Petroleum Pipelines Bill

Date: 27th May 2003.
Subject: Written submission on the Petroleum Pipelines Bill [B 22 – 2003].

CompetitionCommission
Private Bag x23
Lynnwood Ridge 0040
Att: Ms Shanaaz Isaacs
Parliament

Dear Ms Isaacs

Herewith the Competition Commission’s submission on the Petroleum Pipelines Bill. The Commission appreciates this opportunity to participate in the process and the comments that follow are made in the interest of ensuring that competition is promoted and preserved in the long run.

Yours sincerely

Geoff Parr

Chief Economist.

1. Overview of the Bill

1.1 Introduction
To respond to the need for regulatory intervention, a Petroleum Pipelines Bill has been drafted in Parliament and was published on the 8^th April 2003. The main features of the Bill include:

The establishment of a petroleum pipeline regulatory authority with specific powers and duties;
The requirements for licensing or registration in respect of the construction and operation of, and the provision of prescribed commercial services in relation to, a crude oil pipeline, petroleum product pipeline or an off-loading facility; and
The process of licensing or registration and the conditions of licence.

1.2 Objectives of the Bill
The objectives of the Bill, as listed in Chapter 1 section 2, among other things are to:

promote competition in the construction and operation of petroleum pipelines, loading facilities and storage facilities;
promote the efficient, effective, sustainable and orderly development, operation and use of petroleum pipelines, loading facilities and storage facilities;
ensure the safe, efficient, economic and environmentally responsible transport, loading and storage of petroleum;
promote fair and equitable access to petroleum pipelines and related infrastructure;
facilitate investment in the petroleum pipeline industry;
provide for security of petroleum pipelines and related infrastructure;
promote companies in the petroleum pipeline industry that are owned by historically disadvantaged South Africans promote the development of competitive markets for petroleum products; and
promote access to affordable petroleum products.

1.3 Regulation
The regulation of pipelines can be classified into three categories: structural regulation, behavioural regulation and environmental regulation. Comments on this Bill will follow this categorization, where it applies and the section under General will look at other issues falling outside the three categories.

1.3.1 Structural regulation

Structural regulation occurs when a regulatory authority determines which firms can or must engage in particular activities and how many firms will participate in the industry and in what proportions. This is usually done through the licensing powers of regulators. This Bill also makes provision for the licensing of players in the industry in Chapter 2 section 4. Until now government, through Petronet, has managed and operated the country’s pipelines. In this regard, the Bill makes provision for private sector participation in the construction, ownership and operation of pipelines, loading facilities and storage facilities through licences. This is intended to change the structure of the industry as more players come in. From a competition perspective, this would be welcome; the more players in the industry, the better. Under the Conditions of licence [section 20 (1)(c)], the Bill states that firms that are vertically integrated may be required to keep separate accounts and run their businesses separately. Cross subsidization is also disallowed. This is welcome to the extent that it will lead to a proper allocation of costs, so that access charges can be assessed.

However, section 20 (1)(d) of the Bill states that as a condition of the licence, a petroleum pipeline may be licensed for either crude oil or petroleum products, but not both, with the exception of emergency cases. This removes the ability of firms to configure product lines to handle a wide variety of petroleum products. This takes away the economies of scope that could contribute to the minimization of costs.

Why should firms be forced to use separate lines for different products when using one line is economically feasible and environmentally safe? Even though the aim might be to foster more entry into the industry, this type of structural regulation is not desirable because it might result in inefficiency and high prices. The Bill does not explain or give examples of "emergency" cases where the condition of products to be transported might be waived.
This also raises the question of what would happen should there be a need to use the pipeline for another product, e.g. natural gas? Would an alternative use of the pipeline be permitted in terms of a licence issued?
In addition it seems that the definitions should include what is meant by petroleum products: do they include Sasol’s synfuel products?

Although the Bill states that government will continue to own and operate pipelines, it doesn’t say what share of the market will go to private sector participation. Will all new pipelines be built by the private sector? On the other hand, will all existing pipelines remain in the State’s hands or could they be partially or completely sold off?

In terms of section 20 (1)(b) licensees will be required to provide information on the commercial arrangements regarding the participation of historically disadvantaged South Africans in the licensee’s business activities. The industry has already been subjected to an industry charter, which provides targets in terms of achieving black economic empowerment in the sector. Shouldn’t that be seen as a step forward in this regard? Moreover, government has released an Integrated BEE Strategy document, which applies to all industries equally, incentivising firms to achieve BEE objectives. The envisaged Integrated BEE Strategy Bill is the right platform for prescribing BEE conditions.

1.3.2 Behavioural regulation

Conduct or behaviour regulation involves measures to control the conduct of firms. The first objective of the Bill in section 2 of Chapter 1 addresses the issue of competition in the construction and operation of petroleum pipelines, loading facilities and storage facilities. This is in line with the Competition Act No 89 of 1998 whose primary purpose is to promote and maintain competition in the Republic. However, pipelines are potentially natural monopolies that cannot be duplicated profitably. What this suggests therefore is an open access or third party access policy, which ensures that pipeline owners afford users equal access to the network. In competition policy circles this is known as the ‘essential facility doctrine’. A distinction between mandatory open access and third party access should be drawn. The latter refers to a regime providing for an obligation, to the extent that there is excess capacity, on companies operating transmission and distribution networks (in this case the pipeline operator), to offer terms of use of the network to distributors, in return for a payment. The former on the other hand covers both rights that are directly enforceable by virtue of explicit legislation and general obligations.

The tone of the Bill [section 20 (1)(e)] would suggest that third party access as opposed to mandatory open access is proposed. Also, the policy would apply not only to pipelines but loading and storage facilities as well. Where a non-competitor in the upstream and downstream markets owns these, there might be no incentive for anticompetitive behaviour. However, as soon as a facility owner engages in downstream or upstream activities, competition might be stifled, necessitating the involvement of both the competition authorities and the regulator.

Where the pipeline owner is not a distributor as well, the third party access policy offers no competitive advantage to the pipeline owner and allows open access to distributors on a non-discriminatory and transparent basis, thus ensuring a level playing field. The Bill deals with non-discrimination specifically under section 21. It states that ‘licensees may not discriminate between customers or classes of customers regarding access, tariffs, prices, conditions or service except for objectively justifiable and identifiable grounds’. Objectively justifiable and identifiable grounds may not be easy to determine and might fly in the face of competition legislation.

Third party access according to section 20 (1)(e) should be granted where there is uncommitted capacity. However, this principle can also be applied where there is no excess capacity by simply changing the individual shares of players, holding volumes constant. As volumes increase new infrastructure could then be built up which again would be operated on a non-discriminatory access policy. The third party access policy requires monitoring, hence the proposal for a Petroleum Pipelines Regulator. From the Bill, it appears that vertical integration in the industry will be allowed in terms of a pipeline owner venturing into distribution or manufacturing as well. This is where the role of the regulator is critical since such a pipeline owner would have an incentive to discriminate against rival distributors. In some countries big oil companies who distribute and sell petroleum products own pipelines. They might have an incentive to prevent entry by new competitors. Again, this calls for close monitoring by the relevant authority.

1.3.3 Environmental regulation

One of the objectives of the Bill as stated in Chapter 1 section 2 (c) is to ensure the safe, efficient, economic and environmentally responsible transport, loading and storage of petroleum.

1.4 The Petroleum Regulatory Authority

Chapter 2 of the Bill provides for the establishment of the Petroleum Regulatory Authority (the Regulator) whose duties include the issuance of licences for the
i) construction and conversion of petroleum pipelines, loading facilities and storage facilities; and
ii) operation of petroleum pipelines, loading facilities and storage facilities.

It appears that firms will require different licences for the construction or conversion of pipelines, loading and storage facilities on the one hand and the operation of the same on the other.
Section 4 1(g) states that the Regulator will be responsible for monitoring and taking appropriate action to ensure that access to the petroleum pipelines, loading facilities and storage facilities is provided in a non-discriminatory, fair and transparent manner; and to
h) promote competition in the petroleum industry. This raises the question of concurrent jurisdiction with the Competition Commission as well as the need for a separate regulatory authority responsible for the pipelines only. Section 2 of the Memorandum on the Objectives of the Petroleum Pipelines Bill mentions the fact that Cabinet actually directed that a rationalized Energy Regulator be established for the various aspects of the energy sector (electricity, gas, petroleum, nuclear), which will entail broadening the scope of the existing National Electricity Regulator. With this process already under way, one wonders why resources have to be spent on establishing a Regulator that will be short-lived. Moreover, since the Regulator will have jurisdiction on competition matters, a Memorandum of Understanding (MOU) with the Competition Commission is necessary. With so many regulators in the economy, the monitoring and operation of these MOUs can be a daunting task. If the regulation of the pipelines is left with the restructured NER, there will be no need for a separate MOU with each sector of the energy industry.

2. General comment.

It is difficult to see what the real objective of this Bill is. In other words, are the objectives clearly enough defined that the proposed regulatory authority will be able to write, implement, interpret and enforce the Bill's objectives? Importantly for the Competition Commission, it is also unclear how the overlap of competitive issues will be handled. And will the Authority be an independent regulator or just the Minister's enforcement body?

The Bill is at times vague about its objectives. This is especially true given that much of what the Authority is to accomplish seems to need to be determined by regulations that have yet to be written. Without more detail on the objectives, it will be very difficult to write the regulations, and a lack of clarity on the regulations will have potential economic effects, such as investor uncertainty. Section 33 of the Bill seems to describe the Minister as the writer of all regulations and the Authority as an administrative body that creates the processes by which regulations are enforced. If the Authority is to be the regulator, then it needs to have the independence to write and revise the regulations that industry and competitive conditions require. One would hope that as the Authority gains experience in enforcing the regulations, it would be best positioned to revise them, and so giving the drafting pen to the Minister might be a problem.

Section 16 suggests that the license application needs to include the tariffs to be applied by the licensee. But it is not clear that there should be a link between the licence application and the tariffs or price policies. Moreover, it makes it clear that until the regulations are written for how tariffs will be determined, an application cannot be submitted.

Section 20 on the conditions of the licence lists a number of conditions that may be difficult to mesh with other objectives. Items (i) to (p) seem to give interested parties the rights to or ability to negotiate a number of terms, including changes in capacity. The implications of these conditions might be troublesome from a number of perspectives, including inconsistencies in requirements or regulations, and in potential competitive impact.

The Pipelines Bill in its present form is not likely to accomplish its stated objectives of reducing Government involvement, increasing competition, or increase investment from anyone in the private sector. Presumably, the intent of the Bill was to create an independent regulatory agency, but there are problems. These problems will be addressed further in some detail, from the point of view that in order for competition to be stimulated, there must be entry of new firms into the industry. In turn, for firms to want to enter, they must be confident that their activities will not be over-regulated, or at least that any regulations are clear an unambiguous. If those conditions are not met, then investors will understandably look for other uses of their funds.

As to the objectives of the Bill as set out in section 2, there are potentially conflicting objectives: it might be difficult to ensure that access is fair and equitable, while also trying to ensure affordable access to petroleum products, depending on what is meant by ‘fair and equitable’. For example, that term might mean that the same tariffs must be charged to any user of the pipeline, rather than capacity being allocated to the most productive use (whoever can pay the most). If the former, then the objective of affordable access to petroleum products might not be met, if the pipelines were being used for a less valued commodity than petrol.

One of the general problems is the possible perception that the Minister has too much influence. The Minister:

1) appoints the members of the Petroleum Pipelines Regulatory Authority (PPRA) and names the chairman.

2) may terminate an appointment by reference to various vague criteria "fails to perform a duty imposed...by this Act"; "fails to act in a manner that is required and expected from the holder of a public office"; etc.

3) may force the agency to hire persons from other agencies, without any apparent reference to their skills or suitability.

4) approves "persons, institutions, governments or administrations" that are allowed to make donations/contributions to the Authority’s budget. (if the question were, can the Authority receive technical assistance from other governments, that would be one thing. But persons and institutions could certainly include those with an interest in the work of the Authority and there is no limitation.)

5) makes regulations on all the substantive issues including the "methodology to be followed by the Authority in setting and approving tariffs... [and] other matters...". Surely the Authority itself should be tasked with determining the appropriate methodology for setting /approving tariffs?

All these Ministerial powers taken together with the warning in section 4(1)(i) that the PPRA must "take decisions that are not at variance with published Government Policy", is disconcerting.

In section 28(1) we read "The Authority must set as a condition of a license the tariffs to be charged by a licensee in the operation of a pipeline". Although section 4(1)(f) says generally that the Authority must "set or approve tariffs and charges", there is no corresponding section that talks about "approving" tariffs, presumably those of loading and storage facilities, nor is there any indication why there should be different treatment for these.

If there are pipelines that operate in the same area as each other, it would be difficult for them successfully to compete if the PPRA sets their tariffs, regulates access through the licence, and otherwise seems to exert an influence on every aspect of their businesses. This would deter new entry and therefore, the prospect of competition.

3. Section by section comments

4(d): "act as mediator or arbitrator" not clear what this is about; because the Minister sets regulations and fees to be charged.

4(e): "consult, where necessary, with Government departments or other bodies and institutions regarding any matter contemplated in this Act." This does not appear to amount to an acknowledgement of concurrent jurisdiction with the Competition Commission.

7: Titling a section "Vacation of office" is strange, especially when it says a Member must vacate when (s)he becomes of unsound mind. How will (s)he ever know it is time to leave? Perhaps provision should be made for the Minister to remove or terminate the services of the Member should the member not be able to carry out his/her responsibilities.

10(1)(b): Any decision must be "in the public interest", but it is not clear what the public interest is supposed to be. It is not defined in Section 1, whereas it should be defined, or there should be guidelines as to what would constitute public interest considerations. Otherwise there appears to be too much discretion for the Minister to determine what might be done "in the public interest". In general, there should perhaps be clauses on the procedure the Minister should follow if s/he would like to intervene in the various proceedings of the PPRA. The Competition Act contains such clauses.

15(2): The word ‘may’ should be replaced with ‘must’ as this section is material.

18: "Before considering an application..." should read " When considering an application…." as the items that should really be considered during the consideration of an application.

20: The whole section is about conditions that the PPRA may impose.
(1)(i) and (j) "interested parties must be allowed to negotiate changes...licensees are not obliged to incur any additional expenditure...and the total cost for the pipeline must be shared equitably..." If an interested person has to share somehow in the cost of the entire pipeline, that would put them off asking for changes. Surely the cost to be shared is limited to that cost associated with the "change"?
Same applies to 20(1)(m) and (n) re loading facilities.
With 20(1)(r) and (s), why are tariffs "set" for pipelines but "approved" for loading and storage facilities?

2(a) Any person aggrieved by a condition on a licence may apply for an amendment, including it seems, the licensee. In the case of the licensee, the question should rather be dealt with during the initial process, and probably also for any interested third party who should have had notice of the application and an opportunity to be heard.

21: Licensees may not discriminate "except for objectively justifiable and identifiable grounds". Those grounds should be listed.

22: The term of a licence is 25 years and in 22(3) every application for renewal must be granted, so in theory all initial licences are perpetual. This is not conducive to the creation or attraction of competition. Indeed the term of 25 years seems to be very long, and one wonders whether such a long period is necessary to recoup investments made.

24: Perhaps the intention is to deal with the perpetuity problem with section 24, which allows licences to be revoked if the "facility is no longer required...is not economically justified...another person is willing" to do the job. But these terms are not defined, and in light of the Ministerial problem mentioned above, this is carte blanche for Government to take away any licence at any time and give it to some other party. On the other hand, perhaps the intention of section 24 was to cover applications by licensees for the revocation of their own licences? If so, then section 24 should be redrafted to make that absolutely clear.

25: If a licensee "contravenes or fails to comply" the Authority may order them to do so and if they do not, the Authority may "sit as a tribunal" and "decide on the matter" and impose penalties or fines. There should be some process to determine in the first place whether there has been a contravention before the Authority sends out orders to comply. Would that process be spelt out in Regulations? It is not clear that the original question is to be considered when the "tribunal" (whatever that may be) convenes. An aggrieved party may appeal to the High Court. Usually, as in the case of the Competition Commission, such an appeal would go to the Court of Appeals. Also, this is the first and only mention in the bill of any right of appeal, even though there should be some right of appeal with respect to all of the decisions in all of the previous sections, especially in respect of the licence revocation in section 24 (unless 24 is meant to cover only an application for the revocation of one’s own licence). We recommend that the Regulations – when drafted – incorporate more input.

26: This section introduces another method of revocation: by application to the High Court. It is not clear whether PPRA would need to do this when they have their own power in Article 24 (again, unless section 24 is meant to cover only an application for the revocation of one’s own licence).There is no mention of an appeal from the decision of the High Court, although that may otherwise be dealt with in the rules of the court.

29: "[A]ny person authorized in writing by the Authority…" may enter property and demand documents. It would seem that these are functions that should be undertaken by the staff; there is no discussion of who these people might be or why they should be relied on.

30: This section deals with the voluntary resolution of disputes by means of mediation or arbitration undertaken by the PPRA or its designate. There is no mention of what sort of disputes is contemplated, or why the decision of the Authority should be binding without appeal. This section also does not mention the charges that section 12(c) allows the Authority to charge.

31: Requires the Authority to investigate complaints about discrimination or failure to obtain access. No mention is made of failure to abide by tariffs, anticompetitive agreements, predatory or excessive prices, or the like.

33: When the Minister makes regulations (s)he must "consult" with the Authority, "invite" and "duly consider" comments. Nevertheless it appears that the Minister has absolute discretion, once this has been done.

35: The Authority "must grant a licence" to anyone owning or operating any of the relevant facilities unless it finds that he/she/it is "unable or unwilling" to own or operate. The only possible qualification is that they must be willing and able to do so "in a manner consistent with the objectives and provisions of this Act.". That is not a very difficult standard to have to meet.

Memorandum on the Objects…, p.15 Para3:

This paragraph says that the Cabinet has directed the creation of a "rationalized" Energy Regulator, which will be a broadening of the existing National Electricity Regulator. What that means in general or how it is related to this Bill and the PPRA, and how or if they will work together, are all issues that are left up in the air.