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Market environment

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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

Types of refineries in Europe
Source: In-house analysis based on Wood Mackenzie.

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.

Polyethylene

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.

Polypropylene

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.

PTA

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.

Plastics

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.

Fertilizers

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.

c) Poland

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]

Global power generation capacities [GW]
Source: the IEA.

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

Global electricity demand by region
Source: the IEA.

Electricity demand in Poland in 2010−2030 [TWh]1

Electricity demand in Poland in 2010−2030 [TWh]
Source: the IEA.
1 End-user demand for electricity, i.e. excluding transmission losses and own needs of power plants.

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.

RETAIL

In 2015, retail fuel prices fell significantly on the back of the drop in crude oil prices. Lower prices at the pump limited the appeal of economy chains (which compete by offering low fuel prices). Premium stations began to enjoy increased recognition among customers, who became more willing to use more expensive premium fuels, as well as non-fuel and food services. Price was no longer the determining factor in selecting the place for refuelling vehicles. As a result, the fuel chains focused on developing their stores, especially food services. The same trend was seen among economy chains.

There were no significant changes in the number of service stations in the ORLEN Group’s home markets. The market saw an increasing number of independent stations beginning to cooperate with international chains or joining associations.

In 2015, TOTAL, the French chain, entered the Polish market with plans to launch roughly 100 franchise stations in the coming years. Ten services stations started franchise-based cooperation with TOTAL in 2015. Rebranding of Neste service stations taken over by Shell in 2013 was completed.

According to the Polish Organisation of Oil Industry and Trade (POPiHN), in 2015 there were more than 6.6 thousand service stations operating in Poland, and the ORLEN Group’s share in the total number of service stations was down (-) 0.8 pp (yoy), to 26.5%.

Our main competitors include foreign operators, such as Shell, BP, Statoil, and Lukoil, jointly holding 21.9% of the service stations, as well as Grupa LOTOS with a market share of 7.2%. The shares of foreign companies and Grupa LOTOS inched up (yoy) by 0.2 pp and 0.4 pp, respectively.

Service station networks in Poland as at December 31st 2015

 

Source: In-house analysis based on POPIHN data.

In the Czech Republic, MOL of Hungary completed the acquisitions of 44 Lukoil stations and 125 AGIP stations and launched their rebranding. The ORLEN Group is a leader of the Czech market in terms of the number of service stations – as at the end of 2015 Benzina managed 339 stations. MOL is the second largest operator (with 317 service stations), with Slovnaft, Lukoil, Agip and Pap Oil stations in its portfolio. Ultimately, the chain is to comprise two brands only: MOL and PapOil (with 60% and 40% of service stations, respectively). In 2015, some 80 service stations launched operation under the MOL brand. Other important players on the Czech market include OMV, Shell, and Euro Oil.

There were no significant structural changes on the German and Lithuanian markets, where ARAL and Lukoil remain the respective leaders. In December 2015, news broke out on the planned disposal of the Russian chain in Lithuania and Latvia, with the transaction expected to be closed in Q2 2016. In Germany, following the 2014 adoption of mandatory fuel price reporting, the pricing methods changed across all fuel chains. With new competitive monitoring tools in place, chain operators react faster to price changes by competitors, and the number of daily price changes at service stations increased. Major German premium chains decided to rebrand some of their service stations and enter the economy segment.

ORLEN Deutschland GmbH’s major competitors in Germany include international networks: Aral, Shell, Esso, Total, and Jet – our key competitor in the economy segment. The ORLEN Group’s main competitors in that segment in Lithuania are still Lukoil, Statoil, and Neste.

UPSTREAM SEGMENT

The World Energy Outlook 2015 (WEO) report of the International Energy Agency (IEA) anticipates major changes in demand for primary energy in the future. Economic policy will play a crucial role in shaping the global energy sector. All developed scenarios see demand for primary energy rising, with its pace correlated to a given economy’s emissions policy.

According to the base case scenario, in 2013–2040 global demand will increase by 32%, driven mainly by non-OECD economies. As forecast, during the period, demand for primary energy within the OECD will decline by 3%.

Global demand for energy by fuel type [mTOE]1

Item 2000 2013 Current Policies Scenario New Policies Scenario 450 Scenario
2020 2040 2020 2040 2020 2040
Coal 2 343 3 929 4 228 5 618 4 033 4 414 3 752 2 495
Crude oil 3 669 4 219 4 539 5 348 4 461 4 735 4 356 3 351
Gas 2 067 2 901 3 233 4 610 3 178 4 239 3 112 3 335
Nuclear power plants 676 646 827 1 036 831 1 201 839 1 627
Hydroelectric power plants 225 326 380 507 383 531 384 588
Bioenergy 1 023 1 376 1 537 1 830 1 541 1 878 1 532 2 331
Other 60 162 297 694 316 963 333 1 470
Total 10 063 13 559 15 041 19 643 14 743 17 934 14 308 15 197

1 TOE – tonne of oil equivalent

Source: the IEA.

In 2040, global demand for energy will nearly double over 2000, whereas demand for gas and oil will account for over 50% of total demand, with China, India and the Middle East being the largest consumers.

Changes in demand for oil [mTOE]

Changes in demand for oil [mTOE]
Source: the IEA.

Changes in demand for gas [mTOE]

Changes in demand for gas [mTOE]
Source: the IEA.

When faced with an oversupply of crude oil and falling prices, oil producers tend to cut costs and scale back on new projects. The base case scenario presented in the World Energy Outlook 2015 report assumes that oil production will grow by 8% by 2040 (to 104 mbd) –initially, until 2020, chiefly in non-OPEC countries, later on also in the OPEC members.

The growth driver for crude oil demand in the short term is low prices. However, this factor will be gradually offset by reduced expectations of economic growth in a number of key economies as well as improved emissions efficiency and policies. The US, being the largest crude oil consumer in the world, will experience plummeting demand as a result of the introduction of stringent fuel consumption standards in the transport sector. India and China are poised to become the largest consumers of crude oil past 2030.

Currently, gas markets vary significantly between regions, with strong gas demand in the US, the Middle East and China, and poor demand in Europe. The base case scenario assumes that the global gas market will show a steady growth of 1.4% annually, reaching 5,160 bcm in 2040, to become the second fuel in terms of share in the global energy mix. The IEA’s scenario forecasts the largest growth of demand for gas in China and the Middle East. Latin American (Brazil, Argentina) and African (Nigeria, Tanzania and others) countries, as well as India will record the highest increase in natural gas consumption, albeit at varying rates. The US remains the largest consumer of natural gas globally, with demand for this resource rising by 15% by 2040.

Additionally, it is expected that by 2020 the supply of gas produced from unconventional deposits in the US will grow to a level giving it an over 50% share in the global gas market.

In 2009-2012, unconventional hydrocarbons exploration, focusing especially on shale gas, developed rapidly in Poland. 2012 saw the peak of investor activity, with more than 20 E&P companies operating on the market, 115 active licenses and 24 wells drilled within just one year.

However, the results of work published by operators in recent years deviate from the results obtained in key unconventional hydrocarbon production areas in North America. The main deviations were attributable to different geological conditions (including higher depth of shale formations and more complex geological structures). As exploration work progressed between 2013–2015, a majority of operators elected to abandon the Polish market (including ExxonMobil, Marathon Oil, Talisman Energy, ENI, Nexen, Total, Mitsui, RAG, Sorgenia, Dart Energy, 3Legs Resources, Chevron oraz ConocoPhillips) and the pace of work decelerated.

Other European countries with shale potential saw similar developments. Foreign companies discontinued exploration work in Romania, Bulgaria, Sweden, Hungary and Lithuania, and halted it in Ukraine. Considering the outcome of the exploration and appraisal work performed to date, as well as the risk profile of shale gas projects in the context of low crude oil prices, we can expect that E&P companies will seek to further reduce their exposure to most cost-intensive and high-risk exploration projects as much as possible.

See also

CustomersThe ORLEN Group and its environment

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SuppliersThe ORLEN Group and its environment

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Social environmentThe ORLEN Group and its environment

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