John P. Banks
Manager
Oil Industry Consulting International Resources Group Ltd.
Washington D.C.
Since 1989, donor organizations, private investors, and governments in the West have identified and attempted to address the myriad energy related problems plaguing the countries of eastern and central Europe (ECE).
The oil and gas sector has emerged as one of the most vital areas of the ECE economies where immediate technical assistance and investment are required to guarantee continued economic development, national security, and effective integration with the rest of Europe and the world.
International Resources Group Ltd. has been working with governments and various oil industry organizations throughout the region over the past 1-1/2 years and has identified a broad range of opportunities for investment.
We define the ECE as Bulgaria, Czech and Slovak Federal Republic (C.S.F.R.), Hungary, Poland, and Romania.
OIL DEPENDENCE
The key characteristic of the ECE oil sector, clearly evident as these nations emerge from the slumber of centrally planned systems, is the overwhelming dependence on imports of crude oil and petroleum products, particularly from the former Soviet Union.
After World War II, energy played a major role in facilitating the Soviet Union's hegemony over the Eastern Bloc region.
As members of the Council for Mutual Economic Cooperation (Comecon), these nations received most of their oil and gas on relatively favorable, soft currency terms. This dependence has been supported by the extensive Friendship Pipeline network and the lack of pipeline links with western Europe.
The degree of dependence is staggering.
Each country, with the exception of Romania, lacks significant oil production, resulting in almost complete reliance on imported crude and petroleum products.
In 1989-90, as Communist regimes toppled throughout the region, all ECE countries were substantial importers of Soviet crude oil and petroleum products. Bulgaria, the C.S.F.R., Hungary, and Poland received 70-100% of their total net imports from the U.S.S.R. Romania, with significant production, obtained about 20% of its oil imports from Moscow.
ECE countries are fully aware of the dangers of overwhelming dependence on Russian crude supplies, as well as the potential unreliability of imports from the former Soviet Union.
In the immediate aftermath of political independence, most ECE nations moved to diversify their energy supply sources away from the former Soviet Union.
RELIABILITY OF SUPPLY
The collapse of communism in Moscow following the aborted right wing coup in August 1991 has led to an embryonic change in the perception of future energy trading relationships with Moscow.
Moscow's loss of central authority kicked off direct energy supply negotiations between the ECE nations and some constituent republics in the former U.S.S.R. such as Kazakhstan, Azerbaijan, and Turkmenistan and between the ECE nations and the newly independent Baltic countries.
However, all ECE nations continue to worry about the short to medium term reliability of energy supplies from the former Soviet Union. Vexing questions have arisen about the sanctity of oil supply contracts between Moscow and the ECE nations as well as with western Europe.
In the case of the Friendship Pipeline network, Russia's largest export pipeline, crude oil originating in Russia's Volga-Ural fields has to cross Belarus and Ukraine to reach refineries in the C.S.F.R., Hungary, Poland, and the former East Germany. That makes those exports subject to contract renegotiation.
Belarus and Ukraine are demanding an enhanced share of the hard currency profits or increased transit fees on exports through their territories. For example, the Ukrainian government has demanded a 25% fee on the oil's value to be paid in dollars.
In addition, the independence of the Baltic states has led Moscow to lose control of two major oil export outlets--Ventspils in Latvia and Klaipeda in Lithuania--while the independence of Georgia has affected a vital oil export link. Tbilisi wants to levy a $3.42/bbl fee on Russian exports at the Black Sea port of Batumi.
Internal political and military conflicts also are a major factor in the reliability of supplies. Recent clashes have shut down gas pipelines between Russia and Georgia, Armenia and Azerbaijan, and Ukraine and Turkmenistan.
Under those circumstances, ECE nations have undertaken a concerted effort to diversify sources of supply beyond the former Soviet Union.
My firm estimates that in 1991, crude and products exports to the ECE region from the former U.S. S. R. fell to 64% of total net imports from 79% in 1990 and 84% in 1988. Each country has significantly increased its contacts and commercial relationships with Middle East producers, especially Iran, North African countries, Norway, and others.
The changing supply relationships and economic transition process not only have revealed weaknesses in the oil sector, but also have created opportunities for western investment and donor technical assistance.
TRADE PATTERNS
One manifestation of the attempt to diversify crude supplies has been a policy effort to change traditional crude flow and trade patterns as well as the oil supply infrastructure.
Hungary and the C.S.F.R. have sought to increase crude shipments through the Adria pipeline with its origin in Yugoslavia on the Adriatic Sea. This will allow these countries to import crude from North Africa and the Middle East directly to their major refineries: DKV in Hungary and Slovnaft, Litvinov, and Kralupy in the C.S.F.R. However, hostilities in Yugoslavia led to a shutdown of this pipeline in June 1991.
Seeking other options, the C.S.F.R. has embarked on plans to establish pipeline links with the western European network to allow access to the trans-Alpine pipeline, which originates in Trieste.
The Slovnaft refinery has been involved in discussions with OMV of Austria to build a pipeline from the Schwechat refinery near Vienna to Bratislava, and approval has been granted to construct a link between the German refinery at Ingolostadt and the Litvionov and Kralupy refineries.
Also, an Arab-British group has proposed building a pipeline from the Schwedt refinery in Germany to the Litvinov refinery and connecting Schwedt with a Baltic Port so North Sea crude and other waterborne supplies could flow into the C.S.F.R.
Poland is investigating the option of additional pipeline links with the Baltic port of Rostock through Schwedt. In addition, there are plans to double capacity of the pipeline between Petrochemia Plock and the Gdansk refinery, as well as to increase the tonnage capacity at Gdansk to handle larger cargo ships.
Finally, Bulgaria and Romania have attempted to exploit their access to Black Sea ports by diversifying contacts with Middle East suppliers, as well as entering processing agreements with western companies.
All of these links will substantially enhance the ECE region's integration with European and worldwide oil markets.
E&P PROGRAMS
The search for ways to decrease dependence on oil from the former Soviet Union also has focused attention on limited or, in the case of Romania, declining indigenous crude production.
Vigorous plans are being implemented to conduct geological assessments and exploration and production in Bulgaria, Poland, and Romania to enhance domestic production and lessen import dependence.
In addition to E&P, opportunities are emerging to provide assistance in formulating petroleum exploration policies, laws, and concession management systems to encourage private and foreign investment and technology transfer, conduct assessments of major geological basins, and identify economically attractive secondary and enhanced oil recovery projects.
OPPORTUNITIES IN REFINING
There are many investment opportunities in the ECE refining sector.
Process upgrades and modernization, including environmental and efficiency improvements, are required to handle a changing crude slate and produce the quality and mix of products required to meet domestic and export market demands.
This is an increasingly important issue because of the expected gradual implementation of stricter pollutant and toxic specifications on petroleum products to match western European standards. For example, Poland has implemented legislation effective last March limiting the lead content of all gasoline.
There also is a whole range of refinery management and institutional issues that need to be addressed if the oil industry in the region is to attract western--specifically U.S.--investors and compete with western oil companies planning to become commercially active in the region.
Each country has the technical expertise to operate its refineries properly but not to manage them as commercial enterprises.
None of the refineries has applied linear programming models in a manner that would begin to optimize the economics of refinery operations.
There is a general lack of acceptable accounting and management information systems, as well as staff expertise to develop proper business plans and strategies.
For refineries that will operate as separate entities and not as part of an integrated oil company, it is essential to add marketing and supply and distribution departments.
PROCESSING DEALS
Joint venture processing deals are under discussion among trading companies, refineries, and third parties in the West. This is particularly true in Romania and Bulgaria because of their access to the Black Sea, but Poland, Hungary, and the C.S.F.R. also are interested in these arrangements.
Processing agreements can take a variety of structures.
A basic form might, for example, involve purchase of crude oil by the trading company and a processing fee paid to the refiner for a predetermined volume of product taken by a western firm for export, with the balance of the product slate sold locally at the refiner's risk.
Comparable to the notion of a fixed processing fee, the use of futures to lock in the refiner's processing economics, or at least the sales price on the refiner's portion of the barrel, has become a subject of great interest for several refineries.
Several arrangements with western trading companies are in effect with refineries in Bulgaria and Romania.
Opportunities also have emerged further downstream in the distribution and marketing sector.
Many foreign companies are entering local markets to assist in developing a retail base--building or upgrading gasoline stations, for example--with domestic refineries, distribution companies, or other entities taking an equity stake and/or possibly providing the product.
Joint ventures, lease/operate arrangements, and other agreements are being pursued vigorously by western investors throughout the region, particularly in Hungary and the C.S.F.R.
RESTRUCTURING
Restructuring and privatization are other issues with direct ramifications for the ECE oil sector.
Chief among the concerns that need to be addressed is the appropriateness of establishing integrated oil industries vs. creation of independent entities.
In Hungary, this issue has been settled by creation of MOL, a national, integrated oil company owning all Hungarian refineries as well as production, distribution, and marketing. Poland, on the other hand, still is considering structural and organizational alternatives.
In the financial arena alone, economic restructuring will require ECE nations to develop capabilities to evaluate assets prior to corporatization or privatization, to learn how to conduct loan negotiations and issue stock, and to address key tax and regulatory issues.
In addition, technical assistance is required to develop and implement strict profit accountability systems for management. Several western organizations are assisting refineries in the C.S.F.R., as well as entities in Hungary.
UNCERTAINTIES
Although the collapse of communism has rendered the historical Soviet-ECE oil trading network obsolete, there are prodigious financial costs involved in addressing many problems that have emerged in the aftermath.
In addition, it is becoming increasingly clear that a high degree of uncertainty prevails about the way individual nations will introduce the concepts of market forces, privatization, environmental responsibility, and economic restructuring.
ECE countries have to invest to meet their future energy requirements at a time of economic constraints, the prospect of a growing political backlash as witnessed in several recent elections, and enhanced uncertainty over the reliability of oil imports from the former Soviet Union.
It is, therefore, all the more incumbent on western governments, donor organizations, and the private sector to provide technical assistance and investment to guarantee the survival of these nascent democracies.
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
