Government's Response to OFT's Review of Undertakings by Macfarlan Smith Limited

Government’s Response to OFT’s Review of Undertakings by MacFarlan Smith Limited (MSL)

Market Analysis Opium in the UK – Analysis to date

March 08

Sections in this report

I) Background II) Home Office Undertaking III) Market Structure IV) Conclusions from Previous Market Analysis V) Taking the Analysis Forwards VI) Conclusions To Date

Annex A: Copy of text from letter written by the EU Commission to EU Parliament re Opiates Annex B: Summary of responses to Home Office data request.

I) Background a) OFT Review

In 2006 the OFT published a report:

Opium Derivatives, A Review of the Undertakings Given by Macfarlan Smith (MSL)1.

This report recommended that the Government should consider competition when setting licensing policy for opium derivatives. b) Government Response

The Department for Business, Enterprise and Regulatory Reform (BERR) has a general interest in OFT's market studies and co-ordinates Government responses where those studies make regulatory recommendations. Consideration of regulatory and policy issues is a matter for the relevant Department. In its response to the OFT2, the Government agreed to:

Undertake to analyse the effects of MSL’s position as sole supplier on customers and competition, contrasting this with the positions of customers in other countries (both those who impose significant restrictions and those who do not). c) Work Undertaken by ERA & Drugs Liaison & Enforcement Unit (DLEU)

BERR commissioned the Home Office to take forwards this market analysis. It was agreed that, at this stage, rather than repeat the OFT’s work a few years on (which was largely based on a survey of MSL’s UK customers) it made more sense to try and take the analysis forwards.

1 Opium Derivatives – A Review of the Undertakings by Macfarlan Smith, OFT 834, 2006. 2Opium Derivatives: Government’s Response to OFT’s Review of the Undertakings by MacFarlan Smith Limited, Sep 2006, URN 06/1873

1 Despite having no formal data collection powers or significant competition analysis experience the DLEU agreed to seek to obtain the necessary information to take the analysis forwards. ERA has been assisting DLEU in its data requests and the subsequent analysis.

This note summarises the position to date.

II) Home Office Undertaking a) Key Deliverables

The Government set up an action plan to take forwards the OFT review. This contained four actions: 1. Review the licensing policy [for opium derivatives] to ensure that the detrimental impact to competition is prevented, or where other objectives intervened, limited. 2. Repeating this process of review every five years [next due in 2010]. 3. Analyse the effect of MSL’s position as sole supplier on customers and competition, contrasting this with the position of customers in other countries; 4. Present the findings of the market analysis to the European Commission as background information.

This note is concerned with the last two points. b) HO Approach

HO Officials agreed with BERR officials that the key to this analysis was to try and take forwards what the OFT had done rather than repeat that analysis. On this basis HO officials undertook a three pronged approach:

I) Continued monitoring of MSL maximum price lists

The OFT review considered the maximum price lists of MSL over a period of time.

The OFT review noted that “MSL has reacted to our concerns about the lack of customer knowledge about the price list by agreeing to improve compliance and ensure that all bulk customers are kept informed of the maximum price list.”

The OFT’s price analysis has been replicated and extended to cover those issued since the OFT’s report.

II) Analysis of the data provided by MSL to the OFT.

Due to legal constraints generated by the fact that all the information gathered for the OFT review was gathered under the Enterprise Act 2002 the OFT was unable to provide the HO with any of the data it had collated3.

3 Specifically Section 241(1) and Section 244 of the Enterprise Act 2002 states that disclosure of any material disclosed to the OFT under part 9 of the Enterprise Act 2002 cannot be disclosed to third parties without the agreement of the OFT. The OFT had not undertaken the necessary disclosure tests to identify if the information could detrimentally affect the business interests of anyone providing that information. The OFT therefore could not disclose the information to the HO. This position was confirmed by HO Legal Advisers Branch.

2 The HO therefore had to request that MSL provide the HO with copies of the information provided to the OFT. MSL complied with this request and this information was reviewed afresh.

III) Collation of cross EU pricing information

In order to contrast the UK position with “the positions of customers in other countries” the HO wrote to 15 other Licensing Authorities to collate data on overseas markets for Opium Derivatives (essentially data on the market structure, quantities of opium derivatives traded and prices of those opium derivatives which are traded). The response rate has not been sufficient to facilitate any meaningful analysis. c) Regular Reporting

As part of this work BERR is required to provide a regular six-monthly update of progress to Economic Development Committee (Formally EPAC).

III) Market Structure a) Overview

The principal opium derivatives used within the UK are: • Codeine; • Dihydrocodeine; • Morphine; and • Diamorphine.

Of these, codeine is produced in the highest volume, and sold downstream to be incorporated by pharmaceutical companies in a wide range of products, many of which are available commercially. At the other end of the scale, diamorphine is a marginal product, used almost exclusively by the NHS. MSL is the world’s sole manufacturer of diamorphine. The market is worth around £30m per year.

Opium derivatives – especially morphine and diamorphine – are highly prized on the illicit market and actively sought by mis-users. It is important that such products cannot be diverted into the illicit market, but also that the guaranteed purity of pharmaceutical products is not jeopardised. b) Licensing System

The licensing system, and current Government policy, is rooted in a number of multilateral drug treaties4 which rest on the concept of national control by individual states within the limits of their jurisdiction. These deal with the licensing and inspection of cultivation, production, manufacture and trade (including import and export) in the controlled drugs.

4 The 1961 Single Convention of Narcotic Drugs (which was strengthened by the 1972 protocol amending that Convention); the 1971 Convention on Psychotropic Substances and the 1988 UN Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances. The UK is a party to all three conventions.

3 There is therefore a control equation, monitored by the International Narcotics Control Board (INCB), which ensures a balance between legitimate production with legitimate requirements. To enable the functioning of this, the UK Government must provide estimates of our requirements for narcotic drugs to the INCB for confirmation on an annual basis. The UK must not exceed these estimates without good reason and the prior knowledge and acceptance of the INCB.

The UK has to provide the INCB with an annual estimate of the narcotics it expects to be consumed (medical, scientific and manufacture of drugs). The HO must agree any upward/ downward revisions to the estimate.

The HO bases these estimates on info from manufacturers at the end of the proceeding year.

Any manufacturer wanting to produce, supply, manufacture, import or export narcotics requires a license from the HO.

In terms of opiates the HO will authorise imports from the EEA if the drugs are readily available from within the UK.

Licenses are provided if the imports will not cause the UK to exceed its INCB estimate.

Since 1992 the HO has permitted imports of opiates from the EU or EEA. The decision not to import from outside the EEA was upheld in High Court in R v Secretary of State for the Home Office ex parte Arthur H Cox Ltd.

In Aug 04 the HO (in response to inc imports of codeine phosphate and fear of exceeding the INCB estimate) apportioned its estimate for 2005 (39.5 tonnes in total): • 35.5 tonnes for the UK market (cutting MSL’s 2004 figure by 4 tonnes); • Importers up to 4 tonnes (Cutting back import licenses in 2005 for just over 9.7 tonnes in 2005).

In 2008 the apportionment is to allow importers between 4.5 and 5 tonnes.

The most commonly used formulated products using codeine dihydrocodeine and pholcodeine contain only small quantities by weight and can be freely imported without a need for a HO license.

Formulated products must comply with the necessary MHRA licensing procedures. c) Market Structure

The diagram over is adapted from the OFT & MMC reports. This illustrates how the market for opium derivatives, and in turn, the formulated opiate products (the drugs that incorporate opium derivatives) is structured.

4 Fig 1: Market Structure for Opium Derivatives and Formulated Opiate Products

Poppy Straw Raw Material Concentrate of Poppy Straw

Opium Chemical Morphine Codeine Derivatives Reaction

Morphine Codeine Dihydrocodine Diamorphine Pholcodine Salts Salts

Used Formulated For Opiate Analgesics Analgesics (severe) (mild) Analgesics Products Analgesics Antitrussives Antitussives – Antitussives (Moderate) (severe) (mild) (severe) (mild)

Note: • Analgesics – Used for the treatment of mild to severe pain. • Antitussives – Used to suppress the cough reflex.

5 IV) Conclusions from Previous Analysis a) EU Commission

MSL provided the Home Office with a copy of a letter from the EU Commission to the Vice-President of the European Parliament (Dated Jan 99). This states that:

The Commission has during the last ten years repeatedly attempted to obtain from the Member States a definition for a common approach in respect of the controlled circulation of opiates within the Community, as well as the controls on their imports from third countries. These attempts have proven to be fruitless, since a majority of the Member States are unwilling to surrender any of their competence to control the flux of opiates crossing their boarders. Therefore, the Commission is unable, at this stage, to propose any harmonizing measures in this particular domain.”

The full text of the letter is repeated in Annex A. b) OFT Review of the Undertakings by MacFarlan Smith (2006)5

The OFT reviewed the operation of the undertaking given by Macfarlan Smith Limited (‘MSL’) in 1989, to publish and make “generally available” a list of maximum prices for certain opium derivatives, against the background of developments in the production and use of opium derivatives over the past 16 years. The undertaking was given by MSL to the Secretary of State for Trade and Industry following the above MMC report.

The OFT completed a review of the undertakings given by MSL to the UK competition authorities.

Key points from the OFT conclusions include the following:

• In 1989 the MMC found that MSL was able to exploit its monopoly position by charging high prices and engaging in price discrimination at the expense of those customers buying smaller quantities. It also found that MSL achieved very high levels of profitability. It concluded that these practices were against the public interest. The Office of Fair Trading (OFT) finds that these practices continue to be features of MSL's supply.

• MSL's profits from the reference opium derivatives, as measured by return on capital employed, have fallen compared with 1980s levels, but are still high.

• The OFT finds that MSL's undertaking to publish and make generally available maximum price lists has not been consistently complied with.

A key recommendation was that the Government takes into consideration competition issues for the purposes of devising future licensing policy.

5 Opium Derivatives: A review of the undertaking given by MacFarlan Smith Limited, March 2006, OFT 834.

6 c) Monopolies & Mergers Commission Report (1989)6

In 1987 the Director General of Fair Trading asked the commission to investigate the supply in the United Kingdom of six specified opium derivatives. The report made the conclusions summarised below.

• The MMC found that MSL had around 87% of the market for opium derivatives and was therefore a scale monopolist as defined in the Fair Trading Act 1973.

• MSL faces little competition in the United Kingdom and there is little prospect of new entry.

• MSL has exploited this monopoly situation by engaging in price discrimination and has been enabled to charge high prices in the domestic market.

• The MMC recommended that the Home Office, in conjunction with other Government departments, should work towards the creation of a single EC market in the reference products.

Following this report MSL was committed to the undertaking that they would publish their maximum price lists.

V) Taking the Analysis Forwards a) OFT analysis of maximum price lists for Codeine Phosphate

The OFT looked at the maximum price lists drawn up by MSL for Codeine Phosphate 1988 to 2004. The HO replicated this analysis for 1990 to 2004 using the information provided by MSL for the purpose of understanding the OFT’s approach and analysis (see diagram over).

The OFT noted that: • When the price list was updated over the period prices increased on all but one occasion. Before 2004 the only decrease in prices was in 1992 (and only for those customers buying more then 300 Kg); • The price profile remained very similar through the period – prices per KG rise as the quantity purchased falls; • The OFT was informed that raw materials make up 80% of the costs or producing the final product – they would normally expect that (in a competitive market) price variations in these raw materials would be reflected in prices.

6 Opium Derivatives: A report into the matter of the existence or possible existence of a monopoly situation in relation to the supply in the United Kingdom of opium derivatives, The Monopolies and Mergers Commission, cm630, 1989.

7 Fig 1: Maximum price lists for Codeine Phosphate (90-98 Source: MSL)

Maximum price lists for Codeine Phosphate (1990-1998) Source - MSL 900

1998

800 1997(B)

700 2004

) 1997(A) £ ( e 600 c i r

P 1996

500 1993

1992 400 1990

300 Over 2000kg 2000 kg 1000kg 500kg 300kg 50kg 30kg 10kg Under 10 kg Weight kg

b) HO monitoring of price lists for Codeine Phosphate and Diamorphine since the OFT review.

MSL provided the Home Office with the maximum price lists it has drawn up since the OFT review.

Analysis of the price lists for Codeine Phosphate and Diamorphine show that whilst the price profile (i.e. the change in price by weight purchased) has remained constant, the generally upward revisions in prices before 2004 have been halted.

The diagrams over show the maximum price lists issued by MSL for Codeine Phosphate and Diamorphine since 1997.

In the case of Codeine Phosphate the price fall that took place in 2004 has not yet been reversed.

In the case of Diamorphine the price fall for Codeine Phosphate was not matched. The critical fact, however, is that the upward trend in prices has again been halted. The maximum price for Diamorphine has not been increased since 2004.

8 Fig 2: Maximum price lists for Codeine Phosphate (97-08 Source: MSL)

Maximum price lists for Codeine Phosphate 1997-2008 Source: MSL 900 1998

800 1997

700

2005 600 to 2008 P r i c e

( 500 £ )

2004 400

300 Over 2000 kg 1000kg 500kg 300kg 50kg 30kg 10kg Under 10 kg 2000kg Weight kg

Fig 3: Maximum price lists for Diamorphine

Maximum Price Lists for Diamorphine HCL 1997-2008 Source MSL 3500 2004 to 2008

3000 1997

2500 P r i c e £

2000

1500 9 300kg 50kg 30kg 10kg Under 10 kg Weight kg c) Analysis of the data provided by MSL to the OFT.

MSL provided the OFT with considerable information during the OFT review of undertakings. Although the OFT was unable to share this information with us, MSL did provide the Home Office with copies of the information they had provided to the OFT.

Within this information MSL had provided some information on: a) Average domestic and export prices; b) Average prices across a small sample of countries (for which MSL was able to provide data).

The primary opium derivative of concern to previous market investigations by the MMC and OFT has been Codeine Phosphate.

If we look at the data provided by MSL for Codeine Phosphate it does suggest that average UK prices may be higher than some other countries but the sample is not big enough to draw any definitive conclusions.

Figures 4 and 5 (below) show: a) The average domestic and export prices for Codeine Phosphate; b) The average prices for Codeine Phosphate in UK, Germany, Canada & Switzerland

Fig 4: Average domestic and export prices for Codeine Phosphate

Codeine Phosphate - Domestic & Export Average prices (£) Source: MSL 450

400

350 e c Export Average Prices (£) i r

P Domestic Average Prices (£) 300

250

200 1997 1998 1999 2000 2001 2002 2003 2004 Year

10 Fig 5: Average prices for Codeine Phosphate in UK, Germany, Canada & Switzerland

Codeine Phosphate - Averge Prices (Converted to GBP) Source: MSL

500

450

400

350

A Germany v

e Switzerland r 300 a Canada g e P r i c

e 250 (

G 1997 1998 1999 2000 2001 2002 2003 2004 B

P Year ) d) Collation of cross EU pricing information

The above data, while far from conclusive, suggests that it would be beneficial to collect more comprehensive price information from a range of EU states.

The Home Office has no formal data gathering powers from institutions in other states.

Despite this, and in order to compare the position of UK consumers with those overseas, the Hone Office requested data from 15 overseas licensing authorities covering data on: • The productive capacity; • The import and export of opium derivatives; • The prices of opium derivatives per KG; • Whether any investigations into their respective opium markets had been conducted.

Regrettably the response rate from these licensing authorities has been so low and/ or limited in terms of information that it did not provide enough information to make any meaningful analysis possible.

None of the countries who responded has conducted investigations into their own opium industries.

The summary of responses to the Home Office requests is in Annex B.

11 VI) Conclusions To Date

The OFT, in its report, pointed out that as raw materials make up 80% of the costs of producing the final product – they would normally expect that (in a competitive market) price fluctuations in these raw materials would be reflected in prices.

The maximum prices of MSL do not show any fluctuations generated by underlying resource costs. What is apparent, however, is that the price increases of the 90’s appear to have halted.

Analysis of MSL’s own pricing data does show some differences between countries. This data is far from conclusive. The Home Office did ask MSL if they could provide any further data on a wider range of countries. MSL indicated that they did not have information for any other countries.

The Home Office also asked MSL if they could update some of the analysis provided to the OFT in 2004. MSL explained that much of their analysis was done using INCB data. As there is a delay in publishing this data they indicated they would only be able to add one years data at present.

1. It is not possible to say whether this the pricing pattern of the last few years is solely due to regulatory attention – it does suggest, however, that continued monitoring of MSL maximum price lists (and the investigation of any subsequent significant price rises) may provide a downward pressure of prices which, over time, partly counteracts any lack of competitive pressure.

2. Rather than update information piecemeal they offered to provide a full update for several years, using subsequent INCB data, in 2009. It would make sense to take up MSL’s offer in advance of the next five year licensing review.

3. The reason behind the lack of any robust response from licensing counterparts is unclear. What is clear is that the lack of response from EU states has made any comparative analysis of the data that was provided meaningless. The HO needs to discuss next steps with BERR officials.

12 ANNEX A: Text taken from a letter written by the European Commission to the Vice President of the European Parliament. (Source – MSL, Dated – Jan 99)

The free movement of goods is the essential cornerstone of the functioning of the Internal Market. However, due to different reasons, not all products can unrestrictedly profit form this free flow. Opiates, constituting derivatives of opium, hold a particular position, in so far as it is very difficult to create a single market for them. It should be pointed out that opiates fall within the category of narcotics and as such are regulated by the Convention of Vienna 1961, to which all Member States of the European Union have adhered. (The European Communities as such are however not a party to the Convention of Vienna). This Convention lays down, inter alia, provisions on the manufacture, import and the export of narcotics and consequently it also regulates opiates. Given the dangerous nature to human health of such substances and the trafficking that they may give rise to, opiates are, in the absence of harmonisation on a Community level, subject to the national laws of each Member State. Member States may thus, by virtue of Article 26 of the EC Treaty, take measures so as to prohibit or restrict the imports of opiates operating in other member states.

13 Annex B: Summary of responses to Home Office data request.

Data on Country Response Nature of Any Response volumes Price Data? produced? Verbal response referring HO to INCB statistics. No investigations Germany Yes - Verbal into the industry undertaken. No No Italy No Short written response with very Limited data on Spain Yes - Written limited data. quantities No France No Verbal response that no data held centrally. Domestic manufacturer Belgium Yes ceased production in 06. Slovakia No Czech Republic No E-mail referring the HO to INCB Hungary Yes statistics.

Average price for Dihydrocodeine Short written response with very Limited data on and Codeine Ireland Yes limited data. quantities Phosphate Short written response referring to INCB stats and individual Norway Yes manufacturers. USA No Canada No South Africa No Short letter referring to individual Switzerland Yes manufacturers. Australia No