Poland consolidates its energy sector [NGW Magazine]
When – if – PKN-Orlen accomplishes its third corporate acquisition, PGNiG, it says it will have reached “yet another milestone” in its strategy to build a powerful multi-utility group: “a single, all-Polish group with well diversified revenue sources and significant market standing in Europe.”
The takeover of power generator Energa was sealed in April; the merger with refiner Lotos is expected to close, with some disposals needed to satisfy the European Union’s competition authorities.
Owning PGNiG will allow the new company to focus on natural gas and crude oil reservoirs in Poland and Europe and to build an integrated portfolio in Poland based on high-efficiency combined-cycle gas turbines (CCGT) and renewable energy sources. At the same time, a wide-ranging portfolio of assets will optimise wholesale trading in electricity, PKN Orlen says.
The combined financial muscle will give the new entity the significant capital strength it says it needs if it is to grow in today’s world. “Such mergers open up opportunities to generate additional income and cost synergies. It will be a breakthrough process, set to enhance the operational efficiency of both PGNiG and PKN Orlen. Overall integration of certain markets, spanning distribution, sales and trading, points to further directions of growth,” said Poland’s prime minister, Mateusz Morawiecki.
His deputy, Jacek Sasin, who is also the minister for state assets, added: “Poland’s energy transformation is a huge challenge, and our role is to make sure it proceeds as efficiently as possible. Having all the capabilities necessary to carry out this process, PKN Orlen will play the leading role in the planned transaction. We are a part of Europe, where many energy companies have already consolidated with the support of their countries’ governments. The creation of multi-utility groups to become major players in Europe and worldwide is also an element of our government’s economic policy.”
Until the terms of the PGNiG deal have been agreed and approved by the European Commission, nothing can be taken for granted. It is not expected for another 18 months.
Combined, the four entities’ total annual revenue would reach zloty 200 ($53.2)bn, with pre-tax earnings (Ebitda) of its key segments close to zloty 20bn/yr. Two fifths of operating profits will come from refinery and petrochemical operations and about a fifth from upstream, with a total annual output of some 70mn boe of oil and gas. Retail sales of fuels, gas and energy as well as the regulated distribution business, would each generate some 15% of the total figure and generation 10%, a figure that “could be doubled by 2030 through the delivery of new capital projects,” the company says.
Over the last three years Orlen has completed three projects with costs in excess of zloty 1bn, including two CCGT units in its home patch. The company also holds a licence to build a 1.2-GW wind farm in the Baltic Sea: such projects typically cost around zloty 12bn.
Ratings broadly relaxed
Rating agency Moody’s has upheld its credit rating at Baa2 and raised the outlook to positive from negative, following clearance of Lotos and the letter of intent concerning integration with PGNiG.
Moody’s analysts also emphasised PKN Orlen’s strategic role in Poland as the fuel market leader. It is bound to play a key role in the country’s energy transition given its commitment to investing in zero- and low-emission energy sources, including offshore wind farms.
PKN Orlen’s acquisition processes – Energa, Lotos and PGNiG – are positively viewed also by Fitch Ratings, with some reservations, depending on the structure of the deal. Rating Watch Negative would await PGNiG “if the transaction progresses to a stage of a tender offer for PGNiG's shares, announcement of a share swap or another form of ownership change.” Being tightly linked with a lower-rated capital group – assuming PKN Orlen’s rating remains at 'BBB-' after the acquisition of PGNiG and Lotos – would drag down PGNiG, Fitch added.
Fitch last year upgraded PGNiG to 'BBB' from 'BBB-' on account of its more diversified gas import portfolio while maintaining low leverage. It reduces “a potential price-mismatch between imports and domestic sales.” Since then, it has further benefited from the March arbitration award and the delinking of gas from oil prices.
However, “analysts appreciate… our immense potential and determination to build a strong global multi-utility group,” said the president of the PKN Orlen board, Daniel Obajtek.
Moody’s said the acquisition processes, which help to consolidate Poland’s energy sector, will help to improve the stability of its cash flows.
PKN Orlen intends to finance the transactions primarily with its own shares created through capital increase, while keeping debt to adjusted Ebitda at a conservative level not exceeding 2.0x-2.5x.
Analysts backing the deal say the acquisition of PGNiG’s production, distribution and energy assets, combined with the recent acquisition of the Energa Group’s generation and distribution assets, will be profitable to PKN Orlen, considering the expected shift in Poland’s energy mix towards increased use of renewable electricity and natural gas.
Going against the tide
PKN Orlen says its transactions are in keeping with prevailing global trends. For example, the European integrated producers BP, Total, Shell and Equinor have implemented segment-based management models, with the highest priority given to diversified revenue sources. But all but Equinor on that list are privately held and so compete for shareholders.
And many of Europe’s former national utilities also have no state support. An obvious example is Centrica in the UK: it has had to fight off competition in retail supply from foreign-owned rivals ever since it was spun out of the newly privatised British Gas in the mid-1990s. Its prospects weakened still further by the Covid-19 crisis, it will not pay a dividend for the second year running.
The state’s share in French Engie has also fallen sharply. Belgian Distrigaz was bought by Eni, while the German majors were never state owned. Dominant utility E.ON sold off Uniper, the former Ruhrgas, which is now controlled by the Finnish state; E.ON also formed a defensive merger of sorts, swapping assets with compatriot RWE.
Outside Poland as well as inside, governments own a number of gas and power grids: for example, the Dutch state owns both. Many are also owned by pension funds or infrastructure funds and other inactive shareholders, but these are not cash cows, promising only stable but low rates of return, which might become even lower with the need to innovate. So the Polish model appears to go against the grain.
Energy sector integration is ‘long overdue’: PGNiG CEO
Negotiations on the terms of the PKN-Orlen merger have only just begun, the CEO of PGNiG Jerzy Kwiecinski, told NGW the day after the planned merger was announced. “But my term is for three years and I hope to put the company on a very firm footing operationally and financially and to close the merger.”
The state has a direct 27% stake in PKN Orlen and 72% in PGNiG.
"The Polish energy sector remained very Soviet in its structure,” he said, explaining the rationale.
“Separate companies were established in each of the industries, be it oil, gas or electricity and that is not a proper structure in today’s economy. We should have followed instead the Hungarian model and integrated the energy sector earlier. Now we must do it soon. All the different elements of it are dispersed across the table and consolidation is what is needed. Italy, Norway the UK do not have such a dispersed system and they have strong multi-energy companies. Our market will remain open for international entities.
“As we understand it, the state's strategy is to consolidate the existing energy sector to gather competitive advantage and create a single strong multi-energy company that will be able to compete internationally with large multi-energy players from other countries. The first step for PKN Orlen was with Lotos and Energa, and the next will be PGNiG. That is logical. We are the leader in gas and a leading company in power and heating generation. The switch from coal to gas will have a major impact on gas demand for district heating and we are the most suitable company to carry that out. The only economically viable approach is full co-generation: heat and power.
“PGNiG is active in the upstream, the distribution networks and the retail sector, and as the gas market liberalises there will be more players in the sector. I am convinced the market will grow, not only for CNG and LNG and pipeline gas but also new gases such as biomethane from every source – manure, waste and so on – as the circular economy develops. This sector is completely undeveloped: there are 300 biogas facilities in Poland. They produce electricity and some heat, but nothing is left over for injection into the gas grid, and this is our goal.”
'Biomethane must grow as coal shrinks’
“In Poland we should be able to produce as much biomethane as we now produce natural gas domestically: almost 4bn m³/yr in ten years’ time. This will be to meet existing and new demand. We hope to keep a substantial market share and also to see much better margins as the price will be set by the market, not the regulator, which is keeping margins very low. We expect to see substantial changes in the market in 2023-24.
“The share of coal in power generation is falling: last year it accounted for 75% of Polish primary energy but that is down from 80% in 2018. Gas will keep replacing coal and for the next decade or fifteen years gas will have very good prospects, not just for air quality improvements but also reducing carbon emissions and improving the health of the population generally. Natural gas will enable this as well as green gas and biogas. Hydrogen, primarily produced by renewably-powered electrolysis, will also gradually replace natural gas.
“Polish coal is becoming more expensive to produce: the easier seams have been mined and now the coalbeds are further from the surface. Less and less is available for production. It is also becoming harder to raise finance and energy production is very costly. Renewables on the other hand are getting cheaper and they need less and less subsidy and so they are becoming more market oriented.
“Our plan is that our solar PV stations and wind farms will supplement biomethane generation. There are 2,500 administrative communes in Poland and we estimate we will need to place about 1,500-2,000 biomethane stations around the country, with renewable energy as back-up. Any oversupply of renewable energy can be used to split water into hydrogen by electrolysis and then the hydrogen can be injected into the gas grid.”
Gas for district heating
“We also plan to consolidate the district heating sector: cogeneration is almost all coal-based and this must be converted to gas in the coming years and we are naturally positioned to participate in this process. We produce and sell gas. Poland has much colder winters than the UK and the cost of heating is the biggest single expense for a household. We need to invest a lot to convert boilers and district heating to gas.
“And also we need to improve efficiency by introducing new technology. We have been building pipelines to reach villages and we have seen sales rise by about 1bn m³/yr; Polish gas demand in total is now about 20bn m³/yr. We estimate it could be 25bn m³ in 2030 although the process may accelerate depending on the phase-out of coal and other developments.
“All our gas imports came from Russia until ten years ago, under the Yamal contract with Gazprom. Even four years ago it was still almost 90%. Our co-operation has not been easy, there were interruptions and the price was above the market. So we decided to diversify and become less dependent on Russia.
“We opened the so-called Northern Gateway which consisted first of the 5bn m³/yr LNG terminal which is being expanded to 8.3bn m³/yr by 2024. Last year we imported 3.4bn m³ of LNG and this is growing. The second element is the Baltic Pipe which is now under construction and will be ready in the second half of 2022. That line will have 10bn m³/yr of capacity and from this PGNiG has made a booking until 2037 of 8.3 bn m³/yr. This allows us to shift our imports to the north-west.
“This year we solved our pricing dispute with Gazprom through arbitration and we have now settled our obligations with Gazprom on market prices. We have been repaid and this allows us to invest for future growth. It has also improved our share price. We are 72% state-owned, similar to Norwegian Equinor, which is about 68%.
“We want to be present in other markets. Our equity Norwegian gas will reach 0.5bn m³ this year and 0.7bn m³ next year; and potentially up to 2.5bn m³/yr in the following years.
“The so-called Yamal contract with Gazprom expires at the end of 2022 so from then on we will be able to import gas through the Baltic line and through interconnectors with Germany, the Czech Republic, Lithuania and Slovakia, supported by LNG imports and domestic production.
“Our co-operation with Gazprom has been difficult so we have diversified because security is most important. Also Russia uses its revenues from oil and gas sales to fund its expansion: first Crimea and then eastern Ukraine, so it is a political problem.
“There is no contradiction between Russia having to offer up half of Nord Stream 2 (NS 2) while PGNIG has booked majority of the Baltic Pipe connector’s capacity and all of the Swinoujsce LNG terminal. Other companies could have bid for those two projects through a completely open tender process.
“Regarding NS 2, the European Union rightly introduced a set of rules that everyone has to adhere to. No capacity should be derogated from these rules and that was our argument for the BNetzA to consider. They accepted it and refused to grant a derogation for NS 2.
“In terms of our export activities: we sold almost 700mn m³ to Ukraine in the first quarter of this year, and we will have 12bn m³/yr of LNG in LTCs against 8.3bn m³ at Swinoujsce terminal, so we will be trading a proportion of that overseas.”
Note: after the interview, Gaz-System said it was considering installing a 4.5bn m³/yr floating LNG terminal in the port of Gdansk which would cover PGNiG’s excess LNG. The open season lasts for two months, ending September 22.