United States v. Arch Coal, Inc.: U.S. District Court Rejects Likelihood of Anticompetitive Post-Merger Coordinated Interaction Among Leading U.S. Coal Producers

In August of 2004, Arch Coal, Inc. ("Arch") successfully rebutted the Federal Trade Commission's ("FTC" or "Commission") claim that the acquisition by Arch of Triton Coal Company, LLC ("Triton") would substantially lesson competition among leading coal producers in Wyoming's Southern Powder River Basin ("SPRB"). On August 16, 2004, the U.S. District Court for the District of Columbia rejected the FTC's request to enjoin the acquisition pending an administrative hearing.1 Four days later, the U.S. Court of Appeals for the District of Columbia Circuit declined the FTC's request for an emergency stay of the merger pending appeal.2 Arch announced completion of the acquisition that same day.

The decision, rendered after a two-week trial, ended a 16-month long investigation by the FTC, which began shortly after Arch agreed to buy Vulcan Coal Holdings, Triton's sole owner, for $364 million in May 2003. The FTC informed the Court of Appeals on September 9, 2004, that it would not pursue an appeal of the District Court's decision. The following day the FTC also abandoned its plans to hold an administrative hearing to review the transaction before an administrative law judge.3

Arch Coal raises important issues regarding coordinated effects analysis and customer testimony for firms contemplating mergers or acquisitions. In particular, the District Court rejected the FTC's theory of coordinated interaction, finding the agency's reliance on postmerger output collusion to be a "novel" approach to coordinated effects analysis. This aspect of the Court's opinion generated much criticism from the FTC, and was ultimately rejected by the Court of Appeals. However, as in the recent United States v. Oracle4 decision, the Court found customer concerns regarding the transaction unpersuasive. This is significant as the agencies traditionally place great emphasis on customers' views when determining whether to challenge a transaction.

Factual Background

Arch and Triton extract coal from Wyoming's SPRB, which accounts for approximately one-third of the coal produced annually in the United States. SPRB coal is known for its low sulfur content, and is the most economical source of fuel that complies with U.S. Clean Air Act sulfur limitations.5 Virtually all SPRB coal is purchased by electric power companies for use in their coal-fired steam generating units.6 Coal-fired generating plants account for about 92% of all coal consumption, and produce about 50% of all electric power, in the United States.7

SPRB mines are divided into three tiers based on coal quality, heat content, and location, with Tier 1 mines producing the highest British Thermal Unit ("Btu") coal ranging from 8600 to 8900 Btu, Tier 2 mines producing a mid-range Btu ranging from 8300 to 8550, and Tier 3 mines producing a low Btu coal ranging from 7900 to 8450.8 At the time of the District Court's decision, seven companies operated fourteen mines in the SPRB, four of which, including Arch and Triton, the Court considered to be the major producers of SPRB coal, each a Tier 1 producer. The Court recognized RAG American ("RAG") as another significant producer in the SPRB, operating mines only in Tier 2 and Tier 3, and found that the remaining two small mines did not significantly compete with the larger mines.

The assets to be acquired by Arch involved Triton's North Rochelle mine, which operated in Tier 1, and Triton's Buckskin mine, which operated in Tier 3. In order to help win regulatory approval, Arch agreed to sell the Buckskin mine, which accounted for about 40% of Triton's coal production, to Peter Kiewit Sons, Inc. ("Kiewit"), a fringe competitor with mining interests outside the SPRB.

After examination of the evidence, the Court considered, inter alia, (a) the relevant product market, (b) the proper measure of industry concentration, (c) the likelihood of tacit coordination among firms remaining post-merger, (d) the FTC's concerns regarding elimination of an industry maverick, as well as (e) the potential of fringe competitors to defeat a post-merger price increase by the three remaining large suppliers.

Product Market

The FTC asserted that the acquisition by Arch of Triton would violate Section 7 of the Clayton Act9 and Section 5 of the FTC Act10 because, inter alia, the acquisition may "substantially reduce competition in the SPRB market … substantially reduce competition in 8800 Btu SPRB coal … [and] would make coordination among SPRB producers, and among producers of 8800 Btu SPRB coal, easier, more likely, more successful, and more durable."11 Due to the low sulfur, ash, and sodium content, as well as exceptionally low mining costs associated with SPRB coal, the FTC argued that SPRB coal has a strong economic advantage in supplying many electric generators compared to coal produced in other regions of the United States.12 The FTC asserted that 8800 Btu coal produced in Tier 1 is functionally and economically distinct from the 8400 Btu coal produced in Tier 2 and Tier 3 because more 8400 Btu coal must be transported and burned in order to generate the same heat output as would be generated from the same quantity of 8800 Btu coal, and because some customers experienced performance problems such that they could not substitute 8400 Btu coal for 8800 Btu coal, regardless of economics.13

However, in both trial testimony and depositions, virtually all of the testifying utilities acknowledged that they can and do purchase and consume both 8800 and 8400 Btu coal, and that even customers having a preference for 8800 Btu coal have used other Btu coal and have benefited from competition between 8800 and 8400 Btu coal.14 Based on the reluctance of the FTC's own expert to conclude that 8800 Btu coal is a separate relevant market, and on evidence of significant interchangeability between 8800 and 8400 Btu coal, the Court concluded that the relevant product market is "no broader and no narrower than SPRB coal."15 The Court reasoned that "[i]n determining interchangeability . . . the court must consider the degree to which buyers treat the products as interchangeable, but need not find that all buyers will substitute one commodity for another."16

Concentration

The Herfindahl-Hirschman Index ("HHI") is used by the U.S. antitrust agencies to measure the impact of a merger or concentration within a relevant market.17 Sufficiently large HHI figures establish a prima facia case that a merger is anticompetitive.18 The merging parties urged the Court to measure HHI based on reserves of recoverable coal,19 while the FTC argued that the Court should use loadout capacity20 as well as other factors. Because the Court found reserves, loadout capacity, production and practical capacity21 to all be informative, yet imperfect, indicators of the merged firm's future ability to compete, the Court considered all of the measures in assessing whether the FTC had established a prima facie case for an anticompetitive merger.

Given that all of the measures resulted in an increase in HHI sufficient to indicate significant competitive concerns, and possibly a presumption of an anticompetitive merger, the Court found the FTC had established a prima facie case of an anticompetitive merger.22 However, because the postmerger increases in HHI were "far below those typical of antitrust challenges" brought by the FTC and Department of Justice ("DOJ"), the Court concluded that the FTC's prima facie case was not strong, and that, by pointing out shortcomings in the HHI measurements, the parties had rebutted that presumption.23 Thus, the Court concluded that the burden shifted back to the FTC to prove that competitive effects would be likely to substantially lessen competition in the relevant market.24

Coordinated Effects Analysis

1. The FTC's "Novel Theory" of Coordinated Effects

While the case law concerning Section 7 has developed largely based around theories of coordinated interaction,25 until recently, the agencies alleged coordinated effects only as a secondary theory of harm and relied instead on unilateral effects to establish that the merged entity likely would harm competition.26 In recent years, however, the agencies have placed a new emphasis on coordinated effects analysis as evidenced by the 2003 decision in United States v. UPMKymmene Oyj,27 and the FTC's 2002 decision not to challenge the merger of certain cruise lines.28

Consistent with the recent emphasis on coordinated interaction, the FTC's theory in Arch Coal regarding likely harm to competition focused on post-merger tacit coordination among the remaining competitors.29 The FTC theorized that post-merger "the major producers would constrain their production so that increases in supply would 'lag' increases in demand, thus creating upward pressure on price."30 The District Court observed that the theory advanced by the FTC required the agency to "show projected future tacit coordination, which itself may not be illegal, which is speculative and difficult to prove, and for which there are few if any precedents."31

Perhaps the most significant aspect of the Court's coordinated effects analysis was that it distinguished coordinated effects challenges based on price coordination from those based on output coordination: "prior coordinated effects challenges to mergers based on alleged output coordination have invariably been accompanied by a coordinated effects theory grounded on price coordination."32 In so finding, the Court reasoned that "[t]he novel approach taken by the FTC in this case makes its burden to establish anticompetitive effects in the post-merger SPRB market more difficult."33 In other words, the government must meet a higher burden of proof when it attempts to establish that competition is likely to be harmed post-merger as a result of output coordination than when it attempts to establish the likelihood of harm based on post-merger price coordination.

The FTC took issue...