PKN Orlen will build a new energy company with the LOTOS Group, provided certain conditions required by the European Commission are met. One of those is selling a portion of shares in the Gdańsk Refinery. Could Russians use this opportunity to enter the Polish oil market through the back door? On paper – yes, but Orlen argues that it would be impossible in practice – writes Bartłomiej Sawicki, editor at BiznesAlert.pl.
The debate on the merger of Orlen and LOTOS is rife with various opinions. According to Grzegorz Pytel, analyst at the Sobieski Institute, it is impossible for Orlen to become the controlling operator of the refinery in Gdańsk after the merger. In his opinion, Orlen does not have any tools at its disposal to prevent the company that will buy shares in the refinery in Gdańsk from basing its business model on oil supplies from Russia, and closely cooperating or being in a partnership (directly or indirectly, e.g. via a company in Switzerland) with Russians. In his view, this creates an opportunity for Russians to enter the Polish market. Pytel believes that Orlen would not be able to block a scenario where the mentioned company, would use the refinery in Gdańsk to successfully compete against refineries is Płock and Mažeikiai to capture the markets of the Baltic Sea basin.
Pytel based his opinion on three aspects of the EC requirements. He argues that together with the shares of the refinery in Gdańsk and parts of LOTOS, Orlen will need to hand over to the buyer strong governance rights, whose definition will be interpreted by the EC. This means that in our interlocutor’s view, Orlen will lose control over the refinery in Gdańsk. “Interestingly enough, so far this requirement has not been widely discussed in the media by Orlen’s representatives. While it is true that Orlen will select who to sell the assets to, the EC will have to give its consent to that choice and provide an interpretation for the “strong governing rights”. In other words, the EC may use its right to veto to choose with whom Orlen will be able to strike the deal, or block the transaction. In such a case, the EC will probably not be concerned about a specific company or a consortium (which cannot be excluded anyway), but it will make sure that Orlen will carry out the transaction, so that a company that is Orlen’s competitor, not its partner, will enter the Polish market. At the same time, that challenger should be able to efficiently compete with Orlen instead of being its hostage (e.g. because of not being able to sign contracts of its choice for oil supply from Russia),” the expert argues. “The point of the EC decision is that Orlen should divest LOTOS’s assets to introduce a competitor to the Polish market, not a partner. Otherwise, that ruling would be a caricature of itself,” he assesses. Therefore, as Pytel believes, using the word “partner” may be misleading. It would be unacceptable for Orlen to dictate its competitor where and under what terms it is allowed to, e.g. buy oil (especially that Orlen has been buying huge amounts of oil from Russia for years), where and under what terms it is allowed to acquire capital to develop its business in Gdańsk, or how and from whom it will be allowed to borrow money (lien).
Considering the above factors, would Russians, e.g. as part of a consortium with German companies, be able to actually enter Gdańsk through the back door?
Orlen wants to swap assets
The European Commission, on the basis of the EU Merger Regulation approved the takeover of the Grupa LOTOS by PKN Orlen. The decision was made after a year-long investigation into the transaction, and the permit was granted on the condition that PKN Orlen fulfills the requirements presented by the EC. To protect competition, the European Commission proposed the following measures:
– divest a 30% stake in LOTOS’ refinery with the purchaser having the right to approximately half of the refinery’s diesel and gasoline production, a limited package of governance rights. PKN Orlen is to sell its logistics infrastructure to an independent logistics operator, which will offer the capacity to everybody. PKN Orlen will use some of it.
– divest nine fuel storage depots to an independent logistics operator, and to build a new jet fuel import terminal in the city of Szczecin, which would be sold to the independent logistics operator on completion;
– release most of the capacity booked by LOTOS at independent storage depots, including the capacity booked at Poland’s biggest terminal for the import of fuels by sea in Dębogórze;
– divest 389 retail stations in Poland, amounting to approximately 80% of the Lotos network (5% share in the market), and to supply these with motor fuels;
– sell Lotos’s 50% stake in the jet fuel-marketing joint venture that it has with BP, to continue to supply the joint venture, and to give the joint venture access to storage at two airports in Poland;
make available up to 80,000 tonnes of jet fuel per year to competitors in Czechia via an annual open tender;
– divest two bitumen production plants in Poland, and to supply the purchaser with up to 500,000 tons of bitumen/heavy residues annually.
Orlen has already declared it was interested in swapping assets from markets where it is present as well as from new ones. At the same time, it wants to use the cash from sales to invest.
Rosneft’s missing link in Germany
One of the arguments for the thesis that Russians could enter the Polish market as a shareholder of one of the two biggest refineries, is supposedly the fact that they are already present in Germany. However, it is worth reminding that they slipped into Germany thanks to Venezuela’s fondness towards Russian politics. Venezuela’s late president Hugo Chavez agreed for PDVSA, a state-owned oil company, to sell its shares in five German refineries to Russia’s Rosneft. Since then, Igor Sechin’s concern has been trying to acquire the missing link – the retail market and gas stations. Despite interventions, negotiations and investments, Russians have not achieved this goal yet. They have been trying to purchase gas stations in Germany for a few years. This is the next natural step for any oil company that took over shares in a refinery on a new market. After the success on the wholesale market, it wants to earn on the retail market by selling its own oil products. However, nobody wants to sell Russians, in this case Rosneft, any gas stations despite the fact they have been present on the market in Germany for years.
In January 2019, Rosneft Deutschland GmbH, Rosneft’s daughter company, launched a trade and marketing business in Germany. Today it purchases products from three German refineries in which it has shares. Since 2011 it has been pursuing trading activities together with BP. In December 2016 the companies announced they signed an agreement to dissolve a joint venture Ruhr Oel GmbH (ROG), which dealt with refining oil and petrochemicals in Germany. They agreed it would end its operation by the end of 2018. At the end of 2016 Rosneft bought BP’s shares in German oil refineries, as part of the dissolution of Ruhr Oel GmbH. Russians paid USD 1.52 bn. In result of the transaction, Rosneft became a direct stockholder and increased its shares in a few refineries: Bayernoil – from 12.5 to 25 percent, MiRO – from 12 to 24 percent and PCK (Schwedt) – from 35.42 to 54.17 percent. Additionally, the deal made Rosneft the third biggest player on Germany’s refinery market with a total processing capacity of up to 12.8 m tons annually, which is over 12 percent of Germany’s processing capacity.
In January 2019 in an interview with a German daily Handelsblatt, the CEO of Rosneft Deutschland, Brian Chesterman, said that he was considering buying refineries and gas stations in Germany. Igor Sechin, the CEO of Rosneft, did not rule out that his company would start a gas station chain in Germany. Purchasing gas stations after a decision to directly sell oil products seems like a reasonable yet difficult step. This is because such transactions are made on mature markets, such as the one in Germany, only if a bargain on the market appears, such as the sale of less profitable stations, the need to optimize or due to a decision by a regulatory body. Russians would face exactly the same difficulties if they wanted to enter Poland. Acquiring shares in a refinery without gas stations is still a business that is far from being very profitable. However, it does not seem very probable that a Russian company would take over shares in the Gdańsk Refinery.
Rosneft at the Gdańsk Refinery?
Why would Russians want to enter the Polish market? Poland is one of the biggest importers of Russian oil. In 2019 PKN Orlen imported 8.3 m tons of oil from Russia, which makes it one of the biggest importers of this fuel. By entering the Polish market, Russians could achieve synergy by acquiring 30 percent of shares in the refinery. However, similarly to their situation in Germany – they would still need gas stations. It is difficult to imagine this company’s banner on petrol stations in Poland. Russia’s Łukoil is a telling example in this market segment, as it withdrew from the Polish gas stations sector in 2016. On the other hand, Russians could be interested in Poland because it would strengthen their logistics in the Baltic Sea basin. Apart from the economic factors, political issues also come into play, one of which is granting access to critical energy infrastructure to a company from a country, which is perceived as a potential threat. However, there are arguments that speak for the fact that it is rather improbable that Russians would take over 30 percent of shares of the refinery in Gdańsk.
It’s Orlen’s decision, but the EC needs to approve
The statements by the European Commission, as well as detailed analyses of statements by PKN Orlen, talks and discussions with market representatives and other interested parties, reveal that Brussels gave the company from Płock a free hand to choose a partner who will purchase the 30 percent of shares in the Gdańsk Refinery. According to the EC statement on the conditional agreement, and to statements made by officials from Brussels, before the final divestment agreement on the 30 percent of the refinery’s shares is signed, Brussels will be allowed to verify the contract and check whether the purchaser is a reliable partner, ready to implement the remedial measures. It is the Commission’s job to assess whether the purchaser is not a vulture fund with questionable motives, revenue or capital. On the other hand, the EC is concerned that Orlen may purchase the 30 percent through a dummy corporation and in practice monopolize the market, which would go against the intentions of the EU officials. Nevertheless, the EC gave Orlen a lot of leeway and has taken a rather liberal approach to other elements of the contract. In practice it means that the company from Płock is allowed to decide what potential conditions its partner needs to meet and it is Orlen who will choose that partner. It is also worth remembering that the EC didn’t even impose on Orlen any requirements on how the company should choose the partner.
Keeping tabs on the transaction
Considering the standard conduct of large businesses partially owned by the State Treasury in such situations, it is very probable that Orlen is cooperating with all intelligence agencies. BiznesAlert.pl learned in Płock that PKN Orlen has already been contacted by companies whose profile and assets make them very attractive. The list of ten partners with whom Orlen is already having preliminary talks reportedly includes companies that are already present on the Polish and European markets. There are also players from outside our continent, but with whom Orlen already has business contacts. Therefore, these companies are not unknown to Polish intelligence agencies responsible for verifying whether transactions pose a threat to the country’s energy security. PKN Orlen will ask the potential partner a number of questions: who they are, what has been their strategy so far, what is their market experience, what opportunities for development they have to offer to Europe, Central and Eastern Europe and maybe even the Middle East where Orlen is already present, and finally what is their strategy for the Polish market. Other factors that will be reportedly taken into consideration include the partner’s ability to adapt to Orlen’s strategy, as well as an assessment of the impact on the country’s energy security.
A deal to reject
It is worth stressing that PKN Orlen will not sell 30 percent of its shares in the refinery, or any other assets, such as gas stations. The EC remedial measures say that the company should “divest” them, but the way this will be done depends on Orlen, which will want to exchange assets instead of engaging in a financial transaction. The EC did not impose any requirements on Orlen when it comes to the divestment procedure. Importantly, a public tender will not be announced, which means the price will not be the deciding factor. Thus, Orlen will be able to chose its own criteria. This is extremely important, considering the speculations that a Russian company would be able to propose the most attractive offer for the 30 percent of shares, which Orlen could not reject because of market reasons. Since there will be no tender, such a threat doesn’t exist. At the same time, the tender procedure offers a chance to acquire more information on the competitor without the intention to actually purchase the assets. Orlen has announced it was cooperating with a few law firms and foreign banks.
No EC requirements over the contract or the partner
PKN Orlen’s underlying goal was to keep as much of LOTOS’s assets as possible. When it turned out this year that this would be impossible, talks with the market started on what assets Orlen may divest either by exchanging assets or selling them. Orlen’s boundary condition was to keep the refinery. That didn’t really pan out. The refinery’s business model will change to a joint venture. After merging with LOTOS, Orlen will become the joint venture’s operator and guard Poland’s fuel security. Therefore, it seems that the goal of this transaction was to maintain control over the refinery in Gdańsk.
In Orlen’s view, the refinery, which currently belongs to LOTOS and after the merger will belong to Orlen, is to manage a separate entity, which is called Gdańsk Refinery JSC. LOTOS will own 70 percent of its shares and the remaining 30 percent will belong to the partner, who will purchase the package. PKN Orlen will operate the entire refinery, but the new partner will receive an appropriate product volume, proportional to its shares. It is worth explaining that the remedial measures state that Orlen will have to guarantee access to half of oil and gasoline production capacity. However, this does not amount to 50 percent of the refinery’s entire output, as it produces other commodities, which Orlen may use for its own needs. Apart from oil and gasoline, the EC did not say in what proportions other products should be produced because they were not part of the remedial measures. Therefore, this will need to be settled between Orlen and its potential partner. Orlen wants to keep as much naphtha (petroleum) as possible to develop petrochemicals, the company’s third branch next to fuel production and power engineering. The EC did not impose any requirements with regard to the partner company. Its only expectation is that the partner will have the right to veto decisions, which would change the guaranteed output volume. As per the EC’s consent, if Orlen wants to invest in the refinery, but the partner won’t, the Polish company will be allowed to do it on its own. At the same time, if the partner wants to make investments in the refinery, Orlen is free to decide whether it wants to participate. If it determines that the investment will be detrimental to its security strategy, it will be able to block it. However, if the company decides that is not the case, but the decision will not be integral to Orlen’s business model, the partner will be able to pursue it on their own.
A decade of waiting
The remedial measures will be binding for ten years, unless the decision’s specific points say differently. After that time, Orlen will have the preemptive right to repurchase the 30 percent of shares in the refinery. Every partner will want to guarantee that right for themselves. At that point the EC will consider the agreement again. Its decision will depend on the situation on the market. Orlen informed BiznesAlert.pl that during the negotiations with the partner, it will want to add the “change of control” clause. If the partner decides to leave the joint venture, Orlen will have the preemptive right to buy the 30 percent. This is how the company wants to prevent a situation where after a few years, a Russian entity could buy the refinery shares from a European company, with which Russians are already cooperating on other projects, for instance in Germany.
The Gdańsk Refinery under protection?
It looks like the Polish state’s legislation is ready tackle any hostile takeover of companies that are strategically important to the country’s economy. Since 2015 an act on controlling specific investments has been in place. It determines the rules and modes for controlling some investments, which involve the purchase of shares or stocks, all rights and obligations of the partner who has the right to run the company or the right to represent the company, firm or its organized part, which results in purchasing or achieving a significant participation or acquiring domination over the company, which is subject to protection. According to the act, the prime minister publishes a regulation, which includes a list of entities that are under protection. PKN Orlen is already on it. The new venture that will manage the refinery may be added to the list by the prime minister, if the government determines that a potential threat exists. It is worth point out that the list already includes one private company – PKP Energetyka.
Clause on the origin of capital
PKN Orlen will also want the agreement with the partner to include a clause on the origin of capital. Orlen stated that the EC did not block such a possibility. It only stressed it wanted to review the clause once it is ready. The Commission did not raise any objections with regard to this request and showed understanding for the concerns about capital from Russia and China.
How much time does Orlen have?
The EC gave Orlen 18 months to negotiate with its partners, provide documents and take over LOTOS. However, the EC provided for a clause that allows for the talks to take longer if needed. After one year, i.e. in July 2021, Orlen will need to present to the EC together with its business partner how it will introduce the remedial measures. Once the EC gives its consent, Orlen will take over LOTOS’s shares. Contracts with partners will enter into force only if the transaction is finalized.
For and against the merger
The preparations for the merger of Orlen and LOTOS took two years and sparked various opinions on the decision. Some experts argued that a cross-sectoral synergy could yield the same result as the purchase of shares, but without the merger, which would mean the two companies could stay separate. Others believe that the LOTOS Group could cease to exist, or that it may find it very hard to survive on the market in the coming decade because of the growing position of alternative fuels. LOTOS will also need investments, which will be easier to finance once the two companies merge and form a bigger entity. The question remains whether without this, in a few years the country’s key refinery would be taken over by a company that is problematic from the point of view of the country’s security. Sceptics hold the opposite view and claim that the merger is risky and instead of strengthening the security in the oil sector, it may only introduce competition into it. The readers of this article can asses for themselves whether the remedial measures and safeguards introduced by Orlen will be enough to limit the risks discussed in the public debate.