Regulatory and competition law probes in the natural resources sector

Regulatory and competition issues are at the top of the business agenda for natural resources, energy, and multi-utility companies active in the EU. Despite regulatory convergence in some areas (e.g., unbundling and cost of capital), there remain a variety of sector-specific issues.

For example, a number of recent competition law interventions in the water sector in the EU and UK have shown that a sector that historically has not been exposed to the full rigours of competition is nevertheless subject to competition issues. This article reviews three current cases: the European Commission (Commission) launch of competition law proceedings against several French water companies; an investigation by UK Water Services Regulation Authority (Ofwat) alleging abuse of dominance; and the ongoing UK merger control review of the acquisition of Cambridge Water plc by South Staffordshire plc, owner of South Staffordshire Water plc. Many of the issues raised are not unique to the water sector and share similarities with EU and UK competition and regulatory intervention in other utilities and in the energy sector in particular.

European Commission opens proceedings against French water companies

On 18 January 2012, the Commission announced the opening of formal proceedings to investigate whether the French water companies SAUR, Suez Environnement/ Lyonnaise des Eaux, and Veolia, together with their trade association, have infringed the EU prohibition on anticompetitive agreements in Article 101 of the Treaty on the Functioning of the EU (TFEU). [1]

The Commission is investigating whether the undertakings have unlawfully co-ordinated their behaviour on the French water and waste water markets, in particular in relation to their prices charged to final customers. The opening of proceedings means that the Commission is now treating this case as a matter of priority, though no firm finding on infringement has been made.

The Commission’s action follows a similar investigation of energy companies in relation to unlawful agreements under Article 101 TFEU. On 8 July 2009, the Commission announced that it had imposed a fine of EUR 553 million on each of E.ON (and its subsidiary E.ON Ruhrgas AG) and GDF Suez AG for market-sharing in the French and German gas markets. [2] The Commission found that the companies infringed Article 101 TFEU by an agreement not to sell gas transported from Russia over a jointly-owned pipeline into their respective home markets.

Ofwat sends statement of objections to Anglian Water alleging abuse of dominance

On 12 December 2011, Ofwat announced that it had sent a statement of objections to Anglian Water, a UK water and sewerages company. Ofwat suspects that Anglian Water has abused its dominant position (contrary to the Chapter II prohibition of the UK Competition Act 1998, which is the UK national law equivalent provision to Article 102 TFEU and which has some similarities with section 2 of the Sherman Act in the U.S.). [3]

The statement of objections sets out Ofwat’s allegations that Anglian Water imposed an unlawful ‘margin squeeze’ in relation to its pricing for providing water and sewerage services to a development site in Milton Keynes in the UK. Alleged abuse of dominance through margin squeeze has also been raised against companies operating in the energy sector. For example, on 18 March 2009, the Commission announced that it had decided to accept binding commitments under Article 9(1) of Regulation 1/2003 from RWE to address the Commission’s concerns that RWE may have abused its dominant position in the gas transport market by refusing to supply gas transmission services and imposing a margin squeeze. [4] Under the commitments, RWE agreed to divest its West German gas transmission system business to a suitable purchaser.

UK Office of Fair Trading refers water merger to the Competition Commission

On 5 January 2012, the UK Office of Fair Trading (OFT) referred the acquisition of Cambridge Water plc by South Staffordshire plc, owner of South Staffordshire Water plc, to the UK Competition Commission for an in-depth investigation. [5] The Competition Commission must report by 20 June 2012. This is only the second mandatory reference of a water merger made by the OFT since the UK Enterprise Act 2002 came into force.

Mergers between UK water companies are governed by a special statutory regime. Under the Water Industries Act 1991, as amended by the Enterprise Act 2002, the OFT is under a duty to make a mandatory reference to the Competition Commission of anticipated or completed mergers between two water enterprises unless: (i) the value of the turnover of the water enterprise being taken over does not exceed GBP 10 million; or (ii) the only water enterprises already owned by the acquirer each have turnover that does not exceed GBP 10 million.

Where these thresholds are exceeded, the OFT must make a reference regardless of any competition issues. Following reference, the Competition Commission must consider whether: (i) a water merger has taken place or there are arrangements in progress which, if carried into effect, would result in a water merger; and (ii) the water merger has or may be expected to prejudice the ability of Ofwat to carry out its functions under the Water Industry Act to make comparisons between different water enterprises (for example, in the context of regulatory reviews and price determinations). The consequence of the low turnover tests is that, currently, all UK water mergers will be subject to a mandatory reference and in-depth review.

Up to now, consolidation in the English and Welsh water industry has been challenging. However, in 2007 the Competition Commission approved such a water merger. The Cave Review (2009) and ongoing government review and consultation may also bring about regulatory changes. Among the proposals are an increase in the turnover test for water mergers that are subject to merger control, a development that could create merger opportunities.

There is no equivalent special statutory regime for the review of other utility mergers in the UK. Energy mergers will be subject to the normal UK merger control procedure [6] and will be assessed on competition law grounds as to whether they may be expected to substantially lessen competition in the UK. However, in practice and in addition to providing input to the OFT (and, if appropriate, the Competition Commission) on competition issues, the UK energy regulator (Office of Gas and Electricity Markets (Ofgem)) and Ofwat will consider a transaction more generally to assess whether it raises any regulatory concerns. When a utility is being acquired, the sector regulators will also seek to satisfy themselves that a new owner has the operational, financial capacity, and probity to assume the role of a network owner.

Implications for transactions in the EU natural resources, energy, and utilities sectors

Despite challenges presented by the regulation of utility companies and the increasing trends of intervention by competition authorities, there continues to be appetite among national and overseas buyers in owning and acquiring such companies. This may, in part, reflect their potential relatively stable (albeit capped in certain cases) revenue streams.

Quite apart from “usual” due diligence that any potential acquirer will need to undertake (including, for example, employment, environment, litigation, real estate, etc.), it is also important to consider actual or potential non-compliance with competition law, regulatory, or licensing requirements.

Due diligence in relation to potential infringements of general competition law is high stakes in view of the potential penalties, including fines of up to 10 per cent of global group turnover, and potential damages actions from third parties who can show that they have been harmed. In this regard, it is noted that water companies and transmission owners and operators may, by definition, be found to occupy a dominant position where they are each a monopoly in their appointed area. They will therefore be subject to the prohibition against abuse of a dominant position.

These recent and ongoing cases are a reminder that companies active in the natural resources, energy, and utilities sectors and investors weighing opportunities will need to assess complex competition law and regulatory issues impacting the value of their potential investment.