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Eastern Europe: PKN's poisoned chalice

THE EUROPEAN Commission has given its approval to Poland's PKN Orlen for its acquisition of Lithuania's Mazeikiu Nafta. However, a recent fire at Mazeikiu's refinery and a prolonged interruption to piped Russian oil exports to the plant are preventing any celebration.

The EU's competition regulator accepted PKN's plan to buy Mazeikiu, saying it would not significantly harm competition in Europe. PKN immediately said it would attempt to complete the deal before the end of February. The deal is the largest foreign acquisition by a Polish firm and is indicative of PKN's desire to remain an important player in the region's oil sector – alongside Hungary's Mol and Austria's OMV.

PKN won an international tender for Mazeikiu, which owns the Baltic's only refinery, in May, offering to buy a 53.7% stake from bankrupt Russian oil firm Yukos for $1.49bn and a 30.6% stake from the Lithuanian state for $0.85bn. The state will retain a 10% stake in the company, with a five-year option to sell it to PKN.

But the acquisition has been dogged by problems almost from the beginning. At the end of July, an accident on the 1.2m barrels a day (b/d) Druzhba oil pipeline, which carries crude from western Siberia to the heart of Europe, forced Russia to reduce throughputs. Supplies to the Unecha-Polotsk branch of the pipeline have been cut off, halting deliveries to Mazeikiu's refinery and neighbouring Butinge oil terminal.

Russia's Transneft, which operates Druzhba, claims it should have fixed the ageing pipeline by February, although there is speculation that the Russians are using the supply stoppage to attempt to force PKN to sell part of its stake in Mazeikiu to a Russian company, such as Rosneft, TNK-BP or Lukoil – the last two of which were disappointed losers in the May tender. True or not, Mazeikiu has been forced to receive seaborne crude supplies from Russia through Butinge – a much more costly option.

Then more bad news came in mid-October, when a fire at the Mazeikiai refinery caused throughputs to plunge from 146,000 b/d to 88,000 b/d. Throughputs have since returned to around 110,000 b/d, but, the refinery's technical director, Justinas Sestakauskas, told Reuters that replacing an essential component destroyed in the fire would take up to a year. In addition, Mazeikiu Nafta's chief executive officer, Paul Nelson English, has said further delays to install new equipment are possible. No contract has yet been signed with a supplier.

English has also complained that the situation is being aggravated by friction on the Mazeikiu board. Inevitably, these shenanigans have hit Mazeikiu's finances and may affect PKN's too. On 27 October, Mazeikiu revised downwards its 2006 net-profit forecast for the second time in the month, cutting its expected earnings by nearly 50%, to just $88m.

Since the negative news on Mazeikiu began, PKN's market value has fallen by about $1bn. Says Deutsche Bank analyst Gergely Varkonyi: "PKN's low stock price reflects market scepticism about the company's confidence in value creation [from the Mazeikiu purchase]." But with the prospect of significant delays to replacing the damaged equipment at the refinery, Mazeikiu could continue making losses for several quarters, even after PKN has completed the acquisition.

The problems have led to an overall feeling among observers that PKN has overpaid for its first big foreign acquisition. "The stock may trade lower on slower Mazeikiu repairs and concerns that PKN is overpaying," says Bram Buring, analyst at Czech investment bank Wood & Co. Yet the company's management and the Polish government insist there is no question of trying to renegotiate the price. The country's President, Lech Kaczynski, has said PKN is "determined" to complete the deal as it stands.

Still, there remains speculation that PKN will be forced either to bring in a Russian partner to guarantee oil supplies, or even Kazakhstan's state-owned KazMunaiGaz, which also lost out to PKN in the tender for Mazeikiu. In October, Kazakhstan's prime minister, Daniyal Akhmetov, said KazMunaiGaz would still be interested in buying into the refinery, perhaps even in conjunction with a Russian company. Yet this will probably be a political rather than a management decision. "Political motivations aside, I don't think that PKN would like an equity partner in Mazeikiu," says Varkonyi.

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