LPG market inquiry by Competition Commission, with Deputy Minister & Department response

Energy

05 September 2017
Chairperson: Mr F Majola (ANC)
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Meeting Summary

The Competition Commission presented the recommendations of its market inquiry into the Liquified Petroleum Gas (LPG) sector. In 2014, the Commission, in accordance with the powers granted to it under the Competition Amendment Act 2013, conducted a market inquiry in the LPG sector.

The market structure was found to be unfavorably monopolistic as only five refineries were producing LPG and only four major wholesalers, under foreign ownership, accounted for more than 90% of the market. This was as a result of limited local refinery capacity due to little infrastructure investment since refineries are not incentivised to prioritise the production of LPG over other petroleum products. Also, DoE is limited in the capacity of nine inspectors monitoring over 5 000 service stations. This all leads to market abuse by some participants. It was noted the Commission lacks prosecutorial powers.

The LPG sector has a myriad of regulations and licensing requirements which leads to overlaps and misalignments amongst regulators. It was recommended that NERSA should undertake the responsibility of pricing and monitoring the MRGP and the MRP while DoE considers price deregulation in the long term.

On the limited domestic supply, it was recommended that there should be a review of the regulatory framework applicable to the construction of LPG import and storage facilities. Long-term supply agreements were also prone to abuse as they acted as a barrier to new entrants into the market since producers would collude with certain retailers and give them preference in LPG allocation. This has been effected through the issuance of evergreen contracts and discounts of up to 10% which were not made available to small wholesalers. In effect, this provided large wholesalers with undue competitive advantage and they maintain their market position.

It was recommended that supply agreements be limited to a 10-year duration with the removal of automatic renewal clauses. Refineries should allocate a minimum of 10% of LPG to small wholesalers and not more than 90% to long-term wholesalers. Cylinder exchange practices were also problematic due to unreviewed deposit fees, collusion amongst wholesalers and unfair deposit fee rates.

It was recommended that there should be a separation of agreements into LPG supply agreements and LPG equipment agreements. The mandate of NERSA should be expanded to develop guidelines on valuation methodologies for LPG equipment.

The DoE responded that the inadequate domestic LPG supply is due to limited local production and inadequate import infrastructure. DoE is in the process of developing a clear pricing framework. It would be amending the Petroleum Products Act. This will enhance monitoring compliance of suppliers and introduce penalties for non-compliance after amending the Petroleum Products Act. It is DOE's objective to deregulate in the long-term to make LPG economically accessible.  One of the major flaws identified is inadequate infrastructure to produce and import LPG. South Africa’s retail price is among the highest in the world due to poor infrastructure and technical limitations. However, recently there has been some improvement with LPG being imported from Mozambique. Deregulation could be implemented in the long term when there is more supply of LPG and better infrastructure. Incentivisation to refineries would not be appropriate since LPG is a by-product and not a core product. There is an existing MOU between NERSA and TNPA to deal with the overlaps and misalignments in their regulatory mandates.

There is a need to consider new refinery capacity to produce LPG. The Maximum Retail Price (MRP).  has been adjusted twice in December 2015 and 2016. However, it could only be adjusted upwards which would prejudice new entrants, making South Africa non-competitively priced compared to other countries. DoE agreed the long-term agreements should be delinked.

The Committee said that the implementation of the Competition Commission recommendations is up to the Executive. However, the Committee will continue to follow up on the matter.

Meeting report

Liquified Petroleum Gas Market Inquiry Report: briefing by Competition Commission
Mr Tembinkosi Bonakele, Competition Commissioner, said that the 2013 Amendment to the Competition Act conferred powers on the Commission to conduct market inquiries to ensure that markets comply with the objectives of the Competition Act. There may not be an obvious transgression of the law and for the Commission to initiate an inquiry, there has to be features resulting in restriction or distortion of competition. Suspected firms are referred to the Tribunal, recommendations are made to government and policy makers, regulators and even the firms themselves. The Commission submits a report to the Minister of Economic Development with or without recommendations and thereafter it is tabled in the National Assembly.

 On 5 August 2014, a market inquiry was conducted on LPG market structure which was concluded in April 2017. There is limited use of LPG in South Africa compared to other countries. The inquiry process included requesting submissions from about 90 stakeholders and site visits. Thereafter a report was published with draft recommendations for public comment.

Mr Liberty Mncube, Chief Economist: Competition Commission, said that in South Africa, there are five refineries producing LPG. The LPG produced is supplied to four wholesalers who account for about 90% of the market. Some of them have BEE status while others have acquired small black owned firms. However, the market structure was flagged as an anomaly since it was primarily controlled by foreign firms.

There is limited local refining capacity, regulatory gaps and infrastructural problems. There are two levels of regulation, at the refinery level and the retail level. However, reports indicate that that regulation at the refinery level does not incentivise the production of LPG since it retails at a lower price and therefore affects its supply. The regulations at the retail level have not been reviewed since 2012, however, there is a need to constantly review these so as to align them with incentives.

The Department does not monitor the maximum refinery gate price (MRGP) and has a limited capacity to monitor the Maximum Retail Price (MRP). Market participants abuse the preset price ceilings regulations since there are no sanctions against over pricing.

Mr Bonakele recommended that both the MRGP and the MRP be regulated by the National Energy Regulator (NERSA) towards the deregulation of the price, as a long-term objective. This can be done once the supply constraints have been addressed.

Mr Mncube said that LPG has many licensing requirements which causes overlaps and misalignments amongst the various regulators. These overlapping jurisdictions have led to projects being stalled and inconsistent policy outcomes between Transnet National Ports Authority (TNPA) and NERSA.

Mr Bonakele recommended centralisation as there are too many regulators and a coordination problem which could be resolved through legislation. A MOU that bind both NERSA and TNPA should regulate the decision-making process for applications.

Mr Mncube said importation would be one way of unlocking the limitation in domestic LPG supply caused by the misalignment in the market infrastructure.

Mr Bonakele said that there was a need to review the regulatory frameworks applicable to the construction of LPG import and storage facilities as outlined in various pieces of legislation including the National Ports Act and the Petroleum Pipelines Act. There is a need to establish a final authority to fill any regulatory gaps.

Mr Mncube said that LPG is allocated under long-term supply agreements. However, the agreements are a barrier to long-term entry for small investors who seek to come into the market. Historic relationships between producers and certain wholesalers keep the incumbents in and lock out any new entrants into the market.

Mr Bonakele said that some long term agreements favour large wholesalers by granting evergreen contracts with MRPG discounts of up to 10%. This gives them a huge competitive advantage over small wholesalers. The Competition Commission recommends that LPG agreements should be kept at most to 10 years and the removal of automatic renewal clauses to encourage fair competition. Refineries should allocate a minimum of 10% of LPG to small wholesalers with not more than 90% allocated to long-term wholesalers.

Mr Mncube said that there were distortions in the cylinder exchange market. The practice is governed by bilateral agreements which keep new entrants out of the market. The cylinder deposit fee has not been reviewed since 2010 which has in effect enabled the wholesalers to collude to increase the deposit fees themselves. The uniform deposit fee regardless of the size of the cylinder and cross filling of cylinders is also problematic. Despite cross filling being a prevailing practice, it is unlawful and poses safety concerns. Customers should be encouraged to fill their cylinders at accredited sites.

Mr Bonakele said that South Africa is yet to express its stand on cross filling and as such, a hybrid model has been adopted. Any licensed wholesaler should not be unreasonably denied participation in the cylinder exchange program and the long-term agreements should be reviewed. Cross-filling of LPG cylinders should be done within the confines of the law.

Mr Mncube said that the high cost of switching is due to the disruption of supply which may be caused by protracted negotiations and delays in transferring equipment between new suppliers and incumbents. The reasons for not switching suppliers is due to these costs being much greater that the potential savings derived from switching.

Mr Bonakele recommended that there should be separate LPG supply agreements from those of equipment or infrastructure agreements. NERSA should develop and publish guidelines setting out the appropriate valuation methodology of supplying LPG equipment. NERSA's mandate should be expanded to include the settling of disputes about valuation.

Department of Energy (DoE) response to Competition Commission Report
Ms Thembisile Majola, Deputy Minister of Energy, appreciated the Commission presentation and said it was in the best interest of the public that the Commission had presented to the public. The Commission has raised concerns about regulation and growth in the sector. Such growth should not just benefit those who have been in the sector but also new entrants.

Mr Tseliso Maqubela, DoE Acting Director General, replied that the market inquiry showed areas which needed attention. One of the major flaws identified is inadequate infrastructure to produce and import LPG. There needs to be better coordination between DoE and the Department of Labour (DoL) on cylinder safety issues. However, cylinders are regulated as pressure vessels under the DOL's Occupational Health and Safety Act. DoE has no authority to monitor the filling practices of pressure vessels.

South Africa’s retail price is among the highest in the world due to poor infrastructure and technical limitations. However, recently there has been some improvement with LPG being imported from Mozambique.

Mr Jabulani Ndlovu, DoE Director: Petroleum Policy, replied that deregulation could be implemented in the long term when there is more supply of LPG and better infrastructure. Incentivisation to refineries would not be appropriate since LPG is a by-product and not a core product. There is an existing MOU between NERSA and TNPA to deal with the overlaps and misalignments in their regulatory mandates.

The DoE is currently in the process of reviewing the pricing structure in the supply chain to solve some of the identified challenges. This will enhance monitoring compliance of suppliers and also introduce penalties for non-compliance after amending the Petroleum Products Act. The Department aims at the overall objective of deregulation, as prescribed in the Energy White Paper.

Mr Maqubela replied that the main obstacle of the inadequate domestic supply is due to limited local production and inadequate import infrastructure. There is a need to consider new refinery capacity to produce LPG. The MRP has been adjusted twice since 21 December 2015 and 2016. However, it could only be adjusted upwards which would prejudice new entrants, making South Africa non-competitively priced compared to other countries. The long-term agreements should also be delinked.

Discussion
The Chairperson asked about the status of the recommendations and the way forward in their implementation.

Ms Z Faku (ANC) asked on how soon could deregulation be done, as a long-term plan. She asked how DoE views the incapacitation of the Commission due to its present limited responsibility for regulation.

Mr M Matlala (ANC) asked when the amendment of the Petroleum Products Act would happen to allow the implementation of the 1998 Energy White Paper’s deregulation objective. He asked how DoE would be able to effectively monitor compliance by considering its limited capacity of inspectors. Also, had DoE considered historically disadvantaged South Africans with regard to the level of BEE in foreign owned companies? He asked the Commission about their current status with NERSA and whether it was working.

Mr R Mavunda (ANC) asked on how often the Commission makes recommendations to government departments. What was the Commission’s recommendation on non-compliance with the law with regard to regulators?

Ms G Nobanda (ANC) asked what DoE was doing to ensure that the 5 000 service stations were effectively covered by the nine inspectors. She suggested that the reviews should be done more regularly to identify and address any issues arising.

Mr Bonakele replied that the Inquiry Report will be handed to Parliament so that the Executive is held accountable and also to inform the Executive on policy. As long as the infrastructure has bottlenecks, there cannot be deregulation. A price adjustment has to be carefully considered since the market fluctuates frequently. The practice of cross filling of cylinders is not in line with the law. Black entrepreneur participation in the market has been frustrated with the ongoing practices by the incumbent companies.

Mr Mncube replied that unlocking supply depends on whether there are incentives and improved infrastructure. NERSA has extensive experience in regulating the pricing in other markets which would be complemented by considering LPG as well.

Ms Faku asked if the Committee could call the Commission back to a later meeting in the event the Committee needs further information. She asked how black participation in the market could be fixed.

Mr Maqubela replied that DoE has been regulating fuel prices for petrol and diesel since 1994 and therefore has capacity. However, DoE could use more inspectors to cover more service stations effectively. Incentivisation of LPG would force companies to import more petrol. Unreliable refinery operations over the winter affect the market negatively since wholesalers cannot get supply.

On deregulation, Mr Maqubela replied that DoE will have to be informed by what happens in the market so as to know how to amend the Gas Act or the Petroleum Products Act to effect deregulation. A socio economic impact assessment on the proposed amendments has been successfully completed.

Ms T Majola (ANC) said that the Commission’s work is important as it assists DoE to identify the challenges better. The DoE will be making changes on LPG prices. NERSA is limited by legislation to regulate only piped gas and as such cannot take on any further responsibilities without a change in legislation.

The Chairperson said that the implementation of the recommendations is up to the Executive. However, the Committee will continue to follow up on the matter.

The meeting was adjourned.

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