Market environment

GRI indicators:

Market trends – Downstream segment

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The ORLEN Group’s operations include the production of crude oil, production and sale of refinery, petrochemical and chemical products, production of heat and electricity in a cogeneration process, and sale of electricity. Given the location of the ORLEN Group’s leading assets in the commodity sector (comprising fungible products made by many companies in Poland, in the region, and globally), the Company is a ‘price-taker’ and so its financial performance is susceptible to price fluctuations on global markets. Over a year, prices on global markets change as a consequence of both one-off, unexpected factors, such as geopolitical events triggering price fluctuations around long-term trends, as well as recurring long-term factors affecting price relationships between, and demand for, primary energy sources.

The COVID-19 pandemic is an unexpected, one-off factor that is affecting prices by disrupting the supply-demand relationship. The biological nature of the factor and the depth of economic losses, including those recognised by the middle of the second quarter and those estimated until the end of 2020 (a 3.5% contraction in global GDP) , are causing the global economy to shrink relative to forecasts from the end of 2019. Its ramifications will include profound structural changes on the demand side (as the pandemic will change people’s habits and behaviours) and the supply side (as excess supply will induce restructuring and consolidation processes across many industries). The biological factor behind these shifts, combined with the effects of social distancing, have probably made people realise that the relationship between the state of the environment and climate and their health and social relations is strong. This may lead to an increase in public support for companies applying ESG (Environmental, Social, Governance) principles in practice. Responsible investors abiding by ESG principles and taking account of long-term factors in their decision making, will also find it easier to raise funding. Read more on this topic in the ‘2020+ Outlook’  section.

Long-term factors include global megatrends, demographic, social and technological ones, and the resultant regulations which, together, drive decarbonisation and sustainable development processes. One indicator reflecting the intensity of these processes in the European Union is the market price of emission allowances (EUETS), which between January 2017 and December 2019 increased by 340% (from EUR 5.4 /tonne in January 2017 to EUR 23.8/tonne in December 2019).

EUETS market price

Source: In-house analysis.

A clear global megatrend, accelerated by the ongoing decarbonisation of transport, is the falling demand for crude oil and liquid fuels in OECD countries observed since 2005. Initially, it had been a structural trend (caused by the ageing population and the economy’s saturation with vehicles), but was then compounded by an increase in oil prices in 2000–2016. A slump in crude oil prices around the middle of 2016 halted the drop in demand for a short time. However, gradual improvement in the energy efficiency of internal combustion engines, introduction of alternative liquid fuels containing bio-components, and increasing uptake of hybrid and electric drives and new mobility models (Car as a Service, car-sharing, autonomous vehicles) have dampened demand for oil and liquid fuels in other parts of the world. At the end of 2019, the peak in global demand for crude oil and liquid fuels was estimated to occur between 2030 and 2040. Now the countdown to peak oil is likely to shorten.

The ORLEN Group addresses these challenges by preparing a comprehensive decarbonisation strategy. The strategy will comprehensively cover emissions from refinery and petrochemical production facilities and related energy consumption. ORLEN is also taking a number of measures to address the direct emission footprint resulting from fuel consumption. These include installing EV chargers in motorway service areas, adapting motorway service areas to new e-mobility needs, investing in bio-refineries, testing innovative biofuel production technologies, and using hydrogen in transport and power production.

A significant strategic challenge for the Company is posed by its petrochemical and chemical production which, due to the accumulation of plastic waste in the environment, raises social concerns and spurs regulators to take specific measures restricting the use of many petrochemical products. Recognising the growing demand for using secondary materials in primary chemical products, ORLEN is taking action to address that.

Google searches for plastic waste-related terms

Source: In-house analysis based on Google Trends data.

Number of new regulations on single-use plastics at the national level

Source: In-house analysis based on United Nations Environment.

Although research on the climate and environmental footprint of various materials throughout their life cycle shows that petrochemical materials are more benign, cheaper and more durable than their alternatives, the ORLEN Group gives due weight to public opinion. For the most part, the Group’s petrochemical and chemical products are not finished goods, which limits the negative impact of its production on the environment and climate. It also upgrades its production processes and gradually increases the use of bio-component inputs.

In a longer term, the petrochemical industry may support demand for crude refining products, thus building refining margins given the growing application of modern plastics in the global economy. Central and Eastern Europe is among the fastest-growing markets in terms of demand for petrochemical products of the kind produced by the Company.

Such products, particularly speciality products tailored to the needs of particular customers, offer a high growth rate. The role of plastics in manufacturing processes is expected to grow considering their new applications in advanced insulation systems, the automotive industry and 3D printers, to name a few examples. Manufacturers are able to compete with one another based on the technologies they use, specialist units they operate or speciality products they sell rather than by offering the lowest price.

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Chemical production [million tonnes]

Baseline scenario

Source: in-house analysis based on IEA.

Alternative scenario

Source: in-house analysis based on IEA.

In Europe, there is room not only for conventional petrochemicals, but also for their bio-based counterparts. Leading petrochemical producers invest in research and development of both petroleum derivatives and bio-based chemicals. The amount of their R&D expenditure is correlated with financial performance, as each Polish złoty spent on R&D activities translates into a PLN 2.3 increase in EBITDA. Some companies within the sector boast an even higher return on their R&D investments.

As refining and petrochemical production are energy-intensive processes, decarbonisation of electricity and heat consumed is an important measure in reducing carbon dioxide emissions. The ORLEN Group already uses electricity and heat generated by two CCGT units, and the one in Włocławek was the first commercial power unit in Poland fuelled by natural gas. Cogeneration is among the most efficient forms of energy production. The opening price scissors between the price of coal-based energy and the cost of energy generation (from natural gas, cogenerated with heat) support the profitability of the Company’s operations in this segment. There are also plans to construct offshore wind farms in the Baltic Sea (where environmental and wind surveys are currently in progress) and to further expand the ORLEN Group’s presence in the green energy sector.

In April 2020, PKN ORLEN closed the acquisition of the Energa Group. The transaction is in line with PKN ORLEN’s strategy to develop into a strong multi-utility player. As for the Energa Group, it owns more than 50 RES generation assets, mainly across the hydro, onshore wind and solar PV segments, as well as an extensive 188 thousand km distribution network, covering almost a quarter of Poland’s territory.

PKN ORLEN concentrates on developing its energy assets towards low- and zero-emission sources. It has declared preliminary intent to get involved in a project to build the Ostrołęka power plant, provided a gas-fired technology is used. 

An increasing share of green energy in the overall mix is not only conducive to the achievement of NIT, but, most importantly, offers a number of decarbonisation opportunities with respect to fuels and petrochemical products. It includes both green hydrogen produced by hydrolysis and its use as an alternative transport fuel, and synthetic gasoline enabling industrial use of captured carbon dioxide. The fully depreciated CCGT units will be an efficient power base for renewable energy support.

Further information on steps taken to decarbonise its production and products, and to reduce its negative environmental footprint (through the implementation of circular economy models) will be provided by the Company’s long-term development strategy, which is now being prepared.

Macroeconomic factors affecting financial performance in 2019

The model downstream margin as well as the refining and petrochemical margins are synthetic indicators of the impact of changing macroeconomic factors on financial performance.

Model margins are a market category, their levels depending on the market prices of leading products and their respective shares in the production and sales mix. Given its limited ability to change the structure of products within a yearly cycle, the model margins are virtually beyond the ORLEN Group’s control.

Changes in the prices of crude oil, fuels and petrochemical products are of the global nature. Due to arbitrage opportunities, a positive or negative impulse emerging on one market (whether regional or product market) spills over to affect all other markets. In the case of crude oil, an example of a regional impulse affecting the prices of various types of crude oil worldwide is a production cut in the Persian Gulf region, after the OPEC’s intervention. In the case of fuels produced simultaneously in certain proportions that are not substitutable, a demand impulse on the market for one fuel triggers an increase of the crack spread on that fuel and spurs refineries to increase processing. This leads to an oversupply of remaining fuels and lower crack spreads. The decline in gasoline prices relative to oil prices at the beginning of 2019 sparked by an increase in demand for diesel oil and its production in the wake of the IMO regulations is a case in point.

Refining margins in Europe [USD/bbl].

Source: IHS Markit

Sales volumes of the Companiesompany’s products largely depend on demand on home markets, which grow faster than other EU markets. They are also dependent on other measures designed to improve competitiveness and build customer loyalty towards the ORLEN brand, such as environmentally and socially responsible investments, methods of management and communication with stakeholders (building the ORLEN brand in the region and globally, educating investors, developing non-financial reporting, and publishing expert reports).

Crude oil price

Crude oil is only seemingly a homogeneous product. More than 300 oil grades are traded on global markets, varying in densities and sulfur contents. Their prices are set relative to the prices of several benchmark oil grades quoted on regional commodity exchanges (Brent on ICE, WTI on NYMEX, or Dubai on DME). Due to arbitrage between markets and oil supply diversification strategies applied by refineries, the prices of various types of crude oil respond quite similarly to economic fluctuations and one-off geopolitical factors, provided that the structure of global demand for liquid fuels is not distorted. How the prices of different types of crude oil react to regulatory events, especially ones triggering a change in the structure of demand, depends on the properties of the crude grade concerned. An expected effect of the IMO regulations, which will cause nearly 4% of global demand for liquid fuels to shift from heavy fuel oil (HSFO) to low-sulfur fuels (with a sulfur content below 0.5%), is a structural change in demand for crude oil. Light sweet crude oils are preferred, while demand for heavy, high-sulfur types is on a downward trend. Consequently, as in the case of fuels, the prices of light sweet crudes, which can yield more middle distillates, are growing in relation to heavy, high-sulfur varieties.

In the area of the ORLEN Group’s operations, prices of refining and petrochemical products are set by reference to Brent crude prices, with Urals being the leading alternative; however, due to its high sulfur content, its value is likely to fall relative to the Brent benchmark.

Changes in crude oil price [USD/bbl]

Source: IHS Markit

In 2019, the daily price of Brent crude varied within a range of USD 50-75/bbl. The average price was USD 64.2/bbl. The lowest price in 2019, recorded at the beginning of the year, was USD 53.2/bbl. On December 31st 2019, the price was USD 66.8/bb (up 24%). The highest daily prices were recorded on April 25th (USD 74.3/bbl) and again on May 16th (USD 74.7/bbl).

Key factors triggering the oil price changes in 2019 included:

  • Economic sanctions imposed by the US on Venezuela and Iran, reducing the oversupply of oil,
  • OPEC+ production cuts,
  • Geopolitical events in the Persian Gulf region (terrorist attacks on oil facilities and tankers),
  • US-China customs war, causing a decline in global trade flows,
  • Higher demand for light low-sulfur crude oils, due to the IMO regulations,
  • Decline in demand for crude oil, due to deteriorated outlook for global economic growth,
  • Steadily growing oil production in the US.

In Q1 2019, oversupply continued on the oil market, but the overall market situation changed relative to Q4 2018. As a result of production cuts in Saudi Arabia, the US sanctions on Venezuela and Iran and the approaching effective date of the revised IMO specifications for bunker fuels, the oversupply of crude oil declined by nearly 1m bbl/d, causing a virtually uninterrupted wave of price increases. The daily price of Brent crude increased by 34% (more than USD 17/bbl) during Q1 2019. In Q2 2019, the situation on the oil market took an unexpected turn. After a spell of continuous growth from the beginning of the year, in the middle of Q2 2019 the oil price was suddenly on a downward slide, despite a continued decline in production volumes and heightened geopolitical risk.

The upward trend was reversed on May 16th, with the daily Brent crude price at USD 75/bbl. Within the next 20 days, the price dropped by USD 13. The bulk of the slump happened in the space of three trading days. Between Thursday May 30th and Monday June 3rd, the current Brent crude price plummeted by as much as 12%. It should be stressed that the price drop occurred at the time when Iranian oil production was at its lowest since 1981, production in Venezuela was lower than in 1945, and Saudi Arabia’s output was 1.4m bbl/d lower than in October 2018. According to IHS Markit’s estimates, the overall global oil production at the end of Q2 2019 was 2.6m bbl/d lower than at the end of 2018.

Geopolitical risk also remained elevated, as six tanker ships were attacked in the Strait of Hormuz, the world’s major oil shipping route (with daily flows accounting for 20% of oil traded worldwide). Yet, geopolitical developments were not the main factor behind the oil price drop. The most plausible explanation is that global demand is growing at a rate much slower than expected. In Q3 2019, the situation on the oil market continued to be affected by geopolitical factors. On the one hand, the prolonged US-China customs war fuelled concerns over the condition of the global economy, and a series of downward revisions of the oil demand forecast dragged the prices down.

On the other hand, armed conflicts in the Gulf region involving Iran, the US and Saudi Arabia, aggravated the risk of oil supply disruptions, creating an upward pressure on the prices. On September 14th 2019, the Saudi Aramco oil facilities were attacked by drones, which immediately sent up the prices of oil futures. On September 16th 2019, the daily prices of crude oil surged by 12%, the steepest increase since Iraq’s attack on Kuwait in 1991. The attack took place when global oil production was reduced, due both to political factors and the producers’ deal. At the beginning of July 2019, the OPEC and other oil producers, including Russia, signed a ‘long-term cooperation’ charter within the OPEC+ framework, which Saudi Arabia named a historical agreement. Thus, the ten non-OPEC oil producing countries, led by Russia, and OPEC formalised their alliance started in 2016 with the aim of preventing dramatic price declines. OPEC+ also announced that their agreement of December 2018 to reduce oil production by 1.2m bbl/d would be extended for another nine months (resulting in an aggregate reduction of 2.5m bbl/d vs Q4 2018).

The negotiated output cuts were implemented amid an expected slowdown in the global economy, to which the customs wars between the US and China had vastly contributed. For a third time in the year, the main analytical centres revised lower their oil demand projections, to less than 1m bbl/d in 2019, compared with 1.6m bbl/d in 2018.

Such downward revisions were made by EIA, IHS Markit, Morgan Stanley, Barclays and Goldman Sachs. The expectations were further dampened by poor PMI readings, especially for the eurozone, but also for the US industry, which, after ten years of expansion, began to falter. In Q4 2019, it was already clear that geopolitical factors, mainly the US-China trade wars, drove up global trade costs, while markedly reducing global exports and increasing production costs. This brought about a stronger-than-expected slowdown in global economic growth (from 3.2% in 2018 to 2.6% in 2019). The economic downturn, which probably could have been avoided, affected the largest consumers of petroleum products, i.e. China, Asian countries, as well as the US and the EU. According to estimates, the increase in demand for crude oil was only 0.8m bbl/d in 2019, a half of the level expected at the year’s beginning. The increase in demand for crude oil and liquid fuels is partly driven by the need to comply with the IMO regulations, although that effect has proved significantly weaker than expected. As shown by numerous analyses, the global oil industry has been adjusting at a cost lower than originally assumed.

Crack spreads and differentials

Anticipated adjustments by the global oil industry and maritime transport to the new IMO regulations were expected to improve model refining margins in 2019. Due to a cap (below 0.5%) on the sulfur content in bunker fuels, it was widely expected that demand would shift to fuels of a quality similar to that of diesel oil, used in land transport. A resulting excess of heavy fractions (HSFO) was expected to lead to a decrease in their price relative to the price of crude oil, i.e. in the crack spread. On the other hand, the emergence of a new consumer on the diesel market should lead to an increase in the price of that fuel relative to crude oil. As maritime transport generates approximately 4% of global demand for crude oil and liquid fuels, the higher demand for diesel oil would require refineries to increase crude processing volumes, as it would not be sufficient to merely increase the conversion rates. It was the prospect of higher refining margins that was expected to prompt global refineries to invest in increasing crude processing volumes and conversion rates, with a view to increasing the share of high-margin fuels (mainly diesel oil and gasoline) in their product mix. The shift in demand towards light products was expected to bring about a corresponding shift in the structure of demand for light and heavy crude types and widening of the Brent/Urals differential.

These expectations proved wrong as in December 2019 refining margins shrank to their lowest in seven years, owing to extremely tight margins on diesel oil, which fell short of any expectations. On the other hand, HSFO outperformed the expectations.

Why has the impact of the IMO regulations proved so different from what was predicted?

  • The global economy has slowed down, partly on account of the customs wars, which have had a strong impact on international trade flows. Consequently, demand for crude oil and liquid fuels has been growing at a pace significantly slower than expected. In 2019, it increased by 0.8m bbl/d, while in the summer of 2019 it was expected to grow by 1.6m bbl/d.
  • At the end of 2019, increased refining capacities were placed in service with a view to increasing the output of diesel oil (thanks to both increased throughput volumes and conversion rates) to accommodate the demand growth of 1.6m bbl/d.
  • The additional volumes of HSFO and gasolines, resulting from increased crude processing, have been marketed as a new bunker fuel – a very low-sulfur fuel oil (VLSFO), a blend of HSFO and naphtha (VGO).
  • Ships have been successfully testing the new, cheaper bunker fuel, which has been gradually denting demand for diesel from maritime transport.
  • As a result, the effects on the light sweet and heavy sour crude differentials are weaker than expected.

The effects of the IMO regulations differ from expectations owing to the combination of the following factors: the increase in refining output to accommodate the expected strong demand and the currently weak demand, as well as the emergence of a new bunker fuel (VLSFO) ousting diesel oil.

Petrochemical margins are driven by the prices of petrochemical products and crude oil. The prices of petrochemical products are strongly correlated with the level of economic activity, which in 2019 fell globally and on the ORLEN Group’s core markets.

For more information, see the ‘2020+ Outlook’  section.

Market trends - Retail segment

2019 saw a year-on-year increase in unit margins on fuel sales in both Poland and the Czech Republic. By contrast, unit margins on fuel sales in Lithuania declined on account of fuel prices kept low by the market. In Germany, margins fell mainly as a result of a very high 2018 base effect reflecting difficulties in fuel logistics. Operating expenses rose across all markets, driven mainly by growing labour costs as a result of an increase in minimum wage rates coupled with competitive and market pressures on pay rises. The higher labour costs and low unemployment rates also had an effect of pushing up other operating expenses, in particular the prices of utilities and services, as well as the costs of plant maintenance.

In 2019, most fuel retail chains upgraded their facilities and expanded their food and beverage offerings. As all the leading chains are modernising their service stations, the premium and economy segments are slowly converging. The only factors that set one segment apart from the other is the price, availability of premium fuels, and loyalty schemes for customers.

As there were no acquisitions or ownership changes involving the main players on the retail fuel market, the leading chains retained their respective market positions in the ORLEN Group’s operating markets. In 2019, the ORLEN Group established a foothold on the Slovak market, by opening its first ten service stations. Slovakia has thus become the fifth country after Poland, the Czech Republic, Germany and Lithuania where the Group has established retail operations.

In 2019, PKN ORLEN commenced a project to co-brand its foreign service stations by combining the logotypes of the local Benzina and Star brands with the ORLEN Group’s logotype.

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