OFT closed case: Anticipated acquisition by SSE of Medway Power Ltd and AES Medway Operations Ltd.
Affected market: Electricity generation
The OFT's decision on reference under section 33 given on 10 November 2003
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 & 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 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 electricity.
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. 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 price.
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.