Liberalization of the EU natural gas sector began almost two decades ago. Since then, the European Commission (the “Commission”) has used various mechanisms to facilitate market opening including competition law enforcement, merger control, and a series of directives culminating in the Third Energy Package. Throughout this period some familiar trends in enforcement can be discerned. One of these is the Commission’s hostility to agreements between competitors on joint marketing or sale of gas. By contrast, there is no such presumption against joint selling in a merger control context.
LNG is a particular case in point where parties seek to manage risk by combining their operations from production, to LNG liquefaction, through to shipping, regasification, and marketing and sale to end customers. The Commission’s recent unconditional merger control clearance of the BP/ Chevron/ Eni/ Sonangol/ Total/ JV [1] approved cooperation in the LNG sector from production to marketing. The case provides a suitable backdrop to re-examine the Commission’s traditional approach to joint selling and the circumstances in which it can be compliant with EU competition law.
EU Competition Policy and Joint Selling
The Commission has traditionally maintained a strict stance towards joint selling in the gas sector. The practice was criticised in a number of high profile cases including GFU [2]; DONG/ DUC [3]; and Corrib. [4]
The Commission’s reluctance to accept joint selling in the gas sector was expressed in its 2001 Competition Report stating that “[i]n the coming years…priority will be assigned to cases that will help put and end to joint marketing activities on the upstream markets (e.g., joint sales). Priority will also be given to cases where the buyer’s ability to sell gas outside a given territory or to certain users is limited.” [5]
The weighting of the Commission’s antitrust enforcement since its energy sector inquiry (2005 – 2007) has been on abuse of dominance cases. Apart from the reported cases and the Commission’s Horizontal Cooperation
Guidelines, [6] which provide a sector-neutral assessment of joint commercialisation, the Commission has not publicly or at least recently clarified its approach to joint selling of gas or LNG.
The typical competition concerns that the Commission has highlighted tend to involve:
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price fixing: most obviously, the agreement may lead to price fixing, directly or indirectly, to the extent that the agreement involves exchange of information on pricing, costs, and marketing strategy (for example, to the extent that the parties will have visibility on each other’s pricing);
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market allocation: the agreement may become a means for the parties to divide the relevant markets or allocate orders or customers, for example through marketing committee meetings and discussions which could be considered as a vehicle to facilitate mutual understandings to avoid entering each other’s markets or customers;
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output restrictions: the agreement may also facilitate output limitation to the extent that the parties may decide on the absolute and relative volume of products to be put on the market, therefore restricting supply; and
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information exchange: the agreement may lead to exchange of commercially sensitive confidential information relating to aspects within or outside the scope of the agreement, for example relating to costs and pricing.
Merger Control: One Route towards legal Certainty
If the structure of a gas or LNG venture constitutes a full function joint venture (“FFJV”) and meets the relevant thresholds for notification, merger control provides a route to achieve legal certainty on the competition treatment of the joint sales arrangements. There is no presumption against joint selling in a merger control context and the joint selling aspects will be examined as part of the overall competition analysis of the merger.
However, this option is not entirely straightforward.
First, the JV must meet the requirements of full functionality. To achieve this, a joint venture must:
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have management dedicated to its day-to-day operations and access to sufficient assets, personnel, and financial resources in order to operate its business activity independently;
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have the ability to conduct its own commercial policy;
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have activities that go beyond one specific function for the parents;
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have no significant purchase or supply agreements between it and its parents which would undermine its independent character; and
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be of a sufficiently long duration as to bring about a lasting change in the structure of the undertakings concerned.
Second, notification of a FFJV to a competition authority may not be optional and will impact on the timing of completion. For example, in the EU, all mergers meeting the relevant thresholds under the EU Merger Regulation (“EUMR”) must be notified to the European Commission and cannot be implemented before clearance.
Third, some JV parties may be reluctant to engage in dialogue with the authorities.
Fourth, review of a FFJV under merger control will not render the structure immune from competition law scrutiny. Under the EUMR it will be necessary to examine whether the concentration gives rise to a significant impediment on effective competition, in particular as a result of the creation or strengthening of a dominant position. Any spillover effects (i.e., harm to competition in related markets) will be scrutinised carefully. To the extent that the joint selling aspects of a JV are “directly related and necessary to the implementation of the merger,” they will be compatible with EU law. If the joint selling cannot be justified as such an ancillary restraint, it will fall to be examined under mainstream competition law (see part 4 below).
Finally, if at the time of the (original) creation the JV does not perform all the functions of an autonomous economic entity or it does not meet the thresholds for notification, it may still be notifiable to a competition authority during the life of the JV. Any subsequent change in the activities of an existing joint venture may be qualified as a concentration. A recent example of a case where the Commission approved a joint venture under merger control after a change in its activities was BP/ Chevron/ Eni/ Sonangol/ Total/ JV. [7]
In 2002, BP, Chevron, Eni, Sonangol and Total created a jointly controlled JV. The parties intended the JV to be active in the production of LNG, based on gas supplied from offshore exploration blocks in Angola. When the JV was initially formed the parents intended for the gas to be sold only to affiliates of the parents for resale in the USA. This did not qualify as a FFJV under the EUMR. Subsequently, the parents decided that the JV should also sell gas to third parties. The JV would transform natural gas, obtained as a by-product from oil production and transported along pipelines to its liquefaction plant in Angola, into LNG for shipment and/or storage in liquid form. The LNG would then be marketed and sold to customers around the world for regasification. Consequently, the JV would have market access and qualified as a FFJV. For this reason, the parents notified the transaction to the Commission under the EUMR.
The Commission’s clearance decision of 16 May 2012 provides interesting insights on how the Commission views competition in the LNG sector and how it viewed the particular arrangements.
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The parties’ activities overlap in the market for the wholesale supply of LNG in the EEA. For the purposes of its merger control decision, the Commission did not decide on the relevant product and geographic market definitions for LNG since the proposed transaction did not give rise to competition concerns under any alternative definition.
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Given the JV’s moderate anticipated market share (0-20 percent on a range of assumptions) and the presence of a number of credible competitors, the Commission found that the JV and its parent companies will continue to face sufficient competitive constraints on the market for the wholesale supply of LNG. The Commission observed that the terms of any coordination between the parent companies could be defeated by numerous competitors on the wholesale EEA and national EEA markets, citing Qatar Petroleum, Sonatrach, ExxonMobil, Shell, and GDF. Looking at LNG and piped natural gas in the EEA and national markets, competition was identified from Gazprom, Statoil, Sonatrach, and GDF.
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Although three of the parent companies (Total, Eni, and BP) hold capacity rights in regasification terminals in Europe, the Commission found that they will not be able to shut out third parties from accessing them. The Commission noted that EU law ensures third party access to gas import infrastructures, including regasification terminals. Thus, the creation of the JV did not lead to any change as regards competitors’ ability to access gas import infrastructures.
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The Commission noted that the JV itself would not facilitate coordination of the parties’ activities since the JV agreements include mechanisms to ensure that the parents do not obtain competitively sensitive information in respect of the JV’s activities. Such information flows from the JV to the parents exclude information such as the JV’s customer and/or pricing information.
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The Commission excluded the possibility of coordinated effects because it found that the upstream supplier base for LNG for supplies to the EEA was wide, most gas volumes were sold via long term contracts with prices negotiated individually, and most incumbent buyers had a portfolio of seven or more counterparties.
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The Commission noted that the rationale for the change in the scope of the JV’s activities from production and sale to affiliates to the parents was to meet increasing LNG demand in Europe (and elsewhere). Thus, it was expected to lead to increased supply to Europe “at a time when demand for gas is increasing significantly and there is a need to diversify gas importation by increasing LNG imports.” The Commission therefore viewed this as overall a pro-competitive outcome.
Self-Assessment of Joint Selling: Between a Rock and a Hard Place
If joint selling arrangements do not qualify as a FFJV they will need to be examined under mainstream competition law.
The analysis under EU competition law is carried out in two steps. The first step is to assess whether an agreement between independent undertakings, which is capable of affecting trade between Member States, has an anti-competitive object or actual or potential restrictive effect on competition (Article 101(1) Treaty on the Functioning of the EU (“TFEU”)). The second step, under Article 101(3) TFEU which only becomes relevant if an agreement is caught by 101(1) TFEU, is to determine any pro-competitive benefits produced by the agreement and to assess whether those pro-competitive effects outweigh the restrictive effects on competition. In summary, the application of this “exception” is dependent on the following conditions being met:
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the agreement must lead to efficiency gains;
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the restrictions must be indispensable to bringing about the efficiency gains;
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consumers (including intermediate customers) must gain a fair share of the resulting benefits; and
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the agreement must not afford the parties the possibility of eliminating competition in a substantial part of the products in question.
Broadly, if the pro-competitive effects do not outweigh the restriction on competition, such restrictions are automatically void and subject to fines of up to 10 percent of turnover.
The Commission has issued guidance in its Horizontal Cooperation Guidelines that commercialization agreements and joint selling between competitors can only have a restrictive effect on competition if the parties have some degree of market power.
If the combined market share of the parties does not exceed 15 percent on a relevant market, it is likely that the agreement will meet the conditions of Article 101(3) (subject to the comments below on price fixing). If the parties’ combined market share is greater than 15 percent, a closer examination will be required. The assessment of the compatibility of the agreement with EU competition law will be informed by the parties’ market power and the characteristics of the relevant market.
Efficiency
Price fixing or coordination on price is rarely justified under EU competition law, even where the parties have a combined market share of less than 15 percent.
Generally, in order to justify coordination on price it would need to be satisfied that:
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any actual or potential coordination on price is indispensable for the joint marketing functions and that this integration will generate substantial efficiencies; and
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the efficiency gains result from actual integration of economic functions (i.e., that the agreement is more than just a sales agency without any actual investments in reducing duplication of resources).
Indispensability
The restrictions must not go beyond what is necessary to bring about the benefits. This is especially important where price fixing is concerned as this can be accepted only under exceptional circumstances.
Pass-on to consumers
Efficiency gains can be as passed-on to consumers where it is likely that the agreement will lead to lower prices or better product quality or variety. Where the combined market share is less than 15 percent it is likely that any efficiency gains will be passed-on to consumers.
No elimination of competition
This condition has to be assessed in relation to the markets concerned by the agreement and any possible spill-over effects into related markets (see further part 5 below). In this case, the parties will continue to engage in a wide range of activities in the international energy sector may suggest a potential risk of spill-over effects. These risks may, however, be mitigated (see part 5 below).
Wider Considerations for Transaction Risk Management
Information exchange
The operation of the arrangements may have certain indirect effects on competition, as a result of the passing-over of confidential commercially sensitive information about prices, costs, and terms and conditions between competitors.
The competition risks inherent in the sharing of commercially sensitive confidential information may be mitigated through:
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appointment of an independent trustee charged with receiving information on prices, costs, and other commercially sensitive information which is necessary to compute and validate each party’s entitlement; or
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firewalls between those involved in the commercial activities relevant to the agreement and other divisions of their company to seek to ensure that commercial information relevant to the agreement and other functions is circulated on a strictly ‘need to know’ basis.
Spillover effects
The risk of coordination giving rise to anti-competitive effects is intensified where the parties have activities in other international energy markets raising a concern that the arrangements could lead to a reduction in competition in other related markets. These risks can be mitigated: (a) through information barrier protocols as described above; or (b) ensuring that the scope of any non-compete arrangements is limited to the scope of activities covered or reasonably contemplated by the arrangements.
Distribution arrangements
Related arrangements should be examined for EU competition law compliance. A particular area of EU competition law concern has been the inclusion of profit share mechanisms (“PSMs”) in contracts between gas producers and wholesalers. Concerns arise where such PSMs have the likely effect of partitioning the EU gas market, for example by providing a mechanism which disincentivises the buyer from selling in particular territories.
Recent cases [8] have suggested some fine distinctions between so-called ‘net’ and ‘pure’ profit share and a differential treatment of CIF, DES, and FOB contracts. However, for transaction planning it is to be kept in mind that EU competition law focuses on the substance of the agreement rather than its form and it would need to be satisfied that any PSM does not materially distort the buyer’s incentives to sell in a particular EU market. As a working principle, PSMs may be considered to maintain the buyer’s incentives to sell in an alternative destination where they are left with a positive incremental margin when selling in that destination. It is therefore recommended that such agreements be reviewed separately for compatibility with EU competition law.
Conclusion
Developments in worldwide gas markets have brought about fundamental changes in supply and demand dynamics. LNG has increasingly become a global market. A large number of import and export terminals have been developed in the USA. Europe has several LNG import terminals and imports of LNG are used to supplement declining indigenous gas supplies. Also, LNG storage facilities can be used during peak periods or when gas supplies may be disrupted thereby contributing to security of supply. The fact that the LNG market has become more ‘liquid’ has made the gas market more competitive and less reliant on traditional sources.
At the same time, the approach of the EU competition authorities towards cooperation in the gas sector beyond the production phase and to joint selling in particular is ripe for a rethink. The competition authorities will question why, having jointly exploited a resource or developed a facility, the parties need to continue to cooperate into the commercialization phase. This should not necessarily result in a regulatory impasse. Rather, the competition law assessment should depend on the size and market position of the parties; the size and strength of competitors; the significance of the resources or LNG train that is subject to joint sales; the reasons for joint selling; the availability of other routes to market; the project structuring arrangements and the extent to which flows of sensitive information are managed to minimize risks to the competitive process; and ultimately, the benefits to consumers of gas.
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Suzanne Rab
London
