Orlen: A future global champion or a giant on clay feet?

Orlen’s imperial plans are to create a ‘multi-energy’ colossus operating in various segments and on many markets. Are such ambitious plans likely to be successful? What are the threats resulting from the mergers so far and still to come under Orlen’s banner?

Game changer?

‘In Poland, there is room for one multi-energy company with a global reach,’ wrote Orlen’s president, Daniel Obajtek, on Twitter, announcing imperial plans to build a powerful business that would have assets in the oil, gas, and energy segment. The Płock-based company—having purchased Energa and secured the European Commission’s consent to take over the Lotos Group—expressed its intention to take over another energy giant, Polskie Górnictwo Naftowe i Gazownictwo (PGNiG).

These plans, communicated rather abruptly, provoked a series of comments and questions. The most important of them are whether the planned acquisitions are even possible under the EU’s competition rules and whether they will be of real benefit to the Płock-based company and the Polish state. These issues are quite closely related, as the latter stems from the former: the conduct of the European Commission and the actual costs of Brussels’ consent to these processes will determine the final evaluation.

Superunit

From the announcements of Orlen’s management, its actions to date, and from the government’s announcements (particularly the Ministry of State Assets), it follows that the plans of the Płock-based company involve the construction of the first multi-energy consortium in Poland, which would combine large assets in such different segments as oil & gas, mining, refineries, retail fuel trade, electrical power, and renewable sources. The foundations of such an entity are already in place: Orlen has purchased Energa, one of the major energy groups in Poland (80% of the company’s shares were acquired in 4 months with the consent of the European Commission), and has now been given the green light to take over Lotos.

The merger of the two Polish oil giants has long been announced by the political camp of the ruling party. The first formal steps in this direction were taken back in 2018, when Orlen submitted the draft version of their request for the European Commission’s consent to the merger. On 14 July 2020, the European Commission approved the merger by issuing conditional consent: Brussels included an obligation for Orlen to maintain competition on the market after the merger and made the acquisition dependent on the sale of 30% of shares in the Lotos refinery (including a package of management rights, e.g. for the production of petrol), the sale of approx. 80% of Lotos’ petrol stations (exactly 389 retail stations in Poland), the release of most of the capacity reserved by Lotos in independent warehouses (together with the capacity at the oil terminal), and a limiting of the influence on the aviation fuel and asphalt markets (e.g. by exiting a joint venture trading in aviation fuel and reselling certain Lotos Asfalt production plants), among other things.

How should Orlen’s current acquisitions be evaluated? The company is moving in the right direction—they have been investing in the electricity segment for some time (including steam and gas units) and plan to enter the renewable energy market (through offshore wind farms), so expanding their assets with Energa’s capacity puts a strong emphasis on the second pillar of the Płock-based giant’s activity, proceeding without reservations on the part of the European Commission (as a curiosity, it can be noted that the head of Orlen, Daniel Obajtek, was Energa’s president in the past). The takeover of Lotos, in turn, ended the internal cannibalism between the two companies controlled by the State Treasury, which did not help develop the Polish market or expansion abroad.

The question about the costs of merging the two oil companies remains for the time being, however, as it is not known who will be the new buyer of the Lotos assets to be resold. One has to consider that they may end up in the hands of foreign companies (some critics of the takeover suggest that the Russians may take them over). However, any transaction regarding these assets must be approved by the European Commission.

The final assessment of this process may therefore be made only after the buyer is identified and the transaction is approved by the European Commission. It will then be possible to state how competition on the Polish market will be affected by the transfer of the assets sold, and whether they will actually fall under the control of the State Treasury (in theory, one can imagine a situation in which the buyer is another state-owned enterprise).

What matters the most here are the rights to Lotos’ refining capacity, which are the jewel in the group’s crown thanks to the EFRA project, which enables advanced crude oil processing and production of high-profit-margin fuels and petroleum coke. The value of this project is 2.3 billion PLN.

It is the management powers over the refineries that are the tastiest morsel Orlen must put up for sale; their relevance greatly exceeds the value of the petrol stations that will go to the new owners (for companies such as Orlen or Lotos, retail sale is a less important part of income, although it is face of the entity for the public).

Creating a new, large entity under the conditions of EU competition law entails the need to sell off some assets in order to prevent market monopolisation. These are the actual costs of the takeover, and in the case of Orlen and Lotos, they limit the scope of the State Treasury’s control over the domestic refining and petrochemical potential. Criticism of this acquisition focusses primarily on the weakening of the two companies on the retail market (due to the resale of petrol stations), the reduced control over logistics (by slowing down access and storage infrastructure), and the deterioration of the position on the aviation fuel and asphalt markets.

As for the first argument, Orlen will maintain a strong position on the Polish market, because (according to 2018 data) the company has almost 300 more petrol stations than all foreign companies operating in Poland combined. The distance between Orlen and its closest competitors (i.e. BP) is too large for the resale of Lotos’ outlets to constitute a gamechanger for the competition. Of course, considering the absolute figures, the number of retail outlets controlled by the state-run companies will decrease, though not to such an extent that it will have a significant impact on the market.

The accusations regarding the lessened control over logistics processes are much more justified, although there are methods of compensating for these losses with the acquired assets, which should—at least to some extent—cushion the potential of exerting competitive pressure on the strengthened Orlen, which (from the company’s point of view) is meant to maintain profits from appropriately high margins. The same applies to the position on the aviation fuel and asphalt markets. For the Płock-based giant, the best solution will be to distribute the assets for resale as widely as possible (so that they go to different actors, which will make their integration difficult), while being careful about the role of this potential for the economic security of the state and its companies.

Similar questions and doubts arise regarding the assessment of the merger between Orlen and PGNiG. In this situation, activities are still in the very early stages, so it is difficult to predict their results, but the resistance of the European Commission and the possibility of setting conditions for the disposal of part of PGNiG’s assets must be taken into account. This is an important factor in the context of the plans the Polish gas giant is pursuing in terms of the diversification of gas supplies to Poland, the gasification of the country, or cooperation in the consolidation of the blue fuel market in Central Europe.

Energy multitool

Why does Orlen intend to merge with PGNiG? There are two main reasons behind this decision. First of all, a consortium with such comprehensive operations will be an excellent tool for implementing the energy transformation provided for in the Polish Energy Policy until 2040. This document—still unofficial—provides for extensive investment, e.g. in solar panels (within 20 years, the installed capacity in this technology is to increase to 16 GW), wind farms (Orlen is already working on such projects), or nuclear energy (construction of 6–9 reactors requires an appropriate entity that can handle this financially and logistically).

By accumulating assets from various segments within one company, the government creates a contractor for the country’s energy strategy which—thanks to portfolio diversification—will be more able to bear capital expenditure in specific departments.

Another reason is the aggregation of the potential to compete not only at the highest European level, but even globally. In Europe alone, we can already hear voices (e.g. from France) that the key challenge facing the continent’s economy is the creation of powerful companies, the ‘champions’ that would be able to compete with actors from the USA or China. As a result, the European Union will be able to bear the burden of competing with economies that, for example, do not approach the issue of climate and environmental protection so rigorously, which allows them to have greater operational freedom in the mining and electricity sectors.

Clash of the Titans

The model assumed by Orlen as the target model is nothing new in Europe. This is because mega-companies with similar profiles already operate on the Old Continent.

A good example is the Austrian consortium OMV, whose portfolio includes assets in the oil and gas mining segment (in Central Europe, the North Sea, Africa, and Russia), refineries (in Austria, Germany, and Romania), a chain of petrol stations (approx. 2,000 in 10 countries), as well as gas-fired power plants (in Romania and Turkey), gas warehouses (in Germany and Austria), and a network of Austrian gas pipelines. The company is also involved in powerful infrastructure projects: it is one of Gazprom’s European partners on Nord Stream 2.

Another European multi-energy giant is the Italian company Eni. This actor is de facto controlled by the government in Rome, which makes it structurally similar to the super-company that Orlen is to become. Eni’s asset portfolio is even wider than that of OMV. The company’s most important assets are in the oil and gas segment—it exploits mining fields, e.g. in Africa, Venezuela, the Barents Sea, Kazakhstan, Iraq, and the Far East. Thanks to its opportunities in the crude oil segment, the company is a leader in the sale of petrochemical products in Italy and one of the key players in Central Europe (it has petrol stations and other assets in Austria, France, Germany, Czechia, Romania, Slovakia, Slovenia, Switzerland, and Hungary).

Eni also has a number of gas-fired power plants with a total capacity of approx. 4.5 GW (almost as much as the Bełchatów Power Plant). The Italian company has renewable sources in its portfolio (including a powerful solar power plant in Nettuno with an installed capacity of 30 MW; for comparison, the largest Polish unit of this type has a capacity of approx. 4 MW). Eni also holds shares in the construction company Saipem, which was responsible for laying the Nord Stream gas pipeline, the construction of the Polish LNG terminal in Świnoujście, and was selected in 2020 to be the contractor for the offshore part of the Baltic Pipe gas pipeline. Eni’s great strength also lies in its subsidiaries, which operate in the chemical industry (Versalis), technologies in the field of electricity generation and industrial steam (EniPower), and engineering services (EniProgetti), among others.

The examples above may look very impressive from the Polish perspective, but none of these companies is included in the ‘Big Five,’ a.k.a. ‘Big Oil,’ which includes ExxonMobil, Shell, BP, Chevron, and ConocoPhillips (although Eni is nearing this top tier).

Nevertheless, looking from this angle, it can be concluded that the business model Orlen is pursuing has proven successful in European realities. Of course, there are other conditions and processes behind the creation of OMV or Eni (which are not subject to the control of the EC, for example), but the very model of the composition of these actors and their business strategies are similar to those of Orlen.

Dream big

The assessment of Orlen’s plans at this stage is rather problematic. The total costs that will have to be incurred are currently unknown; the impact of this process on the Polish market cannot be determined precisely; and the final added value for the Płock-based giant is also an issue that cannot be accurately estimated.

The announcements regarding the construction of the Polish champion are probably pleasing to the heart of every Pole; it is difficult to resist fantasies about the global network of Orlen’s influence, putting the Płock-based company on par with energy powers from various countries worldwide. However, when making such dreams, one must not forget about the potential issues when building such a colossus.

Firstly, the final balance sheet for the takeovers will depend on the European Commission, its approval for the sale of assets and the new buyers, and the plans for the assets acquired. Secondly, Orlen—a company which primarily deals in oil—will operate in less favourable macroeconomic conditions, primarily determined by the EU’s climate policy, which is very restrictive in terms of fossil fuels and the industries based on them. Thirdly, the aggregation of assets alone does not guarantee success; innovation, R&D expenditure, and modern promotion methods are also very important.

Without these elements, it will be difficult for Orlen to compete on foreign markets, which are already demanding and more chauvinistic economically. Whether the Płock-based company becomes a global giant or just a giant on clay feet will depend on an appropriate marketing and development strategy, combined with the maximum use of the assets acquired.

Polish version is available here.