by Robert Tomaszewski, Senior Energy Analyst, Polityka Insight
Poland is the largest hard coal producer in the EU and the 9th largest in the world. The coal mining sector provides fuel for the production of electricity and energy and for the steel industry, which in turn, impacts all facets of the economy. The mining sector is dominated by stated owned companies, with the Polish Mining Group (PGG) taking center stage. It accounts for 1% of GDP and 1% of total employment.
Although coal is still responsible for roughly three quarters of electricity produced in Poland, its importance has decreased slowly yet consistently. The biggest challenge faced by the industry revolves around EU climate policy, which significantly reduces the demand for coal. The largest coal recipient - the energy sector - needs fewer resources than ever as a consequence of the rising prices of CO2 emission allowances. This phenomenon drastically limits the profitability of energy production from fossil fuels.
In 2019, coal accounted for 73.6% of electricity production in Poland, almost 5% less than the year before and 18% less than in 2009. As for now, there are no plans to build additional large coal-fired power plants. In February state-owned companies abandoned the last project of this kind - Ostrołęka C - because no financial institution (not even state-owned banks) intended to lend money for the investment. Existing coal power plants will be gradually replaced by renewable energy and gas.
The second most urgent problem of the coal sector is that of decreasing efficiency coupled with rising costs. Mines in Poland are old - the newest was opened more than 25 years ago - and deep, which causes geological difficulties. Shallow deposits have already been exhausted, meaning that miners have to dig deeper, bringing costs up and productivity down.
In 2019, 739 tonnes of coal were produced per one employee of the mining sector in Poland, 115 tonnes less than in 2016. By comparison, in 2018 an average miner in the United States extracted more than 10.000 tonnes of coal. One of the main reasons for such crass ineffectiveness is the fact that the salaries of miners are not linked to the financial results of the mines. As a result, remunerations are pretty much the same both in profitable and unprofitable mines, which leads to money problems.
Since 1989, the energy policy of various alternating governments has been taken hostage by the miners’ strong position. During prosperous times, they expanded their privileges and gained new ones, and during times of crisis they forced multi-billion support from the state budget or the energy sector. Politicians - regardless of party affiliations - defended coal to sustain support among miners. Cheap fuel from Silesian mines was also a guarantee of low energy bills. However, the sharp rise in electricity prices, caused by more expensive CO2 allowances, dismantled this assumption. As a result, moving away from coal is no longer a political taboo.
Nevertheless, a quick coal-exit for Poland will not, and cannot happen. “Black gold” will remain the most important fuel for the energy sector for a dozen or so years, but its role will decrease significantly faster than the government is assuming. This process may speed up even further due to the COVID-19 pandemic, as miners cannot use their strongest weapon: mass demonstrations, which have always disciplined politicians. On the other hand, an inevitable coronavirus-induced economic slowdown will depress coal demand further, forcing the government to heal the sector by closing the least profitable mines.
Gas: Paving a path to energy independence
Poland has been taking steps to diversify its gas supply in order to guarantee national energy security. It has the potential to become a gas hub for the whole region.
Gas power plants are an ideal backup source for wind farm or PV installations. They emit less CO2, are more flexible and achieve full power in a few minutes after start-up, in contrast to coal power plants that need at least eight hours. Government officials see gas as the transition fuel that can help Poland shift its energy system from coal to cleaner sources. Consequently, gas share in the country’s electricity production is rising - in 2019 it reached 8.8% compared to 7.2% in 2018 and only 2% in 2014. Today Poland uses 18-19 bcm of gas per year, but forecasts assume an increase in consumption to 29 bcm by 2030.
The Polish gas market is dominated by PGNiG (revenue of PLN 42 billion in 2019, ~EUR 9 billion), a vertically integrated and state-controlled company. It is the largest producer of crude oil and gas in Poland. It is also engaged in the imports, storage, sale and distribution of gas and liquid fuels, as well as in heat and electric power generation. PGNiG’s monopoly is guarded by amendments to the Act on Fuel Reserves introduced in 2016 and 2017 limiting the profitability of gas imports by private companies.
As a result, PGNiG's share in the retail market in 2016-2018 increased from 74% to 82%. However, under pressure from the European Commission, the government might soon loosen these rules, making it easier for private entities to compete with PGNiG. The company’s monopoly will be additionally threatened by the release of household gas prices by the end of 2024.
Most of the imported gas comes from Russia. This is a result of the Yamal contract with Gazprom, which obliges PGNiG to receive and pay at least 85% of the contracted volumes (8.7 bcm per year) until the end of 2022. Today Poland has the technical ability to cover all of its gas requirements from other sources, thanks to the LNG terminal in Świnoujście. Within four years of its launching, the terminal accounted for almost 23% of natural gas imports, while the deliveries from Russia reached a share of 60%, down from around 90% in 2015. Though to achieve full gas independence Poland needs to build more infrastructure, especially since the government is not planning to extend the Yamal contract after 2022.
Gaz-System (the national gas network operator) has begun preparations for the building of the Polish-Danish-Norwegian Baltic Pipe (with 10 bcm capacity) and the expansion of the LNG terminal in Świnoujście (from 5 to 7.5 bcm). The investments are to be completed in 2022 and 2023. Moreover, Gaz-System has started the expansion of the national transmission network and the construction of interconnectors with Lithuania, Czech Republic and Slovakia, which are supposed to increase Poland's export capacity from 3 to 20 bcm. Most projects are still in the investment phase – they will be finalized within a few years. The government also made the preliminary decision to build a so-called floating LNG terminal (FSRU). According to recent announcements, it is meant to be in place by 2025.
As for becoming a regional gas hub, Poland does have potential. However sooner or later European regulations will push gas away from the energy market – otherwise reaching climate neutrality by 2050 would be impossible – replacing it eventually with hydrogen and biogas. That creates a new set of risks for countries engaged in various phases of energy transition. If Europe speeds up anti-fossil fuel regulations, the majority of the brand new gas infrastructure in Poland will turn into stranded assets.
Oil: Building a Champion to get Cheaper Fuel
By merging Orlen and Lotos, two of the biggest Polish oil companies, the government wants to create a champion capable of playing a major role in the European market, and also get cheaper oil from Russia.
Poland has four oil refineries. The biggest one in Płock is owned by PKN Orlen, the dominant player with a revenue of PLN 111 billion in 2019 (~ EUR 24 billion) that is also under the control of the state. Orlen has also two smaller facilities in the towns of Trzebinia and Jedlicze. The second largest refinery is in Gdańsk and is controlled by Lotos (PLN 29,4 billion in 2019 ~ EUR 6 billion), also a state-owned company. In 2018, Polish refineries processed record-high amounts of crude oil – 27 mln tonnes, 7.4% more than in 2017. The growing demand for fuels reflects the acceleration of the Polish economy and effective governmental measures aimed at limiting the volume of illicit fuels.
Poland remains heavily reliant on imports of crude oil – in 2018, 96% of the crude oil processed at refineries was imported and more than 75% of it came from Russia through the Druzhba pipeline. However, crude oil from Russia is different from Russian gas. Poland has diversified its oil supplies and in the event of a crisis, Lotos and Orlen may draw in the necessary commodity by sea through the oil terminal in Gdańsk. This is why Poland treats oil as a normal commodity, contrary to gas and Eastern European countries where it is still a geopolitical tool. Therefore, the Polish government does not want to stop buying Russian oil, but looks for solutions to make it cheaper. One of them is a merger of Orlen and Lotos.
The consolidation would create Poland’s largest company with an annual turnover of over PLN 140 billion (~ EUR 30 billion), one that would also control 90% of the country’s wholesale fuel market. Orlen-Lotos will have more leverage when purchasing Russian oil, it will also be able to reduce administrative costs, the cost of refinery operations and fuel logistics. The merger would combine companies that complement one another – Lotos has a well-developed segment of oil and gas exploration, while Orlen – a petrochemical. On the other hand, the merger might affect consumers – there is a risk that without any significant competitors, as a de facto monopolist, the company would raise fuel prices.
In February 2018, Orlen signed a letter of intent to acquire Lotos from the government – as the state holds the controlling stake of 53.2%. In July 2019 the company submitted to the European Commission an official request for the takeover of Lotos. Orlen must convince Brussels antitrust authorities that the proposed acquisition does not threaten effective competition in the Polish wholesale and retail fuel businesses, which will not be easy.
To take over Lotos, Orlen may be forced to sell some of its petrol stations and infrastructure. But the right-wing government, fearing accusations of privatization, might decide not to go ahead with the merger. To avoid such a scenario, Orlen is looking for opportunities to exchange assets with competitors, for instance a trade of petrol stations in Poland for petrol stations overseas. Orlen is hoping that the Commission will take the impact of COVID-19 into account when assessing the deal. The argument is that a merged company will have the financial firepower to make the hefty investments required to help the country, which relies on coal, to decarbonize. The European Commission is expected to make its decision by June 30th.
The transformation of the Polish economy and the energy sector will gain growing momentum in the coming years. How the Polish energy mix will look like in a decade or two is still a mystery, but the gradual decrease of the fossil fuel dependency is inevitable. The pandemic can accelerate this process. The coronavirus-induced recession will lead to a fall in electricity prices and energy demand. As a result, fossil fuels will disappear from the market faster, making way for renewable energy. However, the pace of decarbonization will depend on the packages adopted to stimulate the economy and on whether Poland chooses to focus on the green transformation. It is yet possible.
READ FULL REPORT: Poland's Energy Industry 2020
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