Affected market: Electricity generation
The OFT's decision on reference under section 33 given on 10 November
Scottish and Southern Energy Group (SSE) is a vertically integrated
energy company with significant electricity and gas interests in Great
Britain. SSE is active in the transmission of electricity (in Scotland)
and the distribution of electricity in Great Britain. SSE also has
interests in electricity and gas trading, gas storage, shipping and
supply, metering, connections and contracting services. SSE Generation
Limited (SSE) generates electricity in Great Britain and owns a 37.5
per cent equity share in Medway Power Limited.
Medway Power Limited (MPL) is a joint venture company that owns a
700 MW combined cycle gas turbine (CCGT) power station, located on the
Isle of Grain in Kent. The equity owners in MPL are EDF Energy (South
East Generation Limited) (EDF), which holds 37.5 per cent, AES Medway
Electric Ltd (AES) with 25 per cent and SSE with 37.5 per cent. MPL's
turnover in the year to 31 December 2002 was £146.1 million.
Medway Operations Limited (AESMO) is a wholly owned subsidiary of
AES, which operates and maintains the MPL power station. AESMO's
turnover in the year to 31 December 2002 was £5.3 million.
SSE is acquiring the remainder of the equity interests in MPL from AES
and EDF for a total consideration of £89.8 million in cash, and an
assumption of a net debt of £140.9 million.
In addition, SSE will acquire AESMO for consideration of £11.7 million.
Upon completion of the proposed transaction, SSE will become the sole
owner of MPL.
This is a proposed transaction. It was announced on 3 October 2003. The
40-day administrative deadline expires on 2 December 2003.
The UK turnover of MPL 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 &
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 away from that generator 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.
As a result of the considerations set out above, the relevant frame of
reference in this case would appear to be electricity generation.
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 1]). MPL is located on
the Isle of Grain in Kent, in close proximity to London, and is unlikely
to be affected by transportation constraints.
The relevant geographic market is likely to be England & Wales.
According to the parties, SSE holds a share of supply of electricity
generation in England & Wales of 3.2 per cent by capacity and 3.6
per cent by output (see [note 2]), making SSE the tenth largest
generator in England & Wales. Post acquisition, the merged entity
will have a share of supply of electricity generation in England &
Wales of 3.9 per cent by capacity (increment 0.7 per cent) and 4.5 per
cent by actual output (increment 0.9 per cent), making it the seventh
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 3]).
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). Buyers are likely to be sophisticated,
although it is not clear that they have buyer power.
SSE is a vertically integrated energy company, with interests throughout
the vertical chain of supply of electricity (and gas). At present, the
output from Medway is offered equally to SSE and EDF under the terms of
two station specific Power Purchase Agreements (PPAs). Following the
proposed acquisition, and in accordance with terms set out in a new PPA,
although SSE will acquire a 100 per cent interest in the output from
Medway, EDF will receive the same quantities as it did under the terms
of the old PPA. The new PPA stipulates that the electricity supplied to
EDF may be provided from any station within SSE's portfolio (not just
MPL). This will allow SSE more flexibility in meeting its contractual
obligations with EDF and will grant EDF 'firm' rights for electricity.
In addition, the proposed acquisition will allow SSE to use its
generation assets better to meet its supply business' needs for
THIRD PARTY VIEWS
No third parties, including Ofgem, had any concerns about the
The electricity generation sector in England & Wales has become less
concentrated in recent years with a number of new entrants. In addition,
the recent fall in the wholesale price for electricity reflects excess
capacity and an ability (and willingness) on the part of customers and
suppliers to switch to competing generators to get the best possible
The acquisition will increase SSE's generation capacity in England
& Wales, however the addition of 437.5 MW (based on SSE's
acquisition of the remaining equity share of Medway, 62.5 per cent of
700 MW) to SSE's portfolio will not give rise to 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.
- 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 55.
- Note that SSE's share of output is greater than its share of
capacity in England & Wales. This is due to the fact that capacity
reflects SSE's equity holdings in England & Wales, while the output
number also takes into account SSE's contractual positions with other
electricity generators as well as their equity holdings.
- 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.