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Mol's downstream delivers

An increased stake in Ina provides upstream potential, but it is Mol's refineries that are delivering profits, writes NJ Watson

IT HAS been a good year for Mol. Fresh from seeing off – at least for now – an unsolicited take-over bid from Austrian rival OMV, the Hungarian company has secured the largest shareholding in Croatian energy firm Ina. In October, Mol bought 22.15% of Ina shares not owned by the Croatian state, raising its stake to 47.16%.

Ironically, the global financial crisis worked in Mol's favour. Its tender offer of K2,800 ($508) a share was deemed too low by institutional investors when it was launched at the beginning of September and, initially, few offered up their shares. But when stock markets around the world plunged, as the credit crunch deepened, the price began to look much more attractive and investors, including the Croatian war-veterans fund, rushed to sell Ina shares before Mol's offer closed.

Mol and the Croatian government then established a new shareholders' agreement, which bars Mol from selling its Ina shares for five years and obliges the company to divest Ina's gas business. The two parties had also been expected to begin talks on the future of the state's 44.84% holding, but those talks have been postponed -- some reports claim Mol has already secured majority influence over Ina through a deal with the institutional and private investors that still hold 8% of the company.

Ambitious goals

So what has Mol got for its money? Ina, which Mol's offer values at about $5bn, is a central part of the Hungarian firm's strategy to diversify its business geographically and by segment. Ina is primarily an upstream company, with this sector generating 124% of the group's cash flow in 2007. "While most [Ina] operations lose money, upstream is very profitable," says Deutsche Bank analyst Gergely Varkonyi.

Ina has proved and probable (2P) reserves of 375m barrels of oil equivalent (boe), just 14% less than Mol's, a much larger company. Most of the reserves, primarily gas, are in Croatia, with some in Syria, Egypt and Angola. The average reserves life, at present production rates, is 16 years based on 2P reserves, slightly higher than Mol's 13 years; its three-year reserve replacement ratio to end-2007 stood at 128%.

While its onshore assets, like Mol's, are mature, it has – unlike Mol – a growing production portfolio in the Adriatic Sea through a joint venture with Italy's Eni. Offshore production began in 1999 and accounted for 39% of total gas output in 2007. Total recoverable offshore gas reserves are estimated at 20bn cubic metres and production is expected to continue for over 20 years.

This will go some way to helping Mol meet its ambitious target of raising production from 85,000 boe/d to 120,000 boe/d by 2013 – an aim many analysts claim cannot be achieved. Much of the production growth will have to come from enhanced oil recovery at domestic fields, which account for 72% of production, and exploration and development of newly acquired assets in Russia.

Mol at a glance, 2007

Reserves (2P): 340.6m boe
Reserves replacement rate: oil, 50%; natural gas, 33%
Production: 90,400 boe/d
Refining capacity: 326,000 b/d
Net profit: Ft257.8bn ($1.40bn)
Net sales: Ft2.59 trillion ($14.11bn)
Market capitalisation (mid-September): $9.665bn
Return on average capital employed: 22.6%
Chief executive: Gyorgy Mosonyi
Headquarters: Budapest
Number of employees: 15,058

Source: Mol; Petroleum Economist

Deutsche Bank expects Mol's production to rise by 2.5% in 2010 and by 7% in 2011, driven predominantly by Russian growth and stable Hungarian output. "However, our peak 96,200 b/d estimate in 2012 is at least 30% below the company's target," says Varkonyi.

Indeed, in the second quarter, Mol reported a 9% fall in oil production compared with the second quarter of 2007. The drop resulted from sharply lower Russian output. Inadequate infrastructure, both below and above ground, is cited as the main problem at Mol's fields in western Siberia.

Despite this, Mol more than quadrupled its net income in the second quarter to $0.69bn, mainly through a favourable revaluation of its debt, as the forint soared against the world's main currencies, as well as the high oil price and an outstanding downstream performance (a Wood Mackenzie survey found Mol's refineries in Hungary and Slovakia are the most efficient in Europe).

Meanwhile, the firm's chief executive, Gyorgy Mosonyi, claims falling oil prices will not significantly undermine profitability because, "Mol is a downstream-oriented company ... crack spreads for diesel and gasoline remain stable or have even improved."

"Diesel crack spreads practically exploded in the second quarter, achieving all-time highs, which worked especially in Mol's favour as its products slate is geared towards diesel," says Raiffeisen Group analyst Akos Herczenik.

It is this kind of performance that so attracted OMV. However, the Austrian firm abandoned its bid to take over Mol in August, after an acrimonious year-long battle, saying EU conditions for allowing the merger to proceed were too onerous to make it worthwhile.

This victory for Mol, preventing what it regarded as a hostile take-over by a foreign government (OMV is 32% state owned), pushed the Hungarian parliament to pass a law to prevent "strategic assets" – the state retains no share in the former national oil and gas company – from falling into foreign hands. The company began buying its own shares to prevent OMV securing them. At one point, Mol controlled over 40% of its own stock through share-lending agreements and treasury stock, meaning OMV had little chance of raising further the 21.3% stake in the firm that it had built up over the past year.

What now for OMV?

The question is what OMV plans to do with that stake now it has supposedly given up its take-over aims. OMV has publicly stated that it intends to hold on to its stake in Mol – although, in September, it struck a repurchase agreement with Bayerische Hypo-und Vereinsbank for 10m Mol shares, which will cut OMV's stake to 11.7% until January, when it will buy them back.

The market has been abuzz with speculation over the reason for this deal. Some claim it presages a renewal of hostilities. Mol's statutes limit the exercising of voting rights at 10%, so by transferring a 10% stake to Bayerische, OMV might be able to increase its influence at shareholder meetings if the bank and other shareholders back it. Others say OMV simply wants to put those shares to work and needs financing for the short term. Mol's next shareholder meeting is not scheduled until April, when OMV will probably have its full holding back.

Whatever else OMV is planning, the Austrian firm is likely to block any rival bid for Mol. "There's no way past OMV for any company that wants to take over Mol," says Philipp Chladek, another analyst with Raiffeisen. "As long as OMV doesn't sell its shares in Mol to anybody else, Mol can remain independent."

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