Anticipated acquisition by Centrica plc of a 20 per cent stake in Lake Acquisitions Limited (a wholly owned subsidiary of EDF SA)

Affected market: Energy

No. ME/4133/09

Please note that the full text of the decision can be downloaded by using the link on the right. What follows are extracts regarding the parties, the transaction, jurisidction and decision.

The OFT's decision on reference under section 33(1) given on 7 August 2009. Full text of decision published 25 August 2009.

PARTIES

Centrica plc (Centrica) is publicly listed on the London Stock Exchange. It secures and supplies gas and electricity for domestic (that is, household) and commercial customers. Its primary operations are in Great Britain (GB), North America and Europe. In GB it is active in generation, wholesale trading and supply to end-customers in electricity and gas markets.

EDF SA (EDF) is an integrated energy company with a presence in a wide range of electricity businesses: generation, wholesale trading, transmission, distribution, supply to end-customers (endnote I). Prior to its acquisition of British Energy plc (BE), EDF owned three power stations in the UK (one CCGT and two coal) with a total capacity of approximately 5 GW.  However, EDF has committed to divest one of its CCGT power stations (the 803 MW CCGT power station at Sutton Bridge) as a condition of the European Commission's (EC's) clearance of EDF's acquisition of BE (EDF/BE). EDF is also constructing a new 1.3 GW CCGT plant at West Burton (next to its existing coal plant), which is expected to commence commercial operations in 2011. EDF, partly through its ownership of BE, owns eight sites considered suitable for new nuclear build (NNB).

Lake Acquisitions Limited (Lake Acquisitions) is the subsidiary of EDF SA which owns BE (endnote II). BE is the main nuclear energy generator in GB. It owns and operates eight nuclear power stations in GB with a total installed capacity of 9.4 GW.  It also supplies electricity to large industrial and commercial (I&C) customers in GB (endnote III). For the year ended 31 March 2008, BE's turnover was approximately £2.8 billion, all achieved in the UK.

TRANSACTION

On 11 May 2009, Centrica announced that it had agreed to subscribe for a 20 per cent shareholding in Lake Acquisitions, for approximately £2.3 billion (the merger). As a result of this shareholding, EDF and Centrica will jointly own, on an 80/20 basis, BE, the owner and operator of eight nuclear power stations in GB.

Centrica and EDF (the Parties) have also agreed to enter a number of additional transactions. The main elements of these other transactions are:

• EDF and Centrica will have the right to off-take uncontracted power from the existing BE nuclear fleet in proportion to their respective shareholdings in Lake Acquisitions (the Equity Power Purchase Agreement or PPA)
  
  
• under a commercial power purchase agreement, EDF will make available to Centrica a total of 18TWh of additional power between 2011 and 2016 on market based terms (the Commercial PPA and, together with the Equity PPA, the PPAs)
  
  
• Centrica and EDF will also form an 80/20 joint venture in relation to NNB activities in the UK. Centrica has committed to contribute 20 per cent of the pre-development costs for the first NNB project and will have a right to participate up to 20 per cent in subsequent new NNB projects with EDF in the UK on a project by project basis (the NNB JV). Once the NNB projects become operational, Centrica will be entitled to off-take power from those projects calculated by reference to the investment it has made in the NNB projects that are operational as a proportion of the overall investments that have been made by the NNB JV in those projects.

The transactions, summarised above, will be implemented via Centrica's investment in two separate companies: (i) an investment in Lake Acquisitions, whose subsidiary, BE, owns and operates BE's existing nuclear generating fleet; and (ii) an investment in the NNB JV company, which will take over sites from EDF/BE for the development and operation of NNB plants.

JURISDICTION

Centrica submitted, and the OFT agrees, that Centrica will have material influence over Lake Acquisitions and, in turn, BE (through its proposed 20 per cent shareholding in Lake Acquisitions).  This is on the basis of Centrica's veto power over various important decisions taken by Lake Acquisitions (including those broadly consistent with the key matters requiring special resolution under UK law,  and the incurring of debt or the making of acquisitions above a certain level) and its representation on the Lake Acquisitions Board and the BE Board.

The OFT believes that, as a result of the merger, Centrica will cease to be distinct from Lake Acquisitions, and therefore BE, for the purposes of the Enterprise Act 2002 (the Act).

BE had a turnover of around £2.8 billion to the year ending 31 March 2008, and the 'turnover' test under section 23(1) of the Act is therefore met. Since Centrica is not obtaining full control or decisive influence over BE, the EC Merger Regulation does not apply in this instance. 

The OFT therefore believes that it is or may be the case that a relevant merger situation is in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation.

Centrica also submitted that its participation in the NNB JV forms part of the same overall relevant merger situation, or alternatively forms an additional merger situation, and that either way the JV falls within the OFT's jurisdiction under the Act and should therefore form part of this decision.  Although it is not clear to the OFT that it would have jurisdiction over the JV, the OFT considers that the JV, as currently contemplated by the Parties, does not raise competition concerns (as discussed further below) and therefore the OFT has left open the question of jurisdiction in this respect.

THIRD PARTY VIEWS

The OFT's investigation attracted a great deal of interest from market participants, some of whom raised a number of concerns about the merger. The main concern related to the anticipated negative impact that the merger would have on liquidity by virtue of the combination of EDF/BE's apprehended net long position with Centrica's net short one. Concerns about liquidity in the market more generally were also expressed, although at least one market participant was upbeat about liquidity in the market and noted that it had been increasing recently.

A number of market participants also raised concerns that the Commercial PPA would be used by EDF to partially fulfil its commitments to the EC to trade a minimum volume of electricity into the GB market between 2012 and 2015. This, it was argued, was against the spirit of these remedies and would not promote liquidity and price transparency as they were designed to do. The OFT did not consider these issues to be specific to the merger under its review.

There was a general unease in the market regarding the structural link between two of the 'Big Six' vertically integrated players in the market. Many market participants advised the OFT that they were concerned about increased structural ties between vertically integrated players in the market. Few third parties, however, were able to specify how they saw competitive harm occurring as a result.

Where relevant, these concerns from third parties have been addressed in the decision.

The OFT liaised closely with Ofgem throughout the course of its investigations. Ofgem advised that it has general concerns about liquidity in the wholesale electricity market which have been expressed in its recent discussion paper on the subject. With respect to the potential impact of the merger on liquidity, however, the OFT's approach and conclusions were supported by the discussions it had with Ofgem. Discussions with Ofgem also supported the OFT's approach and conclusions with regard to other potential concerns including NNB.

ASSESSMENT

The merger will result in Centrica acquiring a 20 per cent stake in Lake Acquisitions, entitling it to 20 per cent of the uncontracted output of BE and access to certain information pertaining to the operation of BE Generation. As part of the deal, the Parties have signed a Commercial PPA that will entitle Centrica to 18 TWh of electricity between 2011 and 2016.

Centrica will also gain material influence over BE via representation and veto rights with respect to Lake Acquisitions. Centrica and EDF will also form a JV for the purposes of NNB projects.

Some concerns were raised with respect to a potential reduction in strategic competition. The OFT examined whether the information that Centrica would receive by virtue of the merger would allow it, for example, to alter its output decisions or trade on the wholesale market with the effect of reducing competition. The evidence presented to the OFT cast doubts on this. Significantly, any information of material importance that Centrica will receive must be disclosed to the market very soon after Centrica receives it and it is far from clear that this would give it sufficient time to use it to its advantage. It was also unclear that Centrica would be able to trade on the information in a way that EDF could not do already by virtue of its pre-existing ownership of BE.

The OFT received concerns that the merger may have a detrimental impact on liquidity by (on a total generation versus supply basis) combining EDF/BE's perceived long position with Centrica's short one. However, market enquiries and analysis indicate that EDF is, in fact, effectively short in generation pre-merger, once various factors are taken into account. On the evidence available to it, the OFT also considers that EDF/BE would not, absent the merger, have been materially long in generation over the short or medium term.

Even if EDF/BE might have been slightly long over the medium term absent the merger, the evidence before the OFT suggested that Centrica would not have had the incentive to internalise the full volume it will receive from the merger, or even a substantial proportion of this volume. This reduced level of internalisation further reduces any risk of harm to liquidity from the merger. In addition, if the impact on liquidity is measured only by reference to residential load, which may drive liquidity to a greater extent than I&C load, the merger represents the combination of two companies that are long in generation relative to their residential demand.

Using both these methods, the OFT is not satisfied that there is a realistic prospect that the merger may have a material negative impact on liquidity. In the short-short scenario, the merger represents a transfer of electricity from one net buyer to another. Similarly, in the long-long scenario the merger represents a transfer between two net sellers of electricity. Although Centrica has historically traded more in the wholesale market than EDF, the decrease in Centrica's need to trade in the long-long scenario is not expected to have a material negative impact on liquidity.

Finally, the OFT examined whether the merger could give rise to concerns of a coordinated nature. According to some third parties, this could play out via the Parties not competing, or not competing as hard, for each other's customers in areas where each has a particularly strong presence. Nevertheless, the OFT does not consider there to be a realistic prospect of this occurring due to, inter alia, the apparent absence of any effective punishment mechanism within the JV to deter such behaviour, and the presence of other, well-resourced players in the market who would be likely to disrupt coordination.

Consequently, the OFT does not believe that it is or may be the case that the merger may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom.

DECISION

This merger will therefore not be referred to the Competition Commission under section 33(1) of the Act.

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