Mabanaft Ltd, R (on the application of) v Secretary of State for Trade & Industry

Under EC Directive 2006/67/EC the United Kingdom is obliged to hold compulsory oil stocks for use in times of crisis. This application for judicial review concerns one aspect of the decision of the defendant on 14 February 2007 to introduce a new system of stocking obligations. The new system obliges oil refining companies and oil importers to hold oil stock. Refiners, who have been subject to an obligation since 1973, remain under an obligation to stock 67.5 days’ supply. Importers, who were not previously subject to stocking obligations, are obliged to stock 58 days’ supply. The claimant, the largest of 10 oil importing companies, challenges the decision to fix the differential at 9.5 days supply, and maintains that it should be greater.

Until the defendant’s decision, oil stocking obligations lay on refiners and those selling to final consumers, that is, companies with petrol stations, supermarkets, distributors and others. Non-refiners who supply over 100,000 tonnes per annum have been required to hold 48.5 days of stock, a differential of 19 days from the 67.5 days of stock refiners are obliged to hold. The reason for the differential is that refiners hold higher levels of stock in the normal course of their business than others. The role of importers under the previous system was to arrange for stockholding for their petrol station, supermarket and distributing customers who were obliged to hold oil stocks.

The defendant considers the previous system is no longer adequate to ensure that the United Kingdom complies with its obligations under the Directive. This is because of the increase in the number of small businesses supplying less than 100,000 tonnes per annum and therefore exempt from the obligation. Some 20% of the market now consists of such small businesses.

The new scheme abolishes the 100,000 tonnes per annum threshold and provides that the obligation arises at the point when the products leave the refinery or the terminal. Hence, for the first time, an obligation is imposed on importers of oil products. The defendant proposed to phase in the new system from the second quarter of 2008 with obligations under the previous system ceasing after the end of 2008.

These proceedings were launched on 11 May 2007. The claimant, together with two other oil importing companies, accounts for over 90% of the import market in oil products. Oil imports, however, account for only about 10% of the overall supply of oil in the UK. The market is dominated by oil refining companies. The abolition of the threshold and the imposition of a stocking obligation on importers are not challenged. It is common ground that a differential between refiners and importers is justified by reason of the fact that refiners hold higher levels of stock in the normal course of their business than importers do. The claimant challenges the legality of the decision to fix the differential at 9.5 days.

The claimant maintains that the defendant’s decision fails to comply with the duty under Article 3(2) of the Directive to “ensure that fair and non-discriminatory conditions apply in their stockholding arrangements” and to identify the cost burden resulting from the maintenance of stocks by transparent arrangements. It submits that the method chosen by the defendant to determine the differential, Minimum Operating Requirements (‘MOR’), did not enable assessment of the relative cost burden as between refiners and importers of complying with compulsory stocking obligations. This is because there is no sufficient link between MOR and the economic burden of the stocking obligations and, in particular, because, if the differential is assessed using MOR, regard is had only to part of stocks actually available to fulfil stocking obligations. Moreover, MOR is concerned to measure stocks that would not be available in an emergency, whereas Article 3(1) shows the Directive is concerned with stocks that would be “fully at the disposal” of member states. The claimant also submits that the decision is unlawful because of adjustments made to the differential in respect of exports, fuel oil and naptha. In so doing it argues that irrelevant considerations were taken into account, relevant considerations were not taken into account, and the decision was arbitrary.

In revising the system of stocking obligations the defendant relied on a June 2006 report, Differentiated Obligatory Oil Stockholding Requirements UK, prepared for the defendant by Energy Market Consultants (UK) Ltd. (‘EMC’), oil and energy consultants. A covering note to EMC’s report stated that the differential between refiners and non-refiners “is justified by the higher level of working stocks which refiners hold in the normal course of business and that operating a differential in effect equalises the burden”. The claimant’s application takes no issue with this but focuses on the method of implementing it, and, in particular, the means adopted to identify the level of stocks which refiners would hold in the absence of stocking obligations. Since importers have previously not been subject to stocking obligations, the impact of the obligations on them is relatively straightforward to assess, by reference to actual inventories held. But the inventories of refiners have, for the last 40 years, been affected by their stocking obligations.

At the core of the challenge is the criticism by the claimant of the EMC report. The claimant, relying on reports prepared by another firm of consultants, CRA International (UK) Ltd. and Mr Timothy Keyworth, an associate at the Regulatory Policy Institute, Oxford, submits that there are numerous and fundamental flaws in the methodology of the EMC report which itself contained caveats in respect of the use of MOR. It submits that the stocking position in countries where there is no compulsory stocking obligation on economic operators, in particular that in the Netherlands and Germany, is capable of informing the decision in the United Kingdom and that, since there is thus available a suitable means of achieving fair and non-discriminatory conditions for stockholding arrangements, the defendant should not have relied on MOR as the basis for its decision. CRA and Mr Keyworth also criticise the adjustments made by EMC to the MOR calculations in respect of exports, fuel oil, and naptha which had the effect of reducing the differential.

In broad terms the defendant’s case is that the Directive is not concerned with an assessment of the economic realities of the burden. His position is that one cannot look at actual stockholding because the refiners have been subject to stocking obligations for many years. Actual stockholdings will not give an accurate answer to the question of what the differential should be because they are inevitably distorted by the effects of existing regulation. The refiners have argued that looking at actual stockholding would penalise them simply for having complied with the old system.

The defendant submits that MOR, a concept used by the International Energy Agency (“IEA”) and dependent on data provided in the past which could be easily identified was a rational means of comparing the businesses of refiners and importers and has the advantage that it relied on data that refiners have provided in the past and that companies are able easily to identify. As far as the position of other countries is concerned, EMC did not consider a comparison feasible because of significant differences between the context in the UK and those countries and because the comparative data was not good enough.

The defendant’s power to direct companies to hold oil stocks is found in section 6 of the Energy Act 1976. This provides that directions “may be given to any person who in the course of an undertaking carried on by him produces, supplies or uses crude liquid petroleum, or petroleum products” based on “quantities… supplied by the undertaking to the United Kingdom market in past periods”.

The United Kingdom has been subject to EC stocking obligations since 1973 when it joined the Community. Directive 2006/67 is a consolidation of earlier Directives, the first of which was adopted in 1968. Article 2 requires particular amounts of stock to be held in each of three categories. Category 1 is motor spirit and gasoline aviation fuels (higher distillates). Category 2 is gas oil, diesel oil, kerosene and kerosene based aviation fuels (middle distillates). Category 3 is fuel oils.

By Article 1(1), member states are required to hold stocks of each of the three categories equivalent to 90 days’ average consumption. By Article 1(2), a member state which produces crude oil indigenously may deduct up to a maximum of 25% of internal consumption met from domestic production from its stocking obligation. At present, the United Kingdom, as an oil producing state, is entitled to this 25% reduction and has decided to take it. Article 1(2) provides that a member state should decide on the domestic distribution of such a deduction. Hence its stocking obligation under the Directive is 67.5 days.

Article 3(1) provides that “stocks maintained in accordance with Article 1 shall be fully at the disposal of member states should difficulties arise in obtaining oil supplies”. Article 3(2) provides: “member states shall ensure that fair and non-discriminatory conditions apply in their stockholding arrangements” and “the cost burden resulting from the maintenance of stocks in accordance with Article 1 shall be identified by transparent arrangements…”. By Article 3(3) a member state may decide to have recourse to a stock holding body or entity which will be responsible for holding all or part of the stocks required to fulfil the requirements of Articles 3(1) and 3(2).

By Article 4(2) a member state’s stockholding obligation “shall be based on the previous calendar year’s internal consumption”. States are required by Article 4(1) to submit to the European Commission a statistical summary showing stocks existing at the end of each month drawn up in accordance with Articles 5(2) and (3) and Article 6 and specifying the number of days of average consumption in the preceding calendar year which those stocks represent. Article 6(1) provides: “when the level of minimum stocks provided for in Article 1 is calculated, only those quantities which would be held in accordance with Article 3(1) shall be included in the statistical summary”.

The supplies that may be included in the stocks are identified in Article 6. By Article 6(2), subject to Article 6(1), these are; supplies on board oil tankers in port for the purpose of discharging, supplies held in ports of discharge, supplies held in tanks at the entry to oil pipelines, supplies held in refinery tanks, supplies held in storage by refineries and by importing, storage or wholesale distribution firms, supplies held in storage by large-scale consumers in compliance with obligations to maintain permanent stocks, and supplies held in barges and coasting-vessels engaged in transport within national frontiers. Article 6(3) provides that indigenous crude oil not yet extracted, supplies intended for the bunkers of sea going vessels, supplies in direct transit, apart from those referred to in Article 7(1), supplies in pipelines, in road tankers and rail tank wagons, in the storage tanks of retail outlets and those held by small consumers shall be excluded from the statistical summary.

Article 7 provides that the government of a member state may decide to hold part of its stocks outside its national territory subject to the requirements specified in Article 7(2). Article 8 requires states to adopt necessary provisions and take necessary measures to ensure control and supervision of stocks.

Paragraphs 9 and 18 of the recitals to the Directive are also relevant. Paragraph 9 states “it is appropriate that organisational arrangements for the maintenance of stocks are transparent, ensuring a fair and non-discriminatory sharing of the burden of the stockholding obligation. Therefore, information relating to the cost of holding oil stocks may be made available by member states to interested parties.” Paragraph 18 states: “since the objective of the action to be taken, namely the maintenance of a high level of security and the supply of crude oil within the community, by means of reliable transparent arrangements based on solidarity between member states, while complying with the rules of the internal market and the competition rules, may be better achieved at community level, the community may adopt measures in accordance with the principle of subsidiarity as set out in Article 5 of the Treaty. In accordance with the principle of proportionality, as set out in that article, this Directive does not go beyond what is necessary to achieve that objective.”

The evidence on behalf of the claimant consisted of the following statements; by Craig Roberts, Managing Director of Mabanaft, dated 9 May 2007; by Andrew Owens, Chairman of Greenergy One World Fuels Limited, a leading independent UK wholesaler of petroleum products, dated 10 May 2007; and Christopher Brookhouse, Chief Executive Officer of Harvest Energy Limited, another leading independent UK wholesaler of petroleum products, dated 31 May 2007. There were also two reports, dated 19 October 2007 and 25 January 2008 by Mr Timothy Keyworth, an associate at the Regulatory Policy Institute, Oxford, with expertise in energy sector issues. These assessed the differential between the oil stock holding obligations to be faced by refiners and importers under the new system. Mr Keyworth’s second statement also responded to evidence on behalf of the defendant by Mr Barry and Mr Jenkins.

The claimant also relies on three reports by CRA International (UK) Ltd., dated 10 May, 16 October 2007 and 23 January 2008, prepared by Ed Osterwald and Phil Redman. The second report responded to the defendant’s summary grounds and the third to the contents of the statements filed on behalf of the defendant. Mr Osterwald is CRA’s chemicals and petroleum practice leader in Europe. After 10 years with Mobil, he was a partner in Arthur Anderson’s energy and utilities consulting practice, and then led LECG’s energy and utility practice in London before joining CRA International. Mr Redman is a principal in the London office of CRA’s chemicals and petroleum practice. After 10 years in the oil industry he has worked as a consultant, first with Arthur Anderson and now with CRA.

The defendant relies on EMC’s June 2006 report and statements by Michael Barry, dated 18 December 2007 and 21 February 2008, Owen Jenkins, dated 18 December 2007 and 21 February 2008, and Kristine Kuolt, dated 20 February 2008. Mr Jenkins is an official in the Department of Business Enterprise and Regulatory Reform, formally the Department of Trade and Industry. Until relatively recently he was responsible for introducing a new system to manage the United Kingdom’s emergency stocking system. Mr Barry is one of those who founded EMC in 1989, one of its directors, and, with Mark Lewis, Roy Jordan and Jon Leitch, a co-author of the EMC report. Ms Kuolt is a freelance energy consultant and was formerly deputy head of emergency planning and preparations for the International Energy Agency (IEA).

Mr Barry has almost 30 years experience in oil and energy consultancy and specialises in monitoring and analysing oil markets worldwide, including strategic and commercial stock holding policies, and stock holding practices. Mr Lewis has had over 35 years experience in oil and energy consultancy. After a career at Petroleum Economics Ltd, where he was ultimately Joint Managing Director, he helped found EMC and was its Managing Director when it started. Mr Jordan has 50 years experience of the oil industry, joining EMC five years ago after thirty-seven years with Shell, including two secondments to the IEA, and nine years with the Abu Dhabi National Oil Company.

Ms Kuolt’s statement and the second statements of Messrs. Barry and Jenkins were served less than a week before the hearing. They were responding to evidence by Mr Keyworth and CRA filed on 25 January. The claimant did not object to the admission of this evidence.

The Background: The obligation in Directive 2006/67 is not the United Kingdom’s only oil stocking obligation. As a member of the International Energy Agency (IEA) it is also subject to IEA obligations. The difference between them is that the European obligations are based on national consumption whereas IEA obligations are based on net imports. As a net exporter of oil until 2006, the United Kingdom had no stocking obligation under the IEA regime. It became subject to an IEA stocking obligation in 2007, but, as I have observed, has been subject to the European regime since 1973. States that are members of both the EU and the IEA can use the same stocks to meet both obligations: Mr Jenkins’ first statement §§ 2-5.

The IEA uses MOR to assist member states identifying what stocks companies needed in order to operate at all and thus to identify what stocks would be unavailable in the event of disruption. Under the IEA scheme, the data for MOR consists of working stocks and technically unavailable stocks (mainly tank bottoms). For MOR purposes individual operators are asked to report actual technically unavailable stocks. When the IEA Governing Board determines stockholding obligations, it applies a 10% deduction from total stocks to reflect unavailable stocks: Mr Jenkins’ first statement § 23; Ms Kuolt’s statement, §§ 4-5.

Until the early 1990s the IEA collected MOR data from member countries on a quarterly basis. This was discontinued because the results varied widely and could not be used for country comparisons. More recently the IEA reviewed the accessibility of oil stocks to learn if there were changes in the level of technically unavailable stocks and necessary working stocks in normal circumstances. A questionnaire was issued in October 2002 asking member states to report on their normal working stock levels and their technical unavailable stocks. The IEA’s “Examination of the accessibility of stocks Minimum Operating Stocks Requirements (MOR) study 2002” was published in 2003. It’s preliminary conclusions, accepted by the IEA’s standing group on emergency questions, were that the 10% deduction for unavailable stocks remains valid for the IEA and that industries’ working stocks can be included towards a country’s stockholding obligation although they may not be accessible at the time of a crisis: Ms Kuolt’s statement §§ 6-10.

As far as the European stocking obligations are concerned, UK refiners have a large surplus of fuel oil (category 3) both in terms of its stocking obligations and the needs of the domestic market (Mr Barry’s first statement §10, 14 and 34). Importers do not import fuel oil and the new system does not subject them to a category 3 stocking obligation. The three defined European categories of product which give rise to stocking obligations do not account for the entirety of total inland crude oil products consumption in the UK. Mr Barry’s second statement (§30) says that they account for 84% of the total UK inland consumption.

Under the system that has hitherto applied, companies provide the defendant with figures of sales in tonnes on a quarterly basis. Their stocking obligation is worked out from that by dividing the annual tonnage figure by 365 to work out one days’ supply for that company. In the case of refiners that figure is multiplied by 67.5. In the case of others supplying over 100,000 tonnes per annum and thus subject to the obligation, it is multiplied by 48.5. The result is a figure in tonnes for the stocking obligation of that company: see Mr Jenkins’ first statement §§10-14.

There have been difficulties in meeting the UK’s category 2 stocking obligation. This, in part, reflects the demand in the UK for category 2 products, and in part the increasing proportion of small distributors whose supply is below the 100,000 tonne threshold.

The consultation: As a result of the difficulties in meeting the UK’s category 2 stocking obligation, in September 2003 the defendant gave notice of an intention to hold a public consultation to consider solutions. As part of this it commissioned a report by EMC. EMC’s report “The UK Downstream Oil Marketing and Compulsory Stockholding” was produced in November 2003 and issued together with the defendant’s consultation document on the future of compulsory stocking obligations for oil in December 2003.

Section 4 of EMC’s 2003 report contains a summary and its conclusions. The summary states that since the mid 1970s there have been significant changes in the operating practices of companies, the structure of the industry, and the pattern of UK oil demand all of which combine to raise questions over whether the existing Compulsory Stocking Obligation system is still the most effective for the UK. The report notes a tendency by refiners to withdraw from distribution and marketing and refers to the problems in meeting the stocking obligations for category 2 products. It states these difficulties have been accentuated by the increasing importance of category 2 products in the pattern of UK oil demand.

The consultation document stated that the defendant was minded to move the basis for setting obligations from the retail end of the supply chain to the point at which the product enters the UK market, either from refineries or as imports. As is to be expected the refiners and importers trade associations had different positions about having a differential between their obligations. UKPIA, the refiner’s association, maintained there should not be a differential. It considered a differential does not reflect the considerable investment refiners have to make in infrastructure and that it would lead to a two tier market with traders able to buy from importers more cheaply than from refiners. UKPIA has reiterated its position since, for instance, in letters dated 27 June 2006 and 10 December 2007. The response of AUKOI, the importer’s association, was that there should be a 30 day differential between refineries and importers. AUKOI represents supermarkets and distributors as well as importers. Its importer members, including the claimant, responded separately arguing that there should be no obligation imposed directly on them or not without a differential. Notwithstanding this response, there is no challenge to the decision to move the basis for setting obligations to the point at which products enter the UK market.

The decision to instruct EMC: In view of the polarised views, which were maintained after post consultation meetings, in August 2004 the defendant decided to give further consideration to the question of the differential. In paragraph 12 of his brief to Mr Wicks MP, the relevant Minister, Mr Jenkins stated that a difference between refiners and importers was in principle justified on the grounds of the different working stocks held by the two. He also referred to the fact that if importers withdrew from the market there was a risk that competition would be reduced. It was later decided to seek further independent advice on the question of operating a differential. EMC was formally instructed in August 2005. Paragraph 5 stated:

“the difference in working stocks held by refiners and non refiners justifies a differential but that this might be reduced in size. This is because the difference between refiners and importers in terms of stock holding and access to storage is less than that between refiners and supermarkets and other resellers under the present system, and because the level of stocks held by refiners has declined in recent years”.

The document states that this understanding was based on anecdotal evidence rather than a full survey of the position. The document sets out the different positions of refiners and non-refiners. In paragraph 11 it is stated that the department is interested in receiving independent advice on inter alia the validity of the industries’ respective arguments about the differential and “what size differential, if any, would be suitable for a refiner/importer system”. Paragraph 12 sets out four forms the advice might take but states that the department would consider other proposals. The first of these is:

“designing a questionnaire that we can send to industry to establish a firmer base of evidence on the level of working stocks held in the normal course of business and the difference made by the stocking obligation, and advising on the results. (As far as the refiners are concerned, this could build on the International Energy Agency’s work on Minimum Operating Requirements.)”

The fourth is “advising whether other EU member states’ systems for calculating obligations and imposing them and/or their costs on different types of business have any lessons for us.”

The defendant’s terms of reference asked EMC: (a) to examine and analyse the supply structure of the UK petroleum market with a view to assessing the operating stocks required by refiners and non refiners, and on the basis of this exercise to recommend a differentiated stockholding obligation for the two types of operator; (b) to do this by advising on a survey to be carried out by DTI and, using the results of the survey, to produce a detailed analysis of the supply structures of UK refiners and importers, establishing the principles of minimum operating inventories for refiners and independent importers, assess MOR for the two groups and make conclusions and recommendations regarding the application of differentiated obligations for the two groups; (c) to advise on the implications of introducing recommended differentiated obligations in terms of the impact on costs and competition, storage access and ownership and effect on the ticket system; and (d) to report on the operation of the ticket market”.

The Questionnaire: EMC was asked to suggest changes to the IEA’s MOR questionnaire to make it suitable for completion by importers as well as by refiners. The draft questionnaires were sent to UKPIA and AUKOI on 11 October. The associations replied on 25 October and 22 November. UKPIA was concerned that the exercise would be distorted if it counted stocks refiners had to hold as a result of the stocking obligation system. It stated that the form dealt with a “business as usual” scenario that included an element of compulsory stocking obligations in all activities and was biased. The email states “MOR is a different animal altogether”. AUKOI suggested that, rather than looking at minimum operating levels, the defendant should look at the position in countries that did not impose stocking obligations on refiners and importers. It stated that the MOR regime does not answer the question of what the operating stock would be absent CSO obligations, ignores the discretionary aspects of keeping stocks for profit, seasonal and other motives, and really misses the point.

The questionnaires were sent out in November. The last completed one was received on 30 January 2006 and sent to EMC: see Mr Jenkins’ first report §§ 58-63. At a meeting on 21 February a representative of the OFT stated that it did not see either the current system or the proposed new system as raising competition issues and thought it reasonable to take levels of working stocks into account.

EMC’s Report: EMC’s report was delivered to the defendant in June 2006. The material parts of the report on which the parties relied, are set out in an appendix to this judgment. While containing a number of caveats as to the way of determining a differential between the different categories of market operators, including whether the reporting period of the questionnaire was representative (§ 5.3), it stated (§ 5.1) that MOR seemed the only viable mechanism for doing so.

The report deals with the question whether normal minimum operating stocks could be determined by having regard to other countries relatively briefly. Paragraph 4.7 states that it is virtually impossible to assess accurately the precise level of normal minimum operating stocks in individual markets and differences between countries depend on geographical size, logistical structure, import dependency, and size of refinery sector. It also states that the fact that most OECD countries are also subject to compulsory stock obligations is a further complication making it difficult to assess what levels of stocks would be in the absence of such compulsory obligations, but (see § 4.8) that developments in the USA offer a “clue” as to the trend in MOR and that the “underlying trend” in US company stocks which are not subject to compulsory stocking obligations should represent the approximate average effective MOR. However, in § 4.9 there is reference to stock rises in the USA because of discretionary stocking to deal with concerns about security and an upward shift in Germany.

In the section containing the report’s conclusions it is stated (§ 8.2) that despite the similarity of the UK to other European oil markets in terms of pattern of oil demand and product supply, the uniqueness of the UK in terms of its crude oil self-sufficiency for the past 25 years has had a direct bearing on the level of stocking obligations and probably also influenced decisions relating to the system of mandatory stock holding imposed on the market. It concluded (§ 8.3) that for whatever reasons, the UK has followed a different course from most of its EU partners, being in the minority in adopting a system whereby the commercial operators in the market are responsible for holding the entire compulsory oil stock. Although these paragraphs appear to be primarily concerned with the central stockholding agencies of many European countries rather than the question of a correlation between stockholdings in those countries and “normal working stocks”, it will be seen that the UK’s self-sufficiency is one of the reasons EMC considers that inventories in other European countries, such as Germany and the Netherlands which the AUKOI had asked the defendant to consider, would not be of assistance.

Events after EMC reported: EMC’s report was made available to refiners and importers on 19 June 2006. The department stated that it accepted the recommendations in the report but was willing to discuss points with companies before making recommendations to ministers. Following that, the UKPIA wrote to Mr Jenkins on 27 June stating that the EMC report provided no justification for a differential between refiners and importers and in particular did not take into account the cost of investing in the UK for the refiners. The UKPIA remained dissatisfied with the department’s response at a meeting and sought a meeting with the minister. The claimant wrote to Mr Jenkins on 17 July 2006 making the points that are now the basis of its challenge to the decision. The AUKOI wrote on 24 July stating that the right differential would be 30 days.

On 28 July the defendant sent the associations and their members a timetable for the introduction of the new system stating it was intended to come into effect on 1 July 2007. The letter stated that the department would be sending proposals or options for a transitional period for the benefit of companies which would be subject to obligations for the first time. There were further meetings with the associations and their members in the summer. In particular, Mr Jenkins and colleagues met AUKOI, the claimant, and other importers on 23 August 2006.

On 25 September 2006, after discussing the industries’ responses with EMC, Mr Jenkins wrote to AUKOI. This letter inter alia stated:

“4.

We have always taken the difference in working stocks as the justification for a differential between refiners and non-refiners and in the past AUKOI have supported this. The aim of the report was to establish a robust methodology that would enable a differential to be recommended on a consistent basis.

5.

To use actual stocks as you suggest would raise questions about why different companies had different stocks at different levels at different times, and in particular about the extent to which stock levels were caused by the obligations. What is wanted is some estimate of what stock levels would be in absence of stocking obligations. A generally accepted solution to this is the concept of MOR developed by the IEA, which we ask the EMC to use, and which in this case (for refiners) produced results very similar to those produced by the IEA’s own survey a few years ago.

6.

EMC in their report describe MOR as the “only viable” means of agreeing a differential, that the “only equitable basis for setting a differential is that it should reflect the reality of the difference in working stocks normally carried by the two types of operators” and that “absolute levels of stocks [are] effectively irrelevant”. They have confirmed to us that their use of such words reflected their view that they could think of no other valid way of conducting such an exercise.

7.

AUKOI’s view is that EMC should not have used MOR figures for a single point in time for a supply period of 6 months. EMC have replied that they do not understand this criticism, as such a comparison (i.e. company current inventories with future supply requirements) is common practice in the industry and amongst international bodies such as the IEA.

8.

MOR is seen as a relatively stable concept. As noted, the MOR for refiners closely replicated the results from the earlier IEA study while survey returns from importers varied by a minimal amount. The MOR used should therefore be fairly representative even though based on a single moment in time, but should be measured against a longer average time period to try to smooth out anomalies. Nevertheless, as we said at our meeting, we have rerun the calculations using the average MOR figure across an extended period (based on figures provided by your members and other importers) and this makes no substantial difference to the result.

…

Exclusion of stocks from calculations…

10.

It appears that there has been some misunderstanding here. The only major exclusion was that of category 3 product, which ENC justify in their report. EMC made no general exclusion of stocks related to exports, imports or feed stocks. In any case, the purpose in working on the MOR basis, was not to compare stocks held by companies, or stocks which companies hold in order to meet obligations, but stocks which companies must hold in order to do business.

…

14.

EMC have asked me to say that, although there is nothing in either of your letters which causes them to think that any of their findings should be revised, they would be happy to meet you to discuss your and your advisors’ views on the report directly.”

Mr Jenkins wrote to UKPIA on 2 October responding to the points it made. A submission was sent to the minister and the Secretary of State in 2 October. This stated that if they were to proceed with the new system by 1 July 2007, the need for notice to the industry and for a regulatory impact assessment meant that an agreement to proceed had to be made by the end of 2006. The minister agreed with the submission and stated that he was not keen on a stockholding agency proposal that market operators favoured, because of the cost and the need for legislation.

The minister and officials met UKPIA on 19 October. UKPIA continued to argue that a differential was unjustified and after the meeting wrote to the minister stating that it was particularly anti-competitive that refiners should face a differential on their imports when the process of importing was the same for refiners and importers. There were further exchanges between the defendant and the associations, the claimant, and other importers. Mr Jenkins and colleagues met the claimant and its advisors on 24 November when no progress was made in reconciling views. The claimant, with AUKOI and its other importer members, met the minister on 5 December. Before this, on 27 November UKPIA had made a presentation to the Better Regulation Executive in the Cabinet Office during the course of which they stated they were likely to refer the matter to the OFT or to seek judicial review.

Following AUKOI’s meeting with the minister, it wrote to OFT stating that it was concerned about the competitive impact of the system and asked for a meeting. The meeting took place on 9 January 2007. On 19 January Mr Cassell of the OFT wrote to Mr Jenkins giving him the OFT’s views on the proposed change to the compulsory stocking obligations. Mr Cassell’s letter refers to the concerns of refiners and importers and to the meeting with the importers. The letter states that, notwithstanding the arguments of the refiners and the importers, “there is overall insufficient evidence that the new arrangements may damage competition”. The letter states that the dispute is mainly about the fair distribution of a regulatory burden not its overall level:-

“In order to establish a prima facie case of likely damage to competition, it is necessary to demonstrate that the proposed arrangements are significantly more harmful to competition than a viable alternative arrangement that also complies with the UK’s oil stocking obligations. We have yet to see any evidence of this.”

The letter states that, given the arguments, the OFT cannot see a good reason why the differential favoured by one group (such as the importers) damages competition less than the one favoured by another (e.g. the refiners).

The decision: Mr Jenkins sent a submission, which had been agreed by OFT, to the Secretary of State on 24 January. The submission refers to the statements by both refiners and importers that they were prepared to refer the case to the OFT or to seek judicial review, although by then the refiners had told the department they were not intending to do so. The submission referred to the risk of the importers seeking judicial review but stated that it was considered that the department would be able to show it had sought a fair distribution of the burden of meeting the country’s obligations. The Secretary of State agreed with the submission. On 29 January he sent the regulatory impact assessment to the Prime Minister seeking clearance for the new system. The regulatory impact assessment estimates the cost of operating the compulsory stocking regime as over £1.5 billion a year, depending on the price of oil. After approval was given by the Cabinet Office on 14 February Mr Jenkins informed all interested companies and associations that ministers had decided to change the basis of the UK system for maintaining stocks of oil.

The CRA Report: The claimant had been consulting CRA International. I have referred to the three CRA reports. The first dated 10 May, the day before these proceedings were launched, is very critical of EMC’s approach to the setting of the differential. CRA’s supplementary reports dated 16 October 2007 and 23 January 2008 respectively respond to the defendant’s summary grounds and to Mr Barry and Mr Jenkins’ statements.

In its first report CRA states that EMC should have set out to establish what level of stocks would normally have been maintained by each type of company in the absence of compulsory stocking obligations and then calculated a differential reflecting the underlying position of refiners and importers. Paragraph 27 states:

“actual average inventory over time among refiners and importers must be understood, in order to assess the actual cost burden of imposing a different CSO requirement on each category of market participant”.

CRA argued (§ 22) that, although EMC accepted that market conditions cause companies to carry significant stocks even if there is no stocking obligation, it abandoned this logic in adopting a stocking measurement that is ambiguous and subjective. CRA considers a concept of neutral stocking levels should have been used. A “neutral stock level” or “neutral inventory” is the level of oil that is neither so low as to risk stock outs nor so high that excess working capital is used (§ 63).

CRA’s first criticism of EMC is that it did not assess what stocks would normally be held in the course of business but relied on companies’ subjective estimates of their MORs. These had been obtained by the defendant’s survey which was the only data made available to EMC. EMC proceeded on the basis that minimum operating requirements meant the same as the stock a company would normally hold in the absence of a compulsory stocking obligation, whereas MOR does not reflect variations in discretionary stockholding dependant upon commercial indications. Using MOR fails to establish the level of stocks companies would hold in the absence of compulsory stocking requirements.

CRA also states (§§ 6, 20) that there is no standard definition of MOR and that EMC’s definition was so nebulous as to admit any answer. CRA’s third report sets out communications between it and Ms Kuolt, then of the IEA, in support of its view that MOR is an imprecise and ambiguous concept.

Secondly, CRA considers that the analysis EMC performed on the data was flawed in two ways. First, it arbitrarily excluded fuel oil and naptha stocks from the refiners’ position even though refiners would be allowed to include those to satisfy their stocking obligations. Secondly, it included exports in calculating the minimum operating requirement in numbers of days’ supplies but only inland sales are relevant for the purpose of the stocking obligation. Moreover, CRA considered that EMC made erroneous assumptions about stocking practices and that the significant reservations about the method (the time period), the data (which might be subject to revisions) and the assumptions in it, and its recommendation for further study, for example, as to the impact on the ticket system, were not reflected in its recommendations which were unqualified.

CRA considers that EMC should have examined refiners’ stocks in countries with no meaningful compulsory stocking obligation to determine what their stocking levels would normally have been. It states that, although EMC’s report states that MOR was the only viable method, that was contradicted by its statement that stocking by United States companies offer a clue as to the trend because they are not subject to stocking obligations.

CRA compared the position in refineries in the Netherlands and Germany, in many cases operated by the same companies. It concluded that there is a degree of similarity between Germany and the Netherlands and the UK that enables the use of data from those countries to be used in the determination of the differential. CRA’s method is set out in Part 4 of its first report and in particular at §§ 37 to 67. It used official data published in the Netherlands and Germany. It took account of the size of refineries, their technical complexity, the range of crudes they processed, logistical factors including different patterns of sales by landlocked and coastal refineries, local market factors and proximity to trading hubs.

CRA’s analysis is that the inventories held in Germany and in the Netherlands reflected commercial decisions. Its central hypothesis (see § 68) is that, if oil companies did not have to meet stocking obligations they would operate refineries in the UK in much the same way as the refineries in the Netherlands. CRA compared inventories held by refiners in this country and in those countries. It concluded that whereas the three UK importers carried a combined average of 16.7 days of stock, a UK refinery would hold some 34.2 days. CRA states (§§ 73-75) that since 34% of UK refinery production is normally exported and the Directive’s stocking obligations are based on inland sales, 34.2 days production is equivalent to 51.9 days inland sales, producing a differential of just under 35 days.

The defendant’s response and the claimant’s reply: The defendant’s position as to the utility of comparisons with other countries is principally set out in Mr Barry’s evidence. His statements respond to what is said in the CRA’s report. He says (first statement, §§11(g) and 12(a) and 30(ff)) that, at the outset of its investigation, EMC internally considered using data from other countries but rejected this as a method. It did so because it considered that the differences between the UK and other countries were too great for useful comparisons and because the data was not good enough. Mr Jenkins (§ 120) states that, despite AUKOI’s suggestion when the draft questionnaire was sent to them, the defendant did not think that any other country was sufficiently similar to the UK to suggest comparison as a sound form of analysis.

The first difference between the UK and the other countries relied on by Mr Barry is the great difference in internal oil production. The UK produces 1,700,000 barrels per annum and Germany and the Netherlands produce less than 100,000. Mr Barry states that it is incorrect that the effect of the UK’s large national crude production is not relevant to the volume of oil inventories held in the UK. The EU recognises that it does make a difference and has reduced the UK’s compulsory stockholding by 25%. But Germany and the Netherlands are not entitled to a reduced stocking obligation under the Directive and have had stocking obligations under the IEA for some time.

Secondly, Mr Barry relies on what he describes as a great difference in oil demand in the three countries. Germany is the highest and the Netherlands is the lowest. This difference reflects different levels of natural gas production and fuel oil consumption and demand. In the UK demand for fuel oil is low because of the use of natural gas for domestic fuel. It is high in the Netherlands because of the size of Rotterdam port and the need for fuel oil for bunkers.

Thirdly, Mr Barry refers to the different amounts of oil refined in the countries. Germany refines significantly more than the UK, and the Netherlands significantly less. Fourthly, the geographical location of the refineries is different. In Germany, but not in the UK or the Netherlands, refineries are generally located inland. He states the attitude to potential disruptions in the supply chain and to security of supply is likely to differ. He also states that UK refineries are less sophisticated than those in the other countries, and their costs are usually higher. Total national consumption as a percentage of output is much higher in Germany and much lower in the Netherlands than in the UK because of the different effects of exports.

Mr Barry summarises his position in § 43 of his first statement. He says; “in summary there are clearly significant differences between the three countries which make precise comparison of stockholding levels unsuitable and also indicate the factors affecting stock levels are not substantially the same”. Mr Jenkins (first statement §§ 123 – 126) agrees with Mr Barry. He also states that the fact that refiners run their businesses as a single entity across Europe does not mean that the position in different countries must be comparable. This is (§ 125) because the stocking system is a matter of national policy and governments apply the obligations differently.

In its responses to the defendant’s summary grounds and to Mr Barry and Mr Jenkins’ statements and subsequent correspondence from the Treasury Solicitor, CRA disagree that the absence of significant production in Germany or the Netherlands has implications for inventories, logistics and storage, and sets out its reasons. The recent exchanges also deal with Mr Barry’s view that the CRA calculated German refiners’ total stocks from data that included importers’ stocks. His first statement commented that he suspected the CRA’s figures for Germany were too high because they appeared to include all stocks including those held at German fuel depots. The CRA stated that the relevant German MWV data related only to the inventories of MWV’s members, that is refiners. The Treasury Solicitor wrote to the claimant on 6 February 2008 stating that BAFA data, which CRA acknowledged included all market participants, was the same as MWV’s so that the latter’s data also included the inventories of importers. On 14 February CRA conceded it had made an error and could not exclude the possibility that Mr Barry’s view was correct. However, it maintained that the logic of the statistical reporting process in Germany pointed to the MWV data being only refiners’ data. On 26 February 2008 CRA accepted that the MWV data did include importers data but said that adjusting its analysis would lead only to a reduction of the differential from 35.2 days to 34.4 days.

The CRA and Mr Barry also disagree about the sophistication of UK refineries. This is relevant to two issues. The first is the utility of making a comparison with the other countries. The second is the capacity of UK refineries to convert fuel oil not included as a feedstock with category 1 or category 2 products. CRA had used the “Nelson” index as a measurement (see §12 of its first report) to justify its conclusion that 83% of the UK refineries have the capacity to convert fuel oil, but Mr Barry responded (second statement §14) that, although the table published in CRA’s report shows that nearly all UK refineries have catalytic crackers, most of them do not have a hydro cracker. This is not reflected in the Nelson index. A hydro cracker is the suitable process unit to maximise production of the middle distillates (category 2) for which there is an increasing demand and a deficit in the UK. Mr Jenkins’ second statement (§ 21) says that only two UK refineries are in fact using fuel oil to obtain category 1 and 2 products.

Mr Barry also relied on a May 2007 report by Wood Mackenzie entitled, Review of UK Oil Refining Capacity for Department of Trade and Industry. This states (at p. 2) that “The UK refineries face the challenge of improving their competitiveness – they are presently mid to low performers within the European peer group” and see p. 77 for the position of UK refineries in a European competitive table. The report states (pp. 2, 35) that UK refiners need to adapt to evolving trends and, because of falling North Sea oil production, and to invest to enable them to process poor quality feedstocks, but (pp. 26, 62, 92, 94) that investment in the UK is far behind that in North West Europe. The report also states refinery configuration is an important parameter (74, 75) and (pp 81, 83) that the UK’s configuration is not best aligned with the UK demand profile because most refineries do not have a hydrocracker and development of a hydrocracker configuration will require extensive modifications. It also states (p. 13) that there is a high level of petrol demand in the UK compared with North West Europe.

The principles upon which the court should proceed in a matter such as this are reasonably well established. In the context of European Community obligations the reviewing jurisdiction goes beyond domestic Wednesbury principles. It has regard to the doctrine of proportionality and tests the solution arrived at according to the factual considerations justifying it: see R v Ministry of Agriculture Fisheries and Food, ex p First City Trading Ltd [1997] Eu LR 195 at 219; R v Secretary of State for Trade and Industry, ex p BT3G Ltd and One 2 One [2001] Eu LR 326 at [183-187]. It is, however, not necessary in a judicial review involving rights conferred by Community law for the national court to substitute its assessment of the facts and scientific or technical evidence for the assessment of the competent national authorities: Case C-120/97 Upjohn Ltd. v The Licensing Authority [1999] ECR I-223 at [35].

In the First City Trading case Laws J stated that the court is not concerned to agree or disagree with the decision because that would be to usurp the primary decision maker’s function and that:

“Wednesbury and European review are different models – one looser, one tighter – of the same juridical concept, which is the imposition of compulsory standards on decision makers…”

The court is thus concerned with the range of options open to the decision maker. Laws J stated:

“At least as regards a requirement such as that of objective justification in an equal treatment case, the European rule requires the decision maker to provide a fully reasoned case. It is not enough merely to set out the problem, and assert within his discretion the Minister chose this or that solution, constrained only by the requirement must be one which a reasonable minister might make. Rather the court will test the solution arrived at, and pass it only if substantial factual considerations are put forward in its justification: considerations which are relevant, reasonable and proportionate to the aim in view.”

As to the width of the margin left to the primary decision maker, this depends on the nature of the decision and the context. In the present case, member states are given a choice as to the arrangements for meeting the stocking obligations provided, in particular, the arrangements are fair and non-discriminatory. The choice reflects a decision to allow a general Community policy to be given effect in the particular economic and social circumstances of a member state. Although, unlike R v Secretary of State for Health, ex p Eastside Cheese Co. [1999] Eu LR 968 the present case is not concerned with primary legislation, the approach of Lord Bingham CJ in that case (at 998) suggests that the nature of the issue left to member states by Directive 2006/67 puts the margin left to them as primary decision makers at the broader end of the spectrum.

Assistance as to the scope of review and the width of the margin of appreciation accorded to the primary decision-maker is also provided by Case T-374/04 Germany v Commission a decision of the CFI (7 November 2007). This concerned Germany’s notification of its national allocation plan concerning greenhouse gas emissions to the Commission in accordance with Article 9(1) of Directive 2003/87. The CFI stated that, where a Directive does not prescribe the form and methods for achieving a particular result, the freedom of action of member states as to the choice of appropriate forms and methods for obtaining that result “remains, in principle, complete”: at [78].

Article 9(3) of Directive 2003/87 empowers the European Commission to verify whether the measures adopted by member states are consistent with the criteria set out in Annex III to the Directive and Article 10. The CFI stated (at [81]) that, in carrying out that review, the Commission itself has a discretion “insofar as the review entails complex economic and ecological assessments carried out in the light of the general objective of reducing greenhouse gas emissions…”. It also stated that while the court conducts a full review as to whether the Commission has applied the relevant rules of law properly, it “cannot take the place of the Commission where the latter must carry out complex economic and ecological assessments”. In that respect, “the court is obliged to confine itself to verifying that the measure in question is not vitiated by a manifest error or a misuse of powers, that the competent authority did not clearly exceed the bounds of its discretion and that the procedural guarantees… have been fully observed”.

In the present case, the assessment of the position of refiners, absent the stocking obligations, and the assessment of the difference between them and the position of importers is not straightforward because refiners, but not importers, had been subject to stocking obligations for many years. The evidence submitted by the claimant and the defendant summarised above shows that the assessment depends on analysis of the structure of the market, the business decisions taken by refiners, and economic market analysis and modelling.

In the light of ex p Eastside Cheese and Germany v Commission, in the present case prima facie the defendant has a wide margin of appreciation. Adapting what Laws J said in the First City Trading case, this means that, within the diverse contexts in which the principle of non-discrimination may be called in question, there will be a range of options factually open to the decision maker, here the defendant. The court’s task is not to decide what it would have done had it been the decision maker. It’s task is: “to decide whether the measure in fact adopted falls within the range of options legally open to the decision maker. In the nature of things it is highly unlikely that only one of the choices available to him will pass the test of objective justification; and the court has no business to give effect to any preference for one possible measure over another when both lie within the proper legal limits.”

In ex p BT3G Ltd and One 2 One Silber J, whose judgment was approved by the Court of Appeal ([2001] EWCA Civ.1448), stated at [186] that “the concept of margin of appreciation can be relevant when it is a matter of balancing the relevant considerations”. He stated:

“the balancing and weighing of relevant considerations is primarily a matter for the public authority and not the courts. Courts have, however, been willing to strike down as unreasonable decisions where manifestly excessive or manifestly inadequate weight has been accorded to a relevant consideration irrelevant in determining whether a consideration is relevant.”

Accordingly, while the balancing of relevant considerations is primarily for the public authority, the court may intervene if manifestly excessive or manifestly inadequate weight is given to a relevant consideration. Silber J’s language is similar to and reflects that used by the CFI and the ECJ, as exemplified by Germany v Commission.

I return to the provisions of Directive 2006/67/EC. Article 1 imposes an obligation to hold 90 days stock but leaves it to member states to decide how to implement the obligation. The language of Article 1(1) provides that states shall adopt such laws or administrative provisions “as may be appropriate”. Thus, see Article 3(3), it is for states to decide to do so by means of a stockholding entity, by imposing obligations on refiners and other market operators, or by a combination of the two. Article 1(2) also leaves it to states to decide how to distribute any reduction in their obligation resulting from indigenous oil production.

This power of decision by member states and their freedom to decide how to implement their stocking obligations is subject to the other provisions of the Directive. This case is concerned with Article 3, but there are other constraints on the freedom of a member state. Thus, a state may only hold stock outside its national territory within the conditions set out in Article 7. Article 8 requires states to have measures to ensure control and supervision of stocks, and Article 4 requires them to provide the Commission with a monthly statistical summary of stocks.

Article 3(2) requires member states to “ensure that fair and non-discriminatory conditions apply in their stockholding arrangements” and that “the cost burden resulting from the maintenance of stocks in accordance with Article 1 shall be identified by transparent arrangements…”.

It is, as the defendant submits, clear that the purpose of Article 3(2) is not to iron out competitive advantages and disadvantages between different operators. However, Article 3(2) requires that arrangements to be fair and non-discriminatory. The claimant’s written submissions are that this requirement, read together with the reference in recital 9 to “fair and non-discriminatory sharing” of the burden, and the reference in the second paragraph of Article 3(2) to “the cost burden resulting from the maintenance of stocks” requires an assessment of the actual cost burden of the obligations on market operators: skeleton argument §§ 10, 48, 58, and see grounds §§ 73-74. In his oral submissions Mr Layton QC, however, referred to the relative cost burden.

It is also central to the claimant’s case that it is necessary to equalise the burden between different groups of market operators: skeleton argument §§ 14, 36(a), 58ff. The Directive does not, however, use the language of “equalising the burden” or state that it must be shared “equally”. Since the choice of arrangements within the parameters of the Directive is left to member states, as Laws J observed in First City Trading [1997] 1 Eu. LR 195, at 219, “in the nature of things highly it is unlikely that only one of the choices available will pass the test of objective justification” and qualify as fair, non-discriminatory, and transparent. The existence of such choice also points against construing the Directive as requiring “the burden” to be “equalised”.

What of the requirement in the second paragraph of Article 3(2) that the “the cost burden … shall be identified by transparent arrangements” and “appropriate information” regarding the cost burden be made available to interested parties? I do not consider this requires the identification of the cost burdens of individual refineries and importers. Apart from issues of the practicality of collecting such material, and the possible distorting effects of the stocking obligations on refiners’ businesses, much of the information about companies’ costs will be confidential and could not be published or identified by transparent arrangements. Moreover, the claimant argues that an appropriate differential should be identified, using data about actual stocks held in Netherlands and Germany or the concept of neutral stocking level. But these methods do not identify the cost burden of holding stock.

I have referred to the difficulty of assessing what stocks refiners hold for commercial reasons and will return to this when considering the use of MOR. At this stage, it suffices to note that the claimant acknowledges (see the discussion at [86], [92] below) that one cannot look at refiners’ actual UK stocks because stockholding levels have been affected by some 40 years of stockholding obligations. In these circumstances, any attempt to identify the burden cannot be precise. The fact that, as the claimant now accepts, identification of the cost burden does not require identification of the actual or relative cost burden by a precise calculation, significantly weakens its case that under the Directive it is necessary to equalise the burden between different groups of market operators.

There is some force in the defendant’s submission that the second paragraph of Article 3(2) is primarily understandable in the context of charges imposed on companies for central stock holding rather than as requiring information to be published about individual companies. However, even if it is not to be understood in this way, assessing whether the requirements of fairness and non-discrimination have been satisfied requires consideration of the use of MOR as a measuring tool to determine the differential between the stocking obligations of refiners and importers. This is the first and more fundamental part of the claimant’s challenge. The issue is whether the use by the defendant of MOR as a concept to compare the operational sides of the two types of business while excluding commercial decisions about holding stock, is a legitimate basis for proceeding. It will not be if it does not meet the requirements of fairness and non-discrimination. But if it does meet those requirements, the publication of a method based on days’ consumption based on published criteria satisfies the requirements of transparency.

There are three limbs to this part of the challenge. First, although not emphasised by Mr Layton, it is said there was evidence of an a priori view being taken by the defendant about the use of MOR data to determine the differential and as to its downward revision.

Secondly, and the focus of Mr Layton’s argument, reflecting the criticisms in the CRA reports and by Mr Keyworth, is that the use of MOR to determine the differential in stocking obligations was unlawful because there is no sufficient link between the concept of MOR and the economic burden (in the language of Article 3(2) of the Directive) “resulting from the compulsory stocking obligation on refiners and importers”. EMC’s use of MOR to assess the actual economic burden did not consider the way differential compulsory stocking obligations work in practice. For example, account was not taken of what stocks held would count towards meeting those obligations and thus account was only taken of part of the stocks actually available to fulfil the refiners’ obligation. The CRA reports state that MOR is a concept “of no significance or relevance to day to day commercial decisions regarding inventories” (CRA III §§ 3-4), and depends on a subjective snapshot (CRA I §§ 99-100). Mr Layton submitted that MOR is inherently incapable of ensuring the differential equalises the economic burden resulting from the CSO obligation and should not have been used at all let alone as the exclusive means of determining the differential.

Mr Layton also submitted that MOR is a subjective analysis which results in the omission of a substantial proportion of actual inventory. The assessment of the differential was based on the MOR data in the responses to the questionnaire, i.e. on returns made by parties who were aware that the information in those returns would be the basis of the differential. In the case of the refiners those returns took account of only half their stocks. Moreover, as a snapshot at a particular time, the data is inherently unreliable. He said this unreliability is illustrated by the figures for stocks of gasoline in Table 2(a) of Annex 1 to EMC’s report for the period for which the data was collected. Importers stocks were 22.4 days and were higher than the 14.9 days stocks held by refiners notwithstanding the understanding that refiners hold “far more” stocks than importers.

Mr Layton also relied on the fact that the IEA uses MOR for a different purpose, as a measure of the stocks that would not be available in the event of supply disruption and then as a guide to the total level of potentially accessible stocks in a given geographical area. He submitted that, as Mr Keyworth states in his first report (§§ 66-72), this is a very different exercise from the use of MOR to compute the relative stocks held by different groups of market operators. To do this he argued is to use a macro instrument in a micro context, in a way which is capable of magnifying any errors.

Finally, Mr Layton argued that in focussing exclusively on MOR and disregarding alternative sources of information about stockholding patterns, in particular data from other countries, EMC (and consequently the defendant) has failed to take account of a relevant consideration in the determination of the differential. An assessment of natural average inventory absent compulsory stocking obligations could have been informed by considering the inventory in countries where there is no stocking obligation on market operators. Mr Layton described EMC’s assessment of the possibility of doing this as far more critical than its assessment of the appropriateness of MOR, and, adopting Mr Keyworth (second statement § 2), “unduly asymmetric and binary”. He submitted that it was unreasonable not to have regard to the information about other countries’ inventories

The third limb of this part of the claimant’s challenge is that the defendant erred in relying on EMC’s report notwithstanding that it contains many reservations and caveats which had not been resolved, and notwithstanding the warnings of both the industry associations that it was wrong to use MOR for this purpose. Mr Layton relied on §§4.1, 4.7, 5.1, 5.3, 5.4, 5.6, 5.15, 6.10-6.13, 7.15, 7.16, 8.11, and 8.15 of EMC’s report. He submitted that there was no indication that these caveats and the concerns they reflect were taken into account by the defendant. In one respect, the treatment of exports, he submitted that the defendant failed to appreciate EMC’s analysis. This showed it did not grasp the nature of the advice it was given by EMC.

I have referred to the statements in First City Trading, BT3G and One 2 One, and Germany v Commission as to the approach to be used when considering a member state’s assessment of a complex economic issue concerning a Community matter on which he has been given a choice as to the implementing arrangements. Mr Layton recognises that it is not for the court to carry out that assessment itself but argued that the evidence in the CRA reports and by Mr Keyworth shows that the defendant’s approach was so manifestly erroneous so as to enable the court, within the principle stated by the CFI in T-374-04 Germany v Commission § 81 as justifying intervention by way of judicial review.

For the reasons in the following paragraphs, I have concluded that, in the light of all the evidence before me, the decision by the defendant to accept EMC’s recommendation and to base the differential on MOR and not to use data from other countries was not manifestly erroneous and fell within the margin of appreciation left to it.

There is nothing in the criticism that the defendant influenced or pre-determined the outcome of the EMC’s report by its a priori view. The department’s outline for the proposed work stated that its view was that the difference in working stocks held by refiners and non-refiners justified a differential but that “this might be reduced in size”. The reason given, that the difference between refiners and importers in terms of stockholding and access to storage is less than that between refiners and supermarkets and that the level of stocks held by refiners has declined, is said to be based on “anecdotal evidence” rather than a full survey of the position. As far as using MOR is concerned, the outline states that it wishes advice in designing a questionnaire to send to industry “to establish a firmer basis of evidence on the level of working stocks held in the normal course of business and the difference made by the stocking obligation”. In parenthesis it is said that as far as the refiners are concerned “this could build” on the IEA’s work on MORs. The defendant was entitled to express its preliminary views. The way it did so did not foreclose EMC undertaking the work in the way that it wished. In fact EMC agreed with the defendant that the use of MOR was an appropriate way to proceed: see Mr Barry’s first statement § 11(d).

The first substantive criticism of the use of MOR is that it disregarded part of UK refiners’ and importers’ actual inventories. However, since refiners have been subject to compulsory stock holding obligations for a number of years, actual UK stockholdings in themselves do not provide the answer. The refiners’ position, as communicated to the defendant, was that having regard to actual stocking levels penalised them for compliance with their obligations. The refiners argue that they have had to invest in relevant infrastructure. I bear in mind that their individual costs are confidential to them, and their motivation for holding a particular level of stocks is difficult to ascertain. The defendant was entitled to take these factors into account.

Mr Keyworth stated (first report §103) that actual stockholdings would be expected to have “some relevant information content rather than being determinative”. The difficulty is how to distinguish relevant and irrelevant information. CRA relied on a concept of neutral stocking levels, to assess what stocks would be held in the course of business. Leaving aside the use of data from other countries (which I consider below), it is not clear from the evidence how stocks that refiners hold for commercial reasons are to be identified. The evidence submitted on behalf of the defendant is that there is no easy way of doing so. The claimant appears to accept this since it submits that the answer is to be obtained by considering the data on holdings by market operators in Germany and the Netherlands.

The defendant’s position in relation to actual UK inventories is far from manifestly erroneous or irrational. Indeed, as Mr Barry’s second statement observes (§6), CRA’s own estimates of refiners’ stocks in the Netherlands and Germany, where there are no significant compulsory stocking obligations, show stock levels significantly below those held by UK refiners. That suggests that, absent stocking obligations, UK refiners would not normally hold stocks as high as 67.5 days. Moreover, the complaint that the MOR returns took account of only half of refiners’ stocks does not take account of the fact that some of those stocks were properly excluded. An important reason for the proportion of the refiners’ inventories that are left out in EMC’s assessment is the omission of refiners’ large fuel oil inventories. The MOR calculation considers only categories 1 and 2. While the claimant challenges the total exclusion of fuel oil from the MOR calculation (see [118] below), it accepts that it would not be right to include all refiners’ stocks of fuel oil because importers do not hold stocks.

I do not consider that the criticisms of subjectivity and vagueness stand up to scrutiny. While the MOR data relied on self-assessment by the refiners, there is no evidence that the refiners depressed their MOR figures. Mr Jenkins’ evidence (§110 of his first statement and §5 of his second statement) is that the 2005 survey produced results for refiners similar to those produced in the 2002 survey conducted by the IEA. I accept Miss Lee’s submission that the fact that there was little difference between the 2002 and the 2005 results makes it unlikely there were significant errors in the results provided.

As to the vagueness of the concept of MOR, this concept has been used by the IEA since before 1990 and is well understood: see Kristine Kuolt’s statement, §5. Ms Kuolt’s evidence is that MOR is not an unstable metric and has been “quite consistent over time at the country level”: ibid, §15. The defendant has been familiar with the IEA’s work since the early 1990s: Mr Jenkins’ first statement §23. The real question, to which I shall return, is whether a concept designed to assist IEA member countries identify what stocks companies needed to operate at all in order to identify what level of stocks would be unavailable in the event of disruption was appropriate for calculating the differential. However, in the light of the evidence of Ms Kuolt, Mr Barry and Mr Jenkins, the statement in the first CRA report that there is no standard definition of MOR and that EMC’s definition is so nebulous that it admits of almost any answer must be rejected.

I turn to the criticism that the MOR figures used by EMC are a snapshot in time and that using them was (CRA I §§88-91, claimant’s skeleton §137) perverse. First, EMC used product delivery returns across a six month period (see EMC report §5.2 and Mr Jenkins’ first statement §115). Secondly, in the light of representations by the claimant and other importers, the defendant re-ran average MOR figures for importers across a twelve-month period rather than the single point in time used in the EMC report. It found this made no substantial difference to the result for the time used in the EMC report: see Mr Jenkins’ first report §118. The additional data was collected from importers but not from refiners because the defendant was aware from figures it had previously collected from refiners that there was little variation as far as refiners were concerned over time. Moreover, the defendant was entitled to conclude that MOR was less subject to seasonal variation and other market movements than actual stocks: see Mr Jenkins’ first statement §§107 and 116.

I add that the illustration given by Mr Layton to show the unreliability of data collected on a particular day does not in fact do this. The illustration was based on Mr Keyworth’s observations (first report §72) that it is anomalous that the figures in Table 2(a) of Annex 1 to EMC’s report show the importers’ group with an MOR for gasoline that is significantly higher than that shown for the refiners’ group and that there is no indication that the robustness of this data was adequately tested. Mr Jenkins’ second statement (§15) says the figures for gasoline in the table are those for importers’ and refiners’ stocks of finished gasoline. This will under-record the refiners’ position because they hold large quantities of crude and feed stocks as well as finished products. He says that EMC did not use this figure to calculate the differential. It used the total of crude and products. That total shows refiners’ stocks as significantly higher than importers’: the respective figures for refiners and importers are 27.5 and 6.9 days. Accordingly, this illustration provides no support for an allegation that the data was unreliable and using it was perverse.

I return to whether MOR, a concept designed to assist IEA member countries identify what stocks companies needed to operate at all in order to see what level of stocks would be unavailable in the event of disruption, was appropriate for calculating the differential between the stocking obligations of refiners and importers. The defendant was aware that it was using MOR in a different way to the way the IEA used it. Mr Barry and Mr Jenkins’ evidence is that MOR was considered a suitable (albeit not precise) tool for identifying and quantifying differences between refiners and stockers. I have concluded that this conclusion was not manifestly erroneous or perverse and that the defendant was entitled to conclude that MOR was an adequate means of assessing the relative differences in the operations of the refiners and importers.

First, for the reasons I have given, MOR is not a vague concept but one well understood in the industry. Secondly, there was evidence upon which EMC and the defendant could conclude that MOR levels reflect structural differences in operations between different types of companies: see Mr Barry’s first statement §7(a) and Mr Jenkins’ first statement §§20 and 23. Mr Barry’s evidence (first statement, §5) is that different types of operators will have different levels of MOR because the technical factors determining the amount of available oil in the supplying system or length of the supply chain, the types of processes involved, the range of products carried, the distribution methods, and the geographic range of operations. The defendant was entitled to conclude that the measurement of what stocks companies had to hold in order to carry on their operations was an appropriate sound basis for identifying what the differential should be because it identified the impact of these structural differences.

This is also part of the answer to Mr Layton’s submission that, as a measure of stocks that would not be available for use in an emergency, MOR cannot be used under the Directive which is concerned with “stocks fully at the disposal of member states”. This was both part of his general critique of the use of MOR and of his submission that the use of MOR did not satisfy the requirement in Article 3(1) that “stocks…shall be fully at the disposal” of member states. He also relied on Article 6(1) which provides that only stocks held in accordance with Article 3(1), i.e. fully at the disposal of member states, shall be included in the statistical returns.

MOR was used by EMC and the defendant as a broad way of identifying the impact of structural differences on the operations of the two types of operator. It was not used to establish the extent of the obligation on refiners. The Directive does not state that MOR is to be excluded from stocks available for Article 3(1) purposes. It is not, as such, an excluded category under Article 6(3). Article 6(3) is in part concerned with stocks totally unavailable, such as stocks in pipelines but does not exclude MOR. There was no challenge to the evidence by Mr Jenkins and Mr Barry in their second statements, §§28-31 and 34 respectively that, apart from the exclusions in Article 6(3) under the Directive, all stocks including MOR “working stocks” can be counted towards meeting compulsory stocking obligations and reporting stock levels to the European Commission.

It is also relevant to an assessment of the legitimacy of having regard to MOR that a question on MOR was included in a questionnaire by the European Commission to member states as part of the consideration of the compulsory stocking legislation. It is true that the figures for stocks held specified a total for the industry without differentiating different market operators, and the minimum operational requirements are given as an average of the industry as a whole. But the fact the European Commission considered that MOR was relevant in the consideration of compulsory stocking obligations provides a measure of support for the defendant’s reliance on it.

As to data about the inventory positions in countries where there is no compulsory stocking obligation on market operators, there is a sharp difference between the position of the two consultancies and the experts working for them as to the suitability of such data. The question is whether manifestly inadequate weight was given to this consideration in deciding to use the data: see the passage from Silber J’s judgment in BT3G Ltd and One 2 One at [187], quoted at [73] above.

The defendant knew from AUKOI’s letter of 22 November 2005 that the association wanted it to use inventories in countries that do not impose stocking obligations on importers and refiners. It is clear that EMC considered using the position in other countries and examined data from 15 EU member states but, having rejected this as a method, dealt relatively briefly with it in its report. Contrary to the claimant’s suggestion there is no support in §4.7 for the use of data from other countries, and all that emerges from §§4.8-4.9 is that stocking levels in the USA may offer a “clue” to trends but also to discretionary stock rises to deal with security concerns. §8.2 refers to the similarity “in many respects” of the UK to many European oil markets but also to oil-self sufficiency, one of the reasons EMC does not consider data from other countries to be relevant. The issue, however, is the cogency of the reasons now given by Mr Barry and Mr Jenkins in their evidence.

Notwithstanding the difficulties in doing so, the court must, to an extent grapple with the economic complexities of the issue. Despite the complaint that the approach of EMC and the defendant was “unduly asymmetric and binary”, I have concluded that the critique of the approach of CRA means that it cannot be said that EMC and the defendant erred in deciding not to use inventories in countries where market operators do not have stocking obligations.

CRA’s analysis and the claimant’s case rely on averaging the total refinery inventories in Germany and the Netherlands. However, the figures for each country and for each category of product in each country differ. So, for category 1, the Netherlands has 14.3 days stock, whereas Germany has 21.8, and in category 3 the respective figures are 23.9 and 42.4 days: see Tables 1 and 2, CRA first report pp. 16-17. Mr Barry comments (first statement, at §56) that these differences undermine the claim of similar refinery operations and similar stock-holding practices in the Netherlands and Germany. Moreover, IEA figures suggest that patterns of domestic consumption differ greatly in the three countries; UK 69%, Netherlands 15%, and Germany 81%. Given these differences, and the potentially distorting effect of averaging across different countries, the figures from these two countries do not show that the defendant’s view that use of inventory figures from other countries is not appropriate is wrong, let alone manifestly so.

There is, moreover, the fact, as now acknowledged by CRA, that the German figures it used included importers’ inventories, and thus exaggerated inventories attributed to refiners. CRA have argued that this error only has a small effect on its calculation of the differential. It is, however, relevant that one of EMC’s reasons for rejecting using data from other countries was that it considered the data was not good enough. The fact that the German data does not separate the position of importers and refiners supports EMC’s position. Significantly, Ms Kuolt states (§17) that she is “unaware of any other IEA country establishing or revising mandatory stocks levels based on stocks being held on average in another country or countries. Indeed, the MOR survey results underscore the difficulties of cross-border comparisons”.

One factor relied on by CRA is that UK refineries are not, as Mr Barry states, “less sophisticated” than those in the Netherlands and Germany. The difference between them as to this is another issue on which it is not possible for the court to say that the position taken by Mr Barry is erroneous. The claimant criticised Mr. Barry’s reliance (second statement §15) on the statement in the Wood Mackenzie report that UK refineries are presently mid to low performers within the European peer group” and the position of UK refineries in a European competitive table. Mr Layton argued that this report was about the use of high cost crude and significant exports and not about the sophistication of refineries. The report, however, also states that investment in the UK is far behind that in North West Europe; comments on the UK’s refinery configuration which is stated not to be best aligned with the UK demand profile because most do not have a hydro cracker, and states that development of a hydro cracker configuration will require extensive modifications. CRA assessed similarity of sophistication by reference to an industry index, the Nelson Index. Mr Barry’s evidence (second statement §§14) is that this index identifies refineries with catalytic crackers but not those with hydro crackers.

Finally, CRA’s view (third report, §23) that EMC is fifteen years to twenty years out of date in stating that national markets are affected by national factors and subject to national decision-making is not supported by relevant evidence. The material in Appendix 2 to CRA’s report is from websites and annual reports. It is very general, and primarily concerned with concentration of trading and supply divisions. Save for a reference to adjusting production “to the needs of local markets” on the Total website and to optimising supply of crude and feedstocks for each refinery and the off-take of each refinery’s products in Petroplus’s 2006 Annual Report, the material does not include anything about production decisions or levels of inventory in the different categories.

The defendant also took into account the consultations with the OFT and the OFT’s view that the proposal did not damage competition. Although, as the claimant submitted, it does not appear that the OFT conducted an investigation into the level of the differential, it considered the arguments put by the AUKOI and importers and those put by refiners before it formed a view. The AUKOI wrote to the OFT stating that it was concerned about the competitive impact of the system and asked for a meeting which took place on 9 January 2007. Mr Cassel’s letter dated 19 January to Mr Jenkins was written in the light of the OFT’s considerations of the arguments presented by AUKOI, imports and refiners. It did not query the use of MOR as a way of comparing the respective businesses. It was entitled to form a view without a detailed investigation and the defendant was entitled to take that view into account.

The defendant (see Mr Jenkins §20) recognises that the differential is a blunt instrument. It was entitled to conclude, in the light of the EMC report, that there was no clear way of determining what stocks refiners would hold absent stocking obligations because, given the forty year history of those obligations, there was no way of disentangling stocking because of the obligations from stocking for commercial reasons. EMC had considered whether data from other countries could be used and had concluded that it could not. It was no doubt in part because of its conclusion that it decided that using MOR was the only viable way. Mr Barry has now explained the reasons for EMC’s conclusion. The structural differences between the UK and Germany and the Netherlands set out by Mr Barry, together with the demonstrated error in CRA’s use of the German data have satisfied me that there was no manifest error in the conclusion that it was not possible to determine the differential by using data from other countries.

For the reasons given in paragraphs [75]-[82], I have concluded that the Directive left the defendant with a range of options as to how to impose stocking obligations on market operators’ which are fair and non-discriminatory. For the reasons given in paragraphs [92]-[111] I have concluded that his use of MOR to compare the business of refiners and importers falls within the range of choices legitimately available and does not contravene Article 3(1) or Article 3(2). I do not consider it necessary to make an Article 234 reference of the interpretation of Article 3 of the Directive to the ECJ.

The rival arguments on these issues are arguments about the way to make an appropriate comparison. They involve consideration of relatively complicated economic analysis and market modelling. The decision-making power is given by the Directive to the defendant. In considering the review of a decision of this sort, the court affords the primary decision maker a broad margin of appreciation. The defendant decided that MOR was a concept that enabled it to compare the operational sides of the two groups of businesses while excluding commercial decisions operators may take about holding stock. It did not fall into error in so doing.

On the basis of total MOR reported by refiners and importers measured against total product delivery returns for each, EMC calculated the total MOR for refiners as 28 days supply and for importers at 7 days supply, a differential of 21 days. EMC stated (§5.9) that it did not consider the simplistic calculation of total MOR was an equitable basis for assessing the differential. It considered that the analysis had to take account of the fact that the obligations under the Directive only covered the three specified product categories: gasoline, middle distillates and fuel oils; that importers do not hold stocks of fuel oil or naptha; and that the position of refiners is distorted by the excessively high MOR for fuel oil, which it calculated at about 70 days supply. The report states (§5.11) that:

“For the three EU product categories only (gasolines, middle distillates, fuel oil), while also taking account of exports of those products in the calculation for refiners, the MOR for refiners works out at 10.5 days, for importers at 8.5 days.”

EMC considered (§5.13) that “any meaningful comparison between refiners, which both use fuel oil as a refinery feedstock and sell into final consumption, and non refiners who … do not handle the product, should exclude fuel oil”. It therefore proposed (§5.14) using only the MOR for category 1 and category 2 products as a basis for comparing the refiners’ and importers’ relative stocks of finished products; that is excluding fuel oil. On that basis it calculated that the MOR for both groups worked out at about 10.5 days supply. The report then stated (§5.15) that this ignored crude and feedstock stocks of which account should be taken. It went on to include the proportion of crude and feedstock stocks which equated to the finished products, that is to the refinery yield of category 1 and category 2 in total refinery output. Taking this adjustment into account, EMC calculated (§§5.15-5.16) that the share of these stocks that could be counted towards the two product categories resulted in an adjusted MOR of 9.5 days supply, and that the resulting differential between refiners and importers was 9.5 days supply.

The claimant challenges the legality and rationality of adjustments made by EMC to the differential made in respect of fuel oil, naptha and exports. The claimant calculates that the total effect of these adjustments on the differential is 8.5 days, the bulk of which, 5 days, is represented by exports.

Fuel Oil: EMC excluded fuel oil from the comparisons it made between refiners’ and importers’ MOR because importers do not stock fuel oil at all and thus do not have a stocking obligation in respect of category 3. Accordingly it concluded that fuel oil should not affect the differential. Including refiners’ fuel oil would increase the differential by some 2.5 days.

The claimant has made a number of criticisms of EMC’s treatment of fuel oil. For instance, it has argued that the level of fuel oil is lower than it should be because the survey of MOR was taken during the summer months. It also suggests that the fuel oil returns included both straight run and cracked fuel oil so that Mr Barry’s view that the fuel oil in category 3 is mostly cracked fuel oil which cannot be converted into category 1 and 2 products is “incredible speculation”. Its key criticism, however, is that none of the refiners’ stocks of fuel oil have been counted in assessing the differential. The claimant accepts that it would not be right to include all refiners’ stocks of fuel oil because importers do not hold stocks. It, however, argues that the proportion of fuel oil which can be converted into gasoline should have been counted.

The evidence of Mr Jenkins and Mr Barry is that the large surplus of fuel oil in the UK and low domestic demand for it means that, whenever they can, refiners will use it as a refining feedstock. They have a commercial incentive to convert as much of their surplus fuel oil as they can. When they do so it is allocated by a formula to category 1 or category 2 products. The claimant submits that EMC and the defendant have assumed that all fuel oil that can be used as a feedstock has been allocated to category 1 or 2 but this assumption is not based on evidence. Moreover, it argues that the refiners have an interest in minimising their MORs in categories 1 and 2 when reporting to the defendant in order to minimise the differential.

The defendant also argues that the capacity of UK refiners to convert fuel oil into category 1 and 2 products rather than using it as a feedstock is limited because only two UK refineries UK have the capacity to do so. The evidence submitted by the parties on this issue is summarised at [64]-[65] above.

I have concluded that the decision not to include a proportion of the refiners’ fuel oil when calculating the differential was not unlawful. First, the IEA stock reporting rules state “a refinery feedstock is a processed oil destined for further processing (e.g. straight run fuel oil or vacuum gas oil) excluding blending. With further processing, it will be transformed into one or more components and/or finished products”. Mr Barry’s evidence (second statement, §8) is that under the IEA rules straight run fuel oil is normally counted as a feedstock and allocated to the product categories by a formula depending on refinery yield. It was not manifestly wrong for the defendant to conclude that fuel oil that was so converted or is intended to be so converted would be reported as a feedstock. The argument that refiners had an interest in minimising their MORs in categories 1 and 2 is inconsistent with the fact that the results of the 2005 survey conducted by the defendant are consistent with the results of the 2002 survey when there was no such incentive for refiners: see [43] (paragraph 5 of the letter dated 25 September 2006) and [95] above.

I turn to the claimant’s submission that the defendant’s view that the capacity of the United Kingdom refineries to convert fuel oil to category 1 and 2 products is limited is mistaken. Challenges to factual and discretionary assessments by the primary decision-maker must be supported by evidence. On “sophistication”, the claimant has furnished evidence. However, in the light of the Wood MacKenzie Report and Mr Barry’s evidence that the Nelson Index does not reflect refineries with hydro crackers, it is not possible to say that the defendant’s position on the sophistication of UK refineries is manifestly wrong. The issue of sophistication, however, is not determinative. The key evidence submitted on behalf of the defendant, however, is that only two UK refineries were, at the time of the MOR survey in 2005, and at the present time, using fuel oil to obtain category 1 or category 2 products: see Mr Jenkins’ second statement, §21. This supports the defendant’s position that the capacity of UK refiners’ to convert fuel oil into category 1 and 2 products is limited. There has been no reply to this evidence, and this part of the claimant’s challenge is not therefore made out.

The claimant, while arguing that it is wrong not to allocate a proportion of the fuel oil MOR to the refiners’ MOR in categories 1 and 2, has not said what that proportion should be beyond referring to the distinction between “straight run fuel oil”, which can be refined so as to produce a yield of gasoline and diesel, and “cracked” fuel oil which cannot and criticising Mr Barry’s view that the fuel oil in category 3 is mostly cracked fuel oil which cannot be converted into category 1 and 2 products as “incredible speculation”. In the light of the claimant’s application for judicial review the defendant has considered whether some of the fuel oil in fact counted as category 3 might have been reprocessed and should have been included as category 1 or 2 products: see Mr Jenkins’ second statement §23. It concluded that it would not be possible now to identify the extent to which this might have happened. Moreover, the exercise would involve making a number of assumptions and calculations based on actual stocks held when the basis of the defendant’s approach has been MOR. The defendant also considers that such calculations involve commercially sensitive information about the operations of the two refiners who do use fuel oil to obtain category 1 or 2 products and that this information could not and should not be made public.

The defendant assesses that the amounts involved with these two refineries are unlikely to be significant and would amount to no more than half a day in terms of the differential, a period which the claimant says is significant. The function of the court, however, is not to determine the differential but, in accordance with the principles I have discussed, to determine the legality and proportionality of the defendant’s approach. The claimant accepts that it would not be right to include all refiners’ fuel oil in calculating the differential. The defendant is entitled to conclude, inter alia in the light of the IEA stocking rules that fuel oil used as a feedstock would have been reported as a category 1 or category 2 product. There is no way of transparently ascertaining how much fuel oil is used to obtain category 1 or category 2 products by the two refineries capable of doing so without making public sensitive commercial information. For these and the other reasons I have given, the approach the defendant took in respect of fuel oil was not manifestly erroneous.

Naptha: The claimant’s case on naptha is similar to its case on fuel oil. Naptha can be blended into gasoline and counted as contributing towards a refiners’ stocking obligation. Accordingly, it is argued that the naptha inventory should have been included in the refiners’ MOR. Doing so would increase it by 0.73 or 0.9 days if exports are treated as the claimant submits they should be. Although Mr Jenkins (§137) justifies the adjustment by stating that the quantities of naptha were “not sufficiently material to affect the result”, the claimant submits that this lack of materiality is an argument for keeping the naptha in the calculation rather than making an express adjustment to remove it.

It is common ground that naptha itself is not one of the categories subject to stocking obligations. As far as the argument that it should be counted because it can be blended into gasoline, the defendant’s evidence is that naptha will either be blended into gasoline or used to make petrochemicals. Petrochemicals are excluded from the oil stocking obligations and are thus irrelevant for present purposes. Mr Jenkins states that, where naptha has been blended with petrol, companies would have reported the product as category 1 and it would have been included in their calculations. He states that, in the light of the claimant’s application, the defendant considered whether it should have included the naptha intended for use in making petrochemicals in the differential calculation because such stocks might have been converted into category 1 product. However, he remains of the view that excluding naptha is right: second statement §26. The reason he gives is that the defendant could not tell how much of the naptha intended to be used to make petrochemicals would have been used as a feedstock and thus qualify as a category 1 product. The figures relied on by the claimant assume that all the naptha will be so used.

The submission that, if the defendant considers the quantities of naptha are not sufficiently material to affect the result, the adjustment should not have been made has some attraction. I have nevertheless concluded that the defendant’s decision to make the adjustment was not unlawful.

Naptha itself does not fall within categories 1 to 3. The defendant considers that where refiners use naptha for feedstocks for category 1 and 2 product they will have already included it in their returns for MOR for those categories. The claimant argues that the defendant assumes rather than demonstrates this is so. The defendant’s view is, however, consistent with the way fuel oil feedstocks are counted under the IEA stocking rules (see Mr Barry’s second statement, §8).

Moreover, the claimant’s analysis also rests on an assumption. It assumes that all the naptha is converted into gasoline and diesel products when naptha is also used to make petrochemicals which do not count for the stocking obligation. Since it is known that some naptha stocks are intended to be made into petrochemicals and are so made, the claimant’s assumption is not a reasonable assumption. No way has been identified for telling what proportion of the naptha intended for petrochemical use will be used as a feedstock and thus qualify as a category 1 or 2 product. The amount will depend on market demand and will vary. In these circumstances, the defendant’s decision to exclude naptha cannot be said to be manifestly erroneous.

Exports: The obligation under Article 1(1) of the Directive is in respect of average daily internal consumption. Some 30% of refiners’ stocks are exported. Section 5 of EMC’s report, which deals with the MOR survey, states (§5.16) that the assessment of refiners’ MOR of total products works out at 28 days on the basis of inland “deliveries” (i.e. supplies), but at 19.5 days on the basis of inland deliveries and exports. Since importers do not export, on either basis of assessment their MOR works out at 7 days. The data and methodology are set out in Annex 1 to the report.

The reasons for taking account of exports by EMC are not to be found in the report. It is only from the evidence given by Mr Barry and Mr Jenkins in response to the claimant’s application that the reasoning underlying EMC’s approach to the treatment of export volumes has emerged. The absence of any explanation for this part of EMC’s methodology in the report may reflect Mr Barry’s view (first statement, §19, and [137] below) that what was being done was common practice in the industry. However, the consequence was that the explanations were given in response to the claimant’s challenge and thus only after battle lines had been drawn.

In section 5 of EMC’s report, exports are first referred to in the context of fuel oil. I have referred to EMC’s view that the position of the refiners group was distorted by the excessively high MOR for fuel oil. It stated (see §§5.9 - 5.10) the reason for this was difficult to determine precisely, but appeared to be the low level of inland sales of fuel oils. Paragraph 5.10 of the report states that, if exports of fuel oil are included, the refiners’ MOR for fuel oil measured in days supply comes down to about 10 days, which is similar to the ratio for gasoline and middle distillates if exports of those products are also taken into account. Paragraph 5.11 (quoted at [115] above) works out an MOR for refiners and importers for the three product categories in the Directive “while also taking account of exports of those products in the calculation for refiners” (emphasis added) but does not explain why account has been taken of exports.

The calculations in Annex 1 show that the stock holding position of refiners was calculated on the basis of dividing refiners’ MOR by total daily sales, that is the total of both inland and export sales. An example based on hypothetical figures can be used to show what was done by EMC and to illustrate the positions of the parties. The example assumes the refiners’ group has a total stock of 100,000 tonnes, makes daily inland supplies of 6,000 tonnes, and daily exports of 4,000 tonnes. EMC’s approach divides the 100,000 tonnes by 10,000 (6,000 + 4,000). On these hypothetical figures, the result is that the 100,000 tonnes would represent 10 days supply.

Mr Layton submitted that it was correct of EMC to include total stocks in the top half of the equation (total MOR stocks) because all stocks in fact count towards meeting the stocking obligation. He submitted that it is, however, wrong to divide the total MOR stock figure by total daily sales because it is known which sales are export sales and it is only daily internal consumption that is relevant for the stocking obligation under Article 1(1). The defendant erred in adopting EMC’s approach. Had EMC divided the total stock only by the daily inland supplies, refiners would have been shown to have a larger number of days’ stock. On the hypothetical figures in my example, this would be 16.6 days supply instead of 10 days. Mr Layton argued that the effect of EMC’s calculation was thus artificially to depress the stock holding position of refiners and thus to reduce the differential between them and importers. He also relied (skeleton argument §§27 and 136) on paragraph 10 of Mr Jenkins’ letter dated 25 September 2006, which states “EMC made no general exclusion of stocks related to exports” as showing that the defendant did not understand that EMC had “adjusted the differential to take out of account refiners’ stocks related to exports”.

While paragraph 10 of Mr Jenkins’ letter is not at all clear and does give some support to the claimant’s submission, what is important is the reason for the treatment of exports by EMC and the defendant. I therefore return to the evidence now given by Mr Barry and Mr Jenkins in response to the claimant’s application. The defendant’s position (see Mr Jenkins’ second statement, §27 and Mr Barry’s second statement, §32) is that, although it would have been better if the situation concerning exports had been explained more fully, paragraph 10 of Mr Jenkins’ letter is not inaccurate because exports were not taken out of account. They were in fact taken into account in the way I have set out above. Although it appears from paragraph 10 of Mr Jenkins’ letter that the defendant’s appreciation of that position may have been less than full, it is clear that the defendant was aware that the MOR figures had been divided by both inland supplies and export supplies. The calculation used is evident from table 4 in Annex 1 of EMC’s report. The defendant’s awareness is clear from paragraph 13(c) of Mr Jenkins’ 2 October 2006 memorandum to the Minister, Mr Wicks, and the Secretary of State, and from his second statement (§27).

Mr Barry’s evidence (first statement, §19) is that it is common practice in the industry to compare stocks between different groups of companies (such as refiners and importers) by dividing the total stocks held by the total level of sales by each group. The evidence of Mr Jenkins (see his first statement, § 134) is that they had asked refiners to distinguish between stocks held for inland consumption and those held for export but they could not. His evidence and that of Mr Barry was that, had it been possible to determine which stocks were for inland use and which for export, EMC would have taken into account only stocks intended for inland use and divided those by daily inland sales but this was not possible. Mr Barry’s evidence includes the statement (first statement, §20) that:

“… operators do not always know for sure which stocks would ultimately be destined for exports, such decisions often being made after the stocks have left the refineries. In some cases volumes ultimately destined for export, are held in the same distribution storage facilities as products for inland sales.”

It was for this reason that the figure for total stocks were used.

If EMC had divided a tonnage figure for MOR which included both inland and export sales with average daily sales figures that included only inland sales, the result would have been a figure for days supply that treated all refiners as if they made all of their sales to customers in the United Kingdom. It would thus treat any refiners who did not export at all in the same way as those who did. The evidence is (see Mr Barry’s first statement, §22) that levels of exports vary considerably between different refineries “with some, located for example in South Wales, normally exporting a significant proportion of their products output, whilst others, on the south coast and in the north west of England, for example, to our knowledge exporting little or none of their output.” He concluded that using an average figure for the whole group would penalise some companies unfairly. Mr Jenkins (first statement, §135) states that it would penalise refiners who do not export.

It is common ground that the stocking obligations in the Directive are based on inland consumption. It was submitted on behalf of the claimant (skeleton argument, §81) that if the stocking obligation is calculated in terms of inland supplies, the only basis for calculating the stockholding position of the two groups should be inland supplies. It was also submitted (skeleton argument, §§89-90) that Mr Barry’s observation in the part of his first statement concerned with export stocks, that “any consideration of the way in which [the stocking] obligations were applied in practice was outside the remit of the study” shows a fundamental flaw in EMC’s approach because the additional burden of the stocking obligations on an operator depends on how they actually apply. The second submission, although made in the context of exports, was primarily directed to the contention that the task in fixing the differential is to equalise the burden, with which I have dealt at [75]–[82] above.

I reject the submission that the only basis for calculating the stockholding position of the two groups is that of inland supplies. First, the claimant’s argument that it was right to use the total figure of stocks because stock that may ultimately be exported can count towards satisfying an obligation relating to refiners’ inland business does not sit comfortably with it. Secondly, it treats refiners who do not export as if they do. I return to this. Thirdly, the claimant’s approach involves a partial reversion to the use of actual stocks as a criteria or factor, but the use of MOR represents a decision by the defendant not to use the stocks of refiners because of the distorting effect of the stocking obligations to which they had been subject for so many years. If, as I have decided, it is legitimate to use MOR to compare the operating modes of importers and refiners, what is relevant is the MOR of the two groups expressed as a number of days supply, not what stocks the rules permit an operator to count towards the fulfilment of its stocking obligations.

Since the stocking obligations in the Directive are based on inland consumption, it would not have been correct to treat individual refiners who export a substantial proportion of their sales in the same way as individual refiners who do not. EMC’s view was that stocks exported should be excluded from the calculation of the number of days supply represented by the stocks held. This is in principle correct. In view of the evidence that refiners were not able to report their MOR figures net of exports, that calculation could not be made directly. In these circumstances, it was reasonable for EMC to seek another way of doing so.

Was the method EMC did use manifestly erroneous or unreasonable? Miss Lee argued that what was done produced the same result as would have been produced if it had been possible for EMC to ascertain what stocks were intended to be held for inland deliveries and thus to focus solely on those. She submitted that dividing the total stocks by the total days supplies took refiners’ export business completely out of the equation in a way that conformed to the claimant’s argument that the concern of the Directives is solely with inland supply. She accepted that this calculation assumed that MOR stocks are to be apportioned in the same ratios as inland and export deliveries. This assumption was said to be unfounded by the claimant. However, I observe that it is similar in nature to the assumptions which CRA and the claimant have proposed in relation to fuel oil and naptha. It is not, in my judgment, an unreasonable or manifestly erroneous assumption.

In conclusion, it is common ground that the stocking obligations in the Directive are based on inland consumption. EMC sought to take exports out of the calculations but could not do so directly because refiners were unable to identify their MOR figures net of exports when completing the questionnaire. EMC did not err in its decision to calculate the stockholding position of refiners and importers on the basis of the total of daily inland and export supplies rather than only the total daily inland supplies. Dividing refiners’ total stocks by only the total daily inland sales of all refiners in a market where levels of exports vary considerably between different refineries would treat all refineries as if they did not export and would be unfair to those who in fact export little or none of their output. EMC’s decision to divide total stocks by total sales seeks to achieve the result that would have been achieved if exports could have been stripped out of both sides of the equation. It did so by an assumption that MOR stocks are to be apportioned in the same ratio as the ratio between inland supplies and exports. In the circumstances, that assumption was not unreasonable or manifestly erroneous.

I accordingly refuse this application. I was troubled by the way the EMC report dealt with the approach to exports, in particular the absence of reasons. However, having considered all the evidence put forward on behalf of the defendant in justification of the different elements of the decision that have been challenged, including the reasons for the treatment of exports, I am satisfied that the Secretary of State made a decision which satisfies the test under European law propounded by Laws J in First City Trading of being “fully reasoned” and “within the range of options legally open to the decision maker”. As Silber J stated in ex parte BT3G Ltd and One 2 One, if European law is satisfied, so must English law be because of its wider margin of appreciation.

The UK oil supply structure – the difference between refiners and non-refiners

The nature of oil supply and operating systems means that some stock of oil will be permanently required at most points in the delivery chain. The question of “normal” minimum operating (MOR) is notoriously difficult to specify precisely – partly because it varies considerably, depending on geographical logistical and seasonal factors and will thus differ widely between individual markets/regions. In reality, the MOR of a complete supply system will be determined by the weakest link in the delivery chain: the point at which the flow of oil is interrupted….

In measuring minimum stocks, it is necessary to differentiate between the absolute and relative levels. Any comparison of minimum stocks should thus be measured in terms of sales or deliveries, normally expressed in terms of days supply. It is, for example, clearly evident that commercial stock levels in the main oil consuming areas have been reduced substantially in volume terms since the early 1980s, yet part of this can be accounted for by the reduction in overall oil consumption.

This notwithstanding, commercial oil companies have, especially since the 1980s, been engaged in a relentless drive to reduce costs and increase efficiency, particularly in downstream sector. This has led to the widespread and substantive rationalisation of capital equipment alongside attempts to optimise facilities, reduce supply lines and employ sophisticated management tools to reduce unit costs throughout the supply chain.

All this means that “normal” minimum operating stocks have almost certainly been reduced, but other market developments have slowed this process down: environmental restrictions on product specifications often require segregated storage facilities; similarly, crude input needs at refineries today tend to be more varied than in the past, suggesting greater crude storage requirements.