By Christoph Steitz and Susanna Twidale
FRANKFURT/LONDON (Reuters) - Britain's SSE (L:SSE) and Germany's Innogy on Wednesday agreed to merge their retail activities in Britain, cutting Britain's big six energy providers to five and kicking off what is expected to be biggest European sector shakeout in years.
The announcement comes a day after both groups said they were in talks about the merger, creating a challenger to Centrica's (L:CNA) British Gas as the country's largest energy supplier.
Large energy retailers have bled market share to smaller and cheaper rivals and face a cap on retail prices proposed by the British government, making it hard for established players to earn a decent margin.
Low wholesale prices, a surge in renewables energy capacity and plans for a cap on British power prices is expected to drive further consolidation among established European providers as they seek to cut costs and shore up falling earnings.
"When we look at the competitive landscape and the uncertain political environment for energy retailers in Great Britain, it is clear that Npower would be better placed to offer value to our customers and our shareholders as part of a new company," Innogy Chief Executive Peter Terium said in a statement.
Smaller rivals, often able to offer cheaper deals due to lower overheads, now control around 20 percent of the market up from less than 1 percent a decade ago.
"Given the interference in the market with the price cap, and pressure on margins, the natural reaction is for companies is to try to gain scale," said Peter Atherton, an associate at consultancy Cornwall Insight.
The new firm would have about 11.5 million customer accounts, second only to British Gas which has more than 14 million accounts.
The new firm and Centrica would together control more than 50 percent of the market and analysts have voiced concern about whether the move will get approval by antitrust authorities.
"We are aware of the merger but cannot comment further at this stage," a spokeswoman for Britain's Competition and Markets Authority (CMA) said.
Analysts also expressed concerns about potential problems combining Innogy's and SSE's IT platforms, which according to Bernstein run on two different systems.
SSE will hold 65.6 percent of the new entity, which will consist of Innogy's Npower and SSE's retail customer business and will be listed on the London stock exchange. Innogy will hold the remaining 34.4 percent.
SSE's business retail and Ireland operations will not be included in the combined company, both groups said. Innogy will receive a 60 million pounds ($79 million) break fee if SSE fails to get approval for the move by July 31, 2018.
"This process is likely to take some time and in the interim we remain absolutely focused on the critical job of delivering for customers," said Alistair Phillips-Davies, Chief Executive of SSE.