a) Europe’s refining sector is driven by a number of factors shaping its economics:
In 2016, European refining business will be affected by several factors which will drive the dynamics of the refining margins. The most important of these are:
- Macroeconomic environment of European refineries. Europe’s refining business is presently affected by structural pressures driven by low demand. Moreover, competition from Middle and Far East refineries, as well as enhanced oil production capacities and higher production of fuels in Russia, pose a threat to Europe with potential fuel imports and shrinking margins of local producers.
On the other hand, lifting of the ban on oil exports in the US may result in a narrower BRENT/WTI differential and enhance the competitive position of European refineries against their US competitors, at least to some extent.
- Potential overstocking. Absorbing the excessive supply of oil entails its processing into refining products, which is currently happening at an accelerated pace due to favourable margins. As the increase in margins and processing rates is not backed by higher demand, the market will see an increase in the stocks of refining products, which will in turn put pressure on their prices.
- Position of refineries. European refineries are operating at less than full capacity, which additionally drives up the costs and constrains profitability. They are relatively older and thus less efficient than their competitors in the Middle East and in Asia. Therefore, even though the situation in the refining business has recently picked up, the question of long-term efficiency improvements will continue to be crucial for European refineries.
- Relative stability of demand. A steep decline in margins could lead to collapse in demand for fuels in the wake of global recession caused by geopolitical factors; however, the probability of this scenario coming to life is rather low.
The ORLEN Group’s major competitors in the refining business in Central and Eastern Europe are:
- Grupa LOTOS of Gdańsk − Poland’s second largest refinery.
- Mitteldeutschland refinery at Leuna/Spergau, a Total Group company, located in south-eastern Germany about 150 kilometres from the Polish-German border, currently Germany’s most advanced refinery.
- PCK refinery in Schwedt, north-west of Berlin, about 20 kilometres from the Polish-German border.
- Slovnaft refinery, an integrated refining and petrochemical group with a leading position in the Slovak Republic, located near Bratislava.
- Mozyr refinery, a leading refinery in Belarus.
Types of refineries in Europe
b) The European petrochemical producers’ largest challenge is posed by the expansion of new production capacities in the US, Middle East and Asia. As a result of low prices of natural gas and the North American shale revolution, the cost of petrochemical products in the US has fallen to a level close to petrochemical production costs in the Middle East. Asia is the largest market for petrochemical products, and this is where the strongest increase in production capacities is expected to be seen in the coming years.
Low gas prices in North America over the last eight years have translated into higher supply of ethylene, which can be manufactured there at a lower cost than in Europe, where its production is based on crude oil. In the global petrochemical industry, raw material and energy costs determine producers’ competitive position as they account for as much as 70% of production costs. European petrochemical business will be forced to come face to face with the US petrochemical producers, whose competitive advantage lies in the access to cheaper feedstock. There is a high degree of diversity among Europe-based manufacturers in terms of their potential for economic success, with the key factors including the scale of operations, integration of petrochemical assets with the refining business, location, technologies, and age of process units. Those manufacturers who operate gasoline-fed units are taking steps to switch part of their production process to light LPG blends. European manufacturers can improve their position by reducing costs, improving margins and restructuring their production plants. Further technological progress and innovations in the production process will also play an important part. Other possible optimisation efforts include improvement of pricing policy and developing a portfolio of high-margin specialist products. Launching production of more advanced products requires not only changes in the technological regime of production facilities, but also strong R&D capabilities, capital expenditure, changes in sales channels, and building relations with customers. The enduring gap between polyolefins consumption in Western Europe and Poland on the one hand and Central and Eastern Europe on the other hand is a source of significant development potential for the ORLEN Group.
Our competitors on the European market are manufacturers offering the same petrochemical products.
Europe’s production capacities for high-density polyethylene (HDPE) and low-density polyethylene (LDPE) are currently at approximately 13,617 thousand tonnes per year. The largest polyethylene producer is Lyondell Basell Industries, with annual production capacities of approximately 2,195 thousand tonnes (including a 50% share in BOP), the owner of polyethylene production assets in Germany, France and Poland. The second largest manufacturer is Ineos Olefins & Polymers Europe, with production capacities of around 1,745 thousand tonnes per year and assets in Belgium, France, Germany, Italy and Norway. Third in the list is Sabic, with annual production capacities close to 1,590 thousand tonnes and the asset base in Germany, the Netherlands and the UK. Other major players include Total Petrochemicals, Borealis and ExxonMobil.
Polyethylene manufacturers in Europe
Source: In-house analysis based on POLYGLOBE.
In the case of polypropylene, Europe’s annual production capacities are at around 11,584 thousand tonnes. The largest polypropylene producer is Lyondell Basell Industries, with annual production capacities of approximately 2,365 thousand tonnes (including a 50% share in BOP), the owner of polypropylene production assets in Germany, France, Italy, Spain, the UK and Poland. The second largest manufacturer is Borealis, with operating capacities of around 1,920 thousand tonnes of polypropylene per year and assets in Belgium, Germany, Austria and Finland. Other major players include Total Petrochemicals with annual production capacities of approximately 1,280 thousand tonnes and assets in Belgium and France, as well as Sabic with 1,150 tonnes per year and the asset base in the Netherlands and Germany.
The combined shares of BOP and the Unipetrol Group in Europe’s polyethylene and polypropylene production capacities is approximately 4% each.
Polypropylene manufacturers in Europe
Source: In-house analysis based on POLYGLOBE.
Europe’s annual PTA production in 2015 was about 2,611 thousand tonnes, while the nominal production capacity is approximately 3,883 thousand tonnes per year. The reason is that Artlant’s actual output in 2015 was considerably lower than its nameplate capacity due to long shut-down periods (since Q3 2014, it produced PTA only for three weeks in October 2015, and regular production is expected to resume in mid-2016).
PTA in Europe is used primarily to produce PET granulate for the manufacturing of plastic food-grade bottles (around 85% of Europe’s production volume), polyester fibres (around 5% of Europe’s production volume), and foil (around 3% of Europe’s production volume). European market was home to seven PTA producers; however, 2015 saw the winding-up of Indorama OttanaEnergia JV’s production plant with the nominal production capacity of 190 thousand tonnes per year. Europe’s largest PTA producers are: BP Chembel NV of Belgium with nominal annual production capacity of 1,400 thousand tonnes, Artlant of Portugal capable of producing 750 thousand tonnes per year, and PKN ORLEN with annual production capacity of 600 thousand tonnes of PTA. In total, those three manufacturers accounted for more than 72% of Europe’s nominal PTA production capacities in 2015. The ORLEN Group’s share of Europe’s nominal PTA production capacities in 2015 was 16%, and ORLEN was the only European producer having its own PTA production facilities fully integrated with paraxylene production. Apart from intensification of production at Indorama Rotterdam’s PTA units scheduled for the first half of 2016 (by 250 thousand tonnes per year), Europe’s planned investments in PTA production capacities will be mainly in Russia: at Etana (750 thousand tonnes per year – in 2020), Mogilev (600 thousand tonnes per year – in 2020), and OJSC TANECO (210 thousand tonnes per year – in 2021).
PTA manufacturers in Europe
Source: In-house analysis based on the PCI.
PVC annual nameplate production capacities in Europe are currently at 7,858 thousand tonnes. However, Oltchim and Karpatneftekhim, accounting for 300 thousand tonnes each, have remained closed down for a long time. Europe’s PVC production leaders include INOVYN (a company formed by merging Ineos Chlor and Solvay), Kem One and Vynova, with 31.5%, 11% and 10.5% of Europe’s nominal production capacities, respectively. With annual capacity of 475 thousand tonnes, the estimated share of the ANWIL Group in Europe’s total production capacities is approximately 6%, which currently places it in the 6th rank. The ANWIL Group’s main competitors in the Polish and European PVC markets are BorsodChem, Inovyn and Vynova.
PVC manufacturers in Europe
Source: In-house analysis based on the IHS.
In the case of ammonium nitrate (AN) and calcium ammonium nitrate (CAN), total production capacities in EU-28 (plus Norway and Switzerland) stand at about 7,500 thousand tonnes per year. Those products are used mainly in agriculture as universal fertilizers for crops. Yara is Europe’s largest producer, holding a 23% market share, followed by Borealis and Grupa Azoty with market shares of, respectively, 10% and 9%. In terms of production capacity, Anwil S.A.’s share of the AN and CAN market is 6%, which makes ANWIL the 4th largest producer in Europe.
Ammonium nitrate and calcium ammonium nitrate manufacturers in Europe
Source: In-house analysis based on on Fertilizers Europe.
In 2015, the Polish economy continued on the growth path. According to preliminary estimates of the Central Statistical Office of Poland, in 2015 the GDP growth rate was 3.6% (yoy), up 0.3 pp on 2014. The positive trends were also visible on Poland’s labour market, with the unemployment rate retreating year on year. The sound condition of the Polish economy translated into higher fuel consumption. According to the Energy Market Agency, the years-long downward trend in petrol and diesel oil consumption reversed. In 2015, the consumption of the two fuels increased by 2.6% and 5.8% year on year, respectively. The demand was strongly driven by low fuel prices and more favourable market conditions. Fuel prices declined on the back of historic decline of oil prices on international markets, which further encouraged motorists to use their vehicles even more frequently. A grey market for fuels is a serious problem which the Polish market still has to face. The volume of diesel oil sold illegally is estimated at as much as 10-20% of the fuel’s total consumption.
Diesel oil and petrol consumption is expected to continue growing in 2016, provided that the rate of growth of the Polish economy is maintained and depending on whether steps to combat unfair competition prove successful.
d) Baltic States and Ukraine
Consumption of petrol in the Baltic States fell (-) 2.5% (yoy), most notably in Lithuania, where it was down (-) 4.8% (yoy). Lower petrol consumption is caused by the so-called ‘dieselization’ process, with the number of diesel vehicles growing in this region for years. Reduced inland sales of petrol on the back of lower consumption was offset entirely by sales through sea routes, with significant improvement of trading terms in this distribution channel.
At the same time, demand for diesel oil grew by 7.1%, including by 8.6% (yoy) in Lithuania, 7.4% (yoy) in Latvia and 4.0% (yoy) in Estonia.
The political and economic situation in Ukraine remains extremely difficult. The country sunk into recession, with the falling GDP growth rate – down (-) 9.0% (yoy) and a 50% inflation rate (as estimated by the IMF). Many Ukrainian clients of Grupa ORLENLietuva have lost their assets in areas affected by the continuing military conflict, including service stations and fuel depots. The comparison of Ukraine’s consumption data reported in 2013 (pre-conflict) and in 2015 (estimates) shows that petrol consumption fell by more than (-) 41% (yoy) and diesel consumption by nearly (-) 10% (yoy).
e) The Czech Republic
In 2015, the growth of the Czech economy continued, with the GDP growth rate reported at 4.3% and low inflation. The favourable macroeconomic climate had a positive effect on consumption of diesel oil, which grew by 4.4% (yoy), at the expense of petrol (down (-) 0.5% (yoy)).
f) Power generation
At present, more than 80% of the world’s demand for energy is met by the three main fossil fuels: crude oil, natural gas and coal. While coal still remains the cheapest source of energy, it is expected to be gradually replaced with natural gas and renewable energy sources in the long term, given the current fuel prices and the need to decarbonise industry. Gas will become the main source of energy shortly after 2035. Without a doubt, falling crude prices will drive the prices of gas down. Shale gas, which has evolved into a cheap source of energy in the US and Canada, is an alternative to coal – all the more so in that it offers a substantial reduction of carbon emissions.
Global power generation capacities [GW]
To a large extent, the rate of economic growth determines trends in power consumption. Stronger demand for energy in non-OECD countries will be driven by fast-growing economy and incomes, demographics, and growth of urban areas. According to World Energy Outlook 2015 report of the International Energy Agency, demand for electricity outside the OECD is expected to grow 2.9% p.a. in 2013-2040, compared with only 0.7% in the OECD countries. Despite the fast-growing demand for power per capita, in 2040 non-OECD countries will still consume less than 40% of the average per-capita amount of energy by the OECD members.
Poland is the key market for the power generation business of the ORLEN Group’s Downstream segment, offering good growth prospects due to lower energy consumption compared with most of other European countries. In Poland, electricity consumption per capita is significantly below the EU average – approximately 4.1 MWh in 2015 compared with the EU average of 5.4 MWh. In 2010-2015, demand for energy in Poland rose at the average rate of 1.3% per year, which is expected to increase in 2015-2020 (according to CERA, to approximately 1.8%). Electricity demand in Poland is projected to grow in 2015-2030, driven by the country’s economic growth.
Global electricity demand by region
Electricity demand in Poland in 2010−2030 [TWh]1
Electricity prices grew at a stable rate until 2011. Then the trend reversed in 2012-2014, with prices going down from approximately PLN 180/MWh at the end of 2011 to approximately PLN 140/MWh at the end of 2013. After the prices rose in 2014 (to approximately PLN 190/MWh), in 2015 they settled at approximately PLN 150/MWh.
Given their age and emissions intensity, a significant portion of the existing generation assets in Poland is in need of upgrades and/or replacement. It is estimated that about 5GW in generation capacities should be phased out by 2020.
The Czech power market was fully liberalised in 2006 and is currently one of Europe’s most advanced markets. In 2010-2015, electricity demand stayed relatively flat (CAGR 0.3%), and is expected to increase by approximately 1.5% per year in 2015-2020 according to CERA. Wholesale electricity trading takes place at the Power Exchange Central Europe (PXE) in Prague.
Total consumption of electricity in Lithuania is 10 TWh/per year. The Mažeikiai refinery is the country’s largest consumer of electricity, accounting for 0.6 TWh/per year. In 2010-2015, energy consumption by end users in Lithuania grew by 2.6% per year. CERA predicts the country’s energy demand to grow in 2015-2020 at ca. 2.4% CAGR. Lithuania also imports electricity from neighbouring countries.
Renewable energy sources (RES) are expected to grow globally. It will be supported by regulations designed to limit CO2 emissions and give preferential treatment to RES. The EU’s targets, adopted in 2014, for lower CO2 emissions and higher share of renewable energy in total consumption in 2030 are 40% and 27%, respectively (vs the 1990 baseline). Furthermore, the agreement on reducing greenhouse gas emissions signed between the US and China, the two largest carbon dioxide emitters, is a major step towards reaching a global consensus on this issue.
In Poland, approximately 80% of electricity production is still based on coal, but the share of renewables is gradually rising: from 2.4% in 2005 to 10.4% in 2013 and 12.5% in 2014.