Energy 17 July, 2020 10:00 am   

State Treasury to create a mega-Orlen to handle the challenges of the green revolution

The European Commission issued a positive conditional decision for PKN Orlen to merge with the LOTOS Group. After taking over Energa, a company in the power industry, LOTOS, a company in the oil, petrochemical and alternative fuels sector, PKN Orlen now wants to enter the gas sector by acquiring PGNiG. Its ultimate goal is to establish an energy conglomerate, which will become a tool to implement the European Green Deal. According to its CEO, Daniel Obajtek, PKN Orlen will be the company to conduct the energy transition in Poland – writes Bartłomiej Sawicki, editor at

Remedial measures

After a year of investigating the purchase of LOTOS by PKN Orlen, the European Commission, on the basis of the EU Merger Regulation approved the takeover of the Grupa LOTOS by PKN Orlen. The approval was given on condition that PKN Orlen fulfills the requirements listed in the EC decision. In result of the investigation, the Commission expressed concerns regarding the fact that if the transaction was to be conduced in the original form, it would have harmed competition, especially on the following markets:

• the wholesale supply of motor fuels in Poland;
• the retail supply of motor fuels in Poland;
• the supply of jet fuel in Poland and Czechia;
• the supply of related products such as different types of bitumen in Poland.
To mitigate these competition-related issues, the European Commission, obliged PKN Orlen to meet the following commitments:
• divest a 30% stake in LOTOS’ refinery accompanied by strong governance rights, with the purchaser having the right to approximately half of the refinery’s diesel and gasoline production, while also giving the purchaser access to important storage and logistics infrastructure;
• divest nine fuel storage depots to an independent logistics operator, and to build a new jet fuel import terminal in the Polish city of Szczecin, which would be transferred 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;
• divest 389 retail stations in Poland, amounting to approximately 80% of the Lotos network, 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 tonnes of bitumen/heavy residues annually.

The remedies were agreed upon between the European Commission, PKN Orlen and LOTOS pertain to the following sectors: fuel production and wholesale activities, fuel logistics, retail activities, jet fuel and bitumen. The specifics of these commitments and transactions will be determined with the potential external partners during separate talks and negotiations. The EC will need to approve both the asset purchasers required by the commitments, as well as the terms and conditions of the contracts signed with them.

What about the refinery in Gdańsk?

PKN Orlen’s underlying goal was to keep as many assets of LOTOS as possible. When it turned out this year it would not be possible, the company started negotiations with the EC and the market on what Orlen could divest by exchanging or selling assets. Orlen’s basic condition was keeping the refinery. That goal was achieved, but not entirely. Orlen’s CEO, Daniej Obajtek revealed the EC wanted the company to give up not just one, but two refineries. “We could not agree to this. The negotiations were hard because this process needs to make sense from a business perspective,” Obajtek said.

The business model of the refinery in Gdańsk will change to a joint venture. Once merged with LOTOS, PKN Orlen will operate the refinery, which will be separated as part of the joint venture to guarantee Poland’s fuel security. Therefore, it seems that the overarching goal of this transaction was to maintain control over the refinery in Gdańsk.

The refinery in Gdańsk, which today belongs to the LOTOS Group and after the transaction will be owned by PKN Orlen, will be managed a separate entity – Gdańsk Refinery SA (joint stock company – transl.). Still, LOTOS will own 70 percent of the shares, whereas the remaining 30 percent will belong to a partner who will purchase the package. PKN Orlen will operate the entire refinery, but the new partner will receive a product volume from the refinery that will be proportional to their package. At the same time, the partner will manage the refinery’s wholesale activities. To what degree? We don’t know this yet, because the EC requirements are very liberal and the details will be revealed after the negotiations with the partner. The oil terminal located by the refinery is used to balance production. Orlen will wait for the negotiations before it determines which elements of the refinery and terminal will belong to the new partner, but its aim will be to maintain the best possible efficiency. The rules for governing this entity are to facilitate the refinery’s proper operation. If Orlen wants to make an investment, but the partner will not want to participate, Orlen will be allowed to do it anyway. This rule will work both ways. This model for managing refineries is popular in the West – in Germany and Italy. Orlen will focus mostly on exchanging assets both on the market on which it is already present, as well as on new markets. During a press conference where the possible future transactions were discussed, Hungary’s MOL was often mentioned. The company could capture a bigger share of Poland’s retail market.

The reporters asked whether it would be possible for Orlen to enter the Croatian market where MOL has shares in the local concern called INA, but it cannot agree with the Croatian government on how to manage that company. Orlen did consider taking over INA a few years ago, but back then the company had been too expensive. Today such a transaction would be possible, at least in theory. However, this is one of many options. Another is Romania where Austria’s OMV is already present. Obajtek did not rule out neither of these options, suggesting that there were many others and that they did not pertain to the two companies only. Moreover, Orlen will indeed seek compensation in the form of 30 percent shares in a different refinery, but it will also consider – provided such options appear – other possibilities, such as petrochemical assets or investments in low- and zero-emissions energy generation.
When it comes to replacing retail assets, i.e. petrol stations, Orlen will not strive for taking over just them. The company believes that acquiring retail without guaranteed access to the wholesale market makes no sense. Therefore, one could expect that Orlen will want to have access to the product and wholesale markets if it decides to take over the petrol stations.

Storage depots

Regarding the storage depots, after the merger the potential of PKN Orlen and LOTOS will be decreased by 10 percent, which is a total of 7 percent of Poland’s entire storage capacity. To compare, when TotalFina took over Elf in 2000, the commitments involved divesting a larger package of fuel infrastructure together with pipelines and a number of fuel bases located in various regions across France. The goal was to increase competitiveness on the wholesale fuel market. The requirements pertained to about 14 fuel terminals in France. Whereas in Poland an independent operator will manage 9 fuel bases of LOTOS and Orlen, which have been already selected. This pertains to a capacity of 360 thousand cm in total. Orlen’s depot capacity is 3.1 million cm. This is 54 percent of the country’s total storage capacity. Orlen will give up control only over those bases without which it will be able to continue its operations. It will not sell any fuel bases in the eastern part of the country to insure against fuel imports from the other side. This also pertains to bases that have pipeline connections. Who will acquire shares in those bases? This will be decided by a tender.

Pros and cons of the merger

According to Orlen’s CEO, the merger would have to happen anyway, because in time LOTOS would cease to exist due to the low output of processed oil, and the fact that its only well-developed branch is petrochemical production. In his opinion, LOTOS would not be able to grow other branches. During the 2014 economic crisis LOTOS had to be recapitalized.. According to Orlen, the merger of the two companies will add to their financial abilities to implement large, multi-billion investment projects, such as the planned construction of offshore wind farms. The merger is also an opportunity for both companies to enter new areas of activity and to enhance those, in which they are already present. At the same time, it is assumed that Orlen will be able to buy more oil, which will make its price more attractive. Orlen’s CEO ensured that the project would be financially sound because, among others, after the merger it will be possible to save a lot of money on purchasing oil. It will also contribute to expanding Orlen. LOTOS will keep full tax independence. This means the city of Gdańsk will receive tax revenue as before. The company’s headquarters will stay in Gdańsk, so it will continue to pay the CIT and property taxes there.

The skeptics argue that if the merger is completed on the current terms, the profits from production will drop because part of the production volume from the refinery in Gdańsk will be handed over to the joint venture partner. At the same time selling 389 petrol stations will allow serious competitors to Orlen enter the market, which will make it harder for the company to operate on the domestic market. Another issue is whether the exchange of assets will be enough of a compensation for the accepted remedial measures. The company wants to spend 12 months on negotiations and another 6 on concluding the asset exchange process.

History of transactions

The merger was initiated in February 2018 when a Letter of intent with the State Treasury was signed. The state owns 53.19 percent of LOTOS votes on the general meeting of shareholders. Whereas in April 2018 the due diligence process started in LOTOS, during which its commercial, legal and tax standing were investigated from the point of view of the takeover. In November 2018, PKN Orlen submitted to the European Commission a draft version of an application for the merger. During the works on the document, PKN Orlen and the LOTOS Group received hundreds of questions from the EC, to which the companies responded. Good cooperation between all parties made it possible to draft the final version of the application, which was submitted to the EC at the beginning of July 2019. Additionally, at the end of August 2019 an agreement between PKN Orlen, the State Treasury and the LOTOS Group determining a framework for the merger transaction was signed. At the end of September 2019, following the standard guidelines, the EC used the “stop the clock” procedure for the second part of the negotiations, which was called off at the beginning of March 2020. On the eight of April this year, the EC offered Orlen the possibility to learn about the analyses conducted in the second phase of the merger proceeding. In line with the practice followed for this phase, the “Statement of Objections” procedure was applied. PKN Orlen submitted a formal proposition on the remedial measures at the end of April 2020 and at the beginning of May started a market test.

After oil and power, it’s time for gas

According to declarations made by Orlen’s CEO Daniel Obajtek and Deputy Prime Minister and Minister of State Assets, Orlen is to become an energy conglomerate. As a fuel company, Orlen will widen its impact not only on the market of traditional fuels, but also on alternative fuels, such as hydrogen. After taking over Energa at the end of April, Orlen entered the electricity market and is planning to capture a sizeable portion of the renewable energy sources (RES) sector. The plan is to invest in not only offshore wind farms, which it is already building, but also onshore farms, a sector where Energa has the necessary know-how. In the foreseeable future the company wants to penetrate the onshore wind farms market by acquiring and developing new projects. To become an energy conglomerate, Orlen needs to add low-emission fuel to its portfolio. That fuel is gas. It already has two combined cycle power plants in Włocławek and Płock. New plants that will use this technology will be constructed in Gdańsk, Grudziąc and Elbląg. The Ostrołęka C power plant will also run on gas. To add a gas branch to its structure, PKN Orlen signed with the State Treasury, represented by the Minister of State Assets, a letter of intent to take over the PGNiG Group. PKN Orlen is a leader that will establish a single, Polish company with diversified revenue, and able to compete on the European market. After the merger of PKN Orlen, Grupa Energa, LOTOS and PGNiG the annual revenue of the concern would total at about PLN 200 billion. The EBITDA of key segments would reach about PLN 20 billion a year. About 40 percent of the operating profit would still be generated by the core business of the merged companies, i.e. refinery and petrochemicals. Whereas, production at a total of about 70 million BOE would constitute about 20 percent of the profit. Fuel, gas and energy retail as well as regulated distribution would generate about 15 percent of profit, and promise a high growth potential in the coming years. Energy generation would be responsible for about 10 percent of the operating profit. In this case it would be possible to double the profit by 2030 by making new investments. Orlen is interested in the entire supply chain from CNG to LNG. It make take a year for the EC to issue consent, whereas the pre-notification process may take a few months. Importantly, when we asked Daneil Obajtek about PGNiG’s strategic plans, the CEO confirmed that projects such as the Baltic Pipe would stay intact.

Can Orlen afford this?

Orlen’s goal is to put as little pressure on its balance sheet as possible when going through the mergers with LOTOS and PGNiG. The company wants to take 18 months to design the transaction structure for LOTOS and PGNiG. The strategies may be compatibile. However, the goal is put as little pressure on the budget as possible. According to the company, thanks to good management it is possible to generate EBITDA at a total between over a dozen up to PLN 20 billion. Daniel Obajtek explained that PGNiG is a company working on a regulated market and dependant on regulated profit. He stressed the company had to balance its investments to survive. The energy transition is important, but we have to balance the investments to actually go through with it. “If we don’t do this in a few years we will be devoured, and the transition will be completed by other companies,” Obajtek explained.

Orlen’s schedule suggests the company doesn’t want to negatively impact its budget to have enough money for the necessary investments. The need to balance Orlen’s budget and the uncertainty regarding the macro-economic environment are serious challenges from the financial perspective. However, the macroeconomic conditions should become more predictable within a year once Poland and Europe handle the impact of the coronavirus. So is Orlen still missing anything to become an energy conglomerate? Daniel Obajtek suggested that to establish a fully-fledged energy conglomerate Orlen needs to develop its supply and production chains.