Superior Plus’ Acquisition of Certain Propane Assets in Western and Central Newfoundland from Irving Oil and Irving Oil Marketing

Technical Backgrounder

February 25, 2009

This technical backgrounder summarizes the main findings of the Competition Bureau (the "Bureau") resulting from the review of the acquisition by Superior Plus LP ("Superior") of certain propane assets located in Central and Western Newfoundland from Irving Oil Limited and Irving Oil Marketing Limited (collectively "Irving") (the "Transaction"). The Transaction was not notifiable under the Competition Act (the "Act"); however, the Commissioner commenced an inquiry to assess the potentially significant competition issues raised by the Transaction.

The Bureau concluded that the Transaction would likely result in a substantial lessening or prevention of competition in the retail supply of propane in Central and Western Newfoundland for commercial and industrial use. In particular, the Bureau was concerned that there would be an insufficient level of remaining competition post‑merger, as well as significant barriers to entry. The parties claimed that efficiencies to be gained from the Transaction would outweigh any anti‑competitive effects. While the Bureau agreed that efficiency gains would likely arise from the Transaction, it was unlikely that such gains would be sufficient to offset the substantial lessening or prevention of competition. To address the Commissioner's concerns, Superior and the Commissioner concluded a Consent Agreement (the "Agreement").

Readers are advised to exercise caution in interpreting the Bureau's assessment of the Transaction. Enforcement decisions are made on a case‑by‑case basis and the conclusions discussed in this backgrounder are specific to this Transaction and are not binding on the Commissioner. The legal requirements of section 29 of the Act and the Bureau's policies and practices regarding the treatment of confidential information limit the Bureau's ability to disclose information obtained during the course of a merger review. Moreover, portions of the Agreement entered into by Superior and the Commissioner are confidential.

Backgrounder

In August 2007, Superior contacted the Bureau with respect to the Transaction. Although the Transaction was not notifiable under Part IX of the Act, in light of the apparent potential for serious competition concerns, the Bureau conducted an extensive review to determine the likely competitive effects. In conducting its review, the Bureau collected information from multiple market participants, including customers, suppliers, competitors and government officials. In addition, information was collected on a voluntary basis from Superior and Irving (collectively the "Parties") and under an order issued pursuant to paragraph 11(1)(a) of the Act. The Bureau also retained economic and accounting experts.

In December 2007, following a thorough investigation, the Bureau concluded that the Transaction would likely prevent or lessen competition substantially in the retail supply of propane in Central and Western Newfoundland for commercial and industrial use. To resolve these concerns, Superior and the Commissioner concluded a Consent Agreement on April 15, 2008 that required Superior to divest bulk propane storage tanks and other related assets located in Western and Central Newfoundland. On May 12, 2008, the Agreement was registered with the Competition Tribunal (the "Tribunal") pursuant to section 105 of the Act. On October 2, 2008, Superior entered into an Asset Purchase and Sale Agreement with North Atlantic Petroleum ("NAP") for the sale of the assets to be divested under the Agreement. NAP operates the only oil refinery in Newfoundland and also operates in the retail gasoline and heating oil industry throughout Newfoundland. Prior to the purchase of the assets, NAP was also operating a propane distribution business serving regions outside of Central and Western Newfoundland (i.e. the Avalon Peninsula and the Clarenville area) and, to a smaller extent, in the Grand Falls area in Central Newfoundland. NAP's purchase of the divested assets represents an opportunity to significantly increase its presence in Central Newfoundland and also to enter into the propane business in Western Newfoundland. The divestiture of assets was completed on January 23, 2009.

The parties

Superior is a wholly‑owned subsidiary of Superior Plus Inc. (formerly the Superior Plus Income Fund), a publicly traded corporation. Superior carries on operations through four divisions. Its Superior Propane division supplies retail propane and propane consuming appliances and related services in Canada, and supplies wholesale propane primarily in the United States.

Irving is a family‑owned and privately‑held energy processing, transporting, and marketing company headquartered in Saint John, New Brunswick. Through its Canadian Residential and Commercial Energy Services division, Irving retails petroleum products and propane to residential and commercial customers in Labrador and Newfoundland, Nova Scotia, New Brunswick and Prince Edward Island.

Newfoundland propane industry background

Propane is a fuel that is produced as a by‑product of crude oil refining. In Newfoundland, propane is generally sold at wholesale to resellers at the refinery "rack rate", determined based on the propane exchange market together with a premium that represents differences in market conditions at the local refinery. Resellers transport propane from the refinery to propane storage facilities, which are essentially large, strategically‑located propane tanks. When a customer order is received, propane is delivered from the storage facilities to the end user.

Propane is used in a variety of applications in various sectors of the economy. In commercial settings, propane is generally used for heating, hot water and cooking. In the industrial sector, the main uses of propane are in heating and carburetion (primarily forklifts). In transportation, propane is used as an alternative fuel source to gas and diesel. Propane is also used in the agricultural sector for crop drying and irrigation.

Maximum prices for heating fuelFootnote 1 and motor fuelFootnote 2 are set by the Newfoundland and Labrador Board of Commissioners of Public Utilities under the Petroleum Products Act.Footnote 3 In the relevant markets, propane resellers have typically charged a rate equal to this regulated ceiling price. In such circumstances, there was limited scope for an exercise of market power attributable to the Transaction with respect to the distribution of propane for home consumption; however, the price regulation in question does not apply to commercial and industrial uses of propane, which together represent more than 80% of total propane use in Newfoundland.

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Relevant markets

Product market

In accordance with the Tribunal's decision in the Superior‑ICG case,Footnote 4 the relevant product market is the retail sale of propane.Footnote 5 Industry contacts confirmed that, while alternatives may exist for propane in some primary end uses, such alternatives are not considered viable owing to various reasons, including high switching costs, high relative prices for other forms of energy, and health issues associated with using alternative fuels in confined areas.

In Superior‑ICG, the Tribunal noted that it might be possible to further segment the relevant product market based on end‑uses and market sectors. In this matter, the Bureau concluded that in light of the regulatory environment in Newfoundland, the relevant product market should be further segmented into regulated (mostly home consumption) and non‑regulated sectors (commercial and industrial use). Since non‑regulated users of propane cannot obtain access to propane at regulated prices, a hypothetical monopolist in the provision of non‑regulated propane could profitably impose a small but significant non‑transitory increase in price.

Geographic markets

The Bureau found three geographic markets for the retail retail of propane on the island of Newfoundland. Two of these markets, the Western Newfoundland and the Central Newfoundland geographic markets, were relevant to the Transaction.

Thus, the Bureau extensively analysed the following relevant markets:

  1. The resale of non‑regulated propane in Central Newfoundland; and
  2. The resale of non‑regulated propane in Western Newfoundland.

Competitive analysis

Effective remaining competition

In the Central Newfoundland market, the only remaining competitor was the retail propane business of NAP. In the absence of the divestitures required by the Consent Agreement, the merged entity would have held significant market power in this relevant market. Furthermore, unlike Superior and Irving, NAP did not have bulk storage facilities in the Central market and, as such, faced higher distribution costs vis‑à‑vis the merged entity, as NAP had to deliver propane from the Come‑by‑Chance refinery, increasing the distance between the delivery point and the final customer.

In the Western Newfoundland market, the Transaction would have resulted in a monopoly. At the time the Bureau conducted its inquiry, no other firms were serving this market, and no firms had indicated that they planned to enter or could profitably enter de novo within a two‑year period without a substantial and sustained post‑merger price increase.

Barriers to entry

Entry barriers in the relevant markets are substantial. Market information confirms that, owing to the factors outlined below, entry into the relevant markets is unlikely to occur on a timely and sufficient basis.

Sunk costs

Existing firms have well‑established networks of storage and transportation facilities that would be costly to replicate. In Superior‑ICG, the Tribunal found that market development costs, site‑preparation costs, and discounts to the purchase price on asset disposals would constitute significant sunk costs and would be a significant entry‑deterring factor. Based on market contacts, there was no reason to believe that the findings of the Tribunal in Superior‑ICG were not applicable for the relevant markets in this case.

Reputation

Both Superior and Irving have participated in the supply of propane in Newfoundland for more than ten years and are well‑established suppliers with a track record of reasonable service and safety. Many propane purchasers in Newfoundland indicated that reputation is an important feature when choosing propane suppliers. Further, in Superior‑ICG, the Tribunal noted that the time required to earn a reputation would make profitable entry more difficult, delaying an entrant's competitive impact.

Market size and population distribution

Demand in Newfoundland for propane accounted for less than 1% of total Canadian demand in 2006.Footnote 6 Further, both the Central and Western Newfoundland markets are sparsely populated; as a result, propane customers, especially industrial contracts demanding large volumes, may be located at a considerable distance from each other. Thus, without attracting large numbers of customers in the different areas, high transportation costs would put an entrant at a disadvantage to the incumbent firms.

Economies of scale

The Merger Enforcement Guidelines note that, in markets where economies of scale are significant, entry on a small scale may be difficult. Owing to the size difference between an incumbent firm and a small entrant, it is likely that such a scale‑based cost differential would translate into a significant advantage for the incumbent. As mentioned above, there are density economies in the transportation of propane; this would have a compounding effect in the markets in question.

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Market power

As discussed above, the Bureau's review focussed on the potential for an exercise of market power in the relevant non‑regulated markets.

Unilateral effects

In Western Newfoundland, the merged entity would have had a retail propane monopoly, whereas in Central Newfoundland, the merged entity would have enjoyed a substantial share of the market. In each of these non‑regulated relevant markets, Superior's post‑merger market position could have allowed for a significant unilateral exercise of market power.

Coordinated effects

In addition, in Central Newfoundland, where the merged entity would face only one competitor post‑merger, the potential for coordinated effects was a concern. The investigation in this matter found that many of the "facilitating factors" for coordination as set out in the Merger Enforcement Guidelines were satisfied. Primary concerns included:

  • Significant barriers to entry;
  • Limited remaining competition in Central Newfoundland;
  • A degree of transparency in pricing;
  • Frequent purchases by many small users; and
  • The fact that competitors compete in multiple markets (i.e., Central and Eastern Newfoundland).

While many of these factors continue to be present with the divestiture of assets under the Consent Agreement to NAP, it is the Bureau's view that coordination is materially less likely as a consequence of the divestiture because, among other things, while acquiring significant capital assets, NAP did not obtain customer contracts or lists. As such, NAP has an incentive to compete for customers to enable it to earn a return on the acquired assets.

Efficiencies

In Superior‑ICG, the Tribunal ultimately determined that, while it was likely that the merger would substantially lessen or prevent competition, it could not issue an order under section 92 of the Act owing to the fact that the merger was likely to bring about gains in efficiencies that would be greater than, and would offset, the effects of any prevention or lessening of competition, pursuant to section 96 of the Act.

In the present case, the Parties provided the Bureau with detailed efficiencies claims that were considered by the Bureau and external experts during the review of the Transaction. Ultimately, the Bureau agreed that efficiency gains would likely arise from the Transaction, but it appeared unlikely that such gains would be sufficient to offset the substantial lessening or prevention of competition.

Remedy

An AgreementFootnote 7 was reached between Superior and the Commissioner, in April 2008, to address the Commissioner's concerns. Superior's commitments included:

  • Divesting bulk propane storage tanks and related assets in both Central and Western Newfoundland;
  • Maintaining the competitive viability of the assets during the interim period prior to divestiture; and
  • Allowing existing Irving propane customers to terminate certain supply‑related agreements without penalty, and to notify these customers of such rights at both the time of closing of the Transaction and the time of completion of the divestiture.

Finally, in the event that Superior would have failed to divest the assets during an initial sale period, the Commissioner had a right to appoint a divestiture trustee to complete the sale.

Conclusion

The Bureau is satisfied that, with the implementation of the divestitures required by the Agreement, the Transaction is unlikely to result in a substantial lessening or prevention of competition in the relevant markets outlined above.

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