Central European oil puzzle
after the acquistion of the Lithuanian Mazeikiu Nafta by the Polish PKN Orlen
Maciej Janiec
ReAKKT Report 2006-12-18
http://www.reakkt.comhttp://www.bezpieczenstwo-energetyczne.pl
On Friday, December 15th, the largest Polish oil company, PKN Orlen S.A., completed the acquisition of the Lithuanian oil company Mazeikiu Nafta. The purchase of 30,66% shares of the Mazeikiu Nafta from the Lithuanian government, after acquiring 53,70% from Yukos International UK BV, finalized the process that had begun some 18 months earlier. The purchase of the Lithuanian company costed Orlen $2,34 billion so far. The Lithuanian government still maintains 10% of the shares with option to sale them to Orlen over 5 years. Orlen should also call for sale of the shares possessed by minority shareholders. As a result of the acquisition of Mazeikiu Nafta, PKN Orlen S.A. became the largest oil company in the Central European region in terms of amount of crude oil processed (31,7 million tones per year) and number of petrol stations (2.732). However, it still lags in terms of market capitalization ($7,54 billion) to its main rivals: Austrian OMV and Hungarian MOL.
PKN Orlen S.A. competed for Mazeikiu Nafta with the Russian-British joint venture TNK-BP, Kazakh KazMunaiGas and Russian Rosneft. One of the reasons for the acquisition, justifying the highest price Orlen offered to Yukos and the Lithuanian government for the company, was the need to defend Orlen’s home market against the possibility of flooding it with cheap products by resourceful rival who would control Mazeikiu instead of it. However, this acquisition opens for Orlen an interesting strategic growth position, too.
The Orlen group, which apart from Poland and Lithuania, is also present in the Czech Republic and Germany, became one of the largest buyers of the Russian crude oil (some 15-16% of the total export from Russian outside the CIS) which should give it a leverage in talks with the suppliers. It is also worth to mention that the Polish government-owned oil transport company PERN “Przyjaźń” S.A. controls pipelines transporting over 50 million tones of Russian oil per year, more than half of that destined for Western Europe, mostly German refineries. Some of this crude supplies another Polish company – Grupa Lotos – having a refining capacity of 6 million tones per year (10,5 million planned till 2012). Together it makes Poland an important player in the Russian-European oil relations.
Thanks to acquisition of Mazeikiu Nafta, Orlen became the owner of the Butinge Oil Terminal with the capacity of 14 million tones per year. It allows both exporting and importing of crude oil and refining products. The later capability was used to provide the refinery in Mazeikiu with necessary supplies when the malfunction of the Russian supply pipeline occurred in July 2006. Another regional oil terminal is located in Gdańsk in Poland – Naftoport. It has an annual capacity of 23 million tones. Those two terminals provide a safety valve for the Polish an Lithuanian refineries in case there is any problem with supplies from Russia. Already the second-largest Polish oil company – Grupa Lotos – imports some oil (initially 2 million barrels in 2006) through Naftoport from Kuwait. Lotos wants to reduce the share of imports from Russia to 60% till 2012 (currently 95%).
Since the current Polish government (constituted after the general elections in September 2005) is considered about the security of energy supplies, it promotes the diversification of oil supplies by the local companies, together with infrastructural projects that should allow such diversification. One of such projects is the long planned construction of the Odessa-Brody-Płock-Gdańsk pipeline that could transport the oil from the Caspian region though Ukraine to Poland and further to Western Europe.
Already in July 2004, PERN “Przyjaźń” S.A. together with its Ukrainian counterpart OJSC UkrTransNafta established a joint-venture MPR Sarmatia sp. z o.o. to conduct the studies necessary for the construction. The feasibility study was backed by the European Commission who shell out two million euro and put it on its priority list. In January 2006, Mr. Cezary Filipowicz, who is the general director of Sarmatia was elected to the management board of PKN Orlen S.A., suggesting that Orlen might get involved into the project.
To make the construction of the extension of the Odessa-Brody pipeline economically feasible, it is necessary to find recipients for the crude oil that it would transport. The completed acquisition of the Mazeikiu Nafta may help in that. Even that the Polish refineries process some 20 million tones (Orlen – 14; Lotos – 6) of crude oil per year, due to existing contractual obligations and technical reasons they’re not able to consume all the oil that may reach Poland through Odessa-Brody-Płock-Gdańsk pipeline (9 million tones per year initially, 15 million tons after adding pumping stations and using chemical agents, and possibly up to 45 million tones later). It’s therefore necessary to find other recipients abroad – possibly also in Lithuania.
The construction of the crude pipeline connecting Poland and Lithuania seems justified in the light of the still unresolved problems with the branch of the “Druzhba” pipeline heading to Lithuania – the additional cost of supplying Mazeikiu using tankers instead of the pipeline is estimated at $10 per tone, which at 830 thousand tones of monthly processing capacity of the refinery means potentially $8,3 million of losses every month. If a Poland-Lithuania pipeline connection had been present, Orlen might first provide Mazeikiu Nafta with the Russian oil imported through the more secure Polish section of the “Druzhba” pipeline and later supplement it with the crude from the Caspian region coming from the Odessa-Brody pipeline. Since Orlen has become such an important recipient of the Russian crude and PERN-operated pipelines are so important for the transit of the Russian oil to the Western Europe, it is much less probable that similar malfunction to that which happened in July 2006 would remain unrepaired on the pipeline heading to Poland for so long.
The extension of the Odessa-Brody pipeline to Płock and Gdańsk (where the Naftoport oil terminal is located) may become even more important for Orlen if it gets involved in the production projects in Kazakhstan. The exploration and production activity is what Orlen is still missing to become a truly integrated oil company. One of the most promising E&P targets for PKN Orlen S.A. is Kazakhstan where the concern opened its office in summer 2006. The Polish company plans to start production in this country in 2008. It would make a perfect sense to use the Odessa-Brody-Płock-Gdańsk pipeline for transporting the oil produced by Orlen in Kazakhstan to Polish (and potentially Lithuanian and Czech) refineries and further through Naftoport to Western Europe.
In such a scenario, the Polish oil companies would be perfectly positioned as gate keepers for both Russian and Caspian crude as well as refined products for export to Western Europe either through “Druzhba” pipeline or sea terminals in Gdańsk and Butinge. Such a position might be traded for stakes in production projects in Caspian region or for Russian concessions.
One of the possibilities is closer cooperation between PKN Orlen S.A. and the Kazakh oil company JSC NC KazMunaiGas. KazMunaiGas, which floated its exploration & production subsidiary on the London Stock Exchange in September 2006, had been competing with Orlen for Mazeikiu Nafta. The company also seems interested in the Polish market. The cooperation between the Polish and Kazakh companies may result in joint-ventures or capital participation. KazMunaiGas might even become Orlen’s strategic partner, holding a substantial share in the Polish company. Similarly to the situation at OMV, where Austrian government together with the investment arm of the United Arab Emirates’ national oil company controls the company, the Polish government and government-controlled KazMunaiGas might share control over Orlen. Such cooperation would secure Orlen, whose 72% of share are currently in free float, against a hostile takeover.
However, there are many factors that may prevent the above scenario from realization. First, the current government of Ukraine, lead by Mr. Viktor Yanukovych, is leaning toward using the Odessa-Brody pipeline for the transportation of the Russian crude oil. According to the recent indications (December 2006), the Odessa-Brody pipeline may rather be connected with the Druzhba system to transport the Russian oil to Slovakia, than to the Czech Republic and further to Western Europe. Orlen’s control over the Kralupy and Litvinov refineries in the Czech Republic, where part of the oil from Druzhba is coming, is not enough to influence this plan. Also, Polish PERN has failed so far to acquire 49% in the Slovak oil transport company Transpetrol. When the Slovak government’s veto over the sale of those shares expires in April 2007, the most probable buyer is some Russian company.
Russians control the oil export from Kazakhstan, too. Two main export pipelines – Caspian Pipeline Consortium (CPC) and Atyrau-Samara – pass their territory. Without extending CPC or creating a completely new route bypassing Russia, there isn’t any Kazakh oil available for the Odessa-Brody pipeline at this moment.
The key to untangling the knot that hinders the further development of the Polish oil company is broad cooperation with all the parties having interests in bringing Kazakh oil to the region. These include among others: KazMunaiGas – the national oil company of Kazakhstan, the US oil giants ExxonMobile and Chevron who participate in production projects in Kazakhstan and are members of the CPC consortium, and the European Commission who is interested in diversification of supply to the European Union. As recently as at the beginning of December 2006, Jose Barroso, the president of the EC, was discussing with Nursultan Nazarbayev, the president of Kazakhstan, the construction of the Trans-Caspian oil pipeline that would provide the EU with Kazakh oil without the Russian intermediacy.
It would also be necessary to convince the Ukrainian government to change its position on the Odessa-Brody pipeline, as well as Slovak government to keep its oil transportation system independent or to integrate it with the regional one (cooperation with Polish PERN) instead of giving the control over it to Russians, who already control significant part of the transportation infrastructure.
It might be helpful to discuss the situation with the Hungarian oil company MOL as well. MOL controls the Slovak oil company Slovnaft and is heavily dependent (>80%) on the Russian supplies. It might be tricky though, since MOL already cooperates with the Russians in extraction and production projects. However, there once were plans to merge the Polish and Hungarian companies and maybe it’s time to refresh them now? Especially that the capitalization of both companies are quite close after the Orlen’s acquisition of Mazeikiu Nafta.
The Central European oil market is pretty complicated puzzle. What’s more, substantial government stakes in energy companies make the oil business in the region not a clear commercial activity, but largely a political one. Energy issues from oil and gas sector interweave with each other as well as with totally different topics – such as meat trade (Russia-EU) and military cooperation (Russia-Ukraine) – making the whole problem even more complex. Hence, further Orlen’s development depends on firm government support. Without such backing, even the enlarged Orlen may have problems with defending its market position and value in the near future.