Tobacco Institute of South Africa & Chevron South Africa briefings on industry challenges & transformation

Meeting report

Challenges facing the domestic tobacco industry: briefing by Tobacco Institute of South Africa
Mr Francois van der Merwe, TISA CEO and chairman, said that there are negative perceptions about the tobacco industry from various entities in South Africa, and TISA tries to refute these. Some of the companies within TISA have been in the country for up to 100 years, which indicates their commitment to the long-term future of South Africa.

TISA represents the full value chain of diverse tobacco products, including snuff and roll-your-own tobacco. It represents only the legitimate industry, which complies with government legislation. It acknowledges that tobacco products are harmful, although they are legal. TISA will try to accommodate citizens who choose to use tobacco by providing a high-quality product that accommodates all regulation of the industry. Sensible regulation and education can reduce the consumption of tobacco products, which TISA supports.

The tobacco industry is highly taxed and regulated, as 52% of the financial product of tobacco products goes to the government. TISA values good relationships with public and private entities highly. Constant consultation and engagement can enable consumers to make the right choices for themselves. A study conducted on the industry in 2012 has shown that tobacco is important to the economy of South Africa and specific regions of the country. The tobacco industry adds value to raw products, which is a process that has been highlighted as important for the economy by the President. 184 404 workers make money directly or indirectly from tobacco products in South Africa. South Africa has fewer than 200 tobacco farmers, whereas there are over 700 000 in countries like Malawi. This is because of the commercialized nature of the industry in SA. The climate in SA is also not as appropriate for growing tobacco as it is in other countries, which makes it more difficult.

Many tobacco farmers have good relationships with their workers, and have facilities like crèches, schools, clinics and more available to the workers.

Transformation in SA tobacco
Many different funders have committed to the issue of supporting new, black farmers. The funders include:
- British American Tobacco South Africa (BATSA)
- Small Enterprise Development Agency
- Eskom Foundation
- National Development Agency
- AgriSETA.

There are approximately 100 farming units with 193 people who have received proper training from these initiatives, which is a considerable amount in a tobacco industry with less than 200 commercial farmers. Training includes record keeping, business principles and other skills needed for the farming context. Farmers established by these initiatives have also been enabled to provide food security along with tobacco farming skills. Small areas of land for tobacco farming can empower farmers, as two or three hectares of land can produce enough for a sustainable farming enterprise.

Illicit tobacco products in SA
Illicit cigarettes are a serious problem for the sector and the general public. These cigarettes do not adhere to the Tobacco Products Control Act, or the Customs and Excise Act. There needs to be diamond excise stamp, a quit line number, and other determining features for cigarettes to be legal, and it is easy to identify illicit cigarettes. These cigarettes are also sold below the price determined to be commercially viable, which is R18 for a pack of 20. This should raise red flags and should lead to a SARS investigation. After taxes and excises, a pack of 20 sold at R18 yields R3,50 to the producer, which indicates that it is not commercially viable and is probably violating the law. Consumers can buy cigarettes at R6 a 20 pack in some parts of the country, which clearly disenfranchises government and producers of tobacco. These cheap prices also enable pensioners and children to afford cigarettes.

SAPS should not prosecute the primary sellers of these products in informal settings, as the real issue is with the large syndicates that are producing and distributing these illegal products. Compliance issues and suspect pricing should lead to more investigations. At the moment, South Africa does not have a problem with counterfeit cigarettes, which are illegitimate imitations of brand-name products.

61% of all illicit tobacco products in South Africa were produced in the country in 2014, some of which by SARS-registered companies and entities, with 34% coming from Zimbabwe. Initiatives by SARS have led to the reduction of the ratio of home-produced illicit products down to 45%, although more can still be done.

Tobacco is still smuggled into the country and local manufacturers produce products illegally. These entities declare excise and tax on a small fraction of their output, selling the rest at unrealistic prices without paying excise or tax on most of their products. This enables the companies to seem as though they comply with regulations, while selling their products at unfair prices. There are huge discrepancies with the records of export declarations from SARS, and import declarations in South Africa. This issue has been combated, but it needs to be further addressed. This leads to losses for SARS and the South African government. The R12,45 excise that illegal producers do not pay leads to enticing profits that attract people into the illegitimate South African market.

The volume of the tobacco market enjoyed by the illicit market has decreased to 23% in 2014 due to efforts from TISA and SARS. However, this ratio is still too high. According to estimations, SARS has lost more than R22 billion in the last five years to illicit tobacco sales. This flight of capital funds organized crime and exacerbates many issues, like human trafficking and drug production and smuggling. This also erodes investor confidence in tobacco and in all sectors of the South African economy.

The actions of TISA in combatting illicit trade of tobacco are:
- Investing in independent third party research to understand the illicit landscape
- Continue to emphasize relationship between excessive excise increases and illicit trade – Treasury has been wise to maintain the 52% tax incidence
- Advising SARS to implement the Global Protocol on Illicit Trade in Tobacco Products, which uses various methods to combat illicit tobacco trade
- Sharing information across borders with neighboring countries. TISA has signed MOUs with various entities in other countries to cooperatively combat illicit trade
- Further development of a training manual to guide government officials in combating illicit tobacco trade; over 9000 officials have attended training sessions since 2010
- Engaging with other relevant government departs besides SARS and SAPS, such as the Department of Health and other entities
- Raising of public awareness on the issue
- Destruction of illicit tobacco products, under the supervision of customs officials. Seizing of products is not effective because of illegal channels returning the products to the market.

The government needs to prioritize the illicit trade of tobacco and take it seriously. Government to government dialogue also needs to improve so that source and transit countries can assist. Government and industry forums, although adequate, can be further improved to collaborate on this issue. Enforcement of these crimes must also improve, as the sources of these illegal cigarettes need to be located and prosecuted. SARS needs to address issues regarding excise controls and work with regional and provincial governments to improve regulation. There need to be tighter controls on manufacturers, as it is too easy for these illegal producers to avoid regulation from SARS.

Plain packaging
Government has proposed the use of plain packaging for cigarettes in South Africa, as has been implemented in Australia. This disables branding incentives that are attached to the use of all products, including tobacco products. In this system, there is no way to use brands to sell the tobacco product. This represents a huge problem to the tobacco industry of South Africa. For example, the brand of Marlboro is worth billions of dollars and is present in South Africa. Plain packaging will harm investor confidence in the South African tobacco market, and Indonesia and other countries have taken Australia to court over the market effects of this strategy. The losses from plain packaging will disable the tobacco industry in its efforts pertaining to transformation and the development of the economy.

Discussion
Ms J Fubbs (ANC) reminded the Committee that there are health problems related to tobacco use, as stated by the World Health Organization. The World Intellectual Property Organization also has stakes in this issue, as does the World Trade Organization. The Committee needs to focus on the positive and negative effects that the tobacco industry has on the country in their questioning.

Mr A Williams (ANC) said he gave up smoking two weeks ago, and that he has been prescribed drugs to combat the effects of the addiction. Of the 177 commercial farmers in South Africa, how many are black? What are the farming units that new black tobacco farmers are using, and are they different to the commercial farms? What percentage of the total sector is black-owned and controlled? Although it does contribute to the South African economy, smoking is a commodity that kills people. Plain packaging can help inform the public about the risks of smoking and disable unwisely-used brand power that cigarette brands hold.

Mr B Mkongi (ANC) said that packaging controls can confuse consumers and that their intentions and purpose should be made clear. The initiatives of health entities in combating smoking cannot be understated, as many South Africans have stopped smoking out of concern for their health. TISA should offer more data about how many successful black farmers are now in the tobacco industry, and how effective efforts of skills transfer have been. Why is it difficult for South Africa to combat the production of illicit cigarettes within its own country? Why is plain packaging such a threat to the tobacco industry of South Africa?

Mr G Hill-Lewis (DA) asked if plain packaging would affect the ability of customs officials to identify illicit cigarettes.

Mr N Koornhof (ANC) also emphasized the issue of 61% of illicit cigarettes being produced within South Africa, and asked why this was taking place despite regulation. The influx of illicit cigarettes can even grow the market of tobacco use in the country, and can benefit legitimate cigarette producers in ways as well. SARS made a very bad statement, blaming British American Tobacco South Africa (BATSA) for involvement in illegal smuggling of tobacco, which was heavily denied by BATSA. Does TISA have a MOU with SARS?

Ms P Mantashe (ANC) asked whether TISA has marketing companies abroad.

Mr M Kalako (ANC) asked for clarity about the living conditions of farm workers on tobacco farms, especially housing conditions. TISA clearly has many initiatives with government against illicit cigarette trade and should be commended. Many counterfeit products might be coming into South Africa, and TISA could advise the government about weaknesses in the South African regulation systems that allow for this influx.

Ms Fubbs said that some of the companies involved in legitimate production of tobacco products in South Africa are also involved with illicit and unregulated production of tobacco, using two sets of books and deceiving government regulators. It would be useful for SARS to have initiatives that can address this specific problem and decide on clear steps that can be taken in the future. Plain packaging could increase the illicit trade of tobacco products, and different plain packaging methods could also be explored. Illicit tobacco products are also completely unregulated and cause a greater health risk than legitimate tobacco risks. The loss of national income due to the sale of illicit tobacco products must be a great concern to the country. Tobacco leaf is being smuggled into the country as well, and the technical difference between concealed consignments and outright smuggling should be made clear to the Committee. What happens to confiscated goods from the border that are stored in warehouses?

TISA responses
Mr van der Merwe said TISA has been working with SARS and other law enforcement agencies for many years. SARS and SAPS have done great work, although more can be done. Manufacturers continue to flood the cigarette market with cheap, unregulated cigarettes. The sustained incidence of these producers making illicit products is cause for concern. As SARS improved methods for formal import of tobacco products, so more companies began purposefully incorrectly declaring their tobacco as juice, biscuits, or other products; otherwise, they smuggled it through concealed consignments in tankers, boats, or trains. Outright smuggling also takes place, especially on the South African/Zimbabwe borders, with sophisticated and developed criminal operations present in some parts.

South Africans are brand-conscious and plain packaging diminishes the appeal of tobacco products, damaging the tobacco industry across the country. This will also lead to increased illicit trade in reaction to unsatisfied demand for non-plain packaging. There is no digital marking technology being used by SARS at the moment for tobacco products, and cigarette boxes are easy to counterfeit.

The progress of transformation of the tobacco industry has been very good. TISA members are committed to adhering to the BBBEE guidelines and many empowerment initiatives are in place. Of the 193 black farmers who have undergone training, some are undergoing individual farming and some are working on co-ops. The multi-faceted skill set that farmers receive from training initiatives is important to their success, as is the food security system that farmers learn. Tobacco farmers all over the world, along with other single-crop small-scale farmers, are learning about the merits of diversifying farming efforts, and this is an important part of the training that South African farmers undergo.

The living conditions of tobacco farms have improved greatly in the past few years. It is a labor-intensive crop, as 30 hectares of tobacco farmed employs between 40 and 50 people. Farmers have invested in infrastructure for workers, and workers are not forced to drink from rivers or live in clay huts any more. The 177 tobacco farmers are white, and this is partly due to difficult conditions for tobacco farmers in contemporary South Africa.

If tobacco is banned in the country, people will still use tobacco products. Sensible regulation and education of the effects of smoking can offer a better solution to the reduction of smoking. Heavily regulation leads to illicit trade, which supports organized crime, compromises health, feeds corruption and is generally negative. A legal value chain for tobacco production is in the country and should be supported to prevent the tobacco trade from becoming more and more unregulated.

Ms Fubbs asked for more clarity about living conditions of farm workers.

Mr Mkongi also asked for more clarity about transformation efforts. Trade and industry issues should be separated from issues of health, as it is difficult to discuss these issues simultaneously.

Ms Fubbs asked how many legitimate jobs the country is missing out on due to the illicit tobacco market. Transformation of ownership is important, and it needs to be clear how many of the 177 commercial farmers are black, or are working in partnership with black owners. Further questions will be addressed to TISA in writing via the Committee secretary.

Mr van der Merwe said local manufacturers of illicit tobacco products are not regulated or sufficiently punished and should not be allowed to produce unregulated cigarettes. TISA does not have any marketing operations for itself. It is difficult to separate health issues from trade and industry issues because they are intertwined. Plain packaging destroys the intellectual property of tobacco product brands. A solution or compromise should be sought for on this issue.

Ms Fubbs said the main argument for the government’s support of tobacco production is for the value chain it contributes.

SARS comments on illicit tobacco
Mr Godfrey Baloyi, an executive at SARS, outlined the efforts of SARS in curtailing illicit trade. In 2015/16, SARS has adopted a new guideline for the combating of this issue based on the knowledge and input of various entities. Audits will increase, and anti-smuggling processes are also increasing. Government has adopted a method of concerted effort across departments against this issue in recent years, and the resultant figures of decrease in the illicit market share indicate some successes. Border posts are under-resourced to an extent, but training of officials and infrastructure needs to improve. Stakeholder management, internal and external, needs to be effective so that information about illicit tobacco products can be quickly disseminated. Some SADC countries, and other relevant countries, have signed MOUs with SARS that enable automatic sharing of information that empowers the efforts against illicit trade. SARS has not effectively improved public awareness of the issue of illicit tobacco products. The penalties imposed on illicit tobacco producers and sellers are being restructured, as they do not seem to be sufficiently dissuading at the moment. Global Protocol on Illicit Trade in Tobacco Products will be adopted by SARS in the near future. SARS is always open to receive information and tip-offs and encourages TISA and other industry players to share information with SARS. Manufacturers who produce illicit goods need to be shut down. Many cigarettes are not accounted for and surprise inspections, among other initiatives, need to occur more often.

Ms Meshenah Padayachy, from the Department of Trade and Industry Intellectual Property unit, said South Africa is a member of the World Health Convention on Tobacco Control, the WTO and the World Intellectual Property Organization. The DTI, along with the Companies and Intellectual Properties Commission, works with SAPS and SARS to improve enforcement measures and education campaigns on issues such as this. There is now a call for an intellectual property tribunal, which would hopefully improve communication on this issue.

Mr van der Merwe said he would not make any comments about allegations against BATSA at this time.

Ms Fubbs said that the Committee should revisit this issue, and invited members to ask further questions in writing to the Committee secretary. She thanked representatives from DTI and SARS for their presence, as well as Mr van der Merwe from TISA.

Chevron presentation
Ms Nobuzwe Mbuyisa, chairperson of Chevron, thanked the Committee for the chance to make a presentation, and emphasized that Chevron values stakeholder cooperation highly. Chevron is a Proudly South African company, even though it has links to international companies. Notable investments from Chevron into South Africa over its history include a lubricants plant in Durban and a refinery in Cape Town. Chevron is currently at Level 2 of B-BBEE. Chevron employs and trains locals and procures goods from local suppliers. Chevron focuses on education, health and economic development in its social investment.

Transformation within Chevron
Chevron considers its goals aligned to government. Transformation is an example of this, as Chevron constantly works towards it. Chevron has 25% direct black ownership, and formed a consortium in 2001. It has a broad ownership spectrum, with different kinds of entities invested into the country. Chevron has a programme called brand marketer, under which it sold about 60% of the network of service stations to black-owned companies. These companies are empowered and have autonomy over their businesses. Chevron is proud to have maintained level 2 B-BBEE status, which they have held since 2013. Chevron is working hard to maintain its status under new B-BBEE codes in the future. Chevron has a ratio of 80% black employees, fulfilling mainly high-value jobs, 47% of which are management and professional quality positions. Chevron has a 60% board black. 57% of executive directors are black, and 29% are black females.

90% of Chevron’s services are sourced locally and Chevron SA spends R5 billion annually in South Africa. Close to 100% of local suppliers are B-BBEE accredited. 25% of Chevron SA’s spend goes to black-owned companies. Chevron’s refinery spends over R700 million on local suppliers.

Chevron stimulates production value of R95 billion in the SA economy. It contributes R18 billion in GDP and R21 billion in indirect taxes annually. Chevron also contributes R200 million per year to the economy of Saldanha.

Chevron has various programmes across the country. It has recently partnered with the Cape Town Science Centre to foster a love for maths and science among school children. It has partnered with the Nelson Mandela University in Port Elizabeth to support students from Cradock and Graaf-Reneit with technology and training of students and teachers.

Fuel entities and the Department of Energy, along with Treasury, are discussing a policy document regarding clean fuels. Chevron understands why South Africa wants to move towards these goals, and supports it.

Concerns about imports
Chevron has not been able to agree on a cost-recovery mechanism with government. This is due to Chevron’s involvement in a regulated industry, which makes it difficult for it to recover its costs. Chevron would need at least five years to upgrade its refinery, and plans for clean fuel regulations would have to be put in place for 2020. Chevron is therefore experiencing uncertainty about its future business and is suffering a drop in consumer confidence.

There is a growing market for low sulphur fuel, although there is a limited capacity to produce it locally. Refineries therefore need to be upgraded.

Imports are coming into the market and displacing local production, and local refineries. Chevron has raised concerns about the development of import infrastructure in Cape Town Harbour, which crowd out local producers. The energy sector has import guidelines that state if there is a local product available, then import permits will not be granted. These should be amended to include clean fuels and accommodate for the current situation.

The coastal storage of imported goods offers 151 jobs from a Level 4 BBBEE contributor and a R650 million once off investment. Local refining from Chevron is a level 2 BBBEE contributor, offering 13 500 jobs, a R1 billion spend and R300 million annual capital expenditure. It is possible for these two initiatives to co-exist, but these imports and storage facilities should not be promoted at the expense of Chevron’s market share. Local manufacturing and local refineries should be protected, as this would be in line with the agenda of the South African government. The Industrial Policy Action Plan places a responsibility on government and private industry to improve the capacity of industry in South Africa. It is important for Chevron to be in a strong market position to enable it to move efficiently towards clean fuel products. Amendments of import guidelines can ensure an outlet for local crude refinery production. Chevron has engaged with the DTI, through the minister, the director general, and other officials about this issue. Although there is mutual understanding, immediate action is not clearly planned. Chevron asks the Committee to encourage amendment of import guidelines in the near future.

Discussion
Ms Fubbs reminded the Committee that they needed to keep in mind the issue of fossil fuels. The established context of what is imported into South Africa is also relevant to the issue.

Mr Williams asked whether legal transfer pricing is used by Chevron, and whether it affected the transformation of ownership that Chevron was undergoing.

Mr Mkongi asked why Chevron remained at level 3 from 2010 to 2013, instead of moving to level 2 faster. More clarity is required on the black ownership that Chevron has encouraged, as many black owners are not South African. Who are the people referred to as black employees in management and professionally qualified positions? What is their age, and where are they coming from?

Mr Koornhof asked if Chevron’s supply of diesel to Eskom might run dry in the future. Is Chevron ready to move into the gas industry?

Mr Hill-Lewis asked about Chevron’s compliance with national air pollution regulations. He personally lives near to a refinery and has concerns about the effects of it on local air quality.

Ms Fubbs asked how much of the costs from the implementation of clean fuel regulations Chevron would like to recover from government. In 2013, the level 2 BBBEE status of Chevron would not have been related to new standards. How will the new requirements influence the position of Chevron internationally? The Committee asks for radical transformation of the ownership of large entities in South Africa, and asks whether Chevron thinks it is effectively moving towards this.

Chevron response
Ms Mbuyisa said that transfer pricing does not affect the BBBEE and transformation efforts of Chevron. Chevron practices fully legal transfer pricing in its business dealings, and constantly monitors itself to maintain this. Some charges go to other partners for research and development, but Chevron maintains compliance with regulations.

Mr Martin Donohue, Chevron CEO, said the service level agreement should be discussed.

Ms Mbuyisa said Chevron remained at level 3 BBBEE from 2010 to 2013 because it had evaluated the possibilities for transformation over those years, and had decided that level 3 was a competitive and acceptable status for that period, although it is constantly working towards improving its BBBEE status. Details of its 80% black employees can be given to the Committee at a later stage.

There is a supply and franchise agreement with service stations across South Africa, but these stations remain independent businesses. Many service stations will be evaluated under new BBBEE guidelines, and Chevron will communicate with them in order to assist them in adhering with guidelines.

Mr Steve Hegarty, General Manager: Strategy, Chevron, emphasized that Chevron will look towards improving transformation efforts. The problem with supplying to Eskom is the unreliability of its demand. There are plans to produce products for Eskom and store them, which could make it more feasible for Chevron to produce diesel gas for Eskom.

Mr Donohue said that there are two organizational pieces to Chevron, one upstream and one downstream. The other organizational part of Chevron is responsible for its involvement in the gas market. The MPRDA amendment bill is going through government and it remains to be seen whether shale gas developments will move forward.

Ms Donna Fata, Chevron:  Policy, Governance&  Public Affairs Manager, said Chevron complies with national air quality regulations nationally and internationally. Chevron strives to reduce its environmental impact, and has reduced it significantly over the years. It is far below the required air pollution limits and communicates with ratepayers in the areas of its refinery.

Ms Mbuyisa said Chevron would not move its refinery, as it would be extremely expensive. It will continue to use technology to reduce its impact on the environment and the community.

Three of the ten directors on the board are from the black-owned consortium that owns 23% of Chevron, and the board constantly works towards making decisions by consensus rather than voting. The BBBEE status of Chevron is based on previous coding systems, and the introduction of new codes will require Chevron to strengthen its transformation efforts.

Mr Hegarty said that the cost-recovery mechanism Chevron wishes to implement does not hope to recover monies from government, but rather from the consumer through regulatory intervention. The estimated cost of refinery upgrades will be between R40 billion and R50 billion, and some of these costs will need to passed on to consumers. The mechanism will enable Chevron to pass costs in adhering to new regulations onto consumers in an equitable fashion.

Mr Donohue said that the main reason Chevron came to the Committee meeting is to encourage various government entities to change legislation so that domestic manufacturing of fuel products is encouraged. Imports of clean fuels destabilize the local market, and legislation should be amended to protect local industry entities like Chevron.

Mr Hegarty said the key request of Chevron is for the Committee to recognize that the inability of the consumer to bear the R40 billion or R50 billion costs of upgrading refineries at the moment leads to an unfair advantage for entities importing clean fuels.

Mr Mkongi said that the Industrial Policy Action Plan guides much of the agenda of the DTI, and that some governmental entities work against this agenda in certain policies. Chevron should present a clearly articulated progamme for regulations that it thinks should be implemented. How many possible jobs could the importing of clean fuels into South Africa displace? Why will the South African economy be more capable of carrying costs of refinery upgrades in 2020? The DTI will meet with the Department of Energy to discuss these issues. One of the IPAP objectives is the creation of jobs, and if Chevron-supplied service stations employ foreign nationals they are contributing to the unemployment of South African youth.

Ms Fubbs asked about Chevron’s strategy for empowering young South African engineering students. There is a lack of a business strategy in general to deal with new BBBEE regulations, and radical transformation is needed. Ownership and management does not move towards transformation rapidly enough. There have been talks of expansion of Chevron’s activities in South Africa, is this still planned? What is the lifespan of Chevron’s infrastructure? There needs to be more clarity about Chevron’s position on the influx of imports of clean fuel into South Africa.

Mr Hill-Lewis asked whether Chevron had signed a storage agreement with Burgan, the entity that owns the new storage facility.

Ms Mbuyisa said that a permanent policy action plan would be a priority for Chevron in the near future. The impact on other industries that are supported by Chevron’s refineries will be further explained.

Ms Faia said the refinery supports engineering students through its technical department hosting career days. The Cape Town Science Centre works with younger children, and Chevron works with various entities to give matriculants basic skills to make them employable. Artisan learnerships are also offered, which make learners employable.

Ms Mbuyisa said Chevron recognizes that it needs to upgrade its transformation efforts significantly.

Mr Hegarty said that Chevron is personally invested into transformation, and that over half of its service station network is partnered with 10 black-owned companies. This equates to an additional 5% of black ownership in these entities. Chevron is not looking towards expanding its refinery capacity. The infrastructure of Chevron’s refineries is constantly maintained.

Ms Fubbs said that a chemical engineering student from the Cape Peninsula University of Technology was present at the meeting, and he had asked about the efforts of Chevron in empowering such students. The cCmmittee would like to visit Chevron at some stage.

Mr Hegarty said that there is space for new entrants for competition in terms of imported fuels, but that Chevron could not compete at the moment with the production of international low-sulfur fuel.

Ms Mbuyisa said Chevron does not have storage agreements with Eskom.

Ms Fubbs thanked Chevron and said she looks forward to the clearly articulated policy plan from Chevron.