The main legislative act governing the hydrocarbon exploration and production business in Poland is the Geological and Mining Law. It regulates the ownership of minerals, the organisation and supervision of mining and geological work, and the responsibility for damage caused by mining operations. Geological and mining activities are subject to supervision by competent geological and mining supervision authorities. The Geological and Mining Law provides for criminal sanctions for a failure to comply with its regulations, and specifies the upper and lower limits of royalty fees.
On January 1st, an Act Amending the Geological and Mining Law came into force, with new or amended secondary legislation thereto taking effect as of May 2015, introducing a number of material changes to the regulatory environment of the Exploration and Production segment, including an integrated licence (covering hydrocarbon exploration, appraisal and production) and obligatory qualification procedures. It also allowed consortia to apply for licences and markedly increased royalty fees (while maintaining the previous royalty regime for marginal deposits).
The new licensing system may significantly slow down the administrative processes, leading to a decline in the number of hydrocarbon exploration and appraisal licences issued in Poland.
Under the new Act a qualification procedure was carried out for PGNiG during which the Company was reviewed and evaluated in terms of both the state’s security and relevant experience. At the end of 2015, PGNiG and Lotos Petrobaltic SA were Poland’s only companies to have been approved following the qualification procedure. The approval is required to apply for new licences for exploration and appraisal of hydrocarbon deposits and for production of hydrocarbons from deposits, which are to be awarded in 2016 in ex officio tender procedures announced by the Minister of Environment, and for the purposes of converting the hydrocarbon exploration and appraisal licences held by the Company into integrated licences.
As at December 31st 2015, PGNiG held the following licences, granted pursuant to the Geological and Mining Law:
The Act on Special Hydrocarbon Tax, passed on July 25th 2014, introduces to the Polish tax regime a tax on profits from hydrocarbon production and adds crude oil and natural gas production to the list of activities specified in the Act on Tax on Production of Certain Minerals of March 2nd 2012 subject to the tax on production of certain minerals. Under the Act, PGNiG is obliged to pay a royalty calculated based on the value of the extracted resource. The Act came into force on January 1st 2016. The obligation to pay the special hydrocarbon tax and the tax on production of certain minerals in respect of production of oil and gas will arise as of January 1st 2020. Introduction of those taxes will significantly increase PGNiG’s tax burden, which may have an adverse effect on the Company’s financial performance and, consequently, on its ability to invest.
The PGNiG Group’s exploration and production operations abroad are regulated by local legislation and executed agreements (such as the Exploration and Production Sharing Agreement (EPSA) in Libya).
In Norway, a licence governs the holder’s rights and obligations towards the Norwegian state. The document supplements the requirements provided for in the Petroleum Act and sets out detailed terms and conditions for cooperation. It grants exclusive rights to carry out surveys, exploration drilling and production of oil and gas within the defined geographical area and time frame. Each interest holder owns its share of the oil and gas produced under the licence.
Licences are awarded solely through Licensing Rounds (no bilateral talks may be held, which supports competitiveness of the process).
In Norway, there are two types of Licensing Rounds: (1) ‘numbered’ Rounds – in which new exploration areas are licensed (previously unavailable) – organised every two or three years; and (2) the APA Rounds − in which mature areas, relinquished by other interest holders, are relicensed (held every year).
Each Round begins with the Ministry of Petroleum and Energy indicating the open exploration blocks (a list is prepared based on earlier nominations of companies and analyses carried out by the Norwegian Petroleum Directorate). Licences may be applied for by any company, individually or as part of a group.
The award process is based on the ranking of applications. The winning applications are the ones showing the best understanding of geology rather than those providing for the largest scope of work. It is in the Ministry’s interest to award a licence to the most competent applicant.
The Norwegian petroleum tax system is based on two parallel regimes:
Although the marginal tax rate on oil production is high, the effective tax rate is markedly lower and the tax solutions in place allow operators to see a relatively quick return on investment.
The main risk inherent in exploration activities is the risk of failure to discover reserves, i.e. exploration risk, meaning that not all structures identified as potential hydrocarbon bearing formations actually contain a sufficient accumulation of hydrocarbons.
The reserves estimates and production projections may be erroneous due to imperfections inherent in the equipment and technology, which affect the quality of acquired information concerning the geological factors and reservoir characteristics. Irrespective of the methods applied, data on the volume and quality of commercial reserves of crude oil and natural gas are always estimates. The weight of this risk is further increased by the fact that in the full business cycle the period from the commencement of exploration to the launch of production from a developed field takes six to eight years, while the production phase lasts from 10 to 40 years. Each downward revision of the size of reserves or estimated production quantities may lead to lower-than-expected revenue and adversely affect the PGNiG Group’s financial performance.
The risk is managed by including in the economic analyses of exploration projects both the chance of success and various levels of recoverable reserves (P90, P50 and P10), representing the expected probability distribution of the size of reserves.
A risk associated with exploration for unconventional gas in Poland relates to the lack of proved reserves of shale gas and tight gas. Even if the existence of in-place petroleum is confirmed, its production may prove uneconomic due to poor gas recovery and high investment expenditure necessary for well drilling and construction of production infrastructure. Another material factor is that access to unconventional gas plays may sometimes be difficult given the environmental regulations and the necessity to obtain the landowners’ consent for access.
Under the applicable Polish laws and regulations, the process of obtaining a licence for exploration and appraisal of crude oil and natural gas reserves lasts from one to one and a half years. In the foreign markets, such procedures may take up to two years from the time that the winning bid is awarded until the relevant contract is ratified. Prior to the commencement of field work, the Company is also required to make a number of arrangements, for instance to obtain legal permits and approvals for entering the area, and to meet the environmental protection requirements and, in some cases, requirements related to the protection of archaeological sites. It is also required to hold tenders to select a contractor. All this delays the execution of an agreement with a contractor by another few months. Frequently the waiting time for customs clearance of imported equipment is very long.
Formal and legal hurdles, often beyond PGNiG’s control, are factors that significantly delay its investment projects and on-site construction work, which increases the risk related to underestimation of capital expenditure.
The risk is managed by ongoing monitoring of the project status and taking action by the licence Operator whenever any issues arise.
Exploratory work is capital intensive, given the prices of energy and materials. The cost of exploratory work is especially sensitive to steel prices, which are passed onto the prices of casing and production tubing used in well completion. An increase in the prices of energy and materials drives up the cost of exploratory work. To reduce the cost of drilling operations, in 2011 PGNiG introduced a daily rate system into its procedure to select drilling contractors.
Both on the Polish market and abroad there is a risk of competition from other companies in the acquisition of licences for exploration and appraisal of hydrocarbon deposits. Certain competitors of the PGNiG Group, especially those active globally, enjoy strong market positions and have greater financial resources than those available to the PGNiG Group. Thus, it is probable that such companies will be able to acquire promising licences, offering better terms than the PGNiG Group could offer given its financial and human resources. This competitive advantage is particularly important on the international market.
In some countries where the PGNiG Group is engaged in exploration activities there are a number of risks, which may lead to limitation, suspension or even discontinuation of the exploration and production activities. These risks include armed conflicts, terrorist attacks, social or political unrest, internal conflicts and civil disturbance.
In 2011, all non-Libyan employees of POGC‑ -Libya B.V. were evacuated from the country following the occurrence of a force majeure event. The company’s operations were resumed in the second half of 2012. Another force majeure event was reported in January 2014. All Polish employees working in the Murzuq 113 licence area were withdrawn to Poland. The site was sealed and secured by Libyan government forces and was left to be overseen by local subcontractors.
In Pakistan, in 2014 PGNiG had to declare a force majeure event and suspend work on the Rizq-1 exploratory well on two occasions due to armed attacks in the region. Work on Rizq-1 was resumed in December 2014.
Hydrocarbon deposits developed by the PGNiG Group are often at great depths, which involves extremely high pressures and, in many cases, the presence of hydrogen sulfide. Consequently, the risk of hydrocarbon blowout or leakage is very high, which in turn may pose a threat to people (workers and local populations), the natural environment and production equipment.
The PGNiG Group and its partners are engaged in exploration for and production of hydrocarbons on the Norwegian Continental Shelf. Offshore operations are much more complicated than those carried out onshore. If a serious failure or uncontrolled release of hydrocarbons occurs at sea, remediation can be very costly.
The need to ensure compliance with environmental laws in Poland and abroad may significantly increase the PGNiG Group’s operating expenses. Currently, PGNiG incurs significant capital expenditure and costs on ensuring compliance of its operations with the ever more complex and stringent regulations concerning safety and health at work, as well as environmental protection. The Act of May 18th 2005 amending the Natural Environment Protection Law and certain other acts rendered the regulations governing the execution of projects which might affect Natura 2000 sites more stringent and enhanced the environmental protection-related requirements with regard to entering the areas of the occurrence of protected plant species and habitats of protected animals.
The PGNiG Group is highly exposed to the risk of falling hydrocarbon prices, which may translate into markedly lower margins delivered by the Group’s Exploration and Production segment. This risk is highly material for PGNiG UI, a subsidiary. However, it is largely mitigated at the PGNiG Group level as falling gas and oil prices on global markets allow the Trade and Storage segment to generate higher margins on the sale of gas (thanks to lower purchase costs of imported gas).
Foreign exchange risk affects primarily PGNiG UI’s revenue, which is derived in the euro (gas sales) and in the USD (oil sales). Additionally, a major part of costs and all tax expenses are settled in the Norwegian krone. Given the risk of adverse movements in foreign exchange rates, any exchange differences between revenue and costs may negatively impact PGNiG UI’s financial performance. The risk is partially mitigated by external financing in the form of a bank loan (Reserve Based Loan), denominated in USD and EUR.
Probability that the risk will materialise:
Risk materiality level
