3]). In its last financial year, AES Drax reported a UK turnover of £524,831,000.
AES's 1999 acquisition of AES Drax was largely financed through bank loans and the issue of secured bonds. In November 2002, AES defaulted on the financing obligations which effectively placed AES Drax under the control of the creditor banks and bond holders. Since November 2002, AES Drax has been operated as a merchant plant by AES, separately from the other AES stations in England & Wales, under a trading policy agreed with creditor banks and bond holders. In effect, AES no longer has any control over AES Drax. On 30 August 2003, AES Drax entered into an exclusive arrangement with IP with regard to the restructuring of AES Drax. The restructuring arrangements are yet to be finalized but it is anticipated that they will result in IP acquiring approximately 17.7 per cent of the total outstanding debt, representing a 33.6 per cent stake in AES Drax. The balance of the equity in AES Drax would be held by a variety of banks and bondholders.
This is a proposed transaction. It was announced on 24 July 2003. The 20-day statutory deadline expires on 27 October 2003.
The UK turnover of AES Drax exceeds £70 million, so that the turnover test in section 23(1)(b) of the Enterprise Act 2002 (the Act) is satisfied. A relevant merger situation has been created.
The parties overlap in the generation of electricity in England & Wales.
From the demand-side, customers view electricity as essentially homogeneous. Large electricity customers negotiate annual bilateral contracts with generators, setting prices by means of a formula based on the varying costs of generation or may buy electricity in the forward market to hedge their exposures to price increases. Suppliers also enter into contracts with power plants to ensure they can meet their contractual obligations to their end-customers. Prices agreed with customers and suppliers are likely to reflect the marginal cost of generation which will vary according to the type of plant, its age and operational efficiency, and a host of other factors. An increase in price charged by a particular generator will result in customers switching to buy power from a cheaper source. An increase in price for electricity generated from a particular fuel source will see similar demand-side switching away to cheaper power. Electricity customers are generally indifferent (or unaware) of location of plant, type of fuel or plant ownership.
On the supply-side, the ability (or 'flexibility') of a plant to respond to increased prices by increasing output in the short term (supply side substitutability) varies according to its input (nuclear power is virtually fixed, wind power is unpredictable as it depends on how strong the wind blows, while gas and coal-fired plants are flexible). Most power stations operate below their full capacity so that an increase in demand can be met by the surplus of that same plant by increasing the plant's output.
There is no need to reach a final view on product market definition due to the absence of competition concerns.
The prevailing regulatory regime for electricity in England & Wales differs from that in Scotland. Electricity is imported into England & Wales from Scotland and France by means of two inter-connectors. Transportation constraints on the gas pipeline system or electricity grid mean that, at times, market power may accrue to a small player because the geographic market for wholesale electricity is reduced to generators in a particular area (or transmission zones) as a result of the transportation constraints. (see [note 4]) The parties do not overlap in any administrative zones and, therefore, this transaction does not give rise to any concerns associated with local market power.
The relevant geographic market is likely to be England & Wales.
According to the parties, the merged entity will have a share of supply of electricity generation in England & Wales of 7.9 per cent by capacity (increment 5.9 per cent) and [5-10 per cent] (see [note 5]) by actual output (increment [5-10 per cent] ) (see [note 6]). Post merger, IP will become the fourth largest generator of electricity in England & Wales.
Barriers to entry and expansion
The difficulty of obtaining financing, coupled with local planning permission, regulatory and environmental controls, suggest that the barriers to entry are high (see [note 7]).
In the past four years, prices for wholesale electricity are reported to have fallen some 40 per cent. The fall in prices have led firms to exit the market and other firms to mothball plants. New entry into the electricity generation sector appears more likely if the entrant has a strong supply base with which to offset the lower output prices.
Contracts between generators and suppliers (or large customers) are negotiated bilaterally on an annual basis. There is currently a surplus of generating capacity so suppliers are able to negotiate lower prices (and possibly better terms). AES Drax's top five customers currently account for [a significant part] (see [note 8]) of its trades whilst IP's account for […] (see [note 9]). Buyers are likely to be sophisticated, although it is not clear that they have buyer power.
The merger raises no vertical issues.
THIRD PARTY VIEWS
No third parties, including Ofgem, had any concerns about the transaction.
The electricity generation sector in England & Wales has become less concentrated in recent years with a number of new entrants. The merger does not result in a significant increase in concentration given the relatively small increment that will be created by the acquisition of AES Drax. As a result, it is unlikely to raise any significant competition issues.
The OFT does not believe that it is or may be the case that the creation of the relevant merger situation 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.
The parties wish to point out that International Power Plc is commonly abbreviated to IPR.
On 3 October, 2003, AES Drax Holdings Limited formally changed its name to Drax Holdings Limited.
The parties wish to point out that AES Drax Holdings Ltd (now known as Drax Holdings Ltd ), is ultimately owned by US energy company AES Corporation.
CC Inquiry, AES and British Energy, a report on references made under section 12 of the Electricity Act 1989, CC report no. 453, December 2000, paragraph 7.285, page 155.
Figure excised and replaced with a range at the request of the parties.
See note no. 5 above.
New power stations require consent under section 36 of the Electricity Act 1989 (as amended) and section 14 of the Energy Act 1976 before construction can begin. They also need local authority planning approval and an environmental impact assessment.
Commercially sensitive information has been removed and replaced with a range at the request of the parties.
Commercially sensitive information has been removed at the request of the parties.