Shell Oil Company and Pennzoil-Quaker State Company; Analysis To Aid Public Comment

FEDERAL TRADE COMMISSION

[File No. 021 0123]

Shell Oil Company and Pennzoil-Quaker State Company; Analysis To

Aid Public Comment

AGENCY: Federal Trade Commission.

ACTION: Proposed consent agreement.

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SUMMARY: The consent agreement in this matter settles alleged

violations of federal law prohibiting unfair or deceptive acts or

practices or unfair methods of competition. The attached Analysis to

Aid Public Comment describes both the allegations in the draft

complaint that accompanies the consent agreement and the terms of the

consent order--embodied in the consent agreement--that would settle

these allegations.

DATES: Comments must be received on or before October 28, 2002.

ADDRESSES: Comments filed in paper form should be directed to: FTC/

Office of the Secretary, Room 159-H, 600 Pennsylvania Avenue, NW.,

Washington, DC 20580. Comments filed in electronic form should be

directed to: [email protected], as prescribed below.

FOR FURTHER INFORMATION CONTACT: Dennis Johnson, FTC, Bureau of

Competition, 600 Pennsylvania Avenue, NW., Washington, DC 20580, (202)

326-2712.

SUPPLEMENTARY INFORMATION: Pursuant to section 6(f) of the Federal

Trade Commission Act, 38 Stat. 721, 15 U.S.C. 46(f), and section 2.34

of the Commission's Rules of Practice, 16 CFR 2.34, notice is hereby

given that the above-captioned consent agreement containing a consent

order to cease and desist, having been filed with and accepted, subject

to final approval, by the Commission, has been placed on the public

record for a period of thirty (30) days. The following Analysis to Aid

Public Comment describes the terms of the consent agreement, and the

allegations in the complaint. An electronic copy of the full text of

the consent agreement package can be obtained from the FTC Home Page

(for September 27, 2002), on the World Wide Web, at ``http://

www.ftc.gov/os/2002/09/index.htm.'' A copy can be obtained from the FTC

Public Reference Room, Room 130-H, 600 Pennsylvania Avenue, NW.,

Washington, DC 20580, either in person or by calling (202) 326-2222.

Public comments are invited, and may be filed with the Commission

in either paper or electronic form. Comments filed in paper form should

be directed to: FTC/Office of the Secretary, Room 159-H, 600

Pennsylvania Avenue, NW., DC 20580. If a comment contains nonpublic

information, it must be filed in paper form, and the first page of the

document must be clearly labeled ``confidential.'' Comments that do not

contain any nonpublic information may instead be filed in electronic

form (in ASCII format, WordPerfect, or Microsoft Word) as part of or as

an attachment to email messages directed to the following email box:

[email protected]. Such comments will be considered by the

Commission and will be available for inspection and copying at its

principal office in accordance with Section 4.9(b)(6)(ii) of the

Commission's Rules of Practice, 16 CFR 4.9(b)(6)(ii)).

Analysis of Proposed Consent Order To Aid Public Comment

I. Introduction

The Federal Trade Commission (``Commission'' or ``FTC'') has issued

a complaint (``Complaint'') alleging that the proposed merger of Shell

Oil Company (``Shell'') and Pennzoil-Quaker State Company

(``Pennzoil'') (collectively ``Respondents'') would violate section 7

of the Clayton Act, as amended, 15 U.S.C. 18, and section 5 of the

Federal Trade Commission Act, as amended, 15 U.S.C. 45, and has entered

into an agreement containing consent orders (``Agreement Containing

Consent Orders'') pursuant to which Respondents agree to be bound by a

proposed consent order that requires divestiture of certain assets

(``Proposed Consent Order'') and a hold separate order that requires

Respondents to hold separate and maintain certain assets pending

divestiture (``Hold Separate Order''). The Proposed Consent Order

remedies the likely anticompetitive effects arising from Respondents'

proposed merger, as alleged in the Complaint, and the Hold Separate

Order preserves competition pending divestiture.

II. Description of the Parties and the Transaction

Shell Oil Company, headquartered in Houston, Texas, is the United

States operating entity for the Royal Dutch/Shell Group of Companies

(collectively referred to as ``Shell''). Shell is engaged in virtually

all aspects of the energy business, including exploration, production,

refining, transportation, distribution, and marketing. As part of the

relief ordered by the Commission in Chevron/Texaco, Docket C-4923 (Jan.

2, 2002), Texaco divested its interest in Equilon Enterprises LLC to

Shell and its interest in Motiva Enterprises LLC to Shell and Saudi

Refining Company. Equilon and Motiva are engaged in the production,

distribution and marketing of refined products, including base oil,

gasoline, diesel fuel, and other products. During fiscal year 2001,

Shell had worldwide revenues of approximately $135.2 billion and net

income of approximately $10.9 billion.

Pennzoil, headquartered in Houston, Texas, is engaged in the

business of manufacturing and marketing lubricants, car care products,

base oils, branded and unbranded motor oils, transmission fluids, gear

lubricants, greases, automotive polishes, automotive chemicals, other

automotive products, and specialty industrial products. Pennzoil

manufactures and markets conventional and synthetic motor oils

primarily under the Pennzoil and Quaker State brands. Pennzoil is also

engaged in the franchising, ownership and operation of quick lube oil

change centers under the Jiffy Lube name. During fiscal year 2001,

Pennzoil had worldwide revenues of approximately $2.3 billion.

Pennzoil has a 50/50 joint venture with Conoco Inc. called Excel

Paralubes that operates a base oil refinery located in Westlake,

Louisiana, adjacent to Conoco's petroleum products refinery at Lake

Charles, Louisiana. Pennzoil obtains a substantial portion of its base

oil requirements from its interest in Excel Paralubes. Pennzoil also

has a 10-year base oil supply agreement with Exxon Mobil Corporation,

which became effective August 1, 2000, as a result of the Commission's

order in Exxon/Mobil, Docket C-3907 (Jan. 26, 2001). Pursuant to that

agreement, Pennzoil is entitled to obtain up to 6,500 barrels per day

of base oil from ExxonMobil, in grades and quantities that are

proportionate to ExxonMobil's Gulf Coast base oil production. Part of

this volume consists of Group II paraffinic base oil, which is the

relevant market alleged in the Complaint.

Pursuant to an agreement and plan of merger dated March 25, 2002,

Shell intends to acquire all of the outstanding voting securities of

Pennzoil. The transaction is structured such that Shell ND, a wholly-

owned subsidiary of Shell, will acquire the Pennzoil shares and then be

merged into Pennzoil, with Pennzoil surviving as a wholly-owned

subsidiary of Shell. Each outstanding common share of Pennzoil will be

converted into the right to receive $22 in cash.

III. The Complaint

The Complaint alleges that the merger of Shell and Pennzoil would

violate section 7 of the Clayton Act, as amended, 15 U.S.C. 18, and

section 5 of the Federal Trade Commission Act, as amended, 15 U.S.C 45,

by substantially lessening competition in the refining and marketing of

Group II paraffinic base oil in the United States and Canada. To remedy

the alleged anticompetitive effects of the merger, the Proposed Order

requires

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Respondents to divest Pennzoil's 50% interest in Excel Paralubes, which

represents Pennzoil's only base oil ownership position. Respondents

also have agreed to freeze at approximately current levels Pennzoil's

right to obtain Group II base oil supply under the contract with Exxon

Mobil that was obtained as part of the relief in the Exxon/Mobil merger

proceeding.

Shell and Pennzoil are competitors in the refining and marketing of

Group II paraffinic base oil in a geographic market that consists of

the United States and Canada. The refining and marketing of Group II

paraffinic base oil in this market would be highly concentrated as a

result of the merger. Following the proposed merger, Shell would

control at least 39% of Group II refining capacity in the United States

and Canada. Overall market concentration, as measured by the

Herfindahl-Hirschmann Index (HHI), would increase by more than 700

points to a level in excess of 2,300.

The refining and marketing of Group II paraffinic base oil is a

relevant line of commerce (i.e., product market). Paraffinic base oil

is a refined petroleum product that is the principal component, or

``basestock,'' of finished lubricants used for a variety of

applications, including passenger car motor oil, heavy duty engine oil,

automatic transmission fluid, and other lubricant products. In the

Exxon/Mobil investigation, the Commission concluded that paraffinic

base oil constitutes a relevant market.

Developments in the industry since the Exxon/Mobil merger indicate

that a market consisting of Group II paraffinic base oils has evolved.

The American Petroleum Institute divides paraffinic base oil into three

groups (Groups I, II and III) based on differences in sulfur content,

saturates level, and viscosity index. Group II paraffinic base oil has

less than 0.03% sulfur by weight, more than 90% saturates by weight,

and a viscosity index ranging from 80 to 120. Group II base oil is

needed in order to meet current performance standards for lighter-

viscosity motor oil formulations (such as 5W-20 and 5W-30), as well as

requirements for other lubricants. As new performance standards are

adopted, there will be even greater demand for Group II base oil for

the production of motor oil and other lubricants. If the price of Group

II base oil were to increase by 5-10%, blenders of motor oil and other

lubricants would not substitute to other bases stocks in sufficient

quantities to prevent the increase.

The Complaint alleges that the proposed transaction would lessen

competition in a geographic market consisting of the United States and

Canada. There is little Group II production outside of the Untied

States and Canada. Further, imports of Group II base oil would be

subject to significant freight penalties and would not be competitive

with production in the United States and Canada. If the price of Group

II base oil in the United States and Canada were to increase by 5-10%,

blenders of motor oil and other lubricants would not switch to sources

of supply outside the Untied States and Canada in sufficient quantities

to prevent the increase.

There are few significant producers of Group II base oil in the

Untied States and Canada. The proposed merger would eliminate Pennzoil

as a major competitor, and would combine Shell, the market leader, into

a close partnership with Conoco, another leading producer. As a result

of the proposed merger, Shell would control at least 39% of Group II

refining capacity in the United States and Canada, and concentration in

the relevant market as measured by the Herfindahl-Hirschmann Index

would increase by more than 700 points to a level in excess of 2,300.

Entry into the relevant market is difficult and would not be

timely, likely or sufficient to prevent the anticompetitive effects

that are likely to result from the proposed merger. Constructing a new

refinery or converting an existing Group I refinery to make Group II

base oil would require substantial investment, would be subject to

significant regulatory obstacles, and would take several years to

accomplish. As a result, new entry would not be able to prevent a 5-10%

increase in Group II base oil prices.

The Complaint charges that the proposed merger, absent relief, is

likely to substantially lessen competition and lead to higher prices of

Group II paraffinic base oil, by eliminating direct competition between

Shell and Pennzoil, by increasing the likelihood that the combined

Shell/Pennzoil will unilaterally exercise market power, and by

increasing the likelihood of collusion or coordinated interaction among

competitors in the refining and marketing of Group II paraffinic base

oil.

To remedy the likely competitive harm, the Proposed Order requires

Respondents to Divest Pennzoil's interest in Excel paralubes and to

freeze Pennzoil's ability to obtain additional Group II supply under

the agreement with ExxonMobil. This relief will effectively remedy any

anticompetitive effects that would be expected to arise from this

transaction.

IV. Resolution of the Competitive Concerns

The Commission has provisionally entered into an Agreement

Containing Consent Orders with Shell and Pennzoil in the settlement of

the Complaint. The Agreement Containing Consent Orders contemplates

that the Commission would issue the Complaint and enter the Proposed

Order and the Hold Separate Order for the divestiture of certain assets

described below.

In order to remedy the anticompetitive effects that have been

identified, Respondents have agreed to divest Pennzoil's 50% interest

in Excel Paralubes, and to freeze Pennzoil's right to obtain additional

Group II supply under the contract with ExxonMobil at approximately

current levels. If the required divestiture has not been accomplished

within the required time, then Respondents are required to transfer

Pennzoil's interest in Excel paralubes to a trustee, who will have the

responsibility of accomplishing the required divestiture.

Paragraph II.A. of the Proposed Order requires Respondents to

divest Pennzoil's interest in Excel Paralubes, at no minimum price,

within twelve months after executing the Order, to an acquirer that

receives the prior approval of the Commission.

Paragraph II.B. requires Respondents to negotiate with the

acquirer, at the acquirer's option, a supply agreement for Respondents

to purchase Group II base oil. Such agreement may not exceed one year,

may not contain renewal or evergreen rights, and is subject to prior

approval by the Commission. Paragraph II.C. provides that, prior to the

effective date of divestiture, Respondents may not enter into any

agreement to purchase Group II base oil from the acquirer other than

one made pursuant to Paragraph II.B.

Paragraph II.D. of the Proposed Order explicitly provides that

Respondents may not divest the Pennzoil Excel Paralubes Interest to

Conoco, and must enforce a letter agreement with Conoco relating to

Excel Paralubes. Conoco already has a significant share of the Group II

market, and the addition of Pennzoil's share of Excel Paralubes would

result in a significant increase in concentration. In addition, under

the Joint Venture Agreement forming the Excel Paralubes partnership,

Conoco may, under certain circumstances, have a right of first refusal

or a first option to purchase Pennzoil's interest in Excel Paralubes.

Conoco has centered into an agreement with Respondents dealing with its

waiver of such rights, and consenting to the assignment of a

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supply agreement pursuant to which Pennzoil purchases base oil from

Excel Paralubes.

Paragraph III limits Respondents' use of their rights to purchase

Group II base oil from ExxonMobil under the ExxonMobil/Pennzoil Base

Oil Agreement. That agreement allows Pennzoil to obtain base oil from

ExxonMobil in the proportionate types and amounts corresponding to

production at designated ExxonMobil refineries. Pennzoil currently is

taking approximately 1,500 barrels per day of Group II under this

contract. Any significant increase in that amount could unduly increase

concentration. Accordingly, Paragraph III prevents Respondents from

increasing their share of the market for Group II Base Oil through

additional supply under this agreement.

If Respondents have not accomplished the divestiture within the

required time period, Paragraph IV provides that the Commission may

appoint a trustee to divest the Pennzoil Excel Paralubes Interest, at

no minimum price, to a buyer approved by the Commission. The trustees

will have the exclusive power and authority to accomplish the

divestiture within twelve months, subject to any necessary extensions

by the Commission. Paragraph IV.C.5 requires that the trustee will have

access to information related to Atlas and Excel Paralubes as necessary

to fulfill his or her obligations. (Atlas is the wholly-owned

subsidiary of Pennzoil that holds Pennzoil's interest in the Excel

Paralubes partnership.) The trustee shall use his or her best efforts

to negotiate the most favorable price and terms for the divestiture,

subject to the Respondents' absolute and unconditional obligation to

divest expeditiously at no minimum price. If the trustee receives more

than one bona fide offer from entities approved by the Commission, the

trustee will divest to the party selected by the Respondents.

Other provisions of Paragraph IV.C. generally provide that

Respondents are responsible for management expenses incurred by the

trustee, that the trustee has authority to employ other persons

necessary to carry out his or her duties and responsibilities, and that

Respondents indemnify and hold the trustee harmless against any

liabilities or expenses arising out of, or in connection with,

performance of the trustee's duties. Respondents may require the

trustee to sign a customary confidentiality agreement, provided that

such agreement may not restrict the trustee from providing any

information to the Commission.

Paragraphs V-VIII of the Proposed Order contain certain general

provisions. Pursuant to Paragraph V, Respondents are required to

provide the Commission with a report of compliance with the Proposed

Order every thirty days until the divestiture is completed and annually

for nine years after the first year the Order becomes final. Paragraph

VI provides for notification to the Commission in the event of any

corporate changes in the Respondents. Paragraph VII requires that

Respondents provide the Commission with access to their facilities and

employees for the purposes of determining or securing compliance with

the Proposed Order. Finally, Paragraph VIII terminates the Order ten

years from the date it becomes final.

V. Opportunity for Public Comment

The Proposed Order has been placed on the public record for thirty

(30) days for receipt of comments by interested persons. The

Commission, pursuant to a change in its Rules of Practice, has also

issued its Complaint in this matter, as well as the Hold Separate

Order. Comments received during this thirty day comment period will

become part of the public record. After thirty (30) days, the

Commission will again review the Proposed Order and the comments

received and will decide whether it should withdraw from the Proposed

Order or make final the agreement's Proposed Order.

By accepting the Proposed Order subject to final approval, the

Commission anticipates that the competitive problems alleged in the

Complaint will be resolved. The purpose of this analysis is to invite

public comment on the Proposed Order, including the proposed

divestiture, and to aid the Commission in its determination of whether

it should make final the Proposed Order contained in the agreement.

This analysis is not intended to constitute an official interpretation

of the Proposed Order, nor is it intended to modify the terms of the

Proposed Order in any way.

By direction of the Commission.

Donald S. Clark,

Secretary.

[FR Doc. 02-25756 Filed 10-9-02; 8:45 am]

BILLING CODE 6750-01-M