Eastern Europe

Economies in Transition

Eastern European countries are also undergoing major political and economic structural reforms. Previously under strong central government control, they have begun to decentralize their economies, transforming them through various programs consisting of industry restructuring and privatization. Former state-owned firms are being internally restructured, shifting from public ownership with state control to various types of private ownership. To address the need of potential investors for clearly defined property rights, each country has attempted to develop viable legal structures, contract laws, regulatory systems, capital markets, trade policies, and domestic bond and stock markets. However, while investment has not been as forthcoming as anticipate--due to the low pace of reform--any countries are proceeding with various degrees of privatization, such as joint ventures. Foreign investment is higher in the countries where reform has made the most progress, namely the Czech Republic, Hungary, and Poland. The diversity of reform among the countries in eastern Europe--which includes voucher sales, direct sales, and National Investment Funds--is related to how each country addresses the issue of sovereignty over strategic national assets.

As in the FSU, the Communist regimes left eastern European countries with bloated and inefficient hydrocarbon industries that suffered from decades of neglect, outdated technology, heavy debt, and environmental problems. Unlike Russia's large reserves, eastern Europe produces little oil and natural gas--only Romania has a sizeable endowment of reserves. The eastern European countries are dependent on imports, mainly from Russia, to meet primary energy demand.

The condition of eastern European refining is similar to that of upstream petroleum. All eastern European countries have refinery industries (Table 2). Most are badly in need of restructuring and upgrading. The petroleum marketing sector is the fastest growing sector in eastern Europe's energy industry, partly due to the introduction of foreign competition in many countries.

Thus far, most energy enterprises are still publicly-owned and government-run. However, to meet the petroleum needs of those economies where privatization efforts are strongest, private ownership is beginning to emerge. For example, Hungary has sold an 18.8-percent stake in its vertically integrated petroleum company, MOL {see Endnote 128}. The Czech Republic merged its two largest refineries and sold 49 percent to IOC, a western consortium.

Eastern Europe under central planning was virtually closed to foreign investors. Foreign capital could play a pivotal role in helping diversify energy supplies, increase energy efficiency through modernization, and improve the environment. Although foreign direct investment has increased in these areas, inflows remain modest. Foreign direct investment has been slow to materialize due to continuing macroeconomic instability and insufficient institutional reforms. To date, most foreign investment has been through joint ventures.

Each country has a unique socioeconomic context, causing variation in the transition process across all countries in the region. Different ownership structures are emerging under different privatization schemes. Reform has continued, even in the face of economic decline and decreasing production since the fall of communism and the beginning of efforts to move to market economies. Only now are these countries beginning to recover economically, spurred by exports and increasing domestic demand.

Albania

After decades of neglect, Albania began to reform its oil and gas industry by establishing a state-owned oil and gas company and allowing joint ventures with foreign companies, mainly in the form of production-sharing agreements. The national oil and gas company, Albpetrol, was established in 1992. It currently controls 46 energy and petroleum-related enterprises {see Endnote 129}.

Foreign oil companies were initially restricted to offshore drilling {see Endnote 130}. Since legislation opened up onshore concessions to foreign investors in 1993, there have been two international onshore licensing rounds. In the first round, foreign companies were invited to bid for three oil-recovery enhancement projects {see Endnote 131}. Included in the second international onshore licensing round was the concession for two onshore blocks not awarded in the first licensing round and one offshore block in the Adriatic Sea, which previously had been relinquished by Agip of Italy {see Endnote 132}. Over the past four years, $100 million has been invested by foreign oil companies, with a further investment of $60 million expected during 1996 {see Endnote 133}.

Bulgaria

Bulgaria's economy, which was one of the Eastern European economies most closely patterned after the Soviet system, is one of the most energy-intensive in the world. Although Bulgaria generates 40 percent of its electricity from nuclear energy, the country is also heavily dependent on coal {see Endnote 134}. The country's dependence on coal has created severe environmental problems.

Due to constant shifts in government, economic reform in Bulgaria has been among the slowest in eastern Europe {see Endnote 135}. Heavy subsidies and government-controlled prices still exist in the energy sector. Privatization of the energy sector was excluded from the 1995 privatization program, although the country's two largest refineries, Neftochim and Plana,were placed in a separate category reserved for enterprises that require special government approval prior to privatization. Even so, Bulgaria was the first eastern European country to offer petroleum exploration concessions to western countries {see Endnote 136}. Three international auctions - in 1991, 1993, and 1995 - have bseen held so far. Eight companies received oil exploration licenses in the first, while no licenses were awarded in the second. Final results of the third have yet to be announced. Production results have been mixed. In addition, foreign filling stations have been allowed to compete with the dominant state-owned oil and petroleum products distributor, Bulgargas.

Bulgaria is trying to use its unique position (connecting supply from the countries of the Commonwealth of Independent States and from the Middle East with western European markets) to reestablish links with Russia's newly integrated oil companies. However, the pipelines establishing these links have had oil transit disrupted by the United Nations' embargo against Iraq and the outbreak of war in the former Yugoslavia. In May 1995, Gazprom and Bulgargas set up a joint-venture company to control the flow of Russian gas through Bulgaria, build gas supply systems, invest in Bulgaria's 2,000-kilometer gas network (linked to Russia via two pipelines running through Ukraine and Romania), and market Russian gas to other countries {see Endnote 137}.

Czech Republic

Separated from Slovakia on January 1, 1993, the Czech Republic has been an aggressive economic reformer with foundations of a market economy firmly in place. On November 28, 1995, the Czech Republic became the first post-Communist state in eastern Europe to sign an agreement to join the Organization for Economic Cooperation and Development (OECD), becoming the group's 26th member {see Endnote 138}.

Like Bulgaria, the country produces little energy, except for coal. The country is a net importer of all energy supplies and is largely dependent on Russia for its energy imports. Even though the Czech Republic is considered a lead reformer in eastern Europe, the country has yet to finalize plans on how it will restructure its oil and gas industry.

Even though the Czech Republic is considered a lead reformer in eastern Europe, the country has yet to finalize plans on how it will restructure its oil and gas industry. Currently, the gas distributor Transgas remains under full state control. Initially, with only one pipeline--the Friendship line from Russia--and with refining badly in need of upgrading, the Czech Republic has sought foreign investment to help it fully integrate with Europe and to reduce its dependency on Russian oil. In March 1996, the Czech Republic will acquire alternative sources of oil with the opening of its second crude pipeline. The pipeline to Germany was built under an agreement between the two countries. Downstream, the Czech government consolidated operations prior to privatization. The two largest Czech refineries, Chemopetrol and Kaucuk, were merged to form Czech Refineries, with the state's 51-percent interest being retained by Unipetrol--a newly established holding company, which currently owns the remaining petrochemicals industry, and Benzina, the partially privatized petroleum distributor {see Endnote 139}. In November 1995, the largest refinery privatization in eastern Europe and the Former Soviet Union took place when the Czech government signed a $672-million agreement to sell the remaining 49-percent state-owned share in Czech Refineries to IOC, a consortium including Royal Dutch/Shell, Agip, and Conoco.

Slovakia

Slovakia is largely dependent upon imported oil and gas. Slovnaft, the country's third largest petroleum company, is the industry's refiner and petrochemical company. By the time of Slovakia's separation with the Czech Republic, Slovnaft was already 20-percent privatized {see Endnote 140}. In 1995, to increase its attractiveness as an investment prospect, Slovnaft bought a 51-percent stake in Benzinol, which controls 60 percent of the retail gasoline market and is a major Slovnaft customer. The government is negotiating with Agip of Italy to buy an additional 34-percent stake in Benzinol. The company recently offered additional equity through a global-depository-receipt offering to raise money for a modernization program {see Endnote 141}.

There is uncertainty regarding the pace of structural reforms. Privatization virtually came to a halt in late 1994, and decisions to dispose of state property have been reversed on several occasions. In July 1995, the "Golden Egg Law" was passed. It listed dozens of firms that will not be privatized or in which the state will keep a right of veto over key decisions {see Endnote 142}. Utilities will remain under permanent state control, and the state will keep decisive influence on the oil refiner Slovnaft and the energy company Nafta Gbely. Also passed was a law that scrapped the final wave of voucher privatizations and replaced them with a direct sale method. However, foreign participation has been the lowest since the inception of privatization in 1992, with only 3 out of 232 foreign companies accepting direct sales offers between January and August 1995 {see Endnote 143}.

Hungary

Hungary has embarked on one of the most ambitious of privatization schemes. Hungary is the only country in the region to build a vertically integrated company, the Hungarian Oil and Gas Company (MOL) {see Endnote 144}. MOL was founded in 1991 and is Hungary's largest company. Its utility segment ranks as one of Europe's top 15 oil and gas utilities. Currently, Hungary produces about one-fourth of its oil and half its natural gas needs. MOL accounts for 90 percent of the nation's oil and gas production, refining capacity, and reserves {see Endnote 145}. Political uncertainty in the Ukraine and continuing problems with pipeline access to the Adriatic has jeopardized secure energy supplies. As a consequence, MOL has sought to diversify its gas supplies and to develop oil and gas reserves abroad by acquiring exploration licenses in the Former Soviet Union, Algeria, and Tunisia. In 1994, MOL and OMV, Austria's state oil company, agreed to jointly construct a 120-kilometer pipeline linking Baumgarten, Austria, and Gyor, Hungary, providing Hungary with its first access to western gas {see Endnote 146}. Germany also has agreed to sell western natural gas to the company {see Endnote 147}.

In addition, MOL is seeking joint venture partners in oil and gas exploration and production. After several postponements, the first bids for domestic exploration were offered in 1994, with the five concessions being awarded to a consortium of Blue Star, Coastal, and affiliates of Occidental and Mobil {see Endnote 148}.

Before privatizing, MOL began restructuring. In May 1995, the assets of Mineralimpex (previously Hungary's gas importing monopoly and, at the time, the country's second hydrocarbons trader after MOL) were transferred to MOL {see Endnote 149}. Both MOL and its new Mineralimpex subsidiary have been cutting staff, and MOL expects a profitable 1995 {see Endnote 150}.

In June 1995, the Hungarian parliament passed the long-awaited Privatization Act. After a promising beginning and several false starts, the first wave of energy sector privatization went forward with a "combined offer" during October/November 1995. Companies in western Europe, Russia, and the U.S. competed for stakes in Hungary's oil, gas, and electricity businesses. In November 1995, Hungary sold an 18.8-percent stake in MOL, the first time ownership in an eastern European oil company had been sold {see Endnote 151}.

Foreign investment and competition have been visible in the retail sector for some time. Two decades ago, Shell Hungary was allowed its first franchised filling station through a local agreement with the state trading company, Interag {see Endnote 152}. By 1993, the company was 100-percent Shell-owned. By 1994, Shell had 15 percent of all service stations and held a 20-percent share of product sales. MOL still leads the retail gasoline market in Hungary, with 50-percent of the service stations and a 35-percent share of product sales. Other major gasoline marketers in Hungary include Mobil, Exxon, Conoco and Total, with each holding about a 5-percent share of the country's gasoline market {see Endnote 153}.

Poland

Since 1989, Poland has undergone several changes in government, a fact that has delayed privatization {see Endnote 154}. In 1995, after a three-year delay, Poland finally took the first serious steps to privatize major state-owned enterprises by launching their long-awaited mass privatization initiative. Instead of a voucher system, Poland has set-up 15 National Investment Funds (NIFs). The NIFs are joint stock companies that were allocated 60-percent shares in 44 industrial companies created from the privatization of state enterprises.

The government is currently deciding on how to restructure and privatize the Polish oil and gas industry {see Endnote 155}. Poland intends to rapidly modernize its energy industry, but to date no part of its energy industry has yet been privatized. As a result of legislation passed in 1995, privatization in most energy sectors, including coal mines, oil and gas sectors, and energy distributors, requires parliamentary approval. Poland's modest oil onshore production is in the hands of the Polish Oil and Gas Company (POGC) and offshore production is performed by the joint stock company Petrobaltic. The POGC, one of the last fully integrated, state-owned monopoly petroleum enterprises in Europe, has sole responsibility for exploration and production of both gas and oil, gas imports, transmission, storage, and distribution. The government has tentatively adopted a restructuring plan for the POGC intended to transform it (in stages) into separate, independent companies for exploration, drilling, production, transmission and distribution. The government is considering limiting foreign ownership in such privatized major companies to minority stakes.

The country produces only around 1 percent of its domestic oil needs {see Endnote 156}. Russia supplies Poland with 60 percent of its natural gas. However, unlike other eastern European countries, Poland is less dependent on Soviet crude oil due to its Baltic Sea ports. In 1991, licensing for gas exploration was opened to domestic and foreign companies. Since then, two licensing auctions have been held. Several foreign companies have participated, including Exxon, Shell, British Gas, and Amoco.

Downstream, seven refineries organized as joint stock companies supply the bulk of the country's product needs. Under preliminary government plans, they are to be merged with CPN, the state-owned gasoline distribution network. Shares in refineries are to be offered separately to strategic investors. Minority shares (of 20 to 30 percent) in refineries may go on sale under a plan to consolidate and later privatize the oil sector. Poland's second largest oil refinery, Rafineria Gdanska S.A., has signed a contract with Chevron to use the company's licensed technology in a planned $400-million upgrading {see Endnote 157}. Plock and Gdansk, the two main refineries, are embarking on modernization programs worth more than $1.5 billion.

Polish authorities have introduced competition in gasoline wholesaling and retailing, and both foreign and domestic suppliers are entering the market. Foreign investment in the Polish gasoline retailing business has been modest so far due to uncertainties. Norway's Statoil and Finland's Neste have 11 gasoline stations each, Conoco has nine, Esso and Royal Dutch/Shell have six each, and Germany's Aral has four {see Endnote 158}. Amoco is expanding into gasoline retail operations in Poland {see Endnote 159}. The company opened its first stations in Poland this year, with plans to build 150 of them over the next decade. Texaco is about to start its own gasoline station building program and Sweden's OK Petroleum bought a controlling interest in Va-Po SA, which owns 22 gasoline stations.

Romania

The Romanian oil and gas industry is eastern Europe's largest oil and gas producer. It also has the region's largest petrochemical industry {see Endnote 160}. With 1.6 billion barrels of proved oil reserves, more than four times the total of other eastern European countries combined, it has the most to gain from energy foreign investment. However, along with Bulgaria, its reform is one of the slowest in eastern Europe.

Romania's oil and gas industry was restructured twice, in 1990 and in 1993 {see Endnote 161}. It now consists of a series of state-owned units. These include: Rompetrol (responsible for oil and gas imports, and licensing foreign companies), Petrom (oil exploration and production), Conpet (oil distribution), Peco (gasoline distribution and sales), and Rafirom (refining). Romgas is the nation's gas distribution company. There is a possibility that further restructuring will take place, creating a single, vertically-integrated company in which up to 49 percent of the equity could be sold.

After a decade of declining crude oil production (attributed both to neglect and to the use of outdated technology), production between 1994 and 1995 began to level off {see Endnote 162}. Currently, the country produces about half its oil requirements and consumption is rising rapidly. Romania needs to invest in further exploration and has therefore attempted to encourage foreign investment.

Even though privatization legislation was passed in 1991, the lack of progress in restructuring and privatizing has thus far been discouraging to foreign capital. However, even with later modifications, the law still lacks clear guidelines for negotiating leases and does not allow disputes to be settled by international arbitration. Due to these uncertainties, Amoco, which has an onshore concession, has threatened to pull out of its proposed $60-million investment to build a network of 60 filling stations {see Endnote 163}. Most foreign investment in the energy sector is performed through joint ventures.

In 1992, Romania held its first licensing auction since the end of Communism, offering both onshore and offshore concessions. Shell and Amoco each were awarded an onshore block and an Enterprise Oil-Canadian Occidental consortium was awarded two offshore blocks {see Endnote 164}. Romania's National Agency for Mineral Resources (NAMR), a newly formed agency created in 1995, is currently holding its first, and the country's second, licensing auction that includes 15 new blocks, all onshore, except one that includes an offshore block in the Black Sea continental shelf.

Romania's refining industry is inefficient and suffers from overcapacity. The use of outdated technology raises the price of the end product to over twice that of imported refined products. Romania is seeking foreign investment to help finance a $230-million planned investment program to upgrade its five largest refineries (which account for nearly 85 percent of the country's total capacity) to western standards by 1999 {see Endnote 165}. The other five refineries will be devoted to petrochemicals. Many problems have delayed the project, and western companies, including Amoco and Texaco, are reevaluating prior commitments {see Endnote 166}.

In marketing, Royal Dutch/Shell was the first western firm to open and operate retail gasoline stations in Romania {see Endnote 167}. Other western companies, such as Amoco, are considering retail investment options {see Endnote 168}.