Report on the Chatham Gasoline Market

I. Background On The Competition Act And The Competition Bureau

The Competition Act is a federal statute whose purpose is to maintain and encourage competition in Canada by prohibiting certain types of conduct which interfere with the competitive process and may substantially or unduly prevent or lessen competition.

The Competition Bureau (the "Bureau") has responsibility for the administration and enforcement of the Act. While the Act defines a number of practices which are either prohibited as criminal offences or are subject to a civil law review by the Competition Tribunal, the Act does not provide the Bureau with any regulatory authority to decide the law, control prices, or compel entities to adopt any particular type of conduct or policy. The Bureau's role is to examine such practices and, where appropriate, refer them to the Attorney General for prosecution for matters involving the criminal provisions of the Act, or make an application to the Competition Tribunal under the civil provisions for a remedial order.

The Act does not provide the Bureau with the power to regulate prices. In fact, the federal government does not have the constitutional power to enact legislation to regulate the retail price of gasoline except in a national emergency. The constitutional power to regulate retail gasoline prices rests with the provincial governments. Only Prince Edward Island and Quebec have elected to do so in some manner, although Newfoundland has announced plans to consider legislation that would regulate gasoline prices. Other provinces have chosen to rely on market forces as the most effective means to determine an appropriate price while maintaining incentives to innovate and reduce costs.

When an application has been filed with the Tribunal, the burden of proof is on the Commissioner to satisfy the Tribunal that all of the elements of the relevant civil section of the Act are met and that an order of the Tribunal should be granted. Likewise, with respect to the criminal provisions, the burden of proof is on the Attorney General on behalf of the Crown to establish the offence to the satisfaction of the courts. In other words, the Bureau cannot directly compel changes in business behaviour. In order to do so, it must take on the role of a litigant before the Tribunal. Alternatively, the Attorney General assumes this role before the criminal courts and must produce evidence and prove a breach of the Act.

Nature of the Complaint

Mr. Mike Crombez, an independent gasoline retailer in the Chatham Ontario area requested an investigation of various pricing practices alleging that there was anti- competitive behaviour ongoing during the spring of 1999. The Bureau has examined the Chatham retail gasoline market during this period of time, to determine if there is a basis for believing that any issues under the Act's predatory pricing and abuse of dominant position provisions exist.

A telephone interview was conducted with the complainant on March 5, 1999. From March 1999 to August 1999, interviews were conducted by telephone with persons identified by the complainant as having relevant information or evidence and with other retailers, wholesalers, and refiners. In addition, we have collected and analysed data from both industry and independent sources.

III. Structure of the Chatham Market

Gasoline, as a fuel for passenger motor vehicles is the most efficient and lowest-cost fuel now available. As other potential fuels like propane, diesel, or natural gas are not functionally interchangeable without major modifications and switching costs, there are no economically viable substitutes to gasoline. While there are a variety of gasoline brands, the product itself is homogenous and consumers are highly price sensitive. For the purposes of this analysis, the relevant class or species of business and product market is gasoline for motor vehicles.

With respect to the relevant geographic market, it is necessary to consider both the wholesale and retail levels, as the relevant geographic area will vary accordingly.

At the wholesale or refinery level, there are essentially three distinct geographic markets in Canada; the Atlantic region, Ontario/Quebec, and Western Canada. This conclusion has been reached largely on the basis of product movement between refiners. Supplies from Eastern Canada and import sources are available in Ontario. The information received on Chatham indicated that the supply of gasoline was available from a variety of sources, namely: national refiner-marketers, regional refiner-marketers, and imports from the United States.

At the retail level, the Bureau takes the view that the city of Chatham constitutes one geographic market. Given the limited distance that drivers will travel to refuel, it is concluded that it is a separate market from other cities. A price increase in one sector of the city will be generally matched in other city sectors.

In the "downstream" side ( marketing and distribution) of the Chatham market, there are essentially three types of retail sellers of gasoline: national refiner-marketers, regional refiner-marketers, and independents. Independents source product from the national refiner-marketers, regional refiner-marketers and brokers. Exchange or swap agreements exist between refiners. There are a variety of players at the retail level in Chatham, including national refiner-marketers (Petro-Canada, Imperial Oil, Shell), regional refiner-marketer (Sunoco), and non-integrated retailers (AMCO, Canadian Tire, CO-OP, Maple City, 7- Eleven, Pioneer, Sunys, Fill ?n' Go). In Chatham there are a high number of stations (23) including non-integrated retailers. Thus there are a variety of players in this market.

The highest market share was held by Sunoco but its market share was less than one fifth of the market. Likewise Pioneer's market share was approximately 10%. The combined market share of Pioneer and Sunoco was approximately 25% of the Chatham market. The total market share of the top four firms was less than 65%. The group of integrated companies (including Sunoco and Pioneer) had a combined market share under 50%. Independents as a group, excluding Pioneer, account for just over 50% of the market.

IV. Allegations and Findings

While the complaint involved a number of allegations and concerns, the Bureau conducted its examination on the basis of the following allegations which were deemed relevant in the context of enforcing the various provisions of the Competition Act.

Allegation # 1

During March, 1999 the complainant was being charged higher wholesale prices by Sunoco than the price Pioneer is charging at the retail level, thus rendering it difficult to continue to operate his business. It should be noted that the complainant believes that Pioneer's actions are dictated by Sunoco which owns an equity interest in Pioneer and supplies it.

The concern that stems from such alleged behaviour is that independent retailers of gasoline are the subject of some form of abuse of dominant position by integrated refiner- marketers which not only supply the independents, but compete with them for retail sales. In particular, the complainant is concerned that when prevailing retail prices fall below wholesale prices, so called "inversion", he is unable to compete.

Findings:

The evidence revealed that during this period, Pioneer charged a retail price lower than its wholesale price only on March 5, 1999. The complainant provided the Bureau with prices data for the Chatham market. In the period, Pioneer's retail price was lower than the complainant's wholesale price between February 28 and March 5, 1999 and equal on February 27, 1999. The price data also reveals that on several occasions within the same period, the complainant's retail price was below that of Pioneer.

While the complainant's wholesale prices were higher in some instances than the retail price of Pioneer, this difference can be attributed to certain factors. Variations in wholesale price levels paid by non-integrated gasoline retailers are explained largely by varying volumes purchased, the level of volume discounts, and the differences in the terms of the agreement negotiated between each company and its supplier. Volume discounts do not contravene the Competition Act. The complainant does not purchase the same volume as Pioneer. In addition, the complainant was supplied by a gasoline broker and not directly by a refiner (ie. Sunoco). The use of an intermediary combined with his relatively small volume purchased likely explains the higher prices charged the complainant. The implications of the one day price inversion are discussed later in the report. (ie. Section V)

Allegation # 2

Pioneer Petroleum (Pioneer) was selling below its acquisition costs in Chatham.

The competition concern normally associated with this sort of allegation is that a competitor is engaged in a strategy of predatory pricing aimed at disciplining or eliminating a competitor or group of competitors from the market.

Findings:

The examination conducted by the Bureau produced no evidence to support the allegation that Pioneer has a strategy to sell below its acquisition cost. The cost data that we have accumulated shows that during the period from the beginning of February to the end of March 1999, the time period which encompassed the incident in the complaint, there was only one day in which Pioneer's retail price was less than its wholesale price. The data also indicates that on all other days during the time period, its retail prices were above its wholesale prices.

IV. Allegations and Findings

Predatory Pricing - Section 50(1)(b) and 50(1)(c)

Section 50(1)(b) of the Act, which concerns regional predatory pricing, prohibits businesses from engaging in the policy of selling products in any area of Canada at prices lower than those charged elsewhere in Canada, if the sale's effect, tendency or design is to substantially lessen competition or eliminate a competitor.

Section 50(1)(c) of the Act prohibits businesses from engaging in a policy of selling products at prices unreasonably low, if the sale has the effect or tendency of substantially lessening competition or eliminating a competitor, or is designed to have that effect.

Thus, under the Act, predatory pricing occurs when a dominant firm prices below its costs over a long enough period of time that it forces the exit of some or all of its competitors. The purpose of predatory pricing is to allow the predator to raise its prices to monopoly levels. This, in turn, requires that barriers to entry be sufficiently high so that charging monopoly prices does not attract competitive entry before the predator has recouped its previous losses.

Based on the evidence obtained during the course of our examination, the Bureau has determined that no one competitor in this market, including Pioneer, which was the target of the complaint, dominates the Chatham market for gasoline. During the period in question, there were eleven companies with twenty-three stations in the Chatham area competing for retail gasoline sales. The Predatory Pricing Enforcement Guidelines state that it "is unlikely that an alleged predator with a market share of less than 35 percent would have the ability to unilaterally affect industry pricing." During the relevant period, no competitor had a market share at or above this threshold. Neither Sunoco (which had the highest market share) or Pioneer individually had market shares even approaching this threshold. Thus no firm can be considered as dominant.

Under the Act, there must also be a policy of charging prices which are unreasonably low. As previously indicated, Pioneer's retail price was only lower than its wholesale price on the one day in March. This one day price inversion does not constitute a policy. A short term price inversion such as this is not illegal under the Act. Predatory pricing only becomes an issue when a company's retail price is below its wholesale price for an extended period of time. In the Predatory Pricing Enforcement Guidelines, the Bureau takes the view that low prices which exist for " a relatively short period of time" do not meet the definition outlined in the Act of a policy of selling below cost.

It should also be noted that the allegation regarding Pioneer Petroleum also involved a belief that Pioneer in conjunction with Sunoco ( which has an equity interest in Pioneer and supplies it) was engaged in a coordinated effort wherein Pioneer was marketing its products at unreasonably low prices to the detriment of Sunoco's competitors. No such evidence of such a coordinated activity was uncovered during this examination. In fact, the evidence indicated that despite the equity interest in Pioneer held by Sunoco, the two companies have independent pricing strategies and, at the retail level, compete vigorously with one another.

It is important to note that predatory pricing is based upon a comparison of a company's retail price to its wholesale price. It is not a valid comparison to compare one company's retail price with the wholesale price of another company. There are a variety of factors which could explain why one company enjoys a better wholesale price than another. As long as Pioneer's prices remain above its costs, it is difficult to find that its prices are unreasonably low. The pricing data available does not indicate that Pioneer has or can reduce prices sufficiently for a long enough period of time to characterize it as predation. Rather, prices in Chatham have been volatile and have in fact risen.

From the jurisprudence associated with the predatory pricing provision it is clear that one must look at all the surrounding circumstances of low prices to distinguish between vigorous price competition and prices that may be predatory.¹ For instance, the courts have considered whether low prices were defensive or offensive in nature, whether industry over-capacity encouraged low prices, whether low prices minimized losses, and the duration of the prices in question. An important point made by the court in the Consumer Glass case was that the law against predatory pricing should not interfere with legitimate competition. The Court observed, for example, that it is possible for a competitor to be eliminated from the market without offending the law:

The whole object of competition is to maximize profits by taking as much business as possible away from rivals, and so the mere fact one competitor lowers prices so as to take business away from a rival to the point that the rival might be forced from the marketplace cannot, by itself, determine whether predatory pricing was involved.²

Another important consideration in assessing the complaint arose in the Producers Dairy case, in which the judge acquitted the accused because he was "satisfied that there was no intent on the part of Producers to lessen competition but rather their action was solely for the purpose of meeting competition.³

Furthermore, comparatively low barriers to entry into retail gasoline markets suggests that a strategy of predatory pricing would not substantially lessen competition, and indeed would make little economic sense, because a firm would not be able to increase its prices in the long run without attracting new competition.⁴

The final aspect of the predatory pricing would be the ability of the competitor to raise prices, after the elimination of many of its competitors, to recoup its lost profits. Even after a period of low prices, it is unlikely that enough of the twenty three stations would exit the Chatham market to allow Pioneer to raise prices above competitive levels. Even in the unlikely event that exit did occur on a large scale, potential competition, given the limited barriers to entry, would prevent sustained price increases above competitive levels. Thus, there is no reason to believe that the pricing policies of Pioneer in the Chatham area would constitute predatory pricing under the Act.

VI. Civil Provision

Abuse of Dominant Position - Section 79

Section 79 is designed to remedy situations where one or more firms have been abusing their position of dominance to substantially lessen or prevent competition. Before a remedial order may be obtained from the Competition Tribunal under this section, the Commissioner must satisfy the following three elements:

(a) that one or more persons substantially or completely control, throughout Canada or any area thereof, a class or species of business;

(b) that the dominant firm or firms have engaged in or are engaging in a practice of anti-competitive acts; and

(c) that the practice of anti-competitive acts, has had, is having, or is likely to have the effect of preventing or lessening competition substantially in a market.

Element (a) - control of a class or species of business

Interpretation

"Class or species of business" has been held by the Tribunal to be synonymous with the relevant product market. This market along with the relevant geographic market, are the two initial determinations the Tribunal has made in its analysis of previous section 79 cases. In defining the relevant product market, the Tribunal has cited factors such as direct and indirect evidence of substitutability, functional interchangeability, trade views and switching costs. In determining the relevant geographic market, the Tribunal has considered the boundaries within which competitors must be based if they are to provide effective competition and where prices tend toward uniformity.

"Control" has been equated with market power or the ability to set prices above a competitive level for a considerable period of time. While the measures for determining market power will vary from case to case, a high market share⁵ together with significant barriers to entry are necessary to support such a finding.

Analysis

In the period in question, the market shares do not indicate that any one firm or group of firms dominates the market. For the purpose of enforcing section 79, the Bureau generally considers that a firm with a market share below 35% is not dominant. The highest market share was held by Sunoco but its market share was less than the 35% threshold by a considerable margin. Likewise, Pioneer's market share was even further below this limit.

The complaint also raises the issue of joint dominance by suggesting action by Sunoco and Pioneer. For the purpose of enforcing section 79, the Bureau is likely to be concerned if the market share of the largest firms in question exceeds 65%. The test is the combined market share of the top four firms. The total market share of these four firms did not meet the threshold of 65%.

In addition, the market shares of Pioneer and Sunoco do not exceed the Tribunal's limit of 50% to find market power. The group of integrated companies had a combined market share under 50% thus below the level set for joint dominance. Also important to the analysis is that independents as a group, excluding Pioneer, account for 50% of the market which further suggests that no one group or company controls this market. Therefore, there is no joint dominance in the Chatham market.

Throughout our investigation, we have found no evidence that Pioneer and Sunoco are engaging in the type of coordinated conduct or joint behaviour which has resulted in a lessening of competition. In addition, it is our understanding that the complainant's gasoline station is supplied by a gas broker. There is no evidence that this broker has the ability or the intent to act alone or jointly in any way to exercise any control in the market. The broker accesses its supply of gasoline from a variety of sources. These sources include the national refiner-marketers (Petro Canada and Shell) as well as regional refiner-marketers (ie. Sunoco). Supply is also available from the United States. Thus, the gasoline supplied to the complainant comes from many sources.

Once the gasoline is sold to the broker, the supplier has no direct control over its resale price. In other words, the supplier cannot tell the broker what price to charge. Naturally the market price will determine the price that the gas broker can charge. Thus, Sunoco does not have the direct control over the complainant's wholesale price due to the presence of the broker acting as an intermediary and accessing its supply from several sources.

Thus, the necessary direct link or influence at the retail and wholesale level required to engage in the sort of anti-competitive conduct that was alleged does not exist. At the retail level, there is no joint price determination between Pioneer and Sunoco. Likewise at the wholesale level, there is no joint control or action by Sunoco and the gas broker. Thus, Sunoco and Pioneer do not have the required control at the retail and wholesale level for squeezing under the Act. Squeezing is the attempt by a vertically integrated supplier to cause an increase in the wholesale price to an unintegrated customer (competitor) and a decrease in this customer's retail price, thus reducing the margin available to this customer.

As the first element, "control" has not been established, there are no grounds to proceed with an application to the Tribunal under section 79.

VII. Conclusions

The required conditions to find predation under the criminal predatory pricing provisions of the Act do not exist in the Chatham market. It is the comparison of a company's own retail and wholesale price which is the main test for predation. The price data shows only one day during which Pioneer's retail price was lower than its wholesale price. This period of time is insufficient to support a finding of predation. Furthermore, market share figures indicate that no one company controls the market. It is therefore highly unlikely that Pioneer or Sunoco could subsequently raise its prices above competitive levels after any elimination of competitors.

With respect to a potential contravention of the Act's civil provision of abuse of dominant position, the Bureau's assessment has disclosed that the first required element has not been met. In the product and geographical market, namely retail gasoline sales in Chatham, there is no dominance by a single firm or group of firms at either the retail or wholesale level as required by section 79.

Competition Bureau
December 29, 1999

Retail Sellers of Gasoline in the Chatham Market

National Refiner-Marketers

Imperial Oil
Petro-Canada
Shell

Regional Refiner-Marketer

Sunoco

Unintegrated (Independent) Marketers

AMCO
Canadian Tire
CO-OP
Maple City
Pioneer
7-Eleven
Sunys
Fill'n'Go

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Notes

¹ In particular, R. v. Consumer Glass Co. (1981), 330 R. (2d) 228 and R. v. Hoffman La Roche (1980), 28 O.R. (2d) 164; affirmed (1981), 33 O.R. (2d) 694 (C.A.).

² Consumer Glass, decision, at 247.

³ R. v. Producers Dairy Ltd. (1966), O.J. No. 140. Ontario Magistrate's Court, Ottawa, Ontario, Strike, Magistrate, March 4, 1966, p. 4.

⁴Some entry impediments are generally found to exist in most markets. Therefore, the analysis of entry conditions does not focus upon whether barriers to entry exist, but on whether entry conditions are sufficiently low that they constrain a dominant firm's (or firms') ability to significantly raise the market price.

⁵ The Tribunal has stated that if a firm has a market share greater than 50%, there would be a prima facie finding of market power, while a market share below 50% would not.