No. 1, 2004
Stanislav Roginsky
PRAGMATIC POSSIBILITIES
For more than half a century Central Europe has been a strategically important region for the Russian oil and gas industry both because of its significance as a transit route and because of the predominance of Russian oil and gas on its market. The system of economic ties, which existed at the time when the socialist camp was still strong and which later collapsed almost everywhere, has lately been developing steadily in the oil and gas sphere. Both sides have shown interest in the normal movement of Russian oil, and the acceptable mechanisms of oil supply and transit have been preserved.
Moving toward "greater" Europe
Quick and effective economic reforms and a well-considered investment policy have resulted in a stable growth of production in Poland, Czechia, Slovakia and Hungary, and their economies have attracted sizable foreign investments.
Their successes in the economic sphere have facilitated the integration of these countries into various Euro-Atlantic structures. For instance, in 1999 Poland, Czechia and Hungary joined NATO. Approximately about that time there arose the question of their membership of the European Union which is the main trading partner of the Central European countries. That is why former socialist countries faced the need of modernizing their economies to bring them in line with high Western European standards. In the process, their governments paid particular attention to the implementation of energy-saving and environmentally friendly technologies aimed at minimizing air, soil and water pollution.
A result of the efforts made by the Central European countries was that on April 16, 2003, the European Union summit held in Athens decided that on May 1, 2004, Poland, Hungary and Czechia would become full-fledged EU members. Obviously, certain changes resulting these countries joining the European Union will take place in the oil and gas segment of the European energy market. Russian companies are already working on a new strategy for their activities in Central Europe, one that would take into account the on-going integration processes there.
In terms of proven oil reserves, the four above-mentioned Central European countries are rather unimportant-even by European standards. As estimated by the International Energy Agency (IEA), Hungary's reserves total 102.5 million barrels and Poland's - 96.4 million barrels, while those of Czechia and Slovakia are quite insignificant - 15 and 9 million barrels, respectively.
Because of the absence of large proven reserves of oil suitable for commercial development, in 2001-2002 oil production in the region was approximately 47,000 barrels per day. Nevertheless, even in the absence of good prospects for any sizable reserves increment, prospecting works, in which a number of foreign companies take part, continue. According to IEA estimates, in 2002 the Central European countries managed, with their own oil production, to meet approximately 5.7% of their domestic demand for that type of fuel.
Since the time of the "socialist commonwealth" 12 refineries are operating in the region. Together they are capable of processing about 826,000 barrels of oil per day (according to the estimates published in the Oil and Gas Journal). Obviously, these, close to markets facilities and the existing oil pipeline system are of major interest of the large foreign companies intending to preserve or enter that regional market.
The Central European oil transportation hub
Despite the presence of several regional oil and gas companies (for instance, Hungary's MOL and Poland's PKN Orlen), which are quite competitive, Russian oil majors are becoming active at the Central European market, acquiring assets both in the field of hydrocarbon transportation and refining.
However, when Poland, Hungary and Czechia become EU members, they will have to abide by the EU rules, which may affect the prospects of their cooperation with the Russian oil industry.
Today, the Druzhba oil pipeline, constructed back in the Soviet time, is still the chief trunk line which connects Russia with Central Europe. Actually, the pipeline has three branches which pass through the territory of all the countries of the region. The northern branch brings crude oil to Poland and Germany; the central branch passes across Czechia and Slovakia, while the southern branch turns off to Hungary and there it joins with the Adria pipeline, reaching eventually the Croatian port of Omisal. According to the Russian Energy Ministry, 51.7 million tons of oil were transported in 2002 along that major trunk line linking Russia with Europe (and that not counting the deliveries to the oil refineries in the Baltic countries).
The Central European countries have been exploring possibilities of buying hydrocarbons not only from Russia. But first of all, in order to achieve some sort of real diversification of oil deliveries they had to find new suppliers who would be prepared to appear on those countries' markets and, secondly, to find a pipeline which would bring that oil to these markets.
For Central Europe, one of the possibilities to diversify oil deliveries could be signing agreements with Caspian producers, who today increasingly orient themselves to projects associated with the Mediterranean. The only alternative to the Russian oil transportation system now is the Ukrainian Odessa-Brody pipeline which was built in 2001. According to Ukraine's Naftogaz company, its throughput is estimated at 9 to 14 million tons per year. There are plans of extending this pipeline to the Polish city of Gdansk. But without EU support and, more importantly, without securing stable oil deliveries such extension is hardly possible. Today, however, neither Azerbaijan nor Kazakhstan is prepared to supply oil to Central Europe along the Odessa-Brody pipeline. The most optimistic forecasts made by Ukrainian experts say that in 2004 this pipeline may be filled with oil to the half of its capacity only.
Today, only oil deliveries to Czechia have been diversified. The MERO pipeline keeps the country supplied with oil which comes from the Italian port of Trieste through a trans-Alpine network of pipelines.
And so the question of a real full-scale diversification of oil deliveries remains an open one, and in the foreseeable future Russian companies will retain their foothold on that market. There is at least one oil and gas company in the region which is trying to work quite aggressively - even in the constrained conditions of Central Europe. This is the Hungarian state-owned company MOL which can offer some competition to Russian companies, primarily in the field of refining. In its strategic planning today, the Hungarian company focuses on refining as the most profitable line of activity.
This company has tried to conduct an aggressive strategic policy of expansion in other countries of the region. For instance, in 2001-2002 its targets were the Greek Hellenic Petroleum (HP) and the Polish PKN Orlen - two companies which were also of interest to Russian companies, including JSC LUKOIL.
Today, MOL's capitalization is $2.3 billion, and its management, as well as the Hungarian government, see the way to raising its operating efficiency, once Hungary has joined the European Union, in its partial privatization which will be implemented in the new conditions on the basis of the EU legislation.
To a degree, Russian companies may be interested in buying a block of MOL shares. However, practice shows that Russian companies are mainly interested in acquiring a controlling interest which enables the buyer to influence managerial decision-making.
Russian oilmen in the countries of Central Europe
So far the prospective entry of Central European countries into the European Union has not become an important factor determining the strategy of business development of the Russian companies in that region. From the Russian side the main market participants who may be expected to take resolute action aimed at acquiring assets in the region are still LUKOIL and its rival YUKOS.
At present, through the efforts which YUKOS launched some ten years ago, it has managed to take up certain advantageous strategic positions in Central Europe. Owing to its acquisition of the 49% controlling interest of the Slovak Transpetrol company, YUKOS managed to make a springboard for oil deliveries to refineries in Slovakia, Czechia, and southern Germany. According to YUKOS, the Slovak pipeline is capable of pumping through up to 20 million tons of oil per year; however, only half of its capacity is being used today. Nevertheless, the ambitious project proposed by the YUKOS management to reverse the MERO oil pipeline will hardly be supported by Czechia's government pending the country's membership of the European Union, since this would lead to the loss of a source of oil deliveries which at present is the only alternative to the Russian source.
Quite naturally, LUKOIL is also trying to fortify its presence in the countries of Central Europe. The Company already has its representative offices in Czechia, Hungary and Poland. A network of gasoline filling station is being set up there. It was for this purpose, among other things, that the Company bought in the late 1990s such major refineries as Petrotel (Ploesti, Romania) and LUKOIL Neftochim Bourgas (Bourgas, Bulgaria). The production potential of these facilities could well be used to cover the needs of the fuel market in a number of Central European countries.
At present, Poland is the Central European country which LUKOIL finds the most attractive. This country is not only the largest oil consumer in the region (422,000 barrels per day-according to the BP Statistical Review), it also has the biggest refining: five refineries with a combined production of 350,000 barrels per day. Whereas in the case of Hungary one of the factors that makes this country attractive for Russian companies is its central geographical position in Europe, which makes it possible to transport oil nearly across the entire continent, in the case of Poland such a factor is the existence of refinery in the vicinity of Gdansk, the country's largest sea port whose infrastructure is suitable for exporting oil beyond the European continent. Joining battle for the Rafineria Gdanska (RG) plant was the first step in LUKOIL's expansion to Poland.
At the start of the 21st century, the Polish government decided to carry out a large-scale privatization of the key enterprises in the country's economy. RG was one of them, and 75% of its shares, belonging to the state-owned Nafta Polska concern, were put up for sale in 2001. For a long time afterward, the Polish press ran the story of the bidding won by the British Rotch Energy (RE) Group which furnished no financial guarantees to the Polish side concerning the deal and which behaved incorrectly in regard to LUKOIL.
And yet, the Russian oilmen did not give in. In an interview he gave around that time, LUKOIL President Vagit Alekperov said: "We are still interested in RG, and we are working on new proposals concerning that facility. I hope very much that, in taking decision on its privatization, the Polish government will be guided by purely economic interests. In any case, we are not going to leave the Polish market; we shall continue looking for an opportunity to buy refining facilities in Eastern Europe."
It is planned to complete the privatization of Poland's oil industry by 2005. Being considered at present is the idea of establishing a Central European Concern. Some Polish experts believe that such an entity will be able to ensure an uninterrupted supply of the country's market with petroleum products and that it will be open to foreign participation. As for LUKOIL, it is continuing talks on its own participation in Poland's oil industry. The Company's management is still determined to buy refineries in Poland.
It seems, there are both positive and negative aspects to the process of integration of the Central European countries into the Euro-Atlantic structures. The governments of Poland, Czechia and Hungary are determined to boost competition between oil companies for their oil industry facilities. This is certain to create more problems for Russian companies in their struggle for leadership. However, their chances of winning are still very good owing to Russia's geographical proximity to the region, while under competitive conditions they may be able to gain additional experience in preserving their leadership. Also, they may be able to devise new mechanisms of interaction with the governments and companies of the Central European countries.
