Justifying BNTCL Sale to SOL
Submitted by Tony E. Gibbs (Energy Commentator)
The promotion and maintenance of fair competition requires that business activities and trading practices be closely monitored and scrutinized to ensure that consumers’ welfare is protected and their interests served through competitive markets. This requirement seems particularly appropriate in the proposed sale of BNTCL to SOL, an agreement that appears difficult to justify.
Anti-competitive market behavior and concentrated market power can be justified if based on public interest grounds, and if such actions promote economic progress and real efficiencies of which consumers can share. Consumer welfare is therefore paramount. It is considered the key driver of fair competition policy, but also it brings with it, to center stage, the important concept of market power. The nexus of consumer welfare and market power is well established. Dominant firms have the ability to use their market power to either raise prices above competitive levels or restrict their rivals’ output. Such actions contribute to the detriment of consumers by reducing their welfare and by transferring wealth to producers.
Fair competition deliberations that attempt to determine the extent of a firm’s market power must begin with a clear definition of the relevant market. This is a necessary first step in arriving at an entity’s market share, which in turn is a proxy measurement for market power and dominance. In our jurisdiction, the threshold of excessive market power in merger investigations is a 40 percent market share.
Since this threshold has been exceeded in the proposed merger, regulators are now required by law to examine the legality of this agreement. To do so, they need to weigh certain factors. First, they must look at the structure of the market likely to be affected by the merger; second, they must determine the degree of market power and control that will be exercised by the enterprise concerned; third, they must determine whether this merger is likely to serve as a detriment to competition; and fourth, they must evaluate the likely impact of this merger on consumers and on the economy.
In analyzing the market structure for petroleum products, one will immediately recognize that there are two relevant markets to be considered in this merger; one upstream and the other downstream. The upstream market is currently dominated by BNTCL, an unregulated public monopoly, which offers, at a minimum rate of return, services that relate to the bulk receipt, storage, and delivery of petroleum products. The ownership and operations of this entity, post acquisition, will change to that of a regulated private monopoly that enjoys a guaranteed utility rate of return.
The downstream market is made up of two segments, one regulated and the other unregulated. In both of these markets segments BNOCL is the sole importer of petroleum products, except for LGP, aviation fuel and marine fuel. The regulated segment is one in which the Division of Energy controls the retail pump prices of gasoline, diesel and kerosene products, and which represents 48 percent of local throughput volumes. SOL already controls 70 percent of this segment.
The retail pump price in this segment is built-up from several sources that include government taxes (V.A.T. and excise) and a CESS of 22 cents per litre on gasoline and diesel. The CESS was introduced in 2009 as part of a loss recovery pricing mechanism, designed to halt the losses on the sale of gasoline and diesel, and to facilitate the recovery of earlier losses brought about by subsidies. The CESS currently generates 46 million dollars in revenue based on a yearly throughput of 1,242 million barrels of these fuels. Technically, the CESS component in the retail pump price should be discontinued when these prior year subsidy losses are recovered. But to use the CESS in the manner now chosen, so as to guarantee investor’s profits and returns, harms consumers and is a detriment to their welfare.
The unregulated downstream market segment is made up primarily of the heavy fuel oil (HFO) and to a lesser extent aviation fuel, two products used locally in the production of electricity. This segment is currently valued around $300 million at retail prices and represents 52% percent of the domestic throughput volumes. However, these throughput volumes and their associated revenues that accrue to BNTCL will continue their steady decline with the emergence of the green economy, and as BL&P makes more changes to its fuel usage and mix and retires large ageing generation plant.
The purchase of BNTCL puts SOL in a dominant position to capture in its entirety this large unregulated market segment. BNTCL currently owns and controls the pipelines which carry heavy fuel oil (HFO) from Holborn to BL&P generation plant at Spring Garden. This is part of a $140 million infrastructural investment it made by BNTCL in 2005. SOL, on the other hand, through its purchase of ESSO owns the HFO storage tanks. By combining these two entities, potentially gives SOL the complete control of the storage, delivery and ultimately the importation of all HFO entering the island.
The HFO market is characterized by a single supplier (BNOCL) and a single buyer (BL&P). SOL has had exclusive access to this market prior to 2005, through their purchase of Shell. But they lost it to BNOCL as a result of a controversial and contested Cabinet decision taken at the time, a decision that essentially denied them access to pipelines from Holborn to Spring Garden. The court ultimately ruled in SOL’s favour. SOL, naturally, would very much like to recover this market when BNOCL’s current contract with BL&P comes up for renewal in 2018 and this acquisition puts them in an unassailable position to do so. It will come, however, at an increase cost to consumers of electricity in terms of increased fuel charges, since the returns on capital will be higher than that of BNOCL.
BNTCL is an organization that is in steady decline. Apart from falling throughput volumes, revenues and profits, it has a debt overhang of $ 80 million owed to Republic Finance & Trust that will immediately become due as soon as this sale is completed. A financial makeover therefore was necessary to make this deal attractive to any private investor. First, it was deemed necessary to declare BNTCL an essential facility as a matter of public policy for at least the next 15 years. This means that no permission will be given for the duplication of these resources, even if it were feasible to do so. And second, it was necessary to shore up revenues and profits to achieve an acceptable utility rate-of-return. To do this, it was necessary to raise throughput fees across the board by 32 percent before completion of the sales and purchase agreement (SPA). This increase in fees contributes an additional 10 million dollars in profits and allows for a guaranteed risk free return-on- equity of around six percent. It also signals government’s imminent departure from the oil importing business. Notwithstanding assurances given, government can no longer offer value in the new supply chain and, consequently, would be unable to justify importing, storing and reselling oil products.
There are the many assurances being given to make this merger acceptable to the public and to regulators. These assurances are built around the central concept that nothing changes with this merger and that the transfer of ownership from public to private will be seamless. We are also assured that this merger will not harm consumers, change the market structure, or concentrate the market power of any given competitor.
It is now left to the regulators, through the enforcement of fair competition law, to verify these claims and ensure that consumers’ welfare is well protected.
However, to the average observe there can be no doubt that this proposed merger, if successful, will bring about a degree of concentrated market power and dominance that will be a detriment to competition and will reduce the opportunity for others to participate equitably. At face value, this merger is difficult to justify. But, there may be other mitigating factors that the regulators may consider to be in the best interest of the consumers and the economy, the effect of which may very well result in SOL being asked to give up part of the combined