Pacificorp and The Energy Group Plc: A Report on the proposed acquisition

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Summary

On 1 August 1997 the Secretary of State for Trade and Industry (the Secretary of State) asked us (see Appendix 1.1) to investigate and report on the proposed acquisition by PacifiCorp of The Energy Group plc (TEG). We were also asked to examine whether there was already in existence a merger between PacifiCorp and TEG: but we found this not to be the case.

The PacifiCorp group is an electricity utility which operates primarily in the western USA and in Victoria, Australia. TEG is the parent company of Eastern Group plc (Eastern Group), whose subsidiary Eastern Electricity plc (Eastern Electricity) distributes electricity in the east of England, supplies electricity in that area and elsewhere in the UK and is the fourth largest generator of electricity in the UK. PacifiCorp currently has no activities in the UK and the merger does not have any direct effect on competition in the UK.

Eastern would be the eighth regional electricity company (REC) to be owned by a US parent company, but we saw no reason to expect adverse effects to result from foreign owner-ship in itself. Concern was expressed to us about the effect of the merger on the availability of information necessary for the effective regulation of the licensed activities of Eastern Electricity, but we found the existing provisions of Eastern Electricity's licence sufficient to ensure availability of adequate information to the Director General of Electricity Supply (DGES). There was also concern about the extent to which information about Eastern Electricity would be publicly available: but we concluded that such problems did not arise from the merger and could be appropriately addressed elsewhere, for example in the interdepart-mental review of utility regulation currently being carried out.

Our main area of concern was the effect of the intended financial arrangements for the acquisition, which would be financed to a large extent by borrowing. The higher the level of gearing (the ratio of debt to debt plus equity), the greater the likelihood of financial pressures on a firm in servicing debt in the event of adverse economic conditions. The gearing of Eastern Electricity itself would not be increased by the merger, but Eastern Group's new holding company?PacifiCorp Acquisitions?would initially be almost entirely debt financed, and would rely heavily on the dividends paid to it from Eastern Group to service that debt. Although we do not expect financial difficulties to arise, we believe that, in the absence of adequate controls, the high level of gearing resulting from the merger would give rise to a significant risk of finan-cial pressure on the holding companies of Eastern Electricity, potentially leading to a require-ment for higher cash flows from Eastern Electricity than would otherwise be the case, and to under-investment, poorer service standards and/or higher prices for electricity in the longer term as a consequence.

However, Eastern Electricity's existing licence conditions include a number of provi-sions designed to `ring-fence' its licensed activities from those of the group of which it is a member, and to ensure that it has adequate financial resources to undertake these activities. In our view, the existing controls, which include the provisions of the Electricity Act 1989 (Electricity Act) subsuming the enforcement powers of the DGES, and Eastern Electricity's licence, together with licence amendments previously agreed in principle between PacifiCorp and the DGES, are sufficient to address the risk that Eastern Electricity would be adversely affected by any such financial pressures. The DGES should therefore be in a position to ensure that investment and service standards can be maintained, without higher prices resulting from the merger.

We have therefore concluded that the proposed merger may not be expected to operate against the public interest.

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