OMV Aktiengesellschaft (OTCPK:OMVJF) Q2 2022 Earnings Conference Call July 28, 2022 5:30 AM ET
Company Participants
Florian Greger – SVP, IR
Alfred Stern – CEO
Reinhard Florey – CFO
Conference Call Participants
Josh Stone – Barclays
Mehdi Ennebati – Bank of America
Peter Low – Redburn
Henri Patricot – UBS
Raphaël Dubois – Societe Generale
Tamas Pletser – Erste Bank
Bertrand Hodée – Kepler Cheuvreux
Florian Greger
Good morning, ladies and gentlemen, and welcome to OMV’s Earnings Call for the Second Quarter 2022. With me on the call are Alfred Stern, OMV’s CEO, and Reinhard Florey, our Chief Financial Officer.
As always, Alfred will walk you through the highlights of the quarter and discuss on these financial performance. And after his presentation, those gentlemen are available to answer your questions.
And with that, I’ll hand it over to Alfred.
Alfred Stern
Thank you, Florian. Ladies and gentlemen, good morning, and thank you for joining us today.
The markets in the second quarter of 2022 experienced a lot of pressure and unprecedented uncertainty. Oil and gas prices continued to rise, the refining margins reached all-time record highs, and daily headlines on the sharp decline of Russian gas supply to Europe dominated news feeds.
At OMV, we were confronted with the incident at our Austrian refinery at the beginning of June. Since then, a large team of specialists has been working tirelessly to mitigate the impact. We are continuously optimizing our supply system and have been in constant contact with our customers to minimize the impact on their operations. Despite these headwinds, the second quarter of 2022 proved to be an exceptional one for OMV in terms of earnings.
Let me start with a brief review of the market environment. Brent prices continued to rally in the second quarter, averaging US$114 per barrel, which is 65% higher year-on-year. The development was highly volatile during the quarter, with concerns over demand, most notably in China, and Russian supply risks. Prices exceeded US$130 per barrel in June, the highest levels since 2008. So far this year global demand has been strong, but supply has been extraordinarily tight on the back of the Russia-Ukraine crisis and disruptions in various OPEC+ member states such as Libya and Nigeria. At €102 per megawatt hour, Central European gas prices were more than four times higher compared to the previous year’s quarter. Prices eased in April and May compared to the first quarter of this year. Thanks to mild weather, healthy LNG inflows into Europe and lower demand in China due to the lockdowns. June saw prices rallying again, driven by further reductions of Russian natural gas supplies to Europe.
Before I comment on the refining indicator margin, I want to make you aware that starting with the second quarter, as Urals is no longer a relevant reference for OMV refining margins; OMV Petrom changed the crude oil transfer price from Urals to Brent. As a consequence, our Group refining indicator margin calculation is now entirely based on Brent. The change triggered a profit shift between refining and marketing and Exploration & Production, with a neutral impact at Group level. Historical financial results of the segments have not been adjusted, but the refining indicator margins for previous periods have been recalculated and our comments will refer to those going forward.
The European refining indicator margin soared from 2.2 in the second quarter of 2021 to US$20.5 per barrel in the second quarter of this year. This was primarily triggered by surging middle distillate and gasoline cracks, which offset the increase in Brent price. Following the announcement of the EU ban on Russian oil imports by the end of this year, the diesel cracks surged to a record high. The gasoline cracks also rose to a record high at the beginning of June as demand had been ramping up ahead of the summer peak driving season in the U.S. and Europe, further supported by growing U.S. import requirements from Europe.
The European olefin indicator margins increased substantially year-on-year, with ethylene up 38% and propylene up 47%. Strong European demand, supply shortages and logistical constraints led to higher olefin prices, which were able to more than offset increases in naphtha prices. The European polyolefin indicator margins normalized from the record high level of the prior-year quarter, when the global supply chain experienced severe bottlenecks, caused by the winter storm on the U.S. Gulf Coast, the blockage of the Suez Canal, and shortages of container ships. Year-on-year, the European polyethylene indicator margin decreased by 45% and the polypropylene indicator margin by 39%, impacted by rising feedstock prices, softer demand and increased imports from the Middle East and the U.S.
I would like to point out that despite this decline, indicator margins for polyolefins were substantially above historical averages from the last five years. In addition, 40% of our polyolefin sales are specialty products, which have more stable and higher margins, not directly linked to the market indicators.
In the second quarter of this year, our clean CCS Operating Result rose sharply to €2.9 billion and the cash flow from operating activities, excluding net working capital effects soared to around €2.4 billion.
Looking at operations year-on-year, total polyolefin sales volumes slightly increased, while fuel sales were slightly lower, impacted by the incident at the Schwechat refinery. The utilization rate of our European crackers and refineries decreased due to the planned turnarounds and the incident at the refinery. Oil and gas production was lower, primarily due to the exclusion of the Russian volumes following a change in the consolidation method.
Following a successful IPO, Borouge was listed on the Abu Dhabi stock exchange on June 3rd with a market capitalization of $20 billion at the time of listing. The IPO raised gross proceeds of $2 billion for 10% of the company’s total issued share capital. The IPO facilitates the expansion of the company and the ongoing efforts in providing innovative and differentiated polyolefin solutions. Upon listing, ADNOC owns a majority 54% stake and Borealis a 36% stake in Borouge plc. The Borouge 4 project was carved out of Borouge plc. OMV still holds a 40% stake in Borouge 4 LLC.
An important milestone in our growth strategy in Chemicals & Materials was reached a week ago. Baystar started commercial operations at the new ethane cracker with an annual production capacity of one million tons of ethylene. The ethylene will be used as feedstock to supply Baystar’s existing polyethylene units, as well as the new 625,000 ton Borstar polyethylene unit scheduled to start operations in Bayport, Texas until end of this year. Baystar will run a world-scale one million ton ethane-to-polyethylene integrated production complex. We are pleased to bring Borealis’ proprietary Borstar technology to North America for the first time, allowing Baystar to produce enhanced polyethylene products for the most demanding applications, such as wires and cables.
Executing on our strategic direction to become a leader in circular economy solutions, in May we agreed to form a new joint venture with Reclay Group, the international experts in waste management, with the aim of designing a smart systems-thinking approach to ensure more post-consumer lightweight packaging is sorted and recycled into high-quality materials. This complements the cooperation we signed with Alba Recycling in the first quarter to jointly build and operate an innovative sorting plant in Germany with a capacity of 200,000 tons of post-consumer mixed waste per year.
Looking at divestments, in May we closed the sale of 285 retail stations located in southern Germany to Euro Garages Group with a purchase price of €485 million. At the beginning of June, we received a binding offer from Czech-based group AGROFERT for the acquisition of Borealis’ nitrogen business. The offer values the business on an enterprise value basis at €810 million. We expect to close the deal in the second half of this year.
Let’s now turn to our financial performance in the second quarter of this year. Our clean CCS Operating Result rose sharply to €2.9 billion, an increase of more than €1.6 billion compared with the second quarter of 2021, which was significantly impacted by the COVID-19 pandemic. All three business segments contributed to this strong performance, with the largest contribution coming from Exploration & Production.
The clean CCS tax rate increased to 37%, which was 4 percentage points higher than in the same quarter last year. This was due to a significantly larger earnings contribution from Exploration & Production, especially from high-tax regime countries, partly offset by a higher contribution from Refining & Marketing and from at-equity accounted investments. Clean CCS net income attributable to stockholders more than doubled to €1.4 billion. Clean CCS earnings per share surged to €4.34.
Let’s now discuss the performance of our business segments. The clean Operating Result of Chemicals & Materials decreased by 7% to €602 million. Considering that the second quarter in 2021 was a peak at unseen levels, the results of this year’s quarter were very strong. While European polyolefin margins normalized from the record highs of last year, the contribution from the nitrogen business and from Borealis JVs increased considerably.
The performance of OMV’s base chemicals business was slightly higher. The stronger market environment was to a large extent offset by reduced production at Schwechat, higher costs of the feedstock mix, and higher customer discounts resulting from the rising olefin prices. The negative impact of the customer discounts was largely recovered in our polyolefin business, as the majority of the olefins are sold to Borealis. In addition, lower benzene margins had an impact on the result.
The contribution of Borealis, excluding the Joint Ventures, decreased slightly by 4% to €412 million. Normalized polyolefin margins and a lower contribution from the base chemicals business were almost compensated for by the exceptional performance of the nitrogen business and higher positive inventory effects. In Borealis’ base chemicals business, strong increases in olefin indicator margins were outweighed by the planned Stenungsund cracker turnaround, negative inventory valuation effects, and higher discounts to the polyolefin business.
The performance of polyolefins declined due to substantially lower polyolefin indicator margins, partially offset by higher inventory effects and lower feedstock costs. The high share of specialty products in our portfolio enables higher and more stable realized margins due to the higher performance they provide. Sales volumes excluding JVs declined by 7% compared to the exceptionally strong prior year quarter, mainly in the Consumer Products and Infrastructure segments, while volumes in Energy segment saw slight increases.
The contribution of the JVs rose by 18% to €159 million due to the improved performance of Borouge and a stronger dollar. Sales volumes of the JVs increased by 23%.
While in the previous year Borouge sales volumes were impacted negatively by the implementation of an ERP system and logistical constraints, in the second quarter of 2022 Borouge benefited from the start-up of the new polypropylene plant. Realized premia to benchmark prices improved, reflecting the differentiated product mix and the ability to capture regional price opportunities.
Baystar experienced a softer market environment as increased ethane prices weighed on margins, while sales volumes remained at a similar level.
The clean CCS Operating Result in Refining & Marketing increased by €579 million year-on-year to €745 million, mainly due to substantially higher refining indicator margins, an exceptionally strong result in Gas & Power Eastern Europe, and a significantly higher contribution from ADNOC Refining & Trading. These effects were partially offset by the costs for the refinery turnaround, the impact of the incident in Schwechat of around €90 million, and significantly lower retail results.
Total sales volumes were down 5%, primarily as a consequence of lower supply availability in Schwechat. The retail result decreased due to substantially lower margins, higher costs for utilities, and slightly lower volumes, impacted as well by the divestment of the German OMV retail network in May. Retail margins came under pressure due to price caps in some countries and substantially increased product quotations. This was partly offset by improved non-fuel business performance driven by rebounded customer frequency. The commercial business showed a slightly lower contribution mainly due to price caps on gasoline and diesel in Hungary and Slovenia, partially compensated for by higher jet fuel demand.
The contribution from ADNOC Refining and Trading improved from minus €5 million to plus €112 million, driven by higher refining margins, further efficiency improvements, and the stronger performance of ADNOC Trading.
The result of the Gas & Power business in Romania rose substantially to €167 million, mainly due to higher gas margins, as well as a better power result. The result of the power business was driven by higher selling prices and production volumes, partly offset by the newly introduced power over taxation regulation in Romania.
The clean Operating Result of Exploration & Production rose considerably to €1.6 billion from €512 million in the second quarter of 2021. The driving factors were significantly higher realized oil and natural gas prices and a stronger dollar with a total effect of more than €1.5 billion. Lower sales volumes and a negative result in the gas business partly offset the positive contribution.
Compared with the second quarter of 2021, OMV’s realized oil price increased by 78%, and thus more than Brent, supported by the change in the transfer price from Urals to Brent at OMV Petrom. The realized gas price rose nearly fourfold compared with the prior year quarter, mainly driven by the exclusion of Russian volumes from the Group production and the termination of gas hedges.
Production volumes decreased by 145,000 to 345,000 boe per day, primarily due to the change in the consolidation method of Russian operations and the force majeure in Libya. Planned maintenance works in Malaysia and New Zealand, an unplanned outage in Norway, and natural decline in Romania contributed to the decline. Production increased in the United Arab Emirates after a revision of OPEC restrictions. Production cost rose to US$8.3 per barrel, impacted by the exclusion of the low-cost Russian barrels. Sales volumes were lower following the production decline and fewer liftings in Libya.
The Gas Marketing business in Western Europe recorded a significant loss of €117 million. In addition to the impact of supply curtailments of around €50 million, which we announced at our Trading Update, we recorded customary half-year impairments of receivables, triggered by high gas prices and changes in customer credit ratings, and market-to-market valuation adjustments.
Turning to cash flows. Our second quarter operating cash flow, excluding net working capital effects amounted to almost €2.4 billion, 37% higher than the previous year’s quarter, primarily driven by high commodity prices. This includes dividends from Borouge for the second quarter in the amount of €256 million and tax payments in Norway of around €600 million.
Net working capital effects generated a tremendously high cash outflow in the amount of €1.9 billion, predominantly due to the sharp increase in gas prices. As a result, cash flow from operating activities for the quarter declined to around €0.50.
Looking at the half-year picture, cash flow from operating activities, excluding net working capital effects amounted to €5.7 billion, up by around €2.3 billion compared to the first half of 2021. Despite a sizeable cash outflow of around €2.6 billion, net working capital effects, cash flow from operating activities rose by 19% to €3.1 billion.
The organic cash flow from investing activities generated an outflow of around €1.3 billion, slightly higher than the same period of last year, driven by the investments in the PDH plant in Belgium, the ReOil project and the Schwechat turnaround. After payment of €1.1 billion for dividends to shareholders and minorities, the organic free cash flow amounted to €743 million.
The inorganic cash flow from investing activities generated an inflow of €1.1 billion in the first six months of this year. This was driven by inflows recorded in the second quarter from the Borouge plc IPO in the amount of €745 million, a partial loan repayment from Baystar of €602 million, as well as the divestment of the OMV retail network in Germany of €416 million. The cash flow from investing activities also includes outflows from the capital contribution to Borouge 4, LLC in the amount of €287 million, and cash disposed of in the amount of €208 million related to the loss of control of Russian operations recorded in the first quarter. Consequently, the free cash flow after dividends in the first six months of this year amounted to €1.9 billion, almost double the figure in the same period of last year.
Moving on to the balance sheet, in the second quarter, following a very strong cash flow, we were able to reduce net debt by around €600 million since March this year to €4.6 billion. As a result, our leverage ratio decreased by 3 percentage points to 15%.
We expect to close the divestment of our Slovenian business and of the nitrogen business this year, which will have a further deleveraging effect.
At the end of June 2022, OMV had a cash position of €6.5 billion and €4.2 billion in undrawn committed credit facilities.
Let me conclude with an update of our outlook for this year. Based on the developments we have seen so far, we now expect an average Brent price of above US$100 per barrel for 2022. Our expectation for the average realized gas price is unchanged around €45 per megawatt hour for the full-year.
In Chemicals & Materials, we now estimate the European olefin indicator margins to be above the 2021 level. The guidance for the European polyethylene indicator margin is unchanged at around €400 per ton, while the one for polypropylene is now forecast to be lower, at around €500 per ton.
Looking at operations, the utilization rate of our steam crackers is anticipated to increase in the second half of the year, following the return to operations of the Stenungsund cracker in July and the expected restart of the Schwechat refinery to full operations in September/October. The Burghausen steam cracker is currently undergoing planned maintenance in line with the refinery turnaround. During the refinery turnaround, we are also expanding our steam cracker capacity by around 50,000 tons per year.
The polyolefins sales volumes excluding JVs are now projected to be slightly below the 2021 level, which had benefited from an extremely tight market. The polyolefins sales volumes of the Joint Ventures are estimated to slightly increase compared to the 2021 level, supported by the start-up of the new polypropylene plant at Borouge. In North America, we will see an increase in ethylene sales at Baystar until the new Borstar polyethylene plant will come on stream, expected until end of this year.
The refining indicator margin is projected to be around US$15 per barrel in 2022. The Schwechat refinery is anticipated to run at full utilization again in September/October. The maintenance turnaround of Burghausen started on June 22nd and is expected to be completed in August.
Total fuel sales volumes are projected to be slightly lower than in 2021 due to the reduced supply following the Schwechat incident. Retail margins are estimated to be substantially below the 2021 level and commercial margins are expected to be below the 2021 level.
In Exploration & Production, our average production guidance remains unchanged at around 390,000 barrels per day in 2022. The production forecast assumes that following the lifting of the force majeure in Libya this month, we can increase production to normal levels of around 30,000 to 35,000 barrels per day. As a result, we expect higher liftings in Libya in the third quarter. Total production in the third quarter is expected to be significantly above the level seen in the second quarter. Production in New Zealand and Malaysia resumed after the planned turnarounds and in Norway the technical issues at the Edvard Grieg field have been resolved. No significant maintenance planned in the third quarter.
The organic CapEx is expected to be around €3.7 billion, reflecting the consolidation of the nitrogen business for a longer period than initially projected, additional costs following the Schwechat refinery incident, and higher costs in Exploration & Production due to FX effects. This amount includes non-cash leases of around €600 million, which are expected to decrease next year by around €400 million.
The clean tax rate for the full-year is expected to be in the high 40s.
Before closing, I would like to briefly comment on the gas supply situation. In the last few months, we have worked intensively on various measures to minimize the impact of gas supply cuts from Russia on our customers and on OMV.
First, we reduced the risk of gas supplies from Russia. We have two contracts, one for Germany and one for Austria, delivered to the respective hubs. The pricing is hub-based, one month ahead. There is no oil link, nor a fixed price. We sell the volumes month-ahead and we hedge a portion of our sales in order to adjust to a potential reduction in supply. This means our financial risk is limited to a maximum of 30 days. To reduce the risk of this hedging, we drastically cut the so-called margin calls, which were quite common in the past. We have minimized that exposure and today we mainly use OTC hedges. This means you do not need to inject further money for the margin calls in the event of a price rise.
Second, we worked on the diversification of our natural gas supply. Two weeks ago, we took a major step in that direction. For the coming gas year, we have secured 40 terawatt hours of European transport capacities via pipelines from Germany and Italy to Austria. These capacities enable the transport of the gas we produce in Norway as well as purchased LNG quantities to Austria. For OMV and for Austria, this is an important step towards more independence, because OMV would be able to cover all of its customer delivery obligations in Austria, which corresponds to almost half of the country’s total annual demand.
And third, we started filling our storages back in March and are currently at a level of more than 80%, which is equivalent to around 20 terawatt hours.
Fourth, we have made good progress on ensuring that we are able to run our operations at our major production sites with limited volumes of natural gas. Our crackers in Austria and Germany are supplied with naphtha, while the ones in Stenungsund and Porvoo are able to use naphtha, butane, ethane, propane, or LPG mix. The PDH plant in Belgium is based entirely on propane. In our Western refineries, we have been able to replace some of the natural gas with LPG, steam cracker gases, and naphtha.
Thank you for your attention. Reinhard and I will now be happy to take your questions.
Question-and-Answer Session
A – Florian Greger
Thanks a lot Alfred. Let’s now come to your questions. As always, I’d like you to limit your questions to always two at a time, then you can always re-queue for a follow-up question. The first question comes from Josh Stone, Barclays.
Josh Stone
Yes. Thanks, Florian, and good morning. Two question please. Firstly, you told about securing the gas capacity endorsed from other places right into gasoline pipelines. Can you just talk about what are the guarantees you have like gas can actually flow or how confident are you by gas can flow if it needs to? And maybe how much did you spend or how much did it cost for you to get this pipeline capacity? And then, secondly, on the working capital build. It was well-flagged. Is it reasonable to think that the working capital builds again at 3Q? And maybe if you can just explain where is gas storage levels or where are they at the end of the quarter well, just at the end of 3Q? Could — help us on that? Thank you.
Alfred Stern
Okay. Good. I’ll start with gas capacities to Austria and maybe Reinhard can take the working capital question then following this.
So what we did, Josh, is that, we participated in an annual auction and we were successful in securing 40 terawatt hours of pipeline capacity from Germany and Italy into Austria. This is the basis for a diversification of supply sources to Austria as we are a landlocked country here and it makes it possible then to also utilize norbertian gas both from our own production, but also from supply contracts that we have with other regional producers, such as Quinoa in Norway and it also makes it possible to bring capacities from our — or bring volume from the LNG capacities that we have on the Gate’s Terminal in Rotterdam. And currently, we are supplying those direct customer quantities from our Gazprom contract and this is now giving us a option to secure the supply in case this Gazprom supply should be reduced too much or fall away.
The situation — the regulatory situation may have influence on this as you point out. If the laboratory of the security of supply regulation comes in place there is to a degree intervention then of the governments how the gas is allocated to different sectors or customers. At this point, we would — the government would take over this allocation and we would also of course then be released of our supply obligations.
Reinhard Florey
Yes. Josh, maybe a question on working capital. If you look into the recent history you can see that in the past four quarters we had working capital cash outflow in each of those four quarters — last four quarters. However, the biggest negative increment was in this second quarter where we had in total net working capital buildup of €1.9 billion out of which around €1.6 billion are attributable to the gas storage. We have built up significant levels of gas storage. As Alfred said, gas storage levels of around 80%.
Now when we are looking into Q3, will that still rise? Yes, there will be an additional volumes that we intend to store because of the preparation for winter and the preparation for independence of the volatility and the curtailment of Russian gas deliveries are important to OMV also in serving our customers. So therefore, I am expecting that on the E&P side, of course very much depending on commodity prices also increase of working capital will happen. We of course will also see effects from R&M because in R&M you can imagine that with supply that we have as an alternative supply after the damage in our Schwechat refinery we have lowered our inventory levels and we have to bring them back up when the refinery is up and running again, so that’s effecting both Q3 and Q4. Whereas, we’re expecting that working capital in the Chemicals & Materials business are rather reducing. So, yes, Q3 probably will be still a negative cash out on net working capital.
Florian Greger
Thanks, Josh. We now come to Mehdi Ennebati, Bank of America.
Mehdi Ennebati
Good afternoon, all. Thanks for taking my questions. So first question is just maybe a follow-up on your gas inventory level, which are now above 80%. Should we consider that this could help you to get quite nice gas marketing business in the second half of this year? If the gas price keeps increasing, or did you already hedge your gas margin for that gas currently underground? I am asking because there is less in your gas marketing business in the second quarter creating a little bit of confusion here, so if you can help us that would be great? And the second question is on the Chemical business. Can you maybe explain us why or what are the reasons of the decrease in the polymer margin, polypropylene margin that you are expecting in the second half? Why at the same time the monomer margin remain quite resilient if I am not mistaking? So it would be good to have your view here. Thank you.
Reinhard Florey
Yes, sure Mehdi. Thanks for the question. Regarding the gas effects, of course whatever we put in storage in our gas business we have already sold forward and we’ve had also hedged. So you can image that of course we are trying to altercate positive results from that in the current environment that certainly also is possible. But there is not an exposure to the volatility of gas price now to what we have stored or what we are storing because that is immediately hedged. This is a little bit different and there might be some part of the confusion with the gas supply.
You remember that I mentioned that there is some negative effect on our gas business from the curtailments on the Russian volumes. So of course in principle if you have a month ahead contract and a month ahead supply, then you immediately hedge that to avoid the exposure to a market volatility. However, if then volumes are being reduced then you have to make up for that loss in buying gas on the market to be able to supply your customers that you have contracts with. And in that sense, there has been a loss of around €50 million from these kind of hedges that we have made and that is why also Alfred has indicted that we are now dynamically reducing also the hedging on these contract to reduce this exposure to this volatility in anticipation of further curtailment, which we, I think, have met too quite well.
So this is the areas that we are seeing. You might then wonder why the gas business is even less than the minus €50 million because we also have to apply IFRS 9 which is more or less collective liabilities or collective write-downs when it comes to credit risk of some of the counterparties that you can imagine are also suffering there. So part of the loss of around €150 million in the gas business is also attributable to this.
Mehdi Ennebati
Thank you. And then, Chemicals?
Alfred Stern
Okay. Mehdi, yes, I’ll take the second question maybe on Chemicals, on propylene, specifically. As you point out, we have, say, taken down the guidance for the full-year to the €500 per ton for the rest of the year. And before I explain it, I want to make sure to point out that we are talking here about the standard propylene margins that you have in the market, right. And when you look at this margin development and look, for example, at the Q2 result, you can see that our business is much more resilience to those moves because we have 40% of specialty contribution here with a higher margin contribution that does not follow exactly these things.
But on the standard polymer on this indicator margin why do we believe it has come under pressure, it is so that we see a certain headwinds for the demand situation and at the same time improvement in their logistic situation that we see somewhat impacts — imports coming into Europe in the — in — with the polypropylene also.
I do want to point out that we have at the same time now also increased our indicator margins for ethylene and propylene, which are import materials, right, the import cost into making polypropylene. So we think that a bit of a pricing shift from polypropylene into propylene and with this we still get quite a good situation than in this integrated supply chain for the rest of the year.
Florian Greger
Thanks, Mehdi. And next is Peter Low, Redburn.
Peter Low
Hey, thanks for taking my questions. Yes, the first, I’m sorry to get back to this is another child of flying one just on gas. And I’m just trying to better understand your exposure and, I guess, the tail risk event that there is a full Russian cutoff of volumes. So you talked about being able to use gas on storage of other hubs, but that would still likely put you in a position where you’re buying some gas on this spot market to fulfill your obligations. Am I thinking about the right way and is there any way you can eliminate, kind of, that exposure or risk entirely? And if that’s linked to that, kind of, what are the pricing terms you’re offering to your customers at the moment? Are they fixed prices or they linked to a blind spot? So that will be my first kind of question. The second should be a bit more straightforward. So the reduction in the effective tax rate quarter-on-quarter was a bit great from what I expected. Can you just give any guidance on how you expect that to evolve through the second half of the year? Thanks.
Reinhard Florey
Peter, let me start with the gas topic. As I briefly explained, the major exposure that we have is actually a month ahead pricing situation. And that has nothing to do with fixed prices or any kind of oil-linked prices or something like that. We don’t have any of that. We have, of course, only spot-related pricing in our contract.
So if your question is what happens if the Russian supply is fully cutoff? Then the — I would say burden that we have to take is actually the rest of margins, the rest of hedges, that we still have on the volumes that we have hedged because we, of course, cannot do that on zero when there is gas still flowing, that we have to buy this kind of volumes still on the market.
Now, it is important to see that we are trying to reduce this exposure with anticipations that we have on curtailments but, of course, it’s very hard to fit that 100%. So therefore, we expect that there will be some negative effects, but maybe also comparable to what I have explained for June respectively quarter two.
Then your question was on the tax rate. Indeed, we came out with a lower tax rate in Q2 than compared to Q1. In principle, there are three major reasons for that. The first is if you compare our results, Q1 versus Q2, in Q2, we have a clearly higher share of R&M and also Chemicals in there, which traditionally have lower tax rates than the E&P business. The second is that in R&M, we, of course, have also a higher result because of better results of ADNOC refining. And in ADNOC refining, as this is a minority share, this is already fully taxed as we get it and as we show it, so there is no tax on that. So in average then your tax rate also goes down.
And then, specifically on E&P, if you look at where the volumes have been coming in Q2 versus Q1, there have been significantly lower volumes from Libya, and we all know Libya is a high tax country, and more from Romania and this is comparably lower. So those are the key topics.
Maybe still one comment that the tax rate that we are showing, of course, is totally detached from the tax payment that we are showing. So the tax rate shows the tax liabilities and not the tax payments, because as Alfred has mentioned that we paid more tax in Norway, yes, because the tax schedules, which we are undergoing in each of the countries, of course, give us a schedule on what we pay when. But the total liabilities, we show in the tax rate, so this is the, I would say, independent of what we have to in a certain period pay the relevant tax rate.
Florian Greger
Thanks Peter. We now come to Henri Patricot, UBS.
Henri Patricot
Definitely going to thanks for the presentation. I have two questions, please. The first one on refining, in the Schwechat refinery. You’re expecting full utilization September/ October. You were talking briefly about the second half of the third quarter. I just wonder if you could expand on what’s proving a bit more challenging in terms of getting that feedback on stream, or at least taking a little bit longer. What’s that we’re scared that could take a bit longer than you think? And the second one, I wanted to ask about the realized gas price guidance that you’ve left and shame that that 45 for the year. And I understand that it’s only part of the production that’s linked to European spot prices. But we’ve seen a very significant increase in prices recently. So why did you decide to leave that guidance unchanged? Thank you.
Alfred Stern
Let me maybe just start with the refining incident. Here the incident happened beginning of June and then immediately we put the taskforce in place that is looking at multiple things. Two of the key parts that they look at is to build up an alternative supply system, and the second one, to come with a repair concept. And we are making very good progress along the repair concept and the plan where we are moving forward. And — but as you imagined, right, as we move forward, in the beginning of June, we did not have all the insights that we have. So we have now become a little bit more cautious to say end of September/October, because we are now fully understanding and have a more solid plan that is allowing us to make that prediction. We believe in the startup by in September/October is a realistic timeframe. Also, we were able to build that alternative supply system to ensure that we have the capability to supply the market and our customers to this. On the realized gas price, Reinhard will try and explain this to you.
Reinhard Florey
Sure, Henri. If we are looking at the realized gas price, you have seen a strong hike between Q1 and Q2. The main reason actually was that the Russian volumes were deconsolidated, and therefore the relatively low realized gas price that was in Russia partly from the buffer price, but also 50% Russian domestic price which is very low falling away, that has increased in average very much to the realized gas price.
Now, looking ahead, this realized gas prices is anticipated to be a little bit lower in the coming quarters. And the reason for that actually a positive one, that we have more volumes from Malaysia and more volumes from New Zealand compared to Q2, but both are in regulated price environments and not in the European hub price environments. So the average of the realized gas price will slightly decrease, but the volumes will go up.
Florian Greger
Thanks. So the next questions come from Raphaël Dubois, Societe Generale.
Raphaël Dubois
Good afternoon. Thank you for taking my questions. The first one will be on significant cash inflows to expect in the second part of the year. You mentioned you expect to close the transactions for nitrogen and the Slovenian fuel stations. Can you maybe say whether we should expect several loan repayment from Baystar and also any dividends may be to be received from ADNOC refining and trading now that it starts to contribute nicely to your — to your results. That will be my first question. And then, secondly, it’s again about this — this gas situation, just to better understand, who is going to bear the extra cost of the gas access? I understand that you have secured the volumes. But when it comes to importing gas that will be transported via this new pipeline access presumably it will be more expensive. So in the end, will it be you the customer or the Austrian government that will bear the fruit of the extra cost? Thank you.
Reinhard Florey
Raphaël, let me start with the cash inflows for the rest of the year, and then, Alfred, will comment on the gas situation.
Regarding the transactions of nitro and Slovenia, indeed, we are planning that those go ahead as planned. The nitro business we certainly expect until the end of this year. Slovenia, we actually also expect, but we are a little bit reliant there on what European Commission with their antitrust regulation will actually move forward. So this is something which we cannot fully commit at the moment, but nitros, looks very good, but Slovenia, although also we don’t see an execution risk at the moment maybe a little bit of a risk of timing.
Regarding other areas, dividends from ADNOC refining, actually according to the dividend schedule, there is some dividends actually planned there. Of course, we are only a minority shareholder there. So we are not fully in charge or in control of the dividends as such. But this is something at least, where we see also an opportunity as situation has improved.
And regarding the second part of the Baystar loan, this is something we are actually looking into very much how the situation of external financing is developing. You are seeing that interest rates are rising, which is another significant fed interest rate, so this is something that we are quite flexible on. And to be honest, that is a face value of gaining some cash, but indeed the liability just changes from internal to external. So I would not see that as something where we have a lot to change, if we are moving along the schedule here.
Alfred Stern
Raphaël, and the on the additional costs for the alternative gas supplies there, maybe what I would like to comment there is that, I think it will depend a little bit on the situation that we will find ourselves because some of these costs, of course, you will find reflected in the hub pricing depending on where the gas flows come and what the demand is.
And as Reinhard pointed out before, all our contracts both on the sourcing, but also on the supply side hub, in some way hub-based. But in any case, in for this particular pipeline capacities I want to mention diversification law that was put into effect in Austria, that was aimed to compensate for some of the additional cost for diversification of the supplies. The Austrian government has approved in this diversification law about 100 million to be to be assigned for those — for the diversification of gas supply and added costs to this.
Florian Greger
Thanks, Raphaël. Next is Tamas Pletser, Erste Bank.
Tamas Pletser
Yes. Good morning. There is only one question on my side. I remember when you had this accident in Schwechat you received some products from the Austrian strategic reserves. Can you tell us a little bit more about this situation? Did you receive from these strategic reserves more than one times these products? And how do you plan or what is the obligation for you to give this product back? Would you pay for this strategic reserves or would you give it back in time, I mean, in products later on? Thank you.
Alfred Stern
So maybe I start with what, what happened and how it went and maybe if I can’t cover everything on the costs, Reinhard may add.
So at the time of the accident, we were at the end of a multi-week turnaround, which also implied that our own storage was on the low side. And this triggered us to immediately inform the energy ministry here in Austria about this situation and request them to make an emergency release of some quantities that are required in the market. That was also approved then and released.
And then at the same time as we started working on our repair concept and the alternative supply concept, we identified some weeks later that we still had some gaps in some of the product areas. And through discussions, further discussions, with the government here in Austria, but also discussions in surrounding countries we came to the conclusion and got some that we needed some additional quantities and got also some further quantity supplied here in Austria to make sure that we can cover the required market demand and supplies. So that — that happened so far.
And the requirement is, of course, that we need to replenish those quantities that we have that we have received to ensure also that they are then in the reserves again after we get through this emergency accident here. And there we have a slightly different kinds of arrangements, how we do that, but always there is a requirement to replenish the quantities.
Tamas Pletser
And do you some timeframes for that?
Alfred Stern
Yes, there is some timeframes that are looking to replenish those in the months after the startup, again, off the — off the refinery, as you will realize right is required the balancing of the supply/demand situation there that that we cannot then not use their entire capacity just to replenish, but so we will have a couple of months going forward from there.
Reinhard Florey
And regarding the financial impact of that, as Alfred explained, this is more or less giving back in kind. So all what we are doing actually is when we are taking something then, we are, of course, buying immediately something forward in the future at that point of time in the market. So there are some smaller effects coming from that, the — maybe some small positive effects if the market is in backwardation, but this is not a major impact.
Florian Greger
There’s a follow-up question from Mehdi.
Mehdi Ennebati
Yes, hi, Mehdi, again, Bank of America. Two questions please. First one, on Baystar, so you started the — you will start the polyethylene, the steam cracker, this year and you have been highlighting quite a long time that this is a new technology, et cetera. Should we expect pretty high margin, or let’s say, top range margin from Baystar or at least to your other chemical assets or no? And should we consider that most of Baystar polymer production will be, kind of, a specialty chemical, meaning that you will have enough fixed margins or no? Just for me, you know, to try to model that? And the other question is, again, on the gas side regarding what you said earlier, so you said that you can fill-in your contractual obligation in Austria thanks to the new, let’s say, pipeline capacities that you have been securing. What about your German obligations? Are you able to cover them? And also when you say you are able to cover your obligations, is it from now on, is it from 2023, and does this include your gas inventory that current value which is particularly high or no? Thank you.
Alfred Stern
Thank you. Maybe let me start with the Baystar joint venture. What we had as a, so the Baystar joint venture started off with about 400,000 ton of polyethylene capacity that was not integrated. The project that we had was to build a cracker for a 1 million ton of ethylene and polyester polyethylene for 625,000 tons of polyethylene, polyester polyethylene, and with this it then becomes fully integrated 1 million ton complex that will produce polyethylene. They are based on ethane — ethane from U.S. source.
Now, the first step we have now succeeded in the beginning of July to startup the cracker that is converting ethane into ethylene. And the complex, while the polyester polyethylene is not yet on stream, we are making good progress in constructing this and we are expecting that before the end of the year, in the fourth quarter, we will startup that polyester polyethylene plant. In this transition period we will be lone ethylene, but we will of course, start supplying the already existing 400 kilotons of PE capacity there.
As in general, your statement that our aim is to make differentiated polyethylene products that are aimed for specialty segments such as wire and cable, for example, is correct. However, the procedure with these very big complexes that you have to start them up and you have to get them running at full capacity, so that this will go over a couple of months before you can come to the full capacity, but it is based on advantaged ethane from the U.S. and the aim is to go into differentiated products there.
On the gas situation, this — okay, so let me try and figure out the — if I remember all your question there. On the gas situation, you are correct; we were talking about the 40 terawatt hours coming to Austria and contractual obligations that we have towards the customers here. We do also have a German contract which is built in a similar way. So we don’t have any fixed price and we don’t also have any will linked prices, which means the exposure there is also in a similar way to the 30 day ahead as Reinhard was explaining it. We believe that situation in Austria is fundamentally different, because it is a landlocked country and it does require the entry capacity into Austria either through Germany or Italy, because historically only the entry capacities from the East were available and booked for the Gazprom contracts and that’s why this is a — this was a important step for our gas business.
Mehdi Ennebati
Okay. But just to illustrate to what I wanted to understand, so imagine Russia gets its whole gas supply to Germany, will you be able to supply your customers, your German customers, with natural gas or no?
Alfred Stern
So, if they — if really this is cut 100% I am afraid the government will need to step in and start allocating to certain segments where they want to continue operations, and that would basically relieve us from our capability of doing our own allocations.
Mehdi Ennebati
Okay. Thank you. And last question. Is there a risk — would you say that there is a risk or there are some discussions between the industry and government of gas price gap for households in Austria in case gas prices keep increasing or just because gas prices are relatively high currently? I am asking because this is already the case in Romania and yes, and why not in Austria?
Alfred Stern
I think under the current situation with the inflation and the high energy prices; I think this discussion is taking place everywhere in Europe. But also in many other places in the world, which is also understandable. I think the Austrian government here has so far chosen a different approach to find ways how to support low income or households that are coming to their limits in terms of spending and maintaining the things. We do not know at this point of such a idea here.
Florian Greger
Thanks, Mehdi, for your follow-up questions. I lost count on how many that were but anyway, now we come to Raphaël Dubois, Societe Generale with another follow-up question.
Raphaël Dubois
Thank you. Two quick follow-ups. The first one is on the inventory effect in Chemicals & Materials. Could you please tell us how much it was this quarter on? And also on PP5 at Borouge, can you just say where you are in the ramp up process of this unit because when I look at your quarterly data for polypropylene GV volumes, it’s still roughly what it was in 2020. So I just like to understand when do we see a step-up in volumes on that line?
Alfred Stern
Yes. Let me maybe start with PP5 in Borouge and then maybe, Reinhard can help me out on the inventory question in Chemicals & Materials.
On PP5, we were actually able to start up the plant and ramp it up to the full production. What we observed at the same time in the second quarter was some curtailment of propylene supplies from the refinery in ADNOC. We expect this to improve on the way forward and with this also to then see the volume increase.
Raphaël Dubois
Great. Thank you.
Reinhard Florey
And Raphaël, on the inventory effect, you’re right, there was a positive inventory effect in Chemicals in the second quarter. It’s in the range of some €50 million and we are expecting that this falls away in Q3 because we are not expecting that the prices are going up further. So this is something where we have to adjust in the expectations.
Florian Greger
Thank you, Raphaël. And now we come to Bertrand Hodée, Kepler Cheuvreux.
Bertrand Hodée
Yes, hello, I only have just one question left again on gas hedging on a month ahead. You indicated at Q2 Trading Update a loss of around €50 million in Q2 to cover your month ahead exposure after gas from curtailed volumes. Can you give us any color if you had a similar impact in July?
Alfred Stern
I cannot give you exact details of course, Bertrand. But if you follow what has happened in July, then you see that there was again volatility, and every volatility actually is something that is then taking us off path from an expected level of hedge. So you can expect that there is a negative impact from that also in July on the on the gas side. But as said we are trying to mitigate that by also having different levels of hedges according to the anticipation of how curtailments would come.
Florian Greger
So we now come to the end of our conference call. Thanks a lot for joining us today. If you have follow-up questions, the Investor Relations team is happy to help. Have a good day. Thanks again
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