Request for a variation of undertakings given by Centrica plc and Centrica Storage Limited pursuant to section 88 of the Fair Trading act 1973 in relation to Centrica plc’s acquisition of Dynegy Storage Ltd and Dynegy Onshore Processing UK Ltd

Affected market: Gas storage

No. ref

Please note that square brackets indicate information excised, or exact figures replaced by a range, at the parties' request for reasons of commercial confidentiality.

The OFT's advice to the CC under section 88(4) Fair Trading Act 1973 (the Act) on a request from Centrica plc (Centrica) on behalf of itself and Centrica Storage Limited (CSL) for the variation of the undertakings it and CSL signed on 18 December 2003, pursuant to section 88 of the Act (the Undertakings). Advice published 5 April 2006.

TIMING

Routine. Although there are no statutory or administrative timetables in force for variation of undertakings, the OFT is of the view that it would be appropriate for the usual 40-day administrative timetable to apply, which would give the deadline for advice as 20 January 2006.

BACKGROUND

On 14 November 2002, Centrica, through its wholly-owned subsidiary Centrica Storage Holdings Limited (CSHL), acquired the entire issued share capital of Dynegy Storage Limited and Dynegy Onshore Processing UK Limited. The acquisition was referred by the Secretary of State for Trade and Industry (SoS) to the Competition Commission (CC) for investigation on 25 February 2003, under sections 64 and 69(1) and (2) of the Act.

The effect of the transaction was to combine Centrica with two companies which owned and operated the Rough gas storage facility, the largest gas storage site in the UK, and associated assets.

The CC concluded in its report (see note 1)  that, in the absence of further constraints, Centrica may have been expected:

• to discriminate between customers in giving access to capacity at Rough
• to use to its advantage sensitive information gained from the operation of Rough
• to withhold information about the operation of Rough
• to be less innovative in marketing Rough products than another owner, and
• to invest less in expanding Rough's capacity than another owner.

The CC also believed that the merger would increase the uncertainty faced by other industry participants and potential entrants.

As a result of the above detriments, the CC considered that competition in the markets for flexible gas and domestic gas supply would be weakened, with the likely consequence that prices would be higher than in the absence of the merger. The CC also believed that innovation and investment at Rough would be lower than under another owner. The CC consequently found that the completed acquisition may, therefore, have been expected to operate against the public interest.

In order to remedy the identified adverse effects of the merger the CC requested a number of behavioural undertakings from Centrica. These covered, among other things, maintaining legal, financial and physical functions separate between Centrica's gas storage arm, CSL (a wholly-owned subsidiary of CSHL), and all other parts of the group and ensuring that no commercially sensitive information arising from the operation of Rough is passed to other parts of Centrica. The CC also recommended that Centrica arrange for an independent review of compliance with the undertakings by Centrica's Audit Committee, with annual reports to the OFT and Ofgem.

Pursuant to a request by the SoS, the OFT (in concert with Ofgem) consulted with Centrica and CSL with a view to obtaining from them undertakings in accordance with section 88(1) of the Act. The SoS accepted the Undertakings on 18 December 2003.

CENTRICA'S REQUEST FOR VARIATION

Centrica submitted a request on 22 November 2005 that the Undertakings be reviewed under section 88(4) of the Act with a view to certain variations being made by the CC.

Paragraph 5.1 of the Undertakings stipulates a general obligation that CSL be maintained legally, financially and physically separate from all other businesses of Centrica and that certain conditions must be met by Centrica in order to comply with this obligation. The first such condition is set out at paragraph 5.3(a): 

 "5.3 In order to comply with the general obligation contained at paragraph 5.1 above, Centrica and CSL will ensure in particular (but without limitation) that:

(a) No member of the Centrica Group except Centrica, GBGH or CSHL shall, directly or indirectly:

(i) hold any Interest in CSL
(ii) hold any Interest in any company which exercises or otherwise has Control of CSL or any of its assets
(iii) hold any Interest which gives the holder an entitlement to vote at the general meeting of CSL or in any company which exercises or otherwise has Control of CSL

save that BGPGS Limited (a subsidiary of GBGH) may hold non-voting preference shares in CSHL…"

The request for variation applies in respect of Centrica's wish, as part of an internal group restructuring, to establish a new intermediate holding company, Centrica Holdings Limited (CHL), [ ] within the Centrica group. CHL is to be inserted between Centrica and GB Gas Holdings Limited (GBGH) (a holding company and wholly-owned subsidiary of Centrica) which controls the entire interest of CSHL (see note 2). CHL's directors and secretary will be the same as those of GBGH.

Centrica submits that the creation of CHL will not affect the operation of or compliance with the Undertakings other than in respect of paragraph 5.3(a) noted above. Consequently, Centrica seeks a variation of the Undertakings by way of amendments (in bold below) to paragraph 5.3 as follows:

"5.3 In order to comply with the general obligation contained at paragraph 5.1 above, Centrica and CSL will ensure in particular (but without limitation) unless the Office of Fair Trading has given prior written approval to alternative arrangements that:

(a) No member of the Centrica Group except Centrica, Centrica Holdings Limited, GBGH or CSHL shall, directly or indirectly:

(i) hold any Interest in CSL
(ii) hold any Interest in any company which exercises or otherwise has Control of CSL or any of its assets
(iii) hold any Interest which gives the holder an entitlement to vote at the general meeting of CSL or in any company which exercises or otherwise has Control of CSL

save that BGPGS Limited (a subsidiary of GBGH) may hold non-voting preference shares in CSHL…"

THE OFT'S ADVICE ON VARIATION

Pursuant to section 88(4) of the Act, the OFT shall consider whether by reason of any change of circumstances the Undertakings are no longer appropriate and need to be varied or superseded and shall give such advice to the CC as it thinks proper in the circumstances where it appears that an undertaking needs to be varied or superseded.

The OFT considers that Centrica's proposed internal group restructuring [ ] within the Centrica group is a relevant change of circumstances for the purposes of s88(4) of the Act.

The OFT is of the view that the insertion of CHL into the Centrica group structure would not adversely affect the operation of the Undertakings or compliance thereto by Centrica and/or CSL. In the view of the OFT, in light of the submitted rationale for the restructuring, the requested amendment to paragraph 5.3(a) of the Undertakings seems proportionate and reasonable. Consequently, the OFT advises the CC to accede to Centrica's request to amend paragraph 5.3(a) of the Undertakings as detailed in paragraph 12 above.

Centrica's second suggested amendment relates to the first sentence of paragraph 5.3 of the Undertakings and would allow the OFT to give, at its discretion, prior written approval to alternative arrangements in respect of Centrica and CSL's compliance with any of the conditions specified in sub-paragraphs 5.3(a) – (l). These conditions were included to ensure that Centrica and CSL satisfied the general obligation of separation between Centrica and CSL (as set out at paragraph 5.1 of the Undertakings). These conditions are stated to be without limitation.

Centrica has offered no additional reasoning as to a change of circumstance which requires such a variation. The second variation is not required to address the issue of [ ]. As such it does not meet the requirements of section 88(4) of the Act. In itself such a variation would not undermine the operation of the Undertakings or compliance thereto by Centrica and/or CSL. However, it would introduce a degree of flexibility into the process of ensuring that the general obligation of separation at paragraph 5.1 is complied with, which may result in further requests for consent for variations to sub-clauses 5(a) to (l) covering physical, legal and financial separation. In addition, such an amendment could potentially give the OFT a broad discretion as to how Centrica and CSL comply in practice with the general obligation of separation in paragraph 5.1. For this reason, it could be deemed to potentially circumvent the statutory obligation on the OFT, as set out in section 88(4) of the Act, to advise the CC (or as the case may be the SoS) in relation to any possible variation of undertakings to be accepted or rejected by it (or him).

THIRD PARTY VIEWS

An invitation to comment was issued on Friday, 25 November 2005. No comments have been received. Ofgem was contacted and commented that in its view the variation will not affect the operation of the Undertakings. The OFT did not contact any other third parties directly in view of the minor nature of the variations being requested.

CONCLUSION AND RECOMMENDATION

The OFT's advice in this case is relatively brief due to the minor nature of the request for variations to the Undertakings by Centrica. Since the proposed inclusion of CSL between Centrica and GBGH is due to a change in circumstances in relation to the internal organisation of the Centrica group of companies, and the proposed amendment to paragraph 5.3(a) of the Undertakings to reflect this, does not in the view of the OFT affect the separation of CSL from other parts of the Centrica group (or the operation of any other part of the Undertakings) the OFT recommends that the CC should vary the Undertakings as requested by Centrica in this respect.

In respect of the second aspect of Centrica's request for variation (i.e. the amendment to the first sentence of paragraph 5.3 of the Undertakings enabling the OFT to give prior written approval to alternative arrangements for Centrica and CSL to ensure compliance with the particular conditions set out in that paragraph) as indicated above, the OFT considers that the requirement for a change of circumstances is not met, may be too broad and could be interpreted as potentially circumventing the CC's role in sanctioning requests for variations in undertakings.

NOTES

1. The CC Report on the merger situation between Centrica plc and Dynegy Storage Ltd and Dynegy Onshore Processing UK Ltd, dated August 2003.

2. It is proposed that the creation of CHL will be effected through the acquisition by CHL of all the shares in GBGH in return for an issue of shares to Centrica. CHL will then undergo a court-approved reduction of capital under section 135 of the Companies Act 1989. [ ]

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