Irish Competition Authority Decisions

1. Notification was made by Irish National Petroleum Corporation Limited (INPC) on 13 August, 1996 with a request for a certificate under Section 4(4) of the Competition Act, 1991, or in the event of a refusal by the Authority to issue a certificate, a licence under Section 4(2) in respect of a proposed standard agreement with purchasers of petroleum products.

2. The notification concerns a standard Supply Agreement and General Terms and Conditions of Sale which Irish National Petroleum Corporation Limited (INPC) wishes to conclude with purchasers of petroleum product from INPC's Whitegate oil refinery, with effect from 1st January 1997. The Supply Agreement (“the Agreement”) covers the commercial terms, including product quantities, product grades and the pricing and credit provisions for such products. The General Terms and Conditions of Sale cover physical arrangements for the transfer of products into ships and road transit vehicles, payment terms, liability etc. The Agreement relates to petroleum products sold on a commercial basis and not to the sale of product under the mandatory regime referred to at (e) below.

3. INPC is a state-owned company which has, since 1982, been supplying petroleum products to oil companies in the State. The bulk of this supply (87% in 1995) has been under the terms of the Fuels (Petroleum Oils) Order, 1983, as amended, (the "Fuels Order"). INPC will be the contracting party in the Agreements. INPC has three subsidiary companies:- Irish Refining plc, Bantry Terminals Ltd and National Oil Reserves Agency Ltd. The other parties to the agreement are the purchasers of petroleum products, i.e. wholesalers and importers.

4. The agreement would cover the following products:-

Gasolines (Petrols):

- super unleaded gasoline

- eurograde unleaded gasoline

- premium leaded gasoline

Aviation jet fuel

Kerosene

Diesel

Gas oil

Fuel oil.

These products are freely available from the refining sources set out below. There are several other petroleum products available from some of these refineries set out below, e.g. bitumen and lubricating oils, which are not available from Whitegate refinery and would therefore not be included in the proposed agreements. Although all these products are derived from a common raw material, crude oil, they have relatively low demand-side substitutability between them or among them in the short term.

5. INPC is aware of approx. 21 importers into the State. Each importer, depending on size, could have a number of these types of sales/purchase agreements from different suppliers. INPC would therefore estimate that there could be 30 - 50 similar type agreements in place with importers.

6. INPC's turnover for sales in the Irish market, as noted in the 1995 annual accounts is approximately £146 million. The total turnover of the petroleum oil market in Ireland is estimated at approximately [£860 million], excluding excise duty.

7. There are a number of stages involved in the structure of the oil industry in Ireland.

Stage 1 - Product Supply from Refineries .

This sector of the industry is dominated by the high capital costs of petroleum refining. These costs are sunk, in that the fixed costs of petroleum refining are huge when compared with the variable costs. Relative capacity sizes are therefore important and utilisation of that capacity critical in reducing unit fixed costs.

8. The table below sets out the total capacity in barrels per day of the refineries which supply product to Ireland. However this table is not exhaustive, as there is no restriction on the source of product imported into Ireland other than relative transportation costs.

Refining Capacity Relative Size of

Texaco refinery, Pembroke 180,000 15%

Elf/Murphy Oil refinery, Milford Haven 108,000 9%

Gulf Oil Refiner, Milford Haven 112,000 9%

Esso refinery, Fawley (near Southampton) 317,000 27%

Shell refinery, Stanlow (near Merseyside) 262,000 22%

Statoil refinery, Mongstad (west Norway) 154,000 13%

Irish Refining refinery, Whitegate, Co. Cork 65,000 5%

Total 1,198,000 100%

The 1994 data for the EU - 15 countries - shows refinery capacity utilisation at close to 90%. Given maintenance and unplanned interruptions, this is close to full utilisation. The total refinery capacity in the EU - 15 countries as at the beginning of 1995 was 12,750,000 barrels per day.

9. Due to the heavily capital-intensive nature of petroleum refining, there are substantial sunk costs in terms of insurance, maintenance and personnel costs all of which are fixed for a given investment in the short term, irrespective of capacity utilisation levels. As marginal costs (chemicals, water and fuel) are relatively low, there is intense competition in the industry to ensure that capacity is utilised. The opportunity costs of unused refinery capacity are therefore high. As a result, refiners will compete strongly to obtain and/or stabilise market share, particularly in markets located closest to the refinery where lower transportation costs permit a locational premium. INPC's competitors for product supply into the State will therefore be largely those refineries based on the west coast of England/Wales where the freight cost to Ireland is low. Ireland is an attractive market for these refineries as their alternative is bulk exports to Continental Europe or the United States of America, at higher costs than sales into Ireland.

10. There were 93 refineries in the EU-12 countries - at the beginning of 1995. INPC stated that in North West Europe there are only five refineries, including Whitegate refinery, that are not vertically integrated. Although independently owned, these other refineries have contractual and pricing conditions with their customers which provide similar incentives to vertical integration.

11. The function of these companies is to import petroleum product into the State and then break bulk using depots, normally located in a port. The normal means of transport into the State is by coastal shipping. There are currently 14 sea ports, containing 26 different petroleum storage depots.

12. Wholesaling companies, who are presently all importers, are mainly supplied by one of the refineries noted in Stage 1. Wholesaling companies in Ireland are dominated by companies integrated back to the refining stage; e.g. Esso, Shell, Texaco, Statoil and Conoco. Approx. 70% of imports into the State are supplied by these companies and the remaining portion supplied by companies not vertically integrated.

13. The full range of petroleum products is normally imported into the State by these wholesalers. There are a small number of wholesalers who specialise only in heating oils (heating gas oil and kerosene) and limited quantities of diesel fuel, but with no gasoline. This is often because the depot facilities required to import gasoline are more specialised and require higher capital investment.

14. These companies purchase product from a participant in Stage 2 and transport product from a sea-fed depot inland by vehicle to a smaller distribution depot. This is a bulk breaking operation.

15. There are many more companies involved in this stage. Some of these companies may be vertically integrated up to Stage 2 or Stage 1 through wholly owned subsidiary companies. The majority of the companies at Stage 3 are independently owned. However despite this, for most of them, the nature of the contracts with their suppliers means that they are vertically integrated through exclusive purchasing/territorial arrangements.

16. These companies are tied up with Stage 2 companies through exclusive dealerships and therefore INPC cannot supply these companies during the period of their exclusive arrangements. In addition, supplies of gasoline and diesel to service stations are in the vast majority of cases, company owned facilities or covered by agreements with dealers. In both cases, INPC would not be able to supply such outlets except through the company owning the site or party to the solus agreement with the dealer.

The independently owned inland distributors deal mainly with heating, agricultural, commercial and light industrial oils and diesel fuel.

INPC is not represented at Stage 3 of the industry.

17. Retailing is the stage of the industry where products are delivered to the final consumer of the product. There are two main retailing methods; sale from service station forecourts and sale from road tank vehicle into tankage located at the consumer's premises.

18. The largest number of companies are present at Stage 4. This stage of the market is dominated by either sales from vertically integrated companies to the consumer, (e.g. from petrol stations or wholly owned marketing subsidiaries) or by independently owned distributors which may be also present at Stage 3 or uniquely at Stage 4.

19. In the counties of Cork, Kerry, Limerick and Clare, INPC understands that there are approx. 73 oil distributing companies. These companies would range in size from family owned firms with 1 delivery vehicle to an authorised distributor with 15 delivery vehicles. There are also approx. 800 service stations in the region represented by the above counties.

20. The vertically integrated companies operating at Stage 4 (Esso, Shell, Texaco, Statoil, Conoco) are involved mainly in gasoline and diesel fuel. The independently owned companies’ sales are concentrated on heating, agricultural, commercial and light industrial oils with limited diesel fuel sales.

INPC is not represented at Stage 4 of the industry

.

21. The notified agreement concerns a Supply Agreement and a set of INPC's General Terms and Conditions of Sale. The purpose of the Supply Agreement is to set out the terms and conditions applicable to the supply and lifting of petroleum products from Whitegate refinery for fixed duration periods. The duration of the contracts would be for a maximum of 5 years. The minimum notice period for termination of the Agreement by either the buyer or the seller would be 6 months. The minimum notice period for review of the price terms contained in the Agreement by either the buyer or the seller shall be 30 days prior to the start of each calendar quarter. In the event the buyer and seller cannot agree on revised pricing terms, the Agreement will terminate at the end of the relevant quarter.

22. Under this agreement the quantities of each petroleum product to be supplied under the Agreement shall be stipulated in the Agreement, together with commitments from the buyer to lift minimum quantities of products from the jetty and INPC's roadloading facility. The Agreement states that the minimum quantity supplied under the Agreement would be 25,000 tonnes per annum.

23. The Agreement also sets out the nomination procedure and the requirement to have an agreed supply pattern from the seller to the buyer to ensure synchronisation between the buyer's demand requirements and the production capacity of the seller. The pricing formula for each petroleum product shall be specified in the contract together with the credit period and terms of credit for the Agreement, i.e. open credit, maximum outstanding credit, provisions for requiring letters of credit.

24. The Agreement contains the following clauses:

“6 Price Review

6.1 No later than thirty (30) days prior to the commencement of any Quarter during the continuance of this Agreement either party may seek a review of the pricing formula to apply from the commencement of the ensuing Quarter onwards. Should the parties fail to agree a new formula prior to ten (10) days before the commencement of the relevant Quarter the existing price formula shall continue to apply for that Quarter and this Agreement shall terminate at the end of that Quarter.”

“8. Duration and Termination

8.1 This Agreement shall be deemed to come into force on the Effective Date and, subject to the following provisions of this clause and clause 6 above, shall continue in force for a period of five years unless or until terminated by either party giving to the other party at any time not less than six (6) months’ written notice or other such period as may be agreed.”

The General Terms and Conditions of Sale contains provision for termination of the agreement by one party in the event of a breach of any of its provisions by the other.

25. Most of the supply of petroleum products by INPC to companies in the State - 87% in 1995 - has been under the terms of the Fuels (Petroleum Oils) Order, 1983, as amended (“the Fuels Order”). This order regulates both the prices and the quantity of petroleum products that INPC supplies to companies to which the Fuels Order applies - i.e. to companies which import various petroleum oils into the State. Under the terms of the Fuels Order, until November 1996 any person who imported gasoline or gas oil into the State was obliged to purchase 35% of their gasoline and gas oil requirements from INPC at a price determined by the Minister for Energy. In late 1993 the Minister approved a three-year commercial plan for the company, under which a series of investments were made at Whitegate refinery to put the refinery onto a commercial basis. The investment programme is described by INPC as “relatively modest in petroleum refining terms at IR£36m. It relates to small-scale improvements in energy efficiency, logistics and an increase in capacity. However there are no major additions to the plant which change its present configuration. It therefore remains a relatively simple refinery, particularly when compared with its competitor refineries which are heavily upgraded and produce a much bigger percentage of higher value products from crude oil. A critical element in the Commercial Plan is that INPC will sell the bulk of the gasoline, kerosene and gas oil production into the ‘local market’ in the State where there is a transport cost advantage.”

26. It was the intention of the government at that time that the Fuels Order provisions would not be renewed for 1997 and that from 1st January 1997, INPC would be able to supply companies with the entire capacity of the Whitegate refinery on fully commercial terms. The removal of the Fuels Order would have changed the import stage of the gasoline and gas oil market in Ireland from a market in which importers were obliged to purchase 35% of their gasoline and gas oil sales from INPC, to a fully competitive market. Therefore INPC would have moved into a more competitive environment, against companies which are integrated from the refining stage back to consumer sales (and, in some cases, back to the crude oil production stage). This was the context in which INPC drew up the notified agreement. In fact, in November 1996, the Minister of State at the Department of Transport, Energy and Communications announced that the Government had decided, on security of supply grounds, that the mandatory purchase of petroleum products from the Whitegate refinery would continue in modified form. The effect of the modifications were to reduce the purchase obligation from 35 per cent to 20 per cent, and to limit the additional income to the refinery arising from the mandatory regime to £3 million in 1997.

27. INPC states that all of the competitor refineries on the west coast of England/Wales are vertically integrated and have control of marketing outlets for their production to ensure that capacity is efficiently and fully utilised. Such vertical integration keeps refining and marketing unit costs low and maximises returns in an industry which has poor and volatile margins. The existence, nature and level of these sunk costs means that vertical integration is the norm in the industry. Those refineries that are not vertically integrated are at a competitive disadvantage, unless they make alternative arrangements which would enable them to gain the benefits of vertical integration. One of the critical features in such contractual arrangements is the synchronisation of liftings of product from refineries with production. Any inefficiency in the synchronisation process will be critical, given the high opportunity costs of unused refinery capacity.

INPC has stated in its submission that it is in a weak position given the relative size of Whitegate refinery to its competitor refineries.

28. INPC has made the following arguments in support of its request for a certificate:

“Neither the provisions noted at paragraph 3.2 [of the Information annexed to relating to duration, notice periods and minimum purchase quantity] nor the Agreement itself have as their object or effect the prevention, restriction or distortion of competition in trade in any goods or services in the State or in any part of the State within the meaning of Section 4(1) of the Competition Act.

29. In relation to the provisions of the Agreement noted at paragraph 3.2 above, the following comments should be noted:

The maximum duration of the Agreement is 5 years and the Buyer has the option at the negotiation of the contract to negotiate a shorter duration of the Agreement (subject to a minimum of one calendar year) or to evoke the provisions in Section 8.1 of the Agreement for termination at an earlier date.

Period of notice required is the minimum necessary to ensure full capacity utilisation. INPC would incur significant costs if the Agreements could be terminated at shorter notice.

Substantial additional costs would be imposed on INPC by supplying a large number of customers, each purchasing relatively small quantities of products. These costs would be incurred in several areas: e.g. marketing, accounts, credit control, management and co-ordination of the loading facilities. In the latter case, the degree of co-ordination required grows exponentially with the number of different customers supplied.

In addition, companies with demand in excess of 25,000 tonnes per annum have a more regular demand pattern, as they market to a wider range of customers and over a larger number of products then smaller companies. This is critical in assisting the synchronisation of demand with production.

In the absence of these agreements, INPC could be forced to sell a significant proportion of its production into the bulk export market at prices $4-$5 per tonne lower than that achievable in the local market, due to transport costs to more distant markets. These lower prices would entail a reduction in revenues of $4-$6 million per annum. Such loss of revenue would seriously jeopardise the financial position of INPC and could force the cessation of crude oil refining at Whitegate refinery.

30. In addition it should be noted that there is no territorial restriction imposed by this Agreement on any company re-selling this product and/or supplying it to any region of the State or elsewhere. There is no restriction on parallel importing, as Buyers are free to purchase from INPC or from other suppliers either within or outside the State. Furthermore, the Agreement is non-exclusive in nature as it does not prevent any importer into the State purchasing from suppliers other than INPC and it does not prevent INPC from selling to other companies in addition to the specific Buyer covered by an Agreement.”

31. In the event of a refusal by the Authority to issue a certificate, INPC has made the following arguments in support of the grant of a licence:

“In relation to the conditions listed in Section 4(2) of the Competition Act, INPC considers that the Agreement:

(a) contributes to improving the production or distribution of petroleum products.

These arrangements will improve efficiency in production and distribution. The Agreement is specifically designed to co-ordinate demand and production cycles to ensure that optimal use is made of refinery capacity. This is critical given the high opportunity costs of unused refinery capacity. Such optimal use of capacity will enable INPC to compete with its vertically integrated competitors.

(b) allows customers a fair share of the resulting benefit

INPC will pass on the efficiency gains set out in (a) to its buyers.

(c) does not impose on the parties terms which are not indispensable to the attainment of those objectives.

32. The critical elements in ensuring that INPC is not at a disadvantage with vertically integrated competitors is to ensure that its capacity utilisation is maximised and that it is operated efficiently through synchronisation of demand and supply. The provisions of the Agreement and in particular those noted in paragraphs 3.2 and 4.2

[of the Information annexed to Form CA, relating to duration, notice periods and minimum purchase quantity] are essential to achieve these objectives.

(d) does not afford the parties the possibility of eliminating competition in respect of a substantial part of the products or services in question.

33. There are no territorial restrictions or exclusivity clauses in the Agreement. There are no barriers to contestability or to entry or growth. The minimum purchase quantity is less than 2.5% of INPC’s projected sales and well below INPC’s current average sales quantity per company of 80,000 tonnes per annum. The level of 25,000 tonnes has been chosen as it is not restrictive on the above basis.”

34. Section 4(1) of the Competition Act 1991, as amended, states that “all agreements between undertakings, decisions by associations of undertakings and concerted practices, which have as their object or effect the prevention, restriction or distortion of competition in goods or services in the State or in any part of the State are prohibited and void.”

35. Section 3(1) of the Competition Act defines an undertaking as “a person, being an individual, a body corporate or an unincorporated body engaged for gain in the production, supply or distribution of goods or the provision of a service.” INPC is a corporate body engaged for gain in the importing, refining and wholesale of petroleum products. INPC is therefore an undertaking within the meaning of the Act. The buyers may be either bodies corporate, unincorporated bodies of persons or sole traders, who purchase petroleum products for resale to distributors and retailers, and they are thus engaged in the supply and distribution of petroleum products for gain. They also are undertakings within the meaning of the Act. The Supply Agreement is an agreement between undertakings. The relevant product market is that for the petroleum products detailed in paragraph 4, above. The relevant geographical market is the State.

36. Under the notified agreement the sole indigenous importer and refiner of certain petroleum products is entering, on a commercial footing, into long-term supply contracts with wholesalers and distributors. The sale of product by INPC to those customers is largely regulated by the terms of the Fuels Order 1983, as amended; and indeed importers of petroleum products are obliged to take 20% of their requirements from INPC. This Agreement relates to sales not covered by this mandatory system, i.e. those which are undertaken on a purely commercial basis in competition with other suppliers. The Authority does not regard supply contracts, per se , as offending against Section 4(1) of the Competition Act unless the arrangements have the object or effect of preventing, restricting or distorting competition in trade in any goods or services within the State.

37. Neither does the Authority believe that the effect of the notified agreement is to prevent, restrict or distort competition. The agreement is not an exclusive one; purchasers are free to acquire petroleum products from other suppliers in addition to INPC. The duration of the agreement is five years, with the option to terminate for any reason at six months’ notice, and to terminate because of failure to agree on price at a maximum of seven months’ notice. In its decision on ESB Industrial Holdings Ltd./Irish Cement Ltd. (Decision No. 390, 12 April 1995), the Authority recognised the legitimacy of “long-term assurances regarding supply and purchase of the product” (in that case, a 10-year supply contract) where substantial capital investment was required.

38. The applicants have stated that “Due to the heavily capital-intensive nature of petroleum refining, there are substantial sunk costs in terms of insurance, maintenance and personnel costs all of which are fixed for a given investment in the short term, irrespective of capacity utilisation levels. As marginal costs (chemicals, water and fuel) are relatively low, there is intense competition in the industry to ensure that capacity is utilised. The opportunity costs of unused refining capacity are therefore high. As a result, refineries will compete strongly to obtain and/or stabilise market share.” As part of its plan to achieve full commercial viability, INPC has undertaken substantial (IR£36 million) capital investment and it is therefore good commercial practice to enter into long-term arrangements with purchasers of the product.

39. The Authority therefore does not consider that the duration and notice terms of the supply contract have the object or effect of preventing, restricting or distorting competition.

40. In the Authority’s opinion, INPC and buyers of its product are undertakings within the meaning of Section 3(1) of the Competition Act 1991, as amended, and the notified agreement is an agreement between undertakings. In the Authority’s opinion, the notified agreement does not prevent, restrict or distort competition and thus does not offend against Section 4(1) of the Competition Act.

41. The competition Authority has issued the following certificate:

The Competition Authority certifies that, in its opinion, on the basis of the facts in its possession, the Supply Agreement and General Terms and Conditions of Sale between INPC and buyers notified under Section 7 of the Competition Act on 13 August, 1996 (notification no. CA/24/96) does not offend against Section 4(1) of the Competition Act, 1991, as amended.

For the Competition Authority

Isolde Goggin

Member

12 June 1997.