BP SOUTHERN AFRICA (Pty) Ltd

PETROLEUM PRODUCTS AMENDMENT BILL 2003

PETROLEUM PRODUCTS AMENDMENT BILL (B25-2003): PUBLIC HEARINGS

Please find attached a memorandum which constitutes the representations that B P

SOUTHERN AFRICA (PROPRIETARY) LIMITED, CALTEX OIL (SOUTH AFRICA)

(PROPRIETARY) LIMITED, ENGEN PETROLEUM LIMITED and SHELL SOUTH

AFRICA MARKETING (PROPRIETARY) LIMITED ("THE CRUDE COASTAL

REFINERS") wish to make to the Portfolio Committee on Minerals and Energy, for

consideration during the upcoming public hearings on the Bill.

These representations are in addition to, and are furthermore intended to serve as clarification of, those areas where the position of the Coastal Refiners extend beyond, or necessarily due to situation differs from, that of other members of SAPIA.

The Coastal Refiners request the opportunity to make presentations in person, preferably after the Committee has dealt with the presentations of SAPIA. The details of the persons who will represent the Coastal Refiners during the presentation session shall be forwarded as soon as these have been finalised. Hard copies of this paper and slides will be made available at your convenience.

Carlo Germeshuys on behalf of the Coastal Refiners

B P SOUTHERN AFRICA (PROPRIETARY) LIMITED

CALTEX OIL (SOUTH AFRICA) (PROPRIETARY) LIMITED

ENGEN PETROLEUM LIMITED

SHELL SOUTH AFRICA MARKETING PROPRIETARY) LIMITED

("THE CRUDE COASTAL REFINERS")

A. Background

The ambit of regulation of the liquid fuels industry will at all times be determined by the ambit of the purpose statements selected for inclusion in the legislation creating the regulatory powers, and of the general public interest considerations capable of being served in the context of the particular purposes being pursued. All acts of regulation of any elements of the industry must as a consequence, if they are to escape being susceptible to attacks of being unlawful, assist in the attainment of the purposes and public interest considerations intended to be served by the regulatory actions in question.

2. Regulation could conceivably extend across the following levels of industry activities:

2.1 the production and supply to refiners of the feedstock used by them to manufacture liquid fuels (in the SA context hydrocarbons, coal and in the near future natural gas)

2.2 the refining of feedstock into liquid fuels

    1. the sale and distribution of liquid fuels to various distinctive markets (wholesale/retaiI/

local/export)

{The regulation of future competition between alternative sources of energy performing the same tasks (electricity, natural gas, liquid fuels, sun energy) is clearly not contemplated by the purpose statements contained in the Pipelines Bill and the Petroleum Products Act, as proposed to be amended by the Petroleum Products Amendment Bill.]

3. The inclusion of "crude oil" and "petroleum products" in the definition of "petroleum" in the Pipelines Bill, and a mirror definition of "petroleum products" in the Petroleum Products Act, indicates an intention to limit the application of the proposed regulatory regime in the case of 2.1 above to the storage and conveyance of crude oil only. From this it must be assumed that the purposes and public interest considerations to be served by the proposed regulatory regime are already, as far as the delivery (actually in the case of the production and supply of coal and crude oil and prospectively in the case of natural gas) of feedstock to the respective refinery processes are concerned attained through the application of normal market principles, and no regulatory intervention is required. The coastal crude refiners agree this proposition. The same seems not to be the case as far as the storage and conveyance of crude oil is concerned, and the coastal crude refiners are in agreement that regulatory intervention in this area is required.

It is necessary to understand the context within which a selective rather than an overarching approach to regulation of the liquid fuels industry is proposed, in order for Parliament to pass laws for the purposes of such regulation that will be rationally consistent with the Constitutional framework and optimally serve the stated purposes and public interest considerations.

B. The context within which the introduction of selective reguIatory measures is proposed

 

1. Historical context of Government intervention in the liquid fuels industry and the impulses that drive the need for re-regulation

The history of the origin and development of the Apartheid regime is well recorded. One consequence of that regime was the need for creating the infrastructure for progressive displacement of imported feedstock/liquid fuels with locally produced liquid fuels. The history and success of the establishment of the South African synfuels industry is equally well recorded. What is less well-recorded are some of the consequences of that establishment process: the initial mothballing and de-mothballing of crude refining capacity in favour of optimising synfuel production and the costs to the economy associated with this; the resultant marketing restraints in terms of which the crude refiners undertook to purchase for resale into the South African economy most of the synfuel production to ensure the economic viability of the synfuel producers; the reciprocal undertaking by the synfuel producers not to market the balance of their production directly into defined parts of the South African markets and the distortive effect of these on competition in the liquid fuels industry; the resultant creation of a monopoly wholesale supplier in the "heartland" of the South African economy; the inescapability of the consequences of the balance in refining infrastructure (crude refiners would become dependent on synfuel supplies or imports for as long as their own refining capacity remained insufficient to supply their own marketing needs); the subsidies from time to time paid to both synfuel- and crude refiners.

As soon as the Apartheid regime ended, pressures started mounting for the return to the application of free market principles and the consequential abolishment of distortive (protective) mechanisms (import control; subsidies). The new SA constitutional dispensation including competition law reform progressively increased the pressure on continuation of collusive practices necessitated by the need to achieve the former strategic objectives, with new strategic objectives in support of building a new democratic regime for South Africa putting further pressure on the continuation of the "old" dispensation.

The improvement of synfuel technology such that its application could make the conversion of natural gas into liquid fuels economically viable will add a further feedstock "competitor" to the South African liquid fuels industry, whose entry into the market is already made possible by the legislative support infrastructure created by the Gas Act. Securing its relative competitive position may require regulatory intervention.

2. The characteristics of the present profile of the liquid fuels industry that requires confirmatory/corrective action

The following restraints and interventions are at present in place around various elements of the liquid fuels industry:

· sourcing of feedstock/refined products: import control

· refining capacity: freedom of expansion limited by implications of Government interpretation of public interest considerations served by preferment of increase in syn fuel production capacity

· distribution of products: State ownership of essential facilities (pipelines; rail lines); subsidies through pricing mechanisms around use tariffs

· marketing: market allocations through the Rationalisation Plan; control of

investment in marketing infrastructure

· product pricing: resale price maintenance; margin control at wholesale- and retail levels

· product quality: SABS specifications

The application of the listed mechanisms in support of the Apartheid regime objectives has left a legacy of distortion of competition and diseconomies in the liquid fuels industry that will continue to hamper the achievement of Government's high-level objectives for the SA economy [promotion of global competitiveness of domestic economy (cost of capital; return on investment); address discontinuities brought about by Apartheid government practices; remove value-destroying cost elements present in the economy due to continued pursuit of defunct strategic objectives, by e.g. cessation of unjustified subsidies]. The residual impact is most visible in the liquid fuels distribution infrastructure:

· crude oil and a gas resulting from the synfuel production process at Secunda ("MRG") are in competition for access to a sub-optimal distribution infrastructure, including the Petronet pipeline system

· the efficiency profile of this distribution infrastructure is less than optimal

· It is not possible to expect that price competition by itself will efficiently resolve problems of allocation of capacity in the infrastructure

· Historical regulatory intervention in the allocation of infrastructure has resulted in a present allocation profile that increases the risk of non-availability of supplies in force majeure situations

· the pursuit of Constitutionally induced public interest considerations will tend to increase inefficiencies located in the distribution infrastructure until these considerations are fulfilled

3' Fundamental principles that should govern Government intervention in commercial activities

Government intervention in commercial activities that results in distortion of the application of universally accepted market principles (one of which is fair competition) is acceptable in the following circumstances:

· the intervention must be aimed at the achievement of an objective that is strategic and in the public interest (e.g. black economic empowerment)

· the application of market principles itself gives rise to consequences contrary to

the public interest (e.g. absence of regulation of competition results in the abuse of market dominance) These principles necessitate application of the following methodology to establish the legitimacy and content of proposed interventions:

· identity the strategic objective(s) that will determine the presence and content of intervention(s) in the liquid fuels industry

· identity and test for legitimacy the public interest consideration(s) that will justify any intervention(s) that might be proposed to achieve the objective(s) so identified

· identify the appropriate intervention required to achieve the objective(s)

· identify and place in context the element of the liquid fuels industry (structure or process) which will prospectively be subject to intervention

· evaluate the distortive effect(s), if any, that the proposed intervention(s), or their absence, will have in the affected market, and take corrective action, if necessary.

The perception of the coastal crude refiners is that this methodology has been properly applied by the promoters of the proposed regulatory regime for the liquid fuels industry in their proposed framework for regulation.

C. Proposed framework for reguIation of the liquid fuels industry

The;

· Gas Act, 2001 (to the extent that transmitters intend to use natural gas as feedstock for the manufacture of liquid fuels)

· Pipelines Bill, 2003 ("the PB")

· Petroleum Products Act, 1977, as proposed to be amended by the Petroleum Products Amendment Bill, 2003 ("the PPA")

aim at the establishment of an integrated basis for managing, as much as is necessary, the infrastructure and processes involved in the supply of liquid fuels as an energy option to the South African economy, on the basis of the strategic objectives as stated in the PPA (ensuring a saving in, and the efficient and safe use of; petroleum products, and achieving an economy in the cost of distribution of petroleum products) and in pursuit of the public interest purposes espoused by the Constitutional framework and the existing/proposed framework of statutes around the liquid fuels industry.

When considering approval of the PPA, Parliament, in order to achieve the overriding objectives, must ensure that

· There are no conflicts between the statutes ultimately making up the regulatory system

· The structures, processes and techniques of governance created by the existing and proposed statutes are consistent with, and in support of; the overall Constitutional framework and the stated objects and public interest considerations (the result will be incontestable good law)

It is therefore imperative that Parliament give consideration to the Pipelines Bill and the Petroleum Products Amendment Bill at the same time, and that the one is not approved without ensuring its rational consistency with the other.

Coastal Crude Refiners support the overriding and specific objectives of the compendium of statutes, for as long as their application is necessary to override free market principles in order to secure the outcomes ( fast-track entry for HDSA's to saturation level; increased local job creation; increased local investment by locals and foreigners; optimum level of import displacement; assurances regarding management of the impact of liquid fuels supply and use on the environment) that will signify substantial achievement of the public interest purposes pursued by the proposed regulation (the operation of market principles should drive realisation of the objectives, and any intervention should be in addition to and not in replacement of market principles).

These outcomes are achieved at two levels:

· At the "macro" level", through the optimisation of competing energy sources (the formulation of strategy in this regard is work-in-progress). This include the promotion of the creation and maintenance of an optimum capacity in and infrastructure around each stream such that temporary disruptions in the supply from each stream that threatens the economy can efficiently be substituted with supplies from another stream

Such optimisation will logically be assisted by the achievement of the optimum levels of efficiency and effectiveness within the respective spheres of each energy stream (the "micro" level)

· At the "micro" level of the liquid fuels industry, through structuring and restructuring of the liquid fuels distribution infrastructure such that captive dependency on the present refining-, supply- and distribution capacity is displaced with an optimum range of alternative supply sources; optimisation of the balance between regulation and the application of market principles at all levels of competition within the liquid fuels industry such that market competition becomes the preferred tool for achieving the desired level of efficiency; the creation of appropriate fuel specification standards

The successful management of the relationship between synfuels- and hydrocarbon-based fuels for now, and synfuels-, hydrocarbon- and natural gas based fuels in the future, will play a significant role in the realisation of these outcomes.

Synfuels have the potential at one and the same time to produce significant benefits for the economy on the one hand, and significant damaging anti-competitive effects on the other, under both a scenario of Government intervention and of -non-intervention. As such synfuels represent the single most influential factor as far as stability in the inland market is concerned, both as a tool in support of; and a threat to, stability.

Crude oil as a source of energy has an equally important role to play, holding the promise of consistency of availability at globally competitive prices over the long term, and therefore being capable of continuing to meet the greater part of the national requirements which synfuels will not be able to supply.

Any regulatory approach to the liquid fuels industry must, apart from any other considerations, promote as a governing objective the optimum balance for co-existence

within a context of fair competition of synfuels, natural gas and hydrocarbons in the SA economy.

The proposed compendium of legislation appears to succeed in the creation of the tools and impulses for optimisation, but there appears to be an intention to preserve some of the efficiency-destroying historical mechanisms either in perpetuity or for a stated period of time.

D. Factors standing in the way of optimising under the proposed regulatory framework

 

· The allocation of pipeline use capacity between crude oil, refined products and gas assumed perpetuation of the anti-competitive relationship between crude oil based- and syncrude based liquid fuels. The termination of the supply arrangement between Sasol and the crude refiners will bring an end to this relationship, but competition aimed at reducing end user prices will be restricted even more than under the previous relationship unless an appropriate reallocation of the overall use capacity is done.

It should be noted that Sasol's historic right to supply the economic heartland of RSA led directly to a reduction in the use of Petronets second white oil pipeline. This, in turn, led to project Lilly, in which the second product line and the crude line were re-configured to allow Sasols MRG gas to be delivered into the Durban industrial heartland. This pipeline re-configuration has had the follow-on effect that the current Petronet pipeline configuration will not allow Crude Coastal Refiners sufficient pipeline capacity to move their own production into the economic heartland of RSA.

Based on current negotiations with Sasol for future supplies, it has been confirmed that the best way of achieving optimum price competition for the benefit of inland customers would be for Coastal Crude Refiners to have the ability to move product by pipeline inland from refineries at the coast. Petronet has confirmed that they cannot meet current requests for pipeline capacity and will have to ration available capacity. Inability to move these volumes will result in consumers being subject to the (pricing) whims of what would be a dominant inland supplier.

· The preferment of expansion of the synfuel industry by the Apartheid Government have assisted in the establishment of an extremely anti-competitive tariff arrangement as far as the conveyance of crude and refined products sourced from Secunda are concerned (the so-called "tariff linkage" agreement between Petronet and the Natref refiners).

To the extent that the historical situation has resulted in the accumulation of a number of unfair, non-transparent and anti-competitive arrangements these should be terminated or modified to the extent that they run counter to the objectives of the Petroleum Products Act, and at the same time no new unfair, non-transparent and anti-competitive measures should be allowed to creep into the proposed regulatory regime: the only guaranteed outcome will be damage to the South African economy.

Examples of retention of historical arrangements are at present included in the currently worded Pipelines Bill:

[The Coastal Crude refiners have with appreciation taken note of the recent statements by Dr Crompton of the Department of Minerals and Energy to the Honourable committee that these provisions will be removed from the bill- reference is made in this submission for sake of completeness sonly]

Section 20(l)(d) of the Pipelines Bill which precludes unutilised capacity in what is known as the crude line to be used for movement of product in the normal course of business. Even if the inland crude refinery were to run at full capacity, there would be spare capacity available in the crude line.

Petronet would thus be denied, by law, the ability to optimise their assets and maximise their revenue, which in turn could have resulted in a reduction in pipeline tariffs.

The current wording of that Bill arbitrarily eliminates this commercial possibility, and impacts negatively on the achievement of the objectives of the Petroleum Products Act, as proposed to be amended.

Section 20(l)(f)(ii)&(iii) of the Pipelines Bill results in the condonation of existing contracts that, on the basis of a reading of 21 (f)(ii),are acknowledged to be in contravention of the provisions of the draft Bill.

There is no indication in either the Memorandum on that Bill or the Bill itself of the nature and content of these contracts, nor the reasons why Parliamentary condonation is sought.

Coastal crude refiners are concerned about the possible deleterious effect that such condonation may have on their ability to supply their customers at the best commercial prices.

· The historical requirements of the South African economy has resulted in a perception of inequity between synfuel producers and crude oil refiners in South Africa

Previously Inland Synfuel producers willingly accepted restricted participation in the Retail service station industry - in exchange for an undertaking by crude oil refiners to purchase effectively the whole of their production of synfuels

During the development of the Bill, it has been argued by synfuel producers (in particular Sasol), that they should receive preferential treatment in the future allocation of retail site licences, in order to facilitate their desired entry into the retail service station market. In support of this argument, it is suggested that historically synfuels producers have been "excluded from the market", and are therefore deserving of special treatment "to promote a balance between local production and marketing access".

The coastal crude refiners submit that these arguments are particularly one-sided, and do not stand up to objective scrutiny from a public interest perspective. It is indeed in the public interest that the production of indigenous synthetic fuels should continue to be placed in the local market, thereby generating significant foreign exchange savings. However, whether Sasol

Markets its production directly or sells it to other marketers makes no difference at all from a national perspective, but merely reallocates profits between Sasol and others.

It is conveniently forgotten by those who argue previous "exclusion" from the market that Sasol has always enjoyed the massive benefit of receiving full import parity prices from the other oil companies, not only for all its synfuels production but also for almost a~ its crude based production from Natref. No other crude refiner has enjoyed the benefit of having its production placed preferentially in the local market. On the contrary, the advent of Sasol caused the other crude refiners to cut production, defer expansions and export surpluses, resulting in their losing to Sasol huge amounts over more than 20 years in manufacturing profits they would otherwise have made. The only partial quid pro quo for the preferential benefits Sasol has enjoyed on the manufacturing side is the limitation placed on its direct marketing. The oil companies had no option but to cede refining profits to Sasol. It would have been unreasonable to expect them to cede their marketing profits as well, and indeed then, as now, there was no public interest reason for them to do so.

Sasol has now made a commercial decision to enter the retail market, which it is entitled to do. However, the coastal crude refiners contend that there is no valid rationale for preferential treatment of Sasol at the expense of its competitors. The coastal crude refiners are already concerned about the potentially anti-competitive consequences of having Sasol, as a dominant supplier of product to other oil companies, also competing directly with us in our downstream markets. Their concern would be greatly increased were Sasol to gain unfair competitive advantage through preferential treatment at our expense. Sasol is at liberty to enter the market to the extent it chooses, but should grow its market presence through fair competition on a level playing field. It should not expect to receive more preferential treatment on top of that which it has historically enjoyed.

The coastal crude refiners would like to make it clear, as established marketers, that they accept that there will be preferential treatment for HDSA's in the allocation of licences. But apart from necessary actions to promote BEE, there should be no special treatment of any company.

The coastal crude refiners contend that neither side should now receive preferential treatment in relation to the historical situation under the proposed regulatory regime, unless a specific public interest purpose will be served. There does not appear to be such a public interest purpose present in the context.

E. Other concerns regarding the specific content of the draft Petroleum Products Amendment Bill

The coastal refiners share the concerns expressed by SAPIA in a separate submission regarding Sections 2(b), 2(c), 2(g), 2A(4), 2B(3), 2C(4)(a), 2C(4)(b), 12C(a)(v) and i2C(a)~v11) of the bill.

In addition, the coastal refiners wish to draw attention to the following:

· The proposed section 2(f) can logically only apply to products in respect of which prices are not prescribed. The requirement will have the effect of neutralising price competition to the detriment of consumers

· The disjunctive "or" in the proposed section 2A(l) creates confusion, as there could be a link required between the requirement to have a manufacturing license and the ability to hold or develop a (retail service station) site. The section should be restated to make the required links clear (e.g. the link between a "site" license and the "holding or development" of a site

· It must be clarified that section 2A)4)(b) is intended to apply to retail outlets only

· The purpose statements in the PPA requires that the ambit of section 2B(a) be extended to wholesalers

· The facilitation envisioned by section 2B(b) should facilitate investment in the achievement of the objectives of the PPA, not "commercially justifiable" investment.

 

F. Proposed amendments to the draft PB and PPA

1. Structure of regulatory authority:

It is proposed that the proper implementation of the regulatory intent will succeed only if recognition is given to the need for distinction between regulation of a relational- and operational character on the one hand, and regulation (whether relational or operational) firstly at the micro level and secondly at the macro level (once the strategy for integrated management of energy sourcing is finalised) on the other.

Regulation of operations at the micro level is best dealt with by state employees within the affected Departments (there should logically be one for gas and one for liquid fuels) who have the requisite competencies and experience in the fields within which regulation will take place. In the liquid fuels industry under the proposed regulatory regime this will e.g. include the proposed licensing in the distribution-and retail service station fields and resale price maintenance.

Regulation at the relational level requires a single regulator for gas and liquid fuels who is able to

· Assess from time to time the overall contribution of the total infrastructure serving the liquid fuels industry to achievement of the stated objectives of regulation

· Assess from time to time the overall impact of all the constituent elements generating input costs, and engage in debate with regulators of competing energy sources as to the optimum allocation of resources

· Assess from time to time the extent to which the need for regulation has become obsolete, and for subjugating his regulatory functions to the application of market principles

It follows that whilst the regulator at operational level must of necessity be subject to

Ministerial control, the regulator at relational level should be independent from the

Ministerial Executive.

2. Proposed amendments to the draft legislation

2.1 Create reference to the liquid fuels regulator in both the PB and the PPA, and provide for issues of a relational nature to be decide by him, and for his decisions to be reviewed by the Minister. Scrap the mechanism of arbitration in the PPA, as Ministerial decisions should be subject to review by the High Court (or alternatively create a special Tribunal for resolution of disputes)

2.2 Clarify the language of Section 2D(2 (c) such that the link between retail licences and total mass of production or consumption is utilised to prevent inefficient proliferation of service stations

2.3 Amend the various sections around which SAPIA and the coastal crude refiners have expressed concerns

2.4 Ensure that the appropriate amendments are made to the Pipelines Bill to remove the concerns expressed in D of this document