THE QUIET REVOLUTION: ENERGY in the CEE ACCEPT OR CHALLENGE? at MOL Group We Address the Challenges of Innovation, Regulation and Changing Customer Demand

THE QUIET REVOLUTION: ENERGY IN THE CEE ACCEPT OR CHALLENGE? At MOL Group we address the challenges of innovation, regulation and changing customer demand. We are leading the industrial transformation in Central and Eastern Europe by becoming the premier chemicals company, by diversifying our non-fuel products, and by being the first choice of those on the move.

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The energy economics of Central and Eastern Europe are changing. One group, MOL, has recognised that there are opportunities among the difficulties, says Zsolt Hernadi, chairman and CEO

Over the past 15 years, MOL has moved to a Tomorrow”, the objective of which is not only CONTENTS pre-eminent position in Central and Eastern to sustain and strengthen our regional position Europe (CEE), becoming a truly international in our core businesses, but also to once again 04 | The quiet revolution oil and gas company with market-leading drive the changes in CEE. Political and economic sands are shifting positions across the core parts of our business. Demand for hydrocarbon-based motor fuels in the CEE – for the better We committed ourselves to international looks certain to decline in the long run. As MOL growth and the efficient operation of our looks to diversify from motor fuels, we will 08 | Mapping growth integrated business model, setting the pace further diversify and expand our petrochemicals CEE oil and gas infrastructure, laid out by in regional consolidation. In that period, our portfolio with the aim of becoming a leading Petroleum Economist’s cartography team earnings have grown seven-fold and market chemical company in CEE. capitalisation has grown five-fold. While the on-going drive for greater 10 | Economics of growth Since well before the current downturn efficiency and profitability at MOL’s refineries The CEE is set for growth, but would in global oil prices, MOL has endeavoured will continue, we are also looking to grow the benefit from wider geopolitical stability – successfully – to improve the efficiency of share of non-motor fuel products, moving its downstream operations and grow its retail up the value chain to target those semi- 12 | Opportunity in diversity network, whilst optimising and intensifying commodity and speciality petrochemical Regional finances are set for steady upstream performance in the region. The products with a higher added value. growth, and wider stability beckons oil price context since mid-2014 has merely We believe that serving one million proved that this was the correct path to take. customers every day across our CEE retail 14 | CEE oil and gas companies MOL faces the same challenge as its network gives us insight into the needs of embrace Energy Union peers, however – how to evolve and consumers – and these needs are changing. By working together, regional players can continue growing in a lower carbon future, MOL is aiming for an evolution in retail feel the benefits of scale economics characterised by constant technological similar to that in its petrochemicals business, innovation and ever-shifting customer habits so that customers use our network of service and needs. At MOL we see this time of change stations to do more than just fill up their cars. Editor as a clear opportunity to improve ourselves, Upstream will continue to play a key role, Derek Brower rather than a threat to be resisted. Using the operating profitably and adding value even in Managing editor capability, the financial means and the leading a low oil price environment. This will mean Michael McCaw regional market position we have built up as maximising value from MOL’s existing asset Design a foundation, we want both to address this base, while sustaining our production at least Sam Millard opportunity and to ensure that our business at today’s level. Cartography Kevin Fuller, Peregrine Bush can respond dynamically to future trends. I am confident that through the Publisher It’s true that with our resilient business combination of our high quality assets, Elliot Thomas model we are well-positioned to continue to financial strength, growing markets, talented deliver strong returns, but by no means will we people and the right corporate culture, MOL The Petroleum Economist Ltd is part of Gulf Publishing bury our heads in the sand. Now is the time will once again set the pace for the next 15 Holdings LLC. Registered in England. Company No: 04531428 All rights reserved. Petroleum Economist is a to lay down the foundations of operations that years, offering competitive returns to our Registered Trade Mark. © Petroleum Economist, London, are sustainable in the long term. shareholders and contributing to the long- 2016. Reproduction of the contents of this publication in any manner whatsoever is prohibited without prior MOL recently set out its new long term social and economic prosperity of the consent from the publisher. term strategy, “MOL Group 2030 – Enter economies in the region.

THE QUIET REVOLUTION: ENERGY IN THE CEE | 03 THE QUIET REVOLUTION

As the energy infrastructure in the CEE develops across a number of projects, the political and economic sands are shifting – for the better

As the north-south gas corridor steadily on the Hungary-Croatia interconnector into September CESEC signed off four important approaches completion, it brings closer the Hungary due to missing developments on initiatives. The so-called BRUA project, one of EU’s strategy of making Central Eastern the Croatian side, and the LNG terminal the most important for the region, connecting Europe more energy independent. Of vital proposed for the Croatian island of Krk is at Bulgaria, Romania, Hungary and Austria is importance to Brussels in the wake of the an early stage of development. It will require gaining traction. Four countries – Greece, gas crises of 2006 and 2009, the corridor the support of the Croatian government and Bulgaria, Romania and Hungary – agreed will enhance regional interconnectivity with the EU in order to reach completion. to work together on the “ vertical corridor” liquefied natural gas terminals located at each The delays have been particularly that would share gas between them. A end of the system. disappointing for Hungary which has been an memorandum of understanding was signed A significant bonus is that regional early champion of an efficient, integrated gas on achieving reverse flows on the trans-Balkan interconnectivity will enable liquid gas market at both domestic and regional levels. pipeline. markets with gas-on-gas competition by On a brighter note, a broad and high-level And Bulgaria and Romania declared giving access to LNG sources. initiative has been formed to speed up gas themselves close to completing an Much of the infrastructure is already in integration in the wider region. Under the interconnector that would also have the knock- place. One of the first countries off the mark umbrella of the Central and South Eastern on effect of facilitating more interconnections was Hungary, where two large gas storages European Gas Connectivity (CESEC), it with neighbouring countries. have been built and interconnectors developed combines 15 nations with a vital interest in With all this going on, the CEE is now with most of the neighbouring nations. the creation of a gas network. Established far better-placed in the diversification of However there’s still work to be done. in early 2015, CESEC is working to resolve its gas imports than it was a decade ago. At Although the Polish LNG facility has interconnector delays by taking into present Russia provides almost a quarter of been completed at the northern end, the consideration all relevant issues including Europe’s natural gas but the CEE is much less southern end needs extra infrastructure to those pertaining to regulation, technology dependent on this supplier than it was. And reduce bottlenecks and boost flows. Just one and finance. as Brussels is beginning to deploy funding for example: there’s still no reverse flow capacity The results are already showing up. In the further development of gas infrastructure,

04 | THE QUIET REVOLUTION: ENERGY IN THE CEE MUCH HAS BEEN ACHIEVED IN THE LAST FEW YEARS IN OIL AND GAS SECURITY IN THE REGION, PARTICULARLY SINCE THE RUSSIAN INVASION OF EASTERN UKRAINE AND THE EARLIER GAS CRISIS OF 2009

contributes to energy security right across the region because of the interlocking nature of the network. For instance, when the recently- announced €187m Baltic interconnector linking Finland and Estonia is activated in 2020, it will unite the eastern Baltic Sea region with the rest of the European energy market. In the event of a crisis such as occurred in 2009 when Russia turned off the pipeline through Ukraine, the new pipeline will take some of the pressure off the CEE. An LNG tanker cruises toward Poland Technically challenging, the pipeline will run 172km including 80km off shore. A two- way transmission system, it will transport Russia’s influence on the region’s energy needs inaugural berthing: “The receiving terminal’s 7.2m cubic metres of gas a day in both will inevitably reduce. potential makes us an important player in directions. But when the gas starts flowing, Meantime think tanks such as the German energy independence in the whole region.” energy consultants point out that the benefit Institute for Economic Research believe that Before that happens though, Poland needs for Finland – until now heavily reliant on existing infrastructure could be used more to install missing infrastructure such as a Russian gas – and the broader Baltic region efficiently, but that would require more Poland-Slovakia interconnector that would will be historic. Thus the planned pipeline cooperation between Member States than boost the flow of its LNG to the rest of the would have an important symbolic as well as there is at present. That view coincides with CEE. Gas experts also say Poland needs to practical value if built. that of energy companies such as Hungary’s develop its internal network. As smaller but essential developments MOL, which believes that small but essential The EU has earmarked a considerable take place, big-ticket projects are exercising a add-ons to the existing networks, combined budget to subsidise the financing of the CEE’s profound influence on gas supplies and will with scalable projects, offer the best bang for pipelines. continue to do so. the buck. Starting in 2009 with a sum of €4bn, the For instance, Nord Stream 2. Germany The increase in LNG terminals will be now-replaced European Energy Programme appears committed to it in the face of important in gas integration in the region. The for Recovery (EEPR) saw its capex capability concerted opposition. biggest such terminal in northern and central expand rapidly in the wake of the Ukrainian- As Russia attempts to decrease its exposure eastern Europe, Świnoujście in Poland, can Russian conflict, which jolted Brussels out to Ukrainian transit to Central Europe, now handle methane carriers with a capacity of its complacency over the region’s and Germany has striven to take over the role of of between 120,000 cubic metres and, in Europe’s energy independence. The current Europe’s gas transit hub with the help of the the case of the Q-Flex class, 217,000 cm. budget devoted to the expansion of Europe’s Nord Stream pipeline that transports Russian And much of that gas can now be pipelined gas network between now and 2025 is about natural gas to Western Europe underneath the beyond Poland into other CEE countries. As €5.35bn. Baltic Sea. This is a position Germany would Jan Chadam, president of terminal operator The increase in the number and capacity of cement if Nord Stream 2 were to go ahead. Polskie LNG, pointed out at the time of the the pipelines, particularly those devoted to gas, The CEE is concerned about the project,

THE QUIET REVOLUTION: ENERGY IN THE CEE | 05 Poland’s Šwinoujšcie, one of the largest LNG terminals in Europe mainly because it runs counter to the EU as well as by the mushrooming of receiving years in oil and gas security in the region, rulebook on energy. terminals around the Caspian Sea and the particularly since the Russian invasion of Not only would it dramatically alter the gas east of the Mediterranean, with yet more on eastern Ukraine and the earlier gas crisis transit axis and dominant flows, it would cause the drawing board. “But in particular, gas is of 2009. Generally, points out CEPI, gas current gas transit income received by Poland transported more and more by sea routes infrastructure has been strengthened and and Slovakia to fall dramatically. under liquefied form,” he explained. “Prices several two-way cross-border pipelines have At the same time, warns the Central are very competitive.” been switched on. European Policy Institute (CEPI), it would And although the South Stream pipeline Poland, for instance, can now be supplied undermine the efforts undertaken by CEE across the Black Sea was cancelled in 2014 from western hubs and Gaz-System, the Polish countries such as Hungary, with the backing and supposedly buried after Russian President operator, is implementing interconnections and financial support of the EU, to diversify Vladimir Putin announced his country’s with Lithuania, Slovakia and the Czech their gas markets. withdrawal from the project in the teeth of Republic. Also, despite entertaining bigger In its support for Nord Stream 2, Germany opposition from Brussels, some believe it’s ambitions, Slovakia now benefits from a two- also puts itself at loggerheads with Brussels. still on the agenda. way flow across its border with the Czech As CEPI explains, the pipeline would improve In July 2016 Dušan Bajatović, head of Republic. It has also boosted the Austrian- Germany’s energy security at the expense of Serbia’s state-owned provider of natural gas Slovak interconnector capacity and has a new the economic and energy security of the CEE. Srbijagas, expressed his conviction that the interconnection with Hungary and Ukraine. More recently, in late July Slovakia’s Maroš project will eventually happen – because it As the CEPI explains: “Compared to a few Šefčovič, Vice President of the European has to. years ago, [the region’s] energy security has Commission for energy, openly attacked the “One way or another, the South Stream improved, especially in gas.” entire rationale for Nord Stream 2. will be completed,” Bajatović predicted on the Indeed experts have coined the phrase As he argued, the original basis for basis that by 2035 Europe will require 150bn “quiet gas revolution” to describe the progress the pipeline has been undermined by cm more natural gas per year than it currently the CEE has made, admittedly after being the approximately 50% fall in the cost of imports. shocked into action by the events of 2009 and seaborne LNG deliveries in the last few years Much has been achieved in the last few 2014.

06 | THE QUIET REVOLUTION: ENERGY IN THE CEE But there are a lot more projects on the horizon. According to CEE’s Gas Regional Investment Plan (GRIP), a cooperative IN ALL, 88 SIZEABLE PROJECTS initiative launched by the European Network ARE PLANNED IN THE REGION. OF of Transmission System Operators for Gas THESE, 24 ARE ALREADY FULLY (ENTSOG), there’s a busy programme to be FUNDED AND 64 ARE UNDER DEVELOPMENT completed between now and 2025. In all, 88 sizeable projects are planned in the region. Of these, 24 are already fully funded and 64 are under development. One such landmark project is the gas A border delivery station at the natural gas pipeline interconnector between Poland and Lithuania, near Rozvadov, Czech Republic part-funded by €30m from Brussels. Due to be turned on in 2019, the interconnector will hook up several CEE countries to gas stored in a floating LNG terminal in Klaipėda on Lithuania’s Baltic coast. The pipeline will, points out CEPI, “put an end to the [energy] isolation of the Baltic states.” In 2014 the European Commission conducted a stress test of the vulnerability of the CEE’s gas supplies. The verdict, as those behind CESEC explained, was “extremely vulnerable” to the risk of a cut by its biggest, and in some countries, sole supplier. And compared with Central Western Europe, consumers were paying a lot more for their gas. CESEC concluded: “The main reasons were missing cross-border infrastructure and poor implementation of energy market rules that would allow reliable gas supplies from a diverse range of suppliers to be delivered at affordable prices to consumers.” Since then CESEC has overseen a rapid turnaround in gas integration. No longer is the CEE so vulnerable – and, as the crude intake from the Adriatic to 33% in the because it provides Poland with another organisation predicts, soon it will be even less next few years to process the most profitable source of supply. so. As Šefčovič said in September: “In working crude and to match the demand for its Both these developments follow Poland’s together we can achieve heightened energy products. PKN Orlen agreement of a long-term contract security and diversification in a region which Other oil companies are following suit in last year with Saudi Aramco – its first ever – has already experienced a severe vulnerability the pursuit of extra output, important in a for delivery of crude to the Polish outfit’s to its gas supplies.” region that is in the middle of what could be refineries. PKN Orlen also has long-term Impressed by what it’s been able to achieve, a long-term process of diversification in its contracts with Rosneft. Some of the Saudi CESEC has lately embraced even bigger source of oil. During 2016, crude from the oil will be moved to Lithuania and the Czech ambitions. Middle East – notably Iran, Saudi Arabia and Republic. Its members have decided to extend their Iraq – has been shipped into the CEE on a Although, as oil experts point out, the cooperation into renewable energy and energy larger scale than before. continuation of Middle East-sourced crude efficiency by reducing their dependence on As with gas, the region has historically been depends significantly on favourable shipping external suppliers, just as they’ve managed to supplied by Russia, mainly pipelined from rates and the volumes hardly put a dent in do with gas. Next up, predicts Commissioner the Urals, and the European Commission is Rosneft’s supplies, they do mark a milestone for Climate Action and Energy Miguel Arias concerned that the burden of supply does not in the region’s pursuit of energy security. Cañete, is the creation of a regional electricity fall on one country. Poland and Germany, Meanwhile, the Czech Republic’s Unipetrol market. for instance, are particularly dependent – owned by PKN Orlen – is also in the market But companies in the region have not on Urals crude. That’s why the berthing of for Adriatic oil. The firm recently signed up to neglected the importance of oil supply the supertanker Atlantas in Gdansk in the a three-year agreement for the transportation diversification as a key element of the CEE’s summer with a cargo of Iranian crude was of crude oil to refineries in Kralupy and energy security. MOL, for instance, have seen as symbolic. Litvinov, via the Adria pipeline. The agreement invested in the Friendship I/Adria crude oil Similarly, the opening of the Naftowy Pern should provide the Czech Republic with pipeline in order to be able to potentially fully oil terminal – also in Gdansk – in April has greater crude supply security, mimicking the supply its Danube and Bratislava refineries been greeted within the EU as another step charge towards a more stable energy market from the Adriatic. MOL plans to increase its forward in the region’s energy diversification across the region.

THE QUIET REVOLUTION: ENERGY IN THE CEE | 07 BA (FR MAPPING GROWTH: CEE OIL AND GAS INFRASTRUCTUREIENDSHIP) Torun Balgzand Kondratki Orel Solegorsk Unecha Lingen Wloclawek Plock Kromy Yelets Legend NETHERLANDS BERLIN Novozybkov Lipetsk Poznan Rechitsa Hannover -EUROPE WARSAW DRUZHBA Gomel oilfield(s) AMSTERDAM Frankfurt/Oder YAMAL (FRIENDSHIP) AL Kobrin oil pipeline Magdeburg G Zielona Góra Brest Mozyr Rotterdam JA THERHOOD Lodz Kursk Europoortoil pipeline under construction,Werne Shchors Shostka BRO Voronezh Vlissingenplanned or proposedGelsenkirchen Odolanow Leipzig Zeebruggeoil refinery Essen Olishevka Lublin Gubkin Antwerp GERMANY Leuna AL Görlitz POLAND tanker terminalDüsseldorf Wroclaw Erfurt OP Belgorod Dunkirk BELGIUM Köln Dresden Kostopol Korosten Sumy gasfield(s) S TEGAL Liberec Lutsk Ostrogozhsk BRUSSELS Aachen Sayda Kielce Bonn Zwickau Litvínov Walbrzych gas pipeline KIEV Schlüchtern Borispol gasBlar pipelineegnies under construction, Kralupy DRUZHBAZhitom (FRIENDSHIP)ir planned or proposed Frankfurt PRAGUE Krakow Brody LUX. Pardubice Trzebinia D UKRAINE Kharkiv gas processing plant Mainz (FRIENDSHIP)DRUZHBA Lviv Würzburg Jaslo BROTHERHOO GAZELLE Belaya Tserkov underLUXEMBOURGground gas storage Waidhaus Plzen Nowy Sacz MEGAL Olomouc Jedlicze Poltava Novopskov Cherkassy Shebelinka existing LNG import terminal CZECH REP Drogobych Ternopol SEL Nürnburg TRANSGAS I & II I Zilina Smela plannedReim sLNG import termMetzinal Vinnitsa Brno SOYUZ Kremenchug Karlsruhe Dolina Ivano-Frankovsk Lisichansk estic and Ingolstadt SLOVAK REP Kosice ODES oup dom (S PARIS MOL Gr Stuttgart core markets Nadvirna ARMARTIA) Nancy Oberkappel Lanzhot Zvolen Uzhgorod Kamenets Reichsett SA Grandpuits WAG Podolskiy Dnipropetrovsk Other countries Nagykürtös -BROD Kirovgrad Berghausen VIENNA Baumgarten Levice Fényeslitke Krasnoarmeysk Troyes CEP Munich Chernovtsy Map prepared by Petroleum Economist Enns Balassagyarmat II Beregdaróc Schwechat ) Cartographic Services. Reproduction of the P Y BRATISLAVA Tiszaújváros HI contents of this mapBourbonne in any manner whatsoever DS Donetsk HA EN Kryvyy Rih is prohibited without prior consent of the Salzburg FRI Botosani G A ( Zaporizhzhia publisher B Ananyev Montbéliard ZH Nikopol AUSTRIA BUDAPEST RU MOLDOVA D Hajdúszoboszló Zürich Szombathely Százhalombatta Rostov Besançon Vecsés Iasi Dneprorudnoye LIE. Bludenz Innsbruck L G Mariupol Taganrog Cressier S Graz TA CHISINAU TA P Azov Nevers FRANCE VADUZ HUNGARY Kecskemét Bicaz Nikolaev Novaya Melitopol

Tiraspol o L Városföld BERN L Cluj-Napoca Dnipr Kakhovka k

Arnoldstein AWP Berdyansk Yeys A SO Yuzhne SWITZ. Kherson Evian Szank Ochakov Lendava Darmanesti Odessa Collombey ADRIA ROMANIA SLOVENIA Horia Illichevsk Sea of Azov Geneva Szeged Onesti Pécs Szöreg Arad Primorsko-Akhtarsk LJUBLJANA ZAGREB Sombor Subotica Hunedoara Tikhoretsk Istrana Trieste Clermont Feyzin Aosta Timisoara Hateg Brasov Ferrand Trieste Dzhankoy Novara Milan Sisak CROATIA Osijek Galati Venice Rijeka Jupa Kerch Izmail Temryuk ADRIA SE Braila C Cremona Novi Sad Isaktcha P Grenoble Turin Omisalj C o Mantova Slavonski Brod Feodosiya rillac Sannazzar Krk Pancevo Pitesti Anapa Krasnodar O LNG Croatia Ploesti TREAM Simferopol FRANCE Pula [FSRU] BOSNIA & (CPC) BELGRADE HITE S Gelendzhik Busalla (Krk Island) W Alushta Novorossiysk Bologna HERZEGOVINA Sevastopol Maykop Cuneo Ravenna Genova O Adriatic LNG Midia-Navodari Yalta

SPLSE BUCHAREST Dzhubga Savona Casalborsetti Zenica Craiova Zadar Bor Giurgiu La Spezia SERBIA Constanta Tuapse

Fos-Tonkin SEPL/ Manosque La Spezia SAN MARINO SARAJEVO Ruse Monaco Florence Uzice TRANS-BALKAN Fos-Cavaou Nice Danube Berre-lEtang Livorno Falconara O Falconara Split Razgrad PIPELINE (TBP) Fos-sur-Mer Marittima Sochi Livorno OLT Cross Gas O Nis La Mede [FSRU] Recanati [FSRU] Pleven Béziers Lavéra Vratsa Varna Toulon Kardijevo TREAM Piombino TURKS MONTENEGRO BULGARIA Black Sea Rosignano Marittimo Kosovo SOFIA Perpignan Pristina TREAM PODGORICA Stara Zagora Rieti Chieti Adriatic Sea Burgas Corsica UE S

Malkoclar BL Ajaccio San Salvo Bar Shkodër AMBO Plovdiv ROME SKOPJE Fiumicino ITALY Manfredonia ALBANIA F.Y.R.O. Bartin Bafra a MACEDONIA Kiyikoy Kastamonu na Eregli Karabük TIRANA Drama Komotini Samsun Ünye Gaeta Bari Marmara Trabzon Cërrik Karperi Istanbul Ordu Olbia Ipsala Ereglisi Fatsa Kavala a Ambarli Giresun Napoli Plati Alexandroupoli Marmar Brindisi Fier Kuçovë Ereglisi Izmit Corum Amasya Taranto Ballsh Thessaloniki Vlorë ATIC Balearic Sea GALSI AP) INTERCONNECTOR Ibrikbaba Tokat TRANS ADRI Karacabey PIPELINE (T TURKEY-GREECE (ITG) Bilecik TURKEY Menorca Bursa Sardinia Máglie Otranto Canakkale ANKARA INTERC GREECE Can Mahon Castrovillari IT Kirikkale Tyrrhenian Sea AL Mallorca Y- Yozgat ONNECTGREECE Eskisehir Ahiboz Sivas Trikala Larrisa Balikesir Palma de Mallorca C OR (IGI) BT Cagliari Volos Crotone Ampeleia Aegean Sea Kirsehir Sarroch Ionian Sea Aliaga Afyon Mediterranean Sea Kayseri Elazig Gioia Tauro Usak MedGas LNG Izmir Izmir Aksaray Nevsehir

GALSI Oinofyta a Palermo Milazzo Elefsis Malaty Aspropyrgos ATHENS Nigde 08 | THE QUIET REVOLUTION: ENERGY IN THE CEE Revythoussa Diyarbakir Ag Theodori Gagliano Revythoussa Aydin Konya Lavrion Sicily Eregli TRANS- Augusta Megalopoli Seydisehir ALGERIA TUNISIA Porto Empedocle MEDITERRANEAN Gela Priolo Karaman Ceyhan BA (FR IENDSHIP) Torun Balgzand Kondratki Orel Solegorsk Unecha Lingen Wloclawek Plock Kromy Yelets Legend NETHERLANDS BERLIN Novozybkov Lipetsk Poznan Rechitsa Hannover -EUROPE WARSAW DRUZHBA Gomel oilfield(s) AMSTERDAM Frankfurt/Oder YAMAL (FRIENDSHIP) AL Kobrin oil pipeline Magdeburg G Zielona Góra Brest Mozyr Rotterdam JA THERHOOD Lodz Kursk Europoortoil pipeline under construction,Werne Shchors Shostka BRO Voronezh Vlissingenplanned or proposedGelsenkirchen Odolanow Leipzig Zeebruggeoil refinery Essen Olishevka Lublin Gubkin Antwerp GERMANY Leuna AL Görlitz POLAND tanker terminalDüsseldorf Wroclaw Erfurt OP Belgorod Dunkirk BELGIUM Köln Dresden Kostopol Korosten Sumy gasfield(s) S TEGAL Liberec Lutsk Ostrogozhsk BRUSSELS Aachen Sayda Kielce Bonn Zwickau Litvínov Walbrzych gas pipeline KIEV Schlüchtern Borispol gasBlar pipelineegnies under construction, Kralupy DRUZHBAZhitom (FRIENDSHIP)ir planned or proposed Frankfurt PRAGUE Krakow Brody LUX. Pardubice Trzebinia D UKRAINE Kharkiv gas processing plant Mainz (FRIENDSHIP)DRUZHBA Lviv Würzburg Jaslo BROTHERHOO GAZELLE Belaya Tserkov underLUXEMBOURGground gas storage Waidhaus Plzen Nowy Sacz MEGAL Olomouc Jedlicze Poltava Novopskov Cherkassy Shebelinka existing LNG import terminal CZECH REP Drogobych Ternopol SEL Nürnburg TRANSGAS I & II I Zilina Smela plannedReim sLNG import termMetzinal Vinnitsa Brno SOYUZ Kremenchug Karlsruhe Dolina Ivano-Frankovsk Lisichansk estic and Ingolstadt SLOVAK REP Kosice ODES oup dom (S PARIS MOL Gr Stuttgart core markets Nadvirna ARMARTIA) Nancy Oberkappel Lanzhot Zvolen Uzhgorod Kamenets Reichsett SA Grandpuits WAG Podolskiy Dnipropetrovsk Other countries Nagykürtös -BROD Kirovgrad Berghausen VIENNA Baumgarten Levice Fényeslitke Krasnoarmeysk Troyes CEP Munich Chernovtsy Map prepared by Petroleum Economist Enns Balassagyarmat II Beregdaróc Schwechat ) Cartographic Services. Reproduction of the P Y BRATISLAVA Tiszaújváros HI contents of this mapBourbonne in any manner whatsoever DS Donetsk HA EN Kryvyy Rih is prohibited without prior consent of the Salzburg FRI Botosani G A ( Zaporizhzhia publisher B Ananyev Montbéliard ZH Nikopol AUSTRIA BUDAPEST RU MOLDOVA D Hajdúszoboszló Zürich Szombathely Százhalombatta Rostov Besançon Vecsés Iasi Dneprorudnoye LIE. Bludenz Innsbruck L G Mariupol Taganrog Cressier S Graz TA CHISINAU TA P Azov Nevers FRANCE VADUZ HUNGARY Kecskemét Bicaz Nikolaev Novaya Melitopol

Tiraspol o L Városföld BERN L Cluj-Napoca Dnipr Kakhovka k

SPLSE BUCHAREST Dzhubga Savona Casalborsetti Zenica Craiova Zadar Bor Giurgiu La Spezia SERBIA Constanta Tuapse

Malkoclar BL Ajaccio San Salvo Bar Shkodër AMBO Plovdiv ROME SKOPJE Fiumicino ITALY Manfredonia ALBANIA F.Y.R.O. Bartin Bafra a MACEDONIA Kiyikoy Kastamonu na Eregli Karabük TIRANA Drama Komotini Samsun Ünye Gaeta Bari Marmara Trabzon Cërrik Karperi Istanbul Ordu Olbia Ipsala Ereglisi Fatsa Kavala a Ambarli Giresun Napoli Plati Alexandroupoli Marmar Brindisi Fier Kuçovë Ereglisi Izmit Corum Amasya Taranto Ballsh IC Thessaloniki Vlorë AT Balearic Sea GALSI AP) INTERCONNECTOR Ibrikbaba Tokat TRANS ADRI Karacabey PIPELINE (T TURKEY-GREECE (ITG) Bilecik TURKEY Menorca Bursa Sardinia Máglie Otranto Canakkale ANKARA INTERC GREECE Can Mahon Castrovillari IT Kirikkale Tyrrhenian Sea AL Mallorca Y- Yozgat ONNECTGREECE Eskisehir Ahiboz Sivas Trikala Larrisa Balikesir Palma de Mallorca C OR (IGI) BT Cagliari Volos Crotone Ampeleia Aegean Sea Kirsehir Sarroch Ionian Sea Aliaga Afyon Mediterranean Sea Kayseri Elazig Gioia Tauro Usak MedGas LNG Izmir Izmir Aksaray Nevsehir

GALSI Oinofyta Malatya Palermo Milazzo Elefsis Aspropyrgos ATHENS Nigde Revythoussa THE QUIET REVOLUTION: ENERGY IN THEDiy CEEarbakir | 09 Ag Theodori Gagliano Revythoussa Aydin Konya Lavrion Sicily Eregli TRANS- Augusta Megalopoli Seydisehir ALGERIA TUNISIA Porto Empedocle MEDITERRANEAN Gela Priolo Karaman Ceyhan ECONOMICS OF GROWTH

Regional finances are set for steady growth, but the CEE could benefit from wider geopolitical stability

It’s just as well the oil and gas industry across ones such as the Baltics are expected to grow around 3.2%. the CEE is used to economic and political at a rapid rate – up to 4% a year between Although the CEE is seen as a cohesive upheaval. For most of the last 20 years, it’s had now and 2020 – while the export-oriented region, most observers believe economic to deal with almost continuous change and it’s countries with “reasonably friendly business prospects will vary considerably, according become a way of life for commerce in general environments”, says Walewski, should achieve to how capable their governments deal in the region. collective annual growth of between 2-3%. with current challenges including that of As PWC Poland’s senior economist Of the latter, Romania, Slovakia, the Brexit. “The Brexit decision will likely drag Mateusz Walewski observed earlier this year, Czech Republic, Hungary and Poland are on confidence and might contribute to a “international and local businesses have prime examples. They already serve as a vital further weakening of investment [in the become used to continual reform over this element of the European supply chain in region], which has already been declining period and executives say it has helped them manufacturing, particularly in the automotive due to lower inflows from EU funds,” predicts to become more agile and less fragile.” industry. Just two in fact, the Czech Republic FocusEconomics. And these nations have to be agile. “The and Slovakia turn out more cars than does majority of CEE countries are small, relatively France despite having just 16m people Energy outlook open and heavily dependent on exports between them. The oil and gas industry has had a particularly for growth, notably to other EU countries,” Ominously, they are increasingly turbulent period created by rock-bottom Walewski adds. “This makes them highly applying their engineering know-how to the crude prices exacerbated by Iran’s return to oil sensitive to developments in advanced development of home-grown brands and exporting after the ending of an international economies.” competing in the wider European market in ban, the after-shocks of the attempted coup in Economists generally divide the region’s their own right. Clearly this will be important Turkey that has already affected exports from countries into three quite distinct camps. There for the development of the region’s energy several countries such as Romania, and the are the smaller Baltic states, the next-biggest sector. And it’s why, estimates consultancy slowdown of Brussels-based investment. and export-focused economies such as the FocusEconomics in a recent forecast, Romania The good news in all of this is low-cost Czech Republic, Bulgaria, Romania, Hungary will be the region’s fastest-growing economy feedstock. and Poland, and the troubled countries such in 2016 with a predicted rate of 4.5%, closely With its ability to transcend national issues, as heavily indebted Slovenia. The nimbler followed by Poland and Slovakia, both with the region’s oil and gas industry is profiting

10 | THE QUIET REVOLUTION: ENERGY IN THE CEE Rising Danube: regional economics are looking strong

from the ever-cheaper crude that is fuelling transit hub as well as an important and fast- the downstream industry. “Taking advantage growing outlet for CEE countries, its long- TAKING ADVANTAGE OF of cheap feedstocks, refiners have made the term stability is considered vital throughout CHEAP FEEDSTOCKS, most of larger profit margins and producing REFINERS HAVE MADE THE the EU. For example Romania, for which higher value products,” points out the World MOST OF LARGER PROFIT Turkey is its biggest single export market, is Refining Association in its latest report on the MARGINS AND PRODUCING already suffering from the economic fall-out region. HIGHER VALUE PRODUCTS of the coup. Rather than rely on the feedstock windfall On the bright side the region can only though, industry in the CEE has launched its benefit from an end to the war in Syria and own initiatives. “There has also been a huge continue to stay at current levels. “The to conflicts with Islamic State that have focus on driving efficiency, cutting costs and majority of respondents see the lifting of destabilised the Turkish market. adapting to change,” adds the association. sanctions as having a positive affect for Of the two major pipelines running through Only by creating efficient, value-driven supply European refineries… Iranian crude offers a Turkey, the one originating from Kirkuk in chains have upstream companies been able to cheap feedstock for refiners in the CEE region northern Iraq has been severely affected by survive. who saw record margins in 2015 and would the fighting. Although it adds to the turmoil, the lifting love to see this trend continue.” “Turkey plays a hugely influential role of sanctions from Iran in early 2016 may be And that’s considered likely because Iran within the region and is seen as a major player helping the downstream industry. Despite the looks like it will continue to pump crude into in the downstream market,” points out the European market already being oversupplied a saturated European market. World Refining Association, citing its strategic to the tune of 1.5m barrels a day, the arrival Making hay while the sun shines, oil and location as a shipping hub and infrastructure of Iranian oil has served to further depress gas industry spokesmen report they are using such as the Star refinery under construction feedstock prices and encourage in the process fatter margins from downstream businesses to on the Petkim Peninsula. deeper investment in petrochemical plants put aside funds for the sprucing up of ageing If and when peace is restored, the across the region. assets in their upstream activities. CEE’s heavy current investments in their According to the association, the industry’s The attempted coup in Turkey alarmed the downstream activities could pay off biggest concern now is that feedstock prices region’s entire energy sector. As a vital energy handsomely in the coming years.

THE QUIET REVOLUTION: ENERGY IN THE CEE | 11 OPPORTUNITY IN DIVERSITY

Using the capability, the financial means and a leading regional market position in CEE, Hungary’s MOL seeks to MOL’s eco-friendly service station in Budapest respond dynamically to future trends

Budapest-headquartered MOL Group for the future.” The refineries are in the explains Horvath. By 2030, MOL’s objective can look back on a successful 15-year vanguard of the makeover. On the one is to be a leading chemicals company in transformation, having achieved a series hand, MOL’s goal is to keep its refineries CEE. To make it all happen, the company of targets. With production plants in eight among the most profitable in Europe. “There has earmarked future cash flows as capital countries and exploration assets in 13, it is still a lot of room for increasing our expenditure. Up to $4.5bn will be invested in now runs four efficient refineries and two efficiency and competitiveness. Our internal five-year cycles. Of this sum, about $2bn will rapidly expanding petrochemical plants in programmes have delivered over $700m be invested in the next five years. its home region. “We’re a highly integrated EBITDA improvement in the past four years With a forward integration strategy in place, group between upstream and downstream. and we will continue with these efforts”, says MOL has ambitions for its retailing division on While a few years ago two-thirds of our Horvath. On the other hand, within the next the back of a revamped corporate culture. “In earnings came from our upstream business, 15 years the group aims to take advantage of the last 15 years we’ve been a rather centralised today the situation is basically the opposite. a number of opportunities. As the company company,” explains Horvath. “This will not be Downstream offsets the decline in profits from plans to diversify its production away from the case in the future as we enter a new era upstream,” explains Ferenc Horvath, Executive motor fuels, MOL wants to boost feedstock to of mobility. We must become much more Vice-President, Downstream. its petrochemical plants as well as to increase entrepreneurial. We have to manage our value And the board has just signed off on an production of high value non-fuel products chain with the understanding that markets even more challenging 15-year strategy that such as chemicals, jet fuel, lubricants and base will be driven by customers’ habits and aims to reconfigure the company by 2030 into oils, while simultaneously expanding its share expectations. That means our thinking will a flexible, more outward-looking, consumer- of the liquefied petroleum gas market across start from the other end, from the customers’ driven organisation. Although MOL believes CEE. Investments will be made into refineries point of view. This is why our internal culture demand will still exist for hydrocarbons in in Hungary and Slovakia, making them more needs to be developed and we have to adjust 2030, it is preparing itself now for a post- flexible producers of propylene and high value our governance and processes for these hydrocarbon world. In the 2030 strategy, non-fuel products, as MOL increases the ratio challenges. We want to become a ‘first mover’, besides the traditional businesses, new of non-motor fuel products from 30% to 50%. ahead of everybody else. No other company in emphasis will be placed on high-margin Higher-margin petrochemical products will the industry is doing this in the region.” petrochemicals and an expanding retail base be developed for the automotive, packaging, As part of MOL’s more outward-looking as MOL embraces the coming era in private construction, furniture and electronics culture, it will seek new talent. “We will build and public transport. The group is laying the industries. Over the next five years the focus stronger relationships with universities and foundation for a new age. “We want to become will be on propylene oxide-based polyols, academic institutions,” he says. “This will the first choice of customers, employees and highly favoured for a wide range of new support education and maintain a talent investors,” says Horvath, one of the architects products. MOL expects to be the only fully- pool for the industry.” Even now, almost a of MOL’s reconfiguration. integrated manufacturer of polyols in the quarter of the managers at its headquarters Echoing those views, Berislav Gaso, region. “There is a shortage of polyols in CEE, are expatriates. “In my management team, six Executive Vice-President, Exploration and we know the customers, have the knowledge out of eight leaders are expats, which gives us Production, underlines how integration is and experience, and therefore we are well- additional experience and knowledge”, adds key: “There are very strong synergies on the positioned. And the fact that all the feedstock Horvath. The company plans to employ big financial side. MOL has very comfortable comes from our own value chain gives us an data to meet the needs of its current 10m gearing, which gives us a strong cash flow even greater advantage over our competitors”, customers as it expands its range of fast-

12 | THE QUIET REVOLUTION: ENERGY IN THE CEE A rig in MOL-operated Tal-Block, Pakistan moving consumer goods (FMCG). “There driven one.” MOL has been agile in adjusting next five years. are tremendous opportunities for handling to this new reality. “We had to move away In MOL’s home region (Hungary and big data in an FMCG way,” enthuses Horvath. from volumetric thinking and focus on our Croatia) the fields are mature, but the “It’s not rocket science, just a different way of cash flow. In other words, as I like to put it company has managed to reverse a production thinking.” to my colleagues, I really like barrels of oil – decline, with oil production growing by 20% The so-called ‘consumer services’ strategy is but I like dollars even more.” MOL’s steps to in 2016 thanks to optimisation measures. “We particularly bold. MOL sees itself meeting the increase efficiency are clearly bearing fruit as know we’re really good at efficient onshore requirements of a highly mobile population, MOL’s unit costs have decreased to the very production and we employ the most advanced for instance providing car-sharing, electric competitive level of $6 per barrel. “I want a technology. And although the CEE region is vehicles, fleet operations and even solutions portfolio of assets that creates value in the a mature area, we will also focus strongly on for urban public transport. Between now current low oil price environment. At present further exploration,” Gaso adds. “We currently and 2030, the group expects external factors this is an efficiency game, but it will become possess more than ten exploration licences and to transform energy consumption around more challenging later as we start to build up we will continue to participate in upcoming the world. Further embracing the transport our reserves.” bid rounds. We also aim to revisit existing revolution, MOL will offer alternative forms He says the focus will be on small to licences with 3D seismic to identify new of power in its 2,000 service stations. medium-sized assets located in geographies geological plays.” The group has already launched its retail that the group knows. “We aim to keep our Although the group is not an operator in transformation by modernising its service production at least at the current levels the hard-hit North Sea, Gaso is working with stations. By 2018, there should be over 700 [110,000 barrels of oil equivalent per day] and MOL’s partners to reduce costs. “It’s important service stations with the fast-food concept, this will also require inorganic investments in that the North Sea returns to cost discipline,” Fresh Corner, in the CEE region. “We will reserves replacement, but these have to make he says. sell our customers everything they need. financial sense in a low oil price environment.” “In the last five to eight years the entire UK Currently customers come primarily to refuel Meantime Gaso has a robust budget to upstream industry got lazy and now we need and make adjacent purchases. In the future we develop MOL’s existing portfolio and he to find our way back to the old discipline. I want to be the first choice of customers even believes that the upstream business can believe substantial cost deflation is possible in if it is not about refuelling their cars,” says generate $3.5bn-4bn EBITDA between 2017 the North Sea and together with Enquest on Horvath. As the consumer-facing businesses and 2021. MOL Upstream will invest $2bn Scolty & Crathes, we have just proven that.” grow, the group expects them to deliver a third in organic capex during that period with Safety will remain a priority. “MOL has of EBITDA by 2030. an additional pre-tax $500m earmarked a solid record in safety but we’re aiming for While MOL’s downstream businesses is for Norwegian exploration. About 20% of zero incidents,” Gaso says. Similarly, the a key focus for transformation, upstream the $2bn will be invested in exploration, downstream division is setting its sights won’t be neglected. “Upstream is a core notably in the CEE and Pakistan, and 55% for higher. “In sustainability we’re aiming to stay pillar of the business,” Gaso says, explaining development projects in MOL’s home region, in the top 15% of companies,” hopes Horvath. that his division must be self-funding and the UK, Pakistan, Kazakhstan and the highly “In safety there can be no compromises.” value generating even in a low oil price profitable Baitugan field in Russia. As a result As MOL embarks on its 15-year environment. “The world has changed. This Upstream will generate around $1bn post- transformation into a more advanced group, oil crisis is different from previous ones. It’s tax free cash flow, which will allow MOL to observers are expecting much, following a not a demand-driven shock but a supply- sustain current production levels during the period of sustained success.

THE QUIET REVOLUTION: ENERGY IN THE CEE | 13 CEE OIL & GAS COMPANIES EMBRACE ENERGY UNION

By working together, regional energy markets natural gas in the Czech Republic fell late last can feel the benefit of scale economics year to the unprecedented point where it’s only 4.5% higher than at the hubs in Germany. However refineries in Europe are under As the CEE’s oil and gas sector rapidly reduces “We will no longer tolerate a situation pressure, not only to ramp up production but its dependence on high-priced Russian where bottlenecks are artificially pushed to also to meet tougher standards in efficiency supplies, it’s moving closer into the European the border, as is still the reality,” he warned. and pollution. Since 2008 EU refining capacity embrace through the so-called Energy Union Meantime consumers are benefiting from has decreased by 10%, according to the IEA. that aims to create a self-sufficient, zero- lower prices. In the gas market, for instance, The oil refining fitness check – completed by carbon future. according to a recent European Commission the European comission in 2015 – evaluates In tandem with the linking up of pipelines report, the estimated import bill for the how ten pieces of the most relevant EU in the Baltics, Central Europe and the Balkans, EU in the first quarter of 2016 plummeted legislation drawn from a variety of fields European Member States are adopting to €14bn. That compares with the average including environment, climate action, European regulatory systems to facilitate the quarterly bill of €18bn in 2015. And as the taxation and energy, influence the sector. The completion of internal market functioning, region is becoming better connected and ten-point check list is by general agreement and the flow of natural gas without LNG becomes accessible, prices should hurting margins and competitiveness, administrative barriers. Energy community continue to fall further. In the first quarter of particularly against higher-producing members like Ukraine are also aligning their 2016, spot prices at European gas hubs fell to refineries in North America and the Middle legal systems so that national companies can €12-15 per megawatt hour, the lowest in seven East. In July, the European Commission’s own harmonise more easily with the EU. “Many years. CEE-based consumers in particular research conceded this was the case, noting countries have recently undergone significant are reaping the rewards. According to the that “the average cumulative cost resulting reforms or expect to implement them shortly,” European Commission, the price of imported from the impact of legislation… is estimated explains Nilüfer Evrenle, technical consultant to account for up to 25% of the total net loss to Azerbaijan’s SOCAR Energy group. of competitiveness of the sector in terms of the As Miguel Arias Cañete, European decline in the observed net margin.” Commissioner for Climate Action and Energy ACCORDING TO THE But refineries shouldn’t expect any reprieve. pointed out in October, there’s a lot at stake. EUROPEAN COMMISSION’S “The costs can be considered proportionate LATEST FIGURES, THE PRICE Thanks to a more efficient oil and gas sector, relative to the benefits achieved,” argues the OF IMPORTED NATURAL GAS improved pipeline networks and lower prices, IN THE CZECH REPUBLIC report, which also insists that regulatory costs the EU as a whole saved $27bn in imports FELL LATE LAST YEAR TO have stabilised in the last four years. in 2015 compared with the year before. The THE UNPRECEDENTED POINT There’s no sign that the EU’s energy czar will commissioner thinks the EU can do more WHERE IT’S ONLY 4.5% back down on fitness checks. Commissioner provided regions such as the CEE continue to HIGHER THAN AT THE HUBS IN Cañete is on a mission to lead an “energy cooperate within the Energy Union, citing by GERMANY revolution”, that converts the CEE and the rest way of example the “huge potential” waiting to of Europe into a carbon-free energy sector by be tapped in existing interconnectors. 2050.

14 | THE QUIET REVOLUTION: ENERGY IN THE CEE

THE QUIET REVOLUTION: ENERGY IN THE CEE