SASOL LIMITED ENGEN LIMITED PETRONAS INTERNATIONAL CORPORATION LIMITED and SASOL OIL (PTY) LTD ENGEN LTD (101/LM/Dec04) [2006] ZACT 15 (23 February 2006)

IN THE COMPETITION TRIBUNAL OF SOUTH AFRICA

CASE NO: 101/LM/Dec04

In the large merger between:

SASOL LIMITED Primary Acquiring Firms

ENGEN LIMITED

PETRONAS INTERNATIONAL CORPORATION LIMITED

And

SASOL OIL (PTY) LTD Primary Target Firms

ENGEN LTD

With the following parties intervening:

BP SOUTHERN AFRICA (PTY) LTD First Intervening Party

SHELL SOUTHERN AFRICA ENERGY (PTY) LTD and

SHELL SOUTHERN AFRICA MARKETING (PTY) LTD Second Intervening Party

CHEVRON SOUTH AFRICA (PTY) LIMITED Third Intervening Party

TOTAL SOUTH AFRICA (PTY) LTD Fourth Intervening Party

MASANA PETROLEUM SOLUTIONS (PTY) LTD Fifth Intervening Party

Reasons for Decision

Order

The proposed joint venture / merger between Sasol Limited, Engen Limited, Petronas International Corporation Limited and Sasol Oil (Pty) Ltd is prohibited. The reasons for this decision follow.

The Transaction

The parties to the proposed transaction are:

Sasol Limited (“Sasol Ltd”);
Sasol Oil (Pty) Ltd (“Sasol Oil” or “Sasol”)¹, also referred to as Sasol Liquid

Fuels Business (“Sasol LFB”), of which 98% is held by Sasol Ltd and 2% is

held by Sizanani Trust;

Petroliam Nasional Berhad ("Petronas"), a Malaysian state oil company;
Petronas International Corporation Limited (“PICL”) is wholly-owned subsidiary of Petronas;
Afric Energy Resources (Pty) Limited ("AER"), a wholly owned subsidiary of Worldwide African Investment Holdings (Pty) Limited ("Worldwide”);
Engen Limited (“Engen”) of which 80% is held by PICL and 20% held by AER;
Engen Holdings (Pty) Ltd, a wholly owned subsidiary of Engen;
Engen Management Services (Pty) Ltd, a wholly owned subsidiary of Engen;
Engen Petroleum Limited, a wholly owned subsidiary of Engen Management Services; and
Leopont 512 Properties (Pty) Ltd which will change its name to Tshwarisano LFB Investment (Pty) Limited (“Tshwarisano”).

The current ownership structure of the various parties is depicted in the diagram below:

The proposed transaction involves the conclusion of a share-for-share exchange agreement which will regulate the formation of a JV to be named Uhambo Oil Limited (“Uhambo”). Engen will acquire the entire ordinary issued share capital of Sasol Oil. In consideration for this, Sasol Limited will acquire 37,5% of the entire enlarged issued share capital of Engen. PICL will retain 37,5% of Engen, AER (PICL’s BEE partner) will retain 12,5% and Leopont (Tshwarisano) will acquire the remaining 12,5% of Engen.²

According to the merging parties, neither AER nor Tshwarisano will acquire control over Engen. However, as a direct consequence of the acquisition by Engen of sole control of Sasol Oil and as consideration there for (and not as a separate transaction), PICL and Sasol Limited will acquire joint control over Engen.³

The post merger ownership structure is depicted in the diagram below:

The transaction will constitute a significant consolidation of the South African petroleum industry. Uhambo, the joint venture, will comprise the white fuels produced by Sasol Oil at Secunda,⁴ Sasol’s 63,64% share of the Natref refinery in Sasolburg,⁵ as well as Enref, Engen’s refinery in Durban. Uhambo’s retail network will comprise those service stations controlled by Engen and those controlled by Sasol. Pre-merger Engen controls what is, by a significant margin, the largest petrol station network in the country. This will now be supplemented by the Sasol and Exel branded stations.⁶

Joint ventures are a standard form of operation in the oil industry globally as well as in South Africa. By way of two important South African examples, the Natref refinery is controlled by a Sasol/TOTAL joint venture and the Sapref refinery is controlled by a Shell SA /BPSA joint venture.

There have, in recent years, been several acquisitions in the marketing segment of the fuel supply chain. The target firms in these transactions have generally been relatively small, black-owned entrants into the industry, while the acquiring firms have been one or other of the much larger, vertically integrated oil companies. We refer particularly to Sasol’s acquisition of Exel,⁷ Shell’s acquisition of Tepco,⁸ and Engen’s acquisition of Zenex.⁹ The pattern of these acquisitions has been for the black-owned target to receive, in compensation, equity in the acquiring company, the marketing branch of the oil company concerned. This is the mechanism through which empowerment shareholders have generally been drawn into partnerships with the major oil interests.¹⁰

The evidence shows that Sasol has long sought a partnership with firms with significant refining and retailing capacities. It appears that the present transaction represents at least the third attempt to merge with Engen. Mr Oberholster – the current Managing Director of Sasol Oil – testified that Sasol had always considered that Engen represented the best fit with Sasol from a synergy and risk perspective.¹¹

Mr. Eric Reid, a witness at these hearings, provided testimony of a Sasol-initiated attempt (in the fourth quarter of 2000) at a JV with BP. Mr. Reid, who was the chief negotiator for BP, testified that Sasol had highlighted a number of benefits for the joint venture including cost savings and synergies, the prospect that a 20% retail market share would offer an excellent springboard for further aggressive growth, and the prospect that the deal would facilitate an increase in wholesale prices.¹²

On the 12^thof May 2005, the Commission finalised its investigation of the Uhambo Joint Venture (“JV”). It found that the merger was likely to lead to a substantial lessening of competition. However it recommended to the Tribunal that the transaction be approved subject to the imposition of a condition which is intended to ameliorate the likely threat to competition. The recommended condition – essentially a behavioural condition requiring the merged entity to supply refined product to its downstream competitors – is appended to this decision and is discussed further below. However in its closing argument the Commission indicated that it had revised its position and decided to recommend prohibition.

The Merging Parties

Sasol Limited

Sasol Ltd, which shall acquire 37.5% of the JV, is a public company incorporated within the Republic of South Africa and listed on the JSE Securities Exchange and on the New York Stock Exchange. Shareholding in Sasol Ltd is widely spread with no single dominant shareholder.¹³

Sasol is an integrated oil and gas group with substantial chemical interests. It is headquartered in South Africa and operates in numerous countries throughout the world. Sasol provides liquid fuels in South Africa and is an international producer of chemicals. Sasol also uses in-house technology for the commercial production of synthetic fuels and chemicals from low-grade coal and manufactures over 200 fuel and chemical products, which are sold in more than 90 countries. In addition, Sasol operates coal mines to provide feedstock for its synthetic fuel and chemical plants, manufactures and markets synthetic gas and operates, in partnership with TOTAL SA (TOTAL), the only inland crude oil refinery in South Africa. During 2004 Sasol began to supply Mozambican natural gas both to customers and to its petrochemical plants in South Africa. Sasol is also developing two gas-to-liquids fuel plants in Qatar and Nigeria in joint ventures with Chevron.

Sasol has sole control over Sasol Oil by virtue of its current shareholding of 98%, with the remaining 2% owned by Sizanani Trust.¹⁴ (“Sizanani”). Sizanani is the BEE entity of Sasol, holding shares of former Exel Petroleum (Pty) Ltd (“Exel”) shareholders. All of Sasol’s liquid fuel businesses are housed in Sasol Oil.¹⁵ Sasol Oil owns significant interests in a number of companies - most important for our purposes is its 63.64% share of Natref (Pty) Ltd. Apart from Sasol Oil and its sole ownership of Sasol Synfuels (Pty) Ltd, other significant Sasol subsidiaries include Sasol Chemical Industries Ltd, Sasol Technology (Pty) Ltd, Sasol Investment Company (Pty) Ltd, Sasol Mining (Pty) Ltd, Sasol Financing (Pty) Ltd and Sasol Holdings (Pty) Ltd. Sasol also holds a 1% preference share in Leopont, one of the empowerment participants in this transaction and which will be known as Tshwarisano post-merger.

Sasol Oil markets the Sasol group’s liquid fuels, lubricants and tar-derived products manufactured by Sasol Synfuels, Natref and other plants. Products include petrol, diesel, jet fuel, fuel alcohol, illuminating paraffin, fuel oils, cokes, creosote and other tar-derived products. It oversees Sasol’s joint venture interests in the Natref oil refinery and the Tosas bituminous products manufacturer and marketer.

Since July 2003 Sasol Synfuels’ main activity has been the manufacture of fuel components and chemical feed streams. Sasol Synfuels operates the world’s only coal-based synfuels manufacturing facility which is located at Secunda. It uses unique Sasol Fischer-Tropsch technology to produce gas from coal and to convert this feedstock into petrol, diesel, liquefied petroleum gas, chemical feedstock and industrial pipeline gas. Sasol Synfuels produces most of South Africa’s chemical building blocks, including ethylene, propylene, ammonia, phenolics and solvents.

Note that on 1 November 2004 Sasol Synfuels and Sasol Oil entered into the Components Supply Agreement – hereinafter referred to as the “CSA”.¹⁶ In essence, the CSA governs the arrangement by which Sasol Synfuels will sell a basket of components produced at the Secunda refinery to Sasol Oil and, post-merger, to Uhambo. These components are then blended into petroleum products in the pumps and tanks immediately adjacent to the synfuel facilities. The pumps and tanks are located on the Secunda refinery premises, but are currently owned by Sasol Oil and will be incorporated into the Uhambo JV. The pumps and tanks are a prerequisite for blending the components into petroleum products. Mr Oberholster, a Sasol witness in these proceedings, conceded in his evidence that it would be extremely difficult for any of the other oil companies to erect their own pumps and tanks to perform the same blending function as the pumps and tanks located on the Secunda premises. Pertinent aspects of this immensely complex agreement are elaborated below. It suffices now to note that it effectively specifies the boundaries between the assets of Sasol Oil – and hence to be part of Uhambo – and Sasol Synfuels, whose assets are not to be incorporated within the JV.

Sasol Oil thus includes all of Sasol’s assets in the liquid fuels business, encapsulating the entire value chain from crude oil procurement for Sasol’s stake in the Natref refinery and procurement of fuel components from the Sasol Synfuels refinery at Secunda through to retail marketing of the various fuel and other products. All of Sasol’s assets in the distribution, marketing and storage of fuel are also to be part of the Uhambo JV.

We should note here – and this is considerably elaborated below – that Sasol and the other oil companies (OOCs) operating in South Africa have until recently been party to an agreement dubbed the Main Supply Agreement (MSA) or the Sasol Supply Agreement (SSA). This agreement was brokered by government and has existed, in periodically amended form, since Sasol first started producing fuels in the ‘fifties. In its barest essentials it provides that the inland marketing arms of the OOCs will, to the extent possible, satisfy their inland marketing requirements by uplifting Sasol’s inland output in preference to conveying product from their coastal refineries. The price at which the product is to be purchased is based on a variant of the import parity price, currently referred to as the Basic Fuel Price. The quid pro quo for securing Sasol a market for its refined output, was a narrowly circumscribed limitation on Sasol’s participation in the retail market. The MSA thus effectively provided for an allocation of markets between Sasol and the OOCs.

In 1998 Sasol gave the OOCs the stipulated five year notice necessary to terminate the agreement which duly ended in December 2003.

We will return to this pivotal agreement throughout this decision. Although it has not been in operation for over two years now, its consequences continue to permeate the industry and an understanding of the MSA is essential for an appreciation of the factors underpinning the transaction before us and its likely impact on competition.

PICL

Petroleum Nasional Berhad (Petronas) is the Malaysian national petroleum company and is wholly owned by the government of Malaysia. It is an integrated international oil and gas company with business interests in 35 countries. The Group is engaged in a wide spectrum of petroleum activities, including upstream exploration for, and production of, oil and gas, downstream oil refining, the marketing and distribution of petroleum products, trading, gas processing and liquefaction, gas transmission pipeline network operations, the marketing of liquefied natural gas, petrochemical manufacturing and marketing, shipping, automotive engineering and property investment.

Petronas, through its subsidiary, PICL, and Worldwide African Investment Holdings (Pty) Ltd (“Worldwide”)¹⁷ respectively hold 80% and 20% of Engen. PICL shall acquire 37,5% of Uhambo.

Engen

Engen is a South African company controlled as to 80% by PICL with the remaining 20% held by a BEE firm, Worldwide.¹⁸ Engen owns and controls a number of subsidiaries including Engen Holdings (Pty) Ltd and Engen Management Services (Pty) Ltd.

Engen’s core business entails refining crude oil, marketing and retailing primary refined petroleum products and providing consumer convenience services through its retail network. In South Africa Engen has approximately 1 250 service stations and some 450 Quickshop convenience stores. Engen owns and manages a 125 000 barrel per day (bbl/d) crude oil refinery (Enref) and a state-of-the-art lubricants blending plant in Durban. Engen is represented in 13 other countries of sub-Saharan Africa.

Empowerment parties

There are two empowerment parties to the proposed JV, namely, AER (PICL’s BEE partner in the Engen business) and Tshwarisano (Sasol Limited’s BEE partner). AER is wholly owned by Worldwide African Investment Holdings, a black-owned and managed investment holding company founded in 1994. Tshwarisano is a broad-based consortium comprising many historically disadvantaged groups. Dr Penuell Maduna, Ms Hixonia Nyasulu and Mr Reuel Khoza¹⁹ will, through various businesses, collectively hold about 30% of equity in Tshwarisano, whilst other key shareholders will own the majority 70% of equity.²⁰ Tshwarisano and Worldwide will each own a 12,5% share of the Uhambo JV.

The Intervening parties

Prior to the commencement of the hearing of the proposed JV a number of other oil companies filed notices of intention to intervene in the merger proceedings. These were BP South Africa (“BP”), Shell Southern Africa Energy (Pty) Ltd and Shell Southern Africa Marketing (Pty) Ltd (collectively referred to as “Shell”), Caltex South Africa (“Caltex”), Total South Africa (Pty) Ltd (“TOTAL”) and Masana Petroleum Solutions (Pty) Ltd (“Masana”). The intervenors are collectively referred to as the “other oil companies” or “OOCs”. The merging parties did not oppose these intervention applications which were granted by the Tribunal.

BP Southern Africa (BP) is a subsidiary of one of the world’s major oil companies. There are 790 BP branded service stations, 26 depots and other distribution sites, including three coastal installations. company has, in partnership with Shell, a 50% stake in, the South Africa Petroleum Refineries (Sapref) at Reunion, 16 kilometres south of Durban.

Caltex

Caltex, a joint venture between two of worlds major oil companies, Chevron Corporation and Texaco, Inc.²¹ Caltex owns the Calref refinery which is located in Cape Town. It controls a network of approximately 1000 service stations.

Shell

Shell is a global group of energy and petrochemical companies operating in over 140 countries and territories. Its South African subsidiary produces refined oil products at Sapref in Durban in a 50:50 joint venture with BP and distributes and markets those products to commercial and retail customers throughout South Africa. Shell has a total of 746 branded service stations.²²

TOTAL

TOTAL, which is controlled as to 50,1% by the eponymous French oil company, controls a national network of some 680 service stations. It hold 36,36% of the Natref refinery with Sasol holding the remaining equity.

Masana

Masana is a black empowerment energy company which entered the South African petroleum industry during 2005 when it acquired BP’s commercial fuels business. Masana is 55% owned by historically disadvantaged South Africans and 45% owned by BP. It markets BP branded products in the commercial and industrial segment of the retail market.

Department of Minerals and Energy

On 6 June 2005, the Department of Minerals and Energy (“DME”) filed its intervention application. The DME’s concerns included, amongst others, fears that the merger would:

Result in a need for government interference in product pricing between industry players. Oil firms supply each other's retail outlets in regions where they do not have refining operations;
Impact on entry into the market by BEE players and small businesses; and
“Undermine and compromise" the government's market liberalisation policy for the energy sector by raising the costs of doing business.

The DME was also concerned at the condition proposed by the Commission when it recommended approval of the deal. The recommended condition - which is discussed below - essentially provided that Uhambo continue supplying rival oil firms pending the commissioning of an expanded petroleum products pipeline conveying white fuel products between Durban and the inland market. The DME had said that this could oblige the parastatal, Petronet, to construct a pipeline of greater capacity than that necessitated by the aggregate shortfall for petroleum product in the inland region.²³ However, the DME subsequently withdrew its intervention application on 17 June 2005.²⁴ In withdrawing its application, the DME said it had since been assured that the Commission's condition included all logistical means, including road and rail, to move product inland.
During the hearing, the Tribunal was presented with evidence to the effect that the DME had, in drafting its intervention papers, been assisted by the attorneys of record for BP and Masana. The evidence revealed that the DME has communicated its misgivings regarding the proposed transaction to the then Competition Commissioner who suggested that it approach BP’s attorneys for assistance in drafting its intervention application.
Further evidence suggested that DME’s subsequent withdrawal was linked to several meetings between certain of its official and senior Sasol Oil executives. Both Mr Oberholster and Mr Gumede, Chief Director of Hydrocarbons, testified that the purpose of the meetings was to address the concerns raised by the DME in its intervention application. evidence showed that Sasol had even prepared the DME’s media statement explaining the department's revised position.
While the lobbying of government by the private sector is a legitimate activity, the degree of intervention by BP’s attorneys and by the Sasol Oil management reduces the weight that we accord to the DME position on this transaction.

The Hearings

The hearing took place over 19 days during the period 3-31 October 2005. Argument was presented on the 9^thand 11^thNovember 2005. During the hearing a number of witnesses testified. The merging parties led the following witnesses: Ernst Oberholster²⁵; Robert Stillman²⁶; Quinton Swart²⁷; Lourens Coetzer²⁸; Stephan Malherbe²⁹; and David Wright.³⁰ The intervenors led the following witnesses David Scheffman;³¹ Eric Reid³²; Deyar Natha;³³ Patrick Milner;³⁴ Simon Baker;³⁵ Simon Bishop;³⁶ Richard Fienberg;³⁷ and Sizwe Mncwango.³⁸ The Commission led two witnesses, viz. Lennie Moodley³⁹ as well as the Commission’s Chief Economist, Geoff Parr. The Tribunal subpoenaed the DME, which in turn designated Nhlanhla Gumede to testify on its behalf. Mr Gumede is the Chief Director: Hydrocarbons of the DME.

The following person’s statements formed part of the record but were not called upon to give oral testimony: Ian Baxter,⁴⁰ Salomon Millard,⁴¹ and Frans Kanfer for the merging parties;⁴² Robert Stewart,⁴³ Peter Linnegar,⁴⁴ Neil Biggs,⁴⁵ Kevin Baart,⁴⁶ Michael Holland,⁴⁷ Nicola Theron,⁴⁸ Etienne de Fortier,⁴⁹ Ellen Corrigall,⁵⁰ Anthony Twine,⁵¹ Tania Slabbert,⁵² Keshan Pillay,⁵³ and Cornelius Kramer⁵⁴ for the intervenors. While these statements have been considered they are given less weight than the evidence of witnesses who gave oral testimony and who were therefore subject to cross-examination.

Refining And Marketing White Fuels In South Africa – The Background

Introduction⁵⁵

This transaction cannot be evaluated without an understanding of certain critical background features. This requires a brief excursion into the history of the refining and marketing of white fuels in South Africa. A number of diverse factors are pertinent to this background. Primary amongst these are, firstly, the strategic significance that fuel products assume in all countries, compounded by the apartheid government’s vulnerability to oil sanctions. Secondly, there is South Africa’s historic reliance on imported crude oil and the consequent establishment of refinery capacity at the coast, some considerable distance from the country’s inland industrial hub, the major market for fuel products.

These factors led the South African government to search for fuel sources that were not dependent on crude oil. That source was found in the country’s abundant supplies of low-grade coal, which enabled the establishment of government initiated and funded synthetic fuel plants in the inland area adjacent to the coal fields. The upshot, we will show, is a fuel industry characterised by complex locational economics. These, in turn, have given rise to a regulatory system and a logistical infrastructure that respond, in significant part, to these geographic features. These characteristics of the market are largely common cause and are extensively canvassed in the record. They are reproduced here insofar as they are required for a proper understanding of the transaction that is before us.

We should not lose sight of the fact that these industrial policies, underpinned by vast historical subsidies, have established a highly competitive domestic producer of fuels and chemicals. However, it appears that little of the competitive advantage that Sasol Synfuels, wholly owned by Sasol Ltd, enjoys, inures to the benefit of South African consumers of fuel products. We have already mentioned and will further examine the Components Supply Agreement, which precisely ring fences this advantage, with the shareholders of Sasol Ltd inside the ring and those who consume the product – starting with Uhambo and ending with the consumers of fuel products – firmly on the outside. It is our finding that a principal objective of the transaction, is to ensure that Sasol Ltd’s multiple sources of competitive advantage – technological and locational – are withheld from South African consumers.

The development of white fuel production capacity

Caltex, Shell, Mobil and BP (then known as Atlantic) commenced downstream marketing of petroleum products in South Africa some 100 years ago. Until the commissioning in 1954 of Mobil’s (now, Engen’s) Genref (now Enref) refinery, South Africa did not have any refining facilities. Almost all petroleum product sold in South Africa was imported as refined product by the respective marketing companies who distributed this to their branded retailers and various commercial customers.⁵⁶ The pricing of the products to the end-user was based on import parity.

Government, with an eye to the strategic importance of petroleum products and the balance of payment implications of its reliance on imported product, investigated technologies that would help overcome the lack of indigenous crude oil reserves. In the first half of the 1950s, the government-initiated project to produce oil from South Africa’s abundant low-grade coal reserves saw the formation of the South African Coal, Oil and Gas Corporation Limited, later Sasol Limited, initially funded by the state-owned Industrial Development Corporation.

In 1955 the first oil-from-coal-synthetic fuel plant – Sasol One – was constructed. It was located in the heart of the inland market at Sasolburg, adjacent to the coal resources that are the most important input into the production process. We have already briefly noted that in 1954 government had secured the conclusion of agreements – dubbed the Sasol Supply Agreements (SSA) or the Main Supply Agreement (MSA) - between Sasol and the oil companies.⁵⁷ These agreements – effectively a government-brokered and sanctioned form of private regulation - obliged the oil companies to service their marketing requirements in the inland or ‘Sasol supply area’ by purchasing all of Sasol One’s production volumes pro-rata to their market shares. The price of these volumes would be based on the ‘in-bond landed cost’ (‘IBLC’), calculated on the basis of the import parity price for fuel products. This basis and its build-up to the wholesale and the retail prices are provided for in government regulation and are outlined below. The Sasol Supply Area is depicted on the map below:

Source: Petronet presentation

In return Sasol undertook to limit its entry into the retail market to the location of Sasol-branded ‘blue pumps’ on the forecourts of service stations belonging to other oil companies - hence that component of the MSA referred to as the ‘blue pump agreement’. The principles of this market sharing agreement effectively underpinned the regulation of the petroleum products market until its termination, at Sasol’s instance, in 2003. Note that Sasol One only produced some 250 million litres per annum and, hence, when the MSA initially came into effect, the inland marketers still relied on refined product brought in from the coast.

The international oil crisis of 1973 accelerated government’s plans to expand the capacity of Sasol’s oil-from-coal facilities. The UN’s imposition – in 1977 - of a mandatory crude oil embargo underlined these concerns, as did the Iranian revolution of 1979. Sasol Two and Sasol Three were commissioned at Secunda, also in the inland region, in 1980 and 1982 respectively. Sasol Two and Three later combined to form Sasol Synfuels.⁵⁸

In 1987 when natural gas condensate was discovered off shore, the Government built a gas-to-liquids plant at Mossel Bay (now owned and operated by PetroSA). The Mossgas plant commenced production in late 1992.⁵⁹

Government, in addition to its direct intervention through Sasol to secure indigenous sources of petroleum product, also encouraged private sector initiatives aimed at addressing these concerns. These included incentives to invest in local refining capacity.

The first crude oil refinery was commissioned by Mobil – later Engen - in 1954. It was established south of Durban. This is the Enref refinery. In 1962 a Shell-BP joint venture commissioned a second crude refinery in Durban. This is the Sapref refinery.⁶⁰ At about the same time Caltex also decided to establish a refinery in Durban but it was ultimately incentivised to locate its refinery in Cape Town. This is the Calref refinery which was commissioned in 1966.⁶¹ Government was also determined to establish a crude oil refinery in the inland region. To this end, in 1969 government initiated the formation of a company whose shareholders were Sasol, TOTAL and the National Iranian Oil Company (NIOC) with the intention of establishing an inland crude oil refinery. Natref was commissioned in 1971 and is located at Sasolburg.⁶²

The MSA was regularly extended as new inland refining capacity was brought on stream. Hence, at the time of the establishment of Natref an agreement was struck which guaranteed purchase by the oil companies of Sasol and the NIOC’s share of the new crude oil refinery. The price paid by the oil companies for this bulk supply was, as in the original agreement, also based on IBLC, the basis specified in public regulation. In 1976, in anticipation of the expansion of Sasol’s oil-from-coal capacity, government again initiated discussions regarding the upliftment by the oil companies of the product of Sasol Two.

However, the context for the extension of the MSA after the commissioning of Sasol Two and Sasol Three differed in one significant respect from the earlier contexts – with a combined output from Sasol Two and Three of some 5,3 billion litres per annum, South Africa came to have surplus refining capacity. And the extension of the MSA now meant that the OOCs would henceforth source a considerably greater proportion of their inland requirement from Sasol’s synthetic capacity than from their own coastal refineries. The upshot was the under-utilisation and subsequent decommissioning of some 30% of the coastal refineries’ capacities.⁶³ Both the coastal refineries and Natref were compensated – in the shape of the payment of ‘synlevies’ – for the loss of refining margins on production volumes that were foregone in consequence of the operation of the MSA. Note too that the mothballing of refining capacity was also compensated by the introduction of the ‘PAR’ mechanism which effectively protects the oil companies' returns on investment in marketing assets. However, whereas the ‘synlevy’ was recovered by government through a levy imposed on consumers, the PAR-based adjustments were recovered from consumers through a build-up of the wholesale margin which then fed in to an adjustment of the retail price.⁶⁴

The last of the MSA agreements was concluded between Sasol and the oil companies in 1988. In terms of this agreement the oil companies were obliged to purchase Sasol product up to a maximum of 7 740 million litres per year. Purchases by the OOCs thus accounted for some 90% of Sasol’s white fuel output. For the rest, the principles of the original MSA were effectively retained – the Sasol volume uplifted by the individual oil companies was based on their respective market shares; the price was based on IBLC; and Sasol limited its retail presence to the so-called ‘blue pumps’, although the new agreement did afford Sasol certain marketing rights in the commercial and industrial sectors. The marketing of Sasol petrol through “blue pumps” at the oil companies’ service stations was capped at a 9.23% market share. Sasol was also permitted to market 22.5 million litres of diesel into the commercial market.

In summary, then, there are, today, seven major oil companies operating in South Africa, namely BP, Caltex, Engen, PetroSA, Sasol, Shell, and TOTAL. All of these companies, except PetroSA, are vertically integrated in South Africa, that is, they operate at each stage of the supply chain, namely refining and production, storage, wholesale marketing and retail. South Africa has four crude oil refineries (Natref, Calref, Sapref and Enref), one synthetic refinery utilising natural gas (Mossref) and one synthetic refinery currently utilising coal (Secunda). The map below identifies the location of the refineries in South Africa:

Source: Simon Baker Witness Statement

All six facilities produce a broad range of white fuels, as well as black fuels. Enref, Sapref, Calref and Natref use crude oil as an input while the synthetic fuel facilities at Secunda and Mossel Bay use coal and natural gas, respectively. Although synthetic fuel and crude oil refineries use different inputs and technologies in their production processes, they nevertheless produce similar products. The composition of the output of a refinery is, within fairly narrow limits, fixed by the technology used at the refinery and the composition of its raw materials. Coastal refineries typically produce a balance of high value (or white fuels) and low value products (or black fuels), based on the need for bunker oil (a lower value product). The inland refineries typically produce more high value products than the coastal refineries.

The “white fuels” are petrol,, jet fuel,⁶⁵ illuminating paraffin and liquefied petroleum gas (“LPG”).⁶⁶ The “black fuels” are Bitumen,⁶⁷ Fuel oil products⁶⁸ and Lubricants.⁶⁹

South African fuel production facilities (2004)

Production facility	Input	Owner	Nominal Capacity (bbl/d)	Location
Enref	Crude	Engen	125 000	Durban
Calref	Crude	Caltex	100 000	Cape Town
Sapref	Crude	BP (50%)	90 000	Durban
		Shell (50%)	90 000
Natref	Crude	Sasol Oil (64%)	69.120	Sasol Oil
		TOTAL (36%)	38.880
Synfuels	Coal and Gas	Sasol Oil	150 000*	Secunda
PetroSA	Gas and Condensate	Central Energy Fund	45 000*	Mossel Bay

* Crude oil equivalent

Source: Swart witness statement (original source: SAPIA)

There is a locational disjuncture or ‘imbalance’ between production of white fuel and its consumption. This demand/supply imbalance is present from a national and regional (that is, sub-national) perspective but most particularly from the perspective of each of the oil companies. Natref (jointly owned by Sasol and Total) and Secunda (Sasol) supplies the inland area and some overland exports while Sapref (BP and Shell) and Enref (Engen) supply the eastern coastal areas, ship some product to the inland area, ship some product to the Western Cape area and export some product by sea to other countries. Calref (Caltex) and PetroSA supply the Western Cape area and also export some product.

Public Regulation⁷⁰

We have characterised the MSA as a form of government-sanctioned private regulation. As we have noted this agreement principally goes to the obligatory upliftment by the OOCs of Sasol product in the inland area, and Sasol’s concomitant exclusion from all but a limited share of the retail market. Expressed in the lexicon of competition law, the MSA is concerned with the geographic allocation of the market for the production of refined fuel as well as the wholesale and retail markets for fuel. The price at which this product is exchanged is set by government regulation. We turn now to a brief description of those aspects of public regulation that have bearing on this transaction.

The two cornerstones of the present regulatory regime are the control of petrol retail prices and import control on certain products. Buttressed between these is the voluntary Service Station Rationalisation Plan (‘Ratplan’).

The regulated prices are based upon import parity.⁷¹

The IBLC (‘in-bond landed cost’) formula was introduced in the 1950s and was used as the basis for calculating retail fuel prices in South Africa up until April 2003. It was characterised as the international price element in the petrol price. It was calculated by taking the average of the Singapore spot price and the posted prices in (US cents per gallon) for diesel and for 93 and 87 octane gasoline, taken on the 15th day of each month, at the Caltex Refinery in Bahrain, and 3 refineries in Singapore, (the Esso, Singapore Petroleum Company and Mobil Jurong refineries), plus insurance and shipping costs from these refineries, plus amounts for losses arising from evaporation and leakage en route, plus wharfage and landed charges for products deemed to have been shipped from Bahrain and Singapore. Retail prices were then derived by adding, as appropriate, the following elements to IBLC prices: retail margin, zone differential, service differential, Equalisation Fund levy, fuel tax, Customs and Excise duty, MVA levy, CRSF levy, and wholesale margin.

In April 2003, the Basic Fuel Price (BFP) was introduced to replace the IBLC component of the pump price. According to the DME, the formula change was necessary because an investigation by the DME in conjunction with the oil industry, found that the previous formula had become outdated because of changes in global markets.

Like the IBLC, the BFP is conceptually an import parity pricing formula and it was intended to establish a realistic estimate of what it would cost to import substantial volumes of refined fuel.⁷² The most important difference between IBLC and BFP is that BFP is based on the spot prices quoted daily in international markets whereas the IBLC was based mainly on certain refinery gate postings that have, to a large extent, fallen into disuse and are no longer reflective of actual market prices.

The other elements of the BFP are:

Freight costs from these refining centres to South African ports;
Demurrage (loading and discharging waiting time for tankers at ports);
Insurance and minor shipping costs;
The allowed value for product loss through evaporation during marine transportation;
Wharfage (harbour landing charges);
Coastal storage to cover the cost of providing storage and handling facilities; and
Stock financing.

A comparison between the IBLC and the BFP from 1996 to September 2002 has shown that the BFP has on average been lower by 4 cents per litre on 93 leaded petrol, 7 cents per litre on diesel and 10 cents per litre on paraffin. The BFP is reviewed once a month based on the average over the prior month of the daily internationally quoted prices of petrol, diesel and paraffin. Since international prices are quoted in US$, the Rand/US$ exchange rate will always be a factor in determining local prices.⁷³

Working from the BFP, the pump price is built up as follows:

1. Basic Fuel Price +

2. Government taxes and levies 2. (Customs and Excise Duties, Fuel Levy, Equalisation Fund Levy, Road Accident Fund Levy, Illuminating Paraffin Marker Levy) +

3. Wholesale Margin: (Cents per litre gross marketing margin set by an annual oil industry profitability review and subject to the approval of Minister)+

4. Service Differential: (Covers oil company depot operating costs and road delivery expenses (from depot to customer) This is determined annually, subject to ministerial approval) +

5. Zone Differentials: (Cents per litre costs of moving fuels from coastal port/refinery locations to inland distribution centres, by pipeline, rail or road. These are determined by individual Magisterial Districts and calculated by the oil industry, subject also to ministerial approval for inclusion in oil company wholesale price structures) =

6. Wholesale Price: (The maximum price oil companies are permitted to charge service stations or wholesale customers for fuels). These are set each month and are the sum of all price structure elements except the petrol dealer margin) +

7. Dealer Margin: (Cents per litre which Service Stations are permitted to add to the petrol price. The dealer margin is updated regularly and is subject to the approval of the Minister for Minerals and Energy)+

8. Pump Rounding Factors (Ensures that oil companies do not gain or lose by charging wholesale price levels in whole cents and so that service stations recover the full dealer margin) =

9. Retail Price at the pump

The other major site of public regulation sets the framework for the opening, closing and operation of retail service stations. This was initially enshrined in the Service Station Rationalisation Plan or ‘Ratplan’. The apparent purpose of the Ratplan was to regulate the growth of the retail market and to give smaller companies an advantage in terms of growth potential. It attempts to realise these objectives through the imposition of limits on the opening of new sites. In order to protect employment at retail service stations, the Ratplan prohibits self-service. It appears that the ‘ratplan’ was superseded by the Petroleum Products Amendment Act 58 of 2003 which will come into operation later in this year. The establishment of a retail petrol station site and the acquisition of a licence to operate as a fuel retailer, wholesaler or refiner is subject to an elaborate licensing regime. Note that a retail license is not transferable and is confined to a particular site. The license will lapse if a licensed retailer does not commence retailing from the designated site within six months of the date of issue of the license. It also lapses if the licensed activity is no longer a going concern. Section 2A(5)(a) provides that a wholesaler may not hold a retail license except for training purposes.

In December 1998 government published a White Paper outlining energy policy. Suffice to note that the White Paper commits government to wide-ranging deregulation of the white fuels industry. Of particular significance for present purposes is the commitment to deregulate prices, including the retail pump price of petrol.

The Petroleum Products Act empowers the Minister of Minerals and Energy to prescribe ‘the price, or a maximum or minimum or a maximum and minimum price, at which any petroleum product may be sold to any person’. prices that were previously fixed by regulation are no longer regulated or only regulated as to the maximum price that may be charged. The structure of price controls is outlined in the table below:

Structure Of Price Controls⁷⁴

	Petrol	Diesel	IP	Jet Fuel	LPG
Wholesale Price	Maximum	Maximum	Maximum	None	Maximum
Retail Price	Fixed	None	Maximum	-	None
Commercial and Industrial	None	None	None	None	None

The most important price that remains fixed by government regulation is the retail pump price of petrol. Documentary evidence establishing Sasol’s opposition to the deregulation of the retail price of petrol has been presented at these hearings and is discussed below. However we have already intimated – and will further elaborate – that Sasol’s major pre-occupation (and, ultimately, the basis of its opposition to deregulation of the retail price) is with the protection of the Basic Fuel Price or BFP, the basis on which the retail pump price is calculated and the price at which Sasol volumes have been sold to the inland marketing arms of the OOCs.

It is, of course, recognised that important interest groups are implicated in this projected deregulation and that, accordingly, it will be necessary to implement deregulation in a series of phased steps. The stated objective is to achieve deregulation of pricing by 2010. We note that Mr. Gumede, the witness from the Department of Mineral and Energy, indicated that this would probably be delayed, largely, it appears, because of limited progress in the introduction of black economic empowerment investors into the industry and in order to protect the returns of BEE players already invested in the industry.⁷⁵

The Development of Logistics Capacity

We have already referred to a number of factors clearly destined to impact significantly on the development of logistics capacity. The major market for fuel products is the inland region containing, as it does, the country’s industrial hub. Until the ‘fifties South Africa relied entirely on refined product shipped in through the ports of Durban and Cape Town which was then transported by rail and road to the inland markets. The ‘fifties and ‘sixties saw the development of considerable crude oil refining capacity in the coastal areas with, obviously, the continued requirement to move refined product to an expanding inland market. But the ‘fifties also witnessed the development, in the shape of Sasol One, of some inland synthetic fuel capacity and then, some years later, in the shape of Natref, the development of an inland crude refinery. The inland capacity established at this time did not – especially when coupled with the growth of inland demand – relieve the necessity for the coastal importers, and, later, refiners, to move considerable volumes of refined product inland. And the establishment of Natref also meant that the crude oil feedstock required for this plant had to be moved from the coast to the inland region.

However, the commissioning, in the early ‘eighties, of the Secunda capacity significantly changed the logistics requirements, particularly when placed in the context of the MSA. The supply-demand imbalance between the coastal and inland regions had been significantly reduced in consequence of the Secunda output – that is to say the inland requirement for refined product could be met by product from the inland refineries. However significant supply-demand imbalances were maintained, indeed were exacerbated, in respect of each of the individual oil companies.

Sasol, with its Natref and Secunda capacity, was extremely long in inland supply and prevented, by the strictures on marketing contained in the MSA, from altering even the extent of this imbalance. TOTAL, with its share of the Natref capacity, was approximately balanced in the inland, but supply-short on the coast. The coastal refiners, were, demand-long in the inland region and were prevented by the MSA from using their long coastal supply position to rectify this – hence the requirement to mothball coastal capacity and the consequent compensating subsidy.

This was the logic of the MSA – the inland refiners will satisfy inland demand; and the coastal refiners will satisfy coastal demand. The means of achieving this was a government-sanctioned cartel – the MSA – that not only allocated markets and, effectively, reduced output from the coastal refineries and Natref, but which also effectively dictated the development of the logistical capacity which was patterned around the market sharing arrangement.

In the period up to the ‘sixties refined product was moved from the coast to the inland by rail and road. However, there can be no doubt – and this is constantly affirmed by evidence submitted for this transaction – that the most cost-efficient mode of conveying petroleum products is via pipeline. The comparative costs of alternative logistics are discussed below. Note however that clearly the most cost effective mechanism for squaring demand-supply imbalances at the level of the individual oil companies with the distribution of demand and supply across the country is through product swaps. These are ubiquitously employed both in South Africa and in other oil markets throughout the world. This belies the notion that this market requires individual companies to be ‘balanced’ as between refining capacity and market demand. The use of product swaps illustrates that this is a highly efficient market quite capable of containing transactions costs without resorting to vertical integration.

In the early ‘sixties the state-owned South African Transport Services (SATS) commenced construction of a 12 inch diameter pipeline intended to convey refined product from Durban to Johannesburg. This pipeline – the Durban-Johannesburg pipeline or DJP – was commissioned in 1965. In 1972 in order to accommodate the steady growth in inland demand for fuel products, the DJP was extended to Pretoria West, Waltloo and Benoni from Alrode and to Klerksdorp via Potchefstroom from Sasolburg.

Government also decided to accumulate crude oil reserves in disused coalmines in the inland area at Ogies and at tank farms throughout South Africa. To this end an 18-inch diameter crude oil pipeline – the COP – was commissioned in 1969. Once Natref was commissioned in 1971, the COP was also used to convey the inland refinery’s crude oil requirements. Also following the commissioning of Natref, a pipeline was constructed from Natref to Johannesburg Airport in 1973 for the conveyance of jet fuel.

Demand growth for refined oil product in the inland market resulted in the DJP becoming capacity constrained. In 1978, SATS commissioned the Durban-Witwatersrand Pipeline or DWP. This 16-inch white oil pipeline from Durban to Alrode via Ladysmith, Volksrust and Secunda and from Secunda to Witbank via Kendal was intended to augment the DJP’s capacity in order to meet growing inland demand for white fuels.

However, as already noted, Sasol Two and Sasol Three were commissioned in the early ‘eighties. The last of the MSA agreements was concluded between Sasol and the oil companies in 1988. In terms of this agreement the oil companies were obliged to purchase Sasol product up to a maximum of 7 740 million litres per year. This meant that the DWP and the DJP were significantly under-and so Petronet – the entity within Transnet (SATS’ successor) responsible for the pipeline network – began to examine initiatives aimed at improving the utilisation of its pipeline network. It appears that the precise shape which this reconfiguration ultimately took was driven by Sasol’s desire to transport methane rich gas (MRG) from Secunda to Durban. However, it is clear that Petronet did not envisage that this reconfiguration of the logistical capacity necessary for the transport of liquid fuels from the coast would threaten inland supplies of white fuel products precisely because, as we elaborate below, its thinking was rooted in the assumption that the MSA would maintain in perpetuity.

While it is not, at this point, necessary to recount the precise detail of the pipeline reconfiguration the upshot was that a significant portion of the pipeline capacity that was previously available to all the oil companies for the transportation of refined product from the coast – the DWP - was now dedicated to conveying Sasol’s MRG, leaving a single 12 inch pipeline, the DJP, for the conveyance of refined product from the Durban refineries to the inland. The net result was a reduction in white fuel product pipeline capacity to some 35% of previous capacity.

Mr. Fienberg, a BP witness, testified that the OOCs opposed the reconfiguration of the DWP on the basis that this would severely limit the ability of the coastal refiners to supply their inland markets from their own coastal refineries. However, avers Fienberg,

Petronet’s response was to contend that the Sasol Supply Agreement would remain in force, which precluded the oil companies from supplying their inland market demand from their own refineries.⁷⁶

Fienburg testifies further that, despite Petronet’s assurances that adequate capacity for the conveyance of white fuels would be brought on when circumstances demanded it, in 2005, when the ratio of pipeline capacity to inland demand had fallen to 25%, the OOCs established that Petronet had concluded a further agreement with Sasol that reserved the DWP line for the conveyance of MRG for a further 17 years, the rest of the pipeline’s useful life, thus locking in the constraint.

The relationship between inland demand, inland refining capacity, inland demand and pipeline logistical capacity is clearly illustrated in the following diagrams submitted by Mr. Fienberg in the course of his oral testimony:

The first diagram shows the development of refining capacity. The yellow bar – that is the left hand bar – shows the development of inland refining capacity, while the green bar, the bar on the right hand side, shows coastal refining capacity. The blue line indicates inland demand. For our purposes the significant events indicated in this diagram are the commissioning of Natref in 1971 when, for a brief period inland refining capacity exceeded inland demand. By 1976 inland refining capacity stood at about 40% of coastal refinery capacity. In 1982 Secunda comes on-stream and the inland is significantly supply long. The commissioning of Secunda gives rise to excess refining capacity nationally, to such an extent that, in the same year, the green bar indicates that the coastal refiners reduced their capacity by approximately 30%. The supply-long position of the inland pertains throughout the decade of the ‘eighties into the early ‘nineties when a significant increase in inland demand brings the region into a demand-long position. The green bars for 1994 and 2004 indicate that the coastal refiners have re-commissioned the plant mothballed in 1982 or have commissioned new capacity.

The second diagram plots pipeline capacity and inland demand. In the early period inland demand was serviced by the relatively small Sasol 1 volumes and by rail and road conveyance from the coastal refineries. In the mid-sixties the DJP, with an annual capacity, of 3.2 billion litres was commissioned and was, for a brief period, capable of meeting all inland requirement from the coast. The DWP was commissioned in the late ‘seventies and this brought an additional 6 billion litres per annum pipeline capacity on-stream. Mr. Fienberg points out that with the commissioning of the DWP all inland demand could theoretically have been serviced from the coast. The graph shows that this pertained until the mid-‘nineties. However, once Secunda came on-stream – a few years after the commissioning of the DWP – the pipeline system was significantly underutilised.

In 1995 – precisely when pipeline capacity was approximately equal to inland demand - Petronet turned the DWP over to Sasol for the exclusive conveyance of gas from Secunda to Durban. This is the step down of the product pipeline capacity line on the graph. At this stage the ratio of pipeline capacity to inland demand fell from approximately 100% to 30%. A few years later, with the extent of the logistics constraint climbing steeply, Sasol terminated the MSA.

By 2005 the ratio of pipeline capacity to inland demand had declined to 25%. Utilising the BP growth projections, Mr. Fienberg estimates that this would have fallen to 20% by 2010. The extended DJP is expected to be commissioned in the latter part of 2010. This is the final step-up of the pipeline capacity line on the diagram. Recall that it will replace the existing DJP and will provide total pipeline capacity of approximately 6 billion litres per annum. This means even after the commissioning of the expanded DJP total pipeline capacity for the conveyance of white fuels will still be significantly less than in the period from 1978 to 1995, that is the period from when the DWP was commissioned to when it was reserved for the conveyance of Sasol gas. This bears out the contentions examined later that argue that the relief offered by the expanded DJP will be for an extremely limited period at best.

Mr. Fienberg sums up the contents of the two diagrams as follows:

First of all we have Sasol’s acquisition in special circumstances, if you like, of 80% of inland refining capacity and then there is a reconfiguration of the pipelines, which really has the consequence of creating dependence of the oil companies on the inland production capacity, and this would be passed on to Uhambo with very little solution or limited solution post 2010. I think it’s the take-away from those two slides.⁷⁷

In summary then there are three pipelines that link the inland to the coast, namely:

The 18-inch crude oil pipeline (“COP”) from the coast to Natref (used, as the name suggests, to transport crude stock) and the crude oil strategic storage facilities at Kendal (near Secunda);
The 12-inch Durban-Johannesburg Pipeline (“DJP”) which links Durban to Sasolburg and then extends to areas north of Sasolburg and is used to transport white fuel products from the coast to the inland; and
The 16-inch Durban-Witwatersrand Pipeline (“DWP”) also referred to as the ‘Lilly’, which links Secunda to Durban and is used by Sasol to transport methane rich gas. ⁷⁸

The DJP is the most significant means of transporting refined product inland. There are two distinct sections of the DJP pipeline. The southern section of the pipeline runs north from Durban to Sasolburg and is used by the coastal producers to transport their product inland, off-loading their product at a series of terminals along the way. The northern section of the pipeline runs north from Sasolburg. Sasol and TOTAL inject Natref product into the DJP at Sasolburg from which point the pipeline is then used to convey this product plus product of the OOCs coastal refineries further north.⁷⁹ In other words, product is injected into the pipeline at Durban (by the OOCs) and at Sasolburg (by Natref). The DJP has 11 terminals where the refined products are removed and transported by road or rail to the relevant depots or service stations.

Allocation of pipeline capacity is done by Petronet, based on usage in the previous period, and allocated every six months. The price is uniform for all users and is specified in a Petronet published tariff.

We must reiterate – and logistics will be examined in depth when we discuss the likelihood of foreclosure – that pipeline conveyance is significantly more cost effective than its nearest alternatives, namely road and rail. Ms. Corrigall, a BP witness, whose witness summary is on record, sums it up thus:

“Moving product by rail and road is not only less efficient and safe than moving it by pipeline, but it is also more expensive. By way of example, the current pipeline tariff from Island View (BPSA’s depot at the Sapref refinery in Durban) to Pretoria is 12,661 cents per litre, whereas the cost of moving product by rail from Island View to Pretoria is approximately [confidential: range from 18-21] cents per litre. Recent experience has shown that the average cost of moving product at short notice by road is [<

South Africa: Competition Tribunal

SASOL LIMITED ENGEN LIMITED PETRONAS INTERNATIONAL CORPORATION LIMITED and SASOL OIL (PTY) LTD ENGEN LTD (101/LM/Dec04) [2006] ZACT 15 (23 February 2006)