CT 89/
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-.. ' IMPERIAL OIL LIMITED ·~-"·--· .-"":~ 1. .. - --· ! 0~iversiey and hAvv baen retained ~Y the Diracto~ of F I l f' D .-:_. ;_!
Texaco Canada Inc. Now shown to me and a~tached as Exhihit "A" to this my affidavit is. a cop;,· of my Report.
2. The contents of this Report attached as Exhibit "'A'i tc' t.his my ~ff1d~vit and the opinions expressed therein .;::::1;: tt·u.e I;.:) the best of my kfio_,led~e, information and f;e lief.
3. I make this affidavit pursuant to Rule 42(1) of th..:~ Cornpetltion Tribunal Rules.
SWORN b~fore me at the City of Ottaw~. in the Province ot Ont~rio, this 19th day of July, 1989. I / / ,! , / /. ~' -. - ~ c-/. ~ ' A Commis -siolner: o t .h s i "n '\ "nd for the Prov~. nee of o . Ld ~ :_1 u . j ._' CJ d
This is EXBIBIT •A• to the Affidavit of Donald G. Mcfetridge sworn before me on July ie 1989 EFFICIENCIES RESULTING FROM THE IMPtFIAL OIL TEXACO ME~GER
D.G. McFetridge d ,~· 1) ! :j H _LS.:? '-_; :1 . 1 l:i Id ~ J 1_, d .::J
INTRODUCTTON . .l. • The purpose of this document is to report on the magnitude of the efficiencies expected to result from the merger of Imperial Oil Limited and Tex~co Canada In~. The opinions expressed in this report are based on my review of information and docufl\ents provided by Imperial Oil Li.m.ited.
2. The mer9er is expected to result in resource savings resulting from the rationalization of retail and commercial sales forces, service station networks, distribution terminals and promotional activities. In addition. significant synergies are li~ely to be achieved by the joint operation of the Sarnia and Nanticoke refineries.
The present value of the savings achieved in the ten years following the merger is approximately $~ million. This assumes a lC percent real discount rate (end of year discounting) and no change in the relative price of crude c>il. Taking a longer time horizon and allowing for increases in the relative pric~ of crude oil results in capitalized savings 1Ahich are approximately 60 percent
4. It is unlikely that these efficiency 9ains would be a~hieved in the absence of the merger.
... 2 -5. It has been put forward that the merger will f.,cilHat-e efficiency gains i.n the following functional ~re as:
retailing cornroercial sales terminal operation refinery operation other supply admi n ist r.at. ion
6. These s~vings take the form of on~oing resovrce savings and lncreases in surplus as well as one-time savings. To express thern in common terms they are capitalized over a ten-year horizon using a 10 percent real discount rate.
Retailin9 includes all activities associated with the mark~~ting o~ niotor gasoline through service st&tions and the marketinQ of domestic heating oil. lJnperia.l and Texaco are pre6ently marketing the same products to the same cu.stomers throuQh parallel organizations. The combination of retail s~les forces will enable Imperial and Texaco to reduce their combined retail sales force by ~employees or -percent. '!tds reduction is to occ\.n.'· by attrition over a
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three year period~ The annual saving in employment costs would amount to appro~imately $81111million in 1992.
e. Imperial and Texaco currently spend a total of .::oi$-.-million annua.lly on advertising. Imperial calculates that the optimal level oi advertising for the single larger vol~me Esso brand annually. The annual saving in prc.">mot ion cost W01.lld ar11ount to $.mill ion.
9. Jn order to maintain their presence in the market Imperial and Te,.aeo would i-nvest -a annually over the next eight years in new service station construction. The merger will eliminate the construction of duplicate Imperial and Texaco stations in new areas. The result ~ill be fewer but higher volume stations in new locations. The esti~ated annual saving in construction eosts w.ould amount to samillion.
10. The present value of all retail efficiencies less relocation retraining, credit card conversion and ele~n-up costs wc.uld amount to. $.,rnillion. These efficiencies would 1H:»t be realized it"l the absence of t.he merger.
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Commercial Sales Efficiencies ~--,,,_.·-~ ........ -11. Col'!l.merci.al sales are sales made to commercial and industrial customers, airlines, railways, shipping companies and resellers. The supply plannin.g, crude acquisition and pipeline planning funct, ions are included under eonwercial sales.
12. the merger will allow the rationalization of the commercial sales forces and product supplyt crude acquisition and pipeline staffs, 0£ Imperial and Texaco. The result will be a ~eduction in the combined workforce in this area by tlfernp loyees or. percent by 1992. The annual saving in employment eost will amount to $9'roillion (198S dollars} by 1992. !n present:. value terms and net of one-time relocatior1 and. retraining costs this arnounts to S9'rnillion. this saving could not. be realized in the absence of the merQer.
13. Imperial and Texaco operate a number of terminals which are often side-by-side. In many cases neither terminal is fully utilized. In these cases the combined volume of both terminals could be handled by one with minimal additional investment. This results in resource savings of several kinds.
- s -14. Imperial plans to close or sell .terminals. This will ultimately result in a workforce reduction ofl A
e1t1Ployees or -percent of the existing workforce. This reduction is to occur by attrition over three years. The ann~al employment cos~ savings {in 1989 dollars) is expected to be ~illion by 1992. The present discounted value of this savin9 over lO years less the one-time cost of relocation and retraining is e.xpected to be $-million.
15. The closure of duplieate terminals will elso result in a saving in terminal operating costs. This will amount to 'Ill mill ion annually. Discounting this savini;i over 10 years and deducting the cost of one-time investments necessary to ex;iand some Imperial terminals ($.million_.) · and to decommission the Texaco terminals {$19million) yields a net gain of under $111fttiltion.
16. There will also be a reduction in the value of stock tied 1,1p in inventory. Imperial ~rgues that virtu~lly all of the safety stocks and all of the stock that is techn5.cally unavailable for normal use can be saved. The result is a one-time inventory saving of approximately $Ila ir:il 1 i.on.
17. Tne total saving in present value terms amounts to approximately $•mil lion. These saY"ings could not be achieved in the absence of a merger.
- 6 -lS. The Sarnia and Nanticoke refineries differ in :heir technical characteristics with the Sarnia refinery being more compl~x and more ~ble to accommodate heavy and high-sulphur crudes. The differences in the capabilities of the two refineries offer opportunities for speeiali~ation by product or by st.age of production.
19. To estimate the benefits of joint optimization of the two refineries Imperial Oil made use of linear programming :model$. These models are commonly used by refinery operators. In this case Imperial used the existing model of its Sarnia refinery and developed a model of the Nanticoke refinery using Texaco •s supply ·planning,.•·model.>e' ~ The two separate models were then combined so that the crude slates of each refinery could be processed in the rnost efficient location and the product dem~nds could be filled from the most efficient location.
20. The analytical approach employed by Imperial is to optimize each raf inery individually and then to optirnize them jointly. The difference in surplus given inp\lt end product prices is the value of the synerQies derived from joint operatio•'I.
- 7 -21. The linear programming model essentially performs the task of prof it maximization. Confronted with a set of pt<";d~ct and inpvt prices and proccssfrig capacity eonst.raints the model chooses the mix and level of outputs that maximize refinery profit. Given different product and input prices the output level afid configuration will differ as ~ill profit~ Imperial•s synergy esti~ate is based on 1989 input and product. prices.
22. The joint optimization exercise reveals that the ~wo ref i~eries would produce a substantially different product mix if operated together than they do operating .:.ilOfle,
In addition to changing the product mix at each refinery the joint optimization facilitates an increase in throughput. That is~ the capacities of the two refineries operated jointly exceeds the sum of their stand alone capacities.
23. This increase in capacity is ~ehieved without any physical change or investment at either refinery. It occurs (as do all synergies) because each refinery has a bottleneck or capacity constraint in a different place •
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- a -•a. ...........u.. ...1.11 111. ............ ., 24. This increase in potential throughput enables the combined operation to reduce its product purchases and makes additional product available for sale to independents or for export. The reduction in product purchases either reduces imports o:r frees up capacity c-f other Canadian refiners to export. The economic benefit of reduced product imports {by refiners for resale) is the diffe!'."ence bet~een the pt" ice of imports and the mar9inal cost of domestic production. The benefit from increas~~a exports by either Imperial or by other Canadian refiners is the exces~ of the export price over marginal cost.
25. One source of prof it is the increase in refining capacH.y that comes from joint operation. Another source is the highet· value of the product mix~ Joint operation allo'ifls these two refineries to produce a higher valued product mix from a given slate of crude than they could on a stand alone basis. Conversely a given product mix can be obtained from ::::. l Cl. 3~!'::Jd
- 9 a lower-valued slate of crude (i.e. heavier, higher sulphur) by the two refineries together than on a st~nd alone basis. The val1,1e 0£ the synergies or additional surplus obtained as a consequence of joint operation i$ expected to be S.-. million (1989 dollars) annually. This estimate depends on the price {and margin) at which surplus gasoline can be sold. lt also depends on the ability of other Canadian refineries, from whom Imperi~l and Texaco would purchase product on a stand alone basis, to export the product formerly sold to Imperial or Texaco. Given the size and proximity of the u.s. market there is a reasonable likelihood that freed up domestic capacity can be used for export. In the longer term this freed up capacity will be available to meet .increased domestic requirements. This is a cost-effective way of expanding domestic refining cap8city.
26. The syneroies from combined operation of Sarnia and Nanticoke could not be re~lized in the absence of a merger. There are a number of reasons for this. First, the potential synergies become apparent only after a detailed ~nd sophisticated analysis of each refinery. It is highly unlikely that two competinQ refiners would agree to share proprietary data about their production capabilities and r~osts.
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- 10 -27. Second, Joint optimization req~ires that interroediate product (catalytic cracker feed, reformer feed) be transferred between refineries. This requires a high degree of co-ordination between refineries~ Co-ordlna.tion of activities ran9ing from crude purchases to product mix decisions would be required. t>etailed arrangements of this n~ture are likely to be extremely costly to negotiate on an arms-length basis (between two independent and competlng parties). Moreover as crude and product price$ change so will the tasks assigned to each refinery. Arrangements would have to be renegotiated and both parties are likely to take this opportunity to attempt to improve their relative positions.
28. Third, as a consequence of these co-ordination costs, extensive transfers of feedstock between independent refineries are simply not observed.
29. Capitalized over ten years t.he increase in surplus from joint refinery optimization would amount to $ ...... mill ion ..
30. The merger would allow the Sarnia and Nanticoke refineries to specializetE;ttrsrn•1• du 0 1. :l
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- 11 ----1 H F 2 2 . . I - ·-a . · . 1 .. -. E .- •& . • mLL This will eni1ble Imperial to sa'ile $1lmillion it would have had to invc~i;t in Sarnia in 1992 to comply with. ne~ on-road sulphur emission standards for diesel fuel. The r>resent value of this savino is $.million.
31. The meroer 'Ill ill also enable Imperial to avoid the investment necessary to upgrade its Finch terminal. The Finch terminal provides a link between the Sarnia refinery and the Trans Northern Pipeline which links Nanticoke to
32. In the absence of the mer9er Imperial would. have been obliged to invest some $tlmillion in improving its connection with the Trans Northern Pipeline at the Finch terminal. With the merger Nanticoke can take responsibility for shipments east of Toronto on the Trans Northern while Sarnia handles the area west of Toronto using the Sarnia Products Pipeline. This will reduce trans-shipment at the Finch terminal and obviate the need for both new investment and tne buffer stocks presently held there+ The buffer stock reduction is a one-time $ ...m illion saving. The total saving ls Stf'million.
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- 12 -33. The merger is expecte~ to allow the two companies to combine their f inaneial aeeountin9, refinery engineering, planning and systems organization as well as their managements. The combination of these functions will allow a work force reduction of "11111 employees or• percent of
current combined staff. This •orkforce reduction will occur by attritio~ and is expected to take three year$. The annual s~vin~ in employment costs is expected to reach $. . million (1989 dollars) by 1992. Associated with this staff reduction are one-time· relocation and retraining costs of s• million and a one-time cost of $'1111imillion for system reorganization. The present val~e of the head off ice overhead saving d t sco1,1nted l 0 ye at' time horizon is $-million. These savings could not be ~chieved in the absence T-,o-t.a.....l... Effici....e.... _nc...... .. i es ... -~_..........,. "'"""'··.~ .. .-34. Capitalized over ten years at a 10 percent (real) discount rate the efficiencies resulting from the merger are:
Efficiencies in Retailing $. . million Commercial Sales Eff i.ciencies •million Terminal Efficiencies 9J million Joint Optimization of Sarnia and Nanticoke Refineries ..m illion Other supply eff ieiencies -million Administrative efficiencjes ~ 'TOTAL 9'9million 35. Using an infirdte time horizon, mid-year discounting and all owing for the ef fee ts of incre~ses in the !"'elati ve price of: c:r1.H:1e oil l.rnper ial Oil obtains ~fficiencies i,.iith a capitalized vi,.ll,l.e of over $Sbillion.