Hellenic Petroleum — Introduction to decarbonisation plans

Hellenic, a leading oil refiner in Greece, operates three refineries that account for 344kbod of capacity and 65% of the Greek refinery output. Two refineries (Aspropyrgos and Εlefsina) are complex, integrated and provide significant flexibility of feedstocks and throughput. The third, Thessaloniki, is small and simple, but houses Hellenic’s petrochemicals units. A composite Nelson complexity index (NCI) of 9.3 for all three refineries indicates the complex’s flexibility and ability to produce a high percentage of light products from every barrel. The refineries are linked, allowing better integration to take advantage of their strengths of location, size, storage and complexity. Hellenic is active in the fuels marketing, power and gas sectors and since 2020 it has built up its renewable power generation capacity, with the acquisition of the Kozani 204MW PV project.

Amid future decarbonisation (with the EU’s binding target of becoming carbon neutral by 2050) and the prospect of decline in oil demand in Europe, the company decided to take action to protect its core business. Hellenic has placed its environmental, social and corporate governance (ESG) and greenhouse gas (GHG) emissions targets as core pillars of the strategy of creating a balanced portfolio across its refining business (with improved competitiveness) and its new energy (RES) business. In June 2021 Hellenic amended its corporate governance to comply with new national (L.4706/2020 and L.4548/2018) and European legislation, which ensures a compliant composition of the board of directors with regards to independence and gender representation. By this strategy, Hellenic hopes to ensure its business is competitive for the next decades. This step addresses both investors’ growing focus on ESG factors (affecting market valuation) and significantly increasing costs of CO2 emissions coming from current EU decarbonisation actions.

Hellenic is also redesigning the group structure, aimed at supporting its Vision 2025 strategy, giving it a fit-for-purpose legal structure and the ability to better capture growth opportunities, through appropriate financing strategies. On 29 July 2021, Hellenic initiated its hive-down process with the spin-off of its refining, supply and trading, and petrochemicals businesses, and their transfer to a new 100% owned entity. The balance sheet and valuation date of the hive-down business has been set as 30 June 2021. Completion of this process is subject to the normal approvals.

The EU has adopted integrated rules towards its 2030 climate and energy targets and international commitments under the Paris Agreement (the objective is to keep the global temperature increase well below 2°C). In April 2021, the EU raised the climate target to reduce net GHG emissions by 55% by 2030 (compared to 1990) from the previous target of a 40% reduction. Achieving that target should be supported by the ‘Fit for 55’ package of climate proposals introduced on 14 July 2021.

One of the tools that supports reducing emissions is the European Union Emissions Trading System (EU ETS), which previously covered roughly 40% of total emissions in the EU. With the Fit for 55 proposals, the EU plans to expand it to other sectors (such as maritime, with the introduction of new ETS for transport and buildings from 2026). The new proposal will affect fuel suppliers as they will have to buy allowances to sell fuel on the market (for transport and buildings). Another proposal that will affect fuel demand includes measures to ban the sale of new gasoline- or diesel-powered vehicles from 2035, thereby mandating a complete switch to electric cars and leading to a further decline in oil demand.

Greece is becoming one of the leading countries in the EU in terms of energy transition, exceeding by 30% its 2020 target for the share of RES in gross final energy consumption (24% vs target of 18%). Additionally, the country accelerated the phase out of all lignite power plants by 2025 (versus the previous aim of 2028) and is planning further increases of RES (aiming at 35% RES share in the gross final consumption of energy and 14% in the transport sector by 2030; to be revised upwards to become compliant with Fit for 55) supported by government reforms to standardise and simplify licensing procedures for renewable projects. Greece’s countrywide focus on RES bodes well for Hellenic’s own transformation plans.

To address increasing CO2 costs and changes in regulations, Hellenic intends to drastically decarbonise its activities, aiming at a 50% reduction in CO2 emissions by 2030, which should also improve its competitiveness. It plans to reduce the carbon footprint of its refining operations by approximately 30% in terms of direct (scope 1) and indirect (scope 2) emissions investing in new green technologies. Hellenic wants to achieve this through:

The remaining 20% of CO2 reduction should come from significant expansion of Hellenic’s RES portfolio, with a medium-term goal of 600MW of installed capacity by 2025 and 2GW by 2030. Hellenic plans to realise the targets organically, through acquisitions or joint ventures, allowing for faster market entry and growth.

Hellenic plans to spend €3.5–4bn on these initiatives by 2030 (implying up to €400m in annual capex on average vs €200m average capex spent 2015–2020), with about half of these investments to be spent on the core refining business, including decarbonisation initiatives as well as maintenance; and the rest (c €1.7bn) on expanding the RES portfolio toward 2GW by 2030.

The strategic plan also includes changes in corporate structure and governance, and in the group's name. Management is considering setting up a new holding company and removing ‘petroleum’ from its name to reflect the new structure, which is not focused on oil alone.

Hellenic plans to implement its strategy starting at the Elefsina refinery (currently 106kbod, NCI 12.0), making the refinery a testbed for energy transition and decarbonisation. It plans to invest in a cogeneration unit to improve the security of supply and make investments towards energy efficiency. In the long term, it plans to derive blue hydrogen through carbon capture, start pilot production of green hydrogen using RES electricity and produce on-site solar energy. However, at this stage no details on these plans have been provided.

Additionally, Hellenic plans to upgrade the Thessaloniki refinery (current conventional products capacity of 90kbod, NCI 5.8) with a second-generation biodiesel coprocessing unit to increase sustainable feedstock in fuel products. At this stage, it is unclear whether this will be a conversion of conventional capacity or an additional unit. Strategically, this makes sense for Hellenic as it leverages the competencies in its core refining business. We await information from Hellenic on the level and timing of investment, along with targeted biofuel production capacity before including this planned business unit in our forecasts and valuation.

The investment in the biodiesel production would be a response to growing demand for biofuels, supported by the EU’s decarbonisation policy, with the 14% binding target of renewable energy share in the final energy consumption in the transport sector (based on the Renewable Energy Directive (REDII), which is now under revision to comply with the new 2030 target of 55% emissions reduction).

Further efforts to improve the competitiveness of Hellenic’s refineries include the ongoing digital transformation programme (introduced in 2020) and procurement reorganisation projects. Both should lead to optimisation of the refining operation model, maximising the capabilities of all refineries and the synergies between them, resulting in potential financial benefits. On the trading side, the company plans to increase exports to the Mediterranean and the Balkans (FY20 exports accounted for 61% of total refinery sales), improve international oil trading capabilities and transform fuels marketing towards new energy services and products, such as electric vehicle charging infrastructure. We await details from Hellenic on the targeted number of charging stations and timeline.

Hellenic is targeting a significant expansion of its RES portfolio to 600MW by 2025 and 2GW by 2030, initially via PV and onshore wind projects, growing organically and through acquisitions within and outside Greece. In addition to the Kozani 204MW PV project, which is expected to start operations in Q122 and will be the largest solar plant in Greece, the company has secured 300MW of PV and wind projects at an advanced permitting stage (receiving environmental terms and/or binding connection agreements). It has 26MW of RES in operation, comprising 19MW of solar PV and 7MW of wind and the construction of further 2MW PV is expected in 2021 (in Mandra, adjacent to the Elefsina refinery). Hellenic plans to deploy €1.7bn of capital by 2030 to reach its target of 2GW. Wind and solar projects in Greece offer the potential for stable, long-term cash flows based on a combination of feed-in tariffs and power-purchase agreements. Hellenic’s expansion in RES will leverage the experience it has gained in power generation through a 50% stake in Elpedison (the second largest independent power producer in Greece with c 5% market share and 810MW installed capacity). In addition, the company sees potential synergies from the renewable investments with the rest of the business.

The transition would be supported by the local political environment since the Greek government has committed to shutting down all lignite-run electricity production units by 2025 – the Public Power Corporation, controlling all lignite power generation assets in Greece, will phase out c 2.8GW of lignite assets by the end of 2023. Greece has a target (under EU law) of increasing the share of gross energy consumption from renewable sources to 35% in 2030 (vs 24% in 2020). To achieve this, it is targeting 19GW of RES in 2030, up from an estimated 10GW by end-2020; that means Greece needs an additional c 9GW of new RES capacity by 2030. Thus, clearly there is an opportunity for Hellenic to add significant capacity in Greece. If a total of 2GW is invested in new installations in Greece, Hellenic would have a c 20% share in new RES capacity in the country and become a significant market player.

Additionally, Hellenic wants to scale up its petrochemical business, deepen vertical integration with refining and expand the output of high-value products. It sees petrochemicals as the main source of global oil demand growth in the coming years. In May 2021, Hellenic announced plans to increase the capacity of its PP plant in Thessaloniki by 25% (to 300,000 metric tonnes). Currently, Hellenic is the only petrochemical producer in Greece, with a market share of c 50% and approximately 72% (in FY20) of sales volumes exported (to Turkey, Italy, the Balkans and the Iberian).

We compare Hellenic’s energy transition plans with those of its peer group. We summarise our findings in the table below (Exhibit 2). We note that Neste is an outlier as it has been an early mover, expanding into renewable diesel for more than a decade. Renewable diesel accounts for more than half of Neste’s earnings (more than 90% in 2020, when conventional refining was especially weak). For the rest of the peer group, which comprises Motor Oil, PKN Orlen, Lotos, Saras and Tupras, we find no significant differentiation. Although most companies have explicit near-term RES targets, only Hellenic and PKN Orlen have 2030 RES targets and committed reduction of c 50% CO2 emissions by 2030. All companies in the peer group with the exception of Neste mention long-term plans for renewable diesel, carbon capture and storage (CCS), blue/green hydrogen and plastic recycling, but with limited specific strategic investment plans or targets for each of these areas.

Neste’s example shows the potential for valuation increase as a result of the transformation from a regional oil refinery to a global leader in renewable diesel. With this transformation process starting in the 2000s, Neste’s 12-month forward P/E valuation has increased from 16.4x in 2010 to 30.8x currently. All mentioned companies (except for Neste) present partial transformation plans, maintaining high-carbon product through investing in renewable sources of energy (eg Saras), or have no clear transition plans but a focus on waste management, emissions and energy consumption (eg Tupras).

Our updated forecasts and valuation are based on Hellenic’s existing portfolio of assets. Due to a lack of information, we have not included any future projects presented in Vision 2025, required capital expenditure or potential returns associated with them in our model. We await more details from Hellenic on its transformation plans, which would enable us to incorporate new strategic projects into our financials and valuation.

For Hellenic, as for all other refineries, earnings are highly dependent on changes in refining margins, affected by global supply/demand and price trends. As a price taker, Hellenic can do little to mitigate this in the short term. However, to address this issue in the medium term, it is focusing on increasing its vertical integration and the share of operations that are not dependant on refining margins, such as the petrochemical business, and diversification towards RES (the Kozani project).

Crude oil prices averaged c US$69/bbl in Q221 compared to c US$61/bbl in Q121 and were significantly higher than the FY20 average of c US$42/bbl. H121 saw a recovery in oil prices from the multi-year lows recorded in Q220, supported by the agreement to control crude oil production and exports from the Organization of the Petroleum Exporting Countries and their allies (OPEC+). Refining margins have seen a recovery in H121, as inventory started to clear, supported by signs of post-COVID-19 economic improvement. After a month of uncertainty (negatively affecting margins) OPEC+ reached a compromise on 18 July to increase oil supply gradually, phasing out the 5.8mbod production cuts it made in spring 2020. As a result of the agreement, crude oil prices are expected to decline and benchmark refining margins have started to increase.

The overall macroeconomic environment is likely to improve as progress in coronavirus vaccination programmes gradually increases domestic traffic and air travel. Hellenic should benefit from the resultant tourist inflow, with Greece reopened to tourists from mid-May, and from pandemic restrictions lifting around the world. These should drive the increase in domestic demand for jet and road fuel in Greece and neighbouring countries. However, there is rising uncertainty surrounding future demand for oil due to the spread of Delta variant in some regions, although it is difficult to quantify the potential effect and its duration.

We expect an operating cashflow of €458m in FY21 (versus €425m previously), which will cover a high level of capital expenditure of €266m in FY21 (€288m in FY20) and dividend payments of €31m. The elevated capex includes €106m investment in the Kozani PV project (out of €130m) and €160 maintenance capex for scheduled turnarounds (company’s guidance: €150–180m). For FY22 and FY23, we include the €35m PP plant capacity expansion project (assumed €17.5m each year), which should be completed by FY24, and we expect it should generate EBITDA of c €6–7m annually. Apart from those clearly specified investments (PP expansion project) for our forecasts, we include only maintenance capex (€130m annually), which excludes any potential benefit from any future growth programme from Vision 2025 (such as capital costs, revenue or margin improvement).

In Q121, higher net debt (€2.2bn excluding leases, versus €1.7bn as of end-2020) was driven by higher working capital (due to increased payables and inventory), mostly affected by a significant increase in oil prices. Hellenic improved its capital structure in FY20, leading to financing costs at multi-year lows and below the €100m annual run-rate. As the capital structure and refinancing plans are under review on account of Vision 2025, we await more details. Hellenic may be able to fund some of its decarbonisation activities through issuing green and sustainable bonds. We note that in Q221 PKN Orlen issued €500m of 1.125% green bonds due in 2028 for its transition strategy initiatives.

Key changes to our near-term financial estimates and market expectations include improved performance in petrochemicals in FY21 (+14% vs previous estimates), supported by high margins in PP and higher expected oil prices and the impact of the PP capacity expansion project (that should become operational in FY24), which we now include in our model for the first time. Our oil price assumptions, based on the most recent US Energy Information Administration’s forecasts for FY21 (US$69/bbl), are up 10% compared to our June estimates.

We have lowered our refining margin estimates to reflect realised margins in Q221: Aspropyrgos averaged US$2.19/bbl, Thessaloniki US$1.95/bbl and Elefsina US$0.01/bbl, resulting in a refining margin implied by benchmarks of c US$0.70/bbl versus US$1.50/bbl in our previous estimates. We expect margins to improve in H221, as oil demand should increase with the summer tourist season, the gradual recovery of the global economy and the positive effect of removing the uncertainty around the OPEC+ decision on supply increase. As a result, we keep our refining margin assumptions unchanged for H221.

All in all, our FY21 total adjusted EBITDA estimate is 2% higher compared with our previous estimate, while FY22 EBITDA remains unchanged as the changes offset each other.

Our forecasts and valuation are based on the current shape of the company. We do not include future projects presented in Vision 2025, capital expenditure or returns associated with them and we await further information from the company.

We value Hellenic using a blend of DCF, leveraged and unleveraged EV/EBITDA, and P/E multiples, arriving at a valuation of €6.73/share, 3% lower versus our last published estimate (€6.91/share). This decline is mainly driven by the lower peer group-based valuation, affected by unfavourable market movements: increases in oil prices and rising uncertainty surrounding future demand for oil due to the spread of Delta variant in some regions.

Our DCF valuation has increased from €6.80 to €7.46 per share on the back of the favourable PP price movements (based on revised oil price assumptions) and €35m PP capacity expansion project (€0.22/share), which we have now included in our model. Changes to our forecasts are shown in Exhibit 6 above. Our valuation is based on cashflows to 2035, using a 7% cost of capital. We incorporate a terminal value, which assumes the unwinding of working capital, and 1% terminal growth.

In the absence of more detailed information from the company, we provide a preliminary, high-level estimate of the potential impact from the addition of the 2GW RES portfolio. We expect this could add c €0.35 per share of potential upside to our valuation with the project internal rate of return (IRR) at 8.3% (IRRs for such projects can vary in the range of 5–8% for acquisition projects and 8–10% for organic development projects). For our estimates, we have assumed the 2GW is 100% solar and based them on the data available for Greece RES market (which includes an electricity price of €40/MWh based on recent auctions in Greece, a capacity factor of 20%, nominal project debt finance of 75%, cost of debt at 2%, total investment cost at €550/kW (engineering, procurement, construction, development) and operation and maintenance costs at €10/kW). In that scenario the RES segment may potentially generate €110–160m in annual EBITDA (when 2GW become operational), leading to a significant addition to total EBITDA (vs €617m average EBITDA during 2017–2020). We note that the company also plans to develop onshore wind as well as batteries and offshore wind projects in the future. At this stage it is too early for us to include these future projects in our valuation.

Hellenic trades at FY22e multiples of 7.8x P/E and 6.4x EV/EBITDA, compared with the European group averages of 7.5x and 5.2x, respectively. Its EV per complexity-adjusted barrel is higher than European peers’ average at $1,577bod. At the same time, it trades at a discount to its US peers on most valuation metrics.

In 2020, the market caps of Hellenic and its peers decreased by an average of c 35%, hitting low points in March and November. Concerns about lower global demand for oil and petrochemicals had a negative effect on global refining systems. Nonetheless, compared with its European peers, Hellenic benefits from a flexible refining system with large storage capacity. Between November 2020 and mid-June this year, its share price increased 59%, in line with peers, as the market responded favourably to the vaccination programme and higher oil demand. However, since mid-June 2021, refining companies’ stock prices were negatively affected by unfavourable market movements and rising uncertainties: between 18 June and 20 July Hellenic’s price dropped c 15%, while its peers declined 17%. That was mostly an effect of US dollar strengthening (translating to higher oil prices in local currencies, which adversely affects oil demand and refiners’ profitability), record-high oil prices (implying high feedstock costs for refiners), uncertainties from the OPEC+ decision, and a decline in refining margins due to lower demand for some oil products (demand for jet fuels has not recovered). With the OPEC+ agreement (on 18 July) to increase oil supply positively affecting benchmark refining margins, share prices have started to increase (Hellenic’s price is up 4% since then).