Notorious Polish oil trader J&S at least boasts IPO name recognition

By bne IntelliNews March 7, 2007

Jan Cienski in Warsaw -

J&S Group, the mysterious oil trader that sprang up out of nowhere during the chaos of post-communist Poland and swiftly seized a dominant position in importing crucial Russian crude, announced Monday that it's planning an IPO on the Warsaw Stock Exchange. Its floatation will undoubtedly be as talked about as its often controversial past.

Now called Mercuria Energy Group, the Cyprus-registered company, has long been the subject of media scrutiny and political attacks in Poland, where concern over the reliance on Russian energy and little-known companies that supply the oil has national security overtones. For many in Warsaw, the memory of living in a country where Moscow called all the shots remains fresh.

Lech Kaczynski, Poland's president, has said that while the prospect of Russian tanks clanking westwards back into Poland is remote, the country has to remain on guard to not fall under Moscow's control through other means.

J&S was founded in 1993 by two former Soviet citizens, Slawomir Smokolowski and Grzegorz Jankilewicz – a pair of musicians who had moved to Poland in the 1980s and made a small fortune trading musical instruments and household appliances.

One of their contracts was supplying Russian oil companies everything from washing machines to photocopiers. In an interview with Poland's Rzeczpospolita newspaper, Smokolowski said: "At one point they proposed that we buy crude from them." The reason, he explained, was that the pair of traders were more worldly than the Siberian oil barons, and spoke better English.

Armed with that surprising assurance, the two set up their company and then approached Poland's state-owned oil refinery in Plock, signing a first contract to supply 30,000 tonnes of crude. Within a few years J&S had seized a dominant position on the Polish market, supplying more than two-thirds of the country's crude.

"It's very unclear how they got a start in this business and how they've managed to get such great contracts," says one sceptical oil analyst.

Even so, the company has always maintained that all of its business has been clean and above-board, despite the corruption-ridden image of the Russian oil industry.

By the late 1990s, a startled Polish government woke up to the fact that it was almost entirely dependent for its crude imports on a tiny and little-known company. Warsaw began to take a closer look at the company, amid worries that it was linked to Russian intelligence. However, numerous investigations have failed to find any incriminating evidence about J&S.

"This is one of the most investigated companies in Poland," says David Ensor, Mercuria Energy Group's spokesman, calling all allegations of wrongdoing, "complete nonsense."

"If we'd ever done anything illegal, we'd have been dead already," he says, sitting in the J&S's downtown Warsaw office, the scene of a well-publicised raid by Polish security officials last year.

Controversy over ties with J&S was one of the reasons behind the spectacular 2002 arrest of Andrzej Modrzejewski, the former chairman of PKN Orlen, Poland's largest oil company, which is 28% state owned. He was arrested by armed officers in the glare of television cameras to prevent him from signing a new contract with J&S, a step officials in the ex-communist government at the time said was to protect the country's energy security.

Poland's parliament set up an investigative commission to look into the arrest, PKN and Poland's energy security. Both Smokolowski and Jankilewicz testified before the commission, denying they had any ties to Russian intelligence services.

Although Modrzejewski was cleared of all wrongdoing last year by Polish courts, the 2004 parliamentary hearings helped discredit the ex-communist Democratic Left Alliance party so thoroughly that it was trounced by the centre-right in the 2005 elections. Despite the change in governing parties, J&S continues to have a difficult time with Warsaw politicians. Modrzejewski's successor signed contracts with other energy traders, lessening PKN's dependence on J&S.

Notorious J&S

The numerous controversies have made the J&S name one of the most notorious in Poland. In most countries the average citizen has never heard of obscure oil trading firms; this is certainly not the case with J&S in Poland. Even sponsoring Poland's most prestigious tennis tournament, the J&S Cup, has not burnished the oil trader's image.

Nevertheless, management is convinced the company’s controversial name will not scare off investors interested in any IPO. Grzegorz Zambrzycki, the company’s CEO, told the Gazeta Prawna newspaper that "there is great appetite" for J&S Energy shares.

Although not as dominant in the past, the newly named Mercuria Energy Group's local oil trading affiliate, J&S Service and Investment, continues to play a large role in Polish energy, supplying about 55% of the country's crude under two contracts with PKN and with the smaller Lotos Group, which are set to expire in 2009.

"We don't intend to abrogate the contract," says Piotr Kownacki, PKN's new chairman.

Despite an oft-stated preference for dealing directly with oil producers, Polish oil importers have little choice but to deal with these oil traders. Russian oil companies refuse to sell directly to end consumers, instead authorizing middlemen like J&S to sell on the crude supplied by the Druzhba pipeline.

"These aren't decisions over which we have any influence," says Kownacki. "Transneft (the Russian oil pipeline monopoly) decides who will send oil down the pipeline and sell it."

It is not just contracts with J&S that are controversial. Kownacki's immediate predecessor, Igor Chalupec, has been criticized for signing a $6bn agreement for delivery of 3.36m tonnes of crude with Petraco Oil Co., an oil trader registered in the tax haven of Guernsey. Poland's Internal Security Agency reportedly suspects Petraco of money laundering.

Having made their fortune in Poland – Smokolowski and Jankilewicz were ranked Poland's 10th and 11th richest men with fortunes of about $500m each in the latest annual survey by Wprost magazine – the pair have begun to diversify their company away from relying on the Polish market and on supplying pipeline-borne Urals-grade crude.

"Poland is a much smaller part of the business than it was a few years ago," says spokesman Ensor.

In 2004, they hired two top oil traders, Marco Dunand and Daniel Jaeggi, and set up Geneva-based Mercuria Energy Trading, a name which earlier this year was adopted by the whole group. Dunand and Jaeggi have about 30% of shares in the group, which together with several smaller shareholders is thought to put the original founders at just above 50% of the company. It is not clear what effect the IPO will have on the shareholder structure.

The group now earns two-thirds of its revenue outside of the Russian market. Last year it traded about $20bn of oil and other energy products, up from $15bn a year earlier. The privately held company does not release profit figures, but estimates put the group's value at about $200m.

Mercuria trades oil from Angola, the Caspian Sea basin, Canada and the North Sea, sells about a third of Russian crude destined for China, and is looking at entering the liquefied natural gas (LNG) market. In all, the company buys oil and petroleum products from about 20 countries and sells them on to 46 others.

Mercuria has entered into a joint venture with US-based Cheniese Energy, and plans to build four LNG regasification plants on the US Gulf coast, as well as commissioning two LNG tankers.

In Poland, Mercuria's two subsidiaries are retaining their J&S names. J&S Service and Investment supplies Russian crude to Polish refiners, while J&S Energy runs a network of filling stations, is involved in fuel distribution, import and export of chemicals, and is looking at expanding into biodiesel.

"We're not running from our past," says Ensor, explaining the decision not to shy away from the J&S name in Poland.

J&S Energy has decided to build two biodiesel plants in Poland, as well as one near Amsterdam, at a cost of about €95m. Taking into account possible future acquisitions, J&S Energy expects to be producing as much as 700,000 tonnes of biodiesel a year, making the company one of the largest producers on the continent. About three-quarters of the plants' production will go to Mercuria Energy Group.

J&S Energy's expansion into biodiesel is expected to be funded by the IPO on the Warsaw Stock Exchange.

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