Proposed acquisition by Dynegy Europe Limited of BG Storage Limited

No. ME/1361/01

Undertakings in lieu of reference – Director General's advice, dated 14 November 2001, to the Secretary of State for Trade and Industry under section 75G(1)(c)

In this submission I advise under section 75G(1)(c) of the Fair Trading Act 1973 (the Act) on the particular effects adverse to the public interest which, in my opinion, this merger situation may be expected to have.

I recommend that, in lieu of a reference to the Competition Commission, you accept undertakings from Dynegy Europe Limited (Dynegy) in the form attached to this submission. These undertakings are, in my view, appropriate to prevent the effects adverse to the public interest that might be expected to arise from the merger and which are specified below. If you agree with my recommendation the undertakings will need to be published together with this advice.

Timing

Urgent. In your Department's announcement of 10 September, I was asked to report, in the light of a consultation by Ofgem, by 23 October. Discussions between Ofgem and Dynegy over the terms of the consultation led to delay in the process, such that I did not receive Ofgem's report until 12 November. I have considered Ofgem's report and prepared this advice as quickly as possible, since I understand that the parties are now eager to complete the transaction without further delay.

Background

On 10 September you announced that you had decided, in accordance with my advice of 31 August, not to refer this merger to the Competition Commission provided that Dynegy gave undertakings to remedy the competition concerns raised by the merger. Ofgem was to consult publicly on the form which undertakings from Dynegy might take. Ofgem's consultation paper, which sought views from interested parties on alternative sets of undertakings proposed by Ofgem and Dynegy respectively, was published on 16 October.

The gas storage business to be acquired by Dynegy includes two large storage facilities (Rough and Hornsea). The operation of these facilities is currently subject to regulation by means of non-statutory assurances given by BG plc to Ofgas in February 1999, which apply for the five years up to and including the 2003-04 storage year. These assurances are designed:

to prevent the owner of the facilities from exploiting its market position, for example by withholding storage capacity from the market, and/or offering storage capacity on unduly discriminatory terms and thereby distorting competition in the storage market and/or gas related markets such as gas supply. This could raise prices to storage customers by reducing the storage capacity available, and thus lead to final gas customers paying higher prices. This issue is addressed by requiring BG Storage to auction the maximum physical capacity of the storage facilities; and

to ensure that information acquired by the owner in its role as an operator of storage facilities (for example, on the use being made of the facilities by other parties) cannot be used to benefit it in its role as a trader. This is achieved by the effective separation of the storage business from BG's other commercial activities.
The purpose of the undertakings that are now proposed is to ensure that, following the acquisition, these concerns continue to be adequately addressed. The undertakings would be confined to addressing the adverse effects of the merger and, as such, cannot extend beyond the term of the existing assurances, ie the end of the 2003-04 storage year.

Adverse effects of the merger

The assurances given by BG to Ofgas recognised the potential competition problems arising from the very high share of physical gas storage capacity held by the owner of Rough and Hornsea, and from their ownership by a company which also has interests in the wholesale market. By virtue of the fact that these assurances would no longer apply following the acquisition by Dynegy of Rough and Hornsea, such problems would be a consequence of the merger.

In my view the scope and scale of the potential adverse effects arising from this merger are sufficient to justify reference to the Competition Commission.

The proposed undertakings

In my advice of 31 August, I proposed that a similar form of regulation to that currently applying to BG Storage should be maintained, and envisaged that Dynegy would give to Ofgem a revised version of the existing BG assurances, given statutory force by means of undertakings in lieu of reference that would essentially require Dynegy to comply with the terms of those assurances. Following further discussion between Dynegy, Ofgem and the Office of Fair Trading, however, it has been agreed that future regulation should be in the form of undertakings alone. The net result, in terms of scope and enforceability, is the same and the approach now agreed is simpler than that originally envisaged. Dynegy has indicated, by signing them, that it is prepared to give the undertakings set out in the annex to this advice. The objectives of the undertakings are as envisaged in your announcement of 10 September, namely to ensure that all gas storage capacity is released to the market on non-discriminatory terms, and that the commercially confidential and market sensitive information available to a storage owner cannot be misused by any affiliated trading business.

The main points arising from the Ofgem consultation were as follows:

• Ofgem originally proposed that Dynegy should be required, as BG Storage has been, to auction the maximum physical capacity of the Rough and Hornsea facilities. A number of respondents expressed the view, however, that Dynegy should be able to sell capacity other than by auction, eg through tenders or bilateral sales, provided that this was done on non-discriminatory terms. The undertakings now proposed would allow Dynegy in the first instance to sell capacity on non-discriminatory terms using methods other than auctions, with any capacity remaining unsold being made available by auction 30 days before the start of the storage year in accordance with the procedures currently used by BG Storage. Ofgem believe, and I accept, that this approach meets the concerns expressed by respondents that the undertakings should not unduly restrict the means of marketing of storage products, while still ensuring that all capacity is brought to market on non-discriminatory terms;
• the concerns about access to confidential information are addressed in the proposed undertakings by Dynegy's agreement to the separation, in terms of finances, information and systems, of its storage business from its other commercial activities. The majority of responses to Ofgem's consultation endorsed their proposed line on this issue. Ofgem conclude, and I accept, that the proposed undertakings satisfactorily address this area of concern;
• since the current assurances came into effect, BG Storage has offered up to 50% of each facility's capacity on a one-year basis. This is to facilitate new entry to the gas market and prevent access to storage from becoming a barrier to entry, in the absence of a well developed secondary market for storage services. Based on the responses to its consultation, Ofgem now proposes that 20% of each facility's maximum physical capacity should be made available on this basis. I accept Ofgem's recommendation that the undertakings to be given by Dynegy should be amended in this way.

Representations

Nineteen responses were received to Ofgem's consultation paper, and have been taken into account in Ofgem's report to me on the proposed undertakings. In addition to the issues already mentioned, a number of respondents expressed concern about the regulatory arrangements which would apply after the proposed undertakings expired in 2004. As I said in my earlier advice, it is possible that competition problems will continue beyond this date. But such problems, were they to occur, would not be a consequence of the merger, and it would, therefore, not be appropriate to address them by means of undertakings in lieu of reference. Ofgem have, however, agreed with Dynegy to begin discussion of arrangements beyond 2004 on completion of this transaction, and if necessary will launch a review of the potential development of competition for storage and related products beyond 2004.

Recommendation

Having considered the representations received by Ofgem and Ofgem's report to me, I recommend that, in lieu of making a reference to the Competition Commission, you accept the undertakings offered by Dynegy as appropriate to prevent the effects adverse to the public interest which this merger might be expected to have. I also recommend that you publish the text of the undertakings and this advice in accordance with the requirements of section 75H of the Act.

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