COMMENTS ON THE PETROLEUM PRODUCTS AMENDMENT BILL( B25 - 2003)
1 Introduction
The Petroleum Products Amendment Bill (the Bill) seeks to bring the petroleum industry in line with the socio-economic developments that have taken place in the country pursuant to a democratic dispensation. It aims at, among other things, fostering the entry of small firms, protecting the jobs of pump attendants and ensuring the availability of petroleum products at competitive prices. Whilst these objectives are welcome, the manner in which the Bill proposes to achieve them might compromise productive and allocative efficiency in the industry. Of particular concern is the provision that restricts vertical integration of any form in the industry. It is our submission that government should consider removing other obstacles that serve as barriers to entry instead of tempering with the structure of the industry.
2 Vertical integration
Section 2A (4)(a) of the Bill proposes the prohibition of activities that would result in vertical integration in the industry. It states that:
"No person may make use of a business practice, method of trading, agreement, arrangement, scheme or understanding which is aimed at or would result in -
(a) vertical integration of ownership in respect of manufacturing, wholesaling or retailing of petroleum products; ......"
According to the Bill, this is meant to facilitate the entry of small businesses in the industry. It would appear that this proposal is premised on the idea that vertical integration is a barrier to entry and is thus anti-competitive. Whilst the facilitation of small business entry is a welcome and noble objective, the restriction on vertical integration might serve to disadvantage bigger companies that are already vertically integrated, or those that may want to exploit economies of scale as a result of growth in the future. Vertical integration may or may not be anti-competitive depending on the specific circumstances of the industry concerned. Of particular importance is the level of market concentration, the entry and exit pattern and the history of abuse in the industry in terms of the behaviour of firms. This later aspect can be dealt with through competition legislation. These issues call for an in-depth competitive analysis of the industry rather than relying on a general presumption that views vertical integration with scepticism.
It should also be noted that a statutory provision outlawing vertical integration could itself be anti-competitive. Although the clause on vertical integration is intended to promote the entry of small firms into the industry, care should be taken not to achieve this at the expense of consumer welfare and economic efficiency. Breaking up the industry into many tiers is likely to increase transactions costs. These costs could either be translated into higher retail prices or a squeeze on company profits, often with adverse effects on employment. Either way, this is not a preferred outcome. A vertical separation of the industry could compromise some of the efficiencies that are inherent in co-ordinated activity. Thus, a clause restricting vertical integration could lead to a misallocation of resources. The decision to vertically integrate should be the prerogative of firms, based on efficiency considerations. In this respect, section 2A (4)(a) is in conflict with section 2B (1) (a), (b), (c) and (d) which states the objectives of licensing in terms of this Act as being to promote an efficient retail petroleum industry, facilitate an environment conducive to commercially justifiable investment and ensure the availability of petroleum products at competitive prices. These objectives cannot be achieved in a heavily regulated environment.
3 Barriers to entry
The question that needs to be answered is whether or not entry into the petroleum industry is being impeded by the structure of the industry, in particular the tendency by firms to vertically integrate. Since the critical issue appears to be barriers to entry, a brief discussion of the concept would be in order here.
Barriers to entry in any industry can be grouped into two broad categories: a) regulatory and institutional barriers and b) cost-related barriers. The first type of entry barriers relates to government regulations and stipulations with which industry players have to comply. These have played a significant role in determining entry into the South African petroleum products industry. The petroleum industry remains a heavily regulated industry in terms of the way firms operate, including the sourcing, distribution and pricing of petroleum products. Government regulates this industry through import taxes and quotas, licensing requirements, price controls, product standards, zoning regulations, environmental and safety regulations, the number of service stations allowed at a point in time, etc.
From a competition policy perspective the most effective measure to ensure low prices, facilitate entry, promote consumer welfare and ensure allocative and productive efficiency is to maximize competition. Any measure that
(1) increases the cost of doing business at any level in the petroleum market by compromising economies of scale,
(2) controls the supply or purchase of fuel in any market
(3) regulates the import or export of petroleum products into or from any market or
(4) regulates the price of petroleum products in any market, is most likely to be anticompetitive.
Deregulation
Instead of a further regulation of the structure of the industry, a possible solution would be a process of phased-in or partial deregulation to allow market forces their free play. Deregulation should be a managed and phased-in process that will occur over a period of time to ensure a smooth transition. However, there are fears that deregulating the industry would let big oil companies on the loose. The result would be market power abuse and collusion. These fears should be allayed by the fact that South Africa has a renowned competition policy regime that is able to deal with such anti-competitive behaviour effectively. Another concern is that deregulation might lead to a proliferation of service stations that are not economically viable. The market system should be able to deal with such a scenario by eliminating those businesses that are not viable and promoting those that are efficient.
Cost as a barrier to entry relates to the long run cost advantages that incumbent firms enjoy over new entrants. These cost benefits can either be natural, determined by demand and supply forces in the market or artificial, arising from government regulations and policies. Still, cost barriers could result from strategic behaviour by incumbent firms to raise the costs of entrants. The cost advantages that incumbent firms could have over new entrants include: information and industry knowledge, access to product supplies, access to technology, access and proximity to facilities and brand loyalty. These issues, as opposed to vertical integration, play a more significant role in preventing or promoting entry.
The foregoing discussion serves to highlight the fact that there are many sources of entry barriers. Restricting vertical integration might not necessarily promote the entry of small firms; rather, government should consider removing some of the obstacles that stand in the way of effective competition. Evidence from Australia, New Zealand and the UK indicates that vertically integrated firms in the petroleum industry have not been able to prevent entry at any stage of the production chain. Instead, deregulation in these jurisdictions has resulted in lower fuel prices as a result of competition. Entry into the South African petroleum industry can take place in a number of areas including gas and oil exploration, crude oil refinery, synfuel manufacturing, imports, provision of facilities, companies (e.g. a supermarket chain) diversifying into petroleum retailing, joint ventures between incumbent firms and new entrants, transportation, storage and marketing of product and private and public sector procurement.
4 The industry charter
In 2000 the petroleum and liquid fuels industry released a charter that aims at transferring no less than 25% equity-ownership of the industry to previously disadvantaged people within a ten-year period. One could suppose that the charter gives clearly defined measures of achieving this objective and in that sense takes care of the barriers to entry concern expressed in section 2A of the Bill. Besides company ownership and control, the charter further identifies private and public sector procurement, and joint ventures as areas of potential entry. Whilst the charter rightly points out the issue of finance as a huge obstacle to entry into the industry, it does not mention the structure of the industry as an impediment. Perhaps it is not.
5 Self service
Section 2A (4)(b) of the Bill outlaws the sale of petroleum products using a system of self-service by consumers. The objective here is the preservation of pump attendants' jobs. This understandable for as long as unemployment prevails. However, given that the economic landscape of the country is likely to change for the better, in terms of a decrease in the level of unemployment, this restriction might not be necessary in the future under a different set of economic circumstances. The Bill should therefore accommodate self-service by consumers should unemployment cease to be an economic menace.
6 Jurisdiction on competition matters
Section 12B provides for the process of arbitration in the event of a dispute. It states that (1) "The Controller of Petroleum Products may, on request from a retailer alleging an unfair contractual practice by a wholesaler, or vice versa, require, by notice in writing to the parties concerned, that the parties submit the matter to arbitration." It further provides for the appointment of an arbitrator chosen by the parties to the dispute and in accordance with the rules agreed between the parties.
What is not clear from this provision is the role of the Competition Commission in the event that the nature of the dispute is competition-related. This is likely to raise the issue of concurrent jurisdiction. In order to avoid a duplication of roles, it is recommended that all disputes that have a competition aspect be notified with the Competition Commission. The Controller of Petroleum Products may then refer for arbitration any other dispute that has no competition component.
The same can be said about section 12C (b), which provides for the Minister to make regulations "prohibiting a business practice which conflicts with any objective referred to in section 2B (1)" Some of the said objectives in section 2B (1) have a competition aspect. As such, the issue of jurisdiction over competition matters arises. It is recommended, therefore, that the Minister refer all business practices that are anti-competitive to the Competition Commission.