Driving to market

27 September 2004 00:01 [Source: ICB]

In the topsy-turvy world of Polish chemicals some logistics just do not make sense, as Cath O’Driscoll discovered. The country needs investment, restructuring and consolidation to take advantage of its rich base of raw materials such as sulphur, rock salt and coal

The trouble with Poland’s chemical industry, says Wejciech Lubiewa-Wielezynski, president of the Polish Chamber of Chemical Industry, is that it doesn’t make sense. Look at where most of the country’s nylon comes from and you see his point.

Poland is one of Europe’s main producers of caprolactam monomer which is needed to make polyamides, the basis of nylon fibres. Every year the country manufactures 160 000 tonne of caprolactam, and then proceeds to use only 30 000 tonne of it to make polyamides – far short of what Polish consumers demand. The rest is exported, while the bulk of the region’s polyamides are imported, at considerable extra expense.

This type of inconsistency is typical of the way the chemical industry in Poland operates, Wielezynski says. Years of state ownership have not helped to advance the sector’s competitiveness and left too few companies focused on more valuable downstream products.

Across the industry as a whole, only 10% of Poland’s manufacturing output is converted directly to end-products by domestic companies, compared with over 20% in Germany, France and the UK. The net result is a negative trade balance of €6bn, and rising.

‘It means that in ten years’ time the negative balance in chemicals will be something like €10bn-€20bn, and it won’t be possible for the Polish chemicals industry to survive,’ Wielezynski warns.

Poland’s chemical industry is in need of investment. While restructuring and consolidation have already gone a long way to improving environmental standards and modernising equipment and processes, in many areas the industry still falls short of the standards set elsewhere in Europe.

Extra cash is vital to continue the reforms the industry urgently needs. Potential investors have a lot to think about. With a population approaching 40m, Poland is the largest of the new EU accession countries and can look forward to an expected growth in GDP next year of 4.8%, well above the 2.1% forecast for the EU-15. Added to that, the country boasts a large and highly qualified workforce, with a central European location offering easy access to Russian and other markets.

Weighed against this, Poland’s relaxed fiscal policy and ‘higher-than-desired interest rates’ will have ‘adverse consequences for investment, activity and output’, warns a recent report by the Organisation for Economic Cooperation and Development (OECD).

Years of rationalisations have left the country’s unemployment rate at 19% of the population, with only slightly more than one in two Poles of working age in employment. Since average per capita income is currently 41% of that of other OECD countries, Poland will also need to be careful that wage inflation does not outstrip growth in demand.

The chemicals sector has other problems to contend with. Privatisation, seen as the key to completing the transformation of Poland’s chemical industry from a state-run to a market-driven economy, has virtually ground to a halt over the past few years, while government ministers contemplate the best strategy. Privatisation of the bulk chemicals sector has also stalled, while industry observers suggest that the plants are too complex and lack the economies of scale needed to interest overseas investors.

So what will potential investors make of Poland’s chemical industry? Where should they be looking for the best returns? And what of the potential pitfalls? The Polish chemical industry is a diverse collection of businesses, founded on the region’s rich base of raw materials, including sulphur, rock-salt, coal and lime, as well as easy access to petroleum and natural gas imported from the Commonwealth of Independent States (CIS).

Over 19 000 chemical companies now operate in Poland, employing roughly 200 000 people. About 80% of these companies are in the rubber and plastics sector, with the vast majority of them being family-run firms employing less than five people. The industry’s main exports are fertilisers, with soaps, detergents and plastics articles also seeing strong growth, while its main imports are final products including plastics and pharmaceuticals, and cosmetics.

Wielezynski is confident that the biggest area for future growth will be downstream products, particularly polymers. On average, each Polish consumer spends €300/year on chemicals, compared with the €1000 spent by consumers elsewhere in the EU. Even before entry to the EU, Spain had a per capita consumption of €800, Wielezynski points out. Only 40% of domestic demand for plastics is currently met by the Polish chemical industry, down from over 60% a decade ago.

West European company Basell is banking on the fact Wielezynski is right. Basell Orlen Polyolefins (BOP) – its joint venture with Polish refiner PKN Orlen – is due to bring onstream its twin polypropylene (PP) and high-density polyethylene (HDPE) plants next year. Once in operation the two world-scale plants will produce an extra 720 000 tonne/year of polymer to meet the expected rise in demand, including new grades that will open up markets for novel and more sophisticated plastics.

BOP’s ceo, Hartmut Lueker has ambitious plans for the area surrounding the plants’ site in Plock, central Poland. The Plock Technology Park could become Poland’s answer to ‘silicon valley’, Lueker believes, attracting local and overseas investors who will benefit from easy access to the required feedstocks, the availability of a skilled workforce and the opportunity to capitalise on growing markets.

Basell is not alone in seizing the opportunity. Between January and September this year, investors both at home and abroad ploughed Zloty35.3bn (€8bn/$9.9bn) into the Polish chemical industry, a dramatic turnaround starting in the third quarter of 2003, Wielezynski says. In 2003, capital investments had fallen by 0.9%, after an even bigger, 5.8% fall, in 2002.

On the domestic front, fertilisers and chemicals firm ZA Pulaway spent Zloty300m building a new melamine plant that began operations in June, while trading company Ciech reports that it will spend Zloty96.6m on development this year.

In terms of foreign investment, South Korea’s SK Chemicals is also looking to reap rewards from polymers. New European subsidiary SK Eurochemicals is overseeing construction of a $75m PET plant in Wloclawek, about 160km north of Warsaw. Due to begin production in spring 2005, the plant will produce 120 000 tonne/year polymer, rising to 400 000 tonne/year by 2007.

Poland needs more of this type of investment, Wielezynski says, from companies prepared to manufacture chemicals in Poland, and not just as a base to sell products produced elsewhere.

Pawel Peplinski, a partner at PricewaterhouseCoopers based in Warsaw, agrees that the industry needs to do more to attract investment. Logistics advantages alone may not be enough for companies that already have plants in western Europe, Peplinski says: ‘The chemical industry is a very capital-intensive industry, rather than a labour intensive one, so from a chemicals perspective, even though labour is much cheaper in the region, it is not going to be the critical factor.’

Current lack of progress on the privatisation front is not helpful. State agency Nafta Polska, charged with the task of overseeing restructuring of Poland’s petrochemicals and bulk chemicals sectors, submitted its final privatisation strategy to the government in July, and has yet to hear a response.

‘We are still talking with the treasury minister, but it is possible that there will be a decision by the end of September [this month],’ says Nafta Polska spokesman Krzysztof Mering.

Most important of these decisions will be what to do with PKN Orlen, Poland’s main petrochemicals and chemicals player. PKN Orlen accounts for about 10% of Poland’s state-budget revenues and includes 90 subsidiary and associated companies, including Poland’s main PVC producer Anwil, caprolactam producers Zaklady Azotowe Pulawy and Zaklady Azotowe Tarnowie-Moscicach, and oxo alcohols producer Zaklady Azotowe Kedzierzyn.

In Q2 2004 companies from the Orlen capital group generated consolidated net profit of Zloty57.3m (€13.1m/$16m). The state now owns only 27.7% of PKN shares (including Nafta Polska’s 17.5% holding), worth $3.6bn, and still as a lot of influence over what goes on, industry observers note. Full privatisation of PKN needs to happen, Paplinsky urges, ‘to allow these companies to start organising themselves along market lines’.

Hungarian petrochemical concern Mol, US oil giant Conoco Phillips and Russian energy group Lukoil have all previously expressed interest. Talks with Mol ended in deadlock earlier this year, while industry observers suggest that a Russian investor is unlikely to be acceptable for political reasons, especially for such an important area for the country’s security.

Meanwhile, PKN Orlen is itself interested in buying Grupa Lotos, Poland’s second largest refinery at Gdansk. Still 100% state owned, as are the remainder of Poland’s refineries, Grupa Lotos is due to make an initial public offering on the stock exchange in the first half of next year. Its acquisition by PKN Orlen would prevent a takeover by a Russian firm, thereby heading off any unwanted competition.

Over 90% of Poland’s oil and almost all of its gas comes from Russia. Not surprisingly, recent events surrounding oil giant Yukos, one of PKN Orlen’s suppliers and currently at the centre of controversy over alleged tax evasion, have brought security issues sharply into focus.

Should the Russian government ever decide to cut supplies to Poland, it would affect the whole chemical industry, says Aurelia Kuran-Tuszkarska, president of the Polish Chamber of Liquid Fuels, an organisation representing the owners of private petrol stations as well as major petrochemicals firms. Tuszkarska estimates that PKN Orlen and other Polish refiners have just 60 days’ supply in reserve.

Until the Polish government can resolve this problem adequately, investors will tread warily. Other pipelines are under consideration including a possible 500km extension of the planned Broda-Odessa pipeline, from Broda in the Ukraine to Plock. This could potentially bring Caspian, as well as Russian, oil to the region.

Elsewhere in the industry, government approval is also holding up plans for restructuring of the bulk chemicals sector. The government’s Great Chemical Synthesis programme got under way two years ago and, while restructuring has already made big inroads, further consolidation and privatisation is needed to complete the transformation of the sector.

Following privatisation, production of phosphorus fertilisers is likely to be centred at Zaklady Chemiczne Police, supported by Ciech, while consolidation of Tarnowie-Moscicach and Zaklady Azotowe Kedzierzyn would be done in two sectors, chemicals and fertilisers, with the support of PKN Orlen and Anwil, which is said to be interested in acquiring the two nitrate plants. All privatisations will be backed by local capital.

‘Some investors have already come forward, but we are not talking about the details,’ says Nafta Polska’s Mering, pointing out also that Pulawy is likely to be the first company to come onto the stock exchange next year, with Police likely to float by the end of 2005.

All six companies have seen a dramatic turnaround in fortunes in the past two years, reporting healthy profits this year, Mering continues. ‘Previously, these companies had too many employees and were also operating in difficult markets. Now things have changed because there has been a lot of restructuring, and also because there has been an upturn in world markets.’

Poland’s agrochemical sector should be an attractive bet for investors. Fertilisers are big business in Poland. In 2003, the Polish chemical industry as a whole produced 16.16m tonne/year of nitrogenous fertiliser ingredients, together with 23.2m tonne/year of ammonia in both gas and liquid forms. With current consumption levels still significantly lower than EU averages, and a sizable proportion of the country’s land area turned over to agriculture, there is plenty of room for growth.

Across the Polish chemical industry as a whole, recent months have seen impressive gains. Industry sales in December 2003 were 13.9% higher than in December 2002, and 8.7% ahead for the full year 2003 compared with 2002.

This upward trend looks set to continue. Wielezynski estimates the industry will require a further €8bn investment just to meet the expected increase in demand for chemicals following EU entry.

Competition for investment, in Poland, as elsewhere in Europe, is mainly from Asia. The biggest threat, as far as Wielezynski is concerned, comes from EU regulations, which explain ‘why a lot of European companies have decided instead to invest in Asia’. Environmental issues, and particularly obligations surrounding the clean up of contaminated land, will be a major challenge in Poland.

In other areas, however, Wielezynski argues: ‘Polish environmental legislation is, in many cases, more severe than EU legislation. Product stewardship lately initiated in the EU is foreseen by the Polish Environment Law, which requires producers to watch the whole life-cycle of their products.’ Though only 32 Polish companies are party to the industry’s global Responsible Care initiative, many more are eligible, he says.

Even more onerous are plans for the future regulation and testing of chemicals in Europe. Despite revisions to make the current Reach proposals more workable, Wielezynski warns this will threaten many Polish companies. Investment in the industry has never been more critical. If many of Poland’s chemical companies are to continue operations, Peplinski urges, ‘they are going to need the financial backing of much larger players’.

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