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25 April 2024
In April 2024, following consultations which concluded in January 2024, the energy regulator, Ofgem, published its approach to energy network mergers, including its statement of methods (SoM). In parallel, the CMA issued its guidance on the procedure and assessment in energy network mergers (Guidance). These documents incorporate clarifications which reflect feedback from the consultations (including that of Linklaters as well as a small number of energy networks, available at Ofgem’s consultation page and the CMA’s consultation page).
While publication of the SoM is a necessary step before the new Energy Mergers Regime can come into full effect, there have not yet been any mergers falling within the scope of the new rules, and areas of uncertainty remain as to how Ofgem and the CMA will approach these mergers going forward. That said, learnings from the equivalent Water Mergers Regime will be useful in navigating this process going forward, and the CMA itself references its experience of the Water Mergers Regime in its Guidance.
The Energy Mergers Regime was introduced by the Energy Act 2023. This is the second utility sector in the UK which is subject to a special merger regime which goes beyond assessing the impact on competition of any given merger. It is also separate from national security reviews under the National Security and Investment Act 2021. The equivalent Water Mergers Regime has been in place for a number of years, and it is aimed at preserving the ability of regulators to continue to regulate and set price controls in a sector where there is no competition (save for certain exceptions/segments of the market) and where the conditions of normal competition are not present. The role of the regulator in setting prices and incentivising operators to improve non-price factors such as quality of service and innovation is critical and the Energy Mergers Regime seeks to control and preserve such role.
The Energy Mergers Regime follows the standard two-phase structure of merger control, with the CMA as the decision-maker. However, before deciding on whether to refer a case to Phase II, the CMA must consider Ofgem’s opinion on: (i) whether the creation of the merger situation has prejudiced, or is expected to prejudice, Ofgem’s ability to make comparisons; and, if so, (ii) whether such prejudice is outweighed by RCBs. In forming its opinion, Ofgem will apply the SoM.
Following publication of Ofgem’s SoM in April 2024, the regime is now in full force, and any mergers involving two networks of “the same type” will now be captured if the relevant turnover threshold is met. Therefore, the regime applies to mergers of enterprises holding the same type of licence, e.g. gas distribution and gas distribution, electricity distribution and electricity distribution, electricity transmission and electricity transmission.
The Energy Mergers Regime will capture mergers of enterprises holding the same type of licence in Great Britain, including:
Regional network licensees (i.e., Gas Distribution Networks (GDNs) and electricity Distribution Network Operators (DNOs)), as well as independent networks for both gas (i.e., Independent Gas Transporters (IGTs)) and electricity (i.e., Independent Distribution Network Operators (IDNOs)) will be captured. GDNs and IGTs, for example, are licensed by Ofgem and qualify as transporter networks. Other licences authorising supply, for example interconnector licences held pursuant to Section 6(1)(e) of the Electricity Act 1989, would not be captured by the regime.
GDNs and DNOs are regional monopolies for which Ofgem sets allowed revenues, service quality requirements and incentives for five-yearly periods using the price control framework. This relies on comparative benchmarking. The loss of a comparator reduces the number of independent observations (historical and forward-looking), which could, in some circumstances, affect Ofgem’s ability to set effective price controls and performance levels for the sector.
Conversely, IGTs and IDNOs are subject to competition for connecting properties on new developments to the infrastructure of the incumbent. Ofgem regulates last mile charges through relative price controls, which set the maximum charge that a last mile network can levy by reference to the equivalent charge of the incumbent GDN or DNO. Most aspects in the DNOs’ and GDNs’ licences relate to economic regulation (across costs, revenues and incentives) which are not relevant to IGTs and IDNOs. As such, the impact of a merger involving IGTs and/or IDNOs on Ofgem’s ability to make comparisons is minimal. Following feedback from the consultation, Ofgem’s SoM helpfully notes that Ofgem does not anticipate that there will be any prejudice to Ofgem’s ability to make comparisons where a merger involves IDNOs and/or IGTs but that this will be assessed on a case-by-case basis.
The test to be assessed under the Energy Mergers Regime is whether a transaction results in a substantial prejudice to Ofgem’s ability to make comparisons between energy network enterprises. At Phase I, the CMA considers whether there is a “realistic prospect” of such prejudice, while, at Phase II, it assesses whether the merger would, on a “balance of probabilities”, cause substantial prejudice. This follows the standard of proof under the general merger control regime.
While Ofgem’s opinion will address “whether and to what extent the creation of the relevant merger situation has prejudiced, or may be expected to prejudice” Ofgem’s ability to make comparisons between energy network enterprises, only the CMA is able to opine on whether such prejudice is “substantial”.
The CMA and Ofgem have declined to include further explanation of the term “substantial prejudice" at this time. Instead, the CMA references the types of factors that it may consider, and the approach to “substantial” lessening of competition, in its general Merger Assessment Guidelines and related jurisprudence. Uncertainty remains, however, given the fundamental differences between the Energy Mergers Regime (which is designed for local monopolies) and the merger control regime governed by the Enterprise Act 2002 (which aims to preserve competition).
The CMA must consider any potential benefits to customers that a merger might bring, such as efficiencies that could lead to lower prices or improved services. These benefits must be weighed against any identified substantial prejudice to Ofgem's ability to make comparisons.
One of the more substantial amendments to the updated SoM is the addition of a new chapter, detailing the potential benefits of mergers in the energy network sector and how RCBs might arise from such mergers. Respondents to the consultations requested explicit acknowledgement of the potential benefits for customers and other stakeholders arising from such mergers. This is a welcome addition, particularly given that, under the general merger control regime, it remains rare for merger-specific customer benefits to be sufficient to outweigh a substantial lessening of competition.
Furthermore, the SoM now sets out that management approaches and practices in mergers may not always adversely affect efficiency and performance and may in fact have a positive impact. Ofgem has reflected this feedback throughout in order to “remove any inadvertent inference that [Ofgem] deem[s] mergers to be inherently negative”.
Separately, Ofgem has also addressed concerns relating to the evidential bar for determining prejudice, and whether this is lower than the threshold for establishing countervailing RCBs. It now acknowledges that RCBs are not subject to a higher standard, albeit emphasising that such benefits must be supported by robust evidence.
Before making a Phase II reference or accepting undertakings in lieu of such reference, the CMA must consult Ofgem for its opinion on the potential prejudice and any RCBs that may counterbalance such prejudice. The legislation also enables the CMA to make combined references under the Energy Mergers Regime and general merger regime, in which case the same group may consider a Phase II reference jointly.
With this potential for combined references in mind, the CMA has expressed its intention to run reviews under the two regimes in parallel. However, acknowledging feedback from stakeholders, the CMA has now updated the guidance to reflect that this starting point may be displaced in certain circumstances. Merger parties can discuss with the CMA during pre-notification if the circumstances of the case would make a different approach more appropriate.
In light of parallel reviews, information sharing between the CMA and Ofgem is also envisaged in the Guidance and SoM. Whilst the CMA declined to engage substantively with feedback on equivalency of information sharing, referring instead to its pre-existing guidance relating to the general merger regime, in a welcome update to its SoM, Ofgem has softened the wording relating to merger parties being expected to share all information with Ofgem and the CMA at the same time. This responds to feedback relating to the confidentiality of information. In line with equivalent wording under the Water Mergers Regime, the SoM now recognises that parties are “encouraged” to share equivalent information rather than “expected” or “required” to do so. The CMA also notes that it expects to publish a joint statement with Ofgem later this year containing information on how the two organisations envisage working together, which would provide further clarity. A similar statement of intent is available in relation to the Water Mergers Regime.
In response to feedback, Ofgem has also provided helpful guidance in relation to:
The Energy Mergers Regime intends to preserve Ofgem’s ability to use comparative regulation, addressing a possible enforcement gap in the regulatory toolkit. The SoM and Guidance provide a clearer roadmap for enterprises considering transactions in the sector, including a welcome clarification on the positive impact that such mergers can have, as well as detailed guidance relating to RCBs. However, the guidance documents have fallen short in addressing some of the concerns raised – notably in relation to the applicability of the new regime to independent networks (IDNOs and IGTs) – and have not provided additional guidance relating to the standard of review and the practicalities of new regimes. Merging parties can expect rigorous examination of their proposals, especially in the first few mergers falling within scope of the regime, with a focus on detailed quantitative assessments and the provision of robust evidence to support claims of RCBs.
In practice, the use of regulatory economists and lawyers who understand both the CMA merger process and approach, as well as economic regulation and how price controls are set and measured, will be critical to navigating this new regulatory tool.