Documentation

CT-01/ OOff THE COMPETITION TRIBUNAL IN THE MATTER OF an application by the Commissioner of Competition for a Consent Order pursuant to sections 79 and 105 of the Competition Act, R.S.C. 1985, c. C-34 as amended;

AND IN THE MATTER OF certain practices of anti-competitive acts by Enbridge Services Inc. ("ESI") within certain markets in the province of Ontario;

AND IN THE MATTER OF an abuse of dominant p~·w.·. u..u.1.1.-________ the supply of conventional or power vented natural ga fuelle!ct~~>J~:·n;1001 Y"?''.~?·~,~:l water heaters not used for commercial purposes ("Wate~,:,t c:: L~ c::ic.,:.,;::.::·.:cE P

heaters") and related services within certain marke ~ in the R · province of Ontario. I t DEC 18 2001 g r I l. """ .. ""· .. ,,,.,.s:.<.11RE Y BETWEEN: OHA'iiA, viH. -----l#/~_!_ THE COMMISSIONER OF COMPETITION Applicant

-AND-ENBRIDGE SERVICES INC. Respondent

STATEMENT OF GROUNDS AND MATERIAL FACTS

CT-01/ THE COMPETITION TRIBUNAL IN THE MATTER OF an application by the Commissioner of Competition for a Consent Order pursuant to sections 79 and 105 of the Competition Act, R.S.C. 1985, c. C-34 as amended;

AND IN THE MATTER OF certain practices of anti-competitive acts by Enbridge Services Inc. (“ESI”) within certain markets in the province of Ontario;

AND IN THE MATTER OF an abuse of dominant position in the supply of conventional or power vented natural gas fuelled water heaters not used for commercial purposes (“water heaters”) and related services within certain markets in the province of Ontario.

B E T W E E N: THE COMMISSIONER OF COMPETITION Applicant

- AND -ENBRIDGE SERVICES INC. Respondent

STATEMENT OF GROUNDS AND MATERIAL FACTS

I INTRODUCTION 1. The Commissioner of Competition (the “Commissioner”) brings this application for a Consent Order on the grounds that certain practices of Enbridge Services Inc. (“ESI”) have prevented or lessened competition substantially in the natural gas fuelled water heater markets within the franchise territory of The Consumers’ Gas Company Ltd. operating as Enbridge Consumers’ Gas (“ECG”) in the province of Ontario.

2. The Commissioner, with the consent of ESI (the “Respondent”), respectfully submits for approval a Draft Consent Order (“DCO”) that, if implemented, will eliminate the substantial prevention or lessening of competition within the relevant markets in the province of Ontario.

3. The Commissioner alleges certain material facts and makes certain submissions in this Statement of Grounds and Material Facts (the “Statement”). The Respondent does not contest the facts or submissions herein for the purpose of this application, but nothing in this application shall be taken as an admission now or in the future by the Respondent of any such facts or submissions.

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II THE PARTIES 4. The Applicant is the Commissioner appointed pursuant to section 7 of the Competition Act and is the sole person authorized to make this application to the Competition Tribunal (the “Tribunal”).

5. The Respondent is ESI, an indirect, wholly-owned subsidiary of Enbridge Inc. with its head office in Markham, Ontario. ESI was incorporated in Ontario on November 1, 1996. ESI provides a variety of retail products and services in the energy field. In particular, ESI supplies natural gas appliances, such as water heaters and related services.

6. The involvement of two other companies, ECG and Enbridge Commercial Services Inc. (“ECS”) with the ESI water heater rental program, was also considered in the Inquiry (see paragraph 10 below). After a review by the Bureau, these companies have been excluded as Respondents due to their current roles and responsibilities in regards to the ESI water heater rental program.

7. ECG is the regulated natural gas distribution company for its franchise territory covering much of Ontario. It is an exclusive distributor which is regulated by the Ontario Energy Board (“OEB”). ECG is an indirect, wholly-owned subsidiary of Enbridge Inc. ESI has advised the Bureau that ECG has no ownership, -3-

management or operating role regarding the ESI water heater rental business. Certain undertakings which have been given to the OEB by ECG on the type of business that it can directly operate may prohibit its involvement in this business. ESI’s ability to comply with the terms of the DCO is not prevented by any ECG operations or activities. Any remaining services or facilities still shared by ESI and ECG fall outside the issues covered by the DCO and the services fall under the OEB conditions governing the relationship between utilities and their affiliates.

8. ECS is an unregulated affiliate of ECG and a direct wholly-owned subsidiary of Enbridge Inc. ECS provides call centre and billing services to ESI and ECG. The Bureau was advised in writing that ESI has retained full authority over its business. This control includes areas such as the content of communications provided by ECS call centre personnel. ECS furnishes ESI with other services such as support relating to IT systems and its fleet. These services or the underlying agreements between the two companies do not involve management or control of the above business of ESI.

9. The above facts have been confirmed in a statement under oath by the vice-president of the operating division of Enbridge Inc. which includes ESI, ECS, and ECG. In particular, he has confirmed the business roles and relationships of ECS and ECG in relation to the ESI water heater rental business.

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III THE COMMISSIONER’S INQUIRY 10. On May 9, 2001, the Commissioner, pursuant to subparagraph 10(1)(b)(ii) of the Competition Act, initiated an Inquiry into the activities of ESI in relation to the rental, sale, and servicing of conventional and power vented natural gas water heaters not used for commercial purposes (“water heaters”) within certain geographic markets in the province of Ontario. The investigation leading to initiation of the Inquiry commenced in February 2000 in response to concerns expressed to the Competition Bureau (the “Bureau”) by competitors of ESI regarding the implementation by ESI of rental water heater exit and pick-up charges in January 2000 applying to ESI’s existing rental water heater customer base and new customers.

11. In initiating the Inquiry and making this DCO application, the Commissioner has relied on information provided voluntarily by ESI and on information obtained by the Bureau from the complainants, from other industry participants and from independent sources. In addition, the Commissioner obtained information and analysis from an external industry expert and an external economic expert.

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12. Discussions between the Commissioner and the Respondent to resolve this matter began on June 19, 2001. After a series of negotiations, concluded during the month of November 2001, the Commissioner and the Respondent agreed to an Agreement in Principle including the terms of the DCO to address the Commissioner’s concerns.

IV DESCRIPTION OF THE INDUSTRY 13. The industry under consideration in this application consists of the supply of water heaters and related services to households in certain geographic markets in the province of Ontario. These markets include close to 1.4 million installed residential water heaters. During year 2000, there were 128,000 new water heater installations in these markets representing an annual market for installations in excess of $90 million dollars. For the period of January to September 30, 2001, it is estimated that 91,100 new water heaters were installed representing an estimated market of about $64 million dollars.

14. The water heaters under consideration are directly fueled by natural gas and typically have a capacity in the range of 40 to 75 gallons. They come in two basic configurations, conventionally vented and power vented. Both are constructed as self-contained units requiring no external fitting prior to operation, other than the connections for venting, gas, and water. They include a coated and insulated inner

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steel cylinder of 16 to 20 inches in diameter to contain water and are covered by a venter assembly.

15. Conventional water heaters are usually vented by means of a single walled vent to an existing masonry chimney. Power vented water heaters are vented with a plastic vent which is exhausted through the basement foundation to the outside using an electric fan. Conventional water heaters represent the majority of all installed water heaters, approximately 70% of ESI’s installed base. They are prevalent in older homes having existing chimneys. Power vented water heaters are more prevalent in newer homes constructed with gas heating as they allow builders to avoid the expense of constructing a chimney.

16. The average useable life of water heaters is approximately 15 years for most households. However, it tends to be shorter in areas with hard water. These are generally areas outside of major urban centres that rely on well water. In these areas, calcium deposits can build up within a household water heater significantly shortening its lifespan.

17. The water heaters are installed on-site in households and are directly connected to incoming natural gas lines. In order to install and disconnect water heaters in Ontario, contractors must be certified by the Ontario Ministry of Consumer and Commercial Relations under the Technical Standards and Safety Act, 2000.

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18. The supply of water heaters and related services to Ontario households is carried out through a variety of arrangements. They include: rental programs combining the supply of a water heater and 24 hour servicing; lease-to-own arrangements; the sale of installed water heaters; the supply of extended warranties; and the separate purchase of services and water heaters.

19. The price of water heaters varies depending upon their type and capacity. As an example, the after tax prices of installed ESI conventional 40 and 60 gallon water heaters are, respectively, $549.98 dollars and $605.62 dollars. For comparison, an ESI 50 gallon vented water heater has an installed price of $953.37 dollars. The above prices include an installation charge of $150.00 dollars.

20. Water heaters are produced by a number of third party manufacturers. There are two that manufacture in Ontario: GSW Water Heating Company in Fergus, Ontario and Rheem Canada Ltd. in Hamilton, Ontario. However, neither company is involved directly in the supply and servicing of water heaters for individual households.

21. Categories of participants or potential participants in the industry include the following: -8-

C affiliates of gas distribution companies including ESI and Union Energy Inc.; • multi-product retailers such as Home Depot, Sears and Canadian Tire which sell water heaters and generally offer installation through contractors;

• large independent energy product and service providers such as Sunoco Inc. and Lennox Canada Inc. which provide gas and equipment on a sale or rental basis; and

• small independent HVAC (heating ventilation air conditioning) contractors, and networks of contractors providing installation, service and sales or rentals of water heaters.

V. COMPETITIVE ANALYSIS 22. Under section 79 of the Competition Act, an abuse of a dominant market position occurs when:

(a) one or more persons substantially or completely control, throughout Canada or any area thereof, a class or species of business;

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(b) that person or persons have engaged in or are engaging in a practice of anti-competitive acts; and

(c) the practice has had, is having or is likely to have the effect of preventing or lessening competition substantially in a market.

23. The Commissioner has determined that: (a) ESI has substantial control over markets for the supply of water heaters and related services in the exclusive gas distribution franchise territory of its affiliate company, ECG;

(b) ESI has engaged in a practice of anti-competitive acts in relation to its water heater supply and servicing activities in the relevant markets; and

(c) ESI’s practice of anti-competitive acts has resulted in a substantial lessening or prevention of competition in the relevant markets.

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A. CONTROL OF A CLASS OR SPECIES OF BUSINESS 24. In previous cases, the Tribunal has defined the various terms contained in the first element of the above section. 1 “Control” has been equated to “market power” or the “ability to set prices above competitive levels for a considerable period.” “Class or species of business” has been determined to mean “product market” and “throughout Canada or any area thereof” to mean the geographic market.

25. Control of a class of business or species of business can be equated to having market power. Therefore, the first step in the analysis of control of a class or species of business is to define the relevant product and geographic markets. The second step involves determining whether the company under investigation substantially controls the relevant markets or has significant market power.

1 Canada (Director of Investigation and Research) v. NutraSweet Co. [1990], 32 C.P.R. (3d) 1 (Comp. Trib.)at 28, 32; Canada (Director of Investigation and Research) v. The D&B Companies of Canada Ltd. [1995], 64 C.P.R. (3d) 216 (Comp. Trib)at 232; Canada (Director of Investigation and Research) v. Tele-Direct (Publications) Inc. [1997], 73 C.P.R. (3d) 1 (Comp. Trib.) at 33; Canada (Director of Investigation and Research) v. Laidlaw Waste Systems Ltd.[1992], 40 C.P.R. (3d) 289 (Comp. Trib.)at 325.

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a. Relevant Market Definition (i) The Product Markets 26. The information obtained by the Bureau supports the definition of a relevant product market in the industry under consideration consisting of the supply to non-commercial customers of water heaters and related services including the installation, disconnection and repair of water heaters. Non-commercial customers are otherwise known as the residential market and consist essentially of households.

27. Water heaters for commercial purposes are not included in the product markets for the following reasons.

• Commercial customers’ water heater requirements differ greatly from those of household customers. More specifically, as compared to household customers, they can have widely varying water heating and associated equipment needs based on the nature of their businesses.

• Commercial customers, because they are often tenants, tend to move more frequently than household customers.

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• Water heaters for commercial purposes can have different performance levels and configurations than household water heaters. Specifically, water heaters for commercial purposes may have a larger output and, in some cases, use a configuration consisting of two separate units, a burner unit and storage tanks, rather than a single self-contained unit as do household water heaters.

• Contracts for water heaters for commercial purposes tend to be tailored to specific users. This practice for commercial purposes is in contrast to ESI’s rental water heater terms and conditions which are standardized for all customers obtaining similar water heaters.

28. As a consequence of these differences, commercial customers form a separate market from household customers. As an indicator of the distinction between the markets, ESI no longer offers to rent new water heaters to commercial customers.

29. In arriving at the above product market definition, consideration was also given to whether other ways of providing hot water to households should be included in the relevant product market. The closest substitute for gas water heating is electric water heating. Electric water heaters, like gas water heaters, provide hot water on demand. The cost of an electric water heater itself is comparable to, or may be significantly less than, a gas water heater of similar performance capability. However, electric water

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heaters were excluded from the relevant market because they normally involve substantially higher annual fuel costs to provide the same amount of hot water.

30. As an example, based on September 2001 gas and electricity rates, ESI estimates the average annual savings associated with natural gas versus electric water heating in Ontario to be in excess of $90 per year for a family of four. Over an anticipated life­time of a gas water heater of 15 years, and using a real discount rate of 3%, this amounts to expected energy cost savings having a net present value of more than $1,000. This saving is in excess of the after-tax prices of installed ESI 40 to 60 gallon conventional and vented water heaters which represent the vast majority of installed ESI rental water heaters. These prices are between $549.98 and $953.37 dollars.

31. A further consideration in excluding electric water heaters from the relevant market is that significant additional installation costs may be required to install them in replacement for a gas water heater. This occurs where, for example, additional electrical work is required to upgrade a household’s electrical panel to provide additional capacity for the electrical wiring required for electric water heaters.

32. Given the manner in which ESI’s rental water heater business was initially developed, as described in the following subsection, consideration was also given to restricting the relevant markets to the installed ESI rental water heater customer

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base. However, this narrower market definition is not adopted for this application as it does not materially affect the Bureau’s finding concerning the contravention of the abuse of dominance provisions of the Competition Act by ESI.

(ii) The Geographic Markets 33. Markets for the supply of water heaters and services to individual households are inherently local in nature, reflecting the travel time and costs to deliver water heaters to customers’ locations and install them on-site. The relevant geographic markets for the purposes of this application include local markets for the sale, installation and servicing of water heaters within the ECG franchise territory.

34. The local nature of the relevant markets is supported by the following considerations. Household water heaters are shipped from manufacturers to storage sites of companies supplying them to households or HVAC wholesalers and distributors. The water heaters are shipped in bulk and are stored locally.

35. From there, the water heaters are either individually delivered to customers’ locations and installed on-site or they are purchased by small independent HVAC contractors for delivery and installation by them. The costs of delivery and installation vary in proportion to the time and distance to travel between the relevant water heater storage site and the household where the heater is being installed. For this reason,

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participants in a local geographic market require access to local storage and installation capabilities and installers operate within limited geographic areas. 36. The restriction of the relevant markets to those falling within the ECG franchise territory reflects the manner in which the ESI rental water heater program was initially developed.

37. ECG is the exclusive distributor of natural gas for the franchise territory and, in this activity, is regulated by the OEB. This territory is composed of three large areas of Ontario: first, Eastern Ontario, including Ottawa but excluding the Kingston area; second, the Greater Toronto Area, extending north to Georgian Bay, and east to Peterborough; and third, the Niagara Region covering most of the Niagara peninsula.

38. The water heater rental business now owned and operated by ESI was initially developed within ECG under OEB oversight. A principal objective in developing the business was to expand the year-round demand for natural gas. The rental program operational costs were assessed on a marginal cost basis. The rental program assets were included in the ECG rate base and subject to a regulated rate of return. Rental rates were not set or approved by the OEB, but ECG was required each year to realize an authorized rate of return above recovery of marginal costs. ESI was

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requirement. Under this form of oversight, ECG developed a large installed base of rental water heater customers but only in its gas distribution franchise territory.

39. The ECG rental water heater business was sold to ESI in October 1999 thereby removing the business from further OEB oversight. ESI, since acquiring the ECG rental water heater business, has offered rental water heaters and services outside the ECG franchise territory. However, ESI has participated in these other markets as a new entrant rather than as the dominant incumbent as is the case in the ECG franchise territory.

b. Control 40. Key considerations in establishing control or market power of relevant markets include the market share of the company under investigation and barriers to entering or expanding in the relevant markets. The information obtained by the Bureau indicates both that ESI has a high market share in the relevant markets and that these markets are characterized by high barriers to entry and expansion.

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(i) Market Share 41. For the year 2001 to date, ESI has maintained a market share in excess of 65% of all new water heater installations in the ECG franchise territory including about 80% of all replacement water heater installations.

42. With respect to the provision of services, such as the examination and repair of installed water heaters, a further important consideration is the share of all such installed water heaters in the relevant geographic markets that are under the ESI water heater rental program. As of September, 2001, this market share, based on the stock of installed water heaters, is estimated by ESI to be 86%. More specifically, such market share is estimated at 81.9% in the Niagara area, 86.5% in the Greater Toronto Area and 85.2% in the Eastern Region.

(ii) High Barriers to Entry 43. Markets for the supply of water heaters and related services are not characterized by high technological, scale or sunk cost barriers to entry.

44. The water heaters themselves employ standard technologies and are purchased from third party manufacturers. Persons disconnecting or installing water heaters are

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required to be licensed. However, licensing is done through the government of Ontario and provides the licensed individual with the opportunity to work on a wide range of gas services and appliances, such as furnaces, stoves and fireplaces, in addition to water heaters.

45. The absence of significant scale barriers to entry is indicated by the wide range of potential industry participants. They range in size from small independent contractors, to large retailers such as Home Depot, Canadian Tire and Sears. Equipment and facility costs to enter the industry are low and involve a limited sunk cost component. For example, for large multi-product retailers, while there is a need for display and storage space, this space will have alternative uses for vending of other products. Small independent HVAC contractors require little in the way of additional equipment and facilities to participate in the supply of water heaters and related services in addition to the supply and servicing of other gas appliances such as furnaces, fireplaces, barbeques and stoves. There is limited need for them to maintain an inventory of water heaters as water heaters generally can be obtained on an as-required basis from HVAC wholesalers and distributors.

46. The principal barriers to entry in the relevant markets are those erected by ESI through its water heater rental program. These barriers are caused, in particular, by the ESI terms and conditions for ESI rental water heater customers (“ESI customers”) to exit the company’s water heater rental program and by the option

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ESI provides to ESI customers to buy-out their installed rental water heaters (the “Buy-Out Plan”) as well as the ESI guarantee to match competitors’ water heater prices (the “Price Match Guarantee”).