Outlook 2023+

Nec temere, nec timide¹: neither timidly nor rashly

¹ Nec temere, nec timide, translating to ‘neither timidly nor rashly’, is a Latin maxim best known as the motto of Gdańsk (but used also as the slogan of the Danish naval academy). While its exact origin is not entirely clear, it appears in Book III of Aristotle’s Nicomachean Ethics, which mentions that a man guided by virtue is neither a coward nor a rash man, but a brave man.

Nec temere, nec timide should thus be our guiding motto on the energy transition journey, which is to lead us to the goal of climate neutrality by 2050. We have only 27 years to go before Europe’s economy must be fundamentally transformed, which leaves little time for grave mistakes. One consequence of misguided and rash decisions that cause, for instance, a drastic increase in the cost of such basic services as heating or transport, could be social resistance, preventing any further transition efforts.

The war in Ukraine brought another shock to energy markets after the SARS-CoV-2 coronavirus pandemic, and highlighted Europe’s overreliance on fossil fuels and Russia that had continued for too long. The prices of natural gas, hard coal, diesel oil and, consequently, electricity have been volatile in recent years, leading to increased uncertainty, difficulty in making investment decisions, and limited economic growth. To address this problem, the European Union is taking steps to reduce its dependence on Russian energy supplies in the short term, and ultimately eliminate fossil fuel imports altogether by transitioning to renewable sources. The ORLEN Group’s updated strategy², which provides for more ambitious renewable energy targets, aligns with this trend. However, we also keep transitional energy sources in mind in order to be able to ensure security by offering reliable energy supplies.

The prices of key energy carriers and carbon emission allowances in 2016³−2022 were as follows:

² https://www.orlen.pl/pl/o-firmie/strategia-2030
³ 2016=100

For ORLEN, the war will have the following implications in 2023:

1. Supply-side effects: Diversification of supply. The conflict has caused an energy market crisis of a scale not seen in decades. As a result of the Russian invasion of Ukraine, imports of oil, finished fuel products (such as diesel), and natural gas from Russia to the EU have been significantly reduced. Poland, as an importer of fuels, had to diversify its sources of supply, resulting in increased complexity and costs of logistics, including longer shipping distances. This process was carried out efficiently as Poland and the ORLEN Group had started diversifying their sources of supply long before the conflict broke out. As a region, we were right to take action to diversify our commodity supplies for some time. We were also able to synchronise our infrastructure investments (such as the Naftoport, LNG terminal and Baltic Pipe) in a timely manner before the outbreak of the war. Russia has never been a reliable supplier and business partner for our region.
2. Demand-side effects: The ongoing military conflict in Ukraine has coincided with the post-pandemic economic recovery in Poland (as well as other countries on the eastern edge of the European Union). Therefore, demand pressures in our region are much greater than in Western countries: we supply fuel to Ukraine and its citizens, as well as for commercial, military, and humanitarian transit, and for the NATO troops stationed there.
3. Strategic implications: The significance of security and risk mitigation has been elevated by the war and its consequences. If we strengthen our leadership position in the energy transition, as is our objective, the diversified group that generates cash flows from various businesses, which often serve as natural hedge for each other, will be able to achieve much better profits across the Group.

At the European Union level, energy transition has gathered pace rather than receded, driven by the energy crisis and war.

European Union achievements in 2022

As noted by Fatih Birol⁴, Executive Director of the IEA, it is important to acknowledge the European governments’ response to this major and complex energy crisis. Public intervention measures, such as support programmes for renewables, subsidies and preferential loans to finance home upgrades and the installation of heat pumps, as well as campaigns to encourage behavioural change, have contributed to reducing demand for gas.

Quick adaptation to the lower gas exports from Russia and the price hikes was also made possible by several decades of reforms and policy initiatives, which enabled large customers to reduce consumption, replace imports, and switch to alternative supplies within the well-planned European gas network.

Despite this progress, Europe has not yet fully overcome the problems. Looking ahead to the next year, it appears that the oil and gas industry in Europe is facing a fragile situation. There remain several uncertainties that could have a substantial impact.

As for the gas markets, it is important to bear in mind that Russia continues to supply certain volumes to Europe by pipelines. However, there is a possibility that this supply may be completely cut off, which would exacerbate the pressures in the markets. On the other hand, China, the world's largest importer of gas, is currently lifting its lockdown restrictions, which last year caused a decline in its gas demand for the first time in 40 years. The question is how much demand will rebound in China. Anyway, it is clear that it will significantly increase competition on LNG markets for European buyers compared with the previous year. This in turn presents an even greater challenge for importers with limited purchasing power, especially in developing countries.

 It should also be remembered that this time Europe was lucky to experience a mild winter, but it cannot assume equally mild weather come the next winter season.

The situation on the oil and fuel markets is bound to change as well. Fuel shortages, especially of diesel oil, are expected to slowly ease off as gas prices (and demand for gas from the power sector) decrease and new refineries are placed in service in Africa, the Middle East and Asia. The sustained high refining margins will encourage faster launch of new refining capacities, and additional fuel supply on the market should bring the refining margins to normal levels. However, a decline in refining margins may not necessarily result in lower fuel prices, as tensions in the oil market are expected to escalate.

Let us remember that in 2022 we saw an oversupply of oil. Contrary to expectations, Russia was able to redirect its crude exports from the west to the east and south, and maintain production levels similar to those seen before the war. On the other hand, substantial oil streams entered the market after the US Government and International Energy Agency released their strategic reserves in an attempt to reduce Russia's budget revenue from sales of oil by bringing down its market price. This objective was achieved despite the intervention of OPEC+, which decided to implement production cuts. This situation is not likely to occur again in 2023. First, the sanctions on imports of Russian fuels will probably force Russia to reduce its oil production and exports. Second, the US and MAE strategic reserves will need to be replenished. Third, OPEC+ countries are struggling with production capacity shortages relative to the declared potential, which is due to the discontinuation of investment projects during the pandemic. Without investments in the short term, they will not be able to step up production to respond to growing demand, for instance from China. Finally, the US production potential is slowly being exhausted. When new refineries in the southern hemisphere come on stream, and China comes back to the market, oil prices may go up.

⁴ https://www.iea.org/commentaries/where-things-stand-in-the-global-energy-crisis-one-year-on 

The commodity crisis and the war have changed our perspective on the development of the energy market in Europe – increasing the role of renewable energy sources and nuclear power

The last two years have been marked by significant changes and challenges – both for the ORLEN Group and the fuel and energy market.

After four years of hard work, we finally completed the mergers with Energa, Grupa Lotos, and PGNiG. These integrations create new opportunities for development. The most significant of them is the opportunity to support the energy transition by coordinating a broad range of assets and leveraging the investment power to undertake large-scale projects. Additionally, the integration of the entire oil and gas value chain in Poland will increase efficiency and streamline operations. Poland's failure to create a large player with international impact placed it behind other countries, which had done so 10 to 15 years earlier. We recognised the need to catch up with others, to prepare for challenges of the energy transition. This can be achieved more effectively by a large player that integrates energy from multiple sources.

Energy transition is accelerating due to the intersection of technological advancements, changing societal attitudes, and new regulatory frameworks such as Fit for 55, REPowerEU, and RED3. In addition, some processes, such as the electrification of industry, are being further accelerated by the ongoing commodity crisis. At the same time, significant changes have been observed in the energy and fuel markets. On one hand, long-term trends are solidifying, as the inevitability of the energy transition is no longer a matter of debate. The question now is when, rather than if, it will happen. New incentives for the energy transition are also emerging, driven by regulatory frameworks such as Fit for 55, REPowerEU: affordable, secure and sustainable energy for Europe, and RED III, as well as the EU's expanded taxonomy. In addition, rising emission allowance (EUA) prices and the availability of new funding sources, such as European funds and ESG, are contributing to the transition.

On the other hand, geopolitical changes and economic cycles also rapidly impact our markets, with the war in Ukraine, restrictions on energy and commodity flows, and disruptions in fuel markets (e.g., crude oil and gas), along with fluctuating energy and commodity prices, among the most obvious examples.

At the same time, there is a growing interest in exploring new business opportunities for oil companies, such as petrochemicals (including advanced recycling), low-emission fuels (such as bio and synthetic fuels), e-mobility (including charging infrastructure), and low-emission hydrogen for use in transport, industry, and energy (both green blue hydrogen).

Despite the current turmoil, the goal and rationale remain the same: to achieve the objectives of energy transition and ensure energy security for our part of Europe. As the ORLEN Group, we have committed to achieving climate neutrality by 2050 in our new strategy. Given the size and scope of our operations, achieving this objective will have a significant impact on the economy of our region.

Decarbonisation remains our primary objective, although at first glance, it may seem that our focus should be on overcoming the current turbulence in the oil and gas markets. Therefore, the new strategy is much more ambitious than before in terms developing renewable energy sources. Our objective is to strengthen the new Green Division of the Group.

The CO2 emission allowances." data-popup>EU ETS reform may lead to EUA prices reaching around EUR 150/tCO₂eq by the end of the decade.

Gas price spikes
The rise in gas prices resulted in a substantial increase  in CO2 emission allowances." data-popup>EU ETS prices during the latter half of 2021 and early 2022. This was partly due to some industries switching back to coal combustion in response to the higher gas prices, which led to a surge in demand for coal.

Secondly, after completion of the M&A process, we have a clear understanding of the pace and direction of the strategic transformation of our assets. Also this process may now be better coordinated and complementary. Building resilience to market turbulence and accelerating the energy transition is currently a priority. The speed of evolution is crucial as the power sector is confronted with numerous long-term challenges at the European level, resulting from the increasing proportion of variable renewable energy sources and the gradual shift towards fully decarbonised electricity by 2050.

This includes investing in measures to support energy supply continuity until large-scale energy storage and other flexibility tools become available. This is necessary not only for renewable energy sources but also for intermittent low-carbon technologies, such as gas.

That's why we put such a strong emphasis on energy security. In the medium term, it is important to secure supplies through the upstream segment by increasing production in Poland and Norway as we reduce our reliance on Russian supplies. In the downstream segment, we are strengthening the potential for liquid fuel production by investing in increasing crude oil throughput, developing bio-refineries and biofuel production, as well as producing biogas and biomethane. This is supported by the recent upswing in investor sentiment towards investment in liquid fuels, including both traditional fuels (likely due to the prolonged prospect of their use in the transport sector, particularly heavy transport and aviation) as well as life-cycle zero-emission alternative fuels (such as higher-generation biofuels and synthetic fuels).

At the core of the increase in investor sentiment is the realisation that the key to energy security (or its price, which must be paid) is to build surplus energy capacity relative to demand. This is what was missing, as premature divestments in the Oil & Gas sector due to fears of stranded assets have created a gap in the required energy capacity. The lesson learned from the shocks of the pandemic and the war in Ukraine is that certain assets that may have been considered stranded in the future are a fair price to pay for today's energy security.

In the long term, achieving energy security is aligned with technological progress and the selection of suitable technologies that are adapted to local conditions and possibilities.

The goal sought by countries which together account for more than 90% of the world’s GDP and nearly 70% of the global population has been clearly defined, they all want to achieve climate neutrality. However, the time frames set for achieving that goal vary – the European Union, United States, United Kingdom, Japan, Australia or Korea have taken the lead, targeting climate neutrality by 2050. China and India, on the other hand, expect to reach the net zero target by 2060 and 2070, respectively.

Also the paths leading towards that ambitious goal are far from settled. The pioneering role entails a lack of available models to emulate and need to deal with considerable technological uncertainty. In its ‘Energy Technology Perspectives’ report released in January 2023, the International Energy Agency (IEA) indicates that a half of the emissions reductions in 2050 will come from technologies that are still at the prototype or demonstration stages. Which specific solutions, and in what order, will make it to the commercial uptake and large-scale deployment stage will depend not only on technological issues, but also on the prevailing regulatory framework and investment decisions concerning public infrastructure projects.

Moreover we can see that, faced with technological uncertainty, the European Union is generally trying to mitigate the related risks both through regulatory frameworks designed to support preferred technologies in various sectors of the economy (such as power generation and passenger transport), and by helping investors and the financial markets understand which economic activities are environmentally sustainable (the EU Taxonomy). However, as there is no such thing as a free lunch in the economy, the outcome is either a heightened regulatory risk or divestments in areas that are currently generating growth. For this reason, the regulatory approach is not the only conceivable one. For example, the US has not introduced as extensive a regulatory regime for green technologies as the European Union, nor has it designed penalties for non-compliance or environmental charges similar to those imposed by the EU. Instead of a stick, the US has chosen to offer a carrot: in particular, the adoption of a USD 369 billion-worth package of subsidies, tax credits and other support measures for investing in green technologies as well as incentives for consumers to switch to green alternatives under the Inflation Reduction Act is expected to entice entire green technology value chains to move to the US, at the expense of Europe and China.

The power sector is undergoing rapid technological changes and this is reflected in ORLEN’s updated strategy.

The war in Ukraine has highlighted the importance of investments in renewable energy sources, which support greater energy independence. But there are more advantages of wind and solar photovoltaic farms: a significant reduction of costs has made renewables cost-competitive relative to conventional counterparts without any subsidies, even before the recent surge in the prices of energy carriers such as coal and natural gas. This is true of both onshore wind assets (with the average global LCOE down 68%, from USD 0.102/kWh to USD 0.033/kWh between 2010 and 2021) and offshore farms (with the metric down 60% over the same period, from USD 0.188/kWh to USD 0.075/kWh). For large-scale solar PV systems, the cost reduction has been even more pronounced, coming to 88% (USD 0.417/kWh, to USD 0.048/kWh). According to BloombergNEF data, solar or onshore wind energy is the most cost-effective source of electricity in the countries that account for 96% of its generation.

The year 2022 highlighted the importance of ensuring the security and diversification of gas supplies. The ORLEN Group's strategy until 2030 also addresses the challenge of ensuring security and diversification of gas supplies. The plan includes an increase in gas production from 8 bcm to 12 bcm. LNG supplies will also increase – from 5.8 bcm to 15 bcm. The ORLEN Group's strategy until 2030 also provides for the development of a direct, low-carbon substitute for natural gas – biomethane. An alternative use for biogas is transport, where bioLNG can be used. By 2030, 1 bcm of biogas will be produced.

 We are also developing new technologies that can solve other ills of the sector. The first small modular reactor (SMR), with a capacity of 300 MW, is expected to be operational by 2030. This will allow us to provide a stable base for the electricity system and can also help to decarbonise district heating.

According to the ‘Energy Transition Investment Trends’ report published by BloombergNEF in January 2023, electrification of transport (which also includes hydrogen vehicles and infrastructure) is the fastest growing (in absolute terms) category among energy transition projects. The Group's strategy is to develop and increase production in all technologies to decarbonise this sector, which accounts for about one-fifth of global CO₂ emissions.

In the short term, a reduction of emissions could be achieved by using e.g. bioethanol as a gasoline additive. We intend to increase our bioethanol output from 275 kt to 3,000 kt by 2030. Bioproducts can be used in hard-to-abate sectors, such as aviation, where SAF (Sustainable Aviation Fuel) is already added into fuel blends. Currently, the maximum blending ratio permitted under EU regulations is 50%, but full replacement of jet fuel is possible by 2030. Work is already under way: the ORLEN Group’s hydrotreated vegetable oil (HVO) project will help bring down emissions by 80%.

However, as the supply of the biofuel feedstock is limited, we are starting work to produce synthetic fuels through the Fischer-Tropsch process from a mixture of carbon oxides and hydrogen, which could also replace traditional jet fuel. By 2030, the ORLEN Group’s output of synthetic fuels will exceed 70 kt.

Our response to the challenges outlined above is the ORLEN Group Strategy until 2030. Under the strategy, the following plans have been adopted for individual segments: 

I. Maximisation of profits from our principal business lines, where we are present and build business value.

II. Our priority area is strategic development. We expect to allocate approximately 60% of our total capital expenditure to projects advancing this strategic pillar. These will be key projects for the ORLEN Group’s development, supporting the transition and modernisation of our business. Such projects support the following areas:

III. We expect to spend up to 10% of our capital expenditure on technologies of the future. These include CCS, hydrogen, synthetic fuels and nuclear power, research and development, and digitalisation. Investments in these areas will provide a springboard for our further growth.