DOWN STREAM OPPORTUNITIES SEEN IN POLISH INDUSTRY

March 21, 1994
Poland's economy and its demand for refined petroleum products are growing, thanks to success of the ambitious "shock therapy" economic restructuring that started in 1990. Coupled with this growth, Poland's downstream oil industry is on the brink of a radical restructuring that will present new investment opportunities for western investors. That's the view of Donald J. Howard, a business adviser to IDMA, Krakow, a supplier of petroleum products, forecourt equipment, and car care

Poland's economy and its demand for refined petroleum products are growing, thanks to success of the ambitious "shock therapy" economic restructuring that started in 1990.

Coupled with this growth, Poland's downstream oil industry is on the brink of a radical restructuring that will present new investment opportunities for western investors.

That's the view of Donald J. Howard, a business adviser to IDMA, Krakow, a supplier of petroleum products, forecourt equipment, and car care systems for gasoline retailers.

On leave from Booz*Allen & Hamilton's energy and chemicals group, Howard is part of the MBA Enterprise Corps, a program that sends alumni of major U.S. business schools to Central Europe to provide business advice to private companies.

In his normal post at Booz*Allen, he is a senior associate focusing on international energy strategies for companies in Europe, Latin America, and North America.

'SHOCK THERAPY'

In 1992, Poland became the first post-Communist country to record growth in gross domestic product (GDP). If expectations of nearly 5% GDP growth for 1993 are confirmed, Poland could become the fastest growing economy in all of Europe, Howard said.

As a part of the shock therapy program, Poland's currency, the zloty, was made fully convertible.

The transition to a market economy has been swift. Nearly 50% of the Polish workforce is employed in the Privatization proposals for Poland's seven refineries, its transportation network, and 1,370 state owned retail stations have been drafted. Privatization could begin next year.

As these economic and political forces converge, Poland is becoming a very attractive area for downstream investment, Howard said. Many western oil companies are beginning to establish relationships and build early growing private sector.

Gasoline demand has grown more than 40% since 1988 despite an initial economic contraction that accompanied restructuring. Diesel consumption, after an initial decline, is also growing. And there is room for continued growth.

In 1990, oil accounted for only 15% of Poland's primary energy consumption vs. 44% in OECD Europe.

Private investment in the refining and retail products sectors is largely unrestricted, Howard pointed out.

Retail margins are low compared with western Europe, but they are expected to improve as the government continues to increase retail prices. The number of retail outlets in Poland is far below western European levels on a per auto basis, and a large number of new retail stations will be required in coming years.

REFINING CAPACITY

Poland's seven refineries process about 12.5 million metric tons/year (250,000 b/d) of crude. Two refineries, at Plock and Gdansk, account for nearly - 90% of the country's capacity.

The Plock refinery, northwest of Warsaw (Fig. 1), is Poland's largest.

Its crude distillation capacity is reported to be 13 million metric tons/year (260,000 b/d) (see table). Some of this distillation capacity is not in use because upgrading capacity is reached at crude throughput levels of 9-10 million metric tons/year (180,000200,000 b/d).

Plock is the only Polish refinery with petrochemicals capacity.

The Gdansk refinery is near Poland's largest port complex on the Baltic Sea. Smaller than the Plock refinery and less technically, sophisticated, it has a distillation capacity of a little more than 3 million metric tons/year (60,000 b/d).

The Plock and Gdansk refineries compare reasonably well with western European refineries on a technical basis, Howard said. However, analysts report there are opportunities for investment to improve Polish processing capabilities, especially for deep resid upgrading.

Modernization plans for the Gdansk refinery call for an increase in processing capabilities of 3-4 million metric tons/year (60,000-80,000 b/d).

Five other refineries are in southern Poland, They are older, much smaller, and less sophisticated than either Plock or Gdansk. Some were built before the turn of the century near oil discoveries.

Their combined production capacities total 1.6 million metric tons/),ear (32,000 b/d), although optimum production levels are reported to be somewhat lower. They mainly produce specialized lubricants, taxes, and solvents. In addition, these refineries blend imported products for domestic consumption.

Plans are being developed for a sixth refinery in southern Poland, at Kedzierzyn-Kozle, to be called the Southern refinery. Site would be adjacent to a chemical plant.

Planned capacity is 6 million metric tons (120,000 b/d) to be made up of 60% gasoline and 40% other products. However, plans are very preliminary. It is unlikely refinery construction will start before the planned privatization of the industry is complete.

Poland's refineries are state owned, but privatization plans are being finalized. In preparation for privatization, the Gdansk and Plock refineries have been commercialized by converting them into joint stock companies in 1991 and 1993, respectively, ownership of all shares.

During the 1960s, Poland's refining and chemicals industries were seen as a priority sector and together received nearly 20% of all industrial investment.

However, in the late 1980s, investment levels fell dramatically.

As a result, average profitability fell, especially for southern refineries. But with the fall in crude oil prices, Polish refinery returns have improved.

CRUDE OIL SUPPLY

Domestic crude resources are very, baited in Poland, typically accounting for less than 1.5% of oil consumption.

Until 1989, virtually all of Poland's crude supplies came from the former Soviet Union (FSU). The Friendship pipeline system, built at the end of the 1950s to supply Central Europe with Soviet crude, now provides only 45% of Poland's crude supplies.

The Plock refinery is connected to the northern branch of the Friendship system, which extends west from Poland into eastern Germany. The Polish share of the Friendship system is 14 million metric tons/year (280,000 b/d). Today, only 35-40% of this capacity is being used.

Since 1991, Poland has paid world prices for all its crude supplies from the FSU. However, some barter trade for crude supplies has continued between the countries, Howard said.

Iranian and British crude account for more than 55% of Poland's crude supply. Some of these supplies are used at the Gdansk refinery, while the remainder moves to the Plock refinery through the 8 million metric ton/year (160,000 b/d) Pomeranian pipeline.

The Pomeranian line, connecting Gdansk with the Plock refinery and the Friendship pipeline, was laid to transport Soviet crude north. By reversing the flow of crude to the south, Poland has been able to achieve a level of supply diversification its Central European neighbors can only hope for.

To extend this degree of diversification, the capacity of Gdansk's northern port complex was doubled to about 16 million metric tons/year (320,000 b/d) in 1992. All crude imports in Poland are organized by Ciech, Poland's state owned foreign trade organization.

Poland's five southern refineries are not directly connected to either the Friendship pipeline or the Gdansk port. These refineries mainly process local crude and other crude shipped by truck and rail.

Plans for the Southern refinery include construction of a pipeline connection to the Plock refinery in the north. Financial backing would come from the European Bank for Reconstruction and Development (EBRD), Howard said.

PRODUCT PIPELINE SYSTEM

Product pipelines connect Plock with terminals near Warsaw to the east, Bydgoszcz to the west, and Lodz to the south.

Two other product lines, not shown in Fig. 1, radiate from Warsaw.

The remaining products move mainly by rail to bulk terminals or directly by truck to retail outlets.

PERN, the state owned Oil Pipeline Exploitation Enterprise "Friendship," controls the Friendship pipeline infrastructure and the other crude and product pipelines in Poland.

There are plans for additional product pipelines.

A new pipeline from the port at Gdansk to the terminal in Bydgoszcz is planned to transport additional product imports. And, to transport more domestically refined products, there are plans for pipelines from Bydgoszcz to Poznan and for pipelines associated with the proposed Southern refinery.

DISTRIBUTION NETWORK

State owned Centralna Produktow Naftowyech (CPN) dominates Poland's products distribution and retail network.

CPN owns and operates 1,370 retail outlets across Poland. In 1992, it sold 5.5 million metric tons (128,000 b/d) of oil products, accounting for 74% of all gasoline and 48% of all diesel consumed in Poland.

CPN also controls the port facilities in Gdansk and the smaller port of Szeczin, as well as all product storage facilities. CPN transports products to its own retail outlets.

About 2,500 new, privately owned distribution outlets have opened in Poland since 1989.

Many of these stations are owned by small independent investors who moved to fill gaps in CPN's distribution network and to respond to Poland's dramatic growth in auto ownership. However, Howard said, some industry participants believe that up to one half of these privately owned stations are not fully operational. They either are open only part of the year, sell only one product, or are otherwise noncommercial.

Depending on assumptions about these stations, the effective number of retail outlets is 2,620-3,870.

Western oil companies also have entered the market, but at present only about 15 western owned stations have opened. Most private stations receive products directly from local refineries or from independent importers.

The level of car ownership in Poland has increased dramatically since economic and political restructuring began.

Car ownership levels have grown more than 8.5%/year since 1985 (Fig. 2). Yet ownership levels remain far behind those in the West. There is only one auto for each 5.9 residents in Poland. In the U.K. there is one auto for each 2.5 residents, and in the U.S. there is one auto for each 1.8 residents.

In addition, Poland remains well behind western countries in retail outlet density. The country has more than twice the average number of automobiles per retail station when compared with many western countries-even those, such as the U.S., U.K., and France, that have been closing marginal stations.

Howard said without factoring in continued growth in car ownership, Poland will require construction of 1,500-3,500 stations to reach retail outlet densities similar to the U.K. or France, depending on the number of private Polish stations assumed to be commercial.

Despite a cumulative 16% decrease in GDP from 1988 levels, gasoline and diesel demand grew during the economic restructuring. Polish consumption of gasoline has climbed dramatically, recording more than 40% growth since 1988 (Fig. 3).

Diesel deliveries fell with the economic contraction but have resumed growth since 1991. Analysts with the Polish Chamber of Liquid Fuels estimate tremendous growth before the end of the decade with increases of nearly 40% in gasoline and 20% in diesel consumption.

Polish refineries have not been able to meet demand for those fuels. Imports grew to nearly 40% of gasoline demand and to 31% of diesel demand in 1990.

Products are imported by refiners, CPN, and private importers. Most of those imports go through Ciech.

A system of quotas, licenses, and taxes has reduced imports since 1992-especially by smaller private importers, Howard said. However, despite those disincentives, 34% of gasoline and 7% of diesel deliveries were imported in 1992.

Retail product prices are capped by the Polish government, but the Ministry of Finance has established a policy for gradual price increases. At the start of 1994, 98 octane gasoline prices were 52cts/1. ($1.98/gal), and diesel was 40cts/I. ($1.50/gal). For the year, the ministry has recommended price increases of 8% for March and July and 6% for October.

Gasoline and diesel excise tax rates are comparable to western European levels.

Full price liberalization for motor fuels was promised as part of Poland's interim agreement with the European Union. However, no deadline was set.

With the inflationary pressure of increasing fuel prices, complete price liberalization may not be achieved for some time. Without real increases in retail prices or reductions in tax levels, relatively, low retail margins will continue (Fig. 4).

Despite current low margins, several western oil companies, expecting price liberalization to continue and recognizing the potential of the Polish market, are planning aggressive investment in retail networks in Poland. Howard said some industry observers also have argued that, with increased profitability at the refining level, a combined investment in refining and retailing, as envisioned in the privatization plan, is economically attractive.

PRIVATIZATION PLANS

Proposed plans for privatizing Poland's downstream oil industry have been designed to introduce western investment while protecting, to some degree, the existing industry.

The initial privatization plan, accepted by the government in 1992, calls for i major restructuring of the industry before assets are offered for sale (Fig. 5). This restructuring would create a vertically integrated downstream oil company called Polska Kompania Naftowa SA (Polish Oil Co., PKN).

PKN would be composed of:

  • At least 40% of CPN's current retail stations.

  • 254517, interest in each of the seven refineries.

  • 10-15% interest in Ciech.

The plan also would transfer CPN's current storage and transportation assets to the Enterprise of Fuel Wholesale (PHDP) and DEC, the directorate for rail systems. PKN will be given a 33% ownership interest in PHDP and DEC to complete its integration from refinery to retail pump.

After restructuring the industry, the government will commercialize the companies and offer ownership shares to investors. Investors will be sought for:

  • 49% of PKN. The Polish Treasury will retain 51%.

  • 55-75% of each of the seven refineries.

  • The remaining 60%, or about 800, of CPN's retail outlets.

Retail stations that will be privatized outside of PKN will be placed into groups, or packets, for tender. Each packet will include stations from a cross section of performance levels and regions.

To provide added incentives to invest in Polish refineries, some portion of the packets will be offered in limited tenders only to companies that invest in refineries. The rest will be sold to investors in unlimited tenders.

A revised restructuring plan was proposed in July 1993. The new plan is very similar to that proposed in 1992 except:

  • Ownership in PKN would be split among the Polish Treasury, strategic investors, and Polish citizens through a stock flotation. The government would retain a "golden share," giving it effective control of PKN.

  • Storage and transport assets (PHDP and DEC) would be combined as Naftohurt. This company would be owned by PKN, investors in refineries, and the Polish Treasury.

  • The oil and motor fuel trading portion of Ciech, Petroimpex would be split off and made part of PKN.

Regulations for the industry will be set mainly by the Ministry of Finance, acting as the state shareholder; Ministry of Industry, setting energy policy; and Ministry of Foreign Economic Cooperation, regulating petroleum product imports.

Import licenses, which will continue to be required until 1997, will be allocated each year through an application process. Environmental and operating regulations will continue to be enforced at the regional level, Howard said.

A final decision on the restructuring plan or privatization timetable has not been made.

Poland's recent parliamentary elections resulted in a shift to the left from the previous center-right governing coalition. The new governing parties support privatization but have advocated a more conservative timetable. So President Walesa's agenda for reform may be somewhat slowed.

However, if experience is a guide, only modest changes in restructuring and privatization plans are likely. Since 1989, Poland has had several changes in government, but each new leadership group largely maintained the agenda and timetable for change.

Howard said some observers predict privatization of the Polish oil industry could be complete before the end of 1995.

WESTERN INVESTMENT

Expectations for growth in the Polish downstream industry have attracted many western investors.

These companies are taking small or, in some cases, rather aggressive first steps to establish a position in the market. Many plan to increase their participation in the market after restructuring and privatization of the industry are complete.

Here's what's happening:

  • Esso completed three stations in Poznan in West Central Poland. Plans are being prepared for two additional stations in Poland.

  • Conoco completed one station and plans to complete 15 more during the coming year. Overall, its plans call for building nearly 200 stations in Poland in the next 5 years.

  • Aral opened its first retail station in Wroclaw in Southwest Poland.

  • Total Poland set a goal of capturing 5-10% of the Polish retail market in the coming years.

  • Neste completed six stations three of them in Warsaw -during 1993. Its plans include a target of 160 stations across Poland along the planned highway connecting the Baltics with southern Europe.

  • Statoil opened its first service station in Poland, north of Warsaw on the road to Gdansk (in Zakroczym). Statoil is reported to have plans to build a total of 70 stations in Poland during the next 5 years.

  • Royal Dutch/Shell plans to build five stations in Lodz province of Central Poland.

Those firms and several others are selling lubricants in Poland.

Several western oil companies have toured Polish refineries to get a first hand look at processing facilities.

Whether in refining or retailing, these firms are investing time and money to gain experience and develop relationships that will benefit them during and after the planned privatization, Howard said. Many have opened offices in Warsaw and are establishing their names among Poland's policy maker and consumers.

Howard said the biggest obstacle to increased western investment in Poland may be a continued lack of understanding of the market potential and the success of Polish economic reforms.

Some western analysts and decision makers seem unable to distinguish the differences in direction or results of the individual national reform programs in Central Europe. Consequently, they fear investment in any part of the region.

A growing understanding of the Polish market and the emerging strength of the Polish economy, coupled with restructuring of the oil industry and pending decontrol of retail prices, is likely to lead to increasing western investment, Howard said.

Copyright 1994 Oil & Gas Journal. All Rights Reserved.