The future of Mažeikių Nafta – PKN ORLEN is planning an increase in the value of the merged enterprises

It has been six months since PKN ORLEN acquired a majority stake in the Lithuanian company Mažeikių Nafta. This $ 2.34bn deal, finalized on December 15, 2006, established the ORLEN Group’s leadership in the Central and Eastern European region. The acquisition of Mažeikių is an investment that directly addresses the third pillar of PKN ORLEN’s strategy – that of actively monitoring the market for the availability of development or interesting acquisition opportunities.

PKN ORLEN currently owns approximately 90% of the shares of Mažeikių Nafta. Upon acquisition, the Group started implementing a repair program and integrating the refinery’s assets with its own. This process was initiated by introducing a new management model - the ORLEN Group’s key assets (PKN ORLEN, Mažeikių Nafta, Unipetrol) are managed jointly and pursue a unified strategy for the entire Group. At the operating level, the refinery was integrated into PKN ORLEN’s segment-based management system. In practice this means that the basic business units report directly to the heads of individual segments within PKN ORLEN and are accounted for through the realization of MBO plans. The process of integrating the Lithuanian company benefited greatly from the company’s experiences with the Czech-based Unipetrol, which significantly accelerated the process and facilitated the efficient implementation of appropriate procedures.

Long-term Value Creation Program for Mažeikių Nafta

Bearing in mind the difficult situation of the Lithuanian company, the management of PKN ORLEN has taken the necessary steps to secure the plant’s future. A special program was prepared to restore the plant to full refining capacity by the end of 2007 and ensure its development over the next six years. In total, the investments in Mažeikių Nafta made under the VCP will amount to $1.6bn by 2012. The planned expenditures are meant to significantly improve the situation of MN and strengthen the ORLEN Group’s leadership in Central and Eastern Europe.

Securing Mažeikių Nafta’s ongoing operations

The first, preliminary, step of the Value Creation Program implemented by PKN ORLEN was to rebuild the lost production capacity caused by the October fire in the refinery. From the point of view of Mažeikių’s future it was also very important to prevent any negative consequences from the malfunction of the Druzhba pipeline, and to secure crude oil supplies to the plant. The refinery was switched to receive crude oil from Butinge, followed by the signing of long-term contracts with PKN ORLEN. At the same time the management is investigating alternative sources. These activities express the PKN ORLEN management’s determination to restore and then increase the plant’s operational capacity, and to make Mažeikių Nafta profitable as soon as possible.

PKN ORLEN’s investments in restoring and improving Mažeikių Nafta’s operational capacity will amount to approximately $ 200m over the next two years, and a further $ 100m by 2012. These expenditures will primarily restore the destroyed installations: the vacuum column of the Bitumen Unit, the Visbreaking Unit, and the start of deliveries of VGO (vacuum gas oil). These investments will also secure the refinery’s production efficiency and prevent possible malfunctions.

Improving efficiency in Mažeikių Nafta.

The core of the VCP is an efficiency-improvement program designed by PKN ORLEN and planned for implementation in 2007-2012. The program will cost approximately $ 550m and will focus primarily on projects involving pipelines and transport terminals, improving operating efficiency and further progress in building the retail network in the Baltic states. The management of PKN ORLEN is therefore planning to seek further opportunities to develop the retail activities, continue reducing logistics costs and secure export channels.

As of 2008 the Value Creation Program will include a new investment program of $ 750m by 2012. The first group of projects ($ 200m) will prepare the installations and equipment to meet EU requirements, in particular in terms of sulphur emissions.

The second group of projects ($ 550m) will consist of modernization investments within the refinery, including the hydrocracking installations, vacuum flasher and propylene splitter. These projects will expand and upgrade the refinery, and eliminate production bottlenecks.

Expected results of the Mažeikių Nafta Value Creation Program

Assuming variable macroeconomic conditions, PKN ORLEN expects that the Value Creation Program in Mažeikių Nafta will increase EBITDA by 70% to $ 700m, compared to the 2005 results.

The business continuity projects (those already implemented as well as forward-looking) should add $ 200m to EBITDA.

Projects to improve Mažeikių Nafta’s operational efficiency will focus on crude oil processing (increasing yield and energy efficiency, reducing operating costs), wholesale and logistics (improving margins, reducing shipping costs, curbing other operating costs), retail (developing the retail network, expanding the franchise model, optimizing margins on non-fuel products and improving network efficiency). This pillar of the Value Creation Program is to contribute $ 250m to EBITDA by the end of 2012.

The new Investment Program to be implemented in 2008 will increase EBITDA by a further $ 200m.

The Mažeikių Nafta Value Creation Program fully reflects the depth of PKN ORLEN’s involvement in the Lithuanian company’s future. Mažeikių Nafta has made a significant contribution to building the ORLEN Group’s current position on Europe’s business map and will remain one of the key components of the Group’s success. In the light of ORLEN’s very involved approach to the Baltic markets and further expansion prospects in this area, the Board of PKN ORLEN is determined to successfully achieve the goals of the Mažeikių Nafta Value Creation Program.