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The Acquisition of Endesa by Gas Natural: An Antitrust Perspective

December 2005

Brief academic opinion of economic professors and scholars on the acquisition of Endesa by GN

Brief academic opinion of economic professors and scholars on the project of acquisition of Endesa by Gas Natural

Julian Barquin, Pontificia Comillas University (Spain), Lars Bergman, Stockholm School of Economics (Sweden), Claude Crampes, University of Toulouse (France), Jean-Michel Glachant, University Paris XI (France), Richard Green, University of Birmingham (United Kingdom), Christian Von Hirschhausen, Dresden University of Technology (Germany), François Lévêque, Ecole des mines de Paris (France), Steven Stoft (Berkeley, USA).

This opinion describes what the signatories believe are consensus views in academia on three major economic questions that arise with the projected acquisition of Endesa by Gas Natural.

1. Do national gas-electricity mergers strengthen or deter the building of the European internal energy market? The belief that national energy champions would make competition more vibrant at the EU level is wrong. On the contrary, the creation of giants combining gas and electricity within national boundaries is likely to slow down the building of the internal market for the following reasons: National gas-electricity mergers create dual fuel barriers to entry that limit possibilities of foreign producers trying to gain a foothold in another EU market while contestable entry to electricity, helped by gas liberalisation, should be an alternative option to enlarge the competitive arena before sufficient new interconnections are built.Gas-electricity national champions have less incentive to grow beyond their borders. The proposed divestitures of Endesa’s existing activities in other EU countries may just signal the national tropism of the new entity.The clearance of a locally anticompetitive merger generates an external effect by increasing suspicion of the Member State’s fair play in building the internal energy market, while cooperation between Member States is crucial for achieving the European internal energy market.

2. For the sake of electricity consumers, should ineffective and overly-stringent remedies be viewed as equally undesirable?In order to protect consumers, economic theory recommends that merger control in electricity markets should be more cautious and stringent than in other sectors. That is, the antitrust authorities should be more willing to risk imposing overly-stringent procompetitive remedies (type I errors) than to risk prescribing ineffective remedies (type II errors). Due to the extremely weak demand elasticity, electricity markets are extremely susceptible to market power. Consequently, a type II error can easily cause a huge transfer of surplus from consumers to producers and force final consumers pay nearly the full cost of the anticompetitive outcomes of inappropriate mergers. By contrast, the cost of prohibiting  mergers that provide efficiency gains (type I errors) will typically do very little harm consumers and suppliers, because significant efficiency gains from mergers are difficult to achieve in the electricity and gas sectors.

To keep the good (efficiency gains) without the bad (increased market power), competition law empowers antitrust authorities to impose merger remedies. But in the electricity and gas sector, the use of merger remedies is a risky game. Remedies can fail in a number of ways. Moreover, the risk of error is higher in markets recently opened to competition because competition authorities have to make guesses not only on the effects of the merger and on the effects of the remedies, but also on the future mode of competition and market boundaries before they are stabilised.

3. What are the potential anticompetitive effects of the projected acquisition?

Removal of an effective and growing independent competitor

Because of some divestments by Endesa to Iberdrola, the Gas Natural/Endesa transaction is designed so that the total generation capacity of the merged company would be below the current capacity of Endesa. However, such a lowering may hide a market power increase in the energy market. The market power of generators depends on whether for a given time (especially in peak hours) and a given place (in load pockets) a generator is indispensable to serve demand and to balance the system. Therefore, the unilateral effect of the merger greatly depends on the redistribution of plants.

As market power exercised by others has the same effects on price without the costs of withholding, the merged company can profit just as much by giving market power to an existing competitor as to itself. The proposed merger could increase the risk of collusion in the Spanish wholesale electricity market, as it would remove the pressure of a strong independent new entrant. The bargaining over remedies between incumbents could also increase the symmetry between the two major Spanish producers and facilitate collusive practices.Elimination of strong and effective dual fuel competitorsWhere both Gas Natural and Endesa are incumbent distributors and retailers, the merger would eliminate a key dual fuel competition. This is because the two incumbents have strong local customer bases, established reputations and can save money in bundling gas and electricity. Moreover it would instantly give to the merged company the advantage of becoming a dual fuel incumbent.

Input foreclosure

Whereas the other anticompetitive effects would simply terminate one source of competition, the vertical integration of GN and Endesa would confer additional market power on the merged company if it was able to profitably raise the price of gas charged to competing generators. The merger could increase the market power of the new entity in three different ways that are detailed in the opinion.

Customer foreclosure

In substituting exchanges through the market by exchanges within a single integrated firm, the merger may impede the development of the wholesale gas market, a key aspect of gas liberalisation. The elimination of a key purchaser may also decrease economies of scale that alternative gas suppliers would have achieved absent the merger, and thus may result in a price increase for their sales. If the integrated firm has enough market power on the wholesale gas market, it will follow the price increase rather than offer a lower price. In the short run, the foreclosure effect may concern only a small amount of gas (e.g. in excess of volumes contracted in the long term), but this would still contradict the objective of an integrated competitive gas market, that is supposed to achieve shorter contract durations and more liquid wholesale markets.To sum up, vertical and horizontal anticompetitive effects of convergent mergers are several, and they may be individually strong. Clearing the merger with ineffective remedies could lead to tremendous costs born by final consumers. The merger would increase dual fuel barriers to entry in Spain, reduce the incentives for the merged company to grow outside its national borders, slow the building of the internal market, and reduce regional cooperation in Europe. We therefore strongly recommend that the pro- and anti-competitive features of the proposed GN/Endesa merger be accurately and thoroughly assessed using a detailed model of the electricity market according to established antitrust standards.

 

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