Competition commission turns up the heat on the liquefied petroleum gas industry

The Competition Commission released its preliminary views on the liquefied petroleum gas (LPG) market inquiry on 10 May 2016, that there are structural impediments to competition that may hinder the growth of the LPG industry, as well as significant bottlenecks in the regulatory environment which restrict the ability of potential competitors to enter into or expand in the LPG market. Comments are due by 7 June 2016.

Background

The inquiry was launched in September 2014, as a result of the longstanding concerns held by the Commission regarding the pricing and supply constraints of LPG in South Africa. Because of the power shortages and increased electricity prices, with LPG being touted as a possible alternative, the Commission decided to exercise its relatively new investigative market inquiry powers.

The Commission also exercised its search and seizure powers and conducted dawn raids at the offices of a number of players in the market in 2015 in relation to a separate investigation.

Barriers to entry

The Commission’s preliminary findings are that the limited ability to secure supply of LPG from refineries is a significant barrier to entry for small or new wholesalers, as a result of long-term and sometimes evergreen supply agreements in place between refineries and larger wholesalers, which are given preference over new entrants seeking supply. Some contracts include notable discounts which are not offered to smaller wholesalers. These agreements have apparently resulted in the major wholesalers maintaining their positions in the market, with little competition from new entrants that have been unable to secure sufficient and consistent volumes of supply.

The Commission’s proposed recommendations include reducing the duration of the supply agreements; cancelling automatic renewal clauses supply agreements; introducing a new mechanism of allocation of supply to be established in terms of which all wholesalers will be able to bid for their required LPG volumes from all refineries, or requiring each refinery to have to allocate a minimum percentage of volumes to smaller wholesalers.

High switching costs

The inquiry also investigated the high costs incurred by LPG end-users when switching suppliers, finding that there were a number of difficulties faced. Suppliers are sometimes unable to reach agreement on the value of LPG equipment installed at end-users’ sites, to allow for a transfer in ownership, and that end-users face a potential disruption in supply while a former supplier removes its equipment to allow for an incoming supplier to install its own. Environmental Impact Assessment requirements also appear to place further restrictions on switching suppliers, because an assessment needs to be undertaken when the total storage capacity of LPG on the end-user’s site is increased by more than 80m2.

The Commission found further that certain supply agreements contain clauses that further restrict end-users’ ability to switch suppliers, including conditions relating to early termination of the agreements. For example, end-users are not only required to pay for the remainder of the capital cost of equipment installed, but also for the removal and installation of the relevant equipment, which has the effect of substantially increasing the costs associated with switching suppliers.

Recommendations in relation to supply-switching issues include having separate agreements between end-users and wholesalers in relation to the supply of equipment and the supply of LPG; the introduction of a dispute resolution mechanism to allow for transfer of ownership in equipment between exiting and incoming suppliers, but standardising the method of valuing the equipment to be transferred.

Gas cylinders

In relation to gas cylinders typically used in households and restaurants not located in large shopping centres, the Commission found that there is frequent direct interaction amongst wholesalers as a result of the empty cylinder exchange program which is undesirable as it may lead to anticompetitive behaviour. The Commission has therefore recommended that this program be done away with and that customers should own their own cylinders (and voluntarily exchange cylinders) which should be refilled at accredited filling sites. The Commission seems to have overlooked the rewards, supply, responsibility and convenience and potential cost impact this may have for consumers.

Regulatory cost consequence

On the regulatory causes of shortage of supply, the Commission’s findings reflect that there are significant bottlenecks in the regulatory environment in which the LPG industry operates. Permissions, licences and concessions required from both the National Energy Regulator and the Transnet National Ports Authority to construct and operate import and storage facilities in South African ports result in prolonged application processes which do not necessarily take one another into account. The recommendations find that policy harmonisation and regulatory clarity is necessary to allow for better sequencing of application processes and possibly even the removal of NERSA’s jurisdiction to regulate any port related activities.

The Commission has interestingly noted a lack of monitoring by the Department of Energy of compliance with price regulation. It further proposes that efforts should be coordinated to move towards a market driven price for LPG in the long term, in a competitive environment where there is adequate supply, so that deregulation of the product can be achieved.

Comment by 7 June 2016

The Commission has requested all stakeholders including market participants to provide further submissions in respect of the proposed recommendations by 7 June 2016. The Commission is also empowered to initiate and investigate formal complaints where potential anti-competitive conduct has been identified during the inquiry process. Parties involved the LPG supply chain should therefore take cognisance of the Commission’s preliminary findings and seek legal advice on submissions to be made to the Commission. Because of the risk of penalties being imposed after successful prosecution of any complaints that may be initiated by the Commission at the conclusion of the inquiry; market participants should obtain legal advice on their compliance and any remedial action necessary to prevent potentially significant administrative penalties being imposed on them.