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Improving Croatia’s energy security

Improving Croatia’s energy security

MOL has invested heavily in enhancing Croatia’s energy security. It has done so by massively developing Croatia’s oil and gas exploration and production, and by constructing the Croatian-Hungarian gas interconnector. INA, and later its subsidiary, has ensured safe and secure supply to households for decades.

Investment in oil and gas exploration in Croatia

Since 2003, when MOL became a strategic investor in INA, almost HRK 18 billion (EUR 2.35 billion) were invested into upstream oil and gas assets, and over HRK 4 billion (EUR 525 million) specifically in Northern Adriatic fields. This resulted in record gas production in 2010-2011 from these gas fields.

Overall during the past decade, more than 3 billion cubic meters of additional proven gas reserves were added to INA’s reserve base through exploration and development activities in the Adriatic.

Under the 2003-2007 Initial Business Plan, annexed to the 2003 Shareholders Agreement drafted under the full control of the Croatian Government, the focus of exploration activities was shifted to Adriatic offshore and international projects. EUR 207 million were allocated in such projects, whilst only EUR 6.6 million were allocated for onshore and offshore exploration activities in Croatia.

After MOL partnered with INA, even before taking over management control in 2009, it championed the development of Croatian exploration activities. After management control was taken over, MOL initiated further exploration projects on Croatian soil that resulted in three major discoveries – one of which is the best-producing well ever drilled in Croatia. This has been a major contribution to Croatian energy security.

Cross-border explorations in the Pannonian Basin, between Croatia and Hungary, were also undertaken at the initiative of MOL in 2006 and 2007. The Zalata-Dravica and Novi Gradac-Potony joint explorations were both successful, and illustrate well the possibilities of good operational cooperation between INA and MOL. Full exploitation of domestic hydrocarbon reserves also greatly benefits the energy security of the region.

At the end of 2012, INA had proven and probable reserves of 267 MMboe (million barrels of oil equivalent), and a production of 48.6 Mboe/day.

Today, INA runs extensive upstream operations in Croatia (in the Pannonian basin and the Adriatic Sea) that are key for the country’s energy security.

Modernization and transformation of INA

MOL recognizes INA’s essential role in Croatia’s energy security and believes that a strong and profitable INA provides the best way to ensure the continued health of the company and improving its performance over time.

In line with this goal, MOL initiated the restructuring of INA’s operation, introducing several rationalization measures and dedicated efficiency improvement programs. As a result, INA’s operational performance and efficiency have been improved considerably. From 2009 to 2012 its operating cash profit was doubled and its debt levels decreased significantly.

This will enable INA to play a key role in further building Croatia’s energy independence.

The Croatian-Hungarian gas interconnector

MOL Group daughter company FGSZ started the construction of the Croatian-Hungarian gas interconnector in 2009. Completed in July 2011, the pipeline provides Croatia with dramatically enhanced energy supply security today. The project was partly financed by the European Union and the cost of the total investment on the Hungarian side reached HUF 80 billion (EUR 275 million). The pipeline runs a length of 205 km in Hungary and 88 km in Croatia and can carry 19.2 million cubic meters of natural gas per day.

The interconnection is also important for the energy priorities of the European Union as it improves the connectivity of the CEE region’s energy supplies and helps to complete the North-South Gas Corridor. It is also an important step towards a unified, transparent internal European gas market.

The necessity and utility of this enhanced connectivity was demonstrated in February 2012. During one of the coldest months of the year, Croatia’s natural gas supply was seriously threatened due to an unplanned pause in production of the North Adriatic gas fields. After receiving a request from Croatia, MOL’s subsidiaries provided significant support to INA by enabling the supply of more than one-third of Croatia’s daily gas consumption through the interconnector. Through this timely action, a critical gas supply disruption to Croatia’s industrial and household consumers was avoided, and no significant interruption in the supply was experienced.

Despite an intergovernmental agreement signed between Hungary and Croatia in 2011, the interconnector still functions only in one direction: from Hungary towards Croatia. The significant investments made by MOL yielded huge benefits to Croatia so far in terms of energy security, but the lack of bidirectional flow prevents the interconnector from fulfilling its role in enhancing the energy security of not only Croatia but the wider region. The lack of bidirectional flow also limits MOL’s ability to achieve returns on its financial investment.

Ensuring security of gas supply for Croatian households

2009: In line with the Gas Master Agreement, the Government-nominated entity, the 100% state-owned Plinacro purchased the gas storage business (PSP Okoli) from INA at fair price confirmed by a reputable international accounting company. At the same time, MOL agreed that INA would lease back this facility for a period of five years at an annual fee of HRK 150 million. This guaranteed a return period of 5-6 years to Plinacro on its investment. In the same agreement, Croatia had also undertaken to take over Prirodni Plin, INA’s gas trading company.

INA has indeed leased back the gas storage facility and among other things MOL agreed to extend the deadline for the takeover of the gas trading business. However, the Croatian government has failed to honour the latter part of the agreement to date.

2009-2011: MOL Group daughter company FGSZ constructed the Croatian-Hungarian gas interconnector, providing Croatia with dramatically enhanced energy supply security.

2011-2012: In winter 2011-2012, the recently finished interconnector pumped additional gas to Croatia averting a severe gas shortage risk to Croatian households.

December 2013: TheGovernment of Croatia published substantial amendments to the Gas Market Act, without announcing the accompanying decrees that are necessary for market players to prepare for the changes. Among others, the Government did not specify which entity would be the wholesaler responsible for supplying households from April 1, 2014. This obligation had been put on INA or its relevant subsidiary for the past 30 years.

Early 2014: The five-year lease agreement for the PSP Okoli gas storage facility was due to expire on March 31, 2014. Prirodni Plin, in charge of supply security until that date, acted in line with its responsibilities and continued to store significant amounts of gas in the storage facility during Q1 2014.

It is the basic precondition of ensuring security of gas supply throughout the entire winter period in Croatia (or any other country) to fill up the underground gas storage to the maximum by autumn.

Only one month before the expiry of the supply obligation of Prirodni Plin, and in the days before the deadline for submitting bids for the tendering of the PSP Okoli’s capacities, did the Ministry of Economy publish the decisions that completed the changes to the Croatian gas market.

HEP, Croatia’s 100% state-owned electricity provider, was given priority access and 70% of the storage capacities in PSP Okoli, and was appointed gas wholesaler. Prior to these decisions, there was no official indication that Prirodni Plin would be removed from this role. The access to the gas storage was not only important to INA to secure safe supply of households through Prirodni Plin, but also to INA’s upstream business in order to balance its production and sales portfolio. With allocating 70% of capacities to HEP, INA can find itself in a situation in the summer period of having no other choice – without seriously jeopardizing the geological status of its fields – than to flare off a large part of its produced gas.

The sudden and material restructuring of the gas market was in general prepared without any meaningful consultation with the primary party concerned, INA.

March 2014: After the drastic and unexpected reallocation of storage capacities, INA had to vacate or sell its 220 million cubic metres of gas still stored in the facility within an unreasonably short, one-month period. Due to the low consumption resulting from a mild winter and the limited daily withdrawal capacities of the storage facility, it was physically impossible to withdraw all of Prirodni Plin’s gas in that timeframe.

As regulation prohibits the export of domestically produced gas (which raises the question of breach of EU Acquis), Prirodni Plin was locked within Croatia and within the PSP Okoli facility with its gas. The company approached all stakeholders (regulators, other public bodies and companies) requesting permission to gradually remove this gas from the storage over the course of several months (a solution which would not have impaired the use of the storage by other capacity holders), but these requests were denied. INA and Prirodni Plin now faced the prospect of a forced auction organized by PSP Okoli of the “unwithdrawn” gas quantities.

April 2014: The requests for deadline extension or consultation by both INA’s and Prirodni Plin’s management remained unanswered. Before the conclusion of the forced auction, INA’s Management Board issued an open letter to Croatian decision-makers as a last-resort solution at stopping the forced sale. The plea was essentially ignored, and more than half of INA’s remaining gas was auctioned off for about 25% of the market price.

It remains to be seen what INA's total revenue losses from the sale of gas from Okoli gas storage will be. It may be as high as 20% of INA’s 2013 investments spent in Croatia. As of today, INA lost approximately HRK 200 million from the 109 million cubic metres of gas sold at below market prices. The buyers were two 100% state owned entities, HEP and Plinacro.

In the redrawing of the Croatian gas market, Prirodni Plin incurred direct losses although it has approached the regulatory changes in good faith and has maintained its responsibilities as the entity responsible for household supply.

Zelimir Sikonja, Executive Director of Exploration and Production Business of INA d.d. stated in an interview: “We are disappointed with a lack of reaction from all institutions whose goal is supposed to be the protection of market supply security and ensuring of equal terms for all participants in the gas business in Croatia.”