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Strategy implementation in 2016

Challenges

The PGNiG Group’s activities depend strongly on external factors. Key challenges facing the Group in 2016:

Developments in the global fuel and energy markets

Notably the slump in oil and gas prices and rapid expansion of the LNG market. The Polish gas market evolved as steep price declines materialised elsewhere in Europe. Moreover, European market gas prices have virtually ceased to move in parallel with petroleum prices: this trend has been observed for the past several years. Gas spot prices in Germany and other European markets have tumbled by more than 40%, thereby making gas imports to Poland much more attractive than the PGNiG SA tariff. Falling oil prices also led to major implications for the Group. The flip side of lower gas procurement costs under long-term contracts making imports a more attractive source of supply takes the form of upending the economics of international upstream projects with a predominant share of oil in their total reserves. Consequently, the international exploration and production segment took a hit to its valuation. Global LNG infrastructure has been expanding rapidly in recent years. On one hand, new export-focused projects have come on line (liquefaction terminals), mainly in North America and Australia. On the other hand, import capacities (regasification terminals), mainly in Europe have grown. The outcome is a glut on the global LNG markets, pushing prices down in the direction of global price convergence. As a participant of the global LNG market, PGNiG will be able to take advantage of favourable pricing terms and secure additional gas supplies for Poland. Since the LNG supply is abundant, gas trading on spot markets using short-term and medium-term contracts has gained in importance. Moreover, the destination clause is losing relevance, the number of market players is on the rise and the global LNG fleet is becoming more available.

Progressing market deregulation

As the obligation to sell a specific portion of gas on the power pool has come into force, PGNiG is compelled to sell high-methane gas on commodity exchanges or other regulated markets. The process of deregulation coupled with the obligation of selling gas on the power pool poses two major risks: significant customer churn and lower storage revenues. PGNiG has also had to adjust its contracts with customers to accommodate the liberalised market in terms of contracted capacity, volumes contracted per gas year and the supplier switching process.

Need to change the mix of imported gas sources

The Group’s current mix of gas supply sources was structured to cover the entire demand for natural gas in Poland. However, considering the risk of losing a part of the Group’s market share and given the insufficient diversification of supplies, the Group’s gas portfolio may be unbalanced. Currently, the PGNiG Group’s gas supply mix is largely made up of contracts priced partly by reference to the prices of oil products (Yamal and Qatar Contracts). The differences in the pricing formulas used by PGNiG versus its competitors may exert some price pressure. Therefore, it has become imperative for the Group to explore opportunities to diversify gas supply and analyse feasibility. With the Yamal Contract nearing expiry, it must build a flexible portfolio of supply sources for Poland beyond 2022.

Policy and regulatory changes

PGNiG’s regulatory environment is undergoing significant changes, particularly in the taxation of hydrocarbon production, the obligation to sell gas on the power pool and the uncertainty surrounding the support model for gas-fired cogeneration. All of these factors adversely affect the Group’s segment revenues.

Implementation

To address the challenges facing the PGNiG Group in the coming years, in early 2016 we revised and updated our strategy. On April 4th, 2016, the PGNiG Supervisory Board approved the PGNiG Group’s updated Strategy for 2014–2022. Following review and verification, we updated the macroeconomic, market and business framework and we redefined our strategic ambitions. As a result, we modified our strategic initiatives and added some new ones. The updated Strategy continues to focus on the following four key business areas:

  • maintaining stable trading volumes (retail and wholesale);
  • maximising cash flows in infrastructure and generation For more information, see Sections 5.3.2. and 5.4.2;
  • strengthening and transforming exploration and production For more information, see Section 5.1.2;
  • laying foundations for value chain growth.

The updated Strategy contemplates a slight increase in the Group’s EBITDA, our principal performance measure, to over PLN 7bn in 2022. In the period covered by the Strategy, capital expenditure on organic growth and acquisitions was maintained at PLN 40bn−50bn, with the net debt to EBITDA ratio comfortably below 2.0 in 2022 and the current dividend policy upheld.

In 2016, the Company delivered on its strategic objectives in each business area. Key achievements in 2016:

For more on Trade and Storage segment, see chapter Trade and Storage

Maintaining stable trading volumes (retail and wholesale)

  • Diversification of supply sources – the Norwegian Corridor – PGNiG, supported by the Polish government, is holding talks with Norway and Denmark about connecting the Polish gas system with the Norwegian Continental Shelf.
  • Diversification of supply sources – LNG terminal – PGNiG received 9 LNG deliveries under a long-term contract with Qatargas. Additionally, as part of short-term balancing, PGNiG purchased LNG on the spot market in Norway (Statoil contract).
  • LNG trading office – opened for business in early 2017. It will be ready to operate by the end of Q1 2017. Ultimately, the London office will be the main trading office for short- and medium-term contracts for liquefied gas.
  • Yamal contract – arbitration – PGNiG is taking steps to bring its long-term contract with Gazprom in line with prevailing conditions on the European market. On February 1st, 2016, the Group filed a claim against OAO Gazprom and OOO Gazprom Export in arbitration proceedings pending before the Arbitration Institute in Stockholm.
  • New gas contracts – The Group’s gas customer profile grew as PGNiG expanded its footprint in neighbouring countries. On August 4th, 2016, the Group signed an agreement with Ukraine’s ERU Trading for natural gas supplies to industrial customers. PGNiG also entered into new gas sale contracts in Poland as the outcome of constantly striving to employ a high quality customised sales approach.
  • Customer offer – The Group is evolving to meet the needs and expectations of its end users by offering them discount schemes. They are appreciated by its largest customers and have delivered superb results.

For more on Distribution segment, see chapter Distribution

For more on Generation segment, see chapter Generation

Maximising cash flows in infrastructure and generation

  • Distribution
    • higher distributed gas volume (to ca. 11 bcm in 2016) by ramping up new connections.);
    • PSG’s new strategy’s primary objectives are (i) to increase the distributed gas volume, (ii) attract new customers, (iii) connect many more communes and municipalities to the mains gas network;
    • PSG‘s intends to align its organisational structure to Poland’s administrative division to simplify interactions with local governments and facilitate access to PSG’s services.
  • Generation
    • on April 28th, 2016, PGNiG TERMIKA acquired a 100% equity stake in Przedsiębiorstwo Energetyki Cieplnej S.A. in Jastrzębie Zdrój;
    •  on August 11th, 2016 it acquired a shareholding in Spółka Energetyczna Jastrzębie S.A. from Jastrzębska Spółka Węglowa S.A.

The PGNiG Group’s strategy for the generation business is to expand its share in the heat generation and distribution market. With these acquisitions, the PGNiG Group expanded its business into new geographical markets in Poland.

shale gas

A type of unconventional gas, produced from sedimentary shale rock located deep underground

PGNiG Upstream Norway AS

Formerly PGNiG Upstream International AS

For more on Exploration and Production segment, see chapter Exploration and Production

Strengthening and transforming exploration and production

  • Exploration & Production in Poland
    • maintain stable natural gas and crude oil production in Poland;
    • discover reserves of new hydrocarbon deposits;
    • explore and appraise shale gas deposits in the most promising concessions. Work was discontinued in late 2016 because the initial estimates and forecasts of shale gas potential did not pan out.
  • Exploration & Production abroad
    • in 2016, PGNiG Upstream Norway AS acquired five new exploration concessions on the Norwegian Continental Shelf. One of the Group’s key operating objectives is to ramp up hydrocarbon production. In connection with the proposed construction of the Norwegian Corridor and the Baltic Pipe (giving Poland access to gas from Norwegian fields), the PGNiG Group’s assets would ultimately help it generate natural cross-segment synergies, thereby leveraging the Group’s resources;
    • PGNiG began to drill a third well on the Rehman field in Pakistan (Rehman-2) with its primary goal being to increase natural gas production. As the next stage of exploration in Pakistan, in April 2016 a 3D seismic dataset was acquired to help the Group make informed decisions on where to drill boreholes in 2017;
    • following the lifting of sanctions imposed on Iran, PGNiG is looking into a possible return. On November 5th, 2016 PGNiG and the National Iranian Oil Company signed a letter of intent for cooperation in Tehran on the Soumar oil field.

Laying foundations for value chain growth

  • Efficiency Improvement Programme − the PGNiG Group continued its efforts to reduce cost base and improve the cost discipline under the Efficiency Improvement Programme. Cost savings generated in 2016 amounted to PLN 830m, 5% above the target, on enhanced organisational and process-related efficiencies across the Group.
  • Disposal of non-core properties and companies – one of the Group ‘s key strategic initiatives is to dispose of its non-core properties. In 2016, aggregate proceeds from property sales exceeded PLN 41m (vs the planned PLN 33m).
  • Research, Development and Innovation – in 2016, the PGNiG initiated changes in its research and development (R&D) area. In particular, efforts were launched to formulate a new, extended R&D&I strategy, covering research, development and innovation.