Excessive pricing verdict in Sasol polymers case

Reena Das Nair, Pamela Mondliwa and Simon Roberts

On 5 June 2014, the South African Competition Tribunal (“Tribunal”) found in favour of the Competition Commission1 (“Commission”) on allegations of excessive pricing of purified propylene and polypropylene, key inputs into plastic product manufacturing, against Sasol Chemical Industries (SCI) and levied a fine of R534 million in addition to behavioural remedies.2

The matter was referred to the Tribunal following an investigation into the polymers market by the Commission upon request by the Department of Trade and Industry (DTI). The DTI was concerned about poor growth of labour-absorbing downstream industries, such as plastic product manufacturing, and high input pricing was identified as a major challenge to downstream beneficiation in the plastics value chain for household products such as buckets, chairs, and industrial products such as motor car parts and water tanks.

Polypropylene, a type of polymer produced by SCI, is an important input for plastic converters and constitutes a significant proportion of the cost of manufacturing plastic products.3 Polypropylene is made from monomer, purified propylene, which in turn is processed from feedstock propylene. Feedstock propylene is a by-product from Sasol’s coal-to-fuel process. The price of both purified propylene and polypropylene, as intermediate products into plastics production, has significant implications on the price and competitiveness of domestic production of a range of plastic products.

Basis of Tribunal’s decision

The Competition Act No 89 of 1998 defines an excessive price as a price for a good or service that bears no reasonable relation to the economic value of the good or service and is higher than this value. Thus the determination of economic value is central to an evaluation of excessive pricing. The Act gives no definition or direction on the determination of economic value and in its decision the Tribunal takes guidance from the Competition Appeal Court (CAC) decision in the matter brought by Harmony Gold against ArcelorMittal (‘Mittal’).

Excessive pricing, as a unilateral abuse by a firm unconstrained by effective competitive rivalry, is about the price charged relative to that which would prevail under conditions of normal and effective competition. It must also be shown that the pricing is to the detriment of consumers. There was no dispute between SCI and the Commission that SCI has very low costs of production and exported about half its production and yet charged local customers at import parity levels. SCI’s low production costs derive from the abundance of feedstock propylene, produced partly as a by-product of the coal-to-liquids fuel production process and the question was whether those advantages were a result of the SCI’s innovation, risk-taking and investment or simply a result of its history of extensive state support.

There is no universal method of determining economic value for every excessive pricing case. It can be measured in a number of ways including through quantifying the economic costs of producing and marketing the good (price-cost test), assessing prices of the same firm for the same product in different markets (export prices), and/or assessing prices of the same/similar products in competitive markets (international comparators). In practice, both in South Africa and in other jurisdictions, economic value has been determined through the different methods described, and a preponderance of evidence is often used to arrive at a more robust conclusion. In the current matter each economic expert led evidence using a variety of tests but the Tribunal’s decision was ultimately based on price-cost tests, export prices and international comparators, as discussed later.

There were numerous disagreements between SCI and the Commission on the prices and costs used in the price-cost tests to assess the extent of the excessive pricing. The Tribunal found that purified propylene prices during the complaint period (2004-2007, although the conduct pre-dated 2004), were in the range of 31.5% to 41.5% above costs.4 For polypropylene, the Tribunal found that the price mark-up over costs were in the range of 17.6% to 36.5% (which includes both a conservative and more realistic measure range).5 Compared to export prices, the Tribunal found that SCI’s local prices for polypropylene were on average, 23% higher than average deep sea export prices, and between 41% and 47% above discounted prices charged in Western Europe.6

In determining the economic value of the products in question, the main issue of contention between the parties was the treatment of SCI’s feedstock cost advantage.7 The Tribunal, taking guidance from the CAC and the Constitutional Court found that history matters when evaluating excessive pricing, and thus central to the debate about SCI’s cost advantage is the history of how SCI acquired its dominant position and the cost advantage. The Tribunal highlights that it is important to consider South Africa’s unique history in the interpretation of its competition law. In other words, legislative imperative is important.8 The preamble of the Act is very clear in that South African competition law seeks to address the previous excessive concentrations of ownership and control within the economy.9 This must be read together with section 2 of the Act which makes clear that ‘a history of such state largesse cannot be permitted to subvert competition nor should the market power inherited from erstwhile status as a state enterprise be exerted with continued impunity’.10 The Tribunal’s enquiry concludes that in the context of this case, the Act intended that history should be taken into consideration.

A review of Sasol’s history of state support led the Tribunal to conclude that SCI’s low cost feedstock propylene arises from South Africa’s natural resources. Sasol significantly benefitted from state support and its position in purified propylene and polypropylene are a result of that. Thus its position is not due to risk taking and innovation but rather due to past exclusive or special rights, in particular very significant historical state support for a considerable period of time. Therefore the feedstock cost advantage as a result of this support should be taken into account in the excessive pricing evaluation.

The notion that history matters in contemplating excessive pricing cases is mirrored in economic literature. Motta and de Streel (2007), Roberts (2008) and Evans (2009) indicate that those markets in which monopolies established dominance due to current or past exclusive or special rights are the very markets in which competition authorities should be concerned about excessive pricing, as high prices are usually merely a rent unrelated to market conditions.11

This decision sets important precedents for a number of reasons, one of which is the emphasis on considering, not only the provisions of the Act, but the preamble as well as the purpose of the Act (Section 2). In this case, the Tribunal reflects on the objectives of the Act when it contemplates whether the respondent’s pricing practice bears no reasonable relation to economic value. The purpose of the Act is to promote the efficiency, adaptability and development of the economy (2(a)) and to provide consumers with competitive prices and product choices (2(b)) and exploitative conduct undermines these drivers of growth. By clarifying that history matters, the decision gives guidance to entrenched dominant firms who acquired their positions due to previous state policies, suggesting that they should be cautious of engaging in conduct which could be considered exploitative, such as excessive pricing.

The Tribunal’s enquiry to determine whether the excessive prices were detrimental to consumers considered the impact on the downstream industry in light of the purpose of the Act. The finding was that the excessive prices, maintained by the exercise of market power by SCI, resulted in missed opportunities for innovation and development for the domestic manufacture of downstream plastic goods.

In effect, the exploitative conduct of the respondent in this matter has undermined industrial policy efforts to build productive capabilities in the plastics sector. Post-1994 industrial policy clearly identified an objective to retain and increase the natural resource advantage that South Africa has, and to encourage the transfer of that natural resource advantage through to the growth of downstream, higher value-added and labour intensive industries.12 One of the efforts to ensure that there was a conducive environment to achieve the industrial policy objectives was to review regulation and in particular in those sectors of the economy where regulation previously was designed and maintained to protect insiders such as incumbents in the fuel industry.

One such review was undertaken for the Liquid Fuels Industry Task Force in 1995 by Arthur Andersen. A key question of this review was whether the protection of Sasol Synfuels (through the regulatory framework) had a negative effect on the pricing of chemical feedstocks and thus on the competitiveness of downstream businesses. Arthur Andersen concluded that the prices charged for chemical feedstocks were generally competitive as the local prices for Polifin’s (which later become SCI) major product streams approximated the export price and were significantly lower than the import price.13 This meant that the low cost advantage of chemical feedstocks (as by-products from fuels production) was at that time being passed on to the downstream plastic producers. However, SCI had apparently changed its pricing behaviour sometime around 2000-2002, when it began charging prices at import parity levels (resulting in a difference of some 20% to 30% between local and export prices).

The South African plastics sector performed well between 1994 and 2002, following which it stagnated and then declined.14 Though there are multiple factors which may have contributed to the decline in the performance of the plastics sector, it is likely that the change in the approach to pricing of the input products by SCI was an important factor. Developing productive capabilities in employment-absorbing sectors such as plastics in middle income countries is imperative to achieve sustainable and more inclusive growth.15 Thus exploitative conduct that undermines the process of developing these capabilities is particularly harmful.

Separate to the administrative penalty the Tribunal sought remedies related to forward-looking pricing. For polypropylene, SCI is required to price on an ex-works basis without discriminating in price between any of its customers no matter where they are located.16 This remedy is consistent with the principles of a notional competitive market. This is because, in a situation where supply vastly exceeds demand, as is the case in South Africa, the expectation is that competition would drive prices towards the export price, which is the next best alternative to local sales, provided that export prices cover all costs and include a reasonable rate of return.

This does not necessarily mean that the local market price will be identical to the export price – the prices will still differ between customers, in both local and export markets, depending on a range of factors including the volumes they buy, the terms of sale, grades of product and any after sales support and assistance.

The implementation of the proposed remedies will lead to a reduction input costs for local plastic convertors as the price of polypropylene accounts for approximately 40%-60% of total costs.17 The remedy will allow convertors to enhance local production thereby enabling them to compete more effectively with imported final plastic products, to manufacture locally rather than overseas and to introduce new products to South African consumers, adding to their choice of product through greater innovation. For purified propylene, SCI and the Commission are required to propose a pricing remedy that is in line with specified principles.18

The Act also allows for victims, in this case mainly plastic convertors, of anticompetitive conduct to claim damages against the respondent, either through individual claims or through class action damages. SCI has appealed the decision at the Competition Appeal Court.

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Notes

  1. The team of economists who worked on this matter for the Competition Commission presently work at CCRED (Simon Roberts (Director), Reena das Nair (Senior Researcher) and Pamela Mondliwa (Researcher)). Simon Roberts testified in the Competition Tribunal hearing.
  2. Competition Commission vs Sasol Chemical Industries, case no. 48/CR/Aug10. The decision as well as the non-confidential expert and factual witness statements are available on the Competition Tribunal website. 
  3. The importance of polypropylene as an input cost for plastic converters was emphasized by industry players who testified in the Tribunal hearings. See factual witness statements of representatives from plastic convertors such as Usabco and SA Leisure.
  4. This range was for what was called ‘Tier 1’ and ‘Tier 2’ sales of purified propylene to the main buyer, Safripol. (See note 2, para 315). 
  5. See note 2, para 357.
  6. See note 2, paras 368 and 374. The Western European mark-ups were for two grades of polypropylene, homopolymer and raffia grade polypropylene, respectively. 
  7. See note 2, para 76.
  8. See note 2, para 96.
  9. See note 2, para 97. 
  10. Mittal (CAC) as quoted by the Tribunal Decision at para 97. 
  11. Motta, M. & de Streel, A. (2007) ‘Excessive Pricing in Competition Law: Never Say Never?’ in The Pros and Cons of High Prices, Stockholm: Konkurrensverket - Swedish Competition Authority 2007: Chapter 2, p. 14-46; Roberts, S. (2008). ‘Assessing Excessive Pricing: The Case of Flat Steel In South Africa’, 2008 (4), in Journal of Competition Law and Economics 871, 888; and Evans, D. S. ‘Why Different Jurisdictions Do Not (and Should Not) Adopt the Same Antitrust Rules’, in Chicago Journal of International Law, Vol. 10, No. 1, Summer 2009, 161. 
  12. Rustomjee, Z. (2012). Witness Statement in Competition Commission v Sasol Chemical Industries. Case No. 48/CR/Aug10 (non-confidential). 
  13. Mondliwa, P. & Roberts, S. (2014). ‘Review of economic regulation of liquid fuels and related products’. Available at: http://www.competition.org.za/regulatory-entities-capacity-building-project/ [23 July 2014]. 
  14. See note 13. 
  15. Tregenna, F. (2007). ‘Which sectors can be engines of growth and employment in South Africa?’ Presented at HSRC EGDI Roundtable, 21 May 2007. 
  16. See note 2, para 507.
  17. See note 2, para 437.
  18. See note 2, at para 491 for discussion on the specified principles.