FINANCIAL TIMES

Fair Trading Commission order on Shell

Question for Commissioners

Was FTC ruling on Shell Gas correct?
By An analyst
The Fair Trading Commission (FTC) last week made a landmark ruling that Shell Gas Lanka has been operating against the public interest and has used its dominant position in a manner that restricts consumers' choice and competition.

The determination follows FTC on its own motion commenced an investigation in Shell since the frequent increases in the price of LPG is a matter of public interest. Among other things FTC said that it is of the view that consumers are entitled at the time the Cylinder is surrendered to the refund of the entire cylinder deposit made by them. Shell had maintained that the cylinder deposit is only meant for the user of the cylinder.

In essence FTC determined that Shell with immediate effect shall refund to the consumer at the time the cylinder is surrendered the entirety of the cylinder deposit taken by it and also pass on potential interest income accurable for a given year based on a certain formula.

Consumers who are affected by the rising cost of living have been relieved by the ruling. However looking at its objectively the ruling warrants further probe and whether the FTC had looked at all aspects in to the matter before making a judgment.

Foremost is was the ruling made following an objective and professional analysis of facts and did the FTC have a panel of professionals that had the capability and competency required to bring out an objective review and did they consider all issues relevant and valid in reaching an objective professional judgement?

Was the process of analysis and judgement sound from a private sector business perspective and will this process and judgement facilitate the Government in achieving its objectives stated in "Regaining Sri Lanka and attracting new foreign and local investments and creating new employment opportunities for the people of Sri Lanka

It is also pertinent to ponder whether the determination of the monopoly status correct and even if so was it interpreted correctly in the order in its application to support the objectives of Regaining Sri Lanka and are the factors taken account of in the financial award correct, complete and professional?

As far as the Monopoly status implications, should not the award separate and also take account of those where Monopoly status is due to regulatory or patent or other external imposed conditions is another issue.

This is in an environment where the monopoly status does not exists in a total open market arena where the Government has not only removed all restrictions and have in fact promoted competition with even special terms and facilities, but the market so created has not been effective for no reason of blocking or strategy of the present dominant supplier

As far as capability and competency is concerned did all engaged in the process have the required knowledge, skills and attitudes to support the review and determination and also to satisfy the stated statutory position of knowlegde of business, management, economics, finance, law and marketing. Did the FTC consult professionals and a panel of persons with such expertise and get different view points before making the order and determination?

In specific were the following facts taken account of enquired and ascertained and brought in to focus in the determination and order

1. Was the business as a whole running at a profit and generating free cash flows and returns commensurate with the investment in competitive investment currency basis and also for the risk of country and business activity?

2. Was the whole business operations and its impact on the operating results considered or only the deposit on cylinder considered in isolation

3. Was working capital and investments in the whole business chain of the company taking replacement costs, returns taken account of, in taking only the value of Cylinder deposits in the working capital chain for determination

4. Did they consider that there is a stock holding cost of the Cylinders (It appears that the application in the determination is only to the cylinder deposit without deducting the costs preferably not historical but replacement cost) and this has a sunken cost and the fact that for every Cylinder in use additional contingent replacement and market anticipation expansion support number of cylinders need to be carried and financed taken account of

5. Is it not that non-refundable deposits are a common feature of business transactions to cover expenses (Government tenders also specify)

6. Did the FTC consider depreciation for economic use life time of cylinder with the customer and is this not fair to recover it through the Cylinder deposit refund payment

7. Did the FTC consider in making this determination how many other firms may be in a similar position and will they adopt the same rationale and rules for others, whether in monopoly or not- and what implication on future investments if so done

8. Is it correct in principle for a determination based on one slice of the transaction without reference to the entire value chain and is this supported by modern competitive advantage theories in practice?

9. Will the facts as stated in the report be held as a justifiable unbiased facts by a businessman/investor and was this validation done by the FTC 10. Did the FTC give sufficient time and have sufficient interactions with Shell and do they have an appeal process available if disadvantaged either to the FTC, Minister or the Courts of Law?

11. Will the Stakeholders evaluate this as a case study and determine the impact within the new Consumer Protection bill passed recently and what impact on the national economy and investment climate?


Order of the Fair Trading Commission
No. 01/2003
Investigation under Section 11 of the Fair Trading Commission Act No. 01 of 1987
Shell Gas Lanka Ltd.

Since the frequent increases in the price of LP Gas is a matter of public interest, the Fair Trading Commission (FTC) on its own motion commenced an investigation in relation to Shell Gas Lanka Ltd (SGLL) in terms of Section 11 of the Fair Trading Commission Act No. 01 of 1987 with respect to the existence or possible existence of a monopoly situation in the LP Gas market of Sri Lanka which operates against the public interest.

In this context, the Commission has to firstly determine the following issues:-

Is SGLL monopolizing the LP Gas market in Sri Lanka?

If the above issue is answered in the affirmative, does such monopoly operate or is it likely to operate against the public interest?

At the commencement, the Commission requested SGLL to submit to it the relevant information considered necessary for the purpose of this investigation. Subsequently the Commission summoned Mr. Robert Moran, the Country Chairman of SGLL, before the Commission on 05/12/2002 to give evidence with respect to the following matters: -

The present market share of SGLL in the LP gas market in Sri Lanka;

The interest income accrued from the Cylinder Deposits and its possible impact on the selling price;

The manner in which the depreciation cost of a Cylinder is being absorbed into the price of a 12.5 kg Cylinder of LP Gas;

The Cylinder Deposit refund procedure; and

The break-down and details of 'company recovery' in the pricing formula of LP Gas.

Issue No. 1: Is SGLL monopolizing the LP Gas market in Sri Lanka?

Section 12 of the FTC Act defines a monopoly situation as follows: -.

For the purpose of paragraph (a) of Section 11 a monopoly situation shall be taken to exist-

1) in relation to the supply of goods of any description in the following cases, that is to say, if-

a) the prescribed percentage of all the goods of that description which are supplied in Sri Lanka, are supplied by one and the same person, or are supplied to one and the same person, or

b) the prescribed percentage of all the goods of that description which are supplied in Sri Lanka, are supplied by members of one, and the same group of interconnected bodies corporate, or are supplied to members of one and the same group of interconnected bodies corporate, or

(c) the prescribed percentage of all the goods of that description which are supplied in Sri Lanka, are supplied by members of one and the same group consisting of two or more persons or are supplied to members of one and the same group consisting of two or more persons. The "two or more persons" referred to in this paragraph in relation to goods of any description, are any two or more persons (not being a group of interconnected bodies corporate) who, whether voluntarily or not, and whether by agreement or not, so conduct their respective affairs as in any way to present, restrict or distort competition in connection with the production or supply of goods of that description, whether or not they themselves are affected by the competition, and whether the competition is between persons interested as producers or suppliers or between persons interested as customers of producers or suppliers, or

d) one or more agreements are in operation, the result or collective result of which is that goods of that description are not supplied in Sri Lanka.

Prescribed percentage is defined in Section 12 (6) of the FTC Act as follows:

For the purpose of this Section "prescribed percentage" in relation to

a) the supply of goods of any description

b) the supply of services of any description; and

c) the export of goods of any description

means such percentage as may be prescribed by regulations by the Minister on the recommendation of the Commission, so however, that such percentage shall not be less than one-third of the supply of goods or services of any description or the export of goods of any description;

As per the gazette notification dated 07/12/1988 the prescribed percentage of LP Gas for the purpose of determining a monopoly under Section 12 (6) of the FTC Act is 50%. At present there are only two suppliers of LP Gas in Sri Lanka, i.e. Shell Gas Lanka Ltd and LAUGFS Lanka Gas (Pvt) Ltd.

On 05/12/2002, Mr. Robert to Moran representing SGLL and giving evidence before the Commission accepted the fact that the current market share of SGLL in the LP Gas market is more than 80%. This is borne out by the information submitted by SGLL and also by the investigations carried out by the Commission.

This makes clear that SGLL has a monopoly of the LP Gas market in Sri Lanka.

Therefore the Commission hereby determines that SGLL holds a monopoly situation in the LP Gas market of Sri Lanka.

Issue No. 2: If the above issue is answered in the affirmative, does such monopoly operate or is it likely to operate against the public interest?

For the purpose of this investigation, the Commission has now to determine whether the monopoly enjoyed by SGLL operates or is likely to operate against the public interest. In this regard, Section 15 (1) (a) of the FTC Act states as follows: -

In determining for the purposes of this paragraph whether any monopoly or merger situation or anti-competitive practice or a proposed merger operates, or is likely to operate, against the public interest, the Commission shall take into account all matters which appear to such Commission to be relevant to the matter under investigation and shall have special regard to the desirability of -

i) maintaining and promoting effective competition between persons supplying goods and services;

ii) promoting the interests of consumers, purchasers and other users of goods and services in respect of the price and quality of such goods and services and the variety of goods and services supplied;

iii) promoting through competition, the reduction of costs the development and use of new techniques and products and facilitating the entry of new competitors into existing markets;

iv) maintaining and promoting balanced distribution of industrial activity and employment; and

v) maintaining and promoting competitive activity in export markets.

Section 15 (1) (a) makes it clear that a principal purpose of the FTC Act is the desirability of competition and the interest of the consumer.

The Commission now considers the conduct of SGLL with special regard to the Cylinder Deposit procedure of the company.

In the course of the investigation it was revealed that the landed cost of an empty 12.5 kg Cylinder was RS. 1,682/- in 2001, whereas presently SGLL takes a deposit of RS. 2,150/- for a new empty 12.5 kg Cylinder.

This deposit has two elements; one is the refundable deposit of RS. 1,150/- and the other is the non-refundable deposit of RS. 1,000/-.

During the inquiry Mr. Moran stated that the monies derived from Cylinder Deposits is re-invested in the business.

However, the Commission reasonably concludes that SGLL earns and / or should be presumed to earn a profit from and out of the re-investment of the said Cylinder Deposits in SGLL.

For the purpose of this investigation, the Commission assumes that the potential rate of interest income accruable on monies collected as Cylinder Deposits would not be less than the One Year Weighted Average Treasury Bill Interest Rate. During the last year (2002), this rate was 12.54% per annum. At present, all such income is considered to accrue purely to the benefit of SGLL.

Therefore, the Commission concludes that, on the current deposit of RS. 2,150/- per 12.5 Kg Cylinder, potentially SGLL earned an annual interest income of RS. 269/60 as revenue per Cylinder in the year ending 31st December 2002.

According to the information submitted, SGLL refilled on average 8,400,000 Cylinders per year in the period of 1999 - 2001. The total number of cylinders in circulation in 2002 was 1,380,000. Reckoning the same usage in 2002 as in the preceding three years, it is deduced that a Cylinder was refilled six times within the last year (2002).

Taking the above circumstances into account, the Commission is of the view that SGLL should pass on to the consumers (depositors) the potential interest income accruable in a given year (based on the One Year Weighted Average Treasury Bill Interest Rate for that year) during the following year.

The Commission is of the further view that SGLL should take into consideration annually the potential interest income accruable during the previous year (based on the One Year Weighted Average Treasury Bill Interest Rate for that previous year) when determining the price of LP Gas for the ensuing year.

However in the event SGLL refills more / fewer Cylinders in the ensuing year than in the preceding year, the loss / profit arising to SGLL due to the total benefit being passed on to the consumer being more / less than the potential interest income accruable during the previous year and the interest on that loss / profit may be adjusted for, when the price of a Cylinder is determined for the following year.

Mr. Moran in the course of his evidence, further stated that the owner of the Cylinder is SGLL, and that the deposit is only meant for the use of the Cylinder, and it is company policy to retain a portion of the Cylinder Deposit as non-refundable when the customer surrenders the Cylinder to SGLL. He also stated that the non-refundable deposit is meant for maintenance of the Cylinder. Notwithstanding this, the selling price of a Cylinder of LP Gas is inclusive of the maintenance cost of a Cylinder under the item of 'operating cost', which is a component of 'company recovery' in the pricing formula for the sale of LP Gas.

The Commission now considers the effects of the above conduct on the prevalence of competition, consumer choice and public interest.

Presently SGLL takes a deposit of RS. 2,150/- for a new empty 12.5 kg Cylinder. This deposit has two elements; one is the refundable deposit of RS. 1,150/- and the other is the non-refundable deposit of RS. 1,000/-. SGLL's practice of refunding only part of the Cylinder Deposit when a Cylinder is returned compels the consumer to be tied-down to SGLL and restricts the freedom of the consumer to change to another supplier. This practice of SGLL restricts competition and distorts the market.

Therefore in view of the foregoing, and especially in view of the assertion by SGLL that the Cylinder Deposit is only meant for the use of the Cylinder, the Commission is of the view that the consumers (depositors) are entitled, at the time the Cylinder is surrendered, to the refund of the entire Cylinder Deposit made by them.

Therefore, in the totality of all the above circumstances, the Commission determines that SGLL, holding the monopoly situation in the LP Gas market in Sri Lanka, has used its dominant position in a manner that restricts the consumers' choice and competition, and has thereby operated against the public interest.

For the reasons given above the Commission hereby determines as follows: -

a) That SGLL shall pass on to the consumers (depositors) the potential interest income accruable for a given year (based on the One Year Weighted Average Treasury Bill Interest Rate for that year) during the following year.

b) That, effective from 15th January 2003, SGLL shall pass on to the consumers (depositors) the potential interest income accruable for the year 2002 (based on the One Year Weighted Average Treasury Bill Interest Rate for the year 2002 being 12.54%) at the rate of RS. 45/= per each and every 12.5 kg cylinder of LP Gas sold during the year 2003.

c) That SGLL shall take into consideration annually the potential interest income accruable during the previous year (based on the One Year Weighted Average Treasury Bill Interest Rate for that previous year) when determining the price of LP Gas for the ensuing year.

d) That in the event SGLL refills more / fewer Cylinders in the ensuing year than in the preceding year, the loss / profit arising to SGLL due to the total benefit being passed on to the consumer being more / less than the potential interest income accruable during the previous year and the interest on that loss / profit may be adjusted for, when the price of a Cylinder is determined for the following year.

e) That, with immediate effect, SGLL shall refund to the consumer (depositor), at the time the Cylinder is surrendered, the entirety of the Cylinder Deposit taken by it.

Signed
Prof. A.D.V. de S. Indraratna (Chairman), Hemaka de Alwis (Member), Dr. Saman Kelegama (Member), Mrs. Rosy Senanayake (Member), N. Warusawitharana (Member), F.D.C. Wijesinghe (Member), Prof. Rajiva Wijesinha (Member).


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