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Freshfields Transactions

| 4 minutes read

The Energy Security Bill – changes for competition and mergers in the energy industry

On 6 July 2022, the UK Government introduced to Parliament the Energy Security Bill (the Bill) which aims to “deliver a cleaner, more affordable, and more secure energy system”. The Bill has had its first and second readings in the House of Lords, and will move through the Committee and report stages and a third House of Lords reading in September-October 2022, before progressing through the House of Commons later in the year.

The Bill is based on three “key pillars”, namely: (i) leveraging investment in clean technologies; (ii) reforming the UK’s energy system and protecting consumers; and (iii) maintaining the safety, security and resilience of the energy systems across the UK. These policy pillars encompass a wide array of reforms, ranging from carbon capture and hydrogen generation to cyber security of smart appliances to licensing of multi-purpose interconnectors, and almost everything in between. The Bill is far too broad for a single article, so this blog will focus on certain measures aimed at enhancing competition in the energy sector, particularly at the network level. 

For our take on the Bill’s proposed changes to Ofgem’s regulatory remit and new technologies, please see our separate blog here.

Bringing competition onshore

The Bill would introduce a new competition regime for the construction, ownership and operation of onshore network infrastructure, modelled on the existing framework for competition for offshore transmission assets. The Bill would empower the Secretary of State to appoint a body to run tenders and to set tender criteria, and extend Ofgem’s power to issue regulations for tender processes.

Ultimately, this measure aims to improve efficiency in investment and foster smart and flexible solutions, in particular those which will increase the capacity of the UK’s electricity network to accommodate increased uptake of low-carbon technology (such as electric vehicles) in the coming years.

A new special mergers regime for energy network companies

At the same time, the Bill would introduce a new special mergers regime, which aims to reduce the risk of mergers between network energy companies having detrimental effects on consumers. Somewhat unusually, the government did not consult publicly on the proposed special mergers regime, for fear of a wave of reactionary mergers being rushed through prior to the introduction of the proposed regime. Nevertheless, the proposal is not novel: UK water company mergers have been subject to a similar regime since 2004, and Ofgem called for a special mergers regime in 2010 to take into account the impact of qualifying mergers on Ofgem’s ability to regulate energy companies effectively through its price control processes.

To date, energy network mergers have been limited to the CMA’s usual assessment of competition. For example, when reviewing National Grid’s 2021 acquisition of Western Power Distribution, the CMA’s substantive assessment was largely limited to competition in the supply of new connections. By contrast, the CMA did not consider in any detail arguably the central issue of National Grid and WPD’s regional monopoly positions in electricity distribution and transmission, respectively, as the effect of that merger on the continuing effectiveness of Ofgem’s price controls was outside its statutory remit.

In line with its water industry counterpart, the proposed energy special mergers regime would aim to preserve Ofgem’s ability to benchmark energy companies against one another effectively as part of its price control processes. Price controls – such as the recently concluded RIIO-T2 (for energy transmission) and the ongoing RIIO-ED2 (energy distribution) processes – allow Ofgem to regulate the prices which energy network companies charge by analysing their business plans for a given five-year period. This involves consideration of proposed capital and operating expenditure, cost of capital, service level targets, environmental initiatives and much more, comparing companies’ proposals with those in other companies’ price control business plans and taking into account historical under- or out-performance. The new regime seeks to address the concern that mergers will lead to a smaller number of companies for Ofgem to compare against one another, which may undermine the reliability of Ofgem’s comparative benchmarking.

Under the Bill, mergers between two energy network companies of the same type (i.e. two or more gas transporters, two or more electricity transmission companies, or two or more electricity distribution companies) would be subject to mandatory pre-merger scrutiny. Other energy companies, such as those holding retail, interconnection and/or generation licences, would continue to be subject to possible scrutiny under the CMA’s standard merger control framework. The new regime would involve consultation with Ofgem as to whether the merger might prejudice Ofgem’s ability to make comparisons between energy network companies, which would issue guidance as to the criteria on which it would base its assessment and the relative weight given to these criteria. In addition, the CMA would consider countervailing consumer benefits arising from the merger which might outweigh any adverse effect on Ofgem’s ability to conduct comparative benchmarking.

While the scale of activity under the new regime will depend on the number of energy network mergers, it is unlikely that reviews will be frequent, nor that they will be straightforward. By way of comparison, only four water mergers have been reviewed in the 18 years since the special water mergers regime came into effect – Mid Kent Water / South East Water (2006), South Staffordshire Water / Cambridge Water (2012), Pennon Group / Sembcorp Bournemouth Water Investments (2015) and Pennon Group / Bristol Water (2022). In all four cases the CMA (or its predecessor, the Competition Commission) found at least some adverse effect on Ofwat’s ability to benchmark during price controls, but also found some countervailing efficiencies and/or customer benefits arising out of the mergers. In three of the four, the merging parties ultimately offered undertakings to address the CMA’s concerns. Accordingly, the water experience suggests this type of mandatory regime may be a deterrent to transactional activity.

Final thoughts

The scale of the Bill’s ambition is remarkable, and many of its measures will – if passed – hopefully achieve significant benefits for consumers and the UK’s green transition. While the advent of onshore competition may boost competition in a way that encourages investment, the new special mergers regime may make potential investors think twice about potential network mergers, given the likelihood of more intense scrutiny going forward.

Please get in touch with us or your usual contact in our Antitrust, Competition and Trade team if you have additional questions or would like to discuss what your business can do to prepare for the Bill entering into force. To read more about antitrust developments globally, including in relation to transforming industries and net zero, please refer to our Global antitrust in 2022: 10 key themes report.