On 17 June 2015, the Competition Appeal Court of South Africa (CAC) overturned the Competition Tribunal’s decision which found Sasol Chemical Industries Limited (Sasol) guilty of excessive pricing.

The CAC’s judgment is thorough and the factual, legal, accounting and economic issues covered are complicated. Although redeeming for Sasol, the judgment may give rise to a number of significant implications for future enforcement action against excessive pricing South Africa.

We set out below a review of the questions raised in the decision as well as the potential implications of the CAC’s answers.

The feedstock debate – Actual costs or notional costs?1

The first and potentially most important question addressed by the CAC related to what the CAC referred to as the ‘feedstock debate’. According to the Competition Act2 , a price charged by a dominant firm is excessive and illegal if it has no reasonable relation to the economic value of the product in question.

In conditions of competition, prices will normally be driven down towards a firm’s costs of production (plus a reasonable return). A firm’s costs (including a reasonable return) therefore usually provide an insightful proxy for the price that would prevail under conditions of competition, and therefore a product’s ‘economic value’.

In the only previous excessive pricing case in South Africa, the Mittal case, the CAC held:

economic value is a notional objective market standard, not one derived from circumstances peculiar to the particular firm… The criterion of economic value…recognizes only the costs that would be recovered in long run competitive equilibrium3.

Sasol has a peculiar cost advantage because it procures its feedstock propylene from its sister company – Sasol Synfuels – at a low internal transfer price. Feedstock propylene is a critical input in the production of purified propylene, which is then converted into polypropylene.

One of the key questions in the Sasol case was how these statements from the CAC’s earlier judgment should be interpreted. Should Sasol’s actual costs, including its special feedstock propylene cost advantage be used to approximate the economic value of propylene and polypropylene? Or, for purposes of determining economic value, should Sasol’s costs be adjusted upwards to reflect the costs of production that would be incurred by a notional producer that did not enjoy the special cost advantage, and that may enter the market under notional conditions of competition? Alternatively, should Sasol’s costs be adjusted downwards, as the Commission argued, because Sasol’s internal transfer price for feedstock propylene was higher than would have prevailed in conditions of competition against equally efficient entrants?

The CAC decided that when using costs as a proxy for economic value, the firm’s actual economic costs (production costs plus a reasonable return) constitute the relevant benchmark.4

This conclusion does not fit comfortably with the preceding 57 pages of the judgment, which all seem to favour adjusting the dominant firm’s costs upwards as contended by Sasol. This conclusion is also difficult to reconcile with the passage quoted above from paragraph 43 of the Mittal judgment.

The reasons offered by the CAC for its decision on this point are not entirely clear. The court says that because Sasol’s internal transfer price complies with applicable transfer pricing rules, ‘a measure of deference is called for in these enquiries not only because of the importance of freedom of pricing but also to obviate converting courts into price regulations’5. This reasoning explains how a value should be attributed to an input cost in the case of a vertically integrated firm accused of excessive pricing, but it does not explain why actual costs should be used instead of notional costs under assumed conditions of competition.

Following this finding, Sasol was able to overturn the conclusion that its prices are excessive by persuading the CAC to adjust the Tribunal’s calculations of Sasol’s actual costs. This required an in depth analysis by the CAC of the parties’ expert evidence on the appropriateness of various accounting practices in the circumstances. The precise details of these conclusions are not repeated here. Suffice to say the CAC found the Commission’s expert evidence on these issues to be unsatisfying.

What was Sasol’s price-cost mark-up, and was it excessive?1

Based on the revised costing methodology applied by the CAC, Sasol’s average mark-up above economic costs (including a reasonable return) for propylene was between 12% and 14%. This is significantly different from the Tribunal’s findings, which were that mark-ups for propylene were between 25% and 51%.

In evaluating whether Sasol’s prices exceeded economic value by an unreasonable amount, the CAC ruled that returns above economic value are not per se unreasonable. Further, a price which is significantly less than 20% above the figure employed to determine economic value falls short of justifying judicial interference in this complex area.

This may lead to dominant firms using a 20% margin over economic costs as a rule of thumb against which to determine whether their prices are excessive.

The CAC also differed from the Tribunal on an important question – ruling that it is not relevant whether the dominant firm obtained its market position and special cost advantage by innovation, risk-taking or otherwise, as was the finding of the Tribunal.

On the CAC’s revised methodology, the price-cost mark-ups for polypropylene produced negative figures. The CAC therefore held:

Manifestly, on these calculations the changes to the [polypropylene] price-cost mark up should not vex any court with respect to an excessive pricing dispute.6

Based on these findings, the CAC upheld Sasol’s appeal in relation to pricing of both propylene and polypropylene. In doing so, the court was critical of the evidence provided by the Commission on the issues of appropriate cost calculation.

Overall policy implications

The case is a major victory for Sasol, and a significant defeat for the Commission.

As the first excessive pricing case to be fully litigated by the Commission, it will likely have emphasized the extreme complexity of these cases, the amount of time and resources they entail and how difficult it is to secure a favourable result.

It is possible, therefore, that the Commission’s appetite to pursue further excessive pricing complaints may be lessened. On the other hand, the critical issue of the feedstock debate appears to have been resolved predominantly in the Commission’s favour. The Commission may feel that with this advantage and by obtaining improved expert evidence, it may have reasonable prospects of succeeding if other cases were to arise.

The CAC was alive to the potential criticism that ‘excessive pricing cases can never succeed before South African courts’. To counter this possibility it expressly stated that this conclusion would be ‘completely unjustified’. It went on to emphasise the importance of expert evidence required in these cases.

The Commission has recently filed a notice of application for leave to appeal the CAC’s judgment to the Constitutional Court. The Commission’s reason for concern included that the CAC’s judgment will constrain competition enforcement against dominant firms. At the time of writing, the Constitutional Court has yet to rule on the application for leave to appeal.