Update to PKN ORLEN's Strategy

The foundations of the updated PKN ORLEN Strategy 2006-2009 - announced today - are a focus on inorganic development accompanied by a continuation of the programmes for efficiency improvements and investments in key business areas. The Group plans to participate actively in the merger market as well as build competencies in production operations. The updated strategy also envisages a proposal for changes in dividend policy and the attainment of higher financial targets than those declared a year ago: EBITDA - PLN 10 billion in 2009, annual average CAPEX - PLN 3.4 billion.

The PKN ORLEN Strategy 2005-2009 announced in February last year envisaged value creation through efficiency improvements and investments with a high rate of return, the strengthening of PKN's presence in key business areas in domestic markets, and also a continuation of the restructuring of our asset portfolio. The potential for expansion into new markets was set by PKN ORLEN as yet another pillar of its strategy.

The strategy of the Group now being presented assumes the continuation of our pro-efficiency measures, with M&A being of central significance in the forthcoming years. ORLEN intends to participate actively in such ventures, despite the fact that the progressive consolidation in the sector is narrowing the number of potential targets. The Group stands out compared to the competition mainly due to its powerful petrochemical sector and the experience it has gained from the implementation of integration projects.

The strategy is further developed by the plan to expand production operations with a view to ensuring our own raw material base. Implementation of these plans will result in the ability to achieve significant growth in the company's value and to enhance its competitive position. The programme for the establishment of the production operations segment is divided into two phases: I - until 2009 and II - until 2015.

The first stage assumes the gradual establishment of organizational structures, and the building of competencies on the basis of one-off asset acquisitions, particularly in such countries as Kazakhstan, Iraq or Russia. In the first two years, the identification of assets for acquisition will focus on lower risk assets, with priority given to projects implemented as joint ventures. At that stage ORLEN intends to acquire minority shareholdings, without assuming the role of operator, in order to take advantage of partner competencies.

In the second stage of the programme, in the case of projects envisaging an involvement of approx. 5 years, the company plans to assume the role of operator, but still employ outsourcing for technical issues. In the case of longer-term projects - 10 years - the Group will become involved in direct exploration to a larger extent, at the same time developing technical capacities and building organizational structures with the use of local human resources.

Assumptions for future production volumes envisage a gradual increase in the volume of raw material from 0.4 million tonnes in 2007 to 4.3 million tonnes in 2015. The capital outlays required for program implementation are estimated at USD 130 million per annum in the years 2007-2009, and in the following 5 years at USD 438 million per annum.

According to the plans, the integration rate, indicating the ratio of crude oil production to processing, will grow from 2.3% in 2007, to 6.2% in 2010, and to 20.6% five years later.

The update to the strategy assumes an increase in the financial targets planned to be attained in 2009. The changes in the plan follow from the fact of taking into account the impact of such factors as: effects of the Unipetrol consolidation, changes in the method of BOP consolidation, additional restructuring reserves, the effects of the sales development plan and implementation of the production programme, as well as the expansion of ORLEN Deutschland and the Optima programme, and the impact of stock appraisal under the LIFO method.

Verification from the point of view of these factors, under the assumption that the macroeconomic conditions of 2004 are maintained, allows for an increase in the financial targets for 2009 as follows: EBITDA, from PLN 7.9 billion to PLN 10 billion, and annual average CAPEX from PLN 1.7 billion to PLN 3.4 billion.

According to our projections the largest share in EBITDA creation will be from the refining segment (43.3%), followed by a slightly lower share from the petrochemical segment (36.8%), retail (12%), chemicals (8.6%) and production (2.6%).

ROACE is now forecast at a higher level than assumed before - a minimum of 18.5%. The forecast financial leverage has not changed (30-40%).

As concerns the dividend, the Group proposes a change to its policy of payments by making their level dependent on the company's involvement in mergers and takeovers, and on the maintenance of an optimal capital structure. This solution is scheduled to be implemented in 2007. The Group will aim at paying a dividend at a level of at least 50% of FCFE (free cash flow to equity). If acquisitions are significant, however, the company's priority will be a return to safe indebtedness levels, which may entail limited payments of the dividend in line with the FCFE-based approach. On the other hand, if Polkomtel is sold and there are no other investment liabilities, the company plans the establishment of a dedicated Dividend Fund, which will enable higher dividend payments in following years.

Press Office

Improvements in efficiency and investment were the main areas of last year's operational activities of the Group.

PKN ORLEN's Strategy 2005-2009, announced in February last year, defined the paths of value creation through efficiency improvements and investments with a high rate of return. This included the strengthening our presence in key business areas in domestic markets, continuation of the restructuring of our asset portfolio, and taking advantage of the potential for expansion into new markets.

The formulation of the assumptions upon which the strategy was based was preceded by a detailed analysis of the situation of the Company. As a result, persons previously employed without the required qualifications were replaced by new staff. Checks, audits and forensic-type research were carried out. Major risk areas were identified - some of the identified problems, e.g. contracts concluded with Agrofert Holdings and Conoco Phillips, irregularities in other companies of the Capital Group, as well as potential tax liabilities, entailed the necessity of setting up additional reserves. Moreover several issues resulted in the necessity to lodge petitions with the Public Prosecutor's Office in connection with a grounded suspicion that a crime had been perpetrated.

The change in corporate culture constituted the foundation for the implementation of PKN ORLEN's strategy.
"A very important task in the first stage of strategy implementation was to purge the situation within the Group and to square up the disgraceful events of the past. We depoliticized the company, implemented the idea of corporate governance and improved both internal and external communications. The introduction of appropriate regulations and of an ethical code now promotes proper corporate behavior within the company. We have put things straight. Now it's the time for the next step - we can focus on expansion to a larger extent" - commented Igor Chalupec, the CEO of PKN ORLEN.

The human resource management policy was changed through the introduction of a new recruitment, evaluation and motivation system for managerial staff. Employment terms have been restructured, and are now based on the results of employee assessments.

In the area of the Capital Group, the transformation of the management rules covered the redefining of the mission and role of the companies' supervisory and executive boards. Moreover the segment management system has been implemented within the Group, thus bringing PKN ORLEN into line with widespread standards in this area.

The long-term process of integration of Petrochemia Płock and CPN was finally completed, making PKN ORLEN a fully integrated company.

The investment policy adopted last year assumed a reduction in the number of entities in the Capital Group from the present 76 to approx. 20 (excluding Unipetrol companies). In 2005 the number of entities within the Capital Group went down by 9. An important and difficult investment project is the sale of Polkomtel, which will be continued in 2006.

In the area of efficiency improvement, a plan for the Group's retail network development was prepared in March 2005. Within less than a year, three fundamental lines of this program were implemented: restructuring of the sales network, strengthening of the operational activities and the implementation of the two brands strategy. As a result the decline in the Group's share in the retail market was arrested at the level of 27%. The number of corporate customers taking advantage of the FLOTA program rose by 20%, and sales of non-fuel goods rose by 1.4%. Two projects implemented in the area of station network restructuring were a success - after the introduction of the BLISKA economy brand, sales growth of 19% was recorded (against forecasts of 15%), and our range of new enhanced quality fuels - VERVA - introduced in the Premium segment attained a share for all fuels sold in this segment of 16% (against forecasts of 10%).

An important element in the implementation of the strategy was the PKN ORLEN - UNIPETROL Partnership programme. The potential synergies to be attained by the Group identified for this Project is estimated at over PLN 157 million, including PLN 90 million to be achieved as early as this year. The main synergies are derived from the coordination of production plans and procurement processes in the refining activities of PKN ORLEN and Unipetrol, and the integration of the fuel wholesale operations in Poland and the Czech Republic. Moreover both companies will modify and integrate logistics, as well as improve the efficiency of technical down-times. According to the plans, procurement for petrochemical production will be also coordinated. Areas for the integration of Czech Spolana and Polish Anwil were also identified in respect of the restructuring of ammonium procurement and coordination of PVC sales. Moreover ORLEN and Unipetrol intend to make joint purchases of non-fuel goods for the retail network, coordinate loyalty programs, and plan expenditure for network development. The operations of the fuel station network in southern Poland will be also optimized.

Cost-saving programmes are an important undertaking for organic growth and efficiency improvements. According to preliminary estimates, the Comprehensive Programme of Operating Cost Cutting, completed in 2005, exceeded the announced savings level by PLN 38 million and yielded total savings of PLN 838 million. Since the beginning of this year a new programme for the years 2006-2009 - OPTIMA - has been implemented. It assumes further cost cutting at a level of at least PLN 600 million as regards operating costs, and a further PLN 600 million in the area of investments.

The projects for efficiency growth were accompanied by undertakings of a pro-development character. The Olefin II installation was re-launched after modernization works and two of the world's largest new installations for the production of polyolefins in the Basell Orlen Polyolefins plant were launched as scheduled. In the frames of optimisation of aromatic fractions management, the installation of Aromatics Extraction was modernized and a new investment was prepared in this area - the construction of a paraxylene and terephtalic acid facility. The construction of a unit for the desulphurization of FCC naphta is underway. Pursuant to decisions that were made, the installation for the hydrodesulphurization of Fuel Oils VI will be modernized.

Moreover the Group defined its participation in the process of ensuring the energy security of Poland.

- The Group plays an important role in the establishment of the country's energy security system. Therefore we are actively participating in the building of this system. We regulated the ownership situation of Naftoport, attaining the ability to fully secure crude oil supplies for the Group from other directions than the existing ones. We increased the number of crude oil suppliers, at the same time diminishing the share of multi-annual contracts in the supply structure and we have prepared a strategy for development of our own extraction segment. We also assumed the burden of coordinating crude oil supplies with Unipetrol., Additionally we are taking part in joint initiatives such as agreements with Nafta Polska, Grupa Lotos and PGNiG. We are also considering the possibility of including in the planned supplies of the future Odessa - Brody - Gdańsk pipeline - said Igor Chalupec, the CEO of PKN ORLEN.

During implementation of its strategic assumptions last year, PKN ORLEN actively participated in tenders for the purchase of selected assets in the Central European region.

The activities of the Company won approval from numerous opinion-leading communities. As a result the Group was awarded:

  • "Bull and Bear" Statuette of Gazeta "Parkiet" - for investments with the highest rate of return of all WIG 20 stock exchange companies quoted in 2004 on the Warsaw Stock Exchange (February 2005
  • First place in Big Capital Chemicals ranking of "Chemical Review" monthly (June 2005)
  • The title of the Best Refinery in Central and Eastern Europe - the prize of the World Refining Association - Central & Eastern European Refining and Petrochemicals 8th Annual Roundtable - for technological innovation, infrastructure, good company strategy and development plans (October 2005)
  • Prize for The Best Stock Exchange Company in the Area of Investor Relations - on the basis of WarsawScan 2005 research commissioned by NBS PR - recognition for the quality, reliability and transparency of the information provided, and the availability of the employees of the Investor Relations department (December 2005). Moreover analysts and investors participating in the WarsawScan research named the most respected CEOs, where the second most valued CEO (just behind Wanda Rapaczyńska, the CEO of Agora SA) was Igor Chalupec, the CEO of PKN ORLEN - for strategy creation, company development and communication skills.