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On the first birthday of the energy network merger regime coming into full force, the CMA and Ofgem have celebrated their electrifying pairing by publishing their decisions in the second case under this regime, Iberdrola’s completed acquisition (through its subsidiary ScottishPower) of North West Electricity Networks (“NWEN”).
The energy network merger regime is a special regime for mergers of energy networks, which requires the CMA – on top of its usual merger control assessment – to carry out a further review of the impact of the merger on Ofgem’s role in overseeing and regulating the relevant sector. In particular, the CMA is required to assess whether a transaction could substantially prejudice Ofgem’s ability to make comparisons between energy companies and regulate energy networks (e.g. set price controls and performance standards effectively). While the energy network merger regime technically entered into force with the implementation of the Energy Act 2023 (in October 2023), the regime did not become operational until the CMA and Ofgem had published their respective guidance and statement of methods (“SoM”) in April 2024 (with Ofgem’s publication of the SoM being a necessary step before the regime could come into full effect) – thus, the unofficial first birthday. The regime is similar to the well established equivalent for the merger of water and wastewater enterprises.
Iberdrola / NWEN is the second case to fall within the scope of these relatively new rules (the first being the acquisition by Macquarie Asset Management of a jointly controlling interest in last Mile Infrastructure). In this post, we take a deep dive into the inner workings of the regime.
The acquirer, ScottishPower (owned by global energy company Iberdrola), is an energy supplier in the UK and regulated by Ofgem to distribute electricity in Central and Southern Scotland, North Wales, Merseyside and parts of Cheshire. The target, NWEN, owns and operates Electricity North West Limited, which is similarly regulated by Ofgem to distribute electricity in the North West of England. The parties are each distribution network operators (DNOs), in effect the regional monopoly owner and operator of their respective electricity distribution networks.
The parties entered into this transaction with a UK foreign investment approval condition and, noting the special energy regime is not suspensory, completed the deal before the CMA had commenced its formal Phase 1 review.
Under this special energy regime, merging parties are required to provide a Merger Assessment Submission (separate to the Merger Notice under the general merger control regime) to the CMA and Ofgem, using a prescribed template. Following its review of the parties’ submission, Ofgem provides an opinion on the merger's impact on its regulatory functions to the CMA. While the CMA remains the ultimate decision-maker, it will place significant weight on Ofgem's opinion on the merger.
The CMA’s decision under the general merger control regime showed a relatively light touch review of the competition aspects of this combination. From a horizontal overlaps’ perspective, there was no direct competition between the parties’ regulated assets, given their status as regional monopolies.
Instead, the CMA’s analysis explored a somewhat speculative theory of harm concerning potential future competition in the last mile electricity connections market. Even then, this was straightforward for the CMA to green light. Neither Iberdrola (through ScottishPower) nor NWEN was active in this market at the time of the merger, and there were already a significant number of established competitors. The CMA also considered broader vertical relationships between the businesses, such as the merged entity’s ability and incentive to use its upstream DNO position to disadvantage downstream rivals in last mile connections. However, given extensive regulatory oversight by Ofgem, which imposes strict rules and licence conditions to prevent such conduct, the CMA was unconvinced that these vertical concerns would materialise in practice (likely with Ofgem's input to support this view).
The Iberdrola / NWEN decision provides the first example of an in-depth review by the CMA and Ofgem of two regional network operators under the energy network merger regime.
While the Macquarie / LMI case was the first to have a decision published under this regime, the licenced Target entities there were not regional monopolies and therefore their data was of minimal relevance to how Ofgem sets its comparative benchmarking (potentially highlighting the limitations of the regime’s one-size-fits-all approach to scoping) rules. In contrast, the presence of two DNOs in Iberdrola / NWEN prompted a more thorough review in this case.
Before delving straight into the decision, it’s first worth re-capping the relevant statutory test and the CMA’s proposed approach.
As noted above, when reviewing an energy network merger, the CMA has to answer a distinct statutory question – whether there is a realistic prospect that the transaction has caused, or may be expected to cause, substantial prejudice to Ofgem’s ability to make comparisons between energy network enterprises.
As part of this assessment, the CMA (and Ofgem) looks at four separate criteria:
There are 16 DNOs in the UK, owned by six (and now, five) different groups. Ofgem’s assessment suggested that the reduction to five groups post-transaction would have a limited impact on its ability to make comparisons between different energy network enterprises. In fact, Ofgem noted that the transaction brings together the two smallest DNOs to form a median-size DNO, which may even improve the comparability of DNO groups for cost benchmarking purposes.
With respect to Ofgem’s approach to cost assessments, the decision noted that 95% of submitted costs as part of price controls were collected at DNO level, while only 5% of submitted costs (being business support costs) were collected at group level (where the merger reduced the number of groups from six to five). While there was the potential for the merged group to change their reporting of business support costs (which would result in a loss in precision of Ofgem’s efficient cost benchmark modelling for its price control decisions), Ofgem did not believe that this (potential) change in the underlying data would be sufficient to prejudice its ability to make comparisons in future.
Both Ofgem and the CMA noted that the reduction in the number of corporate groups would reduce the number of management approaches and practices for it to evaluate. However, Ofgem indicated in its opinion that it had not seen evidence to suggest that a limited reduction in management diversity would have any material impact on the availability of information indicating good performance. Ultimately, the CMA agreed that this reduction would not give rise to a realistic prospect of substantial prejudice to Ofgem’s ability to perform comparisons.
Ofgem noted that the addition of one DNO to a wider corporate group was unlikely to reduce efficiency enhancing investments. In particular it pointed to the fact that the precise framework for the next price control is not yet decided and that the parties would not be able to accurately predict or manipulate certain data in advance. Additionally, Ofgem noted that the performance of one DNO was unlikely to have a material impact on the framework or targets set – particularly as there has been a convergence in DNO efficiency scores over time (meaning that the probability of any one DNO setting the benchmark in the future is unlikely).
The CMA broadly agreed with Ofgem’s analysis and also pointed to Ofgem’s ability to flex its approach to efficiency benchmarking, which would reduce the effectiveness of any post-transaction strategy to decrease efficiency enhancing investments.
Having now assessed two cases under the energy network merger regime, it remains to be seen when the CMA and Ofgem will make their next appearance together. These decisions, especially with the prized unconditional Phase 1 clearance, could instil more confidence in future energy licensees and investors in the sector (in contrast to the numerous mergers in the water sector – where a similar regime is in place - that have resulted in remedies at Phase 1 or even been referred to Phase 2).
Yet at the same time, the specific nature of the Iberdrola / NWEN combination, bringing together the two smallest DNOs to form a median-sized operator, was a key factor for Ofgem – the sectoral regulator’s opinion suggested that this particular deal might even improve its benchmarking exercise. Further consolidation in the sector might not encounter such favourable conditions, and the decisive influence of Ofgem’s opinion will clearly continue. For now, its lights out until next time.