Brief Summary

Competition Law — Merger Control — Conditional approval of merger between Xstrata South Africa (Pty) Ltd and target firms Egalite (Pty) Ltd and International Carbon Holdings (Pty) Ltd — Xstrata acquiring entire issued share capital of target firms to ensure consistent supply of char for ferrochrome production — Transaction evaluated for horizontal and vertical effects in char production market — Approval granted subject to conditions due to concerns regarding market concentration and competition.

Comprehensive Summary

Summary of Judgment

1. Introduction

These proceedings concerned the Competition Tribunal’s determination of a large merger under the Competition Act 89 of 1998. The acquiring firm was Xstrata South Africa (Proprietary) Limited (“Xstrata”), acting through the Xstrata group and with Char Technology (Pty) Ltd (“Chartech”) as the relevant subsidiary for purposes of the transaction. The target firms were Egalite (Proprietary) Limited (“Egalite”) and International Carbon Holdings (Proprietary) Limited (“ICH”), which together controlled the operating entities referred to collectively by the Tribunal as “African Carbon”.

The procedural history reflected that the merger was approved on 20 December 2004, subject to conditions embodied in the Tribunal’s order of that date. The Tribunal subsequently furnished reasons for decision (non-confidential version) dated 15 February 2005. During the Commission investigation, Samancor Chrome (“Samancor”), a downstream ferrochrome producer and competitor of Xstrata, raised concerns and initially sought to intervene. Samancor later withdrew its intervention after concluding a new supply contract with African Carbon, but at the Tribunal’s request a Samancor representative attended and addressed the Tribunal at a hearing held on 15 December 2004.

The dispute concerned the competitive assessment of a merger with both horizontal and vertical dimensions in markets involving char (treated in the reasons as including gas coke) as an input into ferrochrome production. The central subject-matter was whether post-merger control over char production would enable the merged entity to foreclose access to an essential input or raise rivals’ costs in downstream ferrochrome markets, and whether any such risk would be sufficiently constrained by entry or otherwise required conditions.

2. Material Facts

Xstrata was described as a mining and metals group involved in, among other things, chrome (ferrochrome) and operating as a fully integrated ferrochrome producer with chrome ore mines and metallurgical plants. Chartech, Xstrata’s relevant subsidiary, produced gas coke, char and electrode paste, with certain by-products (tar, char fines, and coke fines). African Carbon produced char and gas coke (treated as “char” for purposes of the decision) and related by-products, operating 21 gas coke retorts with four more under construction, as well as five chain grate furnaces that produced char.

The transaction entailed Xstrata acquiring the entire issued share capital of Egalite and ICH, thereby acquiring direct control over African Carbon. For purposes of the assessment, the Tribunal evaluated the merger on the basis that Xstrata would acquire sole control over the African Carbon operations, given the parties’ request that the transaction be assessed as if sole control over relevant operations would result (in light of the indicated intention of an existing shareholder to sell its stake).

A key factual premise accepted in the reasons was that, for competition analysis, char functioned as an essential input into the local ferrochrome production process. The Tribunal accepted evidence that in South Africa ferrochrome producers used several carbon sources (including coke, char, anthracite and bituminous coal), but that bituminous coal and anthracite on their own were not regarded as suitable substitutes for coke, and that char could be used effectively with coke and was therefore preferred by local producers. The Tribunal further accepted that the char produced by Rand Carbide—a vertically integrated firm supplying its own downstream operations—was not an adequate substitute for the retort-produced char of African Carbon for ferrochrome purposes, due to technical characteristics (including greater tendency to break down and quality/sizing constraints raised by customers).

On the upstream market facts, the Tribunal recorded that there were three char producers in South Africa: African Carbon, Chartech, and Rand Carbide. It was common cause on the record that Chartech supplied all its char output internally to Xstrata, and Rand Carbide likewise supplied its output to its own downstream operation. The Tribunal therefore accepted that African Carbon was the only non-vertically integrated char producer from whom other South African ferrochrome producers (competitors of Xstrata) could source retort char. The Tribunal accepted a national geographic market for char supply on the basis set out in the reasons (including transport constraints and economics of imports).

The Tribunal noted market share information reflecting African Carbon at 73%, Chartech at 17%, and Rand Carbide at 10% in the char production market. On the downstream market facts, the Tribunal accepted (for purposes of the decision) a global market for ferrochrome production and supply, and recorded output-based market shares indicating Xstrata as a significant global producer (with the table reflecting Xstrata at 22.10% and Samancor at 20.06%, with South African producers collectively accounting for a substantial portion of world production).

As to customer concerns, Samancor and other downstream producers expressed apprehension that post-merger Xstrata would have the ability and incentive to manipulate char pricing, reduce supply, or discontinue supply, thereby disadvantaging rivals in downstream ferrochrome competition. The Tribunal accepted that, in a situation of supply shortage, the merged entity would likely prioritise self-supply. The Tribunal also accepted evidence that switching to imported alternatives would be costly and that there were no viable local alternatives for retort char in the short term.

On entry, the Tribunal accepted that entry into char production required access to suitable coal and capital to construct a production facility. While the parties suggested relatively modest entry costs for smaller facilities, the Commission’s investigation described higher costs for substantial greenfield capacity and identified additional considerations such as increased environmental standards. The Tribunal accepted that entry was likely, citing indications that Samancor was seriously considering self-supply and that other market participants (including Kumba) were evaluating entry. However, the Tribunal accepted that such entry would not occur within the next year and that a period of approximately three years was a sufficient and realistic timeframe for potential entrants to enter and begin constraining supply concerns.

The Tribunal found it material that African Carbon’s customers generally had supply contracts in place at least until the end of 2005 and that these contracts were described as evergreen in nature, continuing indefinitely until terminated on notice. The Tribunal regarded the protection of supply continuity during the expected entry period as central to the appropriate remedy.

3. Legal Issues

The central legal questions were whether the merger was likely to result in a substantial lessening or prevention of competition through the creation or strengthening of market power in the upstream supply of char combined with downstream ferrochrome production, and in particular whether it would enable input foreclosure or raising rivals’ costs in downstream markets.

The dispute required determinations that combined questions of fact (such as substitutability and technical suitability of different char products, the structure of supply, and expected entry timing) with the application of competition-law principles to those facts (notably the assessment of vertical foreclosure risk and whether potential entry would sufficiently constrain post-merger conduct). The Tribunal’s decision also involved an element of evaluative judgment in calibrating an appropriate set of conditions to address short-term competitive risks while taking account of anticipated entry.

A further issue was remedial and institutional: whether the conditions proposed by the Commission (focused on a particular customer contract) or by Samancor (focused on Samancor’s contractual position) were adequate, and whether any conditions should instead be framed to protect all similarly situated customers who competed with Xstrata downstream.

4. Court’s Reasoning

The Tribunal’s reasoning proceeded from the characterisation of char as an input in ferrochrome production and the evaluation of the merger’s horizontal and vertical effects. While the Tribunal noted overlaps in by-product markets, it found those overlaps immaterial due to small volumes and insignificant market shares, and it confined competitive concern to the char production market and its relationship to downstream ferrochrome production.

On market definition and competitive significance, the Tribunal accepted the Commission’s approach in treating “char” and “gas coke” as functionally equivalent for purposes of the decision. It then assessed substitutability and concluded that, in the relevant local context, char could not be treated as readily substitutable with other carbon sources, nor could Rand Carbide’s chain-grate char be treated as an adequate substitute for African Carbon’s retort char. On this basis the Tribunal accepted that char was an essential input for downstream ferrochrome production in South Africa and that, critically, African Carbon was the only source of such char available to downstream rivals of Xstrata.

The Tribunal attached weight to the post-merger structure of the upstream market. On the figures before it, African Carbon accounted for the overwhelming majority of national char production and Chartech accounted for a further material share, but Chartech’s output was wholly consumed internally by Xstrata. The Tribunal considered that post-merger Xstrata would therefore control supply in circumstances where rivals had no comparable alternative domestic source, creating a credible ability to engage in foreclosure or to raise rivals’ costs. The Tribunal accepted that the likelihood of foreclosure was “great” given the effective monopoly position in an essential input combined with Xstrata’s downstream presence and strength.

In addressing the argument advanced by the merging parties that char represented only a small percentage of total ferrochrome production costs and that substitution to other carbon sources was possible, the Tribunal contrasted these submissions with evidence from downstream customers and the merger record indicating that char supply continuity and pricing were regarded as significant and that suitable local alternatives were not realistically available. The Tribunal treated the concern as one of strategic control over a key input in a market where South Africa was a major global source of ferrochrome production, and thus where disruptions or cost increases could have material competitive effects.

The Tribunal then evaluated entry as the main countervailing factor potentially justifying approval rather than prohibition. It considered evidence relating to access to coal, construction of production facilities, capital costs, environmental compliance requirements, and industry interest in building new capacity. Drawing on the framework described in the reasons (including reference to the need for entry to be timely, likely and sufficient), the Tribunal found itself persuaded that entry into char production was likely, supported by indications from Samancor and other potential entrants, and by the existence of a substantial customer base seeking alternative supply.

However, the Tribunal was not satisfied that entry would be sufficiently timely to address short-term foreclosure risks. It accepted that entry would not occur within the following year and adopted a three-year horizon as a reasonable period within which entry could occur and begin constraining market power. This assessment shaped the Tribunal’s remedial approach: the approval was conditioned on measures to secure supply during the interim period so that downstream rivals could continue to access char while entry materialised or alternative arrangements were developed.

On remedies, the Tribunal examined the Commission’s proposed condition (protecting only the Hernic supply agreement by restricting termination until 31 March 2007) and considered it underinclusive because it had no basis for protecting only one customer. It also considered Samancor’s requested protections as insufficiently general because they would protect Samancor only. Given that multiple competitors had raised supply concerns, the Tribunal adopted the principle that any conditions should apply to all African Carbon customers who were competitors of Xstrata, rather than selectively protecting a single firm. The Tribunal thus required conditions that preserved compliance with the Samancor supply agreement for its stipulated duration and preserved other existing char and/or gas coke supply agreements with other ferrochrome producers for a period aligned with the expected entry timeframe, namely three years from approval. It also ensured that the conditions would bind the merged entity as a whole, including in the event of intra-group transfers or assignment of contractual rights and obligations.

The Tribunal finally recorded that no public interest concerns had been raised in relation to the merger.

5. Outcome and Relief

The Competition Tribunal approved the merger subject to conditions in terms of section 16(2)(b) of the Competition Act 89 of 1998, as reflected in the order dated 20 December 2004.

The substantive relief took the form of behavioural conditions requiring the African Carbon contracting entities to comply with the Samancor supply agreement dated 26 November 2004 for its contract period, and to comply with existing char and/or gas coke supply agreements with any ferrochrome producer other than Samancor for a period of three years from the date of merger approval. The order further provided that if the business of the contracting parties (or their rights and obligations) were transferred within the acquiring firm group, the transferee acquiring firm would remain bound by the conditions as if it were the relevant contracting party.

The Tribunal ordered that a Merger Clearance Certificate be issued in terms of Competition Tribunal rule 35(5)(a). The reasons did not record any separate order as to costs.

Cases Cited

FTC v. Cardinal Health, Inc., 12 F. Supp.2d 34 (D.D.C. 1998).

Legislation Cited

Competition Act 89 of 1998, including section 14A(b) and section 16(2)(b).

Rules of Court Cited

Competition Tribunal rule 35(5)(a).

Held

The Tribunal held that the merger created a significant risk of input foreclosure because char was treated as an essential input for South African ferrochrome producers and, post-merger, Xstrata would control the only meaningful non-vertically integrated source of suitable retort char available to its downstream rivals. Although the Tribunal was persuaded that entry into char production was likely, it accepted that such entry would not be timely in the short term and that foreclosure concerns were credible during the interim.

The merger was therefore approved only on conditions designed to secure continuity of supply for a limited period aligned with the expected timeframe for entry. The conditions required compliance with Samancor’s newly concluded supply agreement for its duration and compliance with other existing supply agreements with other ferrochrome producers for three years from approval, with the obligations binding on the merged group notwithstanding intra-group transfers or assignments.

LEGAL PRINCIPLES

The Tribunal applied the principle that a merger involving a vertically integrated firm may raise competition concerns where it confers control over an essential upstream input that downstream rivals cannot practicably substitute or source elsewhere, creating the ability and incentive to foreclose rivals or raise their costs.

In assessing whether such concerns may be mitigated, the Tribunal treated ease of entry as a significant constraint on market power, but required that entry be sufficiently likely and timely (and of a nature that would constrain competitive harm within a meaningful period). Where entry was likely but not imminent, the Tribunal regarded time-limited behavioural conditions securing interim supply as an appropriate mechanism to address short-term foreclosure risks.

The Tribunal further applied a remedial principle of non-discriminatory protection among similarly situated customers where the competitive concern related to foreclosure risk affecting multiple downstream rivals. It rejected customer-specific conditions that lacked a principled basis for selective protection and instead required conditions that applied across the set of affected customers competing with the merged entity downstream.

Xstrata South Africa (Pty) Ltd and Egalite (Pty) Ltd / International Carbon Holdings (Proprietary) Limited (54/LM/Jul04) [2004] ZACT 77 (20 December 2004)